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HD Supply Holdings, Inc. (NASDAQ:HDS)
Q1 2018 Earnings Conference Call
June 5, 2018, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen. Welcome to the HD Supply first quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. If anyone should require operator assistance during the conference, please press * then 0 on your touchtone telephone. I would now like to turn the call over to Charlotte McLaughlin, Investor Relations. Please go ahead.

Charlotte McLaughlin -- Senior Manager, Investor Relations

Thank you, Operator. Good morning, ladies and gentlemen. Welcome to the HD Supply Holdings 2018 first quarter earnings call. A copy of the earnings press release and presentation can be found on the Investor Relations tab of the company's website at www.hdsupply.com.

Joe DeAngelo, our CEO, will lead today's call and provide an overview of our 2018 first quarter, as well as commentary on your recent execution and outlook. Following Joe's remarks, Evan Levitt, our CFO, will provide an overview of the main areas of interest from the investment community, before going into detail on the 2018 first quarter performance, comment on monthly sales, and provide guidance for the second quarter of 2018. We will then conduct the Q&A and conclude with Joe's closing remarks.

Please note that some of the information you will hear in today's discussion will include forward-looking statements within the meaning of the Federal Securities Law. Forward-looking statements are based on management's beliefs and assumptions and information currently available to management, and are subject to known and unknown risks and uncertainties, many of which may be beyond our control. We caution you that the forward-looking information presented is not a guarantee of future results and that actual results may differ materially from those made in or suggested by the forward-looking information contained in this presentation.

For more information, please refer to our risk factors discussed in our Annual Report on Form 10-K for the fiscal year ending January 28, 2018, and those described from time-to-time in our and HD Supply, Inc.'s other filings with the SEC.

Any forward-looking information presented is made only as of the date of this presentation and we do not undertake any obligation to update or revise any forward-looking information. This presentation contains certain non-GAAP financial metrics. For a reconciliation of such metrics to the nearest GAAP metrics, and other supplemental information, please see our earnings press release and refer to the appendix of the earnings call presentation.

For Q&A, please limit your remarks to one question and one follow-up. We want to provide an opportunity for as many people as possible to ask a question within our allocated 60 minutes. We appreciate your cooperation.

Thank you for participating on the call and for your continued interest in HD Supply. With that, I will now turn over the call to Joe DeAngelo.

Joseph J. DeAngelo -- President, Chief Executive Officer

Well, thank you, Charlotte. Good morning, everyone. Thank you for joining us today for our 2018 first quarter earnings call. As always, it is my privilege to share our company's results with you on behalf of the over 11,000 HD Supply associates who work hard every day as one team, driving customer success and value creation.

I'm extremely proud of the team's first quarter performance. We started the year strong, delivering 14.2% sales growth for the first quarter of Fiscal 2018, 9.9% sales growth on an organic basis. We also achieved 1.5 times operating leverage for the Company, despite significant mixed headwinds. As we highlight on page 3 of the presentation, we delivered 21% adjusted EBITDA growth and 79.5% adjusted net income per diluted share growth versus prior year.

We continue to generate strong free cash flow and delivered $380 million on a trailing 12-month basis. We expect to deliver about $500 million of free cash flow during 2018. Overall, our first quarter sales and earnings came in above expectations, despite significant disruption from severe winter weather in March and a cool start to Spring in April.

The Company saw an overall modest drop in gross margin versus prior year, primarily due to a change in the mix of our business with the recent A.H. Harris acquisition.

Rebar continued to pressure gross margins in the Construction and Industrial business, and we expect that to persist through the first half of 2018. Our Facilities Maintenance team delivered a strong gross margin performance, which Evan will talk more about later on the call.

The A.H. Harris integration is progressing well. We were pleased with results from A.H. Harris, despite the winter weather in March, which impacted the Northeast part of the country particularly hard. W will continue to integrate the A.H. Harris acquisition into Construction and Industrial throughout 2018. Planned synergies are on track and we expect to see benefits from the integration of our Sales and Support team and hand-sourcing capability in combined branch networks. We have significant opportunity to grow faster than the market, while at the same time we align cost synergies with the combined companies. I couldn't be more pleased to welcome the A.H. Harris associates into our HD Supply family.

