10-K 1 d293105d10k.htm 10-K 10-K
Table of Contents
Index to Financial Statements

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended January 29, 2012

- or -

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

For the transaction period from             to             

Commission File number: 333-159809

HD SUPPLY, INC.

(Exact name of registrant as specified in its charter)

 

Delaware    75-2007383

(State or other jurisdiction of

incorporation or organization)

   (I.R.S. Employer Identification Number)

3100 Cumberland Boulevard, Suite 1480,

Atlanta, Georgia

   30339
(Address of principal executive offices)    (Zip Code)

(770) 852-9000

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

Securities registered pursuant to Section 12 (b) of the Act:

Debt securities issued by HD Supply, Inc.

  

12.0% Senior Notes due 2014

13.5% Senior Subordinated PIK Notes due 2015

  

 

  

 

(Title of each class)    (Name of each exchange on which registered)

Securities registered pursuant to Section 12 (g) of the Act:

None

 

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

¨  Yes    x  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨  Yes    x  No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨    Accelerated filer ¨          Non-accelerated filer x    Smaller reporting company ¨
      (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes x No

As of March 23, 2012, there were 1,000 shares of common stock of HD Supply, Inc. outstanding.

 

 

 


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Index to Financial Statements
  HD SUPPLY, INC.

 

INDEX TO FORM 10-K

 

         Page  
 

Background Information and Glossary of Certain Defined Terms

     1   
 

Forward-looking statements and information

     2   
Part I     
Item 1.  

Business

     4   
Item 1A.  

Risk Factors

     9   
Item 2.  

Properties

     28   
Item 3.  

Legal Proceedings

     29   
Part II     
Item 5.  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     30   
Item 6.  

Selected Financial Data

     30   
Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     35   
Item 7A.  

Quantitative and Qualitative Disclosures about Market Risk

     58   
Item 8.  

Financial Statements and Supplementary Data

     59   
Item 9A.  

Controls and Procedures

     99   
Part III     
Item 10.  

Directors, Executive Officers and Corporate Governance

     100   
Item 11.  

Executive Compensation

     107   
Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     119   
Item 13.  

Certain Relationships and Related Transactions, and Director Independence

     122   
Item 14.  

Principal Accountant Fees and Services

     124   
Part IV     
Item 15.  

Exhibits and Financial Statement Schedules

     125   
Signatures      131   


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   HD SUPPLY, INC.

 

Background Information and Glossary of Certain Defined Terms

The Transactions

On August 30, 2007, investment funds associated with Bain Capital Partners, LLC, The Carlyle Group and Clayton, Dubilier & Rice, Inc. (collectively, the “Equity Sponsors”) formed HDS Investment Holding, Inc. (“Holding”) and entered into a stock purchase agreement with The Home Depot, Inc. (“Home Depot” or “THD”) pursuant to which Home Depot agreed to sell to Holding or to a wholly owned subsidiary of Holding certain intellectual property and all the outstanding common stock of HD Supply, Inc. and the Canadian subsidiary CND Holdings, Inc. On August 30, 2007, through a series of transactions, Holding’s direct wholly owned subsidiary, HDS Holding Corporation, acquired direct control of HD Supply through the merger of its wholly owned subsidiary, HDS Acquisition Corp., with and into HD Supply (the “Company”). Through these transactions (the “Transactions”), Home Depot was paid cash of $8.2 billion and 12.5% of Holding’s common stock worth $325 million for certain intellectual property and all of the outstanding common stock of HD Supply and CND Holdings, Inc., including all dividends and interest associated with those shares. During the first quarter of fiscal 2009, the Company received $22 million from Home Depot for the working capital adjustment and settlement of other items finalizing the purchase price of the Transactions.

Description of Indebtedness

In August 2007, we entered into a senior secured credit facility (the “Senior Secured Credit Facility”) comprised of a $1 billion term loan (the “Term Loan”) and a $300 million revolving credit facility (the “Revolving Credit Facility”). The Senior Secured Credit Facility was amended in March 2010. Under the amendment, the maturity date of approximately $874 million of the Term Loan was extended from August 30, 2012 to April 1, 2014. In accordance with the amendment, we also prepaid $30 million of the Term Loan.

Also, in August 2007, we entered into a $2.1 billion asset based lending credit agreement (the “ABL Credit Facility”) subject to borrowing base limitations, a portion of which may be used for letters of credit or swing-line loans. We amended the ABL Credit Facility in March 2010 to, among other things, (i) convert approximately $214 million of commitments under the ABL Credit Facility into a term loan (the “ABL Term Loan”), (ii) extend the maturity date of approximately $1,537 million of the commitments from August 30, 2012 to April 1, 2014, and (iii) reduce the total commitments under the facility by approximately $45 million. Giving effect to the amendment, the ABL Credit Facility is comprised of the $1,841 million asset based revolving credit facility (the “ABL Revolving Credit Facility”) and the $214 million ABL Term Loan.

We refer to the Senior Secured Credit Facility and the ABL Credit Facility as our “Senior Credit Facilities.”

In connection with the Transactions, Home Depot agreed to guarantee our payment obligations for principal and interest under the Term Loan under the Senior Secured Credit Facility (the “THD Guarantee”). The THD Guarantee, among other things, restricts our ability to incur secured debt and pay dividends. Home Depot extended the THD Guarantee in connection with the March 2010 amendments to our Senior Secured Credit Facility and our ABL Credit Facility and consented to any later amendment that would extend the maturity of the remaining $104 million of outstanding Term Loan to a date that is not later than the maturity date in effect from time to time under the Senior Secured Credit Facility, as amended. In addition, in connection with the amendments, we agreed that, while the THD Guarantee is outstanding, the Company would not voluntarily repurchase its outstanding notes, directly or indirectly, without Home Depot’s prior written consent, subject to certain exceptions.

The Company issued $2.5 billion of Senior Notes bearing interest at a rate of 12.0% (the “12.0% Senior Notes”) and $1.3 billion of Senior Subordinated Notes bearing interest at a rate of 13.5% (the “13.5% Senior Subordinated Notes”) in connection with the Transactions.

Our Senior Credit Facilities, the THD Guarantee, the 12.0% Senior Notes and the 13.5% Senior Subordinated Notes are discussed in greater detail under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — External Financing.”

 

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   HD SUPPLY, INC.

 

Glossary of Other Terms

 

ASC

  Accounting Standards Codification     

HDS Canada

  HD Supply Canada     

CTI

  Creative Touch Interiors     

DCF

  Discounted cash flow     

DOT

  U.S. Department of Transportation     

Exchange Act

  Securities Exchange Act of 1934     

Fiscal 2009

  Fiscal year ended January 31, 2010     

Fiscal 2010

  Fiscal year ended January 30, 2011     

Fiscal 2011

  Fiscal year ended January 29, 2012     

Gross margin

  Gross profit as a percentage of net sales     

HD Supply

  HD Supply, Inc.     

HDPE

  High-density polyethylene     

Holding

  HDS Investment Holding, Inc.     

HVAC

  Heating, ventilating, and air conditioning     

IPVF

  Industrial Pipe, Valves and Fittings     

MRO

  Maintenance, repair and operations     

NOLs

  Net operating losses     

PIK

  Payments in kind     

Predecessor 2007

  Predecessor period from January 29, 2007 to August 29, 2007

PVC

  Polyvinyl chlorides     

SKU

  Stock-keeping unit     

Successor 2007

  Successor period from August 30, 2007 to February 3, 2008

U.S. GAAP

  Generally accepted accounting principles in the United States of America

SEC

  U.S. Securities and Exchange Commission     

Vendor rebates

  Vendors providing for inventory purchase rebates

Forward-looking statements and information

This annual report on Form 10-K includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Some of the forward-looking statements can be identified by the use of forward-looking terms such as “believes,” “expects,” “may,” “will,” “should,” “could,” “seeks,” “intends,” “plans,” “estimates,” “anticipates” or other comparable terms. These forward-looking statements include all matters that are not historical facts. They appear in a number of places throughout this report and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth strategies and the industries in which we operate.

Forward-looking statements are subject to known and unknown risks and uncertainties, many of which may be beyond our control. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and the development of the industries in which we operate may differ materially from those made in or suggested by the forward-looking statements contained in this report. In addition, even if our results of operations, financial condition and liquidity, and the development of the industries in which we operate are consistent with the forward-looking statements contained in this report, those results or developments may not be indicative of results or developments in subsequent periods. A number of important factors could cause actual results to differ materially from those contained in or implied by the forward-looking statements, including those reflected in forward-looking statements relating to our operations and business, the risks and uncertainties discussed in this annual report on Form 10-K (See “Risk Factors”) and those described from time to time in our other filings with the SEC. Factors that could cause actual results to differ from those reflected in forward-looking statements relating to our operations and business include:

 

   

Inherent risks of the residential, non-residential and public infrastructure construction and facility maintenance and repair markets;

 

   

Our ability to achieve profitability;

 

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Our ability to service our debt and to refinance all or a portion of our indebtedness;

 

   

Our substantial indebtedness and our ability to incur additional indebtedness;

 

   

Limitations and restrictions in the agreements governing our indebtedness;

 

   

Our ability to obtain additional financing on acceptable terms;

 

   

Increases in interest rates;

 

   

Rating agency actions with respect to our indebtedness;

 

   

The interests of the Equity Sponsors;

 

   

The competitive environment in which we operate and demand for our products and services in highly competitive and fragmented industries;

 

   

Goodwill and other impairment charges;

 

   

Our obligations under long-term, non-cancelable leases;

 

   

Consolidation among our competitors;

 

   

The loss of any of our significant customers;

 

   

Failure to collect monies owed from customers, including on credit sales;

 

   

Competitive pricing pressure from our customers;

 

   

Our ability to identify and acquire suitable acquisition candidates on favorable terms;

 

   

Variability in our revenues and earnings;

 

   

Cyclicality and seasonality of the residential, non-residential and infrastructure construction and facility maintenance and repair markets;

 

   

Fluctuations in commodity and energy prices;

 

   

Our ability to identify and develop relationships with a sufficient number of qualified suppliers and to maintain our supply chains;

 

   

Our ability to manage fixed costs;

 

   

Changes in our product mix;

 

   

The impairment of financial institutions;

 

   

The development of alternatives to distributors in the supply chain;

 

   

Our ability to manage our working capital through product purchasing and customer credit policies;

 

   

Inclement weather, anti-terrorism measures and other disruptions to the transportation network;

 

   

Interruptions in the proper functioning of information technology (“IT”) systems;

 

   

Our ability to implement our technology initiatives;

 

   

Changes in U.S. federal, state or local regulations;

 

   

Exposure to construction defect and product liability claims and other legal proceedings;

 

   

Potential material liabilities under our self-insured programs;

 

   

Changes in U.S. health care legislation;

 

   

Our ability to attract, train and retain highly qualified associates and key personnel;

 

   

Fluctuations in foreign currency exchange rates;

 

   

Inability to protect our intellectual property rights;

 

   

Changes in U.S. and foreign tax law;

 

   

Limitations on our income tax net operating loss carry forwards in the event of an ownership change;

 

   

Our ability to identify and integrate new products;

 

   

Significant costs related to compliance with environmental, health and safety regulations, including new climate change legislation; and

 

   

Our ability to achieve and maintain effective disclosure controls and internal control over our financial reporting.

 

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You should read this annual report on Form 10-K completely and with the understanding that actual future results may be materially different from expectations. All forward-looking statements made in this report are qualified by these cautionary statements. These forward-looking statements are made only as of the date of this annual report on Form 10-K, and we do not undertake any obligation, other than as may be required by law, to update or revise any forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated events, changes in future operating results over time or otherwise. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless expressed as such, and should only be viewed as historical data.

PART I

ITEM 1. BUSINESS

HD Supply, Inc. (the “Company” or “HD Supply”) is one of the largest industrial distributors in the United States and Canada based on sales serving three distinct market sectors: Infrastructure & Energy, Maintenance, Repair & Improvement and Specialty Construction, each of which offers different products and services to the end customer. The three market sectors are made up of eight industrial distribution businesses. Through 679 locations across the United States and Canada, HD Supply operates a diverse portfolio of distribution businesses that provide approximately one million stock-keeping units (“SKUs”) to approximately 450,000 professional customers, including contractors, government entities, maintenance professionals, home builders and industrial businesses.

Our history

In March 1997, The Home Depot, Inc. (“Home Depot”), our former parent, acquired Maintenance Warehouse / America Corp., a Texas corporation organized on January 26, 1985, and a leading direct marketer of maintenance, repair and operations (“MRO”) products to the hospitality and multifamily housing markets. Since 1997, our business has grown rapidly, primarily through the acquisition of more than 40 businesses. We changed our name to HD Supply, Inc. on January 1, 2007 and converted to a Delaware corporation on August 31, 2007.

From fiscal 2000 to fiscal 2004, we extended our presence into new categories while growing existing businesses through 10 acquisitions. New businesses included plumbing and HVAC (through the acquisition of Apex Supply), flooring products and installation (Floors Inc., Floor Works, Arvada Hardwood Floor Co.) and specialty hardware, tools and materials for construction contractors (White Cap).

Growth at existing businesses was driven organically and through “tuck-in” acquisitions, expanding our presence in the MRO segment (N-E Thing Supply, Economy Maintenance Supply) and flooring and design services for professional homebuilders (Creative Touch Interiors). In fiscal 2005, we accelerated the pace of consolidation by acquiring 18 businesses, the largest of which was National Waterworks, a leading distributor of products used to build, repair and maintain water and wastewater transmission systems. In fiscal 2006, we transformed our business with the acquisition of Hughes Supply, which doubled our Net sales and further established our market leadership in a number of our largest businesses, which we supplemented with 11 other strategic acquisitions.

In 2007, through a series of transactions (the “Transactions”), investment funds associated with Bain Capital Partners LLC, The Carlyle Group and Clayton, Dubilier & Rice, Inc. (the “Equity Sponsors”) formed HDS Investment Holding, Inc. and purchased HD Supply from Home Depot. In connection with the Transactions, Home Depot obtained a 12.5% interest in the common stock of HDS Investment Holding, Inc.

Since 2007, we have focused on extending our presence in key growth sectors and exiting less attractive sectors. In February 2008, we sold our Lumber and Building Materials operations to ProBuild Holdings. In June 2009, we purchased substantially all of the assets of ORCO Construction Supply, the second largest construction materials distributor in the U.S., through our White Cap business. In February 2011, we sold all of the assets of SESCO/QUESCO, an electrical products division of HD Supply Canada, to Sonepar Canada. In May 2011, we purchased all of the assets of Rexford Albany Municipal Supply Company, Inc., expanding our Waterworks business in upstate New York. In September 2011, we sold our Plumbing/HVAC operations to Hajoca Corporation.

 

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Our sectors

Through eight industrial distribution companies in the U.S. and a Canadian operation, we provide products and services to professional customers in the Infrastructure & Energy, Maintenance, Repair & Improvement and Specialty Construction market sectors. Most of our businesses operate in markets with a high degree of customer and supplier fragmentation, which typically demand a high level of service and availability of a broad set of complex products from a large number of suppliers. These factors drive the importance of the distributor within the value chain and create barriers to entry for suppliers to sell directly to customers.

The following table sets forth the relationship among our three market sectors, our eight businesses and our four financial reporting segments.

 

Market sector

  

Business

   Financial reporting segment

  Infrastructure & Energy

  

  Waterworks

 

  Utilities/Electrical

 

  Industrial Pipe, Valves  and
Fittings (“IPVF”)

     Waterworks

 

  Utilities/Electrical

 

  Other

  Maintenance, Repair & Improvement

  

  Facilities Maintenance

 

  Crown Bolt

 

  Repair & Remodel

     Facilities Maintenance

 

  Other

 

  Other

  Specialty Construction

  

  White Cap

 

  Creative Touch Interiors (“CTI”)

     White Cap

 

  Other

For segment information, including Net sales, Adjusted EBITDA, Total assets of each financial reporting segment, and financial geographic data see Note 15 to the consolidated financial statements appearing elsewhere in this annual report on Form 10-K.

Customers and suppliers

We maintain a customer base of approximately 450,000 customers, the majority of which represent long-term relationships. Home Depot is our largest customer, accounting for 3.6% of fiscal 2011 Net sales. We are subject to very low customer concentration with no customer, other than Home Depot, representing more than 1% of fiscal 2011 Net sales, reducing our exposure to any single customer.

We have developed relationships with approximately 15,000 strategic suppliers, many of which are long-standing. These supplier relationships provide us with reliable access to inventory, volume purchasing benefits and the ability to deliver a diverse product offering on a cost-effective basis. We maintain multiple suppliers for a substantial number of our products, thereby limiting the risk of product shortage for customers.

Competition

We operate in a highly fragmented industry and hold a leading position in multiple sectors. Our national competitors include Wolseley (Ferguson Enterprises), Rexel, Grainger, Wesco, Fastenal, Watsco, Interline Brands, and McJunkin Redman Corporation. The majority of our competitors, however, are mid-size regional distributors and small, local distributors.

Seasonality

In a typical year, our operating results are impacted by seasonality. Historically, sales of our products have been higher in the second and third quarters of each fiscal year due to favorable weather and longer daylight conditions during these periods. Seasonal variations in operating results may also be significantly impacted by inclement weather conditions, such as cold or wet weather, which can delay construction projects.

 

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Infrastructure & Energy market sector

We serve customers in the Infrastructure & Energy market sector by striving to meet their demand for the critical supplies and services required to support established infrastructure and promote economic growth. The Waterworks, Utilities/Electrical, and IPVF businesses serve this sector. Their broad geographic presence, through a regionally organized distribution network of branches, reduces our exposure to economic factors in any single region.

Products

Waterworks: Pipes, fittings, valves, hydrants and meters for use in the construction, maintenance and repair of water and waste-water systems as well as fire-protection systems.

Utilities/Electrical: Conductors (wire and cable), transformers, overhead transmission and distribution hardware, switches, protective devices and underground distribution, connectors used in the construction or maintenance and repair of electricity transmission and substation distribution infrastructure, and electrical wire and cable, switchgear, supplies, lighting and conduit used in residential and commercial construction.

IPVF: Stainless and carbon steel and special alloy pipe, plate, sheet, flanges, fittings, high performance valves and actuators, as well as high-density polyethylene (“HDPE”) pipe and fittings with primary applications in high temperature, high pressure and high corrosion processing environments.

Maintenance, Repair & Improvement market sector

We serve customers in the Maintenance, Repair & Improvement market sector by delivering supplies and services needed to maintain and upgrade facilities across multiple industries. Our businesses serving customers in this market sector include Facilities Maintenance, Repair & Remodel and Crown Bolt. Facilities Maintenance and Crown Bolt are distribution center based models, while the Repair & Remodel business is a retail outlet primarily serving cash and carry customers.

Products

Facilities Maintenance: Kitchen and bathroom plumbing products, heating, ventilating and air conditioning (“HVAC”) products, tools and repair materials, appliances, cabinet and drawer hardware, door hardware and locksets, fasteners, lighting, electrical maintenance supplies, safety products, guest amenities, textiles, healthcare maintenance and janitorial supplies for the maintenance, repair and ongoing operations of multifamily, hospitality, healthcare, institutional and commercial properties.

Crown Bolt: Fasteners, builders hardware, rope and chain, and plumbing accessories primarily consumed in home improvement, do-it-yourself projects and residential construction.

Repair & Remodel: Kitchen cabinets, windows, plumbing materials, masonry, electrical equipment, lumber, flooring and tools and tool rentals for small remodeling, home improvement and do-it-yourself residential projects.

Specialty Construction market sector

We serve customers in the Specialty Construction market sector by delivering distinct, targeted products and services for commercial, residential and industrial applications. Our businesses serving this market sector include White Cap and CTI. Their broad geographic presence, through a regionally organized distribution network of branches, reduces our exposure to economic factors in any single region.

Products

White Cap: Tilt-up brace systems, forming and shoring systems, concrete chemicals, hand and power tools, rebar, ladders, safety and fall arrest equipment, specialty screws and fasteners, sealants and adhesives, drainage pipe, geo-synthetics, and erosion and sediment control used broadly across all types of residential and non-residential construction.

CTI: Flooring, cabinets, countertops and window coverings, along with comprehensive design center services, for the interior finish of residential, commercial, and senior living projects.

 

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HD Supply Canada

HD Supply Canada (“HDS Canada”) is an industrial distributor that primarily focuses on servicing fasteners/ industrial supplies and specialty lighting markets. HDS Canada operates across nine provinces in 51 locations. In the Canadian specialty lighting distribution market, HDS Canada competes with other large national players as well as regional distributors. In the fasteners market, HDS Canada’s key competitors are a few large, national players, including Fastenal and Acklands-Grainger, as well as regional competitors.

Operations

Intellectual property

Our trademarks and those of our subsidiaries, certain of which are material to our business, are registered or otherwise legally protected in the United States, Canada and elsewhere. We, together with our subsidiaries, own approximately 200 trademarks registered worldwide. We also rely upon trade secrets and know-how to develop and maintain our competitive position. We protect intellectual property rights through a variety of methods, including trademark, patent, copyright and trade secret laws, in addition to confidentiality agreements with suppliers, employees, consultants and others who have access to our proprietary information. Generally, registered trademarks have a perpetual life, provided that they are renewed on a timely basis and continue to be used properly as trademarks. We intend to maintain our material trademark registrations so long as they remain valuable to our business. Other than the trademarks HD Supply (and design), Crown Bolt, National Waterworks (and design), USABluebook, Creative Touch Interiors and White Cap, we do not believe our business is dependent to a material degree on trademarks, patents, copyrights or trade secrets. Other than commercially available software licenses, we do not believe that any of our licenses for third-party intellectual property are material to our business, taken as a whole. See “Risk Factors—If we are unable to protect our intellectual property rights, or we infringe on the intellectual property rights of others, our ability to compete could be negatively impacted.”

Employees

In domestic and international operations, we had approximately 14,400 employees as of January 29, 2012, consisting of approximately 8,800 hourly personnel and 5,600 salaried employees. As of January 29, 2012, less than one percent of our hourly workforce was covered by three separate collective bargaining agreements.

Regulation

Our operations are affected by various statutes, regulations and laws in the markets in which we operate, which historically have not had a material effect on our business. While we are not engaged in a “regulated” industry, we are subject to various laws applicable to businesses generally, including laws affecting land usage, zoning, the environment, health and safety, transportation, labor and employment practices (including pensions), competition, immigration and other matters. Additionally, building codes may affect the products our customers are allowed to use, and consequently, changes in building codes may affect the saleability of our products. The transportation and disposal of many of our products are also subject to federal regulations. The U.S. Department of Transportation (“DOT”) regulates our operations in domestic interstate commerce. We are subject to safety requirements governing interstate operations prescribed by the DOT. Vehicle dimensions and driver hours of service also remain subject to both federal and state regulation. See “Risk Factors—Our costs of doing business could increase as a result of changes in U.S. federal, state or local regulations.”

Environmental, health and safety matters

We are subject to a broad range of foreign, federal, state and local environmental, health and safety laws and regulations, including those pertaining to air emissions, water discharges, the handling, disposal and transport of solid and hazardous materials and wastes, the investigation and remediation of contamination and otherwise relating to health and safety and the protection of the environment and natural resources. As our operations, and those of many of the companies we have acquired, to a limited extent involve and have involved the handling, transport and distribution of materials that are, or could be classified as, toxic or hazardous, there is some risk of contamination and environmental damage inherent in our operations and the products we handle, transport and distribute. Our environmental, health and safety liabilities and obligations may result in significant capital expenditures and other costs, which could negatively impact our business, financial condition and results of

 

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operations. We may be fined or penalized by regulators for failing to comply with environmental, health and safety laws and regulations, or we may be held responsible for such failures by companies we have acquired. In addition, contamination resulting from our current or past operations, and those of many of the companies we have acquired, may trigger investigation or remediation obligations, which may have a material adverse effect on our business, financial condition and results of operations.

