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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended February 2, 2020

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

    

Exact name of Registrant as specified in its charter, Address of principal
executive offices and Telephone number

    

State of incorporation

    

I.R.S. Employer
Identification Number

001-35979

HD SUPPLY HOLDINGS, INC.
3400 Cumberland Boulevard SE
Atlanta, Georgia 30339
(770852-9000

Delaware

26-0486780

333-159809

HD SUPPLY, INC.
3400 Cumberland Boulevard SE
Atlanta, Georgia 30339
(770852-9000

Delaware

75-2007383

 

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

Title of each Class

Trading Symbol

Name of Each Exchange on Which Registered

HD Supply Holdings, Inc.

    

Common stock, par value $0.01 per share

    

HDS

    

The NASDAQ Stock Market LLC

HD Supply, Inc.

None

None

None

 

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.

HD Supply Holdings, Inc.

Yes

No

HD Supply, Inc.

Yes

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.

HD Supply Holdings, Inc.

Yes

No

HD Supply, Inc.

Yes

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 preceding 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.

HD Supply Holdings, Inc.

Yes

No

HD Supply, Inc.

Yes

No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).

HD Supply Holdings, Inc.

Yes

No

HD Supply, Inc.

Yes

No

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

HD Supply Holdings, Inc.

Large accelerated filer 

Accelerated filer 

Non-accelerated filer

Smaller reporting company 

Emerging growth company 

HD Supply, Inc.

Large accelerated filer 

Accelerated filer 

Non-accelerated filer 

Smaller reporting company 

Emerging growth company 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

HD Supply Holdings, Inc.

Yes

No

HD Supply, Inc.

Yes

No

 

The aggregate market value of the voting common stock held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and Directors are “affiliates” of the Registrant) as of August 2, 2019 (the last business day of our most recently completed fiscal second quarter) was $6,591,541,946.

The number of shares of the registrant’s common stock outstanding as of March 13, 2020:

HD Supply Holdings, Inc.

161,984,157 shares of common stock, par value $0.01 per share

HD Supply, Inc.

1,000 shares of common stock, par value $0.01 per share, all of which were owned by HDS Holding Corporation, a wholly-owned subsidiary of HD Supply Holdings, Inc.

HD Supply, Inc. meets the conditions set forth in General Instruction I(1)(a), (b) and (d) of Form 10-K and is therefore filing this Form with the reduced disclosure format applicable to HD Supply, Inc.

Documents incorporated by reference:

Portions of HD Supply Holdings, Inc.’s proxy statement to be filed with the Securities and Exchange Commission in connection with HD Supply Holdings, Inc.’s 2020 annual meeting of stockholders (the “Proxy Statement’) are incorporated by reference into Part III hereof. Such Proxy Statement will be filed within 120 days of HD Supply Holdings, Inc.’s fiscal year ended February 2, 2020.

Table of Contents

INDEX TO FORM 10-K

Page

Explanatory Note

3

Background Information and Glossary of Certain Defined Terms

3

Forward-looking statements and information

5

Part I

Item 1.

Business

7

Item 1A.

Risk Factors

13

Item 1B.

Unresolved Staff Comments

31

Item 2.

Properties

31

Item 3.

Legal Proceedings

31

Part II

Item 5.

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

34

Item 6.

Selected Financial Data

37

Item 7.

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

40

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

62

Item 8.

Financial Statements and Supplementary Data

63

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

120

Item 9A.

Controls and Procedures

120

Item 9B.

Other Information

121

Part III

Item 10.

Directors, Executive Officers and Corporate Governance

122

Item 11.

Executive Compensation

122

Item 12.

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

122

Item 13.

Certain Relationships and Related Transactions, and Director Independence

122

Item 14.

Principal Accounting Fees and Services

123

Part IV

Item 15.

Exhibits and Financial Statement Schedules

124

Item 16.

Form 10-K Summary

133

Signatures

134

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EXPLANATORY NOTE

This Form 10-K is a combined annual report being filed separately by two registrants: HD Supply Holdings, Inc. and HD Supply, Inc. Unless the context indicates otherwise, any reference in this report to “Holdings” refers to HD Supply Holdings, Inc., any reference to “HDS” refers to HD Supply, Inc., the indirect wholly-owned subsidiary of Holdings, and any references to “HD Supply,” the “Company,” “we,” “us” and “our” refer to HD Supply Holdings, Inc. together with its direct and indirect subsidiaries, including HDS. Each registrant hereto is filing on its own behalf all of the information contained in this annual report that relates to such registrant. Each registrant hereto is not filing any information that does not relate to such registrant, and therefore makes no representation as to any such information.

Background Information and Glossary of Certain Defined Terms

Defined Terms for Indebtedness

In this annual report on Form 10-K, unless otherwise indicated or the context otherwise requires:

“December 2014 First Priority Notes” refers to HDS’s 5.25% Senior Secured First Priority Notes due 2021 issued on December 4, 2014 in an aggregate principal amount of $1,250 million.
“April 2016 Senior Unsecured Notes” refers to HDS’s 5.75% Senior Unsecured Notes due 2024 issued on April 11, 2016 in an aggregate principal amount of $1,000 million.
“October 2018 Senior Unsecured Notes” refers to HDS’s 5.375% Senior Unsecured Notes due 2026 issued on October 11, 2018 in an aggregate principal amount of $750 million.
“Senior ABL Facility” refers to HDS’s asset based lending facility issued on April 12, 2012, providing for senior secured revolving loans and letters of credit of up to a maximum aggregate principal amount of $1,500 million (subject to availability under the borrowing base).
“Senior Credit Facilities” refers collectively to the Senior ABL Facility and the Term Loan Facility.
“Term Loan” refers to the term loans issued under the Term Loan Facility.
“Term Loan Facility” refers to HDS’s senior secured credit facility issued on April 12, 2012 (as amended by the First Amendment, dated as of February 15, 2013, the Second Amendment, dated as of February 6, 2014, the Incremental Agreement No. 1, dated as of August 13, 2015, the Fourth Amendment, dated as of October 14, 2016, the Fifth Amendment, dated as of August 31, 2017, and the Sixth Amendment dated October 22, 2018).
“Term B-1 Loans” refers to the tranche of Term Loans issued on October 14, 2016 under the Term Loan Facility in an aggregate principal amount of approximately $842 million.
“Term B-2 Loans” refers to the tranche of Term Loans issued on October 14, 2016 under the Term Loan Facility in an aggregate principal amount of $550 million.
“Term B-3 Loans” refers to the tranche of Term Loans issued on August 31, 2017 under the Term Loan Facility to replace the Term B-1 Loans in an aggregate principal amount of approximately $535 million.
“Term B-4 Loans” refers to the tranche of Term Loans issued on August 31, 2017 under the Term Loan Facility to replace the Term B-2 Loans in an aggregate principal amount of approximately $546 million.
“Term B-5 Loans” refers to the tranche of Term Loans issued on October 22, 2018 under the Term Loan Facility to replace the Term B-3 Loans and Term B-4 Loans in an aggregate principal amount of $1,070 million.

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Refinancing Transactions

On April 5, 2017, HDS amended the Senior ABL Facility to reduce the applicable margin for borrowing, reduce the applicable commitment fee, and extend the maturity date until April 5, 2022.

On April 18, 2017, HDS used cash and available borrowings under the Senior ABL Facility to repay $100 million aggregate principal of its Term B-1 Loans.

On August 25, 2017, HDS amended and supplemented the indenture governing its April 2016 Senior Unsecured Notes to (a) amend the definition of “Permitted Payments,” (b) increase the interest rate to 7.00% on April 15, 2019, (c) amend the definition of “Net Available Cash,” and (d) amend the definition of “Consolidated EBITDA.”

On August 31, 2017, HDS amended its Term Loan Facility, refinancing the Term B-1 Loans with the Term B-3 Loans in an aggregate principal amount of approximately $535 million, and refinancing the Term B-2 Loans with the Term B-4 Loans in an aggregate principal amount of approximately $546 million.

On September 1, 2017, HDS used a portion of the net proceeds from the sale of the Waterworks business to redeem all of the outstanding $1,250 million in aggregate principal of its December 2014 First Priority Notes.

On December 28, 2017, HDS reduced its U.S. borrowing capacity under its Senior ABL Facility by $500 million to $1,000 million.

On October 11, 2018, HDS issued the October 2018 Senior Unsecured notes and used the net proceeds, together with cash on hand and available borrowings under HDS’s Senior ABL Facility, to redeem all of the outstanding April 2016 Senior Unsecured Notes.

On October 22, 2018, HDS amended its Term Loan Facility, refinancing its Term B-3 and Term B-4 Loans with Term B-5 Loans in an aggregate principal amount of $1,070 million.

HDS’s Senior Credit Facilities and October 2018 Senior Unsecured Notes are discussed in greater detail in “Note 6, Debt” in the Notes to Consolidated Financial Statements within “Part II. Item 8. Financial Statements and Supplementary Data.”

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Glossary of Certain Other Terms

ASC

Accounting Standards Codification

DCF

Discounted cash flow

DOT

U.S. Department of Transportation

Exchange Act

Securities Exchange Act of 1934

Fiscal 2017

Fiscal year ended January 28, 2018

Fiscal 2018

Fiscal year ended February 3, 2019

Fiscal 2019

Fiscal year ended February 2, 2020

Fiscal 2020

Fiscal year ended January 31, 2021

GAAP

Generally accepted accounting principles in the United States of America

Gross margin

Gross profit as a percentage of net sales

HDS

HD Supply, Inc.

Holdings

HD Supply Holdings, Inc.

HVAC

Heating, ventilating, and air conditioning

MRO

Maintenance, repair and operations

NASDAQ

The NASDAQ Stock Market LLC

NOL

Net operating loss

OEM

Original equipment manufacturer

SKU

Stock-keeping unit

SEC

U.S. Securities and Exchange Commission

U.S.

