FORM 10-Q

10-Q 1 d10q.htm FORM 10-Q FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark

One)

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

For the quarterly period ended July 31, 2011

- OR -

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

For the transition period from to

Commission file number: 333-159809

HD SUPPLY, INC.

(Exact name of Registrant as specified in its charter)


Delaware		75-2007383
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

3100 Cumberland Boulevard, Suite 1480, Atlanta, Georgia (Address of principal executive offices)		30339 (Zip Code)

(770) 852-9000

(Registrant’s telephone number, including area code)

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

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. Yes x No ¨

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

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


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

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

As of September 8, 2011, there were 1,000 shares of common stock of HD Supply, Inc. outstanding.

INDEX TO FORM 10-Q


		Page
Part I.	Financial Information

Item 1.	Financial Statements

	Consolidated Statements of Operations for the Three and Six Months ended July 31, 2011 and August 1, 2010 (unaudited)	3

	Consolidated Balance Sheets as of July 31, 2011 and January 30, 2011 (unaudited)	4

	Consolidated Statements of Cash Flows for the Six Months ended July 31, 2011 and August 1, 2010 (unaudited)	5

	Notes to Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	41

Item 4.	Controls and Procedures	41

Part II.	Other Information

Item 1.	Legal Proceedings	41

Item 1A.	Risk Factors	41

Item 6.	Exhibits	42

Signatures		43

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

HD SUPPLY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Amounts in millions, unaudited


	Three Months Ended						Six Months Ended
	July 31, 2011			August 1, 2010			July 31, 2011			August 1, 2010

Net Sales	$	2,157		$	1,962		$	4,045		$	3,762
Cost of sales		1,556			1,418			2,917			2,717

Gross Profit		601			544			1,128			1,045
Operating expenses:
Selling, general and administrative		440			421			867			844
Depreciation and amortization		88			93			176			187
Restructuring		–			3			–			8

Total operating expenses		528			517			1,043			1,039

Operating Income (Loss)		73			27			85			6

Interest expense		159			155			317			311
Other (income) expense, net		–			(1	)		(1	)		2

Income (Loss) from Continuing Operations Before Provision (Benefit) for Income Taxes		(86	)		(127	)		(231	)		(307	)
Provision (benefit) for income taxes		15			(12	)		35			10

Income (Loss) from Continuing Operations		(101	)		(115	)		(266	)		(317	)
Income from discontinued operations, net of tax		–			–			1			–

Net Income (Loss)	$	(101	)	$	(115	)	$	(265	)	$	(317	)

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

HD SUPPLY, INC.

CONSOLIDATED BALANCE SHEETS

Amounts in millions, except share data, unaudited


	July 31, 2011			January 30, 2011
ASSETS
Current assets:
Cash and cash equivalents	$	91		$	292
Receivables, less allowance for doubtful accounts of $37 and $36		1,169			907
Inventories		1,178			1,035
Deferred tax asset		81			102
Other current assets		60			45

Total current assets		2,579			2,381


Property and equipment, net		375			390
Goodwill		3,152			3,150
Intangible assets, net		866			992
Other assets		171			176

Total assets	$	7,143		$	7,089

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	848		$	805
Accrued compensation and benefits		105			118
Current installments of long-term debt		10			10
Other current liabilities		283			272

Total current liabilities		1,246			1,205


Long-term debt, excluding current installments		5,501			5,239
Deferred tax liabilities		98			101
Other liabilities		451			448

Total liabilities		7,296			6,993


Stockholders’ equity (deficit):
Common stock, par value $0.01; authorized 1,000 shares; issued 1,000 shares at July 31, 2011 and January 30, 2011		–			–
Paid-in capital		2,669			2,660
Accumulated deficit		(2,828	)		(2,563	)
Accumulated other comprehensive income (loss)		6			(1	)

Total stockholders’ equity (deficit)		(153	)		96

Total liabilities and stockholders’ equity (deficit)	$	7,143		$	7,089

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

HD SUPPLY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Amounts in millions, unaudited


	Six Months Ended
	July 31, 2011			August 1, 2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(265	)	$	(317	)
Reconciliation of net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		177			188
Provision for uncollectibles		7			7
Non-cash interest expense		140			126
Stock-based compensation expense		9			8
Deferred income taxes		22			7
Unrealized derivative gain		(1	)		(3	)
Loss on extinguishment of debt		–			2
Other		(1	)		5
Changes in assets and liabilities:
(Increase) decrease in receivables		(270	)		(191	)
(Increase) decrease in inventories		(139	)		(66	)
(Increase) decrease in other current assets		(5	)		226
Increase (decrease) in accounts payable and accrued liabilities		35			358
Increase (decrease) in other long-term liabilities		(5	)		5

Net cash provided by (used in) operating activities		(296	)		355


CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures		(35	)		(22	)
Proceeds from sales of property and equipment		4			1
Purchase of investments		(21	)		–
Proceeds from sale of a business		11			–
Payment for acquisition of a business		(21	)

Net cash provided by (used in) investing activities		(62	)		(21	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Equity contribution		–			1
Repayments of long-term debt		(5	)		(35	)
Borrowings on long-term revolver debt		632			–
Repayments on long-term revolver debt		(472	)		(482	)
Debt modification and issuance costs		–			(34	)

Net cash provided by (used in) financing activities		155			(550	)


Effect of exchange rates on cash and cash equivalents		2			2


Increase (decrease) in cash and cash equivalents	$	(201	)	$	(214	)
Cash and cash equivalents at beginning of period		292			539

Cash and cash equivalents at end of period	$	91		$	325

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

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – NATURE OF BUSINESS AND BASIS OF PRESENTATION

Basis of Presentation

The consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission that permit reduced disclosure for interim periods. The consolidated balance sheet as of January 30, 2011 was derived from audited financial statements, but does not include all necessary disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”).

In Management’s opinion, the unaudited financial information for the interim periods presented includes all adjustments necessary for a fair statement of the results of operations, financial position, and cash flows. All adjustments are of a normal recurring nature unless otherwise disclosed. Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year. For a more complete discussion of HD Supply, Inc.’s significant accounting policies and other information, you should read this report in conjunction with HD Supply, Inc.’s annual report on Form 10-K for the year ended January 30, 2011, which includes all disclosures required by U.S. GAAP.

Nature of Business

HD Supply, Inc. (the “Company” or “HD Supply”) is one of the largest wholesale distributors in the United States and Canada based on sales serving three distinct market sectors: Infrastructure & Energy, Maintenance, Repair & Improvement and Specialty Construction, each of which offers different products and services to the end customer. The three market sectors are made up of ten wholesale distribution businesses. Through 771 locations across the United States and Canada, HD Supply operates a diverse portfolio of distribution businesses that provide over one million SKUs to over 450,000 professional customers, including contractors, government entities, maintenance professionals, home builders and industrial businesses.

HD Supply has seven reportable segments: Waterworks, Facilities Maintenance, White Cap, Utilities, Industrial Pipe, Valves and Fittings (“IPVF”), Creative Touch Interiors (“CTI”), and Plumbing. Other operating segments include Electrical, Crown Bolt, Repair & Remodel, and HD Supply Canada. In addition, the consolidated financial statements include Corporate, which includes enterprise-wide functional departments.

Fiscal Year

HD Supply’s fiscal year is a 52- or 53-week period ending on the Sunday nearest to January 31. Fiscal years ending January 29, 2012 (“fiscal 2011”) and January 30, 2011 (“fiscal 2010”) both include 52 weeks. The three months ended July 31, 2011 and August 1, 2010 both include 13 weeks and the six months ended July 31, 2011 and August 1, 2010 both include 26 weeks.

Principles of Consolidation

The consolidated financial statements present the results of operations, financial position and cash flows of HD Supply. All material intercompany balances and transactions are eliminated. Results of operations of companies acquired are included from their respective dates of acquisition.

Estimates

Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities, and reported amounts of revenues and expenses in preparing these consolidated financial statements in conformity with U.S. GAAP. Actual results could differ from these estimates.

Self-Insurance

HD Supply has a high deductible insurance program for most losses related to general liability, product liability, environmental liability, automobile, workers’ compensation, and is self-insured for medical claims and certain legal claims. The expected ultimate cost for claims incurred as of the balance sheet date is not discounted and is recognized as a liability. Self-insurance losses for claims filed and claims incurred but not reported are accrued

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

based upon estimates of the aggregate liability for uninsured claims using loss development factors and actuarial assumptions followed in the insurance industry and historical loss development experience. At July 31, 2011 and January 30, 2011, self-insurance reserves totaled approximately $96 million and $101 million, respectively.

NOTE 2 – DISCONTINUED OPERATIONS

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

In accordance with Accounting Standards Codification (“ASC”) 205-20, Discontinued Operations, the results of the SESCO/QUESCO operations are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the SESCO/QUESCO operations as one line item on the Consolidated Statements of Operations. All prior period Consolidated Statements of Operations presented have been restated to reflect this presentation. Additional detail related to the results of operations of the discontinued operations follows (amounts in millions):

Three Months Ended

Six Months Ended

July 31,
2011

August 1,
2010

July 31,
2011

August 1,
2010

Net sales

–

Gain on sale of discontinued operations

–

Income (loss) before provision (benefit) for income taxes

–

Provision (benefit) for income taxes

–

Income from discontinued operations, net of tax

–

NOTE 3 – ACQUISITION

On May 2, 2011, the Company closed on a transaction to acquire substantially all of the assets of Rexford Albany Municipal Supply Company, Inc. (“RAMSCO”) for approximately $21 million. RAMSCO specializes in distributing water, sanitary and storm sewer materials primarily to municipalities and contractors through four locations in upstate New York. These locations are operated as part of the HD Supply Waterworks business. In accordance with the acquisition method of accounting under ASC 805, Business Combinations, the results of the acquisition are reflected in the Company’s consolidated financial statements from the date of acquisition forward.

NOTE 4 – RELATED PARTIES

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

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Home Depot

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

HD Supply derived revenue from the sale of products to Home Depot of $71 million and $127 million in the three and six months ended July 31, 2011, respectively, and $73 million and $147 million in the three and six months ended August 1, 2010, respectively. Revenue from these sales is recorded at an amount that approximates market but may not necessarily represent a price an unrelated third party would pay. Accounts receivable from the sale of products to Home Depot were approximately $27 million at both July 31, 2011 and January 30, 2011, and are included within Receivables in the accompanying Consolidated Balance Sheets. In addition to sales, HD Supply purchased product from Home Depot of less than $1 million in both the six months ended July 31, 2011 and the six months ended August 1, 2010. All purchases were recorded in Cost of sales when the inventory was sold.

Equity Sponsors

In conjunction with the closing of the Transactions, the Company entered into a management agreement whereby the Company pays the Equity Sponsors a $5 million annual aggregate management fee (“Sponsor Management Fee”) and related expenses. The three and six months ended July 31, 2011 include $2 million and $3 million, respectively, in Sponsor Management Fees and related expenses and the three and six months ended August 1, 2010 include $2 million and $3 million, respectively, in Sponsor Management Fees and related expenses. These charges are included in Selling, general and administrative expense in the Consolidated Statements of Operations.

Management of the Company has been informed that, as of July 31, 2011, affiliates of certain of the Equity Sponsors beneficially owned approximately $833 million aggregate principal amount, or 33%, of the Company’s 12.0% Senior Notes due 2014 and approximately $668 million aggregate principal amount, or 39%, of the Company’s 13.5% Senior Subordinated Notes due 2015.

