Q3 2019 Earnings Call
Good morning, ladies and gentlemen, and welcome to the HD supply Holdings 2019 third quarter earnings call.
As a reminder, some of our comments today, maybe forward looking statements based on managements beliefs and assumptions and information currently available to management at this time.
These leases subject to known and unknown risks and uncertainties, many of which may be beyond our control increasingly as detailed in our periodic SEC filings.
Please note that the company's actual results may differ materially from those anticipated and we undertake no obligation to update you statements.
Reconciliations of certain non-GAAP financial metrics with a corresponding GAAP measures are available at the end bus slide presentation and in our 2019 third quarter earnings release, which is available on our IR website at Www HD supply dotcom.
Dig Jody Angelo our CEO will lead todays call with Brad Paulson and John segment, providing further color around their respective business unit.
Evan Levitt, our CFO will provide further information on our recent financial performance on our expectations for the remainder of 2019.
There will be an opportunity queuing for those participating please limit your amounts to one question and one follow up if necessary.
Thank you for your continued interest in HD supply so with that I will now handover the call to Joe Dangelo well. Thank you Charlotte Good morning, everyone. Thank you for joining us today for our third quarter 2019 earnings call.
As always is my privilege to share companies.
On behalf of the over 11500, HD supply associates, who work hard everyday as one team driving customer success and value creation.
Turning to page three the environment continues to be challenging.
And the third quarter fiscal 2019, we delivered 2% sales growth and saw adjusted EBITDA declined by $1 billion.
Well, we have been encouraged by the growth trends throughout the quarter and our strong free cash flow generation of $577 million on a trailing 12 month basis.
This allowed us to take advantage of our capital allocation strategy and Opportunistically repurchase a significant amount of our shares through the quarter.
Turning to page four I want to focus today's call on providing an update on the planned separation of our two business units.
As you are aware in late September we hosted a conference call you announced the AC supply will be separating into two industry, leading public companies.
We are nearly three months into that process that made significant progress we're on the planning and implementation with key milestones being hit around talent alignment and information systems architecture.
As a result, we're now able to give you a little bit more information around timeline.
The current expectation is that construction industrial business will become an independent company in mid 2020 through a tax free distribution to shareholders.
This business will be name white cap consistent with this historical bringing with it in the industry.
Both businesses are currently undergoing an in depth strategic review with the expectation that we'll be filing a form 10 registration statement with the SEC in early 2020.
We expect that the white cap business will have the opportunity meet with analyst and investors ahead of the separation.
The details around capital structure will be finalized closer to the planned separation in mid 2020, we can share that will be targeting a high non investment grade credit rating for both businesses.
This means the both companies are likely to remain in the two to three times net debt to EBITDA range with facilities maintenance targeting the middle to higher end of that range and white cap likely targeting the lower end of that range.
The ratings agencies will make the ultimate determination following an in depth review of the business profile capital structure and capital allocation policies.
Weve. Additionally, disclosed that we expect gold companies to maintain good annual cash flow generation with facilities maintenance generating nearly $300 million post split and white cap generating nearly $200 million subject to final capital structure.
This is inclusive of the expectation that both businesses will be regular federal income tax payers given that our federal net operating loss carry forwards where exhausted during the third quarter of fiscal 2019 as expected.
In November we outlined our expectations for incremental Standalone costs of approximately 50 to 100 basis points for each business and aligned with historic comparably Woodside separation transactions.
We have in the past highlighted that both businesses enjoys significant amount of operational autonomy.
However, they do share considerable back office functionality. This includes departments like payroll tax legal treasury and human resources. In addition to enterprise wide infrastructure and applications.
Right now we allocated costs of these shared functions between the two businesses.
We remain in the process of planning and executing the separation working hard to minimize the amount of standalone cost breach business.
We still have considerable work to do between now and separation.
We believe that both companies will need around three years to offset these incremental costs through efficiency and leverage of fixed cost as they continue to grow.
Our teams are excited and energized.
Each businesses sales now exceed $3 billion on in annual basis, and we believe they now have could scale to stand alone as separate public companies.
This gives both management teams the opportunity to better focus on their markets and best serve their respective customers, while optimizing their capital structure and maximizing the return to shareholders.
Despite the work ahead of US we will not be distracted from the primary job serving our customers with excellence.
Third quarter saw improved growth was still below our expectations.
We continue to listen to our customers and provide them with the best products and services to help them succeed.
I'll provide some closing comments voluntary and eight we'll now turn the call over to breadth buttons and John segment will provide an update on the key areas of investor interest.
Thank you Joe and good morning, I'd like to begin by banking on nearly 6000 associates for the differentiated experience and support they provide toward customers each day.
Turning to page five I'd like to address some of the topics regarding our facilities maintenance business that have recently been top of mind for investors.
End markets. The MRO market is more challenging than it was 12 months ago, given that our customers are facing escalating product costs from tariff related Inflations and continued high turnover of property level maintenance professionals.
These conditions paired with an increasing focus on managing property level operational costs as in some cases impacted customer purchase patterns.
Despite this we fully expect to continue to grow through an increased focus on our national account customer base, which represent approximately 80% of our sales and improved execution of our value proposition for other customer segments, which has historically split purchases among multiple providers. Overall, we are still very encouraged by the resiliency of the break fix name.