Available Information

We are subject to the reporting and information requirements of the Exchange Act and, as a result, we file periodic reports and other information with the SEC. In addition, the indentures pursuant to which our 12.0% Senior Notes and our 13.5% Senior Subordinated Notes were issued require us to distribute to the holders of the notes annual reports containing our financial statements audited by our independent auditors as well as other information, documents and other information we file with the SEC under Sections 13(a) or 15(d) of the Exchange Act.

The public may read and copy any reports or other information that we file with the SEC. Such filings are available to the public over the internet at the SEC’s website at http://www.sec.gov. The SEC’s website is included in this annual report on Form 10-K as an inactive textual reference only. In addition, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are available free of charge to the public through the “Investor Relations” portion of the Company’s web site, www.hdsupply.com, as soon as reasonably practical after they are filed with the SEC. We include our website address in this filing only as a textual reference. The information contained on our website is not incorporated by reference into this report. You may also obtain a copy of any information that we file with the SEC at no cost by calling us or writing to us at the following address:

HD Supply, Inc.

3100 Cumberland Boulevard, Suite 1480

Atlanta, Georgia 30339

Attn: General Counsel

(770) 852-9000

 

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ITEM 1A. RISK FACTORS

You should carefully consider the risk factors set forth below as well as the other information included in this annual report on Form 10-K in evaluating our business. The risks described below are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also impair our business operations. Any of these risks may have a material adverse effect on our business, financial condition, results of operations and cash flows. In such a case, you may lose all or part of your investment in the securities of the Company.

We are subject to inherent risks of the residential, non-residential and public infrastructure construction and facility maintenance and repair markets, including risks related to general economic conditions.

Demand for our products and services depends to a significant degree on spending in the residential, non-residential and infrastructure construction and facility maintenance and repair markets. The level of activity in these end markets depends on a variety of factors that we cannot control.

Historically, both new housing starts and residential remodeling have decreased in slow economic periods. In addition, residential construction activity can impact the level of non-residential construction activity. Other factors impacting the level of activity in the residential and nonresidential construction markets include:

 

   

changes in interest rates;

 

   

unemployment rates;

 

   

high foreclosure rates and unsold/foreclosure inventory;

 

   

unsold new housing inventory;

 

   

periods of economic slowdown or recession;

 

   

availability of financing (including the impact of disruption in the mortgage markets);

 

   

adverse changes in local, regional, or general economic conditions;

 

   

adverse changes in industrial economic outlook;

 

   

a decrease in the affordability of homes;

 

   

vacancy rates;

 

   

capacity utilization;

 

   

capital spending;

 

   

commercial investment;

 

   

corporate profitability;

 

   

local, state and federal government regulation; and

 

   

shifts in populations away from the markets that we serve.

In the infrastructure construction market, the level of activity depends largely on interest rates, availability and commitment of public funds for municipal spending, capacity utilization and general economic conditions. In the facility maintenance and repair market, the level of activity depends largely on occupancy rates within multifamily, hospitality, healthcare and institutional facilities markets. Because all of our markets are sensitive to changes in the economy, downturns (or lack of substantial improvement) in the economy in any region in which we operate have adversely affected and could continue to adversely affect our business, financial condition and results of operations. For example, we distribute many of our products to waterworks contractors in connection with residential, commercial and industrial construction projects. The water and wastewater transmission products industry is affected by changes in economic conditions, including national, regional and local standards in construction activity, and the amount spent by municipalities on waterworks infrastructure. While we operate in many markets in the United States and Canada, our business is particularly impacted by changes in the economies of Texas, California, and Florida, which represented approximately 15%, 14%, and 9%, respectively, in net sales for fiscal 2011.

In addition, the residential, non-residential and public infrastructure construction and facility maintenance and repair markets in which we compete are sensitive to general business and economic conditions in the United States and worldwide, including availability of credit, interest rates, fluctuations in capital, credit and mortgage

 

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markets, and business and consumer confidence. There was a significant decline in economic growth, both in the U.S. and globally, that began in the second half of 2007 and continued through 2009. In addition, volatility and disruption in the capital markets during that period reached unprecedented levels, with stock markets falling dramatically and credit becoming very expensive or unavailable to many companies without regard to those companies’ underlying financial strength. As a result of these developments, many lenders and institutional investors reduced, and in some cases, ceased to provide funding to borrowers. Adverse developments in global financial markets and general business and economic conditions, including through recession, downturn or otherwise, could have a material adverse effect on our business, financial condition, results of operations and cash flows, including our ability and the ability of our customers and suppliers to access capital. Although there have been some indications of stabilization in the general economy and certain industries and markets in which we operate, there can be no guarantee that any improvement in these areas will continue or be sustained.

We have been, and expect to continue to be, adversely impacted by the decline in the new residential construction market since its peak in 2005.

Most of our businesses are dependent to varying degrees upon the new residential construction market. The homebuilding industry is undergoing a significant and sustained downturn. According to the U.S. Census Bureau, actual single family housing starts in the U.S. during 2011 decreased 8% from 2010 levels. We believe that the market downturn over the past several years is attributable to a variety of factors including: the lasting impact of the recent economic recession; limited credit availability; excess home inventories; a substantial reduction in speculative home investment; a decline in consumer confidence; higher unemployment; and an industry-wide softening of demand. The multi-year downturn in the homebuilding industry has resulted in a substantial reduction in demand for our products and services, which in turn had a significant adverse effect on our business and operating results during fiscal years 2008 to 2011. In addition, the mortgage markets continue to experience disruption and reduced availability of mortgages for potential homebuyers due to more restrictive standards to qualify for mortgages, including with respect to new home construction loans.

We cannot predict the duration of the current housing industry market conditions, or the timing or strength of any future recovery of housing activity in our markets. We also cannot provide any assurances that the homebuilding industry will recover to historical levels, or that the operational strategies we have implemented to address the current market conditions will be successful. Continued weakness in the new residential construction market would have a significant adverse effect on our business, financial condition and operating results. In addition, because of these factors, there may be fluctuations in our operating results, and the results for any historical period may not be indicative of results for any future period.

The non-residential construction industry continues to experience a downturn which could materially and adversely affect our business, liquidity and results of operations.

Many of our businesses are dependent on the non-residential construction industry and the slowdown and volatility of the United States economy in general is having an adverse effect on our businesses that serve this industry. According to the U.S. Census Bureau, actual non-residential construction put-in-place in the U.S. during 2011 declined 3% from 2010 levels and 17% from 2009. From time to time, our businesses that serve the non-residential construction industry have also been adversely affected in various parts of the country by declines in non-residential construction starts due to, among other things, changes in tax laws affecting the real estate industry, high interest rates and the level of residential construction activity. Continued uncertainty about current economic conditions will continue to pose a risk to our businesses that serve the non-residential construction industry as participants in this industry may postpone spending in response to tighter credit, negative financial news and/or declines in income or asset values, which could have a continued material negative effect on the demand for our products and services.

We cannot predict the duration of the current market conditions, or the timing or strength of any future recovery of non-residential construction activity in our markets. Continued weakness in the non-residential construction market would have a significant adverse effect on our business, financial condition and operating results. In addition, because of these factors, there may be fluctuations in our operating results, and the results for any historical period may not be indicative of results for any future period.

 

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Residential renovation and improvement activity levels may not return to historic levels which may negatively impact our business, liquidity and results of operations.

Certain of our businesses rely on residential renovation and improvement (including repair and remodeling) activity levels. Unlike most previous cyclical declines in new home construction in which we did not experience comparable declines in our home improvement businesses, the recent economic decline adversely affected our home improvement businesses as well. According to Moody’s Economy.com, residential improvement project spending in the United States increased only 4% in 2011. Continued high mortgage delinquency and foreclosure rates, limitations in the availability of mortgage and home improvement financing and significantly lower housing turnover, may continue to limit consumers’ spending, particularly on discretionary items, and affect their confidence level leading to continued reduced spending on home improvement projects. The impact of these economic factors specific to the home improvement industry is exacerbated by unemployment.

We cannot predict the timing or strength of a significant recovery in these markets. Continued depressed activity levels in consumer spending for home improvement and new home construction will continue to adversely affect our results of operations and our financial position. Furthermore, continued economic weakness may cause unanticipated shifts in consumer preferences and purchasing practices and in the business models and strategies of our customers. Such shifts may alter the nature and prices of products demanded by the end consumer and our customers and could adversely affect our operating performance.

We may be unable to achieve or maintain profitability.

We have set goals to progressively improve our profitability over time by growing our sales, increasing our gross margin and reducing our expenses as a percentage of sales. For the fiscal years 2011 and 2010 we had net losses of $543 million and $619 million, respectively. There can be no assurance that we will achieve our enhanced profitability goals. Factors that could significantly adversely affect our efforts to achieve these goals include, but are not limited to, the following:

 

   

failure to grow our revenue through organic growth or through acquisitions;

 

   

failure to improve our revenue mix by investing (including through acquisitions) in businesses that provide higher margins than we have been able to generate historically;

 

   

failure to achieve improvements in purchasing or to maintain or increase our rebates from vendors through our vendor consolidation and/or low-cost country initiatives;

 

   

failure to improve our gross margins through the utilization of improved pricing practices and technology and sourcing savings;

 

   

failure to maintain or reduce our overhead and support expenses as we grow;

 

   

failure to effectively evaluate future inventory reserves;

 

   

failure to collect monies owed from customers; and

 

   

failure to integrate any businesses acquired.

Any of these failures or delays may adversely affect our ability to increase our profitability.

Our ability to generate the significant amount of cash needed to pay interest and principal on our 12% Senior Notes and our 13.5% Senior Subordinated Notes and service our other debt and our ability to refinance all or a portion of our indebtedness or obtain additional financing depends on many factors beyond our control.

As a holding company, we have no independent operations or material assets other than our ownership of equity interests in our subsidiaries and invested cash, and we depend on our subsidiaries to distribute funds to us so that we may pay our obligations and expenses, including to satisfy our obligations under our 12% Senior Notes, 13.5% Senior Subordinated Notes, our senior secured credit facility (“Senior Secured Credit Facility”) and our asset based lending credit agreement (“ABL Credit Facility” and collectively with the “Senior Secured Credit Facility,” the “Senior Credit Facilities”). Our ability to make scheduled payments on, or to refinance our obligations under, our debt depends on the ability of our subsidiaries to make distributions and dividends to us, which, in turn, depends on their operating results, cash requirements, financial condition, and general business conditions, many of which may be beyond our control. In addition, while our subsidiaries currently have no legal or regulatory restrictions on payments of dividends to us, they may be subject to such restrictions in the future. If we do not receive sufficient distributions from our subsidiaries, we may not be able to meet our obligations to

 

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fund general corporate expenses or service our debt obligations, including our 12% Senior Notes and our 13.5% Senior Subordinated Notes.

If our cash flow and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek to obtain additional equity capital or refinance our debt. We cannot make assurances that we will be able to refinance our debt on terms acceptable to us, or at all. In the future, our cash flow and capital resources may not be sufficient for payments of interest on and principal of our debt, and such alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.

Significant amounts of our outstanding indebtedness will mature in 2014. As discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity, capital resources and financial condition— External financing,” we amended and extended certain of our outstanding debt on March 19, 2010. As of January 29, 2012, approximately $1.0 billion outstanding under our Senior Credit Facilities will mature on April 1, 2014. As a result, we may be required to refinance any outstanding amounts under those facilities prior to the maturity date of our 12% Senior Notes and our 13.5% Senior Subordinated Notes. We cannot make assurances that we will be able to refinance any of our indebtedness or obtain additional financing, particularly because of our anticipated high levels of debt and the debt incurrence restrictions imposed by the agreements governing our debt, as well as prevailing market conditions. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. Our debt facilities and the indentures governing our outstanding notes restrict our ability to dispose of assets and how we use the proceeds from any such dispositions. We cannot make assurances that we will be able to consummate those dispositions, or if we do, what the timing of the dispositions will be or whether the proceeds that we realize will be adequate to meet our debt service obligations, including amounts under our outstanding notes, when due.

We have substantial debt and may incur substantial additional debt, which could adversely affect our financial health and our ability to obtain financing in the future, react to changes in our business and make payments on the notes.

As of January 29, 2012, we had an aggregate principal amount of $5,462 million of outstanding debt, $200 million available under our Revolving Credit Facility, and $993 million available under our ABL Revolving Credit Facility (after giving effect to the borrowing base limitations and approximately $66 million in letters of credit issued and including $57 million of borrowings available on qualifying cash balances). For fiscal 2011, our earnings were insufficient to cover our fixed charges by $440 million.

Our substantial debt could have important consequences to holders of our 12% Senior Notes and our 13.5% Senior Subordinated Notes. Because of our substantial debt:

 

   

a substantial portion of our cash flow from operations must be dedicated to the payment of principal and interest on our indebtedness, thereby reducing the funds available to us for other purposes;

 

   

our ability to obtain additional financing for working capital, capital expenditures, acquisitions, debt service requirements or general corporate purposes and our ability to satisfy our obligations with respect to our outstanding notes may be impaired in the future;

 

   

we are exposed to the risk of increased interest rates because a portion of our borrowings, including under our debt facilities, is at variable rates of interest;

 

   

we may be at a competitive disadvantage compared to our competitors with less debt or with comparable debt at more favorable interest rates and that, as a result, may be better positioned to withstand economic downturns;

 

   

our ability to refinance indebtedness may be limited or the associated costs may increase;

 

   

our ability to engage in acquisitions without raising additional equity or obtaining additional debt financing may be impaired in the future;

 

   

it may be more difficult for us to satisfy our obligations to our creditors, resulting in possible defaults on and acceleration of such indebtedness;

 

   

we may be more vulnerable to general adverse economic and industry conditions; and

 

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our flexibility to adjust to changing market conditions and our ability to withstand competitive pressures could be limited, or we may be prevented from making capital investments that are necessary or important to our operations in general, growth strategy and efforts to improve operating margins of our businesses.

The agreements and instruments governing our debt contain restrictions and limitations that could significantly impact our ability to operate our business and adversely affect the holders of our 12% Senior Notes and our 13.5% Senior Subordinated Notes.

The Senior Credit Facilities contain covenants that, among other things, restrict or limit our ability to:

 

   

dispose of assets;

 

   

incur additional indebtedness (including guarantees of additional indebtedness);

 

   

prepay the notes or amend other specified debt instruments;

 

   

pay dividends and make certain payments;

 

   

create liens on assets;

 

   

engage in certain asset sales, mergers, acquisitions, consolidations or sales of all, or substantially all, of our assets;

 

   

engage in certain transactions with affiliates; and

 

   

permit restrictions on our subsidiaries’ ability to pay dividends.

The indentures governing our 12% Senior Notes and our 13.5% Senior Subordinated Notes also contain restrictive covenants that, among other things, limit our ability and the ability of our restricted subsidiaries to:

 

   

incur additional debt;

 

   

pay dividends, redeem stock or make other distributions;

 

   

make certain investments;

 

   

create liens;

 

   

transfer or sell assets;

 

   

merge or consolidate with other companies; and

 

   

enter into certain transactions with our affiliates.

Home Depot guarantees payment of the Term Loan (the “THD Guarantee”) under the Senior Secured Credit Facility. The THD Guarantee also contains restrictive covenants that limit our ability to and the ability of our restricted subsidiaries to:

 

   

incur additional secured debt;

 

   

pay dividends; and

 

   

voluntarily repurchase our outstanding notes without Home Depot’s prior written consent.

The restrictions in the indentures governing our outstanding notes, the THD Guarantee, and the Senior Credit Facilities may prevent us from taking actions that we believe would be in the best interest of our business and may make it difficult for us to execute our business strategy successfully or effectively compete with companies that are not similarly restricted. We may also incur future debt obligations that might subject us to additional restrictive covenants that could affect our financial and operational flexibility.

Our ability to comply with the covenants and restrictions contained in the Senior Credit Facilities and the indentures governing our outstanding notes may be affected by economic, financial and industry conditions beyond our control. The breach of any of these covenants or restrictions could result in a default under either the Senior Credit Facilities or the indentures that would permit the applicable lenders or noteholders, as the case may be, to declare all amounts outstanding thereunder to be due and payable, together with accrued and unpaid interest. If we are unable to repay debt, lenders having secured obligations, such as the lenders under the Senior Credit Facilities, could proceed against the collateral securing the secured obligations. In any such case, we may be unable to borrow under the Senior Credit Facilities and may not be able to repay amounts due under such

 

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facilities and the notes. This could have serious consequences to our financial condition and results of operations and could cause us to become bankrupt or insolvent.

We may have future capital needs and may not be able to obtain additional financing on acceptable terms.

Although we believe that our current cash position and the additional committed funding available under our Revolving Credit Facility and ABL Revolving Credit Facility is sufficient for our current operations, any reductions in our available borrowing capacity, or our inability to renew or replace our debt facilities, when required or when business conditions warrant, could have a material adverse effect on our business, financial condition and results of operations. The economic conditions, credit market conditions, and economic climate affecting our industry, as well as other factors, may constrain our financing abilities. Our ability to secure additional financing, if available, and to satisfy our financial obligations under indebtedness outstanding from time to time will depend upon our future operating performance, the availability of credit generally, economic conditions and financial, business and other factors, many of which are beyond our control. The market conditions and the macroeconomic conditions that affect our industry could have a material adverse effect on our ability to secure financing on favorable terms, if at all.

We may be unable to secure additional financing or financing on favorable terms or our operating cash flow may be insufficient to satisfy our financial obligations under the indebtedness outstanding from time to time. Furthermore, if financing is not available when needed, or is available on unfavorable terms, we may be unable to take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations. If additional funds are raised through the issuance of additional equity securities, our stockholders may experience significant dilution.

Increases in interest rates would increase the cost of servicing our debt and could reduce our profitability.

A significant portion of our outstanding debt, including under the Senior Credit Facilities, bears interest at variable rates. As a result, increases in interest rates would increase the cost of servicing our debt and could materially reduce our profitability and cash flows. Each one percentage point change in interest rates would result in an $11 million change in the annual cash interest expense on our term loans outstanding under our Senior Credit Facilities before any principal payment based on balances as of January 29, 2012. Assuming all revolving loans were fully drawn, each one percentage point change in interest rates would result in a $30 million change in annual cash interest expense on our Senior Credit Facilities. The impact of increases in interest rates could be more significant for us than it would be for some other companies because of our substantial indebtedness.

A downgrade, suspension or withdrawal of the rating assigned by a rating agency to the notes or our Senior Credit Facilities, if any, could cause the liquidity or market value of the notes to decline.

Our 12% Senior Notes and our 13.5% Senior Subordinated Notes have been rated by Standard & Poor’s Corporation and Moody’s Investor Services. Our Senior Credit Facilities have also been rated by Standard & Poor’s and Moody’s. In determining our credit ratings, the rating agencies consider a number of both quantitative and qualitative factors. These factors include earnings, fixed charges such as interest, cash flows, total debt outstanding, total secured debt, off balance sheet obligations and other commitments, total capitalization and various ratios calculated from these factors. Our outstanding notes and our debt facilities may in the future be rated by additional rating agencies. We cannot make assurances that any rating so assigned will remain for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in that rating agency’s judgment, circumstances relating to the basis of the rating, such as an adverse change to our business, so warrant. The interest rates and other terms within our current credit agreements are not impacted by rating agency actions. Any lowering or withdrawal of a rating by a rating agency could reduce the liquidity or market value of our outstanding notes and make our ability to raise new funds or renew maturing debt more difficult.

Goodwill is subject to impairment testing and may affect future operating results.

As of January 29, 2012, goodwill represented approximately 47% of our total assets. Goodwill is not amortized and is subject to impairment testing at least annually using a fair value based approach. The identification and measurement of impairment involves the estimation of the fair value of reporting units. Accounting for

 

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impairment contains uncertainty because management must use judgment in determining appropriate assumptions to be used in the measurement of fair value. The estimates of fair value of reporting units are based on the best information available as of the date of the assessment and incorporate management assumptions about expected future cash flows and contemplate other valuation techniques. Future cash flows can be affected by changes in industry or market conditions among other things.

The recoverability of goodwill is evaluated at least annually and when events or changes in circumstances indicate that the fair value of a reporting unit has more likely than not declined below its carrying value. The annual impairment test resulted in no impairment of goodwill during fiscal 2011 or fiscal 2010. During fiscal 2009, we recorded a goodwill impairment charge of $224 million driven by a reduction in expected future cash flows for certain businesses primarily as a result of the decline in the residential construction market and general weakness in the U.S. economy.

In view of the general economic downturn in the U.S., we may be required to take additional impairment charges relating to our operations or close under-performing locations.

During fiscal 2009, we recorded impairment charges related to the carrying value of goodwill for four of our reporting units. While a goodwill impairment charge was not recorded during fiscal 2011 or fiscal 2010, if weakness in the residential and/or non-residential construction markets and/or the general U.S. economy continues, we may need to take additional goodwill and/or asset impairment charges relating to certain of our reporting units and asset groups. Any such non-cash charges would have an adverse effect on our financial results.

In addition, we have closed certain under-performing branches. As of January 29, 2012, approximately 235 net branches have been closed and approximately 9,000 employees have been terminated since the Transactions. We may have to close additional branches in certain of our markets. Such facility closures could have a significant adverse effect on our financial condition, operating results and cash flows.

We occupy most of our facilities under long-term non-cancelable leases. We may be unable to renew leases at the end of their terms. If we close a facility, we remain obligated under the applicable lease.

Most of our facilities are located in leased premises. Many of our current leases are non-cancelable and typically have terms ranging from 3 to 10 years and most provide options to renew for specified periods of time. We believe that leases we enter into in the future will likely be long-term and non-cancelable and have similar renewal options. If we close or idle a facility, we generally remain committed to perform our obligations under the applicable lease, which includes, among other things, payment of the base rent for the balance of the lease term. Over the course of the last three fiscal years, we closed or idled facilities for which we remain liable on the lease obligations. Our obligation to continue making rental payments in respect of leases for closed or idled facilities could have a material adverse effect on our business and results of operations.

The industries in which we operate are highly competitive and fragmented, and demand for our products and services could decrease if we are not able to compete effectively.

The industries in which we operate are fragmented, including the residential, non-residential and public infrastructure construction and facility repair and maintenance markets. There is significant competition in each of our businesses. Our competition includes other wholesalers and manufacturers that sell products directly to their respective customer base and some of our customers that resell our products. To a limited extent, retailers of electrical fixtures and supplies, building materials, maintenance repair and operations supplies, and contractors’ tools also compete with us. We also expect that new competitors may develop over time as internet-based enterprises become more established and reliable and refine their service capabilities. Competition varies depending on product line, customer classification and geographic area. The principal competitive factors in our business include, but are not limited to:

 

   

availability and cost of materials and supplies;

 

   

technical product knowledge and expertise as to application and usage;

 

   

advisory or other service capabilities;

 

   

ability to build and maintain customer relationships;

 

   

effective use of technology to identify sales and operational opportunities;

 

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same-day delivery capabilities in certain product lines; and

 

   

pricing of products and provisions of credit.

We compete with many local, regional and, in several markets and product categories, other national distributors. Several of our competitors in one or more of our businesses have substantially greater financial and other resources than us. No assurance can be given that we will be able to respond effectively to such competitive pressures. Increased competition by existing and future competitors could result in reductions in sales, prices, volumes and gross margins that could materially adversely affect our business, financial condition and results of operations. Furthermore, our success will depend, in part, on our ability to maintain our market share and gain market share from competitors.

In addition, our contracts with municipalities are often awarded and renewed through periodic competitive bidding. We may not be successful in obtaining or renewing these contracts. Our inability to replace a significant number of contracts lost through competitive bidding processes with other revenue sources within a reasonable time could be harmful to our business and financial performance.