HD Supply purchased product from affiliates of the Equity Sponsors for approximately $19 million and $36 million in the three and six months ended July 31, 2011, respectively, and approximately $19 million and $31 million in the three and six months ended August 1, 2010, respectively. In addition, HD Supply sold product to affiliates of the Equity Sponsors for less than $1 million and $1 million in the three and six months ended July 31, 2011, respectively, and $1 million and $2 million in the three and six months ended August 1, 2010, respectively. Management believes these transactions were conducted at prices that an unrelated third party would pay.

NOTE 5 - DEBT

Long-term debt consisted of the following outstanding principal amounts presented with respective interest rates as of July 31, 2011 and January 30, 2011 (dollars in millions):

July 31, 2011

January 30, 2011

Outstanding
Principal

Interest
Rate %

Outstanding
Principal

Interest
Rate %

Term Loan due August 30, 2012

1.50

1.56

Term Loan due April 1, 2014

860

3.00

864

3.06

Revolving Credit Facility due August 30, 2013

–

ABL Revolving Credit Facility due August 30, 2012

1.69

–

ABL Revolving Credit Facility due April 1, 2014

138

3.44

–

ABL Term Loan due April 1, 2014

214

3.45

214

3.53

12.0% Senior Notes due September 1, 2014

2,500

12.00

2,500

12.00

13.5% Senior Subordinated Notes due September 1, 2015

1,705

13.50

1,597

13.50

Total long-term debt

5,511

5,249

Less current installments

(10

)

(10

)

Long-term debt, excluding current installments

5,501

5,239

Senior Secured Credit Facility

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

As of July 31, 2011 and January 30, 2011, there were no outstanding Letters of Credit under the Revolving Credit Facility.

Asset Based Lending Credit Agreement

The Company maintains a $2.1 billion asset based lending credit agreement (the “ABL Credit Facility”) subject to borrowing base limitations. As of July 31, 2011, the Company had additional availability under the ABL Credit Facility of $901 million, after giving effect to the borrowing base limitations and letters of credit issued and including $22 million of borrowings available on qualifying cash balances. As of July 31, 2011, there were approximately $10 million and $62 million, respectively, of Letters of Credit outstanding under the ABL Credit Facility due August 30, 2012 and April 1, 2014, respectively. As of January 30, 2011, there were approximately $11 million and $60 million, respectively, of Letters of Credit outstanding under the ABL Credit Facility due August 30, 2012 and April 1, 2014, respectively.

Lehman Brothers and Woodlands Commercial Bank

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

On September 15, 2008, Lehman Brothers filed a petition under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York (“Lehman’s bankruptcy”). Subsequent to Lehman’s bankruptcy, the Company drew down on the ABL Credit Facility and Lehman Brothers failed to fund their portion of the ABL Credit Facility commitment. As of July 31, 2011, outstanding borrowings under the ABL Credit Facility from Lehman Brothers were $5 million. The Administrative Agent of the ABL Credit Facility holds approximately $23 million in escrow funds, which are available to honor Lehman Brothers’ pro rata portion of any ABL Credit Facility draw. The combined available unfunded commitment from Lehman Brothers as of July 31, 2011 (without taking into consideration the ABL Credit Facility borrowing base limitations) was approximately $67 million.

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

12.0% Senior Notes and 13.5% Senior Subordinated Notes

On August 30, 2007, the Company issued $2.5 billion of Senior Notes bearing interest at a rate of 12.0% (the “12.0% Senior Notes”). Interest payments are due each March and September 1st through maturity.

On August 30, 2007, the Company issued $1.3 billion of Senior Subordinated PIK Notes bearing interest at a rate of 13.5% (the “13.5% Senior Subordinated Notes”). Interest payments are due each March and September 1st through maturity except that the first eight payment periods through September 2011 shall be payments in kind (“PIK”) and therefore increase the balance of the outstanding indebtedness rather than be paid in cash. As of July 31, 2011, the outstanding principal balance of the 13.5% Senior Subordinated Notes was $1.7 billion.

Debt covenants

The Company’s outstanding debt agreements contain various restrictive covenants including, but not limited to, limitations on additional indebtedness and dividend payments and stipulations regarding the use of proceeds from asset dispositions. The Company is in compliance with all such covenants.

NOTE 6 – DERIVATIVE INSTRUMENTS

The Company maintained interest rate swap agreements to exchange fixed and variable rate interest payment obligations without the exchange of the underlying principal amounts. At execution, the swaps were designated as hedging the exposure to variable cash flows of a forecasted transaction, whereby the Company pays fixed

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

interest and receives variable interest, effectively converting $400 million of floating-rate debt to fixed rate debt. The swaps outstanding as of January 30, 2011, having a combined $200 million notional value, matured on January 31, 2011, the first day of fiscal 2011. As of January 30, 2011, the fair value of the swaps was a liability of $1 million and was included in Other current liabilities in the Consolidated Balance Sheet.

A subsidiary of Lehman Brothers Holdings, Inc. (“Lehman”) is the original counterparty to these interest rate swap agreements. The expected and ultimate filing of bankruptcy by Lehman caused HD Supply to conclude on September 12, 2008 (the “date of de-designation”) that the ability of the counterparty to meet its obligations under the swap agreements was remote. Therefore, on September 12, 2008, HD Supply removed the designation of the swaps as cash flow hedges, discontinued hedge accounting and considered these swaps economic hedges until their expiration. On June 16, 2009, Lehman assigned the counterparty position on the two interest rate swaps that matured on January 31, 2011 to Wells Fargo Foothill, LLC.

On the date of de-designation, the aggregate fair value of the swaps was a liability of $6 million. In accordance with the derivatives and hedging principles of U.S. GAAP (ASC 815, Derivatives and Hedging), the net loss was retained in Accumulated other comprehensive income (loss) (“OCI”) and was reclassified into earnings in the same periods in which the original hedged forecasted transactions affected earnings. As of January 30, 2011, all of the unrealized losses have been reclassified from OCI into Interest expense. Changes in the fair value of the swaps following the date of de-designation were recognized in earnings.

The following table summarizes the location and amounts of the gains or losses related to derivatives included in HD Supply’s Statements of Operations for the periods presented (amounts in millions):


		Three Months Ended					Six Months Ended
	Location of gain (loss) in statement of operations	July 31, 2011		August 1, 2010			July 31, 2011		August 1, 2010
Changes in fair value	Other income (expense), net	$	–	$	1		$	1	$	3
Amortization of net loss remaining in OCI at de-designation	Interest (expense)		–		(1	)		–		(1	)
Settlements	Interest (expense)		–		(2	)		–		(4	)

NOTE 7 – FAIR VALUE MEASUREMENTS

The fair value measurements and disclosure principles of U.S. GAAP (ASC 820, Fair Value Measurements and Disclosures) define fair value, establish a framework for measuring fair value and provide disclosure requirements about fair value measurements. These principles define a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:


		Level 1 –		Quoted prices (unadjusted) in active markets for identical assets or liabilities;

		Level 2 –		Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly;

		Level 3 –		Unobservable inputs in which little or no market activity exists.

The Company’s interest rate swap contracts were measured at fair value on a recurring basis using Level 2 observable inputs. The fair value of these financial liabilities was $1 million as of January 30, 2011.

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The Company’s financial instruments that are not reflected at fair value on the Consolidated Balance Sheets were as follows as of July 31, 2011 and January 30, 2011 (amounts in millions):


	As of July 31, 2011				As of January 30, 2011
	Recorded Amount⁽¹⁾		Estimated Fair Value		Recorded Amount⁽¹⁾		Estimated Fair Value
Term Loan due August 30, 2012	$	73	$	73	$	74	$	74
Term Loan due April 1, 2014		860		860		864		871
Revolving Credit Facility due August 30, 2013		–		–		–		–
ABL Revolving Credit Facility due August 30, 2012		21		21		–		–
ABL Revolving Credit Facility due April 1, 2014		138		134		–		–
ABL Term Loan due April 1, 2014		214		210		214		207
12.0% Senior Notes due September 1, 2014		2,500		2,425		2,500		2,338
13.5% Senior Subordinated Notes due September 1, 2015		1,705		1,347		1,597		1,198

Total	$	5,511	$	5,070	$	5,249	$	4,688

(1) These amounts do not include accrued interest; accrued interest is classified as Other current liabilities in the accompanying Consolidated Balance Sheets.

The Company utilized Level 2 inputs, as defined in the fair value hierarchy, to measure the fair value of the long-term debt.

The Term Loan is guaranteed by Home Depot. Based on a review of the fair value of debt issued by companies with similar credit ratings as Home Depot, management estimates that as of July 31, 2011, the fair value of the Term Loan due August 30, 2012 was approximately 99-101% of the principal value, or $73 million, and the Term Loan due April 1, 2014 is approximately 99-101% of principal, or $860 million. Management estimated that as of January 30, 2011, the fair value of the Term Loan due August 30, 2012 was approximately 99-101% of the principal value, or $74 million, and the Term Loan due April 1, 2014 was approximately 100-102% of principal, or $871 million.

The Company’s fair value estimates for the ABL Credit Facility, 12.0% Senior Notes, and 13.5% Senior Subordinated Notes were based on recent similar credit facilities initiated by companies with like credit quality in similar industries, quoted prices for similar instruments, and inquiries with certain investment communities. Based on this data, management estimates that as of July 31, 2011, the fair value of the ABL Revolving Credit Facility due August 30, 2012 was approximately 96-100% of the principal value, or $21 million, the fair value of the ABL Revolving Credit Facility due April 1, 2014 was approximately 95-100% of the principal value, or $134 million, the fair value of the ABL Term Loan due April 1, 2014 was approximately 97-100% of the principal value, or $210 million, the fair value of the 12.0% Senior Notes was approximately 89-105% of the principal value, or $2,425 million, and the fair value of the 13.5% Senior Subordinated Notes was approximately 68-90% of principal value, or $1,347 million. Management estimated that as of January 30, 2011, the fair value of the ABL Term Loan due April 1, 2014 was approximately 94-100% of the principal value, or $207 million, the fair value of the 12.0% Senior Notes was approximately 87-100% of the principal value, or $2,338 million, and the fair value of the 13.5% Senior Subordinated Notes was approximately 65-85% of principal value, or $1,198 million.

NOTE 8 – INCOME TAXES

As of July 31, 2011, the Company’s combined federal, state and foreign effective tax rate for continuing operations for the fiscal year ending January 29, 2012 is a 15.2% provision, reflecting the impact of increasing the U.S. valuation allowance, increasing the deferred tax liability for U.S. goodwill amortization for tax purposes, additional unrecognized tax benefits and the accrual of income taxes for foreign and certain state jurisdictions. The Company’s effective tax rate will vary based on a variety of factors, including overall profitability, the geographical mix of income before taxes and the related tax rates in the jurisdictions where it operates, restructuring and other charges, as well as discrete events, such as settlements of audits. The Company is subject to audits and examinations of its tax returns by tax authorities in various jurisdictions, including the Internal Revenue Service. Management regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of provisions for income taxes.