Each of our business and are confident that we are uniquely positioned to grow in these market conditions.
Hospitality sales within our hospitality customer segment have historically outgrown the company average, but this year have slowed and underperformed the company average while we do believe this customers face in its own market pressures. Our team was optimistic about the growth opportunities available in this space.
We plan to be opportunistic and acquiring new customers, while also selling more to our existing customers by expanding our available product offerings and adjusting our service model for coal excuse me corporate owned properties in franchise owner operators.
Tariffs as both Joe and I have shared our recent investment and pricing analytics tools has been a significant help and navigating the unpredictable tariffs environment seen over the last 12 months.
Our category management and pricing teams have successful use these tools to make informed data driven pricing decisions. These tools along with the support from our strategic supplier partners have allowed our team to continue to offer market competitive pricing to our customers.
Going forward, we do expect to be able to continue to pass on the gross margin dollar increase on our tariff impacted skews, but we are expecting gross margin rate contraction as the tariff costs have become two significant to fully passed on enough of a price increase or customers to maintain gross margin rate.
I'm fully confident in our team and its ability to successfully navigate the go forward Terrace environment.
Operations.
Despite a difficult starts in the year, we have recovered from our previous fulfillment issues in our Atlanta distribution center and are delivering the service our customers need and expect through consistent fulfillment. Our next they promised across our national network.
I would like to thank our leaders across our over 40 distribution centers and nearly 1000 drivers for their daily commitment to serving our customers.
We will continue to work towards flawless execution and improved productivity under supply chains to ensure we consistently deliver an experience that exceeds our customers' expectations.
In summary.
We are not satisfied with our performance in the most recent quarter, but do believe we continue to win in our markets as the only national companies solely focused on specific needs of the living space maintenance professional we are uniquely positioned to support our customers in all market environments. Our strategy is sound, we will continue to grow through.
Selling more to existing customers, particularly through our national account programs and will complement our organic growth was opportunistic M&A like our recent presto acquisition in the Houston market, which has now substantially integrated we are encouraged by the results and look forward to pursuing other similar opportunities.
I want to thank you for your interest this morning, and will now hand, the call over to John segment.
Thank you Brad and thank you to everyone on the phone joining us. This morning, I'm excited to be here again, representing all of our white cap associates.
I want to begin today by walking through some recent investor questions before moving on to an update on what you can expect from white cap after our separation.
Construction end markets.
Top of mind for most has been the current state of the construction end markets nonresidential construction continues to be challenging.
We are seeing growth in certain geographies like our Texas markets and continue with strong job site presence in many priority districts.
Our business remains choppy in California, certain markets in the northeast and in the Midwest. However, we have good visibility into our markets and our teams remains very active bidding projects.
While we continue to feel good about the pipeline of large high profile projects activity remains constrained in part by a lack of skilled labor.
As we've said before.
Our residential exposure is significantly smaller than our non residential business.
We have seen a residential slowdown in certain priority districts like San Diego and San Francisco, We're affordable housing is challenging defined.
Post split management and strategy.
I'd like to shift now to introduce you to key leaders on our leadership team.
Alan Sollenberger is currently our president at White cap Alan has been with the company for over 12 years, starting at the home depot and the strategic business development group focused on acquisitions before coming over to the HD supply business. He has been instrumental and leading white cap through the last nine years as chief.
Financial Officer, and Chief operating Officer.
We look forward to the impact Alan will have working with our field leaders to ensure our customers continue to receive exceptional customer service.
I would also like to introduce you to our Chief Financial Officer, Sean Meredith, who joined US this year from watsco.
Sean has over 13 years of experience in industrial products seven of which have been in the distribution space with over 30 acquisitions under her belt. We're delighted to have shown on board to oversee our future investments.
The senior leadership team will also include Betsy, marking our chief Human Resources Officer, who has been with the company for over 13 years.
Betsy is an exceptional leader and we're very excited to have her expertise driving our human resource initiatives.
Over the coming months, we will be introducing you to more of our core team leaders and expanding upon our strategy to drive customer success.
This will include sharing more about our regional Vice presidents, who are critical in fulfilling our customer needs.
Our focus will continue to be supporting our knowledgeable sales teams filling out and density in our national footprint and driving success with our national accounts.
Across multiple trades, we will continue to build out our value added services and ensure our knowledgeable associates jobsite deliberately and training continue to set us apart from the competition.
Our growth initiatives continue to build on today's objectives sales leadership, expanding product assortment and trades greenfield expansions and M&A opportunities.
Our team is energized and highly motivated to win with our customers.
Under the ownership of HD supply, we've been able to leverage our significant scale to more than triple our business in the last nine years.
As an independent company, we look forward to standing on our own strengthening our focus and ability to penetrate our markets deeper providing opportunities to our associates for growth in building value for our shareholders with that I'll hand, the call over to Evan.
Thank you John and good morning, everyone.
Turning to page six I will now review our third quarter results.
In terms of our headline numbers, we delivered third quarter sales of $1.6 billion, an increase of $32 million or 2% over the third quarter of 2018.
Our gross margin rate of 38.9% was down 10 basis points from the third quarter of 2018.
Adjusted EBITDA for the third quarter of 2019 was $247 million a decline of $1 million were less than 1% from the third quarter of 2018.