Our competitors in the residential, non-residential and infrastructure construction and facility maintenance and repair distribution markets continue to consolidate, which could cause these markets to become more competitive and could negatively impact our business.

Our competitors in the residential, non-residential and infrastructure construction and facility maintenance and repair distribution markets in the United States and Canada are consolidating. This consolidation is being driven by customer needs and supplier capabilities, which could cause the industries to become more competitive as greater economies of scale are achieved by distributors. Customers are increasingly aware of the total costs of fulfillment and of the need to have consistent sources of supply at multiple locations. We believe these customer needs could result in fewer distributors as the remaining distributors become larger and capable of being a consistent source of supply.

There can be no assurance that we will be able to take advantage effectively of the trend toward consolidation. The trend in our industry toward consolidation could make it more difficult for us to maintain operating margins and could also increase competition for our acquisition targets and result in higher purchase price multiples. Furthermore, as our industrial and construction customers face increased foreign competition and potentially lose business to foreign competitors or shift their operations overseas in an effort to reduce expenses, we may face increased difficulty in growing and maintaining our market share and growth prospects.

The loss of any of our significant customers could adversely affect our financial condition.

Our ten largest customers generated approximately 8.8% of our Net sales in fiscal 2011, and our largest customer accounted for 3.6% of our Net sales in that same period. We cannot guarantee that we will maintain or improve our relationships with these customers or that we will continue to supply these customers at historical levels. During the economic downturn, some of our customers reduced their operations. For example, some homebuilder customers exited or severely curtailed building activity in certain of our markets. There is no assurance that our customers will determine to increase their operations or return to historic levels. Slow economic recovery could continue to have a significant adverse effect on our financial condition, operating results and cash flows.

In addition, consolidation among customers could also result in a loss of some of our present customers to our competitors. The loss of one or more of our significant customers or deterioration in our relations with any of them could significantly affect our financial condition, operating results and cash flows. Furthermore, our customers are generally not required to purchase any minimum amount of products from us. The contracts into which we have entered with most of our customers typically provide that we supply particular products or services for a certain period of time when and if ordered by the customer. Should our customers purchase our products in significantly lower quantities than they have in the past, such decreased purchases could have a material adverse effect on our financial condition, operating results and cash flows.

 

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The majority of our net sales are credit sales which are made primarily to customers whose ability to pay is dependent, in part, upon the economic strength of the industry and geographic areas in which they operate, and the failure to collect monies owed from customers could adversely affect our financial condition.

The majority of our Net sales volume in fiscal 2011 was facilitated through the extension of credit to our customers whose ability to pay is dependent, in part, upon the economic strength of the construction industry in the areas where they operate. Our businesses offer credit to customers, either through unsecured credit that is based solely upon the creditworthiness of the customer, or secured credit for materials sold for a specific job where the security lies in lien rights associated with the material going into the job. The type of credit offered depends both on the financial strength of the customer and the nature of the business in which the customer is involved. End users, resellers and other non-contractor customers generally purchase more on unsecured credit than secured credit. The inability of our customers to pay off their credit lines in a timely manner, or at all, would adversely affect our financial condition, operating results and cash flows. Furthermore, our collections efforts with respect to non-paying or slow-paying customers could negatively impact our customer relations going forward.

Because we depend on the creditworthiness of our customers, if the financial condition of our customers declines, our credit risk could increase. Significant contraction in the construction and industrial markets, coupled with tightened credit availability and financial institution underwriting standards, could adversely affect certain of our customers. Should one or more of our larger customers declare bankruptcy, it could adversely affect the collectability of our accounts receivable, bad debt reserves and net income.

We are subject to competitive pricing pressure from our customers.

Certain of our largest customers historically have exerted significant pressure on their outside suppliers to keep prices low because of their market share and their ability to leverage such market share in the highly fragmented building products supply industry. The economic downturn has resulted in increased pricing pressures from our customers. If we are unable to generate sufficient cost savings to offset any price reductions, our financial condition, operating results and cash flows may be adversely affected.

We may not achieve the acquisition component of our growth strategy.

Acquisitions will continue to be an important component of our growth strategy; however, there can be no assurance that we will be able to continue to grow our business through acquisitions as we have done historically or that any businesses acquired will perform in accordance with expectations or that business judgments concerning the value, strengths and weaknesses of businesses acquired will prove to be correct. Future acquisitions may result in the incurrence of debt and contingent liabilities and an increase in interest expense and amortization expenses and significant charges relative to integration costs. Our strategy could be impeded if we do not identify suitable acquisition candidates and our financial condition and results of operations will be adversely affected if we overpay for acquisitions.

Acquisitions involve a number of special risks, including:

 

   

problems implementing disclosure controls and procedures;

 

   

unforeseen difficulties extending internal control over financial reporting and performing the required assessment at the newly-acquired business;

 

   

potential adverse short-term effects on operating results through increased costs or otherwise;

 

   

diversion of management’s attention, failure to recruit new, and retain existing, key personnel of the acquired business;

 

   

failure to successfully implement infrastructure, logistics and systems integration;

 

   

our business growth could outpace the capability of our systems;

 

   

unforeseen liabilities inherent in the acquired business that manifest themselves after the acquisition is completed; and

 

   

the risks inherent in the systems of the acquired business and risks associated with unanticipated events or liabilities, any of which could have a material adverse effect on our business, financial condition and results of operations.

In addition, we may not be able to obtain financing necessary to complete acquisitions on attractive terms or at all.

 

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A range of factors may make our quarterly revenues and earnings variable.

We have historically experienced, and in the future expect to continue to experience, variability in revenues and earnings on a quarterly basis. The factors expected to contribute to this variability include, among others: (i) the cyclical nature of some of the markets in which we compete, including the new residential and commercial construction markets, (ii) general economic conditions in the various local markets in which we compete, (iii) the pricing policies of our competitors, (iv) the production schedules of our customers, and (v) the effects of the weather. These factors, among others, make it difficult to project our operating results on a consistent basis, which may affect the price of our securities.

The residential, non-residential and infrastructure construction and facility maintenance and repair markets are cyclical and seasonal.

Although weather patterns affect our operating results throughout the year, adverse weather historically has reduced construction and maintenance and repair activity in the first and fourth quarters in our markets. In contrast, our highest volume of net sales historically has occurred in our second fiscal quarter. To the extent that hurricanes, severe storms, floods, other natural disasters or similar events occur in the markets in which we operate, our business may be adversely affected. In addition, most of our businesses experience seasonal variation as a result of the dependence of our customers on suitable weather to engage in construction, maintenance and renovation and improvement projects. For example, White Cap sells products used primarily in the residential and non-residential construction industry. Generally, during the winter months, construction activity declines due to inclement weather and shorter daylight hours. As a result, operating results for the businesses that experience such seasonality may vary significantly from period to period. We anticipate that fluctuations from period to period will continue in the future.

Fluctuating commodity prices may adversely impact our results of operations.

The cost of steel, aluminum, copper, ductile iron, polyvinyl chlorides (“PVC”) and other commodities used in the products we distribute can be volatile. Although we attempt to resist cost increases by our suppliers and to pass on increased costs to our customers, we are not always able to do so quickly or at all. In addition, if prices decrease for commodities used in products we distribute, we may have inventories purchased at higher prices than prevailing market prices. Significant fluctuations in the cost of the commodities used in products we distribute have in the past adversely affected, and in the future may adversely affect, our results of operations and financial condition.

If petroleum prices increase, our results of operations could be adversely affected.

Petroleum prices have fluctuated significantly in recent years. Prices and availability of petroleum products are subject to political, economic and market factors that are outside our control. Political events in petroleum-producing regions as well as hurricanes and other weather-related events may cause the price of fuel to increase. Within several of our principal and other businesses, we deliver a significant volume of products to our customers by truck. Our operating profit will be adversely affected if we are unable to obtain the fuel we require or to fully offset the anticipated impact of higher fuel prices through increased prices or fuel surcharges to our customers. Besides passing fuel costs on to customers, we have not entered into any hedging arrangements that protect against fuel price increases and we do not have any long-term fuel purchase contracts. If shortages occur in the supply of necessary petroleum products and we are not able to pass along the full impact of increased petroleum prices to our customers, our results of operations would be adversely affected.

Product shortages and cyclicality in the residential, non-residential and infrastructure construction and facility maintenance and repair markets may impair our operating results.

Our ability to offer a wide variety of products to our customers is dependent upon our ability to obtain adequate product supply from manufacturers or other suppliers. Generally, our products are obtainable from various sources and in sufficient quantities. However, the loss of, or substantial decrease in the availability of, products from our suppliers, or the loss of our key supplier agreements, could adversely impact our financial condition, operating results and cash flows. In addition, supply interruptions could arise from shortages of raw materials (including petroleum products), labor disputes or weather conditions affecting products or shipments, transportation disruptions or other factors beyond our control. Short and long-term disruptions in our supply

 

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chain would result in a need to maintain higher inventory levels as we replace similar product domestically, a higher cost of product and ultimately a decrease in our net sales and profitability. A disruption in the timely availability of our products by our key suppliers would result in a decrease in our revenues and profitability, especially in our businesses with supplier concentration, such as our Waterworks business. Although in many instances we have agreements with our suppliers, these agreements are generally terminable by either party on limited notice. Failure by our suppliers to continue to supply us with products on commercially reasonable terms, or at all, would put pressure on our operating margins and have a material adverse effect on our financial condition, operating results and cash flows. Short-term changes in the cost of these materials, some of which are subject to significant fluctuations, are sometimes, but not always passed on to our customers. Our delayed ability to pass on material price increases to our customers could adversely impact our financial condition, operating results and cash flows.

In addition, the residential, non-residential and infrastructure construction and facility maintenance and repair markets are subject to cyclical market pressures. The length and magnitude of these cycles have varied over time and by market. Prices of the products we sell are historically volatile and subject to fluctuations arising from changes in supply and demand, national and international economic conditions, labor costs, competition, market speculation, government regulation and trade policies, as well as from periodic delays in the delivery of our products. We have a limited ability to control the timing and amount of changes to prices that we pay for our products. In addition, the supply of our products fluctuates based on available manufacturing capacity. A shortage of capacity, or excess capacity, in the industry can result in significant increases or declines in market prices for those products, often within a short period of time. Such price fluctuations can adversely affect our financial condition, operating results and cash flows.

We rely on third party suppliers and long supply chains, and if we fail to identify and develop relationships with a sufficient number of qualified suppliers, or if there is a significant interruption in our supply chains, our ability to timely and efficiently access products that meet our standards for quality could be adversely affected.

We buy our products and supplies from suppliers located throughout the world and they manufacture or purchase in the United States and abroad the products we buy from them. Our ability to continue to identify and develop relationships with qualified suppliers who can satisfy our standards for quality and our need to access products and supplies in a timely and efficient manner is a significant challenge. We may be required to replace a supplier if their products do not meet our quality or safety standards. In addition, our suppliers could discontinue selling products manufactured in foreign countries at any time for reasons that may or may not be in our control or the suppliers’ control. Our operating results and inventory levels could suffer if we are unable to promptly replace a supplier who is unwilling or unable to satisfy our requirements with a supplier providing similar products. Our suppliers’ ability to deliver products may also be affected by financing constraints caused by credit market conditions, which could negatively impact our revenue and cost of products sold, at least until alternate sources of supply are arranged. In addition, since a portion of the products that we distribute is produced in foreign countries, we are dependent on long supply chains for the successful delivery of many of our products. The length and complexity of these supply chains make them vulnerable to numerous risks, many of which are beyond our control, which could cause significant interruptions or delays in delivery of our products. Factors such as political instability, the financial instability of suppliers, suppliers’ noncompliance with applicable laws, trade restrictions, labor disputes, currency fluctuations, changes in tariff or import policies, severe weather, terrorist attacks and transport capacity and cost may disrupt these supply chains and our ability to access products and supplies. If we increase the percentage of our products that are sourced from lower-cost countries, these risks will be amplified. Moreover, these risks will be amplified by our ongoing efforts to consolidate our supplier base across our businesses. We expect more of our products will be imported in the future, which will further increase these risks. A significant interruption in our supply chains caused by any of the above factors could result in increased costs or delivery delays and result in a decrease in our net sales and profitability.

We have substantial fixed costs and, as a result, our operating income is sensitive to changes in our net sales.

A significant portion of our expenses are fixed costs (including personnel), which do not fluctuate with net sales. Consequently, a percentage decline in our net sales could have a greater percentage effect on our operating income if we do not act to reduce personnel or take other cost reduction actions. Any decline in our net sales would cause our profitability to be adversely affected. Moreover, a key element of our strategy is managing our

 

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assets, including our substantial fixed assets, more effectively, including through sales or other disposals of excess assets. Our failure to rationalize our fixed assets in the time, and within the costs, we expect could have an adverse effect on our results of operations and financial condition.

A change in our product mix could adversely affect our results of operations.

Our results may be affected by a change in our product mix. Our outlook, budgeting and strategic planning assume a certain volume mix of sales as well as a product mix of sales. If actual results vary from this projected volume and product mix of sales, our financial results could be negatively impacted.

The impairment or failure of financial institutions may adversely affect us.

We have exposure to counterparties with which we execute transactions, including U.S. and foreign commercial banks, insurance companies, investment banks, investment funds and other financial institutions, some of which may be exposed to bankruptcy, illiquidity, default or similar risks. Many of these transactions could expose us to risk in the event of the bankruptcy, receivership, default or similar event involving a counterparty. For example, one of the financial institutions that is committed to fund our ABL Revolving Credit Facility failed to meet a funding request by the Company in the first quarter of 2011. While we have not realized any significant losses to date, the bankruptcy, receivership, default or similar event involving one of our financial institution counterparties could have a material adverse impact on our access to funding or our ability to meet our financing agreement obligations.

The development of alternatives to distributors in the supply chain could cause a decrease in our sales and operating results and limit our ability to grow our business.

Our customers could begin purchasing more of their product needs directly from manufacturers, which would result in decreases in our net sales and earnings. Our suppliers could invest in infrastructure to expand their own local sales force and sell more products directly to our customers, which also would negatively impact our business. For example, multiple municipalities may outsource their entire waterworks systems to a single company, thereby increasing such company’s leverage in the marketplace and its ability to buy directly from suppliers, which may have a material adverse effect on our operating results.

In addition to these factors, our customers may elect to establish their own building products manufacturing and distribution facilities, or give advantages to manufacturing or distribution intermediaries in which they have an economic stake. These changes in the supply chain could adversely affect our financial condition, operating results and cash flows.

Because our business is working-capital intensive, we rely on our ability to manage our product purchasing and customer credit policies.

Our operations are working-capital intensive, and our inventories, accounts receivable and accounts payable are significant components of our net asset base. We manage our inventories and accounts payable through our purchasing policies and our accounts receivable through our customer credit policies. If we fail to adequately manage our product purchasing or customer credit policies, our working capital and financial condition may be adversely affected.

Inclement weather, anti-terrorism measures and other disruptions to the transportation network could impact our distribution system and our operations.

Our ability to provide efficient distribution of products to our customers is an integral component of our overall business strategy. Disruptions at distribution centers or shipping ports, due to events such as the flooding from Hurricane Irene and the outbreaks of tornadoes in 2011, blizzards in 2010, and the hurricanes of 2005, may affect our ability to both maintain key products in inventory and deliver products to our customers on a timely basis, which may in turn adversely affect our results of operations.

Furthermore, in the aftermath of terrorist attacks in the United States, federal, state and local authorities have implemented and continue to implement various security measures that affect many parts of the transportation network in the United States and abroad. Our customers typically need quick delivery and rely on our on-time delivery capabilities. If security measures disrupt or impede the timing of our deliveries, we may fail to meet the needs of our customers, or may incur increased expenses to do so.

 

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Interruptions in the proper functioning of IT systems could disrupt operations and cause unanticipated increases in costs or decreases in revenues, or both.

Because we use our information systems to, among other things, manage inventories and accounts receivable, make purchasing decisions and monitor our results of operations, the proper functioning of our IT systems is critical to the successful operation of our business. Although our IT systems are protected through physical and software safeguards and remote processing capabilities exist, IT systems are still vulnerable to natural disasters, power losses, unauthorized access, telecommunication failures and other problems. If critical IT systems fail, or are otherwise unavailable, our ability to process orders, track credit risk, identify business opportunities, maintain proper levels of inventories, collect accounts receivable and pay expenses and otherwise manage our businesses would be adversely affected.

The implementation of our technology initiatives could disrupt our operations in the near term, and our technology initiatives might not provide the anticipated benefits or might fail.

We have made, and will continue to make, significant technology investments in each of our businesses and in our administrative functions. Our technology initiatives are designed to streamline our operations to allow our associates to continue to provide high quality service to our customers and to provide our customers a better experience, while improving the quality of our internal control environment. The cost and potential problems and interruptions associated with the implementation of our technology initiatives could disrupt or reduce the efficiency of our operations in the near term. In addition, our new or upgraded technology might not provide the anticipated benefits, it might take longer than expected to realize the anticipated benefits or the technology might fail altogether.

We may experience a failure in or breach of our operational or information security systems, or those of our third party service providers, as a result cyber attacks or information security breaches.

Information security risks have generally increased in recent years because of the proliferation of new technologies and the increased sophistication and activities of perpetrators of cyber attacks. A failure in or breach of our operational or information security systems, or those of our third party service providers, as a result of cyber attacks or information security breaches could disrupt our business, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and/or cause losses. As a result, cyber security and the continued development and enhancement of the controls and processes designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. Although we believe that we have robust information security procedures and other safeguards in place, as cyber threats continue to evolve, we may be required to expend additional resources to continue to enhance our information security measures and/or to investigate and remediate any information security vulnerabilities.

Third party service providers are responsible for managing a significant portion of our information systems. Our business and results of operations may be adversely affected if the third party service provider does not perform satisfactorily.

Our combined financial information as of and for periods prior to the Transactions is not representative of our future financial position, future results of operations or future cash flows nor does it reflect what our financial position, results of operations or cash flows would have been as a stand-alone company during the periods presented.

Our combined financial information as of and for periods prior to the Transactions included in this annual report on Form 10-K is not representative of our future financial position, future results of operations or future cash flows nor does it reflect what our financial position, results of operations or cash flows would have been as a stand-alone company during the periods presented. This is primarily because:

 

   

such combined financial information reflects allocation of expenses from Home Depot. Those allocations may be different from the comparable expenses we would have incurred as a stand-alone company;

 

   

our working capital requirements historically were satisfied as part of Home Depot’s corporate-wide cash management policies. In connection with the Transactions, we incurred a large amount of indebtedness and therefore assumed significant debt service costs. As a result, our cost of debt and capitalization is significantly different from that reflected in the historical combined financial information; and

 

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as a result of the Transactions, we experienced increases in our costs, including the cost to establish an appropriate accounting and reporting system, debt service obligations, improving information technology, and other costs of being a stand-alone company.

The interests of the Equity Sponsors may differ from the interests of holders of our 12% Senior Notes and our 13.5% Senior Subordinates Notes.

As a result of the Transactions, the Equity Sponsors and their affiliates own most of the outstanding capital stock of our parent company, HDS Investment Holding, Inc. (“Holding”). Holding entered into a stockholders agreement with its stockholders in connection with the closing of the Transactions which contains, among other things, provisions relating to Holding’s governance, transfer restrictions, tag-along rights, drag-along rights, preemptive rights and certain unanimous approval rights. This stockholders agreement provides that the Equity Sponsors are entitled to elect (or cause to be elected) nine out of ten of Holding’s directors, which includes three designees of each Equity Sponsor. One of the directors designated by the Equity Sponsor associated with CD&R shall serve as the chairman. See “Item 13. Certain Relationships and Related Transactions, and Director Independence—Stockholders agreement and stockholder arrangements.” The interests of the Equity Sponsors may differ from our interest and from those of holders of our outstanding notes in material respects. For example, the Equity Sponsors may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their overall equity portfolios, even though such transactions might involve risks to holders of our outstanding notes. The Equity Sponsors are in the business of making investments in companies, and may from time to time in the future, acquire interests in businesses that directly or indirectly compete with certain portions of our business or are suppliers of our customers. The companies in which one or more of the Equity Sponsors invest may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. Additionally, the Equity Sponsors may determine that the disposition of some or all of their interests in our company would be beneficial to the Equity Sponsors at a time when such disposition could be detrimental to the holders of our outstanding notes. If we encounter financial difficulties, or we are unable to pay our debts as they mature, the interests of our equity holders might conflict with those of the holders of our outstanding notes. In that situation, for example, the holders of our outstanding notes might want us to raise additional equity from our equity holders or other investors to reduce our leverage and pay our debts, while our equity holders might not want to increase their investment in us or have their ownership diluted and instead choose to take other actions, such as selling our assets. The Equity Sponsors have no obligation to provide us with financing and are able to sell their equity ownership in us at any time. Moreover, the Equity Sponsors’ ownership of our company may have the effect of discouraging offers to acquire control of our company.

Our costs of doing business could increase as a result of changes in U.S. federal, state or local regulations.

Our operations are principally affected by various statutes, regulations and laws in the 45 U.S. states and nine Canadian provinces in which we operate. While we are not engaged in a “regulated” industry, we are subject to various laws applicable to businesses generally, including laws affecting land usage, zoning, the environment, health and safety, transportation, labor and employment practices (including pensions), competition, immigration and other matters. Additionally, building codes may affect the products our customers are allowed to use, and consequently, changes in building codes may affect the saleability of our products. Changes in U.S. federal, state or local regulations governing the sale of some of our products could increase our costs of doing business. In addition, changes to U.S. federal, state and local tax regulations could increase our costs of doing business. We cannot provide assurance that we will not incur material costs or liabilities in connection with regulatory requirements.

We deliver products to many of our customers through our own fleet of vehicles. The U.S. Department of Transportation, or the “DOT,” regulates our operations in domestic interstate commerce. We are subject to safety requirements governing interstate operations prescribed by the DOT. Vehicle dimensions and driver hours of service also remain subject to both federal and state regulation. More restrictive limitations on vehicle weight and size, trailer length and configuration, or driver hours of service could increase our costs, which, if we are unable to pass these cost increases on to our customers, would reduce our gross margins, increase our selling, general and administrative expenses and reduce our net income.

 

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We cannot predict whether future developments in law and regulations concerning our businesses will affect our business financial condition and results of operations in a negative manner. Similarly, we cannot assess whether our businesses will be successful in meeting future demands of regulatory agencies in a manner which will not materially adversely affect our business, financial condition or results of operations.

The nature of our business exposes us to construction defect and product liability claims as well as other legal proceedings.

We rely on manufacturers and other suppliers to provide us with the products we sell and distribute. As we do not have direct control over the quality of the products manufactured or supplied by such third party suppliers, we are exposed to risks relating to the quality of the products we distribute and install. It is possible that inventory from a manufacturer or supplier could be sold to our customers and later be alleged to have quality problems or to have caused personal injury, subjecting us to potential claims from customers or third parties. We have been subject to claims in the past, which have been resolved without material financial impact. We are involved in construction defect and product liability claims relating to our various construction trades and the products we distribute and manufacture and relating to products we have installed. In certain situations, we have undertaken to voluntarily remediate any defects, which can be a costly measure.

We also operate a large fleet of trucks and other vehicles and therefore face the risk of accidents. While we currently maintain insurance coverage to address a portion of these types of liabilities, we cannot make assurances that we will be able to obtain such insurance on acceptable terms in the future, if at all, or that any such insurance will provide adequate coverage against potential claims. Further, while we seek indemnification against potential liability for products liability claims from relevant parties, including but not limited to manufacturers and distributors, we cannot guarantee that we will be able to recover under such indemnification agreements. Moreover, as we increase the number of private label products we distribute, our exposure to potential liability for products liability claims may increase. Product liability claims can be expensive to defend and can divert the attention of management and other personnel for significant time periods, regardless of the ultimate outcome. An unsuccessful product liability defense could be highly costly and accordingly result in a decline in revenues and profitability. In addition, uncertainties with respect to the Chinese legal system may adversely affect us in resolving claims arising from our proprietary brand products manufactured in China. Because many laws and regulations are relatively new and the Chinese legal system is still evolving, the interpretations of many laws, regulations and rules are not always uniform. Finally, even if we are successful in defending any claim relating to the products we distribute, claims of this nature could negatively impact customer confidence in our products and our company.