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

With regard to the increase in the valuation allowance and the impact the valuation allowance had on income tax expense, the valuation allowance was directly impacted by the increasing of the deferred tax liability for U.S. goodwill amortization for tax purposes. The deferred tax liability related to the Company’s U.S. tax deductible goodwill must be considered as a liability related to an asset with an indefinite life. Therefore, the deferred tax liability does not amortize and is not available as a source of taxable income to support the realization of deferred tax assets created by other deductible temporary timing differences. The Company does not believe it is “more likely than not” it will realize its U.S. deferred tax assets equal to deferred liability created by tax deductible goodwill and therefore, the Company was required to record an additional tax expense to increase its deferred tax asset valuation allowance. During the six months ended July 31, 2011, the impact of the amortization of the indefinite lived intangibles increased income tax expense by $22 million.

The Company’s unrecognized tax benefits as of January 30, 2011 in accordance with the income taxes principles of U.S. GAAP (ASC 740, Income Taxes) were $192 million. During the three months ended July 31, 2011, the balance for unrecognized tax benefits increased $2 million as a result of gross increases for tax positions in a prior period. During the six months ended July 31, 2011, the balance for unrecognized tax benefits increased $4 million as a result of gross increases for tax positions in a prior period. The Company’s ending balance as of July 31, 2011 for unrecognized tax benefits was $196 million. The Company’s ending net accrual for interest related to unrecognized tax benefits at July 31, 2011 and January 30, 2011 was $17 million and $14 million, respectively.

During fiscal year 2010, the Company determined that it did not meet the “more likely than not” standard that substantially all of its net U.S. deferred tax assets would be realized and therefore, the Company established a valuation allowance for its net U.S. deferred tax assets. With regard to the U.S., the Company continues to believe that a full valuation allowance is needed against its net deferred tax assets in the U.S. As of July 31, 2011, the Company’s U.S. valuation allowance was $346 million and the Company expects to continue to add to its gross deferred tax assets for anticipated net operating losses.

NOTE 9 – STOCKHOLDERS’ EQUITY

Common Stock

The Company is authorized to issue 1,000 shares of common stock, par value $0.01 per share. As of July 31, 2011 and January 30, 2011, 1,000 shares were issued and outstanding.

Accumulated Other Comprehensive Income (Loss)

As of July 31, 2011 and January 30, 2011 accumulated other comprehensive income (loss) is comprised of $6 million and $(1) million, respectively, of cumulative foreign currency translation adjustment, net.

Total Comprehensive Income (Loss)

Total comprehensive income (loss) is comprised of the following components (amounts in millions):


	Three Months Ended						Six Months Ended
	July 31, 2011			August 1, 2010			July 31, 2011			August 1, 2010
Net income (loss)	$	(101	)	$	(115	)	$	(265	)	$	(317	)
Other comprehensive income (loss):
Foreign currency translation adjustment		(1	)		(2	)		7			6

Total comprehensive income (loss)	$	(102	)	$	(117	)	$	(258	)	$	(311	)

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 10 – SUPPLEMENTAL BALANCE SHEET AND CASH FLOW INFORMATION

Receivables

Receivables as of July 31, 2011 and January 30, 2011 consisted of the following (amounts in millions):


	July 31, 2011		January 30, 2011
Trade receivables, net of allowance for doubtful accounts	$	1,094	$	837
Vendor rebate receivables		67		60
Other receivables		8		10

Total receivables, net	$	1,169	$	907

Other Current Liabilities

Other current liabilities as of July 31, 2011 and January 30, 2011 consisted of the following (amounts in millions):


	July 31, 2011		January 30, 2011
Accrued interest	$	131	$	131
Accrued non-income taxes		43		28
Branch closure & consolidation reserves		16		18
Other		93		95

Total other current liabilities	$	283	$	272

Significant Non-Cash Transactions

Interest payments on the 13.5% Senior Subordinated Notes are due each March and September 1st through maturity except that the first eight payment periods through September 2011 shall be paid in kind (“PIK”) and therefore increase the balance of the outstanding indebtedness rather than be paid in cash. The Company made PIK interest payments during the first quarters of fiscal 2011 and fiscal 2010 of $108 million and $95 million, respectively, increasing the outstanding balance of the 13.5% Senior Subordinated Notes.

Supplemental Cash Flow Information

Cash paid for interest in the six months ended July 31, 2011 and August 1, 2010 was $177 million and $182 million, respectively. During the first quarter of fiscal 2010, as a result of recent tax legislation regarding net operating loss carry-back periods, the Company filed for and received a cash refund of $220 million from the Internal Revenue Service for income tax previously paid. This cash receipt is reflected in the Consolidated Statement of Cash Flows as a change in other current assets. Cash paid or received for income taxes, net of refunds, in the six months ended July 31, 2011 and August 1, 2010 was approximately $5 million net payments and $215 million net refunds, respectively.

NOTE 11 – BRANCH CLOSURE AND CONSOLIDATION ACTIVITIES

Fiscal 2009 Plan

In the third quarter of fiscal 2009, the Company initiated a plan to restructure its businesses which included evaluating opportunities to consolidate branches, further reduce costs, more efficiently employ working capital and streamline activities. Under this plan, which was completed in fiscal 2010, management closed or consolidated 25 branches and reduced workforce personnel by approximately 500 employees. The Company does not expect to incur any additional charges related to this plan.

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the activity for the liability balance, included in Other current liabilities and Other liabilities in the Consolidated Balance Sheets, related to closure and consolidation activities under the Fiscal 2009 Plan (amounts in millions):


	Occupancy Costs			Other			Total

Balance – January 30, 2011	$	7		$	2		$	9
Cash payments		(1	)		(1	)		(2	)

Balance – July 31, 2011	$	6		$	1		$	7

Transactions & Acquisition Integration

Concurrent with the Transactions and acquisition integration, management evaluated the operations and performance of individual branches and identified branches for closure or consolidation. In addition, during the fourth quarter of fiscal 2008, as a result of continued acquisition integration efforts, the decline in the residential construction market, and the general decline in economic conditions, management evaluated the operations and performance of individual branches and identified branches for closure or consolidation and a reduction in workforce.

Under these plans, management closed or consolidated 210 branches and reduced workforce personnel by approximately 4,500 employees. The Company does not expect to incur additional restructuring charges under these plans.

The following table presents the activity for the liability balance, included in Other current liabilities and Other liabilities, related to closure and consolidation activities under the Transactions and Acquisition Integration plans (amounts in millions):


	Occupancy Costs
Balance – January 30, 2011	$	44
Cash payments		(6	)

Balance – July 31, 2011	$	38

The Company regularly reviews the assumptions used to estimate the net present value of the on-going lease liabilities and other occupancy costs, net of expected sublease income.

As of July 31, 2011, approximately $16 million of the liability balances for the Fiscal 2009 Plan and the Transactions & Acquisition Integration Plan is classified as a current liability on the Company’s Consolidated Balance Sheet. Payments for occupancy costs, which represent the net present value of future lease obligations, including rent, taxes, utilities, etc., less estimated sublease income of the closed branches, and for other costs, which relate primarily to equipment and vehicle leases, are expected to be substantially complete over the next six years, with certain property lease obligations extending out as far as fourteen years. The Company continues to actively pursue buyout options or subleasing opportunities for the leased properties. The expected timing of cash payments related to the branch closure and consolidation activities could change or adjustments to the reserve may become necessary depending on the success and timing of entering into these types of agreements.

NOTE 12 – COMMITMENTS AND CONTINGENCIES

HD Supply is involved in litigation from time to time in the ordinary course of business. In Management’s opinion, none of the proceedings are material in relation to the consolidated operations, cash flows, or financial position of HD Supply and the Company has adequate reserves to cover its estimated probable loss exposure.

As of July 31, 2011, the Company maintains a $21 million demand deposit account with a financial institution that collateralizes a $20 million letter of credit issued to guarantee the financial performance of the Company for the benefit of one of the Company’s business partners. The demand deposit account is reflected within Other assets in the accompanying Consolidated Balance Sheet.

The Company is currently under examination by the Internal Revenue Service (“IRS”) related to its fiscal 2007 and fiscal 2008 tax returns (the “Audit Years”) and corresponding net operating loss carryback refund claims

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(“Carryback”) for which the Company received cash refunds of taxes previously paid. For the Audit Years, the IRS has issued Notices of Proposed Adjustments (“NOPAs” or “Proposed Assessment”) to the Company pursuant to which the IRS proposes to disallow certain deductions claimed by the Company and also disallow the carryback of net operating losses resulting from the disallowed deductions. The Company believes that the deductions it reported on the tax returns filed for the Audit Years and corresponding Carryback are accurate and appropriate. Therefore, the Company has formally contested the NOPAs. The Company anticipates that before the end of fiscal year 2011, it will receive a Revenue Agent Report (or “30-Day Letter”) from the IRS assessing the Company tax. Based upon the NOPAs, the Company is estimating the 30-Day Letter will contain a Proposed Assessment of tax for approximately $317 million to $325 million including accrued interest. Upon receipt of the 30-Day Letter, the Company will challenge the Proposed Assessment by filing a formal protest with the Appeals Division of the IRS. During the protest period, the Company will not pay the Proposed Assessment as the Company intends to vigorously defend its positions.

NOTE 13 – SEGMENT INFORMATION

HD Supply’s operating segments are based on management structure and internal reporting. Each segment offers different products and services to the end customer, except for Corporate, which provides general corporate overhead support and HD Supply Canada (included in Other), which is organized based on geographic location. The Company determines the reportable segments in accordance with the principles of segment reporting within U.S. GAAP (ASC 280, Segment Reporting). For purposes of evaluation under these segment reporting principles, the Chief Operating Decision Maker for HD Supply assesses HD Supply’s ongoing performance, based on the periodic review and evaluation of Net sales, operating income before restructuring charges and goodwill impairments, and certain other measures for each of the operating segments.

HD Supply has seven reportable segments, each of which is presented below:

—

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

—

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

—

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

—

Utilities – Distributes electrical transmission and distribution products, power plant MRO supplies and smart-grid technologies and provides materials management and procurement outsourcing arrangements to investor-owned utilities, municipal and provincial power authorities, rural electric cooperatives and utility contractors.

—

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

—

Plumbing – Distributes plumbing fixtures, faucets and finishes, HVAC equipment, pipes, valves, fittings and water heaters, as well as related services, to residential and commercial contractors.

—

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

In addition to the reportable segments, the Company’s consolidated financial results include an Other, Corporate, & Eliminations category. Other primarily consists of Electrical, offering electrical products such as wire and cable, switch gear supplies, lighting conduit to residential and commercial contractors; Repair & Remodel, offering light remodeling and construction supplies primarily to small remodeling contractors and tradesmen; Crown Bolt, a retail distribution operator, providing program and packaging solutions, sourcing, distribution, and in-store service, primarily serving Home Depot; and HD Supply Canada, comprised of HD Supply’s Canadian operations

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(other than the Canadian utilities operations, which are included in the Utilities segment, and Commercial Direct, which is included in the Facilities Maintenance segment). Corporate has enterprise management responsibility and centralized support functions for some of the segments, information technology, human resources, sourcing and support services. Eliminations remove intersegment transactions.