On page seven I will discuss the specific performance of our individual business units.
Net sales for our facilities maintenance business were $826 million during the third quarter of 2019.
Up $16 million or 2% from the third quarter of 2018.
Although not yet meeting our expectations sales performance strengthened throughout the quarter.
Facilities maintenance gross margins were down 20 basis points for the third quarter of 2018.
Driven as expected by margin rate pressures from tariffs.
As Brad shared we expect facilities maintenance gross margin rate to continue to be unfavorably impacted by tasks.
We expect facilities maintenance gross margin rate to be down approximately 40 to 50 basis points for the full year of 2019.
Facilities maintenance adjusted EBITDA for the third quarter of 2019 was $149 million flat from the third quarter of 2018.
Net sales for our construction and industrial business were $818 million during the third quarter of 2019.
Up $15 million or 1.9% from the third quarter of 2018.
As John mentioned third party indicators and our internal data show a flattening of growth in the construction end markets being constrained in part by a tightening in the skilled labor force.
Construction and industrial gross margins were flat year over year, while adjusted EBITDA for the third quarter of 2019 was $98 million down $1 million or 1% from the third quarter of 2018.
Turning to page eight we invested $35 million and capital expenditures in the third quarter of 2019.
Inline with our ongoing capital expenditure expectations of approximately 2% of annual sales.
In the third quarter of 2019, we paid cash taxes of approximately $25 million.
As expected during the quarter, we exhausted our federal net operating loss carry forwards and became a regular federal income tax payer.
We expect to pay approximately $19 million to $23 million of cash of cash taxes in the fourth quarter of 2019.
Bringing our total expected cash tax payments to approximately $54 million to $58 million for the full year of fiscal 2019.
We continue to estimate our ongoing GAAP tax rate will be approximately 26%.
In the last 12 months, we generated $577 million of free cash flow.
We expect full year 2019 free cash flow generation to be about $525 million, including the impact of being a regular federal cash income tax payer in the second half of the year.
During the third quarter of 2019, we repurchased approximately 6.2 million shares of common stock for a total of $240 million at an average price of $38.39.
As of November Threerd 2019, the end of our fiscal third quarter, we had approximately $59 million remaining under our share repurchase authorization.
Including the completion of our two previous $500 million share repurchase authorizations, we've reduced our outstanding share count by over 20% since the first quarter of 2017.
We will continue to opportunistically repurchase shares.
As of the ended the third quarter of 2019, our net debt to adjusted EBITDA ratio was 2.4 times.
Comfortably within our targeted range of two to three times.
Our capital allocation strategy remains the same.
We will opportunistically deploy capital to the most attractive return opportunities available.
Including selective bolt on or tuck in acquisitions.
And a return of cash to shareholders currently through our share repurchase program.
That being said the teams are working hard to ensure the success of the white cap distribution and this will meet remain a priority focus.
On page nine we provide third quarter 2019 monthly sales trend performance as well as the 2018 comparable.
In August of 2019, we delivered sales of $521 million.
An increase in average daily sales of approximately 1.6% versus August of 2018.
In September of 2019, we delivered sales of $494 million an increase in average daily sales of approximately 2.6% versus September of 2018.
In October 2019, we delivered sales of $629 million, an increase in average daily sales of approximately 1.7% versus October of 2018.
In both 2019 and 2018 there were 27 days in August 19, selling days in September .
And 25 selling days in October .
November 2019 ended Sunday December Onest, which was the first month of our fiscal 2019 fourth quarter and we have provided our preliminary sales results.
We will not provide information on November results beyond sales.
November sales were approximately $436 million.
Which represents average daily sales growth of approximately 2.5% versus 2018.
Average daily sales growth versus prior year by business was approximately 2.5% for facilities maintenance.
And approximately 2.4% for construction and industrial.
There were 18 selling days in both November 2019, and November 2018.
Turning to page 10, we provide an update on our full year guidance range.
Net sales will be in the range of $6.116 billion.
To $6.166 billion.
This translates to an approximately 3% growth rate at the midpoint adjusted for the impact of the 50 Threerd week in fiscal 2018.
We expect adjusted EBITDA to be in the range of $855 million and $870 million translating to a 1% growth rate at the midpoint again adjusted for the impact of the 50 Threerd week in fiscal 2018.
We expect fiscal 2019 net income per diluted share calculated in accordance with GAAP to be in the range of $2 in 63 cents to $2 in 69 cents.
We also expect full year 2019, adjusted net income per diluted share to be in the range of $3.45 to $3.51.
Our net income per diluted share range and our adjusted net income per diluted share range assume a fully diluted weighted average share count of 167 million and does not contemplate additional share repurchases.
Our full year guidance implies a fourth quarter of fiscal 2019 sales range of $1.355 billion to $1.405 billion.
And adjusted EBITDA range of $161 million to $176 million.
A net income per diluted share range calculated in accordance with GAAP of 40 cents to 47 cents.
And that adjusted net income per diluted share range of 52 cents to 58 cents.
Our fourth quarter net income per diluted share range and our fourth quarter. Adjusted net income per diluted share range assume a weighted average diluted share count of 163 million and do not contemplate additional share repurchases.
In summary, we continued to grow in a volatile market.
We continue to be cautious and we will focus on what we can control.