We are involved in a number of legal proceedings, and while we cannot predict the outcomes of such proceedings and other contingencies with certainty, some of these outcomes may adversely affect our operations or increase our costs.

We are involved in a number of legal proceedings, including government inquiries and investigations, as well as class action, products liability, consumer, employment, tort and other litigation. We cannot predict with certainty the outcomes of these legal proceedings and other contingencies, including environmental remediation and other proceedings commenced by government authorities. The outcome of some of these legal proceedings and other contingencies could require us to take, or refrain from taking, actions which could adversely affect our operations or could require us to pay substantial amounts of money. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management’s attention and resources from other matters. See “Item 3. Legal Proceedings.”

If we become subject to material liabilities under our self-insured programs, our financial results may be adversely affected.

We provide workers’ compensation, automobile and product/general liability coverage through a high deductible insurance program. In addition, we provide medical coverage to our employees through a self-insured preferred provider organization. Though we believe that we have adequate insurance coverage in excess of self-insured retention levels, our results of operations and financial condition may be adversely affected if the number and severity of insurance claims increases.

 

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We may see increased costs arising from health care reform.

In March 2010, the United States government enacted comprehensive health care reform legislation which, among other things, includes guaranteed coverage requirements, eliminates pre-existing condition exclusions and annual and lifetime maximum limits, restricts the extent to which policies can be rescinded and imposes new and significant taxes on health insurers and health care benefits. The legislation imposes implementation effective dates which began in 2010 and extend through 2020, and many of the changes require additional guidance from government agencies or federal regulations. Therefore, due to the phased-in nature of the implementation and the lack of interpretive guidance, it is difficult to determine at this time what impact the health care reform legislation will have on our financial results. Possible adverse effects of the health reform legislation include increased costs, exposure to expanded liability and requirements for us to revise ways in which we provide healthcare and other benefits to our employees. In addition, our results of operations, financial position and cash flows could be materially adversely affected.

Our success depends upon our ability to attract, train and retain highly qualified associates and key personnel.

To be successful, we must attract, train and retain a large number of highly qualified associates while controlling related labor costs. Our ability to control labor costs is subject to numerous external factors, including prevailing wage rates and health and other insurance costs. We compete with other businesses for these associates and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified associates in the future, including, in particular, those employed by companies we acquire. A very small proportion of our employees are currently covered by collective bargaining or other similar labor agreements. Historically, the effects of collective bargaining and other similar labor agreements on us have not been significant. However, if a larger number of our employees were to unionize, including in the wake of any future legislation that makes it easier for employees to unionize, the effect on us may be negative. Any inability by us to negotiate acceptable new contracts under these collective bargaining arrangements could cause strikes or other work stoppages, and new contracts could result in increased operating costs. If any such strikes or other work stoppages occur, or if other employees become represented by a union, we could experience a disruption of our operations and higher labor costs. Labor relations matters affecting our suppliers of products and services could also adversely affect our business from time to time.

In addition, our business results depend largely upon our executives as well as our branch managers and sales personnel, including those of companies recently acquired, and their experience, knowledge of local market dynamics and specifications and long-standing customer relationships. We customarily sign employment letters providing for an agreement not to compete with key personnel of companies we acquire in order to maintain key customer relationships and manage the transition of the acquired business. Our inability to retain or hire qualified branch managers or sales personnel at economically reasonable compensation levels would restrict our ability to grow our business, limit our ability to continue to successfully operate our business and result in lower operating results and profitability.

Fluctuations in foreign currency exchange rates may significantly reduce our revenues and profitability.

As an industrial distributor of manufactured products, our profitability is tied to the prices we pay to the manufacturers from which we purchase our products. Some of our suppliers price their products in currencies other than the U.S. dollar or incur costs of production in non-U.S. currencies. Accordingly, depreciation of the U.S. dollar against foreign currencies increases the prices we pay for these products. Even short-term currency fluctuations could adversely impact revenues and profitability if we are unable to pass higher supply costs on to our customers. Our delayed ability to pass on material price increases to our customers could adversely impact our financial condition, operating results and cash flows.

If we are unable to protect our intellectual property rights, or we infringe on the intellectual property rights of others, our ability to compete could be negatively impacted.

Our ability to compete effectively depends, in part, upon our ability to protect and preserve proprietary aspects of our intellectual property, including our trademarks and customer lists. The use of our intellectual property or similar intellectual property by others could adversely impact our ability to compete, cause us to lose net sales or

 

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otherwise harm our business. If it became necessary for us to resort to litigation to protect these rights, any proceedings could be burdensome and costly, and we may not prevail.

Also, we cannot be certain that the products that we sell do not and will not infringe issued patents or other intellectual property rights of others. Further, we are subject to legal proceedings and claims in the ordinary course of our business, including claims of alleged infringement of the trademarks, patents and other intellectual property rights of third parties by us or our customers in connection with their use of the products that we distribute. Should we be found liable for infringement, we (or our suppliers) may be required to enter into licensing agreements (if available on acceptable terms or at all) or pay damages and cease making or selling certain products. Moreover, we may need to redesign or sell different products to avoid future infringement liability. Any of the foregoing could cause us to incur significant costs, prevent us from selling our products or negatively impact our ability to compete.

Income tax payments may ultimately differ from amounts currently recorded by the Company. Future tax law changes may materially increase the Company’s prospective income tax expense.

We are subject to income taxation in many jurisdictions in the U.S. as well as numerous foreign jurisdictions. Judgment is required in determining our worldwide income tax provision and accordingly there are many transactions and computations for which our final income tax determination is uncertain. We are routinely audited by income tax authorities in many tax jurisdictions. Although we believe the recorded tax estimates are reasonable, the ultimate outcome from any audit (or related litigation) could be materially different from amounts reflected in our income tax provisions and accruals. Future settlements of income tax audits may have a material effect on earnings between the period of initial recognition of tax estimates in the financial statements and the point of ultimate tax audit settlement. Additionally, it is possible that future income tax legislation in any jurisdiction to which we are subject may be enacted that could have a material impact on our worldwide income tax provision beginning with the period that such legislation becomes effective.

The Internal Revenue Service has issued notices of proposed adjustments that propose to disallow certain of our deductions and the carryback of certain of our net operating losses to taxable years during which we were a member of The Home Depot, Inc.’s U.S. federal consolidated income tax return. The Internal Revenue Service is expected to issue in the near future a letter that proposes to assess tax liabilities from such proposed adjustments. We are estimating such letter will contain a proposed assessment of tax liabilities for approximately $322 million to $325 million, including accrued interest. We believe that the deductions we reported on the tax returns in question and carryback of the net operating losses are accurate and appropriate. Therefore, we intend to challenge any proposed assessment by filing a formal protest with the Appeals Division of the Internal Revenue Service. During the protest period, we intend to vigorously defend our positions rather than pay any proposed assessments. If we are ultimately required to pay any such proposed assessments, we could incur significant liabilities and our cash flows, future results of operations and financial position could be affected in a significant and adverse manner. The carryback of the net operating losses was made in accordance with (and subject to the terms of) an agreement entered into between our ultimate parent corporation, HDS Investment Holding, Inc., and The Home Depot, Inc. See Note 14, Commitments and Contingencies, in the Notes to the Consolidated Financial Statements within Item 8 of this annual report on Form 10-K.

Our income tax net operating loss carry forwards could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.

As of January 29, 2012, we had approximately $245 million of federal net operating loss carry forwards and $102 million of state net operating loss carry forwards. Our ability to deduct these net operating loss carry forwards against future taxable income could be substantially limited if we experience an “ownership change,” as defined in Section 382 of the Internal Revenue Code of 1986. In general, an ownership change would occur if there is a change in ownership of more than 50% of our stock over a three-year period. Our inability to utilize net operating loss carry forwards could result in the payment of cash taxes above the amounts currently estimated for future periods and have a negative effect on our future results of operations and financial position.

 

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We may not be able to identify new products and new product lines and integrate them into our distribution network, which may impact our ability to compete.

Our business depends in part on our ability to identify future products and product lines that complement existing products and product lines and that respond to our customers’ needs. We may not be able to compete effectively unless our product selection keeps up with trends in the markets in which we compete or trends in new products. In addition, our ability to integrate new products and product lines into our distribution network could impact our ability to compete. Furthermore, the success of new products and new product lines will depend on market demand and there is a risk that new products and new product lines will not deliver expected results, which could negatively impact our future sales and results of operations.

Our business may be subject to significant environmental, health and safety costs.

Our operations are subject to a broad range of federal, state, local and foreign environmental health and safety laws and regulations, including those governing discharges to air, soil and water, the handling and disposal of hazardous substances and the investigation and remediation of contamination resulting from releases of petroleum products and other hazardous substances. In the course of our operations, we store fuel in on-site storage tanks, and we use and dispose of a limited amount of hazardous substances. We cannot make assurances that compliance with existing or future environmental, health and safety laws, such as those relating to our remediation obligations, will not adversely affect future operating results.

We may be affected by global climate change or by legal, regulatory or market responses to such potential change.

Concern over climate change, including the impact of global warming, has led to significant federal, state, and international legislative and regulatory efforts to limit greenhouse gas (“GHG”) emissions. For example, in the past several years, the U.S. Congress has considered various bills that would regulate GHG emissions. While these bills have not yet received sufficient Congressional support for enactment, some form of federal climate change legislation is possible in the future. Even in the absence of such legislation, the Environmental Protection Agency, spurred by judicial interpretation of the Clean Air Act, may regulate GHG emissions, especially diesel engine emissions, and this could impose substantial costs on us. These costs include an increase in the cost of the fuel and other energy we purchase and capital costs associated with updating or replacing our internal fleet of trucks and other vehicles prematurely. In addition, new laws or future regulation could directly and indirectly affect our customers and suppliers (through an increase in the cost of production or their ability to produce satisfactory products) and our business (through the impact on our inventory availability, cost of sales, operations or demands for the products we sell). Until the timing, scope and extent of any future regulation becomes known, we cannot predict its effect on our cost structure or our operating results. Notwithstanding our dedication to being a responsible corporate citizen, it is reasonably possible that such legislation or regulation could impose material costs on us. Moreover, even without such legislation or regulation, increased awareness and any adverse publicity in the global marketplace about the GHGs emitted by companies involved in the transportation of goods could harm our reputation and reduce customer demand for our services.

Our failure to achieve and maintain effective disclosure controls and internal control over financial reporting could adversely affect our business, financial position and results of operations.

We are subject to the reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended. We are required to evaluate the effectiveness of our disclosure controls and internal control over financial reporting on a periodic basis and publicly disclose the results of these evaluations and related matters, in accordance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. These reporting and other obligations place significant additional demands on our management and administrative and operational resources, including our accounting resources, which could adversely affect our operations among other things. To comply with these requirements, we have upgraded, and are continuing to upgrade our systems, including information technology, implemented additional financial and management controls, reporting systems and procedures and hired additional legal, internal audit, accounting and finance staff. We cannot be certain that we will be successful in maintaining adequate control over our financial reporting and financial processes. Furthermore, as we grow our business, our disclosure controls and internal controls will become more complex, and we may require significantly more resources to ensure that these controls remain effective. If we are unable to continue upgrading our financial and management controls, reporting systems, information technology and

 

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ITEM 1A. RISK FACTORS, CONTINUED   HD SUPPLY, INC.

 

procedures in a timely and effective fashion, additional management and other resources of our company may need to be devoted to assist in compliance with the disclosure and financial reporting requirements and other rules that apply to reporting companies, which could adversely affect our business, financial position and results of operations.

Due to an exemption established by rules of the SEC for non-accelerated filers, we are not required to have and have not had our independent registered public accounting firm perform an evaluation of our internal control over financial reporting as of the end of our fiscal year in accordance with the provisions of the Sarbanes-Oxley Act of 2002. Had our independent registered public accounting firm performed an evaluation of our internal control over financial reporting in accordance with the provisions of the Sarbanes-Oxley Act of 2002, additional control deficiencies may have been identified by our independent registered public accounting firm and those control deficiencies could have also represented one or more material weaknesses.

 

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   HD SUPPLY, INC.

 

ITEM 2. PROPERTIES

As of January 29, 2012, HD Supply reported 679 branches in the United States and Canada, as is shown in the tables below. These locations utilized approximately 21.3 million square feet, of which approximately 8% was owned (including locations subject to a ground lease) and approximately 92% was leased. We generally prefer to lease our locations, as it provides the flexibility to expand or relocate our sites as needed to serve evolving markets.

 

UNITED STATES

            STATE TOTALS

Alabama

       AL            8  

Alaska

       AK            1  

Arizona

       AZ            37  

Arkansas

       AR            4  

California

       CA            85  

Colorado

       CO            16  

Connecticut

       CT            2  

Delaware

       DE            4  

Florida

       FL            72  

Georgia

       GA            23  

Hawaii

       HI            3  

Idaho

       ID            3  

Illinois

       IL            19  

Indiana

       IN            12  

Iowa

       IA            6  

Kansas

       KS            5  

Kentucky

       KY            4  

Louisiana

       LA            11  

Maryland

       MD            11  

Massachusetts

       MA            3  

Michigan

       MI            3  

Minnesota

       MN            6  

Mississippi

       MS            2  

Missouri

       MO            13  

Montana

       MT            5  

Nebraska

       NE            3  

Nevada

       NV            11  

New Jersey

       NJ            5  

New Mexico

       NM            8  

New York

       NY            4  

North Carolina

       NC            29  

Ohio

       OH            21  

Oklahoma

       OK            8  

Oregon

       OR            6  

Pennsylvania

       PA            9  

South Carolina

       SC            14  

South Dakota

       SD            2  

Tennessee

       TN            13  

Texas

       TX            69  

Utah

       UT            10  

Virginia

       VA            18  

Washington

       WA            18  

West Virginia

       WV            4  

Wisconsin

       WI            4  

Wyoming

       WY            6  
       SUBTOTAL (U.S. Only)            620  

 

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ITEM 2. PROPERTIES, CONTINUED   HD SUPPLY, INC.

 

 

CANADA         PROVINCE        
TOTALS        

Alberta

       AB               6   

British Columbia

       BC               4   

Manitoba

       MB               2   

New Brunswick

       NB               1   

Nova Scotia

       NS               2   

Ontario

       ON               40   

Prince Edward Island

       PE               1   

Quebec

       QC               2   

Saskatchewan

       SK               1   
       SUBTOTAL (Canada Only)           59   
               
                                        TOTAL           679   

ITEM 3. LEGAL PROCEEDINGS

The Company is involved in litigation from time to time in the ordinary course of business. The Company establishes reserves for litigation and similar matters when those matters present loss contingencies that it determines to be both probable and reasonably estimable in accordance with ASC 450, Contingencies. In the opinion of management, based on current knowledge, all reasonably estimable and probable matters are believed to be adequately reserved for or covered by insurance and disclosed herein. For all such other matters, we believe the possibility of losses from such matters are remote or such matters are of such kind or involve such amounts that would not have a material adverse effect on the financial position, results of operations or cash flows of the Company if disposed of unfavorably.

 

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   HD SUPPLY, INC.

 

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

There is no established public trading market for the Company’s common stock. The Company had one record holder of common stock on March 23, 2012, and no equity securities of the Company are authorized for issuance under any equity compensation plan.

ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated and combined financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements and related notes appearing elsewhere in this annual report on Form 10-K.

The consolidated and combined financial data are presented below for two periods: Predecessor and Successor, which relate to the period preceding the Transactions and the period succeeding the Transactions, respectively. The Predecessor financial data represent the combined operations of HD Supply, Inc. and CND Holdings, Inc. (which has been dissolved as of February 2, 2009). The Successor financial data represent the consolidated operations of HD Supply, Inc. and its subsidiaries. The Company refers to the operations of HD Supply for both the Predecessor and Successor periods. Prior to the Transactions, HD Supply was a wholly-owned subsidiary of Home Depot.

The Transactions were accounted for as a purchase in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”), which resulted in a new basis of accounting. Pursuant to that guidance, the 12.5% continuing ownership of Home Depot is reflected at fair value, together with the remainder of the purchase price for the Transactions related to new ownership, and such fair value is allocated to the tangible and intangible assets and liabilities based on estimates of fair value in accordance with U.S. GAAP. The Predecessor and Successor financial data are not comparable as a result of applying a new basis of accounting.

The preparation of the Predecessor financial statements includes the use of “push down” accounting procedures wherein certain assets, liabilities and expenses historically recorded or incurred at the Home Depot level, which related to or were incurred on behalf of HD Supply and have been identified and allocated or pushed down as appropriate to reflect the stand-alone financial results of HD Supply for the periods presented. Allocations were made primarily based on specific identification. Management believes the methodology applied in the allocation of these costs is reasonable. Interest expense included in these financial statements reflects the terms of the intercompany debt agreements between Home Depot and HD Supply. These terms may not be indicative of terms reached on a third-party basis.

During fiscal 2011, HD Supply disposed of its Plumbing/HVAC and SESCO/QUESCO operations. In accordance with Accounting Standards Codification (“ASC”) 205-20, Discontinued Operations, the results of the Plumbing/HVAC and SESCO/QUESCO operations and the gain on sale of the businesses are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the discontinued operations and gain on the sale of businesses, net of tax, as one line item on the Consolidated Statements of Operations. All prior period Consolidated Statements of Operations presented have been restated to reflect this presentation.

Our consolidated and combined financial information may not be indicative of our future performance and our combined financial information does not reflect what our financial position and results of operations would have been had we operated as a separate stand-alone entity during the Predecessor periods. See “Item 1A. Risk Factors — Our combined financial information as of and for periods prior to the Transactions is not representative of our future financial position, future results of operations or future cash flows nor does it reflect what our financial position, results of operations or cash flows would have been as a stand-alone company during the periods presented.” In addition, we note that due to the significant size and number of acquisitions we completed in the period from January 29, 2007 to August 29, 2007, our historical data is not directly comparable on a period-over-period basis. See “Item 1. Business – Our history.”

 

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ITEM 6. SELECTED FINANCIAL DATA, CONTINUED   HD SUPPLY, INC.

 

Selected consolidated and combined financial information

 

     Successor       Predecessor    
     Fiscal year ended      Period from       Period from    
            August 30,  
2007 to  
February 3,  
2008  
    January 29,  
2007 to  
August 29,  
2007  
 
(Dollars in millions)    January 29,
2012
     January 30,
2011
     January 31,
2010
     February 1,
2009
      

Statement of income data:

                      

Net sales

     $7,724           $7,015           $6,947           $9,005           $4,148          $6,350     

Cost of sales

     5,545           5,046           5,049           6,548           3,024          4,627     
  

 

 

   

 

 

 

Gross profit

     2,179           1,969           1,898           2,457           1,124          1,723     

Operating expenses:

                

Selling, general and administrative

     1,636           1,537           1,540           1,876           899          1,264     

Depreciation and amortization

     344           358           376           391           163          111     

Restructuring

     –           8           21           31           –          –     

Goodwill impairment

     –           –           224           943           –          –     
  

 

 

   

 

 

 

Total operating expenses

     1,980           1,903           2,161           3,241           1,062          1,375     
  

 

 

   

 

 

 

Operating income (loss)

     199           66           (263)          (784)          62          348     

Interest expense

     639           623           602           644           289          220     

Interest (income)

     –           –           –           (3)          –          –     

Other (income) expense, net

     –           (1)          (208)          11           –          –     
  

 

 

   

 

 

 

Income (loss) from continuing operations before provision for income taxes and discontinued operations

     (440)          (556)          (657)          (1,436)          (227)         128     

Provision (benefit) for income taxes

     79           28           (188)          (291)          (82)         53     
  

 

 

   

 

 

 

Income (loss) from continuing operations

     (519)          (584)          (469)          (1,145)          (145)         75     

Income (loss) from discontinued operations, net of tax

     (24)          (35)          (45)          (110)          (18)         (19)    
  

 

 

   

 

 

 

Net income (loss)

     $(543)          $(619)          $(514)          $(1,255)          $(163)         $56     
  

 

 

   

 

 

 
 

Balance sheet data (end of period):

                

Working capital (unaudited)(1)

     $1,012           $1,176           $1,925           $2,071           $2,009       

Cash and cash equivalents

     111           292           539           771           108       

Total assets

     6,738           7,089           7,845           9,088           10,593       

Total debt(2)

     5,462           5,249           5,775           6,056           5,800       

Total stockholder’s equity (deficit)

     (428)          96           688           1,175           2,433       
 

Other financial data (unaudited):

                

Cash interest expense(3)

     $457           $365           $363           $397           $191          $220     

EBITDA(4)

     545           427           326           (396)          229          462     

Adjusted EBITDA(4)

     569           457           387           610           232          494     

Capital expenditures

     115           49           58           77           75          176     

Ratio of earnings to fixed charges (5)

                   1.4x     
 

Statement of cash flows data:

                

Cash flows provided by (used in) operating activities, net

     $(165)          $551           $69           $548           $364          $408     

Cash flows provided by (used in) investing activities, net

     (6)          (45)          (41)          37           (8,255)         (140)    

Cash flows provided by (used in) financing activities, net

     (10)          (755)          (263)          86           7,977          (269)    

 

(1) We define working capital as current assets (including cash) minus current liabilities, which include the current portion of long-term debt and accrued interest thereon.

 

(2) Total debt includes current and non-current installments of long-term debt and capital leases.

 

(3) Cash interest expense represents total interest expense in continuing operations less (i) amortization of deferred financing costs, (ii) amortization of the asset related to the estimated fair value of the THD Guarantee, (iii) paid-in-kind (“PIK”) interest expense on our 13.5% Senior Subordinated Notes and (iv) amortization of amounts in accumulated other comprehensive income related to derivatives. Effective September 1, 2011, the interest expense on our 13.5% Senior Subordinated Notes is no longer paid-in-kind, but rather paid in cash.

 

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ITEM 6. SELECTED FINANCIAL DATA, CONTINUED   HD SUPPLY, INC.

 

The following table provides a reconciliation of interest expense, the most directly comparable financial measure under U.S. GAAP, to cash interest expense for the periods presented (amounts in millions):

 

     Successor       Predecessor    
     Fiscal year ended      Period from       Period from    
            August 30,  
2007 to  
February 3,  
2008  
    January 29,  
2007 to  
August 29,  
2007  
 
     January 29,
2012
     January 30,
2011
     January 31,
2010
     February 1,
2009
      
  

 

 

   

 

 

 

Interest expense

     $ 639           $ 623           $ 602           $ 644           $ 289          $ 220     

Amortization of deferred financing costs

     (37)          (36)          (33)          (33)          (14)         –     

Amortization of THD Guarantee

     (13)          (14)          (21)          (21)          (9)         –     

PIK interest expense on our 13.5% Senior Subordinated Notes

     (132)          (206)          (182)          (192)          (75)         –     

Amortization of amounts in accumulated other comprehensive income related to derivatives

     –           (2)          (3)          (1)          –          –     
  

 

 

   

 

 

 

Cash interest expense

     $ 457           $ 365           $ 363           $ 397           $ 191          $ 220     
  

 

 

   

 

 

 

 

     Cash interest expense is not a recognized term under U.S. GAAP and does not purport to be an alternative to interest expense. Management believes that cash interest expense is useful for analyzing the cash flow needs and debt service requirements of the Company.