HD Supply evaluates performance of each segment based on operating income before restructuring charges and goodwill impairments. The following tables present Net sales and operating income before charges by segment for the periods indicated (amounts in millions):


	Three Months Ended

	July 31, 2011					August 1, 2010

	Net Sales		Operating Income (Loss)			Net Sales		Operating Income (Loss)

Waterworks	$	496	$	8		$	448	$	5
Facilities Maintenance		507		69			467		58
White Cap		255		(2	)		228		(10	)
Utilities		282		7			247		6
IPVF		171		12			137		6
Plumbing		112		(4	)		107		(8	)
CTI		49		(6	)		58		(7	)
Other, Corporate, & Eliminations		285		(11	)		270		(20	)

Total operations before charges	$	2,157		73		$	1,962		30

Restructuring charge				–					3

Total operating income (loss)				73					27
Interest expense				159					155
Other (income) expense, net				–					(1	)

Income (loss) from continuing operations before provision for income taxes			$	(86	)			$	(127	)


	Six Months Ended

	July 31, 2011					August 1, 2010

	Net Sales		Operating Income (Loss)			Net Sales		Operating Income (Loss)

Waterworks	$	883	$	5		$	857	$	–
Facilities Maintenance		944		115			867		98
White Cap		471		(13	)		433		(28	)
Utilities		551		12			483		12
IPVF		341		23			283		13
Plumbing		223		(11	)		211		(15	)
CTI		90		(14	)		113		(16	)
Other, Corporate, & Eliminations		542		(32	)		515		(50	)

Total operations before charges	$	4,045		85		$	3,762		14

Restructuring charge				–					8

Total operating income (loss)				85					6
Interest expense				317					311
Other (income) expense, net				(1	)				2

Income (loss) from continuing operations before provision for income taxes			$	(231	)			$	(307	)

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following tables present depreciation and amortization by segment for the periods indicated (amounts in millions):


	Three Months Ended
	July 31, 2011						August 1, 2010
	Depreciation & Software Amortization		Other Intangible Amortization		Total		Depreciation & Software Amortization		Other Intangible Amortization		Total
Waterworks	$	1	$	24	$	25	$	1	$	24	$	25
Facilities Maintenance		7		19		26		7		19		26
White Cap		4		5		9		5		5		10
Utilities		–		5		5		–		5		5
IPVF		–		4		4		–		4		4
Plumbing		–		1		1		1		1		2
CTI		3		–		3		3		–		3
Other & Corporate		8		7		15		12		7		19

Total continuing operations	$	23	$	65	$	88	$	29	$	65	$	94


	Six Months Ended
	July 31, 2011						August 1, 2010
	Depreciation & Software Amortization		Other Intangible Amortization		Total		Depreciation & Software Amortization		Other Intangible Amortization		Total
Waterworks	$	2	$	47	$	49	$	2	$	47	$	49
Facilities Maintenance		14		38		52		14		37		51
White Cap		8		10		18		10		10		20
Utilities		1		9		10		1		9		10
IPVF		2		7		9		1		7		8
Plumbing		2		1		3		4		1		5
CTI		4		1		5		6		1		7
Other & Corporate		14		17		31		20		18		38

Total continuing operations	$	47	$	130	$	177	$	58	$	130	$	188

NOTE 14 – SUBSIDIARY GUARANTORS

The Company has issued 12.0% Senior Notes and 13.5% Senior Subordinated Notes (collectively the “Notes”) guaranteed by certain of its subsidiaries (the “Guarantor Subsidiaries”). The Guarantor Subsidiaries are direct or indirect 100 percent-owned domestic subsidiaries of the Company. The guarantees are full and unconditional, to the extent allowed by law, and joint and several. The subsidiaries of the Company that do not guarantee the Notes (“Non-guarantor Subsidiaries”) are direct or indirect wholly-owned subsidiaries of the Company and are made up of the Company’s operations in Canada and a non-operating subsidiary in the United States that holds an investment of $349 million in principal, $221 million net of the discount at July 31, 2011, of the Company’s 13.5% Senior Subordinated Notes, which is eliminated in consolidation.

The following supplemental financial information sets forth, on a consolidating basis, the condensed statements of operations, the condensed balance sheets, and the condensed statements of cash flows for the parent company issuer of the Notes (the “Parent Issuer”), for the Guarantor Subsidiaries and for the Non-guarantor Subsidiaries and total consolidated HD Supply, Inc. and subsidiaries (amounts in millions):

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

CONDENSED CONSOLIDATING INCOME STATEMENTS


	Three Months Ended July 31, 2011

	Parent Issuer			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Total

Net Sales	$	–		$	2,042		$	115		$	–		$	2,157
Cost of sales		–			1,472			84			–			1,556

Gross Profit		–			570			31			–			601
Operating expenses:
Selling, general and administrative		19			400			21			–			440
Depreciation and amortization		3			85			–			–			88

Total operating expenses		22			485			21			–			528
Operating Income (Loss)		(22	)		85			10			–			73
Interest expense		179			84			1			(105	)		159
Interest (income)		(85	)		(1	)		(19	)		105			–
Net (earnings) loss of equity affiliates		(20	)		–			–			20			–

Income (Loss) From Continuing Operations Before Provision (Benefit) for Income Taxes		(96	)		2			28			(20	)		(86	)
Provision (benefit) for income taxes		5			–			10			–			15

Income (Loss) from Continuing Operations		(101	)		2			18			(20	)		(101	)
Income from discontinued operations, net of tax		–			–			–			–			–

Net Income (Loss)	$	(101	)	$	2		$	18		$	(20	)	$	(101	)


	Three Months Ended August 1, 2010

	Parent Issuer			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Total

Net Sales	$	–		$	1,865		$	97		$	–		$	1,962
Cost of sales		–			1,346			72			–			1,418

Gross Profit		–			519			25			–			544
Operating expenses:
Selling, general and administrative		19			385			17			–			421
Depreciation and amortization		4			88			1			–			93
Restructuring		–			3			–			–			3

Total operating expenses		23			476			18			–			517
Operating Income (Loss)		(23	)		43			7			–			27
Interest expense		173			86			–			(104	)		155
Interest (income)		(84	)		(2	)		(18	)		104			–
Other (income) expense, net		(1	)		–			–			–			(1	)
Net loss of equity affiliates		19			–			–			(19	)		–

Income (Loss) From Continuing Operations Before Provision (Benefit) for Income Taxes		(130	)		(41	)		25			19			(127	)
Provision (benefit) for income taxes		(15	)		(5	)		8			–			(12	)

Income (Loss) from Continuing Operations		(115	)		(36	)		17			19			(115	)
Income from discontinued operations, net of tax		–			–			–			–			–

Net Income (Loss)	$	(115	)	$	(36	)	$	17		$	19		$	(115	)

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

CONDENSED CONSOLIDATING INCOME STATEMENTS (Continued)


	Six Months Ended July 31, 2011

	Parent Issuer			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Total

Net Sales	$	–		$	3,826		$	219		$	–		$	4,045
Cost of sales		–			2,756			161			–			2,917

Gross Profit		–			1,070			58			–			1,128
Operating expenses:
Selling, general and administrative		37			786			44			–			867
Depreciation and amortization		6			169			1			–			176

Total operating expenses		43			955			45			–			1,043
Operating Income (Loss)		(43	)		115			13			–			85
Interest expense		357			169			1			(210	)		317
Interest (income)		(169	)		(2	)		(39	)		210			–
Other (income) expense, net		(1	)		–			–			–			(1	)
Net loss of equity affiliates		27			–			–			(27	)		–

Income (Loss) From Continuing Operations Before Provision (Benefit) for Income Taxes		(257	)		(52	)		51			27			(231	)
Provision (benefit) for income taxes		8			8			19			–			35

Income (Loss) from Continuing Operations		(265	)		(60	)		32			27			(266	)
Income from discontinued operations, net of tax		–			–			1			–			1

Net Income (Loss)	$	(265	)	$	(60	)	$	33		$	27		$	(265	)


	Six Months Ended August 1, 2010

	Parent Issuer			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Total

Net Sales	$	–		$	3,576		$	186		$	–		$	3,762
Cost of sales		–			2,580			137			–			2,717

Gross Profit		–			996			49			–			1,045
Operating expenses:
Selling, general and administrative		46			762			36			–			844
Depreciation and amortization		9			176			2			–			187
Restructuring		–			8			–			–			8

Total operating expenses		55			946			38			–			1,039
Operating Income (Loss)		(55	)		50			11			–			6
Interest expense		349			171			–			(209	)		311
Interest (income)		(170	)		(3	)		(36	)		209			–
Other (income) expense, net		2			–			–			–			2
Net loss of equity affiliates		92			–			–			(92	)		–

Income (Loss) From Continuing Operations Before Provision (Benefit) for Income Taxes		(328	)		(118	)		47			92			(307	)
Provision (benefit) for income taxes		(11	)		4			17			–			10

Income (Loss) from Continuing Operations		(317	)		(122	)		30			92			(317	)
Income from discontinued operations, net of tax		–			–			–			–			–

Net Income (Loss)	$	(317	)	$	(122	)	$	30		$	92		$	(317	)

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

CONDENSED CONSOLIDATING BALANCE SHEETS


	July 31, 2011
	Parent Issuer			Guarantor Subsidiaries		Non- Guarantor Subsidiaries		Eliminations			Total

ASSETS
Current assets:
Cash and cash equivalents	$	36		$	14	$	41	$	–		$	91
Receivables, net		–			1,092		77		–			1,169
Inventories		–			1,094		84		–			1,178
Deferred tax asset		42			33		3		3			81
Intercompany receivable		–			2		–		(2	)		–
Other current assets		11			42		7		–			60

Total current assets		89			2,277		212		1			2,579


Property and equipment, net		61			309		5		–			375
Goodwill		–			3,144		8		–			3,152
Intangible assets, net		–			861		5		–			866
Deferred tax asset		150			–		4		(154	)		–
Investment in subsidiaries		2,924			–		–		(2,924	)		–
Intercompany notes receivable		3,054			233		–		(3,287	)		–
Other assets		164			4		244		(241	)		171

Total assets	$	6,442		$	6,828	$	478	$	(6,605	)	$	7,143


LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	11		$	787	$	50	$	–		$	848
Accrued compensation and benefits		36			65		4		–			105
Current installments of long-term debt		10			–		–		–			10
Intercompany payables		–			–		2		(2	)		–
Other current liabilities		157			114		12		–			283

Total current liabilities		214			966		68		(2	)		1,246


Long-term debt, excluding current installments		5,722			–		–		(221	)		5,501
Deferred tax liabilities		–			249		–		(151	)		98
Intercompany notes payable		233			3,054		–		(3,287	)		–
Other liabilities		426			38		7		(20	)		451

Total liabilities		6,595			4,307		75		(3,681	)		7,296


Stockholders’ equity (deficit)		(153	)		2,521		403		(2,924	)		(153	)

Total liabilities and stockholders’ equity (deficit)	$	6,442		$	6,828	$	478	$	(6,605	)	$	7,143

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

CONDENSED CONSOLIDATING BALANCE SHEETS (Continued)


	January 30, 2011
	Parent Issuer		Guarantor Subsidiaries		Non- Guarantor Subsidiaries		Eliminations			Total

ASSETS
Current assets:
Cash and cash equivalents	$	249	$	8	$	35	$	–		$	292
Receivables, net		2		830		75		–			907
Inventories		–		958		77		–			1,035
Deferred tax asset		40		62		4		(4	)		102
Intercompany receivable		–		3		–		(3	)		–
Other current assets		9		35		1		–			45

Total current assets		300		1,896		192		(7)			2,381


Property and equipment, net		62		322		6		–			390
Goodwill		–		3,132		18		–			3,150
Intangible assets, net		–		988		4		–			992
Deferred tax asset		117		–		–		(117	)		–
Investment in subsidiaries		2,752		–		–		(2,752	)		–
Intercompany notes receivable		3,054		304		–		(3,358	)		–
Other assets		172		4		203		(203	)		176