I'd like to thank you for your continued interest in HD supply and I'll turn the call over to Sonia for questions.
Thank you as a reminder to ask the question you need to press Star one on your telephone social your question pressed capacity, please standby Wally Capella Kenny roster.
Our first question comes from David Manthey of Baird. Your line is that open.
Yes. Thank you.
First question is on the.
Business Im wondering you cited higher turnover among customers facilities maintenance professionals and that seems pretty anecdotal or are you seeing that at large national accounts or.
This is a very granular factor the via a driver here given the break fix nature of the business can you just talk a little bit about the the health of that market isn't just that or other other factors at play here.
I think Thats is this is Brad Paulson. This is important piece to understand.
To answer your first question, we're seeing a really kind of across the board at both kind of national customers as well as the smaller regional owners as well. The reason is so important is when you have turnover at that level. There often the primary decision maker and when you have that person's either not there or new to the property. They don't have.
The history of that facility and when you don't have the history of the understanding of what's been purchased third does can introduce some level of uncertainty.
And again for Us Thats, where our sales team comes into play in provides incredible value because in many cases or the continuity and they can have the proper help the property make the correct decision to offer that in the most cost effective and efficient manner.
Yes, it would seem like like an opportunity for you given the confusion.
Second as it relates to again customer labor markets.
Both sides of the business really I, particularly see ally.
Construction labor markets have been tight 2018 prior to that.
But you were able to grow faster in that environment Im just wondering if you talk about.
The changes in your markets in 2019, specifically, even before this the weakness that seems to be looming out there where you went from overall growth rate in the mid to high single digits down to sort of all a low single digit growth rate as a company.
Yeah. This is John segment we.
As I mentioned on the call earlier the markets across the country are choppy, we have some of our priority districts where growth over a much longer extended period, five or six years was double digit for us and we've seen prolong labor issues were some of our key contractors have had to.
Slow down their work dramatically just to be able to perform that quality work that is so important. So I think a long term impact from the labor force being impacted has certainly impacted a lot of our markets out there in certain markets, where we've been very busy also we had some high nine issues were some of our contractors.
Loss almost half of their labor force, having to comply with federal regulations.
Those are unique situations that we.
We are a lot of labor just moves from one contractor to another.
So to be able to account for that so we see all kinds of different situations out there there's still significant opportunity for us we're not happy with our growth performance in the last two quarters of the year.
Typically this is the time when we're able to take market share in we should be doing that so we've got to get back to the growth initiatives that drive our business really well to be able to move forward.
Alright, Thank you very much.
Thank you.
Question comes from Julian Mitchell of Barclays. Your line open.
Hi, This is Jason Mckee shown for Julie and good morning, maybe just a quick one around capital deployment I think that goes the primary driver of the two a split strategy with the idea that both companies could.
Focus more on deploying capital into judicious manner that was beneficial to the businesses. So I guess seen significant capital expenditure towards repurchases return to shareholders et cetera. In the meantime comes with a little bit of a surprise can you just discuss a little bit what the capital deployment strategy will be heading into the two way split.
If theres any sort of consideration as to.
The capital structure of both businesses beforehand.
Yes, so that the overall all our overarching capital deployment strategy that doesn't change in the sense that that we continued to be committed to and both companies as separate businesses will continue to be committed to deploying capital to the highest return opportunities available. The those are.
Tunis.
Changed from time to time, and we'll defer business by business. So for instance, both businesses are interested in in accretive bolt on or tuck in acquisitions.
But those acquisitions occur when they become available both businesses have a robust pipeline of M&A opportunities.
The construction business.
Quite frankly has.
A larger number of opportunities and so.
We may see more frequent acquisitions within the construction business on the facilities maintenance side, there are opportunities as well there aren't quite as many theres a handful of of what I'll call mid sized opportunities and then a number of of smaller ones that the presto acquisition that we did.
That was up $12 million acquisition. So so those acquisitions will occur when they become available.
And.
Each business will deploy that capital without having to consider the needs of the other business once they're separated on excess cash flow will likely continue to be returns to shareholders through through share repurchase a current share repurchase program.
We may at some point.
Consider a dividend at this point our board of directors and the management team have determined that share repurchases are the best way to return capital to shareholders and that will continue as well so.
Not surprising that we are continuing to repurchase shares at this time.
Understood. Thank you and maybe just high level around the topline there's a lot of factors going on whether it be the choppiness of nonresidential market for the alleviation of headwinds and facilities maintenance as relates to Atlanta facility, maybe just discuss relative to the November preliminary growth rates of the overall company of around two and half percent organic.
Is the expectation for an acceleration as the initiatives discussed by Mr. Paulson come to fruition or is this given the current end market rate sort of a good baseline to think about heading into the.
Yes lifted the 2.5% growth rate that we generated in November as a modest step up from.
The third quarter. So we're pleased that is trending in the right direction, but we're not pleased with the overall growth rate of up to and a half percent. We if we have higher aspirations in the teams are working hard to deliver that and we expect to deliver more but right now thats our trend.
Thank you very much.
Thank you and your next question comes from danger of RBC capital markets. Your line now open.
Thanks, Good morning, everyone.
Good morning.
Hey, conspicuously absent was a slide giving us your first look at fiscal 2020.
And look I.