 

(4) EBITDA, a measure used by management to evaluate operating performance, is defined as Net income (loss) less Income (loss) from discontinued operations, net of tax, plus (i) Interest expense and Interest income, net, (ii) Provision (benefit) for income taxes, and (iii) Depreciation and amortization. EBITDA is not a recognized term under U.S. GAAP and does not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. Additionally, EBITDA is not intended to be a measure of free cash flow available for management’s discretionary use, as it does not consider certain cash requirements such as interest payments, tax payments and other debt service requirements. We believe EBITDA is helpful in highlighting trends because EBITDA excludes the results of decisions that are outside the control of operating management and that can differ significantly from company to company depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate, age and book depreciation of facilities and capital investments. In addition, EBITDA provides more comparability between the historical results of HD Supply during the Predecessor periods and results that reflect the new capital structure in the Successor periods. We further believe that EBITDA is frequently used by securities analysts, investors and other interested parties in their evaluation of companies, many of which present an EBITDA measure when reporting their results. We compensate for the limitations of using non-GAAP financial measures by using them to supplement U.S. GAAP results to provide a more complete understanding of the factors and trends affecting the business than U.S. GAAP results alone. Because not all companies use identical calculations, our presentation of EBITDA may not be comparable to other similarly titled measures of other companies.

 

     In addition, we present Adjusted EBITDA because it is a primary measure used by management to evaluate operating performance. Adjusted EBITDA is based on “Consolidated EBITDA,” a measure which is used in calculating financial ratios in several material debt covenants in our Senior Secured Credit Facility and our ABL Credit Facility. Borrowings under these facilities are a key source of liquidity and our ability to borrow under these facilities depends upon, among other things, our compliance with such financial ratio covenants. In particular, both facilities contain restrictive covenants that can restrict our activities if we do not maintain financial ratios calculated based on Consolidated EBITDA and our ABL Credit Facility requires us to maintain a fixed charge coverage ratio of 1:1 if we do not maintain $210 million of borrowing availability. Adjusted EBITDA is defined as EBITDA adjusted to exclude non-cash items and certain other adjustments to Consolidated Net Income permitted in calculating Consolidated EBITDA under our Senior Secured Credit Facility and our ABL Credit Facility. We believe that inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors about how the covenants in those agreements operate and about certain non-cash items, items that we do not expect to continue at the same level and other items. The Senior Secured Credit Facility and ABL Credit Facility permit us to make certain adjustments to Consolidated Net Income in calculating Consolidated EBITDA, such as projected net cost savings, which are not reflected in the Adjusted EBITDA data presented in this annual report on Form 10-K. We may in the future reflect such permitted adjustments in our calculations of Adjusted EBITDA. These covenants are important to the Company as failure to comply with certain covenants would result in a default under our Senior Credit Facilities. The material covenants in our Senior Credit Facilities are discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources— External Financing.”

 

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ITEM 6. SELECTED FINANCIAL DATA, CONTINUED   HD SUPPLY, INC.

 

EBITDA and Adjusted EBITDA have limitations as analytical tools and should not be considered in isolation or as substitutes for analyzing our results as reported under U.S. GAAP. Some of these limitations are:

 

   

EBITDA and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs;

 

   

EBITDA and Adjusted EBITDA do not reflect our interest expense, or the requirements necessary to service interest or principal payments on our debt;

 

   

EBITDA and Adjusted EBITDA do not reflect our income tax expenses or the cash requirements to pay our taxes;

 

   

EBITDA and Adjusted EBITDA do not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments; and

 

   

although depreciation and amortization charges are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements.

The following table presents a reconciliation of net income (loss), the most directly comparable financial measure under U.S. GAAP, to EBITDA and Adjusted EBITDA for the periods presented (amounts in millions):

 

     Successor       Predecessor    
     Fiscal year ended      Period from      Period from   
            August 30, 
2007 to 
February 3, 
2008 
    January 29, 
2007 to 
August 29, 
2007 
 
     January 29,
2012
     January 30,
2011
     January 31,
2010
     February 1,
2009
      
  

 

 

   

 

 

 

Net income (loss)

     $ (543)          $ (619)          $ (514)          $ (1,255)          $ (163)         $ 56     

Less income (loss) from discontinued operations, net of tax

     24           35           45           110           18          19     
  

 

 

   

 

 

 

Income (loss) from continuing operations

     (519)          (584)          (469)          (1,145)          (145)         75     
  

 

 

   

 

 

 

Interest expense, net

     639           623           602           641           289          220     

Provision (benefit) from income taxes

     79           28           (188)          (291)          (82)         53     

Depreciation and amortization

     346           360           381           399           167          114     
  

 

 

   

 

 

 

EBITDA

     $ 545           $ 427           $ 326           $ (396)          $ 229          $ 462     
  

 

 

   

 

 

 
 

Adjustments to EBITDA:

                

Other (income) expense, net (i)

     –           (1)          (208)          11           –          –     

Goodwill impairment (ii)

     –           –           224           943           –          –     

Restructuring charge (iii)

     –           8           21           32           –          –     

Stock-based compensation (iv)

     20           17           18           14           1          32     

Management fee & related expenses paid to Equity Sponsors (v)

     5           5           5           6           2          –     

Other

     (1)          1           1           –          
  

 

 

   

 

 

 

Adjusted EBITDA

     $ 569           $ 457           $ 387           $ 610           $ 232          $ 494     
  

 

 

   

 

 

 

 

  (i) Represents the gain/loss on extinguishment of debt, the gains/losses associated with the changes in fair value of interest rate swap contracts not accounted for under hedge accounting, and other non-operating income/expense.
  (ii) Represents the non-cash impairment charge of goodwill recognized during fiscal 2009 and fiscal 2008 in accordance with Accounting Standards Codification 350, Intangibles – Goodwill and Other.
  (iii) Represents the costs incurred for employee reductions and branch closures or consolidations. These costs include occupancy costs, severance, and other costs incurred to exit a location.
  (iv) The Predecessor period includes stock-based compensation costs for stock options, Employee Stock Purchase Plans and restricted stock. The Successor periods include stock-based compensation costs for stock options.
  (v) The Company entered into a management agreement whereby the Company pays the Equity Sponsors a $5 million annual aggregate management fee and related expenses through August 2017.

Amounts were derived from our consolidated and combined financial statements.

 

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ITEM 6. SELECTED FINANCIAL DATA, CONTINUED   HD SUPPLY, INC.

 

(5) For the purposes of calculating the ratio of earnings to fixed charges, earnings consist of Income from continuing operations before provision (benefit) for income taxes plus fixed charges. Fixed charges include cash and non-cash interest expense, whether expensed or capitalized, amortization of debt issuance cost, amortization of the THD Guarantee and the portion of rental expense representative of the interest factor. The ratio of earnings to fixed charges was calculated as follows (amounts in millions):

 

     Successor       Predecessor    
     Fiscal year ended      Period from       Period from  
            August 30,  
2007 to  
February 3,  
2008  
      January 29,
2007 to
August 29,
2007  
 
       January 29,
2012
     January 30,
2011
     January 31,
2010
     February 1,
2009
      
  

 

 

   

 

 

 

Income (loss) from continuing operations before provision (benefit) for income taxes

     $  (440)         $  (556)         $  (657)         $  (1,436)         $  (227)         $  128     

Add:

                

Interest expense

     639          623          602          644          289          261     

Portion of rental expense under operating leases deemed to be the equivalent of interest

     50          51          54          57          23          34     
  

 

 

   

 

 

 

Adjusted earnings

     $   249          $   118          $    (1)         $    (735)          $     85          $  423     
  

 

 

   

 

 

 

Fixed charges:

                

Interest expense

     $   639          $   623          $   602          $      644          $    289          $  261     

Portion of rental expense under operating leases deemed to be the equivalent of interest

     50          51          54          57          23          34     
  

 

 

   

 

 

 

Total fixed charges

     $   689          $   674          $   656          $      701          $    312          $  295     
  

 

 

   

 

 

 

Ratio of earnings to fixed charges(i)

                   1.4x     
  

 

 

   

 

 

 

 

  (i) For fiscal 2011, fiscal 2010, fiscal 2009, fiscal 2008, and the period from August 30, 2007 to February 3, 2008, our earnings were insufficient to cover fixed charges by $440 million, $556 million, $657 million, $1,436 million and $227 million, respectively.

 

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   HD SUPPLY, INC.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

HD Supply, Inc. is one of the largest industrial distribution companies in North America. With a diverse portfolio of industry-leading businesses and more than 80 years of experience, we provide a broad range of products and services to approximately 450,000 professional customers in the infrastructure and energy, maintenance, repair and improvement, and specialty construction markets. HD Supply has an expansive offering of approximately one million SKUs of quality, name-brand and propriety-brand products at competitive prices. Through 679 locations across 45 states and nine Canadian provinces, we provide localized, customer-driven services including jobsite delivery, will call or direct-ship options, diversified logistics and innovative solutions that contribute to our customers’ success.

Description of market sectors

Through eight industrial distribution businesses in the U.S. and a Canadian operation, we provide products and services to professional customers in the Infrastructure & Energy, Maintenance, Repair & Improvement and Specialty Construction market sectors, as presented below:

Infrastructure & Energy — To support established infrastructure and economic growth, our Infrastructure & Energy businesses serve customers in the Infrastructure & Energy market sector by striving to meet their demand for the critical supplies and services used to build and maintain water systems, oil refineries, and petrochemical plants, and for the generation, transmission, distribution and application of electrical power. This market sector is made up of the following businesses:

 

   

Waterworks — Distributes complete lines of water and wastewater transmission products, serving contractors and municipalities in all aspects of the water and wastewater industries.

 

   

Utilities/Electrical — Distributes electrical transmission and distribution products, power plant maintenance, repair and operations (“MRO”) supplies, smart-grid technologies, and provides materials management and procurement outsourcing arrangements to investor-owned utilities, municipal and provincial power authorities, rural electric cooperatives and utility contractors and distributes electrical products such as wire and cable, switch gear supplies, lighting and conduit to residential and commercial contractors.

 

   

Industrial Pipe, Valves and Fittings (“IPVF”) — Distributes stainless steel and special alloy pipes, plates, sheets, flanges and fittings, as well as high performance valves, actuation services and high-density polyethylene pipes and fittings for oil and gas, petrochemical, power, food and beverage, pulp and paper, mining, and marine industries; IPVF also serves pharmaceutical customers, industrial and mechanical contractors, fabricators, wholesale distributors, exporters and original equipment manufacturers.

Maintenance, Repair & Improvement — Our Maintenance, Repair & Improvement businesses serve customers in the Maintenance, Repair & Improvement market sector by striving to meet their continual demand for supplies needed to fix and upgrade facilities across multiple industries. This market sector is made up of the following businesses:

 

   

Facilities Maintenance — Supplies MRO products and upgrade and renovation services largely to the multifamily, healthcare, hospitality, institutional, and industrial markets.

 

   

Crown Bolt — A retail distribution operator, providing program and packaging solutions, sourcing, distribution, and in-store service, primarily serving The Home Depot, Inc.

 

   

Repair & Remodel — Offers light remodeling and construction supplies primarily to small remodeling contractors and trade professionals.

 

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Specialty Construction — Our Specialty Construction businesses serve customers in the Specialty Construction market sector by striving to meet their very distinct, customized supply needs in commercial, residential and industrial applications. This market sector is made up of the following businesses:

 

   

White Cap — Distributes specialized hardware, tools and building materials to professional contractors.

 

   

Creative Touch Interiors (“CTI”) — Offers turnkey supply and installation services for multiple interior finish options, including flooring, cabinets, countertops, and window coverings, along with comprehensive design center services for residential, commercial, and senior living projects.

For a description of the relationship among our market sectors, our businesses and our financial reporting segments, see “Item 1. Business — Our sectors” within Part I of this annual report on Form 10-K.

Acquisitions

We enter into strategic acquisitions to expand into new markets, new platforms, and new geographies in an effort to better service existing customers and attract new ones. In accordance with the acquisition method of accounting under Accounting Standards Codification (“ASC”) 805, Business Combinations, the results of the acquisitions we completed are reflected in our consolidated financial statements from the date of acquisition forward.

On May 2, 2011, we closed on a transaction to acquire substantially all of the assets of Rexford Albany Municipal Supply Company, Inc. (“RAMSCO”) for approximately $21 million. RAMSCO specializes in distributing water, sanitary and storm sewer materials primarily to municipalities and contractors through four locations in upstate New York. These locations are operated as part of the HD Supply Waterworks business.

On June 1, 2009, we acquired substantially all of the assets of ORCO Construction Supply, a former competitor of the White Cap business, out of bankruptcy, for approximately $16 million. These assets are utilized as part of the HD Supply White Cap business.

Discontinued operations

On September 9, 2011, we sold all of the issued and outstanding equity interests in our Plumbing/HVAC business to Hajoca Corporation. We received cash proceeds of approximately $116 million, net of $8 million remaining in escrow and $4 million of transaction costs. As a result of the sale, we recorded a $7 million pre-tax gain in fiscal 2011.

On February 28, 2011, we sold substantially all of the assets of SESCO/QUESCO, an electrical products division of HD Supply Canada, to Sonepar Canada, and received proceeds of approximately $11 million, less $1 million remaining in escrow. As a result of the sale, we recorded a $2 million pre-tax gain in fiscal 2011.

In accordance with ASC 205-20, Discontinued Operations, the results of the Plumbing/HVAC and SESCO/QUESCO operations as well as the gain on sale of businesses are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the discontinued operations and the gain on the sale of businesses, net of tax, as one line item on the Consolidated Statements of Operations. All prior period Consolidated Statements of Operations presented have been restated to reflect this presentation. For additional detail related to the results of operations of the discontinued operations, see “Note 3, Discontinued Operations,” in the Notes to the Consolidated Financial Statements within Item 8 of Part II of this annual report on Form 10-K.

Subsequent Event

On March 8, 2012, the Company entered into a definitive agreement to sell all of the issued and outstanding equity interests in its Industrial Pipes, Valves and Fittings business to Shale-Inland Holdings LLC for approximately $469 million. The transaction is expected to close in March 2012 upon the satisfaction of customary closing conditions, including certain financing conditions and obtaining requisite government approvals.

 

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Key business metrics

Revenues

We earn our revenues primarily from the sale of approximately one million construction, infrastructure, maintenance and renovation and improvement related products and our provision of related services to approximately 450,000 professional customers, including contractors, government entities, maintenance professionals, home builders and industrial businesses. We recognize our revenue, net of sales tax and allowances for returns and discounts, when persuasive evidence of an agreement exists, delivery has occurred or services have been rendered, price to the buyer is fixed and determinable and collectability is reasonably assured. Net sales in certain of our market sectors, particularly Infrastructure & Energy, fluctuate with the costs of required commodities.

We ship products to customers predominantly by internal fleet and to a lesser extent by third party carriers. Revenues are recognized from product sales when title to the products is passed to the customer, which generally occurs at the point of destination for products shipped by internal fleet and at the point of shipping for products shipped by third party carriers.

We include shipping and handling fees billed to customers in Net sales. Shipping and handling costs associated with inbound freight are capitalized to inventories and relieved through Cost of sales as inventories are sold. Shipping and handling costs associated with outbound freight are included in Selling, general and administrative expenses and totaled $101 million, $96 million, and $89 million in fiscal 2011, fiscal 2010, and fiscal 2009, respectively.

Gross profit

Gross profit primarily represents the difference between the product cost from our suppliers (net of earned rebates and discounts) including the cost of inbound freight and the sale price to our customers. The cost of outbound freight (including internal transfers), purchasing, receiving and warehousing are included in Selling, general and administrative expenses within operating expenses. Our gross profits may not be comparable to those of other companies, as other companies may include all of the costs related to their distribution network in cost of sales.

Operating expenses

Operating expenses are primarily comprised of selling, general and administrative costs, which include payroll expenses (salaries, wages, employee benefits, payroll taxes and bonuses), rent, insurance, utilities, repair and maintenance and professional fees.

In addition, operating expenses include depreciation and amortization, restructuring charges, and goodwill impairments.

Relationship with Home Depot

Historical relationship

On August 30, 2007, investment funds associated with Bain Capital Partners, LLC, The Carlyle Group and Clayton, Dubilier & Rice, Inc. formed HDS Investment Holding, Inc. (“Holding”) and entered into a stock purchase agreement with The Home Depot, Inc. (“Home Depot” or “THD”) pursuant to which Home Depot agreed to sell to Holding or to a wholly owned subsidiary of Holding certain intellectual property and all the outstanding common stock of HD Supply, Inc. and the Canadian subsidiary CND Holdings, Inc. On August 30, 2007, through a series of transactions, Holding’s direct wholly-owned subsidiary, HDS Holding Corporation, acquired direct control of HD Supply through the merger of its wholly owned subsidiary, HDS Acquisition Corp., with and into HD Supply (the “Company”). Through these transactions (the “Transactions”), Home Depot was paid cash of $8.2 billion and 12.5% of HDS Holding’s common stock worth $325 million for certain intellectual property and all of the outstanding common stock of HD Supply and CND Holdings, including all dividends and interest payable associated with those shares. During the first quarter of fiscal 2009, the Company received $22 million from Home Depot for the working capital adjustment and settlement of other items finalizing the purchase price of the Transactions.

 

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On-going relationship

We derive revenue from the sale of products to Home Depot. Revenue from these sales is recorded at an amount that approximates market. In addition to sales, we purchase products from Home Depot. All purchases are at amounts that management believes an unrelated third party would pay.

Strategic agreement

On the date of the Transactions, Home Depot entered into a strategic purchase agreement with Crown Bolt. This agreement provides a guaranteed revenue stream to Crown Bolt through January 31, 2015 by specifying minimum annual purchase requirements from Home Depot.

Seasonality

In a typical year, our operating results are impacted by seasonality. Historically, sales of our products have been higher in the second and third quarters of each fiscal year due to favorable weather and longer daylight conditions during these periods. Seasonal variations in operating results may also be significantly impacted by inclement weather conditions, such as cold or wet weather, which can delay construction projects.

Fiscal year

HD Supply’s fiscal year is a 52- or 53-week period ending on the Sunday nearest to January 31. Fiscal years ended January 29, 2012 (“fiscal 2011”), January 30, 2011 (“fiscal 2010”), and January 31, 2010 (“fiscal 2009”) all include 52 weeks.

Consolidated results of operations

 

                          Percentage
Increase  (Decrease)
 
     Fiscal Year      2011
vs. 2010   
     2010
vs.  2009
 
Dollars in millions    2011        2010        2009          

Net sales

   $ 7,724         $ 7,015         $ 6,947           10.1           1.0     

Gross profit

     2,179           1,969           1,898           10.7           3.7     

Operating expenses:

              

Selling, general & administrative

     1,636           1,537           1,540           6.4           (0.2)    

Depreciation & amortization

     344           358           376           (3.9)          (4.8)    

Restructuring

     –           8           21           *             (61.9)    

Goodwill impairment(a)

     –           –           224           *             *       
  

 

 

    

 

 

    

 

 

       

Total operating expenses

     1,980           1,903           2,161           4.0           (11.9)    

Operating income (loss)

     199           66           (263)          *             *       

Interest expense

     639           623           602           2.6           3.5    

Other (income) expense, net

     –           (1)          (208)          *             *       
  

 

 

    

 

 

    

 

 

       

Income (loss) from continuing operations before provision (benefit) for income taxes

     (440)          (556)          (657)          20.9           15.4     

Provision (benefit) for income taxes

     79           28           (188)          *             *       
  

 

 

    

 

 

    

 

 

       

Income (loss) from continuing operations

   $ (519)        $ (584)        $ (469)          11.1           (24.5)    
  

 

 

    

 

 

    

 

 

       

Other Financial Data:

              

EBITDA(b)

   $ 545         $ 427         $ 326           27.6           31.0     

Adjusted EBITDA(c)

   $ 569         $ 457         $ 387           24.5           18.1   

 

* not meaningful; (a) See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 5, Goodwill and Intangible Assets;” (b) EBITDA is defined as Net income (loss) less Income (loss) from discontinued operations, net of tax, plus (i) Interest expense and Interest income, net, (ii) Provision (benefit) for income taxes, and (iii) Depreciation and amortization; and (c) Adjusted EBITDA is EBITDA plus (i) other (income) expense, net, (ii) goodwill impairment, (iii) restructuring charges, (iv) stock-based compensation and (v) management fees and related expenses, see “Item 6. Selected Financial Data.” For a reconciliation of EBITDA and Adjusted EBITDA to Income (loss) from continuing operations and Net income (loss), see “Item 6. Selected Financial Data.”

 

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            Basis Point
Increase (Decrease)
 
     % of Net sales     
     Fiscal Year      2011
vs. 2010     
     2010
vs. 2009     
 
     2011          2010          2009            

Net sales

     100.0%          100.0%          100.0%          –             –       

Gross profit

     28.2             28.1             27.3             10             80       

Operating expenses:

              

Selling, general & administrative

     21.2             21.9             22.2             (70)            (30)      

Depreciation & amortization

     4.4             5.1             5.4             (70)            (30)      

Restructuring

     –             0.1             0.3             (10)            (20)      

Goodwill impairment(a)

     –             –             3.2             –             (320)      
  

 

 

    

 

 

    

 

 

       

Total operating expenses

     25.6             27.1             31.1             (150)            (400)      

Operating income (loss)

     2.6             1.0             (3.8)            160            480       

Interest expense

     8.3             8.9             8.7             (60)            20       

Other (income) expense, net

     –             –             (3.0)            –             (300)      
  

 

 

    

 

 

    

 

 

       

Income (loss) from continuing operations before provision (benefit) for income taxes

     (5.7)            (7.9)            (9.5)            220             160       

Provision (benefit) for income taxes

     1.0             0.4             (2.7)            60             310       
  

 

 

    

 

 

    

 

 

       

Income (loss) from continuing operations

     (6.7)            (8.3)            (6.8)            160             (150)      
  

 

 

    

 

 

    

 

 

       

Other Financial Data:

              

EBITDA(b)

     7.1             6.1             4.7             100             140       

Adjusted EBITDA(c)

     7.4             6.5             5.6             90             90       

 

* not meaningful; (a) See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 5, Goodwill and Intangible Assets;” (b) EBITDA is defined as Net income (loss) less Income (loss) from discontinued operations, net of tax, plus (i) Interest expense and Interest income, net, (ii) Provision (benefit) for income taxes, and (iii) Depreciation and amortization; and (c) Adjusted EBITDA is EBITDA plus (i) other (income) expense, net, (ii) goodwill impairment, (iii) restructuring charges, (iv) stock-based compensation and (v) management fees and related expenses, see “Item 6. Selected Financial Data.” For a reconciliation of EBITDA and Adjusted EBITDA to Income (loss) from continuing operations and Net income (loss), see “Item 6. Selected Financial Data.”

Fiscal 2011 compared to fiscal 2010

Highlights

Net sales in fiscal 2011 increased $709 million, or 10.1%, compared to fiscal 2010. All of our market sectors realized increases in Net sales, led by the Infrastructure & Energy market sector. Despite continued weakness in the economy, during fiscal 2011, our sales initiatives, continued focus on margin expansion and cost control resulted in an increase in our Operating income of $133 million and our Adjusted EBITDA of $112 million, or 24.5%, as compared to fiscal 2010. In addition, we continue to maintain strong liquidity, with $1.2 billion available as of January 29, 2012.

Our increases in Net Sales and Adjusted EBITDA were achieved despite the continued weak economy and construction markets. Single-family housing starts declined approximately 8% in 2011, but are projected to increase by a 20% to 30% compound annual rate from 2011 to 2014. Non-residential construction declined 2% in 2011 versus 2010. A compound annual growth rate of between 6% and 13% is forecasted from 2011 to 2014.

Net sales

Net sales increased $709 million, or 10.1%, to $7,724 million during fiscal 2011 as compared to fiscal 2010.

Each of our market sectors experienced an increase in Net sales during fiscal 2011 as compared to fiscal 2010. Net sales were positively impacted by improvements in the energy market, sales initiatives, and commodity prices. Our Infrastructure & Energy market sector experienced the largest growth, with an increase of $406 million, or 11.0%, in fiscal 2011 as compared to fiscal 2010.