Total assets	$	6,457	$	6,646	$	423	$	(6,437	)	$	7,089


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	20	$	730	$	55	$	–		$	805
Accrued compensation and benefits		32		80		6		–			118
Current installments of long-term debt		10		–		–		–			10
Intercompany payables		–		–		3		(3	)		–
Other current liabilities		157		104		11		–			272

Total current liabilities		219		914		75		(3	)		1,205


Long-term debt, excluding current installments		5,423		–		–		(184	)		5,239
Deferred tax liabilities		–		222		–		(121	)		101
Intercompany notes payable		304		3,054		–		(3,358	)		–
Other liabilities		415		45		7		(19	)		448

Total liabilities		6,361		4,235		82		(3,685	)		6,993


Stockholders’ equity		96		2,411		341		(2,752	)		96

Total liabilities and stockholders’ equity	$	6,457	$	6,646	$	423	$	(6,437	)	$	7,089

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

CONDENSED CONSOLIDATING CASH FLOW STATEMENTS


	Six Months Ended July 31, 2011
	Parent Issuer			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Total
Net cash flows from operating activities	$	(268	)	$	(21	)	$	(7	)	$	–		$	(296	)
Cash flows from investing activities
Capital expenditures		(8	)		(27	)		–			–			(35	)
Proceeds from sales of property and equipment		–			4			–			–			4
Purchase of investments		(21	)		–			–			–			(21	)
Proceeds from sale of a business		–			–			11			–			11
Payments for a business acquired		–			(21	)		–			–			(21	)
Proceeds from (payments of) intercompany notes		–			71			–			(71	)		–
Net cash flows from investing activities		(29	)		27			11			(71	)		(62	)
Cash flows from financing activities
Borrowings (repayments) of intercompany notes		(71	)		–			–			71			–
Repayments of long-term debt		(5	)		–			–			–			(5	)
Borrowings on long-term revolver		632			–			–			–			632
Repayments of long-term revolver		(472	)		–			–			–			(472	)
Net cash flows from financing activities		84			–			–			71			155
Effect of exchange rates on cash		–			–			2			–			2
Net increase (decrease) in cash & cash equivalents	$	(213	)	$	6		$	6		$	–		$	(201	)
Cash and cash equivalents at beginning of period		249			8			35			–			292
Cash and cash equivalents at end of period	$	36		$	14		$	41		$	–		$	91


	Six Months Ended August 1, 2010
	Parent Issuer			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Total
Net cash flows from operating activities	$	342		$	10		$	3		$	–		$	355
Cash flows from investing activities
Capital expenditures		(2	)		(19	)		(1	)		–			(22	)
Proceeds from sales of property and equipment		–			1			–			–			1
Proceeds from (payments of) intercompany notes		–			7			–			(7	)		–
Net cash flows from investing activities		(2	)		(11	)		(1	)		(7	)		(21	)
Cash flows from financing activities
Equity contribution		1			–			–			–			1
Borrowings (repayments) of intercompany notes		(7	)		–			–			7			–
Repayments of long-term debt		(35	)		–			–			–			(35	)
Repayments of long-term revolver		(482	)		–			–			–			(482	)
Debt modification costs		(34	)		–			–			–			(34	)
Net cash flows from financing activities		(557	)		–			–			7			(550	)
Effect of exchange rates on cash		–			–			2			–			2
Net increase (decrease) in cash & cash equivalents	$	(217	)	$	(1	)	$	4		$	–		$	(214	)
Cash and cash equivalents at beginning of period		479			8			52			–			539
Cash and cash equivalents at end of period	$	262		$	7		$	56		$	–		$	325

NOTE 15 – RECENT ACCOUNTING PRONOUNCEMENTS

HD SUPPLY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

consideration to one or more units of accounting. In addition, ASU 2009-13 expands the disclosures related to a company’s multiple-deliverable revenue arrangements. The Company adopted the provisions of ASU 2009-13 on January 31, 2011. The adoption did not have an impact on the consolidated financial statements or results of operations.

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

Comprehensive income – In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”), to increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity and requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-05 will not have an impact on the Company’s financial position or results of operations.

NOTE 16 – SUBSEQUENT EVENT

On August 25, 2011, the Company entered into a definitive agreement to sell all of the issued and outstanding equity interests in its Plumbing/HVAC business to Hajoca Corporation. The transaction is expected to close in September 2011 upon the satisfaction of customary closing conditions, including obtaining requisite government approvals. Upon the closing of the transaction, the Company anticipates recording a modest gain and expects to utilize the funds from the transaction for growth initiatives. In accordance with ASC 205-20, Discontinued Operations, the results of the Plumbing/HVAC operations and the related gain will be reflected as discontinued operations beginning in the third quarter of fiscal 2011.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking statements and information

This quarterly report includes forward-looking statements and cautionary statements. 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 consolidated 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 consolidated 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 consolidated 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 factors discussed in “Risk factors” in our annual report on Form 10-K for the year ended January 30, 2011 and those described from time to time in our other filings with the U.S. Securities and Exchange Commission (“SEC”). The section entitled “Risk factors” in our annual report on Form 10-K is incorporated herein by reference. Factors that could cause actual results to differ from those reflected in forward-looking statements relating to our operations and business include:

—

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

—

Our ability to achieve profitability;

—

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

—

Our substantial indebtedness and our ability to incur additional indebtedness;

—

Limitations and restrictions in the agreements governing our indebtedness;

—

Our ability to obtain additional financing on acceptable terms;

—

Increases in interest rates;

—

Rating agency actions with respect to our indebtedness;

—

The interests of the Equity Sponsors;

—

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

—

Goodwill and other impairment charges;

—

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

—

Consolidation among our competitors;

—

The loss of any of our significant customers;

—

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

—

Competitive pricing pressure from our customers;

—

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

—

Variability in our revenues and earnings;

—

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

—

Fluctuations in commodity and energy prices;

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

—

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

—

Our ability to manage fixed costs;

—

Changes in our product mix;

—

The impairment of financial institutions;

—

The development of alternatives to distributors in the supply chain;

—

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

—

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

—

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

—

Our ability to implement our technology initiatives;

—

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

—

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

—

Potential material liabilities under our self-insured programs;

—

Changes in U.S. health care legislation;

—

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

—

Fluctuations in foreign currency exchange rates;

—

Inability to protect our intellectual property rights;

—

Changes in U.S. and foreign tax law;

—

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

—

Our ability to identify and integrate new products;

—

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

—

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

You should read this report completely and with the understanding that actual future results may be materially different from expectations. All forward-looking statements made in this report are qualified by these cautionary statements. These forward-looking statements are made only as of the date of this report, 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.

Overview

HD Supply, Inc. (the “Company,” “we,” or “HD Supply”) is one of the largest wholesale distributors, based on sales, serving the highly fragmented U.S. and Canadian Infrastructure & Energy, Maintenance, Repair & Improvement, and Specialty Construction market sectors. Through 771 locations across the United States and Canada, we operate a diverse portfolio of distribution businesses that provide over 1 million SKUs to over 450,000 professional customers, including contractors, government entities, maintenance professionals, home builders and industrial businesses.

Description of market sectors

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

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

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

—

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

—

Utilities – Distributes electrical transmission and distribution products, power plant maintenance, repair and operations (“MRO”) supplies and smart-grid technologies and provides materials management and procurement outsourcing arrangements to investor-owned utilities, municipal and provincial power authorities, rural electric cooperatives and utility contractors.

—

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

—

Electrical – Supplies electrical products such as wire and cable, switch gear supplies, lighting and conduit to residential and commercial contractors.

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

—

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

—

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

—

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

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

—

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

—

Plumbing – Distributes plumbing fixtures, faucets and finishes, heating, ventilating and air conditioning (“HVAC”) equipment, pipes, valves, fittings and water heaters, as well as related services, to residential and commercial contractors.

—

Creative Touch Interiors (“CTI”) – Offers turnkey flooring installation services and countertop, cabinet and window covering installation services for the interior finish of residential and non-residential construction projects.

On August 25, 2011, the Company entered into a definitive agreement to sell all of the issued and outstanding equity interests in its Plumbing/HVAC business to Hajoca Corporation. The transaction is expected to close in September 2011 upon the satisfaction of customary closing conditions, including obtaining requisite government approvals. Upon the closing of the transaction, the Company anticipates recording a modest gain and expects to utilize the funds from the transaction for growth initiatives. In accordance with Accounting Standards Codification (“ASC”) 205-20, Discontinued Operations, the results of the Plumbing/HVAC operations and the related gain will be reflected as discontinued operations beginning in the third quarter of fiscal 2011.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Discontinued operations

On February 28, 2011, HD Supply Canada sold substantially all of the assets of SESCO/QUESCO, an electrical products division of HD Supply Canada, to Sonepar Canada, for approximately $11 million. In accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) (ASC 205-20, Discontinued Operations), the results of the SESCO/QUESCO operations are classified as discontinued operations. The presentation of discontinued operations includes revenues and expenses of the SESCO/QUESCO operations as one line item on the Consolidated Statement of Operations. All prior period Consolidated Statements of Operations presented have been restated to reflect this presentation. See “Note 2, Discontinued Operations,” in the Notes to the Consolidated Financial Statements within Part I of this Form 10-Q for additional detail related to the discontinued operations.

Acquisition

On May 2, 2011, we closed on a transaction to acquire substantially all of the assets of Rexford Albany Municipal Supply Company, Inc. (“RAMSCO”) for approximately $21 million. RAMSCO specializes in distributing water, sanitary and storm sewer materials primarily to municipalities and contractors through four locations in upstate New York. These locations are operated as part of the HD Supply Waterworks business. In accordance with the acquisition method of accounting under ASC 805, Business Combinations, the results of the acquisition are reflected in our financial statements from the date of acquisition forward.

Key business metrics

Net sales

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

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

We include shipping and handling fees billed to customers in Net sales. Shipping and handling costs associated with inbound freight are capitalized to inventories and relieved through Cost of sales as inventories are sold. Shipping and handling costs associated with outbound freight are included in Selling, general and administrative expenses.

Gross profit

Gross profit primarily represents the difference between the product cost from our suppliers (net of earned rebates and discounts) including the cost of inbound freight and the sale price to our customers. The cost of outbound freight (including internal transfers), purchasing, receiving and warehousing are included in Selling, general and administrative expenses within operating expenses. Our gross profits may not be comparable to those of other companies, as other companies may include all of the costs related to their distribution network in cost of sales. We intend to improve gross profit through the continued implementation of analytical pricing optimization tools, which enable more sophisticated and disciplined product pricing at the individual customer level.

Operating expenses

Operating expenses are comprised of selling, general and administrative costs, including payroll expenses (salaries, wages, employee benefits, payroll taxes and bonuses), rent, insurance, utilities, repair and maintenance and professional fees, as well as depreciation and amortization, restructuring charges, and goodwill impairments.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Other than selling expenses, these expenses generally do not vary proportionally with Net sales. As a result, operating expenses as a percentage of Net sales are usually higher in the winter season than the summer season due to the seasonality of Net sales.

Relationship with Home Depot

Historical relationship

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

On-going relationship

We derive revenue from the sale of products to Home Depot. Revenue from these sales is recorded at an amount that approximates market but may not necessarily represent a price an unrelated third party would pay. In addition to sales, we purchase products from Home Depot. All purchases are at amounts that management believes an unrelated third party would pay.