I understand that you may not have the perfect Crystal ball here, but was are you purposely avoiding talking with more specifics about the coming here than you've done in years past as it is there more uncertainty.
As a more going on with a split just maybe share with us with debt from this point, what you're thinking about 20 to 20.
At the gene certainly 2020 will be impacted by the separation of the two businesses. We don't we don't know exactly when that will happen yet as we described we expect that to occur in mid 2020. So that that obviously has a very significant impact yet our outlook for next year.
Beyond that the markets and as as both Brad and John described the markets are a little more challenging that had been in the past and they're feeling like flattish type of markets right now.
And as both Brad as John indicated, there's still a lot of opportunity and a lot of business to be one a lot of jobs being bid.
So that's not that's not an excuse for.
Lack of growth.
Thats, just our our view of the markets today, they feel flattish year over year.
Got it and then as follow up just a couple here one is it looks like free cash flow was ahead historically of what you would do in the quarter or did you take inventory down and then Joe's comment on.
If I understood correctly three years to normalize the stranded cost seems a bit longer than what we would expect for a size of this company. So maybe just clarify why that would take solar thanks.
Sure. So first on the on the free cash flow, we're pleased with our free cash flow performance in the in the third quarter end and the year to date $577 million free cash flow very strong.
That as we set includes.
Paying attack federal income tax for the first time long time here in the in the third quarter now in comparison to last year last year's third quarter, we were carrying a little more inventory than than we ordinarily would and so the fourth quarter of last year as we brought that inventory down was a good cash flow quarter for us.
Yes, we still expect the fourth quarter this year to be a good cash flow quarter as well.
But in comparison to last year, maybe a little softer because of of the elevated levels of inventory entering the fourth quarter last year.
As far as.
The ability to recover the incremental standalone costs for separating the businesses as Joe indicated we're estimating that at about three years right now keep in mind, we're in a slower growth environment right now this 2.5% makes it.
As to 9% Q2, 2% to 3% growth rates that we're in and that we're forecasting for the fourth quarter net growth rate makes a little more difficult to leverage fixed costs.
So it's going to take a little bit of time, we're obviously going to work hard to reduce cost and leverage and grow as quickly as we can but we want to set realistic expectations.
Thank you.
Thank you and our next question comes from Michael mixture of Wells Fargo. Your line open.
Thank you Evan I was wondering if we could put a finer point on the gross margin target for FM. You mentioned I think it came down maybe 10 basis points are we still in in.
Kind of a plan for the worst hold for the best tariff environment or what scenario planning are you doing around December 15th if anything.
Yes, so the incremental tariffs that are scheduled to go into effect on December 15th.
Art actually aren't as impactful to us as the tariffs that are already in effect.
The the tariff list in December 15th is more consumer products then.
Than the products that that we deliver however, certainly tariffs are having an impact.
We are expecting 40 to 50 basis points of margin contraction in facilities maintenance.
In fiscal 2019, we expect continued pressure on gross margin rate into 2020 under the current tariff environment.
And where we're managing yet I believe better than most as Brad shared we've made significant investments into pricing analytical tools.
And our teams are working hard and doing a great job everyday ensuring that we continue to provide compelling value to our customers while recovering the cost of those tariffs.
Okay.
Thank you and then I just wanted to talk a little bit of all the M&A strategy post or.
Three.
Split as you mentioned targets within the AF and can you just there's a lot of competitors out there, who a big box competitors, where.
It's operating within a large organization.
And you're targeting it seems like more of these mid sized.
Bolt ons can you just walk us through what is the buy versus build framework when you're looking to outgrow the market and just how you think about that conceptually.
Yes, well that we're always looking to outgrow the market and we do that with the best.
Sales team in the in the industry and offering the broadest product assortment.
With the best service in the in the industry. So that that is the the bread and butter of of expanding share in growing faster than the market that that being said, where there are players in the market in many of these are local or regional players that have a good niche or a and expertise in a specific price.
As a category.
That could be interesting to us if it's if it's a customer that has expertise in and repair and appliance repair parts or or or HP AC or.
Or some other product category.
That would enhance our capabilities within not only that market, but the ability to take that learning from the market that we acquired in and spread it across the balance of our business would be would be very interesting to us.
Okay, and if I could just sneak one more and more in on this is more numbers space. The 50 Threerd week. It adds a little bit of complexity historically in your business, you've seen a pretty substantial ramp down at the end of the year just it never seems like you've got that peak with from either.
They are aged backward the Atlanta DC now.
Interest rates offer residential are heading in the right direction for you guys in terms of.
Market Tailwinds can you just walk us through what is some.
Theres any excess built up demand in the channel that you see for next quarter that maybe those seasonal headwinds arent as dramatic this year.
I don't know that we've got built up demand certainly this year was was a disappointing year.
Starting off with.
Unfavorable weather in the first quarter that that we had hoped would create some built up demand that we see will lease through the balance of the year.
Didn't play out exactly as as we had hoped.
I do believe there is still a lot of activity out there to be one, but whether you'd characterize that as as built up demand I don't know that I would characterize it that way.
All right. Thanks, I'll pass it along.
Thanks, Yeah, and our next question comes from Ryan Merkel of William Blair. Your line is open.