United States

Vendor rebates

Inventory purchase rebates from vendors

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 that are based on management’s beliefs and assumptions and information currently available to management. 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 (“Part I. Item 1A. 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:

our ability to successfully complete the previously announced separation of our Facilities Maintenance and Construction & Industrial businesses into two independent publicly traded companies and obtain the benefits therefrom;

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the incurrence of significant transaction costs;
the increased demands on management to prepare for and accomplish the separation;
inherent risks of the maintenance, repair and operations market, and the non-residential and residential construction markets;
our ability to maintain profitability;
our ability to service our debt and to refinance all or a portion of our indebtedness;
limitations and restrictions in the agreements governing our indebtedness;
the competitive environment in which we operate and demand for our products and services in highly competitive and fragmented industries;
the loss of any of our significant customers;
competitive pricing pressure from our customers;
our ability to identify and acquire suitable acquisition candidates on favorable terms;
cyclicality and seasonality of the maintenance, repair and operations market, and the non-residential and residential construction markets;
our ability to identify and develop relationships with a sufficient number of qualified suppliers and to maintain our supply chains;
disruptions to our operations caused by natural disasters, contagious diseases and viral outbreaks, or geopolitical events;
our ability to manage fixed costs;
the development of alternatives to distributors in the supply chain;
our ability to manage our working capital through product purchasing and customer credit policies;
interruptions in the proper functioning of our information technology (“IT”) systems, including from cybersecurity threats;
potential material liabilities under our self-insured programs;
our ability to attract, train and retain highly qualified associates and key personnel;
new and/or proposed trade policies could make sourcing product from foreign countries more difficult and more costly;
limitations on our income tax NOL carryforwards in the event of an ownership change; and
our ability to identify and integrate new products.

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 annual report on Form 10-K 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.

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PART I

ITEM 1.    BUSINESS

Our Company

HD Supply is one of the largest industrial distributors in North America. We believe we have leading positions in the two distinct market sectors in which we specialize: Maintenance, Repair & Operations (“MRO”) and Specialty Construction. These market sectors are large and fragmented, and we believe they present opportunities for significant growth. We aspire to be the “First Choice” of customers, associates, suppliers and the communities in which we operate. This aspiration drives our relentless focus and is reflected in the customer and market centricity, speed and precision, intense teamwork, process excellence and trusted relationships that define our culture. We believe this aspiration distinguishes us from other distributors and has created value for our stockholders, driven above-market growth and delivered attractive returns on invested capital.

Through approximately 270 branches and 44 distribution centers in the U.S. and Canada, we serve our markets with an integrated go-to-market strategy. We have approximately 11,500 associates delivering localized, customer-tailored products, services and expertise. We serve approximately 500,000 customers, which include contractors, maintenance professionals, home builders, industrial businesses, and government entities. Our broad range of end-to-end product lines and services include approximately 600,000 SKUs of quality, name-brand and proprietary-brand products as well as value-add services supporting the entire life-cycle of a project from construction to maintenance, repair and operations.

For fiscal 2019, we:

generated $6 billion in Net sales, representing 1.6% growth over fiscal 2018;
generated Net income of $452 million in fiscal 2019, as compared to a Net income of $394 million in fiscal 2018;
generated $873 million of Adjusted EBITDA, representing 0.2% growth over fiscal 2018; and
generated $596 million of Adjusted net income in fiscal 2019, as compared to $619 million in fiscal 2018.

For a reconciliation of Net income, the most directly comparable financial measure under GAAP, to Adjusted EBITDA and Adjusted net income, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Business Metrics—Adjusted EBITDA and Adjusted Net Income.”

We believe our long-standing customer relationships and competitive advantage stem from our knowledgeable associates, extensive product and service offerings, national footprint, integrated best-in-class technology, broad purchasing scale and strategic supplier relationships. We believe that our comprehensive supply chain solutions improve the effectiveness and efficiency of our customers’ businesses. Our value-add services include customer training and certification, material and product fabrication, kitting, jobsite delivery and installation and will-call pickup options. Furthermore, we believe our product application knowledge, comprehensive product assortment, and sourcing expertise allow our customers to perform reliably and give them the tools to enhance profitability.

We reach our customers through a variety of sales channels, including professional outside and inside sales forces, call centers and direct marketing programs utilizing market-specific product catalogs, and business unit websites and digital tools. Our distribution network allows us to provide rapid, reliable, on-time delivery and customer pickup throughout the U.S. and Canada. Additionally, we believe our highly integrated, best-in-class technology provides leading e-commerce and integrated workflow capabilities for our customers, while providing us unparalleled pricing, budgeting, reporting and analytical capabilities across our Company. We believe customers view us as an integral part of the value chain due to our extensive product knowledge, expansive product availability and the ability to directly integrate with their systems and workflows.

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Our Strategy

Since 2007 we have undertaken significant operating and growth initiatives at all levels. We developed and are implementing a multi-year strategy to optimize our business mix. This strategy includes entering new markets and product lines, streamlining and upgrading our process and technology capabilities, acquiring new capabilities and identifying and acquiring acquisition targets that complement our existing businesses. At the same time, we attracted what we believe to be “best of the best” talent, capitalizing on relevant experience, teamwork and change navigation.

Both of our businesses invest in high-growth initiatives that align with our five growth plays:

1.Sell More to Existing Customers (i.e., Share of Wallet)
2.Introduce New Products and Services
3.Expand the Channels to Reach Our Customers (e.g., Internet, Catalog, and Mobility)
4.Acquire New Customers
5.Enter New Geographies (i.e., Open New Locations)

Through investments in these growth plays, we believe we are well-positioned to grow in excess of the markets in which we operate. Specific initiatives focus on increasing penetration within our existing customer base, including the addition of new sales talent across the Company; and the addition of new products and services, including proprietary brands, primarily in our Facilities Maintenance business. We also continue to invest in mobile technologies and e-commerce. We focus primarily on sales talent acquisition, entering new geographies and business combination opportunities to acquire new customers.

HD Supply is managed primarily on a product-line basis and reports results of operations in two reportable segments. The reportable segments are Facilities Maintenance and Construction & Industrial. In addition, the consolidated financial statements include “Corporate and Eliminations,” which comprises enterprise-wide functional departments that operate in a centralized structure.

Facilities Maintenance.    Facilities Maintenance distributes MRO products, provides value-add services and fabricates custom products. Our Facilities Maintenance business unit serves the owners of multifamily, hospitality, healthcare and institutional facilities. Products include electrical and lighting items, plumbing supplies, HVAC products, appliances, janitorial supplies, hardware, kitchen and bath cabinets, window coverings, textiles and guest amenities, healthcare maintenance and water and wastewater treatment products. Facilities Maintenance operates a distribution center-based model that sells its products primarily through a professional sales force, e-commerce and print catalogs.

Construction & Industrial.    Construction & Industrial distributes specialized hardware, tools, engineered materials and safety products to non-residential and residential contractors. Service offerings range from pre-bid assistance and product submittals to engineering and tool repair. Construction & Industrial reaches customers through a nationwide network of regionally organized branches as well as print catalogs and e-commerce. Products include tilt-up brace systems, forming and shoring systems, concrete chemicals, hand and power tools, cutting tools, rebar, ladders, safety and fall arrest equipment, specialty screws and fasteners, sealants and adhesives, drainage pipe, geo-synthetics, erosion and sediment control equipment and other engineered materials used broadly across all types of non-residential and residential construction. Construction & Industrial also includes Home Improvement Solutions, which offers light remodeling and construction supplies, kitchen and bath cabinets, windows, plumbing materials, electrical equipment and other products, primarily to small remodeling contractors and trade professionals through local retail outlets.

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Corporate and Eliminations.    In addition to the reportable segments, our consolidated financial results include “Corporate and Eliminations” which incurs costs related to our centralized support functions, which are comprised of finance, IT, human resources, legal, supply chain and other support services, and removes inter-segment transactions. All Corporate operating overhead costs are allocated to the reportable segments. Interest expense, interest income, other non-operating income and expenses, and provision for income taxes are not allocated to the reportable segments. The Company does not allocate Corporate assets to its reportable segments.

Our Market Sectors

We offer a diverse range of products and services to the MRO and Specialty Construction market sectors in the U.S. and Canada. The markets in which we operate have a high degree of customer and supplier fragmentation, with customers that typically demand a high level of service and availability of a broad set of complex products from a large number of suppliers. These market dynamics make the distributor a critical element within the value chain. Net sales for HD Supply outside of the United States, primarily in Canada, were $161 million, $157 million, and $146 million in fiscal 2019, fiscal 2018, and fiscal 2017, respectively.

Maintenance, Repair & Operations

In the MRO market sector, our Facilities Maintenance business serves customers across multiple industries by primarily delivering supplies and services needed to maintain and upgrade multifamily, hospitality, healthcare and institutional facilities. Facilities Maintenance is a distribution center-based model. We estimate that this market sector currently represents an addressable market in excess of $68 billion annually with demand driven primarily by ongoing maintenance requirements and property improvement projects of a broad range of living environments and traditional repair and remodeling construction activity across multiple industries. We believe Facilities Maintenance customers value speed and product availability over price. We believe our MRO business focus on living spaces, including apartment units, hotel or motel rooms and senior care living facilities, provides stable demand, even in challenging economic environments, when new construction tends to decrease.

Specialty Construction

In the Specialty Construction market sector, our Construction & Industrial and Home Improvement Solutions businesses serve professional contractors and trades by meeting their distinct and customized supply needs in non-residential, residential and industrial applications. We estimate that this market sector currently represents a served market of approximately $42 billion annually with demand driven primarily by non-residential construction, residential construction, industrial and repair and remodeling construction spending. Construction & Industrial serves this sector through the broad national presence of its regionally organized branch distribution network, as well as branches in six Canadian provinces, while Home Improvement Solutions operates through retail outlets in California primarily serving cash and carry customers. We believe we are well-positioned to benefit from the continued expansion of the non-residential and residential construction end-markets.

Our History

On July 2, 2013, Holdings completed an initial public offering of 61,170,212 shares of its common stock at a price of $18.00 per share, for an aggregate offering price of $1,039 million, net of underwriters’ discounts and commissions and offering expenses of approximately $16 million. Upon completion of Holdings’ secondary public offerings in fiscal 2014 and fiscal 2015, The Home Depot, Inc. and three private equity firms, collectively our former parent, sold all of their remaining original investment in Holdings.

During fiscal 2014, we completed the disposal of Litemor through liquidation. In January 2015, we sold substantially all of the assets of our Hardware Solutions business. In October 2015, we sold our Power Solutions business. In May 2016, we sold our Interior Solutions business. In August 2017, we sold our Waterworks business. For additional information on the discontinued operations, see “Note 3, Discontinued Operations” in the Notes to Consolidated Financial Statements within “Part II. Item 8. Financial Statements and Supplementary Data.”