Strategic agreement

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.

Basis of presentation

The three months ended July 31, 2011 (“second quarter 2011”) and August 1, 2010 (“second quarter 2010”) both include thirteen weeks. The six months ended July 31, 2011 and August 1, 2010 both include twenty-six weeks.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Consolidated results of operations


	Three Months Ended						Percentage Increase (Decrease)			Six Months Ended						Percentage Increase (Decrease)
	July 31, 2011			August 1, 2010			Percentage Increase (Decrease)			July 31, 2011			August 1, 2010			Percentage Increase (Decrease)
Net Sales	$	2,157		$	1,962			10.0		$	4,045		$	3,762			7.5
Gross Profit		601			544			10.5			1,128			1,045			7.9
Operating expenses:
Selling, general and administrative		440			421			4.5			867			844			2.7
Depreciation and amortization		88			93			(5.4	)		176			187			(5.9	)
Restructuring		–			3			*			–			8			*

Total operating expenses		528			517			2.1			1,043			1,039			0.4

Operating Income		73			27			*			85			6			*
Interest expense		159			155			2.6			317			311			1.9
Other (income) expense, net		–			(1	)		*			(1	)		2			*

Income (Loss) from Continuing Operations Before Provision (Benefit) for Income Taxes		(86	)		(127	)		(32.3	)		(231	)		(307	)		(24.8	)
Provision (benefit) for income taxes		15			(12	)		*			35			10			*

Income (Loss) from Continuing Operations		(101	)		(115	)		(12.2	)		(266	)		(317	)		(16.1	)
Income from discontinued operations, net of tax		–			–			–			1			–			*

Net Income (Loss)	$	(101	)	$	(115	)		(12.2	)	$	(265	)	$	(317	)		(16.4	)


Other financial data:
EBITDA	$	161		$	122			32.0		$	263		$	192			37.0
Adjusted EBITDA	$	166		$	128			29.7		$	273		$	213			28.2

*	Not meaningful


	% of Net Sales									% of Net Sales
	Three Months Ended						Basis Point Increase (Decrease)			Six Months Ended						Basis Point Increase (Decrease)
	July 31, 2011			August 1, 2010			Basis Point Increase (Decrease)			July 31, 2011			August 1, 2010			Basis Point Increase (Decrease)
Net Sales		100.0			100.0						100.0			100.0
Gross Profit		27.9			27.7			20			27.9			27.8			10
Operating expenses:
Selling, general and administrative		20.4			21.5			(110	)		21.4			22.4			(100	)
Depreciation and amortization		4.1			4.7			(60	)		4.4			5.0			(60	)
Restructuring		–			0.1			(10	)		–			0.2			(20	)
Total operating expenses		24.5			26.3			(180	)		25.8			27.6			(180	)

Operating Income (Loss)		3.4			1.4			200			2.1			0.2			190
Interest expense		7.4			7.9			(50	)		7.8			8.3			(50	)
Other (income) expense, net		–			–			–			–			0.1			(10	)
Income (Loss) from Continuing Operations Before Provision (Benefit) for Income Taxes		(4.0	)		(6.5	)		(250	)		(5.7	)		(8.2	)		(250	)
Provision (benefit) for income taxes		0.7			(0.6	)		130			0.9			0.2			70
Income (Loss) from Continuing Operations		(4.7	)		(5.9	)		(120	)		(6.6	)		(8.4	)		(180	)
Income from discontinued operations, net of tax		–			–			–			–			–			–

Net Income (Loss)		(4.7	)		(5.9	)		(120	)		(6.6	)		(8.4	)		(180	)

Other financial data:
EBITDA		7.5			6.2			130			6.5			5.1			140
Adjusted EBITDA		7.7			6.5			120			6.7			5.7			100

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Highlights

Net sales in second quarter 2011 increased $195 million, or 10.0%, compared to second quarter 2010. All of our market sectors realized increases in Net sales, led by the Infrastructure & Energy market sector. Despite the negative impact of the economy, during second quarter 2011, our sales initiatives, continued focus on margin expansion and cost control resulted in an improvement in our Operating income of $46 million as compared to second quarter 2010. In addition, we continue to maintain strong liquidity, with $1.2 billion available as of July 31, 2011.

Our improvements in Net Sales and Operating income were achieved despite the continued weak economy and construction markets. Single-family housing starts are expected to decline between 5% and 10% in 2011, due in part to the expiration of the housing stimulus in second quarter 2010, but are projected to increase by a 20% to 30% compound annual rate from 2011 to 2014. Non-residential construction is expected to decline 4% to 7% in 2011 versus 2010. A compound annual growth rate of between 6% and 15% is forecasted from 2011 to 2014.

Net sales

Net sales in second quarter 2011 increased $195 million, or 10.0%, compared to second quarter 2010 and $283 million, or 7.5%, in the first six months of fiscal 2011 as compared to the same period in fiscal 2010.

The increase in Net sales in second quarter 2011 was driven by our Infrastructure & Energy market sector, though Net sales also increased at the Maintenance, Repair & Improvement and Specialty Construction market sectors. Net sales were positively impacted by improvements in the infrastructure and energy markets, sales initiatives, and commodity prices.

Gross profit

Gross profit increased $57 million, or 10.5%, during second quarter 2011 as compared to second quarter 2010 and $83 million, or 7.9%, during the first six months of fiscal 2011 as compared to the same period in fiscal 2010.

An increase in gross profit in second quarter 2011 was experienced across all of our market sectors. The improvements in gross profit were primarily driven by increased market volumes, sales initiatives, and commodity prices.

Gross profit as a percentage of Net sales (“gross margin”) increased approximately 20 basis points to 27.9% in second quarter 2011 from 27.7% in second quarter 2010 and approximately 10 basis points to 27.9% in the first six months of fiscal 2011 as compared to 27.8% in the first six months of fiscal 2010. The increases were driven by product mix and the impact of fluctuating commodity prices.

Operating expenses

Operating expenses increased $11 million, or 2.1%, during second quarter 2011 as compared to second quarter 2010 and $4 million, or 0.4%, during the first six months of fiscal 2011 as compared to the same period in fiscal 2010.

Selling, general and administrative expenses increased $19 million, or 4.5%, in second quarter 2011 as compared to second quarter 2010 and $23 million, or 2.7%, in the first six months of fiscal 2011 as compared to the same period in fiscal 2010. The increase in both periods is primarily as a result of increases in variable expenses due to sales volume increases and an increase in employee benefits related to the restoration of the Company’s match on the 401(k) defined contribution plan. Depreciation and amortization expense decreased $5 million, or 5.4%, in second quarter 2011 and $11 million, or 5.9% in the first six months of fiscal 2011 as compared to the same periods in fiscal 2010, primarily due to disciplined capital expenditures. During second quarter 2010 and the first six months of fiscal 2010, we recorded $3 million and $8 million, respectively, of restructuring charges under the fiscal 2009 restructuring plan.

Operating expenses as a percentage of Net sales decreased approximately 180 basis points in both the second quarter 2011 and the first six months of fiscal 2011, as compared to the same periods in fiscal 2010. The improvement reflects the reduction in restructuring charges and Depreciation and amortization expense in both periods of fiscal 2011 as compared to the same periods in fiscal 2010. In addition, the improvement reflects the

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

leverage of fixed costs through sales volume increases and efforts to control variable expenses at all of our market sectors in both periods of fiscal 2011 as compared to the same periods in fiscal 2010. The first six months of fiscal 2011 were also positively impacted by a reduction in personnel expenses at our corporate operations.

Operating income (loss)

Operating income increased $46 million during second quarter 2011 and $79 million in the first six months of fiscal 2011 as compared to the same periods in fiscal 2010, as a result of the improvement in Net sales and Gross profit and control over growth in Operating expenses.

Operating income as a percentage of Net sales increased approximately 200 basis points in second quarter 2011 and 190 basis in the first six months of fiscal 2011 as compared to the same periods in fiscal 2010. The improvement in both periods was driven by our Specialty Construction and Maintenance, Repair & Improvement market sectors and, to a lesser extent, our Infrastructure & Energy market sector.

Interest expense

Interest expense increased $4 million, or 2.6%, during second quarter 2011 and $6 million, or 1.9%, in the first six months of fiscal 2011 as compared to the same periods of 2010. The increase in interest expense in both periods is due to an increase in the principal of the 13.5% Senior Subordinated Notes due to the paid-in-kind interest capitalization, substantially offset by a decline in average debt balances on the ABL Credit Facility and Cash Flow Revolver. The second quarter 2011 interest expense was also impacted by a reduction in interest rates on our variable rate debt as compared to second quarter 2010.

Other (income) expense, net

During first quarter 2011, we recognized a gain of $1 million related to the maturity of our interest rate swaps.

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

Provision (benefit) for income taxes

The provision for income taxes from continuing operations in second quarter 2011 was $15 million compared to a $12 million benefit in second quarter 2010. The effective rate for continuing operations for second quarter 2011 was a provision of 17.4%, reflecting the impact of increasing the U.S. valuation allowance, increasing the deferred tax liability for U.S. goodwill amortization for tax purposes, additional unrecognized tax benefits and the accrual of income taxes for foreign and certain state jurisdictions. The effective rate for continuing operations for second quarter 2010 was a benefit of 9.4%, driven by the impact of a $33 million increase in the valuation allowance on deferred tax assets.

The provision for income taxes from continuing operations in the first six months of fiscal 2011 was $35 million compared to a $10 million provision in the first six months of fiscal 2010. The effective rate for continuing operations for the first six months of fiscal 2011 was a provision of 15.2%, reflecting the impact of increasing the U.S. valuation allowance, increasing the deferred tax liability for U.S. goodwill amortization for tax purposes, additional unrecognized tax benefits and the accrual of income taxes for foreign and certain state jurisdictions. The effective rate for continuing operations for the first six months of fiscal 2010 was a provision of 3.2%, driven by the impact of a $117 million increase in the valuation allowance on deferred tax assets.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

We regularly assess the realization of our net deferred tax assets and the need for any valuation allowance. This assessment requires management to make judgments about the benefits that could be realized from future taxable income, as well as other positive and negative factors influencing the realization of deferred tax assets.

EBITDA and Adjusted EBITDA

EBITDA, a measure used by management to evaluate operating performance, is defined as Net income (loss) less Income (loss) from discontinued operations, net of tax, plus (i) Interest expense and Interest income, net, (ii) Provision (benefit) for income taxes, and (iii) Depreciation and amortization.

EBITDA increased $39 million, or 32.0%, in second quarter 2011 as compared to second quarter 2010 and Adjusted EBITDA increased $38 million, or 29.7%, in second quarter 2011 as compared to second quarter 2010. EBITDA increased $71 million, or 37.0%, in the first six months of fiscal 2011 as compared to the same period in fiscal 2010 and Adjusted EBITDA increased $60 million, or 28.2%, in the first six months of fiscal 2011 as compared to the same period in fiscal 2010. The increase in EBITDA and Adjusted EBITDA in both periods is primarily due to the increases in Net sales and Gross profit. Adjusted EBITDA as a percentage of Net sales increased approximately 120 basis points to 7.7% in second quarter 2011 and approximately 100 basis points to 6.7% in the first six months of fiscal 2011 as compared to the same periods in fiscal 2010, primarily due to the leverage of fixed costs through sales volume increases and efforts to control variable expenses.