Thanks, So first off on at then you mentioned focusing on national accounts. During this period of MRO market disruption can you just elaborate on your national account strategy, and then sort of secondly, it seems that this turnover issues going to be with us for a bit. So does this imply that the MRO market will be flattish soda.
For the foreseeable future.
So as I stated national accounts represent about 80% of our business spend the lions share of our time in the field and with our inside sales team supporting their their efforts at the property level from a structure perspective now we've got the benefit of having a national distribution footprint that they can leverage to support their properties.
Yes, we have a pretty extensive structure national account manager structure. The supports third day to day issues.
So with such a high percentage of our business being run through those customers. It makes sense for us to make sure that we give them everything they need during this very very difficult time.
And then do you think that the market, it's flattish for the foreseeable future as long as turnover issues in the with us.
For the turnover issue has is not a new thing I would say, it's certainly accelerated with the level of unemployment that we have today is having stated we're seeing that being flattish today.
That being said, we feel like we're really well position to grow regardless to the market condition. So for this flat we do have higher expectations going forward. It has this has always been a pretty slow steady growth market.
I think the best we've ever recall that was was 1% to 2% growth. So so flat isn't that measurably different.
As you know the nice part about or the nice thing about this business is that resiliency of that break fix model for a living space creates that that endless ongoing demand. So we do expect the market.
To remain healthy.
And as some of the uncertainty that we see in the marketplace.
As lifted whether it's around.
Around tariffs the election on labor constraints that we do expect the market to continue to grow yes look at I think Brian it's the uncertainty in the market. There really drive anybody is an operator do drive toward a flattish project I mean, that's what.
Our properties are trying to do is maintain your execution within something it's flat I think in the short term it kind of Vale puts pressure on everybody I think in a long term is very healthy for us because we're the ones that can provide this solution. If you only have the same amount with vendors you did last year and as lot of inflationary pressures, we can find ways to help you do that.
And in doing so on being on that property. We can help you purchased more from us at the same time. So look I think is a tougher environment, but it certainly nothing that remarkably different than when folks feel like they don't know what's around the quarter. They tend to hunker down a little bit I think you know and hunker down environment, we can be the solution.
And we can play Thats, where our advantage.
Got it that's helpful.
I can slip one more and as you looked at 2020, if the topline remains sluggish are you going to be looking at cost reductions that protect margins or do you have any contingency plans.
Yes, no question, we're always looking at ways to be more more efficient and more productive in that that includes.
Cost out you always have a a sharper focus in a refined focus on cost out in tougher market environment and so we certainly will be doing that.
And particularly with with the margin rate pressure, we talked about.
Cities maintenance.
Cut cost out and cost containment very important yes. So it. So I think we are very much focused as we separate the businesses. There are things that are going to be unique for each business that are going to be additive, but also we're doing a full sweep on all of our organization structures and make sure. Those are right, we're making sure we're doubling down on our processes.
Going into 2020, so we can get the efficiencies aligned with whatever growth is going to be available and then that in depth strategic review that we're doing is really all around actionable market specific in many cases property specific data. So we can be successful in those markets. So I feel that all the after we report and will allow it for a better.
Our planning and execution in 2020 for both businesses.
Great. Thanks, the color.
Thank you and our next question comes from Robert Barry at Buckingham Research. Your line is that.
Hey, everyone. Good morning.
Good morning.
So I think historically right the target for the growth has been three points curious if you anticipate that holding for both businesses post separation and then if you look over the last decade, I mean in most years you handily outgrew that.
No secret that target now growing four or five six plus basis points curious about.
What needs to happen and what's the line of sight to getting the outgrowth back three and beyond.
Yes, Rob this is Ed we are always going to be growing as fast as we as we possibly can.
In the given market environment.
That's 300 basis points of App growth that we've historically targeted that was set when when we did our IPO back in 2013 and it was set when we had seven different businesses as a as an easy way to model, our businesses and model growth expectations for the company combined.
Now that today, we are two businesses by next year will be.
Individual businesses.
We can be more refined than that so that 300 basis points of growth was really just come a rule of thumb or a benchmark, but we're going to grow as fast as we can in any environment. So.
As you pointed out.
Many times, we've been successful grown faster than 300 basis points, well I will try to do that go forward in the in the future as well, obviously, we're not growing as fast as we'd like today up into the focuses on returning to that accelerated growth.
Got it.
I guess also.
Follow up on the gross margin questions was did you mean to imply that price cost was neutral in the quarter.
We what we are in price cost in the quarter, yes, what we're trying to indicate is that the the F. The increase in cost from the tariffs.
Is being passed along to our customers.
But not enough of a price increase to get a margin on that cost. So while the gross margin dollars that we earned on those in general our call entirely related ski user tariff related categories. The gross margin dollars that we earned per unit of sale is roughly the same as it was a year ago.
But the margin rate is lower.
Got it so it sounds like neutral on a dollar basis.
On a gross margin dollar basis neutral got it and if the current tariff regimes kind of holding his role in as anticipated when do you expect peak headwind to be.
These are the this tariff related inflation.
Yes, so if there is no additional tariffs.
We'll see the peak in the middle of next year.
So take it takes time for the tariff related cost to flow through the supply chain, our imports generally turn more slowly than our domestic product because of the long lead times.