 

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Gross profit

Gross profit increased $210 million, or 10.7%, to $2,179 million during fiscal 2011 as compared to fiscal 2010.

An increase in gross profit in fiscal 2011 was experienced across all of our market sectors. The improvements in gross profit were primarily driven by increased sales volumes. Gross profit as a percentage of Net sales (“gross margin”) increased approximately 10 basis points to 28.2% in fiscal 2011 from 28.1% in fiscal 2010, primarily as a result of product mix.

Operating expenses

Operating expenses increased $77 million, or 4.0%, to $1,980 million during fiscal 2011 as compared to fiscal 2010.

Selling, general and administrative expenses increased at all of our market sectors during fiscal 2011 as compared to fiscal 2010, primarily as a result of increases in variable expenses due to sales volume increases and, to a lesser extent, an increase in employee benefits related to the restoration of the Company’s match on the 401(k) defined contribution plan. Selling, general and administrative expenses as a percentage of Net sales declined approximately 70 basis points to 21.2% in fiscal 2011 as compared to fiscal 2010, through the leverage of fixed costs through sales volume increases and efforts to control variable expenses.

Depreciation and amortization expense declined primarily due to lower capital expenditures in recent years. During fiscal 2010, we recorded $8 million of restructuring charges under the fiscal 2009 restructuring plan.

Operating income (loss)

Operating income of $199 million increased $133 million during fiscal 2011 as compared to fiscal 2010, as a result of the improvement in Net sales and Gross profit and control over growth in Operating expenses. Operating income as a percentage of Net sales increased approximately 160 basis points in fiscal 2011 as compared to fiscal 2010. The improvement was driven by our Specialty Construction and Maintenance, Repair & Improvement market sectors, and, to a lesser extent, our and Infrastructure & Energy market sector.

Interest expense

Interest expense associated with interest-bearing debt was higher in fiscal 2011 as compared to fiscal 2010. The increase is due to an increase in the principal of the 13.5% Senior Subordinated Notes due to the paid-in-kind interest capitalization, partially offset by a decline in average debt balances on the ABL Credit Facility and Cash Flow Revolver as compared to fiscal 2010. Interest expense in fiscal 2011 was also positively impacted by a reduction in interest rates on our variable rate debt as compared to fiscal 2010.

Other (income) expense, net

During fiscal 2010, we recognized a $6 million gain related to the valuation of our interest rate swaps.

In connection with the amendment of our debt agreements in first quarter 2010, we incurred financing fees of approximately $34 million, of which approximately $3 million were charged to Other (income) expense, net in the Consolidated Statement of Operations for fiscal 2010 in accordance with U.S. GAAP (Accounting Standards Codification (“ASC”) 470- 50, Debt-Modifications and Extinguishments). The remaining $31 million was deferred and is being amortized to interest expense over the term of the amended agreements. In addition, in connection with the $30 million prepayment of non-extending Term Loans under the Senior Secured Credit Facility in first quarter 2010, we wrote-off the unamortized pro-rata portion of the THD Guarantee and the unamortized pro-rata portion of the deferred debt costs, resulting in a charge of $2 million, reflected in Other (income) expense, net in the Consolidated Statements of Operations for fiscal 2010.

Provision (benefit) for income taxes

The provision (benefit) for income taxes from continuing operations increased to a $79 million provision in fiscal 2011 from a $28 million provision in fiscal 2010. The effective rate for continuing operations for fiscal 2011 was an expense of 18.0%, mainly driven by the impact of a $243 million increase in the U.S. valuation allowance on deferred tax assets. The U.S. valuation allowance for fiscal 2011 includes an increase of $58 million related to deferred tax liabilities generated by indefinite lived intangibles. The deferred tax liability associated with indefinite life intangibles is not available as a source of taxable income to support the realization of deferred tax

 

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assets created by other deductible temporary timing differences. The effective rate for continuing operations for fiscal 2010 was an expense of 5.1% driven by the impact of a $217 million increase in the valuation allowance on deferred tax assets.

We regularly assess the realization of our net deferred tax assets and the need for any valuation allowance. This assessment requires management to make judgments as to the recoverability of the deferred tax assets and if it is determined that it is “more likely than not” that the benefits will not be realized, valuation allowances are recognized. In evaluating whether it is “more likely than not” that the Company would recover these deferred tax assets, future taxable income, the reversal of existing temporary differences, and tax planning strategies are considered.

EBITDA and Adjusted EBITDA

EBITDA increased $118 million, or 27.6%, in fiscal 2011 as compared to fiscal 2010 and Adjusted EBITDA increased $112 million, or 24.5%, in fiscal 2011 as compared to fiscal 2010. The increase in EBITDA and Adjusted EBITDA is primarily due to the increases in Net sales and Gross profit. Adjusted EBITDA as a percentage of Net sales increased approximately 90 basis points to 7.4% in fiscal 2011, primarily due to the leverage of fixed costs through sales volume increases and efforts to control variable expenses.

Fiscal 2010 compared to fiscal 2009

Highlights

Net sales in fiscal 2010 increased $68 million, or 1.0%, compared to fiscal 2009, led by increased volume in the Maintenance, Repair & Improvement market sector. For the first time since 2006, the residential construction market, measured by single family housing starts, experienced positive growth in 2010, of 7%.

Our Operating income in fiscal 2010 improved by $329 million, primarily as a result of the non-cash goodwill impairment charge of $224 million recorded in fiscal 2009. As a result of our continued cost reduction and margin expansion efforts, our Operating income in fiscal 2010 increased by $105 million as compared to fiscal 2009 excluding the goodwill impairment charge. During fiscal 2010, our Adjusted EBITDA increased $70 million, or 18.1%, as compared to fiscal 2009.

During fiscal 2010, the Company recorded charges of $8 million for branch closures and consolidations under previously announced plans. During fiscal 2009, the Company recorded charges of $21 million for branch closures, primarily at our Specialty Construction and Infrastructure & Energy market sectors under a plan initiated in the third quarter of fiscal 2009. Fiscal 2009 was also negatively impacted by inventory valuation charges of $20 million recorded in the fourth quarter as a result of continued weakness in the construction and oil and gas markets. The inventory valuation charges are included in Cost of sales in the Company’s consolidated statement of operations. We continued to benefit from our ongoing corporate cost reduction efforts and branch closure and consolidation activities.

Net sales

Net sales increased $68 million, or 1.0%, to $7,015 million during fiscal 2010 as compared to fiscal 2009.

The increase in Net sales in fiscal 2010 was driven by our Maintenance, Repair & Improvement market sector, offset by a decrease at our Specialty Construction market sector and a slight decrease at our Infrastructure & Energy market sector. Net sales were positively impacted by market volumes, efforts to gain market share, sales initiatives, commodity prices, and approximately $34 million of positive impact from the Canadian exchange rate in fiscal 2010 as compared to fiscal 2009. Partially offsetting these increases was the negative impact of the continuing weakness in the residential construction market and the continued weakening in the commercial construction market.

Gross profit

Gross profit increased $71 million, or 3.7%, to $1,969 million during fiscal 2010 as compared to fiscal 2009.

 

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The increase in gross profit during fiscal 2010 was driven by our Maintenance, Repair & Improvement and Specialty Construction market sectors. Gross profit for our Infrastructure & Energy market sector was flat during fiscal 2010 as compared to fiscal 2009.

Gross profit as a percentage of Net sales (“gross margin”) increased approximately 80 basis points to 28.1% in fiscal 2010 from 27.3% in fiscal 2009. The increases were driven by improved product sourcing, product mix, and a shift in our business mix toward our higher margin Maintenance, Repair & Improvement sector. In addition, the gross margin in fiscal 2009 was negatively impacted by $20 million of inventory valuation charges.

Operating expenses

Operating expenses decreased $258 million, or 11.9%, to $1,903 million during fiscal 2010 as compared to fiscal 2009. Operating expenses in fiscal 2009 included a goodwill impairment charge of $224 million. Excluding the goodwill impairment charge in fiscal 2009, Operating expenses decreased $34 million, or 1.8%, in fiscal 2010 as compared to fiscal 2009.

Selling, general and administrative expenses decreased at our Specialty Construction and Infrastructure & Energy sectors during fiscal 2010 as compared to fiscal 2009, primarily due to personnel reductions, reduced operating costs due to branch closures, and other cost reduction initiatives begun during fiscal 2009. Substantially offsetting these decreases were increases in Selling, general and administrative expenses at our Maintenance, Repair & Improvement sector primarily related to software implementation, freight costs and personnel expenses supporting new sales growth initiatives and volume increases.

Depreciation and amortization expense decreased during fiscal 2010 as compared to fiscal 2009 due to the timing of asset acquisitions and amortization of intangible assets. This decrease was partially offset by an increase in software amortization expense. In addition, Operating expenses included restructuring charges of $8 million and $21 million during fiscal 2010 and fiscal 2009, respectively.

Operating expenses as a percentage of Net sales decreased significantly in fiscal 2010 as compared to fiscal 2009, primarily due to the goodwill impairment charge in fiscal 2009. Excluding the goodwill impairment charge, Operating expenses as a percentage of Net sales decreased approximately 80 basis points in fiscal 2010 as compared to fiscal 2009. This decrease was driven by personnel reductions, reduced operating costs due to branch closures, and other cost reduction efforts at our Specialty Construction and Infrastructure & Energy sectors, partially offset by volume declines at our Infrastructure & Energy sector, which adversely affected the absorption of overhead costs, and an increase in expenses at our Maintenance, Repair & Improvement sector.

Operating income (loss)

Operating income of $66 million improved $329 million during fiscal 2010 as compared to an Operating loss of $263 million in fiscal 2009, primarily due to the goodwill impairment charge in fiscal 2009. Excluding the goodwill impairment charge in fiscal 2009, Operating income improved $105 million during fiscal 2010 as compared to fiscal 2009, primarily at our Specialty Construction sector, though all of our sectors experienced improvements in Operating income, excluding goodwill impairments. Operating income as a percentage of Net sales increased significantly in fiscal 2010 as compared fiscal 2009, primarily due to the goodwill impairment charge in fiscal 2009. Excluding the goodwill impairment charge, Operating income as a percentage of Net sales increased approximately 150 basis points in fiscal 2010 as compared to fiscal 2009. The improvement in fiscal 2010 was driven by our Specialty Construction sector and, to a lesser extent, our Infrastructure & Energy and Maintenance, Repair & Improvement sectors.

Interest expense

Interest expense associated with interest-bearing debt was higher in fiscal 2010 as compared to fiscal 2009. The increase in interest expense is primarily due to an increase in the principal of the 13.5% Senior Subordinated Notes due to the paid-in-kind interest capitalization and an increase in interest rates as a result of our credit amendments, partially offset by a decline in average debt balances. The lower average debt balances in fiscal 2010 were due to repayments on the ABL Credit Facility, Term Loan, and Revolving Credit Facility, partially offset by the interest capitalization on the 13.5% Senior Subordinated Notes.

 

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Other (income) expense, net

During fiscal 2010, we recognized a $6 million gain related to the valuation of our interest rate swaps.

In connection with the amendment of our debt agreements in first quarter 2010, we incurred financing fees of approximately $34 million, of which approximately $3 million were charged to Other (income) expense, net in the Consolidated Statement of Operations for fiscal 2010 in accordance with U.S. GAAP (Accounting Standards Codification (“ASC”) 470- 50, Debt-Modifications and Extinguishments). The remaining $31 million was deferred and is being amortized to interest expense over the term of the amended agreements. In addition, in connection with the first quarter 2010 $30 million prepayment of non-extending Term Loans under the Senior Secured Credit Facility, we wrote-off the unamortized pro-rata portion of the THD Guarantee and the unamortized pro-rata portion of the deferred debt costs, resulting in a charge of $2 million, reflected in Other (income) expense, net in the Consolidated Statements of Operations for fiscal 2010.

During first quarter 2009, we repurchased $252 million principal amount, plus accrued interest of $15 million, of the 13.5% Senior Subordinated Notes due 2015 for $62 million. As a result, we recognized a $200 million pre-tax gain for the extinguishment of this portion of the 13.5% Senior Subordinated Notes, net of the write-off of unamortized deferred debt issuance costs. In addition, we recognized an $11 million gain in fiscal 2009 related to the valuation of our interest rate swaps.

Provision (benefit) for income taxes

The provision (benefit) for income taxes from continuing operations decreased to a $28 million provision in fiscal 2010 from a $188 million benefit in fiscal 2009. The effective rate for continuing operations for fiscal 2010 was an expense of 5.1%, driven by the impact of a $217 million increase in the valuation allowance on deferred tax assets. The effective rate for continuing operations for fiscal 2009 was a benefit of 28.7%, driven by the impact of the goodwill impairment.

EBITDA and Adjusted EBITDA

EBITDA increased $101 million, or 31.0%, in fiscal 2010 as compared to fiscal 2009 and Adjusted EBITDA increased $70 million, or 18.1%, in fiscal 2010 as compared to fiscal 2009. The increase in EBITDA and Adjusted EBITDA is primarily due to the increases in Net sales and Gross profit. Fiscal 2009 EBITDA was negatively affected by the $224 million goodwill impairment, offset by the $200 million gain on debt extinguishment, net of the write-off of unamortized deferred debt issuance costs. Adjusted EBITDA as a percentage of Net sales increased approximately 90 basis points to 6.5% in fiscal 2010, primarily due to the leverage of fixed costs through sales volume increases and efforts to control variable expenses.

Results of operations by market sector

Infrastructure & Energy

 

     Fiscal Year      Increase (Decrease)  
        2011
vs.  2010
     2010
vs.  2009
 
Dollars in millions    2011      2010      2009        

Net sales

     $4,094         $3,688         $3,695         11.0%         (0.2)%   

Operating income (loss)

     $84         $48         $(161)         75.0%         *   

% of Net sales

     2.1%         1.3%         (4.4)%         80 bps         570 bps   

Depreciation and amortization

     142         140         142         1.4%         (1.4)%   

Restructuring

             1         7         *         *   

Goodwill impairment

                     194                 *   
  

 

 

    

 

 

    

 

 

       

Adjusted EBITDA(1)

     $226         $189         $182         19.6%         3.8%   

% of Net sales

     5.5%         5.1%         4.9%         40 bps         20 bps   

 

* not meaningful; (1)Adjusted EBITDA is Operating income (loss) plus (i) Depreciation and amortization expense, (ii) Restructuring charges, and (iii) Goodwill impairment charges.

 

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Fiscal 2011 compared to fiscal 2010

Net sales

Net sales increased $406 million, or 11.0%, to $4,094 million during fiscal 2011 as compared to fiscal 2010.

The increase in Net sales in fiscal 2011 was driven by increases of $163 million, or 11.2%, at Utilities/Electrical, $130 million, or 22.8%, at IPVF, and $113 million, or 6.8%, at Waterworks.

Net sales growth at Utilities/Electrical and Waterworks was primarily due to sales initiatives, increased transmission and substation projects, and positive impacts from fluctuating commodity prices, primarily copper and steel at Utilities/Electrical and primarily PVC at Waterworks. The acquisition of RAMSCO also contributed to the Net sales increase at Waterworks. The increase in Net sales at IPVF in fiscal 2011 was driven by a recovering market and an increase in large project work in the oil and gas industry during fiscal 2011 as compared to fiscal 2010.

Adjusted EBITDA

Adjusted EBITDA increased $37 million, or 19.6%, during fiscal 2011 as compared to fiscal 2010, driven by an increase of $18 million at Waterworks and $18 million at IPVF. Adjusted EBITDA increased $1 million at Utilities/Electrical.

The Adjusted EBITDA increase at Waterworks was driven by volume increases and positive impacts from fluctuating commodity prices. The Adjusted EBITDA increase at IPVF was driven by volume increases and gross margin improvements. The positive impacts at both Waterworks and IPVF were partially offset by higher Selling, general and administrative costs, primarily due to variable compensation as a result of higher volumes.

Adjusted EBITDA as a percentage of Net sales increased approximately 40 basis points in fiscal 2011 as compared to fiscal 2010. The increase was driven primarily by gross margin improvements at IPVF and the leverage of fixed costs through sales volume increases and efforts to control variable expenses at Waterworks and Utilities/Electrical, partially offset by slight gross margin compression at Utilities/Electrical.

Fiscal 2010 compared to fiscal 2009

Net sales

Net sales decreased $7 million, or 0.2%, to $3,688 million during fiscal 2010 as compared to fiscal 2009.

The decrease in Net sales in fiscal 2010 was driven by a decline of $68 million, or 10.7%, at IPVF. Substantially offsetting these declines were increases in Net sales of $53 million and $7 million at Utilities/Electrical and Waterworks, respectively, representing increases of 3.7% and 0.4%, respectively.

The decline at IPVF in fiscal 2010 was driven by a reduction in large project work in the oil and gas industry during fiscal 2010 as compared to fiscal 2009 and by pricing pressure due to decline in overall market demand. The Net sales growth at Utilities/Electrical was driven by volume increases due to a gradual improvement in the residential market, partially offset by lower capital and maintenance spend by utilities in most customer end-markets primarily due to continued weakness in the overall economy and continued focus on working capital management. In addition, Net sales increased at Utilities/Electrical and Waterworks through sales initiatives and positive impacts from fluctuating commodity prices, primarily copper and steel at Utilities/Electrical and primarily PVC at Waterworks.

Adjusted EBITDA

Adjusted EBITDA increased $7 million, or 3.8%, during fiscal 2010 as compared to fiscal 2009, driven by an increase of $9 million at Utilities/Electrical and, to a lesser extent, an increase of $2 million at IPVF. These increases were partially offset by a decrease in Adjusted EBITDA at Waterworks of $5 million.

The Adjusted EBITDA increase at Utilities/Electrical was driven by volume increases in the residential market, partially offset by volume declines in the utilities sector. The Adjusted EBITDA increase at IPVF was driven by margin improvements as a result of inventory valuation charges taken in the fourth quarter of fiscal 2009. IPVF and Waterworks experienced decreases in Selling, general and administrative costs primarily due to volume

 

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declines and personnel reductions. Offsetting these positive impacts to Adjusted EBITDA, Waterworks experienced margin compression in fiscal 2010 as a result of competitive pricing pressures and product mix.

Adjusted EBITDA as a percentage of net sales increased approximately 20 basis points in fiscal 2010 as compared to fiscal 2009. The increase in fiscal 2010 was driven by margin improvements at IPVF and the leverage of fixed costs through sales volume increases at Utilities/Electrical.

Maintenance, Repair & Improvement

 

     Fiscal Year      Increase (Decrease)  
        2011
vs. 2010
     2010
vs. 2009
 
Dollars in millions    2011      2010      2009        

Net sales

     $2,292         $2,117         $2,023         8.3%         4.6%   

Operating income (loss)

     $254         $205         $156         23.9%         31.4%   

% of Net sales

     11.1%         9.7%         7.7%         140 bps         200 bps   

Depreciation and amortization

     143         146         149         (2.1)%         (2.0)%   

Restructuring

                     1                 *   

Goodwill impairment

                     30                 *   
  

 

 

    

 

 

    

 

 

       

Adjusted EBITDA(1)

     $397         $351         $336         13.1%         4.5%   

% of Net sales

     17.3%         16.6%         16.6%         70 bps           

 

* not meaningful; (1) Adjusted EBITDA is Operating income (loss) plus (i) Depreciation and amortization expense, (ii) Restructuring charges, and (iii) Goodwill impairment charges.

Fiscal 2011 compared to fiscal 2010

Net sales

Net sales increased $175 million, or 8.3%, to $2,292 million during fiscal 2011 as compared to fiscal 2010.

The increase in Net sales in fiscal 2011 was driven by Facilities Maintenance, which had an increase of $188 million, or 11.2%, and, to a lesser extent, Repair & Remodel, which had an increase of $10 million, or 7.1%. Partially offsetting this sales growth was a decline in Net sales at Crown Bolt.

The Net sales growth at Facilities Maintenance was driven by new initiatives primarily in the hospitality, multi-family, and healthcare markets. In addition, Net sales were positively impacted by favorable market conditions in the multi-family and hospitality industries. The Net sales growth at Repair & Remodel was driven by volume, primarily as a result of sales initiatives and the opening of a new location in the Los Angeles market during the second quarter of fiscal 2010. The decrease in Crown Bolt’s Net sales was primarily due to the discontinuation of the audio-visual product line at the end of fiscal 2010. During fiscal 2011 and fiscal 2010, Crown Bolt recorded $20 million and $12 million, respectively, in Net sales in accordance with the minimum purchase requirement provisions of the strategic purchase agreement with Home Depot.

Adjusted EBITDA

Adjusted EBITDA increased $46 million, or 13.1%, during fiscal 2011 as compared to fiscal 2010.

The increase in Adjusted EBITDA was driven by Facilities Maintenance and, to a lesser extent, Crown Bolt and Repair & Remodel. The increase at Facilities Maintenance in fiscal 2011 was due to volume increases and new sales initiatives, partially offset by increased Selling, general and administrative expense related to the volume increases and new initiatives. Also, contributing to the increased Selling, general and administrative expenses were increased average fuel prices and the reinstatement of the Company’s 401(k) match.

Adjusted EBITDA as a percentage of Net sales increased approximately 70 basis points to 17.3% in fiscal 2011 as compared to fiscal 2010, primarily due to the leverage of fixed costs through sales volume increases and efforts to control variable expense at Facilities Maintenance and Repair & Remodel, and gross margin improvements due to product mix at Crown Bolt. These increases were partially offset by investment in sales force additions at Facilities Maintenance and a shift in mix within the sector.

 

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Fiscal 2010 compared to fiscal 2009

Net sales

Net sales increased $94 million, or 4.6%, to $2,117 million during fiscal 2010 as compared to fiscal 2009.

The increase in Net sales in fiscal 2010 was driven by Facilities Maintenance, which had an increase of $73 million, or 4.5%. Crown Bolt and Repair & Remodel also had a combined increase in Net sales during fiscal 2010 of $21 million, or 5.0%, as compared to fiscal 2009.

The Net sales growth at Facilities Maintenance was driven by new initiatives primarily in the hospitality, multi-family, and healthcare markets. The Net sales growth at Repair & Remodel was driven by volume, primarily as a result of sales initiatives and the opening of a new location in the Los Angeles market. During fiscal 2010, Crown Bolt recorded $12 million in Net sales in accordance with the minimum purchase requirement provisions of the strategic purchase agreement with Home Depot. Partially offsetting this positive impact to Crown Bolt’s Net sales was a decrease in Net sales due to volume and price decreases.

Adjusted EBITDA

Adjusted EBITDA increased $15 million, or 4.5%, during fiscal 2010 as compared to fiscal 2009.

The increase in Adjusted EBITDA was driven by the $12 million of Net sales recorded at Crown Bolt in accordance with the strategic purchase agreement provisions. In addition, the sector experienced improvements in gross margin driven by sales initiatives, favorable product mix, and certain one-time costs incurred during fiscal 2009. Partially offsetting these favorable impacts was an increase in Selling, general and administrative costs related to software implementation, freight costs and personnel expenses supporting new sales growth initiatives and volume increases.

Adjusted EBITDA as a percentage of Net sales remained flat in fiscal 2010 as compared to fiscal 2009. The positive impacts of the gross margin increases were offset by an increase in Selling, general and administrative expenses.

Specialty Construction

 

     Fiscal Year      Increase (Decrease)  
        2011
vs. 2010
     2010
vs. 2009
 
Dollars in millions    2011      2010      2009        

Net sales

     $1,171         $1,061         $1,095         10.4%         (3.1)%   

Operating income (loss)

     $(38)         $(84)         $(142)         (54.8)         (40.8)%   

% of Net sales

     (3.2)%         (7.9)%         (13.0)%         (470) bps         (510) bps   

Depreciation and amortization

     43         51         61         (15.7)%         (16.4)%   

Restructuring

             8         13         *         (38.5)%   
  

 

 

    

 

 

    

 

 

       

Adjusted EBITDA(1)

     $5         $(25)         $(68)         *         (63.2)%   

% of Net sales

     0.4%         (2.4)%         (6.2)%         280 bps         (380) bps   

 

* not meaningful; (1) Adjusted EBITDA is Operating income (loss) plus (i) Depreciation and amortization expense and (ii) Restructuring charges.

