Q2 2019 Earnings Call
Hello, and welcome to the HD supply Holdings 2019 second quarter earnings call.
As a reminder, some of our comments today may be forward looking statements are based on managements beliefs and assumptions and information currently available to management at this time.
These beliefs are subject to known and unknown risks and uncertainties, many of which maybe beyond our control, including those 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 these statements.
Reconciliations of certain non-GAAP financial metrics.
With that corresponding GAAP measures are available at the end of our slide presentation and in our 2019 second quarter earnings release.
Which is available on our IR website at Www Dot HD supply dot com.
Jody Angelo CEO will lead todays call, while Evan Levitt, our CFO will provide additional color on our recent financial performance and our expectations for the remainder of 2019.
There will be an opportunity for kunaev for those participating please limit your remarks to one question and one follow up if necessary.
Thank you for your continued interest in HD supply.
And with that I will turn the call over to Jody Angela.
Well. Thank you Charlotte good morning, everyone. Thank you for joining us today for our second quarter 2019 earnings call.
As always it is my privilege to share our company's results with you on behalf of the over 11500, HD supply associates, who work hard every day as one team driving customer success and value creation.
Turning to page three.
Although we navigated a difficult environment the team and I were disappointed with our performance in the second quarter fiscal 2019.
We delivered 1.5% sales growth and saw adjusted EBITDA declined 1% period.
Despite this we generated net income per diluted share growth of 11%.
And adjusted net income per diluted share growth of 9%.
And we continue to generate strong free cash flow of $562 million on a trailing 12 month basis.
We put this cash to work by executing on our capital allocation strategy.
Opportunistically repurchasing our shares and acquiring presto maintenance supply subsequent to the ended the quarter.
Presto maintenance supply of the Houston Metro area and distributor of Emerald products to the multifamily industry.
I want to take this opportunity to welcome the new associates from Presto into the HD supply family. We are excited for you to join the team.
I want to start today's call by providing an update on our new facilities maintenance Atlanta distribution center that opened in May.
As we previously shared we experienced issues with the vendor delivered automated solution, resulting in delays in fulfilling customer orders.
We turned off the automation.
And returned to legacy methods of fulfilling orders through much of the summer.
This enabled us to resume next day deliveries.
A significant improvement from me.
We communicate with our customers throughout the process assuring them that we can deliver with the same reliability and quality that they expect from HD supply.
Customer reaction has been favorable and we believe we are regaining our customers confidence in business in this important market.
Additionally, our IP and supply chain teams, we're continuously with our vendor partner and in late August we relaunched the Atlanta distribution center material handling automation.
This was a regimented and measured process supported by live data from the parallel operation of our legacy processes and systems.
The automated solution is now working as intended.
And we are confident that we'll deliver the efficiency and quality that we originally expected.
And we will share more details, but I want to take this opportunity to recognize the team has been working tirelessly.
To ensure our customers operating in the Atlanta area and throughout the southeast receive exceptional customer service from HD supply.
We walked in facility last week, I was especially proud and impressed by the flexibility and precision that team was executing.
To support our customers in Florida, Georgia, and the Carolinas as they prepared for and recovered from Hurricane Dorian.
While the opening of our new Atlanta distribution Center got off to a difficult start we continue to believe in the improved service capabilities and efficiency anticipated when we initiated the investment.
As we look to the second half of 2019.
The environment remains uncertain.
With a new round of tariffs, having gone into effect September onest.
An increase in tariff rates planned for October Onest.
An additional round of terrace planned for December 15th.
We believe we are better prepared to manage the changing tariff environment than many of our competitors.
The investments that we made in pricing and analytical tools during 2017, and 2018 have significantly increased our visibility into the competitive landscape and the last is the of demand, enabling us to modify pricing with precision on a SKU by SKU basis.
As we shared previously our initial response to any increase in input cost is to avoid or offset as much of the increase as possible through negotiation and productivity.
Then as markets allow we pass on unavoidable cost increases through price.