Got it so late to Q3, Q and it sounds like you I don't want to put words in your mouth, but feel pretty good that you can continue to.
Raise price to offset that even though the markets are weaker.
What is the feeling.
We feel good right now that we can pass along that cost increase to keep the gross margin dollars neutral.
That is dependent upon upon market conditions and as you know we monitor our competitors pricing multiple times a week.
Good piece that I mentioned partnering with our suppliers across the board what we're also seeing exit out of China.
At an accelerated right. So you that partnership that we have I think relative to our competitors is also huge advantage as we navigate through this environment.
Got it got it alright, thank you.
Thank you and your next question comes from John and Jeff Gordon Haskett. Your line is now open.
And if your son is on mute please UN mute.
And our next question comes right on Hello.
Hi, sorry.
Have you bonusing, okay. Good morning, everyone.
Morning, guys, you Peg and Charlotte you Peg Cnine Nonresi markets is choppy and I don't know I do want to read too much into at the language seems to be perhaps incrementally a little more negative.
Im curious how are you then seeing the core the quality projects and associated competitiveness.
And kind of price dynamics, given your characterization of choppy markets.
Yes, when I say choppier I'd be the U.S. as is a big play. So we have priority districts, where we are performing very well.
And we have markets that we have historically performed very well we were not growing to our expectation. So that really defines choppy for me and a lot of that is driven by significant job work that we typically have on our portfolio at any given time.
We still around a lot of very big projects, we're still operating very well as a company we're maintaining our margins Evan indicated a margins were flat in the third quarter I consider that an excellent performance considering.
How challenging the market is right now and how competitive it is.
But our associates out there are significant number of account manager stay very very close to customers and we make service or priority over price and I believe thats why were able to maintain the margins that were maintaining as a company.
John are you sensing competitive pressures ratcheting higher because of the choppiness or relatively static versus the previous trend.
China markets tighten up it's always more competitive we have significant competition that's very local.
No very fragmented that compete with price.
The stay relevant and keep market share.
So.
Yes, I would say that in certain markets the competitive nature of the businesses is always there, but we're seeing that ramp up a little bit and having to fight more for some of the big work that we typically get.
And then switching to FM with these operational issues and Atlanta et cetera kind of mostly behind you are there other items that you see.
In 2020 that.
Good place some sort of adverse roll toward your operating leverage.
No. Our focus is like I said executing our strategy.
I feel as good about our operational effectiveness today's I felt in the four years that I've been here, which is a real vote of confidence for our team I think a reflection of the hard work.
So as we said a couple of times, our expectation going forward is that we're going to operate a very high level and execute our customers' expectations every single day.
With.
Yes.
On that score if it's highly possible that these markets stay relatively flattish for an extended period right for lots of different reasons that we don't have to opine about.
Is there an opportunity for FM to drive incremental operating leverage through say more cost out actions to actually create more of a self help framework because right. Now you are sort of I get the point, having that you made we're sort of writing a kind of flat topline flat bottom line flat ish waiting for some volume leverage.
But in the absence of volume leverage is there something you could do to create more of a self help through some sort of a big I T program or other restructuring or or something like that.
There's always opportunity to get more effective, particularly in the in the supply chain in the distribution network. So we operate for distribution centers across the country.
We monitor very close to the cost of of those 44 facilities and the cost per unit that flows through that the those facilities.
Yes, we've got we've got opportunity to improve productivity in those distribution centers no question about.
And the Atlanta distribution Center, you know its.
Unfortunate that we had the this step that we had in in.
In 2019, because that is is now our that that will go to our best distribution center in the network.
It's the most advanced well thought out well design distribution center, we expect to get efficiency out of a go forward and we will take those learnings and replicated across the across the network now what we have learned is.
From from the Atlanta distribution centers were going to take things in small bite size chunks.
To make sure we don't have a service disruption like we did this year.
We will make sure that we operate in parallel and a time would make a change like that.
Yeah, there's there's certainly opportunities to improve efficiency.
Got it almost sounds like Kevin if the markets where to softened further which may or may not happen.
You could perhaps not without putting words in your mouth kaftan at over these 44 points of distribution to perhaps come up with some more offsetting cost actions, if you needed to kind of fair statement.
There's always opportunity to take cost out the it's an ongoing activity John So certainly we've been we've been ramping up our focus on efficiency and effectiveness and our distribution centers and networks and is a large portion of the cost.
No our other SGN, a which is primarily organizational in both cases, we're going to continuously put a finer point on that so you're exactly right. The self help makes a big difference and when done correctly the improved efficiencies in the cost out in the supply chain actually improves the quality of service to customers enormously right.
Got it thanks very much appreciate it.
Thank you and our next question comes from fans imaginary of Jefferies. Your line is open.
Hey, guys. This is merial quite a lot she on for Hamzah.
So there was some talk about competition at the regional level, but just within FMT just wondering if there's any changes in the competitive environment.
That you maybe seeing from the biggest the big box retailers.
No our competitive environment Hasnt changed as far as new entrance into the market and we continue to feel really good about our ability to win relative to some of the new entrants in our space. What we are seeing this expansion. This this space has been strong for a number of years. So we're seeing new customers expand.
Into markets, but again, we see that as an opportunity for us to get better every single day in delivering experienced that that's different and better from what our competition offers yes look I think the split is really really important I mean with both of these businesses, having a uniquely defined swim lane that is all customer back and solely for that customer is the.