We've continued to execute on our second $500 million share repurchase program, announced in August 2017. We've repurchased approximately 3.4 million shares at an average price of $37.16 per share through June 1 under this program. Evan will provide more detail around this shortly. We remain committed to deploying capital to the highest return investments available. This includes opportunistically repurchasing shares under our remaining share repurchase authorization.

We remain focused on growing our business organically, while also identifying opportunities to consolidate the markets that remain highly fragmented. We will be disciplined in identifying potential, accretive, tuck-in acquisitions for both Facilities Maintenance and Construction and Industrial in an effort to maximize shareholder return and cultural fit.

Talent continues to continues to be our fundamental differentiator and I am proud of the performance of our 11,000 HD Supply associates who work hard every day to deliver on our promises to our customers, fellow associates, and shareholders. I'll provide some closing comments following Q&A, and will now turn the call over to Even for review of topics of recent investor interest and an overview of our financial performance.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Thank you, Joe, and good morning, everyone. On Page 4, we highlight areas of recent investor focus and continue to share with you our latest perspective on these topics. First is weather. We experienced significant winter weather in the Northeast in March. Four consecutive Nor'easters led to branch closures and project delays, particularly in the newly acquired A.H. Harris branches. April, which is the start of our Spring selling season, was unusually cold. This negatively impacted sales within our HVAC category. As Joe indicated, we were pleased with our first quarter performance, despite the headwinds of winter weather and a cool start to Spring.

Our 2018 is off to a good start and we are encouraged by our customers' response to our continued improvements in service, and our ability to grow our business faster than the markets in which we operate.

Next is freight costs. Similar to many of our peers, we have seen an increase in third-party freight costs. We have been able to mitigate the impact of increasing freight costs through productivity enhancements stemming from investments within our supply chain. Additionally, we operate our own fleet for customer delivery, which enables us to more effectively manage our outbound freight costs and leverage our freight cost per unit as we deliver more to existing customers.

Labor inflation. The labor market has been tightening for several months. We are seeing wage rates grow at an estimated 3% annual rate, with variability across geographic areas and job functions. We are committed to providing competitive wages in order to attract and retain the best of the best talent. When wage rate adjustments are necessary, we take a targeted approach to adjusting rates by specific job function by location as necessary to remain competitive.

Tariff impacts. We've seen the impact of an increase on tariffs on imported rebar throughout 2017 and into 2018. The Administration has recently announced additional tariffs on all steel and aluminum products from various countries. Steel rebar comprises approximately 10% of our Construction and Industrial business, or about 5% of our total company business. We have passed along some but not all of the cost increase through pricing adjustments. This has resulted in pressure on our rebar margins for the last 12 months. We expect this pressure to continue through at least the first half of 2018 before it gradually eases.

The non-residential construction end market. We focus on Construction and Industrial business on supporting 15 priority districts, which comprise 15 of the largest MSAs across North America that we believe have the ability to generate strong construction activity for many years. We are currently seeing strong activity across all priority districts. One year ago, we spoke of a gap in large, multi-year construction projects, as a number of large projects reached completion. Since last year, we have seen that gap filled with the start of several large new construction projects that will continue for years to come. We estimate the overall market continues to grow in the low-to-mid single digits, which is a favorable environment for HD Supply.

Tax reform. We currently expect to exhaust our net operating loss carry-forwards and various income tax credits during Fiscal 2019. Since we are primarily a domestic company, once we become a regular taxpayer, we will pay federal tax at about the statutory rate. Therefore, the reduction in the corporate statutory rate from 35% to 21% is a significant benefit for HD Supply. The additional cash flow that we generate as a result of tax reform will be applied to the highest return investments available, including continued organic investment in our business, M&A activity, and a return of cash to shareholders.

Now, turning to page 5, I'll cover our first quarter results. We delivered sales of $1.389 billion an increase of $173 million or 14.2% over the first quarter of 2017. Our organic sales in that period increased 9.9% over the first quarter of 2017. Gross profit increased $68 million or 14% to $552 million. Our gross margin rate of 39.7% was down 10 basis points from the first quarter of 2017. Excluding the change in mix from the acquisition of A.H. Harris, gross margin increased approximately 20 basis points from the first quarter of 2017.