We continue to believe in our ability to execute on avoidable costs increased pass through with excellence.
However, we may see some compression in gross margin rate.
Now turning to construction and industrial during the second quarter, we saw project delays from unfavorable weather year over year and lack of skilled construction labor.
We do see significant activity in the nonresidential construction markets were many large multi year jobs continuing.
However, it does appear that the year over year growth rates are moderating.
Additionally, the residential construction markets, which make up a comparatively smaller portion of our business continue to underperform relative to expectations.
Consistent with external data sources, we have updated our view of the construction end markets, which Evan will discuss shortly.
Despite the slowing end market growth rates, we see significant new large multi year construction projects that are scheduled to begin in the second half of 2019.
Including large multifamily complexes.
Major Deo T. and other infrastructure projects and mixed use developments.
The first half of 2019 underperformed our expectations, however, with major operational difficulties behind US we are confident in our ability to perform going forward as we help our customers succeed.
I'll provide some closing comments bond today, we'll now turn the call over to Evan will provide an update on the key areas of investor interest.
Thank you Joe and good morning, everyone.
On page four I begin with areas of recent investor focus.
First is a section 301 tariffs on Chinese imports.
September Onest saw a new round of 15% tariffs implemented on over $110 billion of Chinese imports.
October Onest is the planned increase in tariff rates from 25% to 30% on approximately $250 billion of Chinese imports and December 15th is the plan date for another round of 15% tariffs on an approximately additional $160 billion of Chinese imports.
Much of the increase in these most recent round of terrorists won't be felt until fiscal 2020 as it takes some time for these cost to work their way through our supply chain.
As Joe indicated our initial reaction to any increase in costs is to avoid as much of the increase as possible by negotiating lower pricing based on the strength of the US dollar we're overall market competitiveness.
As Valuating alternative sourcing.
And identifying additional productivity opportunities.
We continue to believe that we can pass along the unavoidable cost increase through price. So that we maintain our gross margin dollars earned but we may see some compression in gross margin rate.
Pricing actions taken to date to offset tariff related cost increases have been relatively modest and comprised approximately 1% of our facilities maintenance sales.
Next the Atlanta distribution Center has just stated the Atlanta market continues to improve but lagged the company average during the second quarter as a result of the automation issue in the Atlanta distribution Center.
We believe the Atlanta distribution center created an unfavorable impact to facilities maintenance second quarter sales of approximately 100 to 150 basis points.
Our most recent data shows that our performance in the Atlanta market.
And the broader southeast continues to recover.
Next is HIV assay performance.
As we previously indicated cooler weather has unfavorably impacted our HPC business during the second quarter.
Populated weighted cooling degree days as reported by the National Oceanic and atmospheric administration were down approximately 8% year over year in our fiscal second quarter.
Hvdc, an important category for us during the spring and summer months was our worst performing category of the second quarter with a high single digit negative comp.
We estimate that HP, a seed negatively impacted our second quarter sales at facilities maintenance by approximately 50 to 100 basis points.
Next the construction end markets.
The non residential construction markets continue to be productive with many large multi year projects continuing.
Growth rates year over year, however appear to be slowing in part because the cooler wetter spring and summer and a lack of skilled construction labor.
Given this and the continued weakness in the residential construction market as seen in the reduction in year over year single family housing starts we have lowered our market guidance for the full year of 2019.
I will give more color around this later in the guidance section.
Turning to page five I will review, our second quarter results.
We delivered sales of $1.6 billion, an increase of $24 million or 1.5% over the second quarter of 2018.
Our gross margin rate of 39% was up 10 basis points from the second quarter of 2018.
Ill discuss the components of gross margin shortly.
Adjusted EBITDA for the second quarter of 2019 was $244 million, a decline of $2 million or 0.8% from the second quarter of 2018.
On page six I will discuss the specific performance of our individual business units in more detail.
Net sales for our facilities maintenance business was $830 million during the second quarter of 2019.
Up $10 million for 1.2% from the second quarter of 2018.