The way, we're going to win and so this in depth strategic review, we are doing for both businesses is going to give us the exact precision required to win in our market and certainly the big boys play in multiple markets inclusive of off and so we believe that that focus will make a tremendous difference and certainly.
Thats, our intent is to make sure we listen to those customers better than anyone else and we act on a more precise basis on a market by market property by property basis.
Great and then.
Just quick follow up on on FM.
Looking at length about the online business could you just remind us of what you're on exposure is and.
Even longer term or even in the medium term what your expectations are for for your skew count.
Online and do you think that changes significantly over the next few years.
So.
To about 70% to 75% of our business currently goes through a digital channel and I would say that's.
Ordered not shops, and I think thats, an important distinction to make.
We continue to invest in our online assortment, we've had huge investments over the last couple of years.
I think pretty easily understand we can only stocks. So many items in R&D season, as our customers continue to evolve they want to buy more and more from us.
Going a huge success for us we've got a team of dedicated today, each and everyday and we will continue to expand their summer to make sure that we can support our customers' needs on a daily basis.
Great. Thanks, guys.
Thank you and then next question comes from Christopher of Longbow Research. Your line is open.
Hey, good morning, guys. Thanks, taking my question approached the difficulty trying to provide any commentary on 2020, given our things move around but if I take all your comments, so far weve got flat market growth.
Kind of get back to 300 ish basis points on market share growth to gross margin down difficulty leveraging here I guess can you had commit to leasing EBITDA growth next year and I assume just continued EBITDA margin pressures at the way to think about it into 2020.
Yes, so so certainly.
Leveraging at Ed lower sales growth is more challenging than than when you've got mid to high single digit sales growth.
We do expect to to be able to.
Leverage our costs as we grow even in a slower growth environment and so for 2020, while we haven't provided guidance for 2020, yes, we do expect to grow both sales and earnings in 2020.
Got it got it.
Then we talked about competition a bit here I guess within FM historical data has always been a huge driver stickiness in that business. I guess are you seeing competitors really step up in terms of their data capabilities that causing some friction for you guys at all.
No I I've been fortunate I spent a significant amount of time with our customers across all verticals that we support and.
No.
In general we believe that we are offering experience, it's truly differentiated relative to our competition.
There are a lot of folks that promise, what we do but where the one national provider that provided the does a day in day out.
To answer your question, specifically I'm not seeing that.
We have decades of information on our customers across the board I think thats a distinct advantage that we have.
Got it got thanks, so much guys.
Yes.
Thanks, Yeah, and then next question comes from Patrick Baumann of Jpmorgan. Your line is now open.
Hey, good morning, everyone. Thanks for taking my questions.
Maybe just a quick one for having what do you estimate onetime costs the separation from what exactly you're spending on and kind of how will that slow.
Looks like fourth quarter, you have so maybe you had seen third quarter Im just curious into next year should we expect continued yet.
So what one time cost for separation are difficult to estimate the difficult components of that to estimate are.
Cost to potentially make modifications to the capital structure, which will be determined over the next the next couple of months.
And IP related costs to separate the businesses and ensure that both businesses are set up for success with a good IP infrastructure today, we share a datacenter.
And so exactly how we split that out is in the works.
But to give you kind of.
Very very rough rough early indication.
Including those costs as well as all transaction cost bankers lawyers accountants.
We could be look in $50 million to $70 million onetime separation cost.
And what exactly is the capital structure close that you're referring to.
Should we need to.
Pay down debt or adjust our.
Interest with interest rate swaps that we've got in place today.
We continue to manage the fixed versus variable debt.
Fixed versus variable nature of our interest rates.
There could be cost with retiring debt early.
Understood.
Okay. Thanks, maybe one for John .
We know fmbs largely break fix type business, but wondering if you can talk maybe that any plans you have to increasing exposure exposure to more of that recurring maintenance and.
Repair retrofit type work versus new construction.
Yes, I think there's a misnomer out there that our business is basically a new construction business in reality, we have customers that buy from US every day that are buying repair products that can be utilized in both new construction or and repair type applications. So we certainly trying to promote a lot of the products.
That drive profitability in our business, particularly over our counters where customers come in the CS everyday.
We of course deliver a lot of product to job sites as well so.
Probably a good time to start making some commentary on the mix of our business in terms of.
The fact that we are just not a new construction business, but we actually do a lot of repair work in our markets as well.
What what so you said, it's a misnomer what is kind of the mix and new construction do you have you have a good estimate for that now or is it tough to kind of reconcile.
It's very difficult when a customer come to the counter we don't capture the application right, we sell a product, but we don't capture whether they are using that to repair something whether it's a drive way or sidewalk or something that went wrong on a job or whether they are using that.
In just the new construction application for a first time application. So it's very difficult for us to capture although a big part of our product mix our repair type products.
Understood. Okay. Thanks, guys. Good luck.
Thank you ladies and gentlemen, this does conclude and question answer session I would now like to turn the call back over to Joe Dangelo for any closing remarks.
Well. Thank you for your questions. We continue to work hard although we're not happy with our current performance. This quarter did show improvement I'm proud of the teams remain thankful for your continued support and interest in HD supply.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.