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In March 2018, we completed the acquisition of A.H. Harris Construction Supplies (“A.H. Harris”), a leading specialty construction distributor serving the northeast and mid-Atlantic regions, expanding Construction & Industrial’s market presence in the northeastern U.S. For additional information on the acquisition of A.H. Harris, see “Note 2, Acquisitions” in the Notes to Consolidated Financial Statements within “Part II. Item 8. Financial Statements and Supplementary Data.”

On September 24, 2019, we announced our intention to separate our Facilities Maintenance and Construction & Industrial businesses into two independent publicly traded companies. The transaction, expected to be structured as a distribution of the Construction & Industrial - White Cap business unit (“White Cap”) to the stockholders of Holdings by the middle of fiscal 2020, is expected to be tax free to the Company and its stockholders. See "Part I. Item 1A. Risk Factors - Risks Relating to Our Proposed Spinoff of Our White Cap Business."

Customers and Suppliers

We maintain a customer base of approximately 500,000 customers, many of whom represent long-term relationships. We are subject to very low customer concentration with our ten largest customers generating approximately 12.7% of our Net sales in fiscal 2019, reducing our exposure to any single customer.

We have developed relationships with approximately 7,000 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 shortages for our customers.

Competition

We operate in a highly fragmented industry and hold leading positions in both market sectors. The majority of our competition comes from mid-size regional distributors and small, local distributors; however, we also face competition from a number of national competitors, including Fastenal, Grainger, MSC Industrial, Watsco, Home Depot Pro (a division of The Home Depot, Inc.), Maintenance Supply Headquarters (a division of Lowe’s Companies, Inc.) and Ferguson.

We believe the principal competitive factors for our market sectors include local selling capabilities, availability, breadth and cost of materials and supplies, technical knowledge and expertise, value-add service capabilities, customer and supplier relationships, reliability and accuracy of service, effective use of technology, delivery capabilities and timeliness, pricing of products, and the provision of credit. We believe that our competitive strengths and strategy allow us to compete effectively in our market sectors.

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 and customer deliveries.

Products

Maintenance, Repair & Operations:

Facilities Maintenance: Electrical and lighting items, plumbing, HVAC products, appliances, janitorial supplies, hardware, kitchen and bath cabinets, window coverings, textiles and guest amenities, healthcare maintenance and water and wastewater treatment products.

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Specialty Construction:

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

Home Improvement Solutions: 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.

Intellectual property

Our trademarks and those of our subsidiaries are registered or otherwise legally protected in the U.S., Canada and elsewhere. We, together with our subsidiaries, own approximately 145 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 ®, USABluebook ®, Seasons ®, Brigade ®, Maintenance Warehouse ®, White Cap ®, Cotton Bay ®, Fido ®, Champion ®, Shield Security ®, Brafasco ® and AH Harris ®,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 “Part I. Item 1A. Risk Factors—Risks Relating to Our Business - 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 11,500 employees as of February 2, 2020, consisting of approximately 7,500 hourly personnel and approximately 4,000 salaried employees.

As of February 2, 2020, less than 1% of our workforce was covered by 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, 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 salability of our products. The transportation and disposal of many of our products are also subject to federal regulations. 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. See “Part I. Item 1A. Risk Factors—Risks Relating to Our Business—Our costs of doing business could increase as a result of changes in U.S. federal, state or local regulations.”

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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 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.

The public may read and copy any such 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 https://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 website, 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 an inactive textual reference. The information contained on our website is not incorporated by reference into this annual report on Form 10-K. 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

3400 Cumberland Boulevard SE

Atlanta, Georgia 30339

Attn: General Counsel

(770) 852-9000

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PART I

ITEM 1A. RISK FACTORS

Risks Relating to Our Business

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

Demand for our products and services depends to a significant degree on spending in our markets. The level of activity in our 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 non-residential and residential construction markets include:

changes in interest rates;
unemployment rates;
availability of skilled labor;
high foreclosure rates and unsold/foreclosure inventory;
unsold new housing inventory;
availability of financing (including the impact of disruption in the mortgage markets);
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 maintenance, repair and operations market, the level of activity depends largely on the number of units and occupancy rates within multifamily, hospitality, healthcare and institutional facilities markets. Because both 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 again adversely affect our business, financial condition, results of operations and cash flows, and could require us to close under-performing locations. While we operate in many markets in the U.S. and Canada, our business is particularly impacted by changes in the economies of California, Florida, and Texas.

In addition, the markets in which we compete are sensitive to general business and economic conditions in the U.S. and worldwide, including availability of credit, changes in interest rates, fluctuations in capital, credit, and mortgage markets, and changes in business and consumer confidence. 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. Weakness in the non-residential building construction market and the new residential construction market could have a significant

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adverse effect on our business, financial condition, results of operations, and cash flows. In addition, because of these factors, there may be fluctuations in our results of operations, and the results for any historical period may not be indicative of results for any future period.

We may be unable to 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. 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 failure to:

grow our revenue organically or through acquisitions;
improve our revenue mix by investing (including through acquisitions) in businesses that provide higher margins than we have been able to generate historically;
achieve improvements in purchasing or maintain or increase our rebates from vendors through our vendor consolidation and/or low-cost country initiatives;
improve our gross margins through the utilization of improved pricing practices and technology and sourcing savings;
maintain or reduce our overhead and support expenses as we grow;
effectively evaluate future inventory reserves;
maintain an appropriate product mix, particularly with respect to our outlook, budgeting and strategic planning;
collect monies owed to us from customers;
maintain relationships with our significant customers; and
integrate any businesses acquired.

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

We may be required to take impairment charges relating to our operations which could impact our future operating results.

As of February 2, 2020, goodwill represented approximately 42% 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. 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 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. Our annual impairment test resulted in no impairment of goodwill during fiscal 2019, fiscal 2018, or fiscal 2017.

We cannot accurately predict the amount and timing of any impairment of assets, and we may be required to take goodwill or other asset impairment charges relating to certain of our reporting units and asset groups in the event we experience weakness in the non-residential and/or residential construction markets and/or the general U.S. economy. Similarly, certain company transactions could result in goodwill impairment charges being recorded. Any such non-cash charges would have an adverse effect on our financial results.

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We occupy most of our locations under long-term non-cancelable leases. We may be unable to renew leases on favorable terms or at all. Also, if we close a location, we may remain obligated under the applicable lease.

Most of our locations are located in leased premises. Many of our current leases are non-cancelable and typically have terms ranging from three to seven years, with 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. However, there can be no assurance that we will be able to renew our current or future leases on favorable terms or at all which could have an adverse effect on our ability to operate our business and on our results of operations. In addition, if we close a location, we generally remain committed to perform our obligations under the applicable lease, which include, among other things, payment of the base rent for the balance of the lease term. Our obligation to continue making rental payments in respect of leases for closed locations could have a material adverse effect on our business and results of operations.

The markets 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 markets in which we operate are fragmented and highly competitive. Our competition includes other distributors and manufacturers that sell products directly to their respective customer bases. To a limited extent, retailers of electrical and plumbing fixtures and supplies, building materials, maintenance, repair and operations supplies and tools and equipment also compete with us. We also expect that new competitors may develop over time as internet-based enterprises become more reliable and refine their service capabilities. Competition varies depending on product offerings, customer classification and geographic area.

We compete with many local, regional and, in several markets and product categories, other national distributors. No assurance can be given that we will be able to effectively respond to these 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.

Additionally, customers historically have exerted pressure on their outside suppliers to keep prices low in the highly fragmented, competitive bid-based specialty concrete supply industry. If we are unable to generate sufficient cost savings to offset any price reductions, our financial condition, results of operations, and cash flows may be adversely affected.

Our competitors continue to consolidate, which could cause markets to become more competitive and could negatively impact our business.

Although the markets in which we operate are currently highly fragmented, our competitors in the U.S. and Canada continue to consolidate. This consolidation is being driven by customer needs and supplier capabilities, which could cause markets to become more competitive as greater economies of scale are achieved by distributors, or as competitors with new business models are willing and able to operate with lower gross profits. 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 more capable of being consistent sources of supply.

There can be no assurance that we will be able to take advantage effectively of this 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 potential 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 in these markets.

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

We cannot guarantee that we will maintain or improve our relationships with our largest customers or that we will continue to supply these customers at historical levels. 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, a significant customer’s decision to purchase our products in significantly lower quantities than they have in the past or deterioration in our relationship with any of our significant customers could significantly affect our financial condition, operating results and cash flows.

Generally, our customers are 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.

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 is facilitated through the extension of credit to our customers whose ability to pay is dependent, in part, upon the economic strength of the industry in the areas where they operate. Our business units 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. 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 certain of our customers, if the financial condition of our customers declines, our credit risk could increase. Significant contraction in our markets, coupled with tightened credit availability and financial institution underwriting standards, could adversely affect certain of our customers and could adversely affect the collectability of our accounts receivable, bad debt reserves and net income.

Future strategic transactions could impact our reputation, business, financial position, results of operations and cash flows, and we may not achieve the acquisition component of our growth strategy.

We may pursue strategic transactions in the future, which could involve acquisitions or dispositions of businesses or assets. Any future strategic transaction could involve integration or implementation challenges, business disruption or other risks, or change our business profile significantly. Any inability on our part to successfully implement strategic transactions could have an adverse impact on our reputation, business, financial position, results of operations and cash flows. Any acquisition that we make may not provide us with the benefits that were anticipated when entering into such acquisition. Any current or future disposition transactions could also impact our business and may subject us to various risks, including failure to obtain appropriate value for the disposed businesses, post-closing claims being levied against us and disruption to our other businesses during the sale process or thereafter.

In addition, although acquisitions may continue to be a component of our growth strategy, 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, an increase in interest expense and amortization expense and significant charges relative to integration costs. Our strategy could be impeded if we do

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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 for the newly acquired business;
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 and 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; 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, results of operations and cash flows.

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

The maintenance, repair and operations market and the non-residential and residential construction markets are seasonal and cyclical.

Our highest volume of Net sales historically has occurred in our second and third fiscal quarters. Generally, during the winter months, construction and renovation activity declines due to inclement weather and shorter daylight hours. Our results of operations may vary significantly from period to period as a result of this seasonality.

In addition, the non-residential and residential construction 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, results of operations, and cash flows.

Fluctuating commodity prices may adversely impact our results of operations.

The cost of steel, refrigerants, and other commodities used in the products we distribute can be volatile, including as a result of international trade policies and tariffs. 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.