EBITDA is not a recognized term under U.S. GAAP and does not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. Additionally, EBITDA is not intended to be a measure of free cash flow available for management’s discretionary use, as it does not consider certain cash requirements such as interest payments, tax payments and other debt service requirements. We believe EBITDA is helpful in highlighting trends because EBITDA excludes the results of decisions that are outside the control of operating management and that can differ significantly from company to company depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate, age and book depreciation of facilities and capital investments. We further believe that EBITDA is frequently used by securities analysts, investors and other interested parties in their evaluation of companies, many of which present an EBITDA measure when reporting their results. We compensate for the limitations of using non-GAAP financial measures by using them to supplement U.S. GAAP results to provide a more complete understanding of the factors and trends affecting the business than U.S. GAAP results alone. Because not all companies use identical calculations, our presentation of EBITDA may not be comparable to other similarly titled measures of other companies.

In addition, we present Adjusted EBITDA because it is based on “Consolidated EBITDA,” a measure which is used in calculating financial ratios in several material debt covenants in our Senior Secured Credit Facility and our ABL Credit Facility. Borrowings under these facilities are a key source of liquidity and our ability to borrow under these facilities depends upon, among other things, our compliance with such financial ratio covenants. In particular, both facilities contain restrictive covenants that can restrict our activities if we do not maintain financial ratios calculated based on Consolidated EBITDA and our ABL Credit Facility requires us to maintain a fixed charge coverage ratio of 1:1 if we do not maintain $210 million of borrowing availability. Adjusted EBITDA is defined as EBITDA adjusted to exclude non-cash items and certain other adjustments to Consolidated Net Income permitted in calculating Consolidated EBITDA under our Senior Secured Credit Facility and our ABL Credit Facility. We believe that inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors about how the covenants in those agreements operate and about certain non-cash items, items that we do not expect to continue at the same level and other items. The Senior Secured Credit Facility and ABL Credit Facility permit us to make certain adjustments to Consolidated Net Income in calculating Consolidated EBITDA, such as projected net cost savings, which are not reflected in the Adjusted EBITDA data presented in this quarterly report on Form 10-Q. 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 our annual report on Form 10-K, filed with the SEC on April 14, 2011, under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – External Financing.”

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

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

—

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

—

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

—

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

—

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

—

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

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


	Three Months Ended						Six Months Ended
	July 31, 2011			August 1, 2010			July 31, 2011			August 1, 2010
Net income (loss)	$	(101	)	$	(115	)	$	(265	)	$	(317	)
Less income (loss) from discontinued operations, net of tax		–			–			1			–

Income (loss) from continuing operations		(101	)		(115	)		(266	)		(317	)

Interest expense, net		159			155			317			311
Provision (benefit) from income taxes		15			(12	)		35			10
Depreciation and amortization		88			94			177			188

EBITDA	$	161		$	122		$	263		$	192


Adjustments to EBITDA:
Other (income) expense, net (i)		–			(1	)		(1	)		2
Restructuring charge (ii)		–			3			–			8
Stock-based compensation (iii)		5			4			9			8
Management fee & related expenses paid to Equity Sponsors (iv)		2			2			3			3
Other		(2	)		(2	)		(1	)		–

Adjusted EBITDA	$	166		$	128		$	273		$	213

(i)

Represents the loss on extinguishment of debt, the gains/losses associated with the changes in fair value of interest rate swap contracts not accounted for under hedge accounting, and other non-operating income/expense.

(ii)

Represents the costs incurred for employee reductions and branch closures or consolidations. These costs include occupancy costs, severance, and other costs incurred to exit a location.

(iii)

Represents stock-based compensation costs for stock options.

(iv)

The Company entered into a management agreement whereby the Company pays the Equity Sponsors a $5 million annual aggregate management fee. In addition, the Company reimburses certain Equity Sponsor expenses.

Amounts were derived from our consolidated financial statements.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Results of operations by market sector

Infrastructure & Energy


	Three Months Ended								Six Months Ended
*Dollars in millions*	July 31, 2011			August 1, 2010			Increase (Decrease)		July 31, 2011			August 1, 2010			Increase (Decrease)
Net sales	$	1,082		$	954			13.4%	$	2,034		$	1,848			10.1%
Operating income		28			17			64.7%		42			23			82.6%
% of Net sales		*2.6*	%		1.8	%		80 bps		*2.1*	%		1.2	%		90 bps

Net Sales

Net sales increased $128 million, or 13.4%, in second quarter 2011 as compared to second quarter 2010 and $186 million, or 10.1% in the first six months of fiscal 2011 as compared to the same period in fiscal 2010.

All four businesses within the Infrastructure & Energy sector experienced an increase in Net sales in second quarter 2011 and in the first six months of fiscal 2011 as compared to the same periods in fiscal 2010.

The Net sales increase in second quarter 2011 and the first six months of fiscal 2011 was primarily due to improving energy market conditions, new sales initiatives, and favorable impacts from fluctuating commodity prices, primarily copper at Electrical, nickel at IPVF, and polyvinyl chloride (“PVC”) at Waterworks. Net sales at Waterworks were also favorably impacted in second quarter 2011 by the acquisition of RAMSCO.

Operating income

Operating income increased $11 million, or 64.7%, in second quarter 2011 as compared to second quarter 2010 and $19 million, or 82.6% in the first six months of fiscal 2011 as compared to the same period in fiscal 2010.

All four businesses within the Infrastructure & Energy sector experienced an increase in Operating income in second quarter 2011 and in the first six months of fiscal 2011 as compared to the same periods in fiscal 2010.

The increase in operating income during second quarter 2011 and the first six months of fiscal 2011 was primarily due to volume increases and positive impacts from fluctuating commodity prices, partially offset by competitive gross margin pressure and higher Selling, general and administrative costs, primarily due to variable compensation as a result of higher volumes.

Operating income as a percentage of Net sales increased approximately 80 basis points in second quarter 2011 as compared to second quarter 2010. The increase was driven primarily by gross margin improvements at IPVF and the leverage of fixed costs through sales volume increases and efforts to control variable expenses at all four businesses, partially offset by gross margin compression at Electrical, Waterworks and Utilities. Operating income as a percentage of Net sales increased approximately 90 basis points in the first six months of fiscal 2011 as compared to the same period in fiscal 2010. The increase was driven primarily by gross margin improvements at IPVF, and to a lesser extent Waterworks, and the leverage of fixed costs through sales volume increases and efforts to control variable expenses at IPVF and Electrical, partially offset by gross margin compression at Utilities and Electrical.

Maintenance, Repair & Improvement


	Three Months Ended								Six Months Ended
*Dollars in millions*	July 31, 2011			August 1, 2010			Increase (Decrease)		July 31, 2011			August 1, 2010			Increase (Decrease)
Net sales	$	616		$	577			6.8%	$	1,143		$	1,084			5.4%
Operating income		80			60			33.3%		128			106			20.8%
% of Net sales		*13.0*	%		10.4	%		260 bps		*11.2*	%		9.8	%		140 bps

Net Sales

Net sales increased $39 million, or 6.8%, in second quarter 2011 as compared to second quarter 2010 and $59 million, or 5.4% in the first six months of fiscal 2011 as compared to the same period in fiscal 2010.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

The increase in Net sales in second quarter 2011 and the first six months of fiscal 2011 was driven by Facilities Maintenance, which had increases of $40 million, or 8.8%, and $77 million, or 8.9%, respectively. The Net sales growth at Facilities Maintenance in both periods was primarily due to new initiatives in the hospitality, multi-family, and healthcare markets and improving market conditions in the hospitality and multi-family markets. Repair & Remodel also had an increase in Net sales in both periods primarily due to the opening of a new location in the Los Angeles market. In addition, Net sales at Repair & Remodel in second quarter 2011 were favorably impacted by same-store sales increases. Crown Bolt experienced a decline in Net sales in both periods of fiscal 2011 as compared to the same periods of fiscal 2010 primarily due to the discontinuation of the audio visual product line at the end of fiscal 2010 and weakness in the home improvement market.

Operating income

Operating income increased $20 million, or 33.3%, in second quarter 2011 as compared to second quarter 2010 and $22 million, or 20.8% in the first six months of fiscal 2011 as compared to the same period in fiscal 2010.

The increase in Operating income in second quarter 2011 was driven by Facilities Maintenance and Crown Bolt, and, to a lesser extent, by Repair & Remodel. The increase in Operating income in the first six months of fiscal 2011 as compared to the same period in fiscal 2010 was driven by Facilities Maintenance, and, to a lesser extent, Crown Bolt and Repair & Remodel. The increases at Facilities Maintenance in both the second quarter and the year-to-date period were driven by volume increases and new sales initiatives, partially offset by increased Selling, general and administrative expense related to the volume increases and new initiatives. The increases in both periods at Crown Bolt were driven by gross margin improvements and a reduction in operating expenses, including depreciation and amortization. The increases in both periods at Repair & Remodel were driven by volume increases and a reduction in operating expenses, including depreciation and amortization.

Operating income as a percentage of Net sales increased approximately 260 basis points in second quarter 2011 as compared to second quarter 2010 and approximately 140 basis points in the first six months of fiscal 2011 as compared to the same period in fiscal 2010. The increase in second quarter 2011 was driven by gross margin improvements across all three businesses, the leverage of fixed costs through sales volume increases and efforts to control variable expenses at Facilities Maintenance, and the reduction of operating expenses at Repair & Remodel and Crown Bolt. The increase in Operating income as a percentage of Net sales in the first six months of fiscal 2011 was primarily due the leverage of fixed costs through sales volume increases and efforts to control variable expense at Facilities Maintenance and gross margin improvements at Crown Bolt.

Specialty Construction

Three Months Ended

Six Months Ended

Dollars in millions

July 31,
2011

August 1,
2010

Increase
(Decrease)

July 31,
2011

August 1,
2010

Increase
(Decrease)

Net sales

417

393

6.1%

784

757

3.6%

Operating loss

(13)

(27)

(51.9)%

(39)

(66)

(40.9)%

% of Net sales

(3.1)%

(6.9)%

(380) bps

(5.0)%

(8.7)%

(370) bps

Net Sales

Net sales increased $24 million, or 6.1%, in second quarter 2011 as compared to second quarter 2010 and $27 million, or 3.6% in the first six months of fiscal 2011 as compared to the same period in fiscal 2010.

The increase in Net sales during the second quarter 2011 was driven by a $33 million increase at White Cap and Plumbing, partially offset by a Net sales decline of $10 million at CTI. The increase in Net sales during the first six months of fiscal 2011 was driven by a $50 million increase at White Cap and Plumbing, partially offset by a Net sales decline of $23 million at CTI.

The increases in Net sales during both periods of fiscal 2011 at White Cap and Plumbing were driven primarily by sales initiatives and rising commodity prices, primarily steel and copper. The decreases in Net sales during both periods of fiscal 2011 at CTI were driven by volume declines in the residential construction market, in part due to the expiration of the U.S. tax incentives for homebuyers in the second quarter of fiscal 2010.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Operating loss

Operating loss declined favorably by $14 million in second quarter 2011 and $27 million in the first six months of fiscal 2011 as compared to the same periods in fiscal 2010.

The favorable declines in Operating loss in both second quarter 2011 and the first six months of fiscal 2011 were driven by White Cap, and, to a lesser extent, CTI and Plumbing. The favorable declines at White Cap in both periods of fiscal 2011 were primarily driven by gross profit increases as a result of volume and commodity impacts, the leverage of fixed costs through sales volume increases, and efforts to control variable expenses. In addition, depreciation and amortization expense in both second quarter 2011 and the first six months of fiscal 2011 was lower for all three businesses within the market sector and fiscal 2010 Operating loss was unfavorably impacted by restructuring charges at White Cap and CTI in both second quarter and the first six months of fiscal 2010.