As a reminder, we got off to a slow start in the second quarter, beginning with a negative 2% performance in may.
Unfavorably impacted by weather and the Atlanta distribution Center.
Although not yet meeting our expectations, we did improve our sales performance over the course of the quarter to deliver a positive 1.2% growth rate.
Facilities maintenance gross margins were flat from the second quarter of 2018.
Benefiting from the mix impact of lower HIV assay sales and sales in excess of the company average in our core multifamily MRO business.
Partially offset by margin rate pressure from tariffs.
Despite good gross margin performance in the second quarter, we believe that rising tariff costs and potential future mix pressures will make holding the gross margin rate flat for the full year difficult.
As I said, we do expect to pass along the unavoidable tariff increase through price as markets allow.
However, we do not anticipate raising prices enough to maintain gross margin rate.
We now expect to end 2019 with facilities maintenance gross margins down 30 to 40 basis points year over year.
Facilities maintenance adjusted EBITDA for the second quarter of 2019 was $149 million, a decline of $1 million or 0.7% from the second quarter of 2018.
Net sales for our construction and industrial business were $795 million during the second quarter of 2019.
Up $14 million or 1.8%.
We believe that non residential construction activity remains strong.
But that year over year growth has slowed due in part to a scarcity of skilled construction labor and less favorable weather conditions than 2018.
Although less of an impact to HD supply the nonresidential construction, we have seen a weakening residential construction market evidenced by the 3% decline in year to date single family housing starts.
Construction and industrial gross margins were up 10 basis points year over year.
Rebar unfavorably impacted our gross margins by about 10 basis points, while continued strength in larger construction projects also has put pressure on our gross margins. We have now reached the point where year over year rebar costs are no longer unfavorable in our average inventory cost is consistent with current spot prices.
Therefore, we do not anticipate future gross margin pressure pressure at current rebar pricing levels.
Construction and industrials adjusted EBITDA for the second quarter of 2019 was $95 million down $1 million or 1%.
Now turning to taxes and cash flow on page seven we invested $28 million in capital expenditures in the second quarter of 2019.
In line with our ongoing annual capital expenditure plan of approximately 2% of annual sales.
In the second quarter of 2019, we paid cash taxes of approximately $6 million.
We have now exhausted our federal net operating loss carry forwards and will become a regular federal income tax payer in the third quarter.
We now expect to pay approximately $24 million to $25 million of cash taxes in the third quarter of 2019.
And approximately $53 million to $58 million of cash taxes in the full year of fiscal 2019.
We estimate our ongoing GAAP tax rate will be approximately 26%.
In the last 12 months, we generated $562 million of free cash flow.
We expect full year 2019 free cash flow generation to be between 500 and $525 million, including the impact of becoming a regular cash taxpayer in the second half of the year.
During the second quarter of 2019, we repurchased approximately 1.7 million shares of common stock for a total of $69 million at an average price of $39.55.
Following the quarter close and through September six 2019.
We repurchased approximately 3.2 million additional shares of our common stock.
For $121 million at an average price of $38.12.
As of September six 2019, we had approximately $177 million remaining under our share repurchase authorization.
Including the completion of our two previous $500 million share repurchase authorizations, we have reduced our outstanding share count by over 18% since the first quarter of 2017.
We will continue to opportunistically repurchase shares.
As of the end of the second 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. These include organic investments in the business selective bolt on or tuck in acquisitions, such as the Presto acquisition that closed after the quarter and return of cash to shareholders currently through our existing share repurchase authorization.
On page eight we provide second quarter 2019 monthly sales trend performance as well as the 2018 comparable.
In May 2019, we delivered sales of $464 million, an increase in average daily sales of approximately 0.2% versus May 2018.
In June 2019, we delivered sales of $521 million, an increase in average daily sales of approximately 1.9% versus June 2018.
In July 2019, we delivered sales of $639 million, an increase in average daily sales of approximately 2.1% versus July 2018.