Fiscal 2011 compared to fiscal 2010

Net sales

Net sales increased $110 million, or 10.4%, to $1,171 million during fiscal 2011 as compared to fiscal 2010.

The increase in Net sales was driven by a $130 million, or 15.2%, increase at White Cap, partially offset by a decline in Net sales at CTI. The increase in Net sales at White Cap was driven primarily by sales initiatives and, to a lesser extent, rising commodity prices, primarily steel. The decrease in Net sales during fiscal 2011 at CTI was driven by volume declines in the residential construction market, in part due to the expiration of the U.S. tax incentives for homebuyers in the second quarter of fiscal 2010.

 

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Adjusted EBITDA

Adjusted EBITDA improved $30 million during fiscal 2011 to $5 million compared to a loss of $25 million in fiscal 2010.

The improvement in Adjusted EBITDA was driven by White Cap, and, to a lesser extent, CTI. White Cap’s improvement was primarily driven by gross profit increases as a result of volume and commodity impacts, the leverage of fixed costs through sales volume increases, and efforts to control variable expenses. The improvement in CTI’s Adjusted EBITDA was primarily due to a decrease in Selling, general, and administrative expense, as a result of personnel reductions, the closure of certain underperforming branches, and efforts to control variable expenses.

Adjusted EBITDA as a percentage of Net sales improved to 0.4% in fiscal 2011 from (2.4%) in fiscal 2010, primarily due to the leverage of fixed costs through sales volume increases and efforts to control variable expenses at White Cap and, to a lesser extent, improved gross margins at both businesses and a shift in mix within the sector.

Fiscal 2010 compared to fiscal 2009

Net sales

Net sales decreased $34 million, or 3.1%, to $1,061 million during fiscal 2010 as compared to fiscal 2009.

White Cap and CTI experienced declines in Net sales of $20 million and $14 million, respectively, in fiscal 2010 as compared to fiscal 2009, which represent declines of 2.3% and 6.4%, respectively. The Net sales decreases were driven by a continued impact of the weakened construction markets as the residential recovery has stalled. Partially offsetting these declines were favorable impacts to Net sales during fiscal 2010 due to rising commodity prices.

Adjusted EBITDA

Adjusted EBITDA improved $43 million during fiscal 2010 to a loss of $25 million compared to a loss of $68 million in fiscal 2009.

The improvement in Adjusted EBITDA in fiscal 2010 was driven by a decrease in Selling, general and administrative expenses, primarily due to personnel reductions, reduced operating costs due to branch closures, and other cost reduction initiatives begun during fiscal 2009. In addition, fiscal 2010 Adjusted EBITDA was favorably impacted by gross profit increases, driven by product mix, commodity impacts, and one-time costs incurred during fiscal 2009.

Adjusted EBITDA as a percentage of Net sales improved approximately 380 basis points in fiscal 2010 as compared to fiscal 2009. The improvement was primarily due to improved gross margins and significant reductions in fixed costs across the sector.

 

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Liquidity, capital resources and financial condition

Sources and uses of cash

Our sources of funds, primarily from operations, cash on-hand, and, to the extent necessary, from readily available external financing arrangements, are sufficient to meet all current obligations on a timely basis. We believe that these sources of funds will be sufficient to meet the operating needs of our business for at least the next twelve months.

During fiscal 2011, cash inflow was primarily provided by cash receipts from operations and proceeds from the sale of businesses. The fiscal 2011 inflows along with cash on hand were utilized to meet the cash flow needs of the business including, but not limited to, payment of operating expenses, funding capital expenditures, investing in working capital, and the payment of interest on debt. In addition, the Company paid $10 million in net debt repayments.

As of January 29, 2012, our combined liquidity of approximately $1.2 billion is comprised of $111 million in cash and cash equivalents and $1,136 million of available borrowings. The available borrowings include $200 million under our Revolving Credit Facility, which matures on August 30, 2013, and $936 million under our ABL Revolving Credit Facility, based on qualifying inventory and receivables, which matures on April 1, 2014. From time to time, depending on market conditions and other factors, we may seek to refinance a portion or all of our indebtedness.

Although we believe that our end-markets will improve and enable us to generate higher earnings and cash flows in future years, even in the absence of this expected improvement, we believe our current liquidity and earnings are sufficient to meet all of our operating needs and financial obligations through 2013 as illustrated in the chart below (amounts in millions).

 

     Fiscal Year  
     2012      2013  
  

 

 

 

Starting Liquidity

         $1,247               $1,019     

Add:

     

Adjusted EBITDA(1)

     569           569     

Subtract:

     

Cash Interest Payments(2)

     600           600     

Capital Expenditures(1)

     115           115     

Debt Principal Payments(3)

     82           10     

Maturity of Revolving Credit Facility

     –           200     
  

 

 

 

Ending Liquidity

     $1,019           $  663     
  

 

 

 
  (1) Adjusted EBITDA and Capital Expenditures are held constant in this illustration. See “Item 6. Selected Financial Data.” for a reconciliation of Adjusted EBITDA to Net income (loss), the most directly comparable financial measure under U.S. GAAP. By including these assumptions in this report we do not intend to make any projection regarding future Adjusted EBITDA or capital expenditure levels. Actual results in the future may differ materially from historic levels.

 

  (2) Our cash interest payments for fiscal 2011 were approximately $356 million. Beginning in fiscal 2012, we anticipate our annualized cash interest payments to be approximately $600 million as the interest on our 13.5% Senior Subordinated Notes will be paid in cash, rather than paid in kind. The interest rates and other terms within our current credit agreements are not impacted by rating agency actions.

 

  (3) Represents required principal payments on our Term Loans due August 30, 2012 and April 1, 2014.

Information about the Company’s cash flows, by category, is presented in the Consolidated Statements of Cash Flows and is summarized as follows:

Net cash provided by (used for):

 

Amounts in millions        Fiscal 2011              Fiscal 2010              Fiscal 2009      

Operating activities

     $(165)          $551           $69       

Investing activities

     (6)          (45)          (41)     

Financing activities

     (10)          (755)          (263)    
  

 

 

    

 

 

    

 

 

 

 

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Working capital

Working capital, excluding cash and cash equivalents, increased to $901 million as of the end of fiscal 2011 from $884 million as of the end of fiscal 2010. The increase was primarily driven by an increase in receivables and inventory as well as a decrease to accounts payable due to the timing of inventory purchases, substantially offset by the working capital decrease for the sale of businesses and increases in accrued interest and the current maturities of long-term debt.

Working capital, excluding cash and cash equivalents, decreased to $884 million as of the end of fiscal 2010 from $1,386 million as of the end of fiscal 2009. The decrease was primarily driven by the collection of an income tax receivable of $220 million and an increase to accounts payable of $321 million due to the timing of inventory purchases.

Operating activities

Cash flow from operating activities in fiscal 2011 was a use of $165 million compared with cash flows provided by operating activities of $551 million in fiscal 2010. The decrease was primarily due to the timing of payments for the purchase of inventory and the receipt of an IRS refund in fiscal 2010 of $220 million.

Cash flow from operating activities in fiscal 2010 was $551 million compared with $69 million in fiscal 2009. The increase was primarily due to the timing of payments for the purchase of inventory and the receipt of an IRS refund of $220 million in fiscal 2010. These increases were partially offset by the receipt of an IRS refund in fiscal 2009 of $134 million.

Investing activities

During fiscal 2011, cash used in investing activities was $6 million, primarily driven by $115 million of capital expenditures and the $21 million acquisition of RAMSCO, partially offset by $128 million of proceeds from the sale of businesses. During fiscal 2011, capital expenditures increased $66 million as compared to fiscal 2010, driven by the purchase of open-ended vehicle leases and reflecting our commitment to invest in our business through information technology, greenfield expansion, and other strategic initiatives.

During fiscal 2010, cash used in investing activities was $45 million, primarily driven by $49 million of capital expenditures.

During fiscal 2009, cash used in investing activities was $41 million, primarily driven by $58 million of capital expenditures and the $16 million acquisition of ORCO, partially offset by the receipt of $22 million for the final working capital adjustment related to the Transactions.

Financing activities

During fiscal 2011, cash used in financing activities was $10 million, due entirely to net debt repayments.

During fiscal 2010, cash used in financing activities was $755 million, due to net debt repayments of $722 million, including the prepayment on the Term Loan of $30 million, and $34 million in financing fees related to the amendment of our credit agreements.

During fiscal 2009, cash used in financing activities was $263 million, as a result of net debt repayments, including the repurchase of $252 million principal amount of the 13.5% Senior Subordinated Notes for $62 million.

External financing

As of January 29, 2012, we have an aggregate principal amount of $5.5 billion of outstanding debt, $200 million of available borrowings under our Revolving Credit Facility and $993 million of available borrowings under our ABL Credit Facility (after giving effect to the borrowing base limitations and approximately $66 million in letters of credit issued and including $57 million of borrowings available on qualifying cash balances).

 

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Our outstanding debt as of January 29, 2012 and January 30, 2011 consisted of the following outstanding principal amounts with the respective interest rates (dollars in millions):

 

     January 29, 2012      January 30, 2011  
     Outstanding
Principal
     Interest
Rate %
     Outstanding
Principal
     Interest
Rate %
 

Term Loan due August 30, 2012

       $ 73           1.53             $ 74           1.56     

Term Loan due April 1, 2014

     855           3.03           864           3.06     

ABL Term Loan due April 1, 2014

     214           3.56           214           3.53     

12.0% Senior Notes due September 1, 2014

     2,500           12.00           2,500           12.00     

13.5% Senior Subordinated Notes due September 1, 2015

     1,820           13.50           1,597           13.50     
  

 

 

       

 

 

    

Total long-term debt

       $   5,462                $   5,249        
  

 

 

       

 

 

    

Senior Secured Credit Facility

The Company maintains a senior secured credit facility (the “Senior Secured Credit Facility”) comprised of a $928 million term loan (the “Term Loan”) and a $200 million revolving credit facility (the “Revolving Credit Facility”). On March 19, 2010, the Company entered into Amendment No. 3 (the “Cash Flow Amendment”) to its Senior Secured Credit Facility, dated as of August 30, 2007, by and among the Company, Merrill Lynch Capital Corporation, as administrative agent and collateral agent, and the other lenders and financial institutions from time to time party thereto. The Cash Flow Amendment extended the maturity date from August 30, 2012 to April 1, 2014 of approximately $874 million in principal amount of outstanding Term Loan under the Senior Secured Credit Facility. Home Depot, which guarantees payment of the Term Loan under the Senior Secured Credit Facility (“THD Guarantee”), consented to the Cash Flow Amendment. Concurrently, Home Depot and the Company entered into an agreement pursuant to which Home Depot consented to any later amendment to the Senior Secured Credit Facility, as amended, (similar in form and substance to the Cash Flow Amendment) that would extend the maturity of the remaining approximately $104 million of outstanding Term Loan to a date that is not later than the maturity date in effect from time to time under the Cash Flow Amendment. In addition, the Company entered into a letter agreement with Home Depot, pursuant to which the Company agreed that, while the THD Guarantee is outstanding, the Company would not voluntarily repurchase any 12.0% Senior Notes or 13.5% Senior Subordinated Notes, directly or indirectly, without Home Depot’s prior written consent, subject to certain exceptions, including debt repurchases with equity or permitted refinancings. The Company also agreed to prepay $30 million in aggregate principal amount of non-extending Term Loan under the Senior Secured Credit Facility. This prepayment was completed during the first quarter of fiscal 2010. The maturity date of the extended outstanding Term Loan may be further extended to a date not later than June 1, 2014, without further consent by the lenders, if Home Depot provides a notice electing to extend its guarantee of the Term Loan to such later date. However, Home Depot is under no obligation to provide such notice or make such election to further extend its guarantee, and the Company cannot provide any assurance that Home Depot will provide such notice or make such election or on what terms it might do so. The remaining outstanding non-extended Term Loan will mature on the original maturity date of such loan, i.e. August 30, 2012. The Senior Secured Credit Facility can be repaid at any time without penalty or premium.

The Cash Flow Amendment increased the borrowing margins applicable to the extended portion of the Term Loan by 150 basis points, such that the extended Term Loan bears interest at Prime plus 1.75% or LIBOR plus 2.75% at the Company’s election. The remaining non-extended Term Loan continues to bear interest at Prime plus 0.25% or LIBOR plus 1.25% at the Company’s election. Interest on the Term Loan is due at the end of each calendar quarter with respect to Prime rate draws or at the maturity of each LIBOR draw (unless said draw is for a six-, nine-, or twelve-month period, then interest shall be paid quarterly). During fiscal 2011, the Term Loan due August 30, 2012 had an average outstanding balance of $73 million at a weighted average interest rate of 1.56% and the Term Loan due April 1, 2014 had an average outstanding balance of $860 million at a weighted average interest rate of 3.06%. During fiscal 2010, the Term Loan due August 30, 2012 had an average outstanding balance of $149 million at a weighted average interest rate of 1.54% and the Term Loan due April 1, 2014 had an average outstanding balance of $869 million at a weighted average interest rate of 3.11%.

The extended and non-extended portions of the Term Loan outstanding under the Senior Secured Credit Facility, as amended, amortize in nominal quarterly installments equal to 0.25% of the original aggregate principal amount of the Term Loan. Additionally, beginning in fiscal 2009, the Company is required to pay down the Term

 

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Loan in an amount equal to 50% of Excess Cash Flow from the preceding fiscal year, as defined in the Term Loan agreement, such percentage is reduced to 0% upon the attainment of certain leverage ratio targets. Under the Excess Cash Flow provisions of the Senior Secured Credit Facility, the Company is not required to repay a portion of the Term Loan during fiscal 2012 and was not required to repay a portion of the Term Loan during fiscal 2011, fiscal 2010 or fiscal 2009.

The THD Guarantee was valued at $106 million at the issuance of the Senior Secured Credit Facility in August 2007 and was being amortized to interest expense over the original five-year life of the Term Loan on a straight-line basis which approximates the effective interest method. As a result of the extension of the THD Guarantee on the extended Term Loan, the amortization period of a pro-rata portion of the unamortized THD Guarantee has also been extended, on a straight-line basis, until April 1, 2014. During fiscal 2011, fiscal 2010, and fiscal 2009 the Company recorded amortization of the guarantee of $13 million, $14 million, and $21 million, respectively, which is reflected in Interest Expense in the Consolidated Statements of Operations. In connection with the $30 million prepayment of the non-extending portion of the Term Loan under the Senior Secured Credit Facility, the Company wrote-off the unamortized pro-rata portion of the THD Guarantee and the unamortized pro-rata portion of deferred debt costs, resulting in a pre-tax charge of $2 million in fiscal 2010. This charge is reflected in Other (income) expense, net in the Consolidated Statements of Operations.

The Revolving Credit Facility is due August 30, 2013 and bears interest at Prime plus 3.0% or LIBOR plus 4.0% at the Company’s election. The Revolving Credit Facility also has a 0.5% unused commitment fee and a Letter of Credit fee of 4.0% per annum. There were no amounts outstanding under the Revolving Credit Facility as of January 29, 2012 or January 30, 2011. During fiscal 2011, the Revolving Credit Facility had an average outstanding balance of zero. During fiscal 2010, the Revolving Credit Facility had an average outstanding balance of $125 million at a weighted average interest rate of 4.28%. As of January 29, 2012 and January 30, 2011, there were no outstanding Letters of Credit under the Revolving Credit Facility. Interest on the Revolving Credit Facility is due at the end of each calendar quarter with respect to Prime rate draws or at the maturity of each LIBOR draw (unless said draw is for a six-, nine-, or twelve-month period, then interest shall be paid quarterly).

In addition to Home Depot’s guarantee of the Term Loan payments, the Senior Secured Credit Facility is further collateralized by all of the capital stock of HD Supply, Inc. and its subsidiary guarantors and by 65% of the capital stock of its foreign subsidiaries as well as by other tangible and intangible assets owned by the Company subject to the priority of liens described in the guarantee and collateral agreement dated as of August 30, 2007. The Senior Secured Credit Facility contains various restrictive covenants including limitations on additional indebtedness and dividend payments and stipulations regarding the use of proceeds from asset dispositions. The Company is in compliance with all such covenants. The Senior Secured Credit Facility is subject to an acceleration clause under an Event of Default, as defined in the Senior Secured Credit Facility agreement. Management believes the likelihood of such acceleration to be remote.

Asset Based Lending Credit Agreement

The Company maintains a $2.1 billion asset based lending credit agreement (the “ABL Credit Facility”) subject to borrowing base limitations. On March 19, 2010, the Company entered into the Limited Consent and Amendment No. 3 (the “ABL Amendment”) to its ABL Credit Facility, dated as of August 30, 2007, by and among the Company, certain subsidiaries of the Company, GE Business Financial Services Inc. (formerly known as Merrill Lynch Business Financial Services Inc.), as administrative agent and collateral agent, GE Canada Finance Holding Company, as Canadian administrative agent and Canadian collateral agent, and the several lenders and financial institutions from time to time parties thereto. Pursuant to the ABL Amendment, the Company (i) converted approximately $214 million of commitments under the ABL Credit Facility into a term loan (the “ABL Term Loan”), (ii) extended the maturity date of approximately $1,537 million of the commitments under the ABL Credit Facility (the “ABL Revolving Credit Facility”) from August 30, 2012 to the later of April 1, 2014 and the maturity date of the extended Term Loan under the Cash Flow Amendment, and (iii) reduced the total commitments under the ABL Credit Facility by approximately $45 million. The ABL Term Loan does not amortize and the entire principal amount thereof is due and payable on the later of April 1, 2014 and the maturity date of the extended Term Loan under the Senior Secured Credit Facility, as amended. The remaining approximately $304 million of commitments under the ABL Credit Facility mature on the original maturity date of such

 

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commitments, i.e. August 30, 2012. The ABL Credit Facility can be repaid at any time without penalty or premium.

The ABL Amendment provided for a borrowing rate of Prime plus 2.25% or LIBOR plus 3.25% per annum applicable to the ABL Term Loan and increased the borrowing margins applicable to the extended portion of the ABL Revolving Credit Facility, such that the extended ABL Revolving Credit Facility bears interest at Prime plus 2.25% or LIBOR plus 3.25% per annum at the Company’s election and contains an unused commitment fee of 0.75%. The non-extended ABL Revolving Credit Facility continues to bear interest at Prime plus 0.5% or LIBOR plus 1.5% per annum at the Company’s election and contain an unused commitment fee of 0.25%.

As of January 29, 2012, there were no amounts outstanding under the ABL Revolving Credit Facility due August 30, 2012 or the ABL Revolving Credit Facility due April 1, 2014. During fiscal 2011, the ABL Term Loan had an average outstanding balance of $214 million at a weighted average interest rate of 3.50%, the ABL Revolving Credit Facility due August 30, 2012 had an average outstanding balance of $12 million at a weighted average interest rate of 1.76%, and the ABL Revolving Credit Facility due April 1, 2014 had an average outstanding balance of $77 million at a weighted average interest rate of 3.51%. During fiscal 2010, the ABL Term Loan had an average outstanding balance of $214 million at a weighted average interest rate of 3.60%, the ABL Revolving Credit Facility due August 30, 2012 had an average outstanding balance of $59 million at a weighted average interest rate of 2.01%, and the ABL Revolving Credit Facility due April 1, 2014 had an average outstanding balance of $57 million at a weighted average interest rate of 3.58%.

As of January 29, 2012, the Company had available borrowings under the ABL Credit Facility of $993 million, after giving effect to the borrowing base limitations and letters of credit issued and including $57 million of borrowings available on qualifying cash balances. The Company can use up to $400 million of its available borrowing under the ABL Credit Facility for Letters of Credit which are charged a fee of 1.5% per annum for amounts borrowed under the non-extended portion and 3.25% per annum for amounts borrowed under the extended portion. As of January 29, 2012, there were approximately $9 million and $57 million, respectively, of Letters of Credit outstanding under the ABL Credit Facility due August 30, 2012 and April 1, 2014, respectively. As of January 30, 2011, there were approximately $11 million and $60 million, respectively, of Letters of Credit outstanding under the ABL Credit Facility due August 30, 2012 and April 1, 2014, respectively.

The ABL Credit Facility contains various restrictive covenants including a limitation on the amount of dividends to be paid. In addition, if the Company’s availability under the ABL Credit Facility falls below $210 million (a “Liquidity Event”), the Company will be required to maintain a Fixed Charge Coverage Ratio of at least 1.0:1.0, as defined in the ABL Credit Facility. The Company is in compliance with all such covenants. The ABL Credit Facility is collateralized by all of the capital stock of HD Supply, Inc. and its subsidiary guarantors and by 65% of the capital stock of its foreign subsidiaries as well as by other tangible and intangible assets owned by the Company subject to the priority of liens described in the guarantee and collateral agreement dated as of August 30, 2007. The ABL Credit Facility is subject to an acceleration clause in a Liquidity Event or an Event of Default, as defined in the ABL Credit Facility agreement. Under such acceleration, the administrative agent can direct payments from the Company’s depository accounts to directly pay down the outstanding balance under the ABL Credit Facility. Management believes the likelihood of such acceleration to be remote.

In connection with the Cash Flow Amendment and ABL Amendment, the Company incurred financing fees of approximately $34 million, of which approximately $31 million were deferred and are being amortized into interest expense over the term of the amended facilities in accordance with U.S. GAAP for debt modifications (ASC 470-50, Debt-Modifications and Extinguishments). The non-deferred financing fees are reported in Other (income) expense, net in the Consolidated Statements of Operations.

Lehman Brothers and Woodlands Commercial Bank

Lehman Brothers Special Financing Inc. and Lehman Commercial Paper, Inc. (together “Lehman Brothers”) is committed to fund up to $95 million of the non-extended portion of the Company’s $2.1 billion ABL Credit Facility, maturing August 30, 2012, and Woodlands Commercial Bank (“Woodlands,” f/k/a Lehman Commercial Bank, an affiliate of Lehman Brothers) is committed to fund $100 million of the Company’s $300 million original availability under the Revolving Credit Facility.

 

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On September 15, 2008, Lehman Brothers filed a petition under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York (“Lehman’s bankruptcy”). Subsequent to Lehman’s bankruptcy, the Company drew down on the ABL Credit Facility and Lehman Brothers failed to fund their portion of the ABL Credit Facility commitment. Lehman is currently in the process of emerging from bankruptcy and is expected to cure their default on the ABL Credit Facility commitment. As of January 29, 2012, there were no outstanding borrowings under the ABL Credit Facility from Lehman Brothers.

On April 21, 2011, the Company drew down the entire $300 million Revolving Credit Facility and Woodlands failed to fund their $100 million Revolving Credit Facility commitment. The following day, the Company repaid the entire Revolving Credit Facility balance. As a result of Woodlands’ default, the Company no longer pays the 0.5% unused commitment fee on Woodlands’ $100 million Revolving Credit Facility commitment and the Revolving Credit Facility is effectively reduced to $200 million.

12.0% Senior Notes

On August 30, 2007, the Company issued $2.5 billion of Senior Notes bearing interest at a rate of 12.0% (the “12.0% Senior Notes”). Interest payments are due each March 1st and September 1st through maturity. The 12.0% Senior Notes mature on September 1, 2014 and can be redeemed by the Company as follows:

 

Redemption Period    Redemption Price

September 1, 2011 – August 31, 2012

   106% plus accrued interest

September 1, 2012 – August 31, 2013

   103% plus accrued interest

September 1, 2013 – Thereafter          

   100% plus accrued interest

The 12.0% Senior Notes contain various restrictive covenants including limitations on additional indebtedness and dividend payments and stipulations regarding the use of proceeds from asset dispositions. The Company is in compliance with all such covenants.