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If petroleum prices increase, our results of operations could be adversely affected. Conversely, prolonged weakness in the oil and gas industry could negatively impact our financial condition, results of operations and cash flows.

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 our business units, we deliver products to our customers via our own trucks as well as third-party carriers. 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.

A number of our locations serve customers that are either direct or indirect participants in the oil and gas industry. Additionally, a number of our locations are also geographically located in or near areas where the oil and gas industry is a significant component of the overall local economy, such as in Texas and in the various shale gas producing regions within the U.S. and Canada. If the prices of oil and gas remain relatively low and our customers are negatively impacted, then our customers’ demand for our products and services could also be negatively impacted which would have an adverse effect on our financial condition, results of operations and cash flows.

Product shortages 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 available 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, actions taken to combat contagious disease and viral outbreaks or weather conditions affecting products or shipments, transportation disruptions, adjustments to our inventory levels or other factors within and beyond our control.

Short- and long-term disruptions in our supply chain would result in a need to maintain higher inventory levels as we replace similar product, 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. 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 inability to pass on material price increases to our customers could adversely impact our financial condition, operating results and cash flows.

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

We buy our products and supplies from suppliers located throughout the world. These suppliers manufacture and source products from the U.S. and abroad. Our ability 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

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our quality or safety standards. In addition, our suppliers could discontinue selling products 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 some of the products that we distribute are 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.

The occurrence of one or more natural disasters or extreme weather such as earthquakes, blizzards, storms, hurricanes, floods, fires, droughts, tornadoes; viral contagions or pandemic diseases, such as the recent outbreak of a novel strain of coronavirus, now known as COVID-19; geopolitical events, such as civil unrest, acts of terrorism or war (including security measures that could disrupt or impede our distribution networks and supply chains) in a country in which we operate or in which our suppliers are located could result in a disruption of our logistics or supply chain network. For example, should the COVID-19 outbreak continue or spread, it could disrupt our operations and those of our customers and suppliers. Any of these or other natural disasters, catastrophic events or disruptions could cause any of our locations to become non-operational, adversely affect our ability to timely obtain or deliver products and services, impair our ability to meet customer demand for products and services, or result in lost sales, additional costs, or penalties, and/or damage our reputation. Any of these adverse consequences could have a significant impact on our financial condition, results of operations and cash flows.

Evolving trade policies could continue to make sourcing product from foreign countries difficult and costly.

We source a significant amount of our products from outside of the U.S. Considerable political uncertainty exists in the U.S. and abroad that could result in continuing changes to the national and international trade policies around which we have built our sourcing practices and operations. Given our investment in our sourcing and logistics operations and infrastructure, as well as our reliance upon non-domestic suppliers, any significant changes to the U.S. trade policies (and those of other countries in response) may cause a material adverse effect on our ability to source products from other countries or significantly increase the costs of obtaining such products, which could result in a material adverse effect on our financial results. For example, the U.S. currently has imposed tariffs on many Chinese-origin goods and may continue to do so in the future. As a result, the cost of some of our products may increase and our margins could be reduced.

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 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.

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 fulfilling 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.

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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.

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 business units 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 with 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.

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

We use our information systems to, among other things, manage inventories and accounts receivable, make purchasing decisions, manage our fabricating operations and monitor our results of operations, and process, transmit and store sensitive electronic data, including employee, supplier and customer records. As a result, the proper functioning of our IT systems is critical to the successful operation of our business. Our information systems include proprietary systems developed and maintained by us. In addition, we depend on IT systems of third parties, such as suppliers, retailers and OEMs to, among other things, market and distribute products, develop new products and services, operate our website, host and manage our services, store data, process transactions, respond to customer inquiries and manage inventory and our supply chain. Although our IT systems are protected through physical and software safeguards and remote processing capabilities exist, our IT systems or those of third parties upon whom we depend are still vulnerable to natural disasters, power losses, unauthorized access, telecommunication failures and other problems. Despite our policies, procedures and programs designed to ensure the integrity of our IT systems, we may not be effective in identifying and mitigating every risk to which we are exposed. Furthermore, from time to time we rely on IT systems which may be managed, hosted, provided and/or accessed by third parties or their vendors, to assist in conducting our business. Such relationships and access may create difficulties in anticipating and implementing adequate preventative measures or fully mitigating harms after a breach. If critical proprietary or third-party IT systems fail or are otherwise unavailable, including as a result of system upgrades and transitions, our ability to process and deliver customer orders, track credit risk, identify business opportunities, maintain proper levels of inventories, collect accounts receivable, pay expenses and otherwise manage our business would be adversely affected.

Cybersecurity incidents can result from deliberate attacks or unintentional events. These incidents can include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, collecting ransoms, corrupting data, or causing operational disruption. Cybersecurity attacks in particular are becoming more sophisticated and include, but are not limited to, malicious

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software, attempts to gain unauthorized access to data (either directly or through our vendors and customers), denial of service attacks and other electronic security breaches. Despite our security measures, our IT systems and infrastructure or those of our third parties may be vulnerable to such cybersecurity incidents. The result of these incidents could include, but are not limited to, disrupted operations, misstated or misappropriated financial data, theft of our intellectual property or other confidential information (including of our customers, suppliers and employees), liability for stolen assets or information, increased cybersecurity protection costs and reputational damage adversely affecting customer or investor confidence. In addition, if any information about our customers, including payment information, were the subject of a successful cybersecurity attack against us, we could be subject to litigation or other claims by the affected customers or by governments enforcing data privacy regulations. Such claims may result in significant sanctions, monetary costs or other harm to us. Furthermore, we have incurred costs and may incur significant additional costs in order to implement the security measures we feel are appropriate to protect our IT systems.

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 41 U.S. states and 6 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, 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 salability of our products. Changes in U.S. federal, state or local regulations governing the sale 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 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.

We cannot predict whether future developments in law and regulations concerning our business units will affect our business, financial condition and results of operations in a negative manner. Similarly, we cannot assess whether our business units 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 such claims in the past, which have been resolved without material financial impact. From time to time, we are involved in construction defect and product liability claims relating to the products we distribute and fabricate, among other things. 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 traffic 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

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any such insurance will provide adequate coverage against potential claims. Further, while we seek indemnification against potential liability for product liability claims from relevant parties, including but not limited to manufacturers and suppliers, we cannot guarantee that we will be able to recover under such indemnification agreements. Moreover, if 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 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.

From time to time, we are also involved in government inquiries and investigations, as well as class action, consumer, employment and tort proceedings, 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.

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 are self-insured for our health benefits and maintain per employee stop-loss coverage. Although we believe that we have adequate stop-loss coverage for catastrophic claims to cap the risk of loss, our results of operations and financial condition may be adversely affected if the number and severity of claims that are not covered by stop-loss insurance increases.

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 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 adverse. 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 chief executive officer and senior management team as well as our branch managers and sales personnel 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

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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 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 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 us. Future tax law changes may materially increase our prospective income tax expense.

We are subject to income taxation in many jurisdictions in the U.S. as well as 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 and/or import tariffs or border adjustment proposals 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.

Our NOL carryforwards could be limited if we experience an “ownership change,” as defined in the Code.

As of February 2, 2020, we have significant state NOL carryforwards, which expire in various years through fiscal 2038. Our ability to deduct these NOL carryforwards against future taxable income is contingent on the generation of future taxable income in the jurisdiction of the prior NOL. Additionally, our ability to deduct NOL carryforwards could be limited if we experience an “ownership change,” as defined in Section 382 of the Internal Revenue Code of 1986, as amended. In general, an ownership change may result from transactions increasing the

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aggregate direct or indirect ownership of certain persons (or groups of persons) in our stock by more than 50 percentage points over a testing period (generally three years). Future direct or indirect changes in the ownership of our common stock, including sales or acquisitions of our common stock by stockholders and purchases and issuances of our common stock by us, some of which are not in our control, could result in an ownership change. Any resulting limitation on the use of our NOL carryforwards could result in the payment of taxes above the amounts currently anticipated and have a negative effect on our future results of operations and financial position.

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 expansion into new markets may present competitive, distribution and regulatory challenges that differ from current ones. We may be less familiar with the target customers and may face different or additional risks, as well as increased or unexpected costs, compared to existing operations. Growth into new markets may also bring us into direct competition with companies with whom we have little or no past experience as competitors. To the extent we are reliant upon expansion into new geographic, industry and product markets for growth and do not meet the new challenges posed by such expansion, our future sales growth could be negatively impacted, our operating costs could increase, and our business operations and financial results could be negatively affected.

We could incur significant costs in complying with environmental, health and safety laws or permits or as a result of satisfying any liability or obligation imposed under such laws or permits.

Our operations are subject to various federal, state, local and foreign environmental, health and safety laws and regulations. Among other things, these laws regulate the emission or discharge of materials into the environment, govern the use, storage, treatment, disposal and management of hazardous substances and wastes, protect the health and safety of our employees and the end users of our products, regulate the materials used in and the recycling of products and impose liability for the costs of investigating and remediating, and damages resulting from, present and past releases of hazardous substances. Violations of these laws and regulations or non-compliance with any conditions contained in any environmental permit can result in substantial fines or penalties, injunctive relief, requirements to install pollution or other controls or equipment, civil and criminal sanctions, permit revocations and/or facility shutdowns. We could be held liable for the costs to address contamination of any real property we have ever owned, operated or used as a disposal site. We could also incur fines, penalties, sanctions or be subject to third-party claims for property damage, personal injury or nuisance or otherwise as a result of violations of or liabilities under environmental laws in connection with releases of hazardous or other materials. In addition, changes in, or new interpretations of, existing laws, regulations or enforcement policies, the discovery of previously unknown contamination, or the imposition of other environmental liabilities or obligations in the future, including additional investigation or other obligations with respect to any potential health hazards of our products or business activities or the imposition of new permit requirements, may lead to additional compliance or other costs that could have material adverse effect on our business, financial condition or results of operations.

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, over

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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 could be 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 products and services.

Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could materially and adversely affect us.

We are required to evaluate the effectiveness of our disclosure controls and procedures 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 IT, and we have implemented additional financial and management controls, reporting systems and procedures. 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 both organically and through acquisition, our disclosure controls and procedures and internal control over financial reporting will become more complex, and we may require significantly more resources to ensure that these controls and procedures remain effective. If we are unable to continue upgrading our financial and management controls, reporting systems, IT and procedures in a timely and effective fashion, additional management and other resources of the 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.