In 2019, there were 19 selling days in May 20, selling days in June and 24 selling days in July .
In 2018, there were 20 selling days in May 19, selling days in June and 24 selling days in July .
August of 2019 ended September Sunday September Onest, which was the first month of our fiscal 2019 third quarter and we have provided our annual preliminary sales results.
We will not provide information on August results beyond sales.
August sales were $521 million, which represents average daily sales growth of approximately 1.6% versus 2018.
Average daily sales growth versus prior year by business was approximately 1.2% for facilities maintenance.
And approximately 2% for construction and industrial.
There were 20 selling days in both August 2019, and August 2018.
On page nine.
We updated our end market outlook for 2019.
We believe the MRO market will continue to grow approximately 1% to 2%.
We view the non residential construction end market estimate as up low single digits.
And the residential construction market will remain flat or declined low single digits.
These specific end market estimates imply an approximate 1% to 2% end market growth estimate for HD Supplys end markets in 2019.
Turning to page 10, we begin by updating our full year fiscal 2019 guidance, which has been revised to take into account a continued weaker economic environment and increased tariff expectations.
We now believe net sales will be in the range of $6.100 billion.
To $6 billion $200 million.
This translates to a 3% growth rate at the midpoint adjusted for the impact of the 50 Threerd week in fiscal 2018.
Adjusted EBITDA to be in the range of $855 million and $885 million. This translates to a 1% growth rate at the midpoint.
Adjusted for the impact of the 50 Threerd week in fiscal 2018.
2019, net income per diluted share calculated in accordance with GAAP to be in the range of $2.68 and $2.81.
We also expect full year 2019, adjusted net income per diluted share to be in the range of $3 at 45 cents and $3.60.
Our net income per diluted share range and our adjusted net income per diluted share range assume a full year 2019 fully diluted weighted average share count of $168 million.
And does not contemplate additional share repurchases.
For the third quarter of fiscal 2019, we anticipate sales to be in the range of $1 billion of $620 million and $1 billion $670 million.
Adjusted EBITDA to be in the range of $240 million and $255 million.
Net income per diluted share.
Calculated in accordance with GAAP to be in the range of 78 cents and 86 cents.
And adjusted net income per diluted share to be in the range of 96 cents and one dollar five cents.
Our net income per diluted share range and our adjusted net income per diluted share range assume a third quarter fully diluted weighted average share count of $166 million and do not contemplate additional share repurchases.
In summary, we are disappointed with our quarter quarterly results and we are taking a cautious approach to the remainder of the year.
We will continue to focus on what we can control operationally, while navigating an increasingly volatile environment.
Thank you for your continued interest in HD supply and Sonya, we're now ready for questions.
Thank you ladies and gentlemen, if you have a question at this time. Please press Star then one on your touched on telephone. If your question has been answered or you wish may yourself from the queue. Please press the pound key for any background noise assay. Please state your line, let me Whats your question I understand it.
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Our first question comes from Nigel tell Wolfe Research. Your line is now open.
Oh, Thanks, good morning.
Thanks the question.
First of all can you maybe just touch on the.
The company made both tariffs pressuring gross margins, putting spend that dynamic and maybe talk about.
The.
Mitigating factors in terms of operational.
Offsets.
And then also any resourcing that you're doing and then maybe just touch on how.
Your exposure the 12 cents of FM sales that come in from China.
Any resourcing activity that you're undertaking.
Yes, so Nigel obviously, a tariff environment has been has been very volatile.
And we laid out the the current expectations for that type of environment, which of course is subject to change.
We will always attempted to offset any cost increased tariff or otherwise as our first course of action and that starts with good negotiations as part of.
Our overall merchandising process.
The us dollar.
Has continued to strengthen against the local Chinese currency. So we certainly look to take advantage of that.
We also look to take advantage of the overall competitiveness.
Of the Chinese factories, which because of the tariffs are becoming less competitive to the rest of the world.
We're also seeing and we were seeing this even before the tariff dispute began.