Operating loss as a percentage of Net sales improved approximately 380 basis points in second quarter 2011 as compared to second quarter 2010 and approximately 370 basis points in the first six months of fiscal 2011 as compared to the same period in fiscal 2010. The improvement in second quarter 2011 was primarily due to the leverage of fixed costs through sales volume increases and efforts to control variable expenses at White Cap and Plumbing, partially offset by gross margin compression at Plumbing. The impact of volume declines at CTI was offset by improvements in gross margins and a reduction in operating expenses. The improvement in Operating loss as a percentage of Net sales during the first six months of fiscal 2011 was primarily due to improved gross margins at White Cap and CTI, partially offset by gross margin compression at Plumbing and by volume declines at CTI that outpaced the reduction in fixed costs of the business. In addition, Operating loss as a percentage of Net sales in both second quarter 2010 and the first six months of fiscal 2010 was unfavorably impacted by restructuring charges.

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Liquidity and capital resources

Sources and uses of cash

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

During the second quarter of fiscal 2011, the Company’s use of cash was primarily used in business operations, including but not limited to, payments for inventories, payments of operating expenses, funding capital expenditures, and the payment of interest on debt. This use of cash was partially offset by cash receipts from operations and external financing arrangements.

As of July 31, 2011, our combined liquidity of approximately $1.2 billion is comprised of $91 million in cash and cash equivalents and $1.1 billion of available borrowings. The available borrowings include $200 million under our Revolving Credit Facility, which matures on August 30, 2013, and $879 million under our ABL Revolving Credit Facility, based on qualifying inventory and receivables, which matures on April 1, 2014.

Although we believe that our end-markets will improve and enable us to generate higher earnings and cash flows in future years, even in the absence of this expected improvement, we believe our current liquidity and earnings are sufficient to meet all of our operating needs and financial obligations through 2013. The chart below illustrates how our liquidity changes based on historical fiscal 2010 Adjusted EBITDA and capital expenditures, and our anticipated debt service requirements and debt maturities (amounts in millions).


	Fiscal Year
	2011		2012		2013
Starting Liquidity⁽¹⁾	$	1,323	$	1,340	$	1,039
Add:
Adjusted EBITDA⁽²⁾		431		431		431
Subtract:
Cash Interest Payments⁽³⁾		355		600		600
Capital Expenditures⁽²⁾		49		49		49
Debt Principal Payments⁽⁴⁾		10		83		10
Maturity of Revolving Credit Facility		–		–		200

Ending Liquidity	$	1,340	$	1,039	$	611

(1)

Starting liquidity for fiscal 2011 is equal to our fiscal 2010 year-end liquidity.

(2)

Adjusted EBITDA and Capital Expenditures are held constant in this illustration and are based on the fiscal 2010 Adjusted EBITDA and Capital Expenditures. For a reconciliation of Adjusted EBITDA to Net income (loss), the most directly comparable financial measure under U.S. GAAP, see “Item 6. Selected Financial Data” in our annual report on Form 10-K for the year ended January 30, 2011, filed with the SEC on April 14, 2011. By including these assumptions in this report we do not intend to make any projection regarding future Adjusted EBITDA or capital expenditure levels. Actual results in the future may differ materially from historic levels.

(3)

Our cash interest payments for fiscal 2011 are expected to be approximately $355 million. Beginning in fiscal 2012, we anticipate our annualized cash interest payments to be approximately $600 million as the interest on our 13.5% Senior Subordinated Notes will begin to be paid in cash, rather than paid in kind. The interest rates and other terms within our current credit agreements are not impacted by rating agency actions.

(4)

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

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

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

Net cash provided by (used for):


*Amounts in millions*	Six Months Ended						Increase (Decrease)
*Amounts in millions*	July 31, 2011			August 1, 2010			Increase (Decrease)

Operating activities	$	(296	)	$	355		$	(651	)
Investing activities	$	(62	)	$	(21	)	$	(41	)
Financing activities	$	155		$	(550	)	$	705

Working capital

Working capital, excluding cash and cash equivalents, increased to $1,242 million as of July 31, 2011 from $1,097 million as of August 1, 2010. The increase was primarily driven by an increase in Receivables and Inventory, partially offset by a decrease in net deferred tax assets and other current liabilities. We continue to focus on asset management initiatives that are intended to improve our working capital.

Operating activities

Cash flow from operating activities in the first six months of fiscal 2011 was a use of $296 million compared with cash provided by operating activities of $355 million in the first six months of fiscal 2010. This decrease was primarily due to the receipt of an IRS refund in first quarter 2010 of $220 million, which is reflected in the Consolidated Statement of Cash Flows as a change in other current assets, and the timing of payments for the purchase of inventory.

Investing activities

During the first six months of fiscal 2011, cash used in investing activities was $62 million, driven by $35 million in capital expenditures, $21 million in business acquisition payments, and $21 million in investment purchases, partially offset by $11 million of proceeds from the sale of a business. During the first six months of fiscal 2010, cash used in investing activities was $21 million, driven by $22 million of capital expenditures.

Financing activities

During the first six months of fiscal 2011, cash provided by financing activities was $155 million, due to net debt borrowings. During the first six months of fiscal 2010, cash used in financing activities was $550 million, due to debt repayments of $517 million, including the prepayment on the Term Loan of $30 million, and $34 million in financing fees related to the amendment of our credit agreements in March 2010.

External Financing

As of July 31, 2011, we have an aggregate principal amount of $5.5 billion of outstanding debt, $200 million of available borrowings under our Revolving Credit Facility and $901 million of available borrowings under our ABL Credit Facility (after giving effect to the borrowing base limitations and approximately $72 million in letters of credit issued and including $22 million of borrowings available on qualifying cash balances).

Our outstanding debt as of July 31, 2011 and January 30, 2011 consisted of the following outstanding principal amounts with respective interest rates (dollars in millions):

July 31, 2011

January 30, 2011

Outstanding
Principal

Interest
Rate %

Outstanding
Principal

Interest
Rate %

Term Loan due August 30, 2012

1.50

1.56

Term Loan due April 1, 2014

860

3.00

864

3.06

Revolving Credit Facility due August 30, 2013

–

ABL Revolving Credit Facility due August 30, 2012

1.69

–

ABL Revolving Credit Facility due April 1, 2014

138

3.44

–

ABL Term Loan due April 1, 2014

214

3.45

214

3.53

12.0% Senior Notes due September 1, 2014

2,500

12.00

2,500

12.00

13.5% Senior Subordinated Notes due September 1, 2015

1,705

13.50

1,597

13.50

Total long-term debt

5,511

5,249

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Senior Secured Credit Facility

The Company maintains a senior secured credit facility (the “Senior Secured Credit Facility”) comprised of a $933 million term loan (the “Term Loan”) and a $200 million revolving credit facility (the “Revolving Credit Facility”). As of July 31, 2011 and January 30, 2011, there were no outstanding Letters of Credit under the Revolving Credit Facility.

Asset Based Lending Credit Agreement

The Company maintains a $2.1 billion asset based lending credit agreement (the “ABL Credit Facility”) subject to borrowing base limitations. As of July 31, 2011, the Company had available borrowings under the ABL Credit Facility of $901 million, after giving effect to the borrowing base limitations and letters of credit issued and including $22 million of borrowings available on qualifying cash balances. As of July 31, 2011, there were approximately $10 million and $62 million, respectively, of Letters of Credit outstanding under the ABL Credit Facility due August 30, 2012 and April 1, 2014, respectively. As of January 30, 2011, there were approximately $11 million and $60 million, respectively, of Letters of Credit outstanding under the ABL Credit Facility due August 30, 2012 and April 1, 2014, respectively.

Lehman Brothers and Woodlands Commercial Bank

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

12.0% Senior Notes and 13.5% Senior Subordinated Notes

On August 30, 2007, the Company issued $2.5 billion of Senior Notes due 2014 bearing interest at a rate of 12.0% (the “12.0% Senior Notes”). Interest payments are due each March and September 1st through maturity.

On August 30, 2007, the Company issued $1.3 billion of Senior Subordinated Notes due 2015 bearing interest at a rate of 13.5% (the “13.5% Senior Subordinated Notes”). Interest payments are due each March and September 1st through maturity except that the first eight payment periods through September 2011 must be paid in kind (“PIK”) and therefore increase the balance of the outstanding indebtedness rather than being paid in cash. As of July 31, 2011, the outstanding principal balance of the 13.5% Senior Subordinated Notes was $1.7 billion.

Debt covenants

HD SUPPLY, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Continued)

Critical accounting policies

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these consolidated financial statements. The Company’s critical accounting policies have not changed from those reported in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s annual report on Form 10-K for the year ended January 30, 2011.

New accounting guidance

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

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


HD SUPPLY, INC.		Form 10-Q

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risk associated with changes in interest rates, foreign currency exchange rate fluctuations and certain commodity prices. To reduce these risks, we selectively use financial instruments and other proactive management techniques. We do not use financial instruments for trading purposes or speculation. There have been no material changes in our market risk exposures as compared to those discussed in our annual report on Form 10-K for the year ended January 30, 2011.

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective.

There were no changes in the Company’s internal control over financial reporting, as defined in the Exchange Act Rules 13a-15(f) or 15d-15(f), during the second quarter of fiscal 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

HD Supply is involved in litigation from time to time in the ordinary course of business. In management’s opinion, none of the proceedings are material in relation to the consolidated operations, cash flows, or financial position of HD Supply and the Company has adequate reserves to cover its estimated probable loss exposure.

Item 1A. Risk Factors

We discuss in our annual report on Form 10-K for the year ended January 30, 2011 various risks that may materially affect our business. We use this section to update this discussion to reflect material developments since our annual report on Form 10-K was filed. There have been no material changes to the risk factors disclosed in our annual report on Form 10-K. The materialization of any risks and uncertainties identified in Forward-Looking Statements contained in this report together with those previously disclosed in the annual report on Form 10-K or those that are presently unforeseen could result in significant adverse effects on our financial condition, results of operations and cash flows. See Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Forward-looking statements and information” in this report.


HD SUPPLY, INC.		Form 10-Q

Item 6. Exhibits

Exhibits marked with an asterisk (*) are incorporated by reference to exhibits or appendices previously filed with the U.S. Securities and Exchange Commission, as indicated by the references in brackets. All other exhibits are filed or furnished herewith.


		21.1		List of Subsidiaries

		31.1		Certification of President and Chief Executive Officer pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended

		31.2		Certification of Senior Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended

		32.1		Certification of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

		32.2		Certification of Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

		101		The following financial information from the Quarterly Report on Form 10-Q for the fiscal quarter ended July 31, 2011, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Statements of Operations; (ii) the Consolidated Balance Sheets; (iii) the Consolidated Statements of Cash Flows; and (iv) the Notes to the Consolidated Financial Statements, tagged as blocks of text.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


				HD SUPPLY, INC.
				(Registrant)



September 8, 2011	By:	/S/ JOSEPH J. DEANGELO
(Date)		Joseph J. DeAngelo
		President and Chief Executive Officer

		/S/ RONALD J. DOMANICO
		Ronald J. Domanico
		Senior Vice President and Chief Financial Officer