Future changes in financial accounting standards may significantly change our reported results of operations.

The accounting principles generally accepted in the United States of America (“GAAP”) are subject to interpretation by the Financial Accounting Standards Board (“FASB”), the American Institute of Certified Public Accountants, the SEC and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results and could affect the reporting of transactions completed before the announcement of a change.

Additionally, our assumptions, estimates and judgments related to complex accounting matters could significantly affect our financial results. GAAP and related accounting pronouncements, implementation guidelines and interpretations with regard to a wide range of matters that are relevant to our business, including, but not limited to, revenue recognition, impairment of long-lived assets, leases and related economic transactions, intangibles, self-insurance, income taxes, property and equipment, litigation and stock-based compensation are highly complex and involve many subjective assumptions, estimates and judgments by us. Changes in these rules or their interpretation or changes in underlying assumptions, estimates or judgments by us (i) could require us to make changes to our accounting systems to implement these changes that could increase our operating costs and (ii) could significantly change our reported or expected financial performance.

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Risks Relating to Our Indebtedness

We have substantial debt and may incur substantial additional debt, which could adversely affect our financial health, reduce our profitability, limit our ability to obtain financing in the future and pursue certain business opportunities and reduce the value of your investment.

As of February 2, 2020, we had an aggregate principal amount of $2,046 million of outstanding debt, net of unamortized discounts and unamortized deferred financing costs of $3 million and $18 million, respectively. In fiscal 2019, we incurred $110 million of interest expense.

The amount of our debt or such other obligations could have important consequences for holders of our common stock, including, but not limited to:

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 other purposes may be impaired in the future;
we are exposed to the risk of increased interest rates because a portion of our borrowings is at variable rates of interest;
we may be at a disadvantage compared to our competitors with less debt or with comparable debt at more favorable terms 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
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 business units.

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.

We cannot make assurances that we will be able to refinance any of our indebtedness, or obtain additional financing, particularly because of our current debt levels 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. The credit agreements governing our Senior Credit Facilities and the indenture 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 when due.

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Despite our current level of indebtedness, we may still be able to incur substantially more debt. This could further exacerbate the risks to our financial condition.

We may be able to incur significant additional indebtedness in the future, including secured debt. Although the agreements governing our indebtedness contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions, and the additional indebtedness incurred in compliance with these restrictions could be substantial. These restrictions also will not prevent us from incurring obligations that do not constitute indebtedness, including obligations under lease arrangements that are currently recorded as debt under GAAP. In addition, the Senior ABL Facility provides a commitment of up to $1,000 million subject to a borrowing base. As of February 2, 2020, we were able to borrow an additional $598 million under the Senior ABL Facility. If new debt is added to our current debt levels, the related risks that we now face could intensify.

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 common stock.

Our Senior ABL Facility and our Term Loan Facility contain covenants that, among other things, restrict or limit our subsidiaries’ ability to:

dispose of assets;
incur additional indebtedness (including guarantees of additional indebtedness);
prepay or amend our various 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 consensual restrictions on our subsidiaries’ ability to pay dividends.

The indentures governing our outstanding notes contain restrictive covenants that, among other things, limit the ability of our subsidiaries to:

incur additional debt;
make certain investments;
create liens;
transfer or sell assets; and
merge or consolidate with other companies.

Our ability to comply with the covenants and restrictions contained in the Senior Credit Facilities and the indenture 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 indenture governing our outstanding notes 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 indebtedness, lenders having secured obligations, such as the lenders under the Senior Credit Facilities, could proceed against the collateral securing the secured obligations. This could have serious consequences to our financial condition and results of operations and could cause us to become bankrupt or insolvent.

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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 Senior ABL 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 we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing stockholders could suffer significant dilution in their percentage ownership of the Company, and any new securities we issue could have rights, preferences and privileges senior to those of holders of our common stock.

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. Such an effect may occur from changes in regulatory standards or industry practices, such as the transition away from the London Interbank Offered Rate (“LIBOR”) as a benchmark reference for short-term interests. Such a transition may result in the usage of a higher reference rate for our variable rate debt. After giving effect to our interest rate swap agreement, each one percentage point increase in interest rates on our variable-rate debt would increase our annual forecasted interest expense by approximately $6 million based on balances as of February 2, 2020. Assuming all revolving loans were fully drawn, and after giving effect to our interest rate swap agreement, each one percentage point increase in interest rates would result in a $13 million increase 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.

We may not be able to repurchase our existing notes upon a change of control.

Upon the occurrence of specific kinds of change of control events, we will be required to offer to repurchase all outstanding notes until such notes are redeemed in full. Additionally, under the Term Loan Facility and the Senior ABL Facility, a change of control (as defined therein) constitutes an event of default that permits the lenders to accelerate the maturity of borrowings under the respective agreements and terminate their commitments to lend. We may not be able to satisfy the obligations upon a change of control because we may not have sufficient financial resources to purchase all of the debt securities that are tendered upon a change of control and repay our other indebtedness that will become due. Consequently, we may require additional financing from third parties to fund any such purchases, and we may be unable to obtain financing on satisfactory terms or at all. Further, our ability to repurchase our existing notes may be limited by law. In order to avoid the obligations to repurchase our existing notes and events of default and potential breaches of the credit agreement governing the Term Loan Facility, and the credit agreement governing the Senior ABL Facility, we may have to avoid certain change of control transactions that would otherwise be beneficial to us.

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Risks Relating to Our Common Stock

Holdings is a holding company with no operations of its own, and it depends on its subsidiaries for cash to fund all of its operations and expenses, including to buy back capital stock and make future dividend payments, if any.

Our operations are conducted almost entirely through our subsidiaries and our ability to generate cash to meet our debt service obligations, to buy back capital stock and to pay dividends is highly dependent on the earnings and the receipt of funds from our subsidiaries via dividends or intercompany loans. Historically, we have not declared or paid dividends on our common stock. However, to the extent that we determine in the future to pay dividends on our common stock, our Senior Credit Facilities significantly restrict the ability of our subsidiaries to pay dividends or otherwise transfer assets to us. In addition, Delaware law may impose requirements that may restrict our ability to pay dividends to holders of our common stock.

Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.

Our amended and restated certificate of incorporation and amended and restated by-laws include a number of provisions that may discourage, delay or prevent a change in our management or control over us that stockholders may consider favorable. For example, our amended and restated certificate of incorporation and amended and restated by-laws:

authorize the issuance of “blank check” preferred stock that could be issued by our Board of Directors to thwart a takeover attempt;
provide that vacancies on our Board of Directors, including newly-created directorships, shall be filled only by a majority vote of directors then in office;
prohibit stockholders from calling special meetings of stockholders;
prohibit stockholder action by written consent, thereby requiring all actions to be taken at a meeting of the stockholders;
establish advance notice requirements for nominations for election to our Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings; and
require the approval of holders of at least 75% of the outstanding shares of our voting common stock to amend our amended and restated by-laws and certain provisions of our amended and restated certificate of incorporation.

These provisions may prevent our stockholders from receiving the benefit from any premium to the market price of our common stock offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if the provisions are viewed as discouraging takeover attempts in the future.

Our amended and restated certificate of incorporation and amended and restated by-laws may also make it difficult for stockholders to replace or remove our management. These provisions may facilitate management entrenchment that may delay, deter, render more difficult or prevent a change in our control, which may not be in the best interests of our stockholders.

We may not determine to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We may not declare and pay dividends on our common stock in the near future. In the absence of a dividend, the success of an investment in shares of our common stock would depend upon any future appreciation in their value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.

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Risks Relating to our Proposed Spinoff of our White Cap Business

The proposed spinoff of our White Cap business is contingent upon the satisfaction of a number of conditions, may require significant time and attention of our management and may have an adverse effect on us if not completed.

On September 24, 2019, we announced our intention to separate our Facilities Maintenance and Construction & Industrial businesses into two independent publicly traded companies. The transaction, expected to be structured as a distribution of the Construction & Industrial – White Cap business unit (“White Cap”) to the shareholders of Holdings in the 2020 calendar year, is expected to be tax free to the Company and its shareholders. The proposed spinoff is subject to various conditions and may be affected by unanticipated developments or changes in market conditions that could delay, prevent, or otherwise adversely affect the spinoff. Completion of the spinoff will be contingent upon several factors, including, but not limited to, authorization and approval of our board of directors, receipt of governmental and regulatory approvals of the transactions contemplated by the spinoff, receipt of a tax opinion regarding the tax-free status of the spinoff, execution of intercompany agreements, and the effectiveness of a registration statement with the SEC. For these and other reasons, the spinoff may not be completed as expected during 2020, if at all.

In pursuing the proposed spinoff, our ongoing businesses may be adversely affected, and we may be subject to certain risks and consequences, including, but not limited to, the following:

execution of the proposed spinoff will require significant time and attention from management, which may postpone the execution of other initiatives that may have been beneficial to us;
completion of the spinoff will require strategic, structural and process realignment and restructuring actions within our operations, which could lead to a disruption of our operations, loss of, or inability to recruit key personnel needed to operate and grow our businesses and to complete the proposed spinoff;
completion of the spinoff may require certain management and procedural redundancies as we prepare for the separation of White Cap from HD Supply, which may result in operating inefficiencies; and
we will be required to pay certain costs and expenses relating to the spinoff, such as legal, accounting, and other professional fees, whether or not it is completed.

If the spinoff is not completed, we may experience negative reactions from the financial markets.

Any of these factors could have a material adverse effect on our financial condition, results of operations, cash flows, and the price of our common stock.

We may be unable to achieve some or all of the benefits that we expect to achieve from the spinoff.

Although we believe that separating our White Cap business from HD Supply will provide financial, operational, managerial, and other benefits to us and our stockholders, the spinoff may not provide such results on the scope or scale we anticipate, and we may not realize the intended benefits of the spinoff. In addition, we will incur one-time costs in connection with the spinoff that may exceed our estimates and negate some of the benefits we expect to achieve. If we do not realize these assumed benefits, we could suffer a material adverse effect on our financial condition. Further, if the proposed spinoff is completed, our operational and financial profile will change upon the separation of the White Cap business from HD Supply. As a result, our diversification of revenue sources will diminish, and our results of operations, cash flows, working capital, and financing requirements may be subject to increased volatility.

If the proposed spinoff of our White Cap business is completed, we expect that the trading price of our common stock will decline.

We expect the trading price of our common stock immediately following the spinoff to be lower than immediately preceding the spinoff, as the trading price of our common stock will no longer reflect the value of our White Cap business.