A migration away from China.
Into other low source of low cost source countries in Asia, and Mexico, We expect that to continue and if the tariff environment continues we actually expect that to accelerate and I think you are already beginning to see that.
Certainly we look to improve our own productivity through our supply chain in our transportation network in our distribution centers.
And then the unavoidable cost increase after we've mitigated as much as we can we do expect to pass on through price now we pass on.
Cost increased to reprice very surgically.
On a SKU by SKU basis, and that doesn't mean that every every dollar of tariff on a given skew results in $8 increase in that particular skew.
We look at we use our pricing analytic tools to understand the price elasticity of the various skus.
And the market dynamics of the pricing of the various skus to very surgically adjust pricing SKU by SKU.
Not category by category, but SKU by SKU.
And that's been successful for us so far we've been pleased with our margin performance, so far but as you know the tariff environment is getting more and more difficult.
But we'll continue to navigate that we think we can do it better than most as far as our exposure.
18% of our facilities maintenance sales are from our proprietary brands two thirds of which are sourced in China. So thats that about that 12% that you were referring to.
And Thats, what Thats, what we're managing to date, it's been about a 1% increase in overall facilities maintenance sales to pass through the unavoidable cost increase and we'll continue to monitor that and work hard to take cost out to avoid having to raise prices.
Thanks Debbie.
And then a quick one on the Atlanta DC.
Good good recapture.
Inter quarter do you think now that real time Youll get back to you should have been.
In September have you recaptured the share of wallet seat loss.
Yes, I think the Atlanta DC is operating exactly the way it should have been in May when we turned around I think the team did a credible job, making sure that they were appropriate and this launch and so I feel very good that we're right back on the curve and that we will have that be by far of the crown jewel of our network coming into the selling season for next year, Yes customer reaction has been has been favorable.
As as I indicated the Atlanta market is still operating slightly below the company average, but it is improving.
And that connection.
And Nigel just a point of clarification, there that that the sales performance not the operational performance of the operational performance is on because when you have a bank like too big for our game you have to be very flexible because you're for deploying within hours notice of where the storm is moving and the precision. We saw we were down there last week was exceptional team is very proud of that and it should be very proud of that.
Understood Thanks very much.
Thank you and our next question comes from Julian Mitchell Barclays. Your line is now open.
Hi, guys. Good morning, Mr syndication on for Julian.
Hey, good morning.
Just quickly on margin expectations for the back half of the year. It seems as if the implied profit expectation through the second half art.
Far from her ROIC. So if there is anything to call out other than sort of terrorists tourist impacting gross margins or any other margin headwinds to call out there whether it be incremental investment in facilities maintenance or anything else. Besides the 50 Threerd week impact.
That would be helpful. Thank you.
Yes, let growth gross margins as I said for facilities maintenance, we're now expecting.
20 to 40 basis points of of.
Decline for the for the year.
And that and Thats all on the on that on the tariffs that gross margin dollars, we earn on each unit should be.
Pretty good pretty consistent.
Construction and industrials gross margins should be about about flat.
Where the earnings profile declines is because of the drop in volume so the ability to leverage fixed cost is reduced as as volume drops.
We're working hard to take cost out.
And we'll continue to work hard to take cost out.
And so what we've provided to you in the guidance today is based on our current trend in our current expectation, but we're always working to do better.
Understood and maybe just a quick one on the topline is sort of the moderation that was seen in August .
FM growth just purely due to a weakening in a truck environment or I was just wondering if there are any other factors at play there.
HIV assay has been been a little weak there is a little bit of noise between between July and August in the in the calendar shift in where the first of the month falls.
The best way to look at it as July for facilities maintenance was about a three.
August was about a one that I look at the current trend rate of the two of them together. So we're trending about 2% right now.
Understood. Thank you very much.
Thank you and our next question comes from Ryan Merkel of William Blair. Your line is now open.
Hey, Thanks, good morning, everyone.
So my first question is on the asset business can you just talk about it.