13.5% Senior Subordinated Notes

On August 30, 2007, the Company issued $1.3 billion of Senior Subordinated PIK Notes bearing interest at a rate of 13.5% (the “13.5% Senior Subordinated Notes”). Interest payments are due each March 1st and September 1st through maturity except that the first eight payment periods through September 2011 were payments in kind (“PIK”) and therefore increased the balance of the outstanding indebtedness rather than paid in cash. During fiscal 2009, the Company repurchased $252 million principal amount, plus accrued interest of $15 million, of the 13.5% Senior Subordinated Notes for $62 million. As a result, we recognized a $200 million pre-tax gain for the extinguishment of this portion of the 13.5% Senior Subordinated Notes, net of the write-off of unamortized deferred debt issuance costs. As a result of PIK interest capitalizations and the extinguishment of a portion of the principal, as of January 29, 2012, the outstanding principal balance of the 13.5% Senior Subordinated Notes was $1.8 billion. The 13.5% Senior Subordinated Notes mature on September 1, 2015 and can be redeemed by the Company as follows:

 

Redemption Period    Redemption Price

September 1, 2011 – August 31, 2012

   106.75% plus accrued interest

September 1, 2012 – August 31, 2013

   103.375% plus accrued interest

September 1, 2013 – Thereafter          

   100% plus accrued interest

The 13.5% Senior Subordinated Notes contain various restrictive covenants including limitations on additional indebtedness and dividend payments and stipulations regarding the use of proceeds from asset dispositions. The Company is in compliance with all such covenants.

The 12.0% Senior Notes and the 13.5% Senior Subordinated Notes are both fully and unconditionally guaranteed by our direct or indirect wholly-owned domestic subsidiaries. These guarantees can automatically be released under customary circumstances, including the sale of the assets of the subsidiary providing the guarantee. See the section titled “Description of Notes” of our Registration Statement on Form S-4 filed with the SEC on July 27, 2009 for a detailed description of our outstanding notes, including a discussion of each of the circumstances under which subsidiary guarantees may be released.

 

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Interest rate swaps

We maintained interest rate swap agreements to exchange fixed and variable rate interest payment obligations without the exchange of the underlying principal amounts. At execution, our swaps committed us to pay fixed interest and receive variable interest, effectively converting $400 million of floating-rate debt to fixed rate debt. Swaps with a combined $200 million notional value matured on January 31, 2010. The remaining swaps with a combined $200 million notional value matured on January 31, 2011, the first day of fiscal 2011.

The following table summarizes the weighted average rates and notional amounts of these agreements for the periods presented.

 

     Fiscal 2011      Fiscal 2010      Fiscal 2009  

Weighted average notional value outstanding (millions)

     –           $200             $400       

Weighted average fixed rate paid

     –           3.9%         3.8%   

Weighted average floating rate received

     –           0.3%         0.3%   

Commodity and interest rate risk

Commodity risk

We are aware of the potentially unfavorable effects inflationary pressures may create through higher asset replacement costs and related depreciation, higher interest rates and higher material costs. In addition, our operating performance is affected by price fluctuations in the commodity-based products that we purchase and sell, which contain commodities such as steel, copper, aluminum, PVC, petroleum and other commodities. We are also exposed to fluctuations in petroleum costs as we deliver a substantial portion of the products we sell by truck. We seek to minimize the effects of inflation and changing prices through economies of purchasing and inventory management resulting in cost reductions and productivity improvements as well as price increases to maintain reasonable gross margins.

As discussed above, our results of operations were favorably or negatively impacted by fluctuating commodity prices based on our ability or inability to pass increases in the prices of certain commodity-based products to our customers. Such commodity price fluctuations have from time to time produced volatility in our financial performance and could continue to do so in the future.

Interest rate risk related to debt

We are subject to interest rate risk associated with our Senior Secured Credit Facility and our ABL Credit Facility.

As of January 29, 2012, the Senior Secured Credit Facility was comprised of the following:

 

   

A Term Loan due August 30, 2012 that bears interest at Prime plus 0.25% or LIBOR plus 1.25% at the Company’s election. As of January 29, 2012, $73 million was outstanding at an interest rate of 1.53%.

 

   

A Term Loan due April 1, 2014 that bears interest at Prime plus 1.75% or LIBOR plus 2.75% at the Company’s election. As of January 29, 2012, $855 million was outstanding at an interest rate of 3.03%.

 

   

A $200 million Revolving Credit Facility due August 30, 2013 that bears interest at Prime plus 3.0% or LIBOR plus 4.0% at the Company’s election. As of January 29, 2012, there were no amounts outstanding.

As of January 29, 2012, the ABL Credit Facility was comprised of the following:

 

   

An ABL Term Loan due April 1, 2014 that bears interest at Prime plus 2.25% or LIBOR plus 3.25% per annum at the Company’s election. As of January 29, 2012, $214 million was outstanding at a weighted average interest rate of 3.56%.

 

   

A $304 million ABL Revolving Credit Facility due August 30, 2012 that bears interest at Prime plus 0.5% or LIBOR plus 1.5% per annum at the Company’s election. As of January 29, 2012, there were no amounts outstanding.

 

   

A $1.5 billion ABL Revolving Credit Facility due April 1, 2014 that bears interest at Prime plus 2.25% or LIBOR plus 3.25% per annum at the Company’s election. As of January 29, 2012, there were no amounts outstanding.

 

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While changes in interest rates impact the fair value of the fixed rate debt, there is no impact to earnings and cash flow. Alternatively, while changes in interest rates do not affect the fair value of our variable-interest rate debt, they do affect future earnings and cash flows. A 1% increase in interest rates on our variable-rate debt would increase our annual forecasted interest expense by approximately $11 million (based on our borrowings on our credit facilities as of January 29, 2012).

Off-balance sheet arrangements

In accordance with generally accepted accounting principles in the United States, operating leases for a portion of our real estate and other assets are not reflected in our Consolidated Balance Sheets.

Contractual obligations

The following table discloses aggregate information about our contractual obligations as of January 29, 2012 and the periods in which payments are due (amounts in millions):

 

            Payments due by period  
     Total     

Fiscal

2012

     Fiscal
2013-2014
     Fiscal
2015-2016
     Fiscal years
after 2016
 

Long-term debt

     $  5,462         $       82         $  3,560         $  1,820         $    –   

Interest on long-term debt(1)

     1,987         595         1,146         246           

Operating leases

     482         126         180         90         86   

Purchase obligations (2)

     701         701                           
  

 

 

 

Total contractual cash obligations (3)

     $  8,632         $  1,504         $  4,886         $  2,156         $  86   
  

 

 

 

 

(1) The interest on long-term debt includes payments for agent administration fees.

 

(2) Purchase obligations include various commitments with vendors to purchase goods and services, primarily inventory. These purchase obligations are generally cancelable, but the Company has no intent to cancel.

 

(3) The contractual obligations table excludes $214 million of unrecognized tax benefits due to uncertainty regarding the timing of future cash payments, if any, related to the liabilities recorded in accordance with the U.S. GAAP guidance for uncertain tax positions.

Recent accounting pronouncements

Multiple-deliverable revenue arrangements – In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-13, “Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”). This ASU addresses how to separate deliverables under multiple-deliverable arrangements and how to measure and allocate arrangement consideration to one or more units of accounting. In addition, ASU 2009-13 expands the disclosures related to a company’s multiple-deliverable revenue arrangements. The Company adopted the provisions of ASU 2009-13 on January 31, 2011. The adoption did not have an impact on the consolidated financial statements or results of operations.

Fair value measurement – In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”). The amendments in this ASU are intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards (“IFRS”). The amendments in this ASU explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. The amendments in this ASU are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011. The Company does not expect the adoption of ASU 2011-04 to have a material impact on the Company’s financial position or results of operations.

Comprehensive income – In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”), to increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity and requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present

 

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total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. In December 2011, the FASB issued ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”), which deferred the requirement to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income while the FASB further deliberates this aspect of the proposal. The amendments contained in ASU 2011-05 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-05, as amended by ASU 2011-12, will not have an impact on the Company’s financial position or results of operations. However, adopting the guidance will affect the presentation of components of comprehensive income by eliminating the historical practice of showing these items within the Consolidated Statements of Stockholders’ Equity.

Goodwill impairment testing – In September 2011, the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment” (“ASU 2011-08”), which simplifies how entities test goodwill for impairment and permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. ASU 2011-08 will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, although early adoption is permitted. The adoption of ASU 2011-08 will not have an impact on the Company’s financial position or results of operations.

Critical accounting policies

Our critical accounting policies include:

Revenue recognition

We recognize revenue when persuasive evidence of an agreement exists, delivery has occurred or services have been rendered, the price to the buyer is fixed and determinable and collectability is reasonably assured. We ship products to customers predominantly by internal fleet and to a lesser extent by third party carriers. Revenues, net of sales tax and allowances for returns and discounts, are recognized from product sales when title to the products is passed to the customer, which generally occurs at the point of destination for products shipped by internal fleet and at the point of shipping for products shipped by third party carriers.

Allowance for doubtful accounts

We evaluate the collectability of accounts receivable based on numerous factors, including past transaction history with customers, their credit worthiness and an assessment of our lien and bond rights. Initially, we estimate an allowance for doubtful accounts as a percentage of aged receivables. This estimate is periodically adjusted when we become aware of a specific customer’s inability to meet its financial obligations (e.g., bankruptcy filing) or as a result of changes in our historical collection patterns. While we have a large customer base that is geographically dispersed, a slowdown in the markets in which we operate may result in higher than expected uncollectible accounts, and therefore, the need to revise estimates for bad debts. To the extent historical credit experience is not indicative of future performance or other assumptions used by management do not prevail, the allowance for doubtful accounts could differ significantly, resulting in either higher or lower future provisions for doubtful accounts.

Inventories

Inventories are carried at the lower of cost or market. The cost of substantially all of our inventories is determined by the moving or weighted average cost method. We evaluate our inventory value at the end of each quarter to ensure that it is carried at the lower of cost or market. This evaluation includes an analysis of historical physical inventory results, a review of potential excess and obsolete inventories based on inventory aging and anticipated future demand. Periodically, each branch’s perpetual inventory records are adjusted to reflect any declines in net realizable value below inventory carrying cost. To the extent historical physical inventory results are not indicative of future results and if future events impact, either favorably or unfavorably, the saleability of our

 

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products or our relationship with certain key vendors, our inventory reserves could differ significantly, resulting in either higher or lower future inventory provisions.

Consideration received from vendors

At the beginning of each calendar year, we enter into agreements with many of our vendors providing for inventory purchase rebates (“vendor rebates”) upon achievement of specified volume purchasing levels. We accrue the receipt of vendor rebates as part of our cost of sales for products sold based on progress towards earning the vendor rebates, taking into consideration cumulative purchases of inventory to date and projected purchases through the end of the year. An estimate of unearned vendor rebates is included in the carrying value of inventory at each period end for vendor rebates to be received on products not yet sold. While we believe we will continue to receive consideration from vendors in fiscal 2012 and thereafter, there can be no assurance that vendors will continue to provide comparable amounts of vendor rebates in the future.

Impairment of long-lived assets

Long-lived assets, including property and equipment, are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. To analyze recoverability, we project undiscounted future cash flows over the remaining life of the asset. If these projected cash flows are less than the carrying amount, an impairment loss is recognized based on the fair value of the asset less any costs of disposition. Our judgment regarding the existence of impairment indicators are based on market and operational performance. Future events could cause us to conclude that impairment indicators exist and that assets are impaired. Evaluating the impairment also requires us to estimate future operating results and cash flows that require judgment by management. If different estimates were used, the amount and timing of asset impairments could be affected.

Goodwill

Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired in connection with business acquisitions. Accounting Standards Codification 350, Intangibles – Goodwill and Other, requires entities to periodically assess the carrying value of goodwill by reviewing the fair value of the net assets underlying all acquisition-related goodwill on a reporting unit basis, as defined by ASC 350. We assess the recoverability of goodwill in the third quarter of each fiscal year. We also use judgment in assessing whether we need to test goodwill more frequently for impairment than annually given factors such as unexpected adverse economic conditions, competition, product changes and other external events. If the carrying amount of a reporting unit that contains goodwill exceeds fair value, a possible impairment would be indicated.

We determine the fair value of a reporting unit using a discounted cash flow (“DCF”) analysis and a market comparable method, with each method being equally weighted in the calculation.

Determining fair value requires the exercise of significant judgment, including judgment about appropriate discount rates, the amount and timing of expected future cash flows, as well as relevant comparable company earnings multiples for the market comparable approach. The cash flows employed in the DCF analyses are based on the Company’s most recent long-range forecast and, for years beyond the forecast, the Company’s estimates, which are based on estimated exit multiples ranging from six to seven times the final forecasted year earnings before interest, taxes, depreciation and amortization. The discount rates used in the DCF analyses are intended to reflect the risks inherent in the future cash flows of the respective reporting units and range from 13% to 17%. For the market comparable approach, the Company evaluated comparable company public trading values, using earnings multiples and sales multiples that are used to value the reporting units.

There was no indication of impairment in any of the Company’s reporting units during either the fiscal 2011 or the fiscal 2010 annual testing and accordingly, the second step of the goodwill impairment analysis was not performed. At the time of our fiscal 2011 annual testing, the fair value of the reporting units exceeded their carrying value by the following percentages: 17% for Waterworks, 50% for Facilities Maintenance, 68% for White Cap, 32% for Utilities, 4% for Crown Bolt, 24% for Repair & Remodel, and 166% for Electrical.

During fiscal 2009, as a result of our goodwill impairment testing, we recorded goodwill impairment charges of $224 million.

 

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MANAGEMENTS DISCUSSION & ANALYSIS OF  FINANCIAL CONDITION & RESULTS OF OPERATIONS, CONTINUED

  HD SUPPLY, INC.

 

The Company’s discounted cash flow model is based on HD Supply’s expectation of future market conditions for each of the reporting units, as well as discount rates that would be used by market participants in an arms-length transaction. Future events could cause the Company to conclude that market conditions have declined or discount rates have increased to the extent that the Company’s goodwill could be further impaired. It is not possible at this time to determine if any such future impairment charge would result.

Income Taxes

Income taxes are determined under the liability method as required by ASC 740, Income Taxes. Income tax expense or benefit is based on pre-tax financial accounting income. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. This measurement is reduced, if necessary, by a valuation allowance based on the amount of tax benefits that, based on available evidence, are not “more likely than not” to be realized. The Company recorded a valuation allowance related to its U.S. continuing operations of $243 million, $217 million, and $7 million in fiscal 2011, fiscal 2010, and fiscal 2009, as it believes it is “more likely than not” all of the U.S. deferred income tax assets will not be realized. In addition, the Company recorded a valuation allowance related to its U.S. discontinued operations of $9 million and $13 million for fiscal 2011 and 2010 respectively.

The Company follows the U.S. GAAP guidance for uncertain tax positions within ASC 740, Income Taxes. ASC 740 provides guidance related to the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The standard prescribes the minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. Initial recognition, derecognition and measurement is based on management’s judgment given the facts, circumstances and information available at the reporting date. If these judgments are not accurate then future income tax expense or benefit could be different.

Self-insurance

We have a high deductible insurance program for most losses related to general liability, product liability, environmental liability, automobile liability, workers’ compensation, and we are self-insured for medical claims and certain legal claims. The expected ultimate cost for claims incurred as of the balance sheet date is not discounted and is recognized as a liability. Self-insurance losses for claims filed and claims incurred but not reported are accrued based upon estimates of the aggregate liability for uninsured claims using loss development factors and actuarial assumptions followed in the insurance industry and historical loss development experience.

To the extent the projected future development of the losses resulting from environmental, workers’ compensation, automobile, general and product liability claims incurred as of January 29, 2012 differs from the actual development of such losses in future periods, our insurance reserves could differ significantly, resulting in either higher or lower future insurance expense.

Management estimates

Management believes the assumptions and other considerations used to estimate amounts reflected in our combined financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts reflected in our combined financial statements, the resulting changes could have a material adverse effect on our combined results of operations, and in certain situations, could have a material adverse effect on our financial condition.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required by this Item is included under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Commodity and interest rate risk.”

 

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   HD SUPPLY, INC.

 

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to financial statements

 

       Page  

Report of Independent Registered Public Accounting Firm

   60

Consolidated statements of operations for (i) the fiscal year ended January  29, 2012, (ii) the fiscal year ended January 30, 2011, and (iii) the fiscal year ended January 31, 2010

   61

Consolidated balance sheets as of January 29, 2012 and January 30, 2011

   62

Consolidated statements of stockholder’s equity (deficit) and comprehensive income (loss) for (i) the fiscal year ended January 29, 2012, (ii) the fiscal year ended January 30, 2011, and (iii) the fiscal year ended January 31, 2010

   63

Consolidated statements of cash flows for (i) the fiscal year ended January  29, 2012, (ii) the fiscal year ended January 30, 2011, and (iii) the fiscal year ended January 31, 2010

   64

Notes to consolidated financial statements

   65

 

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Report of Independent Registered Public Accounting Firm

To The Board of Directors and Shareholder of HD Supply, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholder’s equity (deficit) and comprehensive income (loss) and cash flows present fairly, in all material respects, the financial position of HD Supply, Inc. and its subsidiaries at January 29, 2012 and January 30, 2011, and the results of their operations and their cash flows for each of the three years in the period ended January 29, 2012 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(c) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule 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 of these statements in accordance with the standards of the Public Company Accounting Oversight Board (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. An audit 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.

PricewaterhouseCoopers LLP (signed)

Atlanta, Georgia

March 23, 2012

 

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HD SUPPLY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Amounts in millions

 

     Fiscal Year Ended  
       January 29,  
2012
       January 30,  
2011
       January 31,  
2010
 

Net Sales

           $ 7,724                     $ 7,015                     $ 6,947       

Cost of sales

     5,545             5,046             5,049       
  

 

 

    

 

 

    

 

 

 

Gross Profit

     2,179             1,969             1,898       

Operating expenses:

        

Selling, general and administrative

     1,636             1,537             1,540       

Depreciation and amortization

     344             358             376       

Restructuring

     –             8             21       

Goodwill impairment

     –             –             224       
  

 

 

    

 

 

    

 

 

 

Total operating expenses

     1,980             1,903             2,161       
  

 

 

    

 

 

    

 

 

 

Operating Income (Loss)

     199             66             (263)      

Interest expense

     639             623             602       

Other (income) expense, net

     –             (1)            (208)      
  

 

 

    

 

 

    

 

 

 

Income (Loss) from Continuing Operations Before Provision (Benefit) for Income Taxes

     (440)            (556)            (657)      

Provision (benefit) for income taxes

     79             28             (188)      
  

 

 

    

 

 

    

 

 

 

Income (Loss) from Continuing Operations

     (519)            (584)            (469)      

Loss from discontinued operations, net of tax

     (24)            (35)            (45)      
  

 

 

    

 

 

    

 

 

 

Net Income (Loss)

           $ (543)                    $ (619)                    $ (514)      
  

 

 

    

 

 

    

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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HD SUPPLY, INC.

CONSOLIDATED BALANCE SHEETS

Amounts in millions, except share data

 

       January 29,  
2012
       January 30,  
2011
 

ASSETS

     

Current assets:

     

Cash and cash equivalents

           $ 111                   $ 292       

Receivables, less allowance for doubtful accounts of $32 and $36

     1,002             907       

Inventories

     1,108             1,035       

Deferred tax asset

     58             102       

Other current assets

     47             45       
  

 

 

    

 

 

 

Total current assets

     2,326             2,381       
  

 

 

    

 

 

 

Property and equipment, net

     398             390       

Goodwill

     3,151             3,150       

Intangible assets, net

     735             992       

Other assets

     128             176       
  

 

 

    

 

 

 

Total assets

           $ 6,738                   $ 7,089       
  

 

 

    

 

 

 

LIABILITIES AND STOCKHOLDER’S EQUITY (DEFICIT)

     

Current liabilities:

     

Accounts payable

           $ 714                   $ 805       

Accrued compensation and benefits

     140             118       

Current installments of long-term debt

     82             10       

Other current liabilities

     378             272       
  

 

 

    

 

 

 

Total current liabilities

     1,314             1,205       
  

 

 

    

 

 

 

Long-term debt, excluding current installments

     5,380             5,239       

Deferred tax liabilities

     111             101       

Other liabilities

     361             448       
  

 

 

    

 

 

 

Total liabilities

     7,166             6,993       
  

 

 

    

 

 

 

Stockholder’s equity (deficit):

     

Common stock, par value $0.01; authorized 1,000 shares; issued 1,000 shares at January 29, 2012 and January 30, 2011

                  –       

Paid-in capital

     2,680             2,660       

Accumulated deficit

     (3,106)            (2,563)      

Accumulated other comprehensive loss

     (2)            (1)      
  

 

 

    

 

 

 

Total stockholder’s equity (deficit)

     (428)            96       
  

 

 

    

 

 

 

Total liabilities and stockholders equity (deficit)

           $ 6,738                   $ 7,089       
  

 

 

    

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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HD SUPPLY, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY (DEFICIT) AND COMPREHENSIVE INCOME (LOSS)

Amounts in millions

 

     Common  
Stock  
     Paid-in  
Capital  
     Accumulated  
Deficit  
     Accumulated  
Other  
Comprehensive  
Income (Loss)  
     Total  
Equity  
 
  

 

 

 

Balance at February 1, 2009

         $  –           $  2,625           $  (1,418)                  $  (32)          $  1,175       
  

 

 

 

Net loss

           (514)               (514)      

Other comprehensive income (loss):

              

Unrealized gains on derivatives, net of tax of $(1)

              2             2       

Foreign currency translation adjustment

              19             19       
              

 

 

 

Total comprehensive income (loss)

                 (493)      

Stock-based compensation

        18                   18       

Change in fiscal year end of subsidiary

           (13)               (13)      

Other

           1                1       
  

 

 

 

Balance at January 31, 2010

         $ –           $ 2,643           $ (1,944)                  $ (11)          $ 688       
  

 

 

 

Equity contribution

        1                   1       

Net loss

           (619)               (619)      

Other comprehensive income (loss):

              

Unrealized gains on derivatives, net of tax of $(1)

              1             1       

Foreign currency translation adjustment

              9             9       
              

 

 

 

Total comprehensive income (loss)

                 (609)      

Stock-based compensation

        17                   17       

Other

        (1)                  (1)      
  

 

 

 

Balance at January 30, 2011

         $ –           $ 2,660           $ (2,563)                  $ (1)          $ 96       
  

 

 

 

Net loss

           (543)               (543)      

Other comprehensive income (loss):

              

Foreign currency translation adjustment

              (1)            (1)      
              

 

 

 

Total comprehensive income (loss)

                 (544)      

Stock-based compensation

        20                   20       
  

 

 

 

Balance at January 29, 2012

         $ –           $ 2,680           $ (3,106)                  $ (2)          $ (428)      
  

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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HD SUPPLY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Amounts in millions

 

     Fiscal Year Ended  
       January 29,  
2012
       January 30,  
2011
       January 31,  
2010
 

CASH FLOWS FROM OPERATING ACTIVITIES:

        

Net income (loss)

               $ (543)                  $ (619)                  $ (514)      

Reconciliation of net income (loss) to net cash provided by (used in) operating activities:

        

Depreciation and amortization

     350             369             392       

Provision for uncollectibles

     13             12             23       

Non-cash interest expense

     183             259             239       

Stock-based compensation expense

     20             17             18       

Deferred income taxes

     76             20             (221)      

Unrealized derivative (gain) loss

     (1)            (6)            (11)      

Loss (gain) on extinguishment of debt