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Following the spinoff, the combined value of your common stock in HD Supply and White Cap may trade at an aggregate price less than what the Company’s common stock might trade at had the spinoff not occurred.

The common stock of each of HD Supply and White Cap that you may hold following the spinoff may collectively trade at a value less than the price at which the Company’s common stock might have traded at had the spinoff not occurred. Reasons for this potential difference include the future performance of either HD Supply or White Cap as separate, independent companies, and the future stockholder base and market for HD Supply’s common stock and those of the White Cap business and the prices at which these shares individually trade.

The spinoff could result in substantial tax liability.

The spinoff is conditioned on our receipt of an opinion from our tax advisors, in form and substance satisfactory to us, that the distribution of shares of our White Cap business in the spinoff will qualify as tax-free to the White Cap business, HD Supply, and our stockholders for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) and related provisions of the U.S. Internal Revenue Code of 1986, as amended, (“the Code”), and other members of our consolidated tax reporting group. The opinion will rely on, among other things, various assumptions and representations as to factual matters made by the Company and the White Cap business which, if inaccurate or incomplete in any material respect, could jeopardize the conclusions reached by such advisor in its opinion. The opinion will not be binding on the Internal Revenue Service, (“IRS”), or the courts, and there can be no assurance that the IRS or the courts will not challenge the qualification of the spinoff as a transaction under Sections 355 and 368(a) of the Code or that any such challenge would not prevail.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Properties

As of February 2, 2020, we had a network of approximately 310 locations, of which approximately 10 were owned and 300 were 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. Our leased locations comprise approximately 15 million square feet while our owned locations comprise approximately 660,000 square feet. Our leases typically have an initial term that ranges from three to seven years, and the leases usually provide for the option to renew. On February 4, 2019, we purchased our leadership development and headquarters facility in Atlanta, Georgia, which is approximately 220,000 square feet. In addition, we lease approximately 110,000 square feet of corporate office space in Orlando, Florida. We believe our locations meet our current needs and that additional locations will be available as we expand in the future.

ITEM 3. LEGAL PROCEEDINGS

On July 10, 2017 and August 8, 2017, stockholders filed putative class action complaints in the U.S. District Court for the Northern District of Georgia, alleging that HD Supply and certain senior members of its management (collectively, the “securities litigation defendants”) made certain false or misleading public statements in violation of the federal securities laws between November 9, 2016 and June 5, 2017, inclusive (the “original securities complaints”). Subsequently, the two securities cases were consolidated, and, on November 16, 2017, the lead plaintiffs appointed by the Court filed a Consolidated Amended Class Action Complaint (the “Amended Complaint”) against the securities litigation defendants on behalf of all persons other than the securities litigation defendants who purchased or otherwise acquired the Company’s common stock between November 9, 2016 and June 5, 2017, inclusive. The Amended Complaint alleges that the securities litigation defendants made certain false or misleading public statements, primarily relating to the Company’s progress in addressing certain supply chain disruption issues encountered in the Company’s Facilities Maintenance business unit. The Amended Complaint asserts claims against the securities litigation defendants

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under Sections 10(b) and 20(a) of the Exchange Act and SEC Rule 10b-5, and seeks class certification under the Federal Rules of Civil Procedure, as well as unspecified monetary damages, pre-judgment and post-judgment interest, and attorneys’ fees and other costs. On September 19, 2018, the Court granted in part and denied in part the securities litigation defendants’ motion to dismiss. On January 30, 2020, the parties executed a written stipulation and agreement to settle the litigation for a payment of $50 million, subject to court approval. On February 21, 2020, the Court approved the settlement on a preliminary basis and scheduled a final approval hearing for July 21, 2020. The full settlement amount is covered under the Company’s insurance policies. The Company and individual defendants continue to dispute the allegations in the complaints, and the settlement is without any admission of the allegations in the complaints.

On August 8, 2017, two stockholder derivative complaints were filed in the U.S. District Court for the Northern District of Georgia, naming the Company as a “nominal defendant” and certain members of its senior management and board of directors as individual defendants. The complaints generally allege that the individual defendants caused the Company to issue false and misleading statements concerning the Company’s business, operations, and financial prospects, including misrepresentations regarding operating leverage and supply chain corrective actions. The complaints assert claims against the individual defendants under Section 14(a) of the Exchange Act, and allege breaches of fiduciary duties, unjust enrichment, corporate waste, and insider selling. The complaints assert a claim to recover any damages sustained by the Company as a result of the individual defendants’ allegedly wrongful actions, seek certain actions by the Company to modify its corporate governance and internal procedures, and seek to recover attorneys’ fees and other costs. On October 22, 2018, upon joint motion of the parties, the Court entered an order conditionally staying the proceedings and administratively closing the matter until after any summary judgment motion filed relating to the Amended Complaint is adjudicated.

On August 29, 2018, a stockholder derivative complaint was filed in Delaware Chancery Court naming the Company as a “nominal defendant” and certain members of its senior management and board of directors as individual defendants. The complaint generally alleges that the individual defendants caused the Company to issue false and misleading statements concerning the Company’s business, operations, and financial prospects, including misrepresentations regarding supply chain corrective actions. The complaint asserts various common law breach of fiduciary duty claims against the individual defendants and claims of unjust enrichment and insider selling. The complaint seeks to recover any damages sustained by the Company as a result of the individual defendants’ allegedly wrongful actions, seeks certain actions by the Company to modify its corporate governance and internal procedures, and seeks to recover attorneys’ fees and other costs. The individual defendants moved to dismiss the complaint on November 2, 2018. On January 14, 2019, upon joint motion of the parties, the Court entered an order conditionally staying the proceedings until after any summary judgment motions filed relating to the Amended Complaint is adjudicated.

The Company intends to defend the derivative lawsuits vigorously. Given the stage of the complaints and the claims and issues presented, the Company cannot reasonably estimate at this time the possible loss or range of loss, if any, that may arise from these unresolved lawsuits.

In March 2019, the Company received a subpoena from the U.S. Securities and Exchange Commission (“SEC”) requesting information and documents from calendar years 2016 and 2017 relating to, among other things, the Company’s Facilities Maintenance business unit and the allegations of the Amended Complaint described above. The Company has responded to the subpoena and intends to continue to cooperate with the SEC’s investigation. We cannot currently predict the timing or outcome of this ongoing investigation.

HD Supply is involved in various legal proceedings arising in the normal course of its 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 are not expected to have a material adverse effect on the Company’s consolidated financial condition, results of operations or cash flows. For all other matters management believes the possibility of losses from such matters is not probable, the potential loss from such

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matters is not reasonably estimable, or such matters are of such kind or involve such amounts that would not have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company if disposed of unfavorably. For material matters with loss contingencies that are reasonably possible and reasonably estimable, including matters with loss contingencies that are probable and estimable but for which the amount that is reasonably possible is in excess of the amount that the Company has accrued for, management has estimated the aggregate range of potential loss as $0 to $10 million. If a material loss is probable or reasonably possible, and in either case estimable, the Company has considered it in the analysis and it is included in the discussion set forth above.

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PART II

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

Stock Exchange Information

Holdings’ common stock is traded on The NASDAQ Stock Market LLC (“NASDAQ”) under the symbol “HDS.” As of March 9, 2020, there were approximately 16 registered holders of record and 634 restricted stock holders of Holdings’ common stock. No dividends were declared during fiscal 2019 or fiscal 2018.

Holdings’ common stock market prices*:

    

First

    

Second

    

Third

    

Fourth

Quarter

Quarter

Quarter

Quarter

Fiscal Year 2019

 

  

 

  

 

  

 

  

High

$

47.00

$

46.51

$

40.82

$

41.38

Low

$

41.45

$

39.15

$

37.15

$

39.08

Fiscal Year 2018

 

  

 

  

 

  

 

  

High

$

39.38

$

44.96

$

45.94

$

41.95

Low

$

35.50

$

38.12

$

36.47

$

35.62

*

Price as of close of business

Stock Performance Graph

The graph below presents Holdings’ cumulative total shareholder returns relative to the performance of the Standard & Poor’s 500 Composite Stock Index and the Industrial Select Sector SPDR® Fund (XLI) for our fiscal 2015-2019 years. The graph assumes $100 invested at the opening price of Holdings’ common stock on

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NASDAQ and each index on February 1, 2015 and assumes all dividends were reinvested on the date paid. The points on the graph represent fiscal year-end amounts based on the last trading day in each fiscal year.

Graphic

    

HD Supply

    

    

Industrial Select

Holdings, Inc.

S&P 500 Index

SPDR® Fund (XLI)

February 1, 2015

$

100

$

100

$

100

January 31, 2016

$

91

$

99

$

94

January 29, 2017

$

148

$

120

$

123

January 28, 2018

$

137

$

153

$

157

February 3, 2019

$

146

$

147

$

143

February 2, 2020

$

141

$

179

$

165

Issuer Purchases of Equity Securities

On March 12, 2020, the Company’s Board of Directors authorized a new share repurchase program for the repurchase of up to an aggregate $500 million of its common stock. The Company will conduct repurchases under the share repurchase program in the open market and through broker negotiated purchases in compliance with Rule 10b5-1 and Rule 10b-18 of the Securities Exchange Act of 1934, and subject to market conditions, restrictive covenants contained in existing debt agreements, applicable legal requirements, and other relevant factors. This share repurchase program does not obligate the Company to acquire any particular amount of its common stock, and it may be terminated at any time at the Company’s discretion.

On November 30, 2018, the Company’s Board of Directors authorized a share repurchase program for the repurchase of up to an aggregate $500 million of its common stock in accordance with guidelines specified under Rule 10b5-1 and Rule 10b-18 of the Exchange Act. Holdings completed the repurchase of all $500 million of common stock authorized under this share repurchase program in January 2020, purchasing approximately 13.0 million shares at an average price of $38.61 per share.

In fiscal 2014, Holdings’ Board of Directors authorized a share repurchase program to be funded from cash proceeds received from exercises of employee stock options. This share repurchase program does not obligate Holdings to acquire any particular amount of common stock, and it may be terminated at any time at Holdings’ discretion. During fiscal 2019, Holdings repurchased approximately 0.2 million shares at an average price of $42.25 per share.

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The number and average price of shares repurchased in each fiscal month of the fourth quarter of fiscal 2019 are set forth in the table below:

ISSUER PURCHASES OF EQUITY SECURITIES

    

    

    

    

Approximate Dollar

Total

Total Number of

Value of Shares that

Number

Average

Shares Purchased as

May Yet Be

of Shares

Price Paid

Part of a Publicly

Purchased Under the

Period

Purchased

per Share

Announced Program

Plans or Programs(1)

October 29 - November 25

 

347,171

$

39.47

 

347,171

$

44,923,541

November 26 - December 23

 

569,824

$

39.67

 

569,824

$

22,450,077

December 24 - February 2

 

623,597

$

39.90

 

623,597

$

33,199

Total

 

1,540,592

$

39.72

 

1,540,592

 

  

(1)The total dollar value of shares that may yet be purchased increases by the amount of cash proceeds received from the exercise of employee stock options as they occur.

HDS Securities

There is no established public trading market for HDS’s common stock. HDS had one record holder of common stock on February 2, 2020, and no equity securities of HDS are authorized for issuance under any equity compensation plan.

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ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data set forth below should be read in conjunction with “Part II. Item 7. 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. Our consolidated financial information may not be indicative of our future performance.

HDS has omitted the information required by this Item pursuant to General Instruction I to the Form 10-K.

On March 5, 2018, HD Supply completed the acquisition of A.H. Harris. In accordance with the acquisition method of accounting under Accounting Standards Codification (“ASC”) ASC 805, Business Combinations, the results of the acquisition are reflected in the Company’s consolidated financial statements from the date of acquisition forward. For additional information on the acquisition of A.H. Harris, see “Note 2, Acquisitions” in the Notes to the Consolidated Financial Statements within “Part II. Item 8. Financial Statements and Supplementary Data.”

In fiscal 2017, HD Supply sold its Waterworks business. In fiscal 2016, HD Supply sold its Interior Solutions business. In fiscal 2015, HD Supply sold its Power Solutions business. In accordance with ASC 205-20, Discontinued Operations, the results of the Waterworks, Interior Solutions, and Power Solutions operations and the gain/loss on disposition of the businesses are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the discontinued operations and gain/loss on the disposition of the businesses, net of tax, as one line item on the Consolidated Statements of Operations. All prior period Consolidated Statements of Operations have been revised to reflect this presentation. For additional information on the discontinued operations, see “Note 3, Discontinued Operations” in the Notes to Consolidated Financial Statements within “Part II. Item 8. Financial Statements and Supplementary Data.”

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Selected consolidated financial information

Fiscal Year Ended

 

February 2,

February 3,

January 28,

January 29,

January 31,

 

2020

2019

2018

2017

2016

 

 

(Dollars in millions, except per share amounts)

Statement of income data:

    

  

    

  

    

  

    

  

    

  

Net sales

$

6,146

$

6,047

$

5,121

$

4,819

$

4,615

Cost of sales

 

3,743

 

3,672

 

3,088

 

2,894

 

2,801

Gross profit

 

2,403

 

2,375

 

2,033

 

1,925

 

1,814

Operating expenses:

 

 

  

 

  

 

  

 

  

Selling, general and administrative

 

1,566

 

1,543

 

1,334

 

1,269

 

1,184

Depreciation and amortization

 

106

 

99

 

85

 

84

 

97

Restructuring and separation

 

8

 

9

 

6

 

7

 

8

Total operating expenses

 

1,680

 

1,651

 

1,425

 

1,360

 

1,289

Operating income

 

723

 

724

 

608

 

565

 

525

Interest expense

 

110

 

130

 

166

 

269

 

394

Interest income

 

 

(1)

 

(2)

 

 

Loss on extinguishment & modification of debt

 

 

69

 

84

 

179

 

100

Other (income) expense, net

 

 

 

 

 

1

Income from continuing operations before provision for income taxes and discontinued operations

 

613

 

526

 

360

 

117

 

30

Provision (benefit) for income taxes

 

162

 

135

 

193

 

51

 

(1,170)

Income from continuing operations

 

451

 

391

 

167

 

66

 

1,200

Income from discontinued operations, net of tax

 

1

 

3

 

803

 

130

 

272

Net income

$

452

$

394

$

970

$

196

$

1,472

Weighted Average Common Shares Outstanding(1):

 

  

 

  

 

  

 

  

 

  

Basic (thousands)

 

166,405

 

181,099

 

192,236

 

199,385

 

197,011

Diluted (thousands)

 

166,989

 

181,929

 

193,668

 

202,000

 

201,308

Basic Earnings Per Share(1):

 

  

 

  

 

  

 

  

 

  

Income from continuing operations

$

2.71

$

2.16

$

0.87

$

0.33

$

6.09

Income from discontinued operations

 

0.01

 

0.02

 

4.18

 

0.65

 

1.38

Net income

$

2.72

$

2.18

$

5.05

$

0.98

$

7.47

Diluted Earnings Per Share(1):

 

  

 

  

 

  

 

  

 

  

Income from continuing operations

$

2.70

$

2.15

$

0.86

$

0.33

$

5.96

Income from discontinued operations

 

0.01

 

0.02

 

4.15

 

0.64

 

1.35

Net income

$

2.71

$

2.17

$

5.01

$

0.97

$

7.31

Balance sheet data (end of period):

 

  

 

  

 

  

 

  

 

  

Cash and cash equivalents

$

34

$

38

$

558

$

75

$

269

Total assets

 

4,715

 

4,233

 

4,318

 

5,707

 

6,016

Total debt(2)

 

2,046

 

2,140

 

2,101

 

3,812

 

4,311

Total stockholders’ equity

 

1,352

 

1,281

 

1,466

 

960

 

744

Other financial data (unaudited):

 

  

 

  

 

  

 

  

 

  

Working capital(3)

$

849

$

840

$

1,254

$

1,004

$

1,112

Weighted average effective interest rate less deferred financing costs

 

5.1

%  

 

6.0

%  

 

5.4

%  

 

6.3

%  

 

7.9

%

Adjusted EBITDA(4)

 

873

 

871

 

731

 

680

 

650

Adjusted net income(4)

 

596

 

619

 

447

 

302

 

135

Capital expenditures

 

106

 

115

 

94

 

81

 

86

Depreciation & amortization(5)

 

113

 

106

 

90

 

88

 

100

Amortization of acquisition‑related intangibles (other than software)

 

23

 

22

 

12

 

12

 

12

Statement of cash flows data:

 

  

 

  

 

  

 

  

 

  

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

$

677

$

584

$

502

$

513

$

422

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

 

(112)

 

(477)

 

2,329

 

(21)

 

726

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

 

(569)

 

(627)

 

(2,348)

 

(687)

 

(962)

(1)Weighted average shares and earnings per share are for Holdings. Due to rounding, amounts may not add to totals.
(2)Total debt includes current and non-current installments of long-term debt, capital leases (for all years prior to fiscal 2019) and associated discounts, premiums, and deferred financing costs.
(3)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 and the current portion of operating lease liabilities.

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(4)Adjusted EBITDA and Adjusted net income are not recognized terms under GAAP and do not purport to be alternatives to net income as measures of operating performance. For additional detail, including a reconciliation from net income and income from continuing operations, the most directly comparable financial measures under GAAP, to Adjusted EBITDA and Adjusted net income for the periods presented, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Business Metrics—Adjusted EBITDA and Adjusted net income.”
(5)Depreciation and amortization includes amounts recorded within Cost of sales in the Consolidated Statements of Operations.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is combined for two registrants: HD Supply Holdings, Inc. and HD Supply, Inc. Unless the context indicates otherwise, any reference in this discussion and analysis to “Holdings” refers to HD Supply Holdings, Inc., any reference to “HDS” refers to HD Supply, Inc., the indirect wholly-owned subsidiary of Holdings, and any references to “HD Supply,” the “Company,” “we,” “us” and “our” refer to Holdings together with its direct and indirect subsidiaries, including HDS.

HD Supply is one of the largest industrial distributors in North America. We believe we have leading positions in the two distinct market sectors in which we specialize: Maintenance, Repair & Operations and Specialty Construction. Through approximately 270 branches and 44 distribution centers, in the U.S. and Canada, the Company serves these markets with an integrated go-to-market strategy. We have approximately 11,500 associates delivering localized, customer-tailored products, services and expertise. We serve approximately 500,000 customers, which include contractors, maintenance professionals, home builders, industrial businesses, and government entities. Our broad range of end-to-end product lines and services include approximately 600,000 stock-keeping units (“SKUs”) of quality, name-brand and proprietary-brand products as well as value-add services supporting the entire lifecycle of a project from construction to maintenance, repair and operations.

Description of segments

We operate our Company through two reportable segments: Facilities Maintenance and Construction & Industrial.

Facilities Maintenance.    Facilities Maintenance distributes MRO products, provides value-add services and fabricates custom products. The markets that Facilities Maintenance serves include multifamily, hospitality, healthcare and institutional facilities. Products include electrical and lighting items, plumbing supplies, HVAC products, appliances, janitorial supplies, hardware, kitchen and bath cabinets, window coverings, textiles and guest amenities, healthcare maintenance and water and wastewater treatment products.

Construction & Industrial.    Construction & Industrial distributes concrete accessories and chemicals, specialized hardware, tools, engineered materials and safety products to non-residential and residential contractors. Products include tilt-up brace systems, forming and shoring systems, hand and power tools, cutting tools, rebar, ladders, safety and fall arrest equipment, specialty screws and fasteners, sealants and adhesives, drainage pipe, geo-synthetics, erosion and sediment control equipment and other engineered materials used broadly across all types of non-residential and residential construction. Construction & Industrial also includes Home Improvement Solutions which offers light remodeling and construction supplies, kitchen and bath cabinets, windows, plumbing materials, electrical equipment and other products, primarily to small remodeling contractors and trade professionals.

In addition to the reportable segments, our consolidated financial results include “Corporate and Eliminations” which incurs costs related to our centralized support functions, which are comprised of finance, information technology, human resources, legal, supply chain and other support services, and removes inter-segment transactions. All Corporate operating overhead costs are allocated to the reportable segments. Interest expense, interest income, other non-operating income and expense, and provision for income taxes are not allocated to the reportable segments. The Company does not allocate Corporate assets to its reportable segments.

Acquisitions

We enter into strategic acquisitions from time to time to expand into new markets, net platforms, and new geographies in an effort to better service existing customers and attract new ones. In accordance with the

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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 the acquisition forward.

On March 5, 2018, our Construction & Industrial business acquired A.H. Harris Construction Supplies (“A.H. Harris”) for a purchase price of approximately $359 million in cash, adjusted for the final working capital settlement received in the second half of fiscal 2019. A.H. Harris is a leading specialty construction distributor serving the northeast and mid-Atlantic regions. This acquisition expands Construction & Industrial’s market presence in the northeastern United States. For additional detail related to the acquisition of A.H. Harris, see “Note 2, Acquisitions,” in the Notes to the Consolidated Financial Statements within “Part II. Item 8. Financial Statements and Supplementary Data” of this annual report on Form 10-K.

Discontinued operations

In August 2017, the Company completed the sale of its Waterworks business. Including the final working capital settlement of approximately $29 million in January 2018, the Company received cash proceeds of approximately $2.4 billion, net of $38 million of transaction cost payments. Including the final working capital settlement, the Company recognized a gain on sale of the Waterworks business of approximately $732 million, net of tax of $197 million.

In accordance with ASC 205-20, Discontinued Operations, the results of the Waterworks operation and the gain/loss on the sale and disposal of the business are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the discontinued operations and gain on the sale of the business, net of tax, as one line item on the Consolidated Statements of Operations and Comprehensive Income. All Consolidated Statements of Operations and Comprehensive Income presented have been revised 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 “Part II. Item 8. Financial Statements and Supplementary Data” of this annual report on Form 10-K.

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

Our fiscal year is a 52- or 53-week period ending on the Sunday nearest to January 31. The fiscal year ended February 2, 2020 (“fiscal 2019”) included 52 weeks. The fiscal year ended February 3, 2019 (“fiscal 2018”) included 53 weeks. The fiscal year ended January 29, 2018 (“fiscal 2017”) included 52 weeks.

Key business metrics

Net sales

We earn our Net sales primarily from the sale of construction, maintenance, repair and operations, and renovation and improvement-related products and our provision of related services to approximately 500,000 customers, including contractors, government entities, maintenance professionals, home builders and industrial businesses. We recognize sales, net of sales tax and allowances for returns and discounts, when an identified performance obligation is satisfied by transfer of the promised goods or services to the customer. Net sales in certain business units fluctuate with the price of commodities as we seek to minimize the effects of changing commodities prices by passing such increases in the prices of certain commodity-based products to our customers.

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We ship products to customers by internal fleet and third-party carriers. Net sales are recognized from product sales when control of the product and services are passed to the customer, which generally occurs at the point of destination.

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. We account for shipping and handling costs associated with outbound freight as a fulfillment cost. Such costs are included in Selling, general and administrative expenses.

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, 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, and restructuring charges.

Adjusted EBITDA and Adjusted net income

Adjusted EBITDA and Adjusted net income are not recognized terms under generally accepted accounting principles in the U.S. (“GAAP”) and do not purport to be alternatives to Net income as a measure of operating performance. We present Adjusted EBITDA and Adjusted net income because each is a primary measure used by management to evaluate operating performance. In addition, we present Adjusted net income to measure our overall profitability as we believe it is an important measure of our performance. We believe the presentation of Adjusted EBITDA and Adjusted net income enhances our investors’ overall understanding of the financial performance of our business. We believe Adjusted EBITDA and Adjusted net income are helpful in highlighting operating trends, because each 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.

Adjusted EBITDA is based on “Consolidated EBITDA,” a measure which is defined in HDS’s Senior Credit Facilities and used in calculating financial ratios in several material debt covenants. 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 covenants that can restrict our activities if we do not maintain financial ratios calculated based on Consolidated EBITDA. Our Senior ABL Facility requires us to maintain a minimum fixed charge coverage ratio of 1:1 if our specified excess availability (including an amount by which our borrowing base exceeds the outstanding amounts) under the Senior ABL Facility falls below the greater of $100 million and 10% of the lesser of (A) the Borrowing Base and (B) the Total Facility Commitment (each, as defined in the Senior ABL Facility). Adjusted EBITDA is defined as Net income less Income 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 further adjusted to exclude loss on extinguishment of debt, non-cash items and certain other adjustments to Consolidated Net Income, including costs associated with capital structure enhancements, permitted in calculating Consolidated EBITDA under our Senior Credit Facilities. We believe that presenting Adjusted EBITDA is appropriate to provide additional information to investors about how the covenants in those agreements operate and about certain non-cash and other items. The Term Loan Facility and Senior ABL Facility permit us to make certain

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additional 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 “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity, capital resources and financial condition — External Financing.”

Adjusted net income is defined as Net income less Income from discontinued operations, net of tax, further adjusted for loss on extinguishment of debt and certain non-cash, non-recurring, non-operational, or unusual items, net of tax.

We believe that Adjusted EBITDA and Adjusted net income are frequently used by securities analysts, investors and other interested parties in their evaluation of companies, many of which present an Adjusted EBITDA or Adjusted net income measure when reporting their results. We compensate for the limitations of using non-GAAP financial measures by using them to supplement GAAP results to provide a more complete understanding of the factors and trends affecting the business than GAAP results alone. Because not all companies use identical calculations, our presentation of Adjusted EBITDA and Adjusted net income may not be comparable to other similarly titled measures of other companies.

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

Adjusted EBITDA and Adjusted net income do not reflect changes in, or cash requirements for, our working capital needs;
Adjusted EBITDA does not reflect our interest expense, or the requirements necessary to service interest or principal payments on our debt;
Adjusted EBITDA does not reflect our income tax expenses or the cash requirements to pay our taxes;
Adjusted EBITDA and Adjusted net income 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 Adjusted EBITDA does not reflect any cash requirements for such replacements.

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The following table presents a reconciliation of Net income and Income from continuing operations, the most directly comparable financial measures under GAAP, to Adjusted EBITDA for the periods presented (amounts in millions):

Fiscal Year Ended

February 2,

 

February 3,

 

January 28,

 

January 29,

 

January 31,

    

2020

    

2019

    

2018

    

2017

    

2016

Net income

$

452

$

394

$

970

$

196

$

1,472

Less income from discontinued operations, net of tax

 

1

 

3

 

803

 

130

 

272

Income from continuing operations

 

451

 

391

 

167

 

66

 

1,200

Interest expense, net

 

110

 

129

 

164

 

269

 

394

Provision (benefit) for income taxes(i)

 

162

 

135

 

193

 

51

 

(1,170)

Depreciation and amortization(ii)

 

113

 

106

 

90

 

88

 

100

Loss on extinguishment & modification of debt(iii)

 

 

69

 

84

 

179

 

100

Restructuring and separation charges(iv)

 

8

 

9

 

6

 

7

 

8

Stock‑based compensation

 

23

 

26

 

26

 

20

 

16

Acquisition and integration costs(v)

 

5

 

6

 

1

 

 

Other

 

1

 

 

 

 

2

Adjusted EBITDA

$

873

$

871

$

731

$

680

$

650

(i)During the fiscal year ended January 31, 2016, the Company recorded a $1,007 million tax benefit for the reversal of substantially all of the valuation allowance on its U.S. net deferred tax assets and a $189 million tax benefit for the reduction in unrecognized tax benefits as a result of IRS and state audit settlements.
(ii)Depreciation and amortization includes amounts recorded within Cost of sales in the Consolidated Statements of Operations.
(iii)Represents the loss on extinguishment of debt, including the premium paid to repurchase or call the debt, as well as the write-off of unamortized deferred financing costs, original issue discount, and other assets or liabilities associated with such debt. Also includes the costs of debt modification.
(iv)Represents the costs incurred for separation activities and strategic alignment of workforce. For additional information, see “Note 15, Restructuring and Separation Activities” in the Notes to the Consolidated Financial Statements within “Part II. Item 8. Financial Statements and Supplementary Data.”
(v)Represents the costs incurred in the acquisition and integration of business acquisitions, including A.H. Harris.

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The following table presents a reconciliation of Net income and Income from continuing operations, the most directly comparable financial measures under GAAP, to Adjusted net income for the periods presented (amounts in millions):

Fiscal Year Ended

February 2,

February 3,

January 28,

January 29,

January 31,

 

2020

 

2019

 

2018

 

2017

 

2016

Net income

    

$

452

    

$

394

    

$

970

    

$

196

    

$

1,472

Less income from discontinued operations, net of tax

 

1

 

3

 

803

 

130

 

272

Income from continuing operations

 

451

 

391

 

167

 

66

 

1,200

Plus: Provision (benefit) for income taxes(i)

 

162

 

135

 

193

 

51

 

(1,170)

Less: Cash income taxes(ii)

 

(53)

 

(13)

 

(16)

 

(13)

 

(16)

Plus: Amortization of acquisition‑related intangible assets (other than software)

 

23

 

22

 

12

 

12

 

12

Plus: Loss on extinguishment & modification of debt(iii)

 

 

69

 

84

 

179

 

100

Restructuring and separation charges(iv)

 

8

 

9

 

6

 

7

 

8

Acquisition and integration costs(v)

 

5

 

6

 

1

 

 

Other

 

 

 

 

 

1

Adjusted Net Income

$

596

$

619

$

447

$

302

$

135

(i)During the fiscal year ended January 31, 2016, the Company recorded a $1,007 million tax benefit for the reversal of substantially all of the valuation allowance on its U.S. net deferred tax assets and a $189 million tax benefit for the reduction in unrecognized tax benefits as a result of IRS and state audit settlements.
(ii)Cash paid for income taxes in the fiscal year ended January 28, 2018 excludes $13 million in tax payments related to the sale of the Waterworks business unit.
(iii)Represents the loss on extinguishment of debt, including the premium paid to repurchase or call the debt, as well as the write-off of unamortized deferred financing costs, original issue discount, and other assets or liabilities associated with such debt. Also includes the costs of debt modifications.
(iv)Represents the costs incurred for separation activities and strategic alignment of workforce. For additional information, see “Note 15, Restructuring and Separation Activities” in the Notes to the Consolidated Financial Statements within “Part II. Item 8. Financial Statements and Supplementary Data.”
(v)Represents the costs incurred in the acquisition and integration of business acquisitions, including A.H. Harris.

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Consolidated results of operations

Percentage

Fiscal Year

Increase (Decrease)

Dollars in millions

    

2019

    

2018

    

2017

    

2019 vs. 2018

    

2018 vs. 2017

Net sales

$

6,146

$

6,047

$

5,121

 

1.6

 

18.1

Gross profit

 

2,403

 

2,375

 

2,033

 

1.2

 

16.8