Our selling, general, and administrative costs were up $38 million, or 11.4% over the first quarter of 2017. As a percentage of sales, selling, general, and administrative costs were 26.8%, a decrease of 70 basis points over the first quarter of 2017. Adjusted EBITDA for the first quarter of 2018 was $190 million, up $33 million or 21%. We benefited from mix and approximately $7 million of Facilities Maintenance supply chain costs in the first quarter of 2017 that did not recur in 2018, partially offset by approximately $3 million of cost incurred for our previously announced accelerated investment.

Adjusted net income for the first quarter was $130 million, up $50 million or 62.5% compared with the first quarter of 2017. This represents adjusted net income per diluted share of $0.70, compared to adjusted net income per diluted share of $0.39 in the first quarter of 2017. The increase in adjusted net income and adjusted net income per diluted share reflects improved operating performance, the reduction in our interest expense from improvements to our capital structure, and a reduction in weighted average shares outstanding. There were 185 million diluted weighted average shares outstanding during the first quarter of 2018.

I will now discuss the specific performance of our individual business units on page 6. Net sales for our Facilities Maintenance business were $723 million during the first quarter of 2018, up $41 million or 6% from the first quarter of 2017. We estimate that the MRL market grew approximately 1% to 2% in the first quarter of 2018. Facilities Maintenance gross margin increased approximately 110 basis points this quarter.

The team continues to do a terrific job in category management. We also benefited from mix, as the lower margin HVAC category was less significant to our first quarter than normal, as Spring got off to a cool start. Facilities Maintenance's adjusted EBITDA for the first quarter of 2018 was $123 million, an increase of $15 million or 13.9% from the first quarter of 2017.

Net sales for our Construction and Industrial were $666 million during the first quarter of 2018, up $130 million or 24.3%. On an organic basis, excluding the sales of the recently acquired A.H. Harris, our Construction and Industrial business grew 14.4%. We estimate the market was up approximately 6% for the quarter. Construction and Industrial's gross margin decreased approximately 90 basis points. Approximately 30 basis points of the decline was due to the mix associated with the acquisition of A.H. Harris.

An additional 30 basis points of the decline is from the reduction in margins of rebar. The remaining decline is from the mix of projects that our Construction and Industrial team supported during the quarter, with a heavy concentration of large jobs that tend to have lower margins. Although these larger, multi-year projects can have slightly lower margins, they represent good, profitable work that give us confidence in the current and future health of the construction markets. Construction and Industrial's adjusted EBITDA for the first quarter was $67 million, up $18 million or 36.7%.

Turning to page 7, as of the end of the first quarter 2018, our remaining gross federal net operating loss carry-forwards approximated $675 million. On a tax-affected basis, our federal and state net operating loss carry-forwards were approximately $205 million, representing the majority of our net deferred tax assets.

We expect these net operating loss carry-forwards and alternative minimum tax and other credits to continue to reduce the amount of cash taxes we pay through mid-2019. During the first quarter of 2018, we paid cash taxes of approximately $2 million, primarily US state and Canadian taxes. We estimate we will pay cash taxes of approximately $10 to $12 million during the full-year of Fiscal 2018. We expect our GAAP tax rate to be approximately 25% to 26% in Fiscal 2018. In the last 12 months, we generated $380 million of free cash flow.

During the first quarter, we intentionally brought in inventory earlier than in prior years to ensure that we were reading for the selling season. This strategy has supported our strong sales during the first quarter of 2018, and we are confident in our ability to meet our customers' needs throughout the 2018 selling season. The early purchase of inventory shifts some of our cash flow generation in 2018 to later in the year. We also invested in additional inventory for A.H. Harris, and their inventory position was lighted than expected upon acquisition in March. During Fiscal 2018, we expect to generate approximately $500 million of free cash flow.

Our capital allocation strategy is simple. We will deploy capital to the most attractive return opportunities available. These include organic investment in the business, opportunistic tuck-in acquisitions, and return of cash to shareholders currently through our share repurchase authorization. Through June 1, 2018, we have purchased 3.4 million shares of HD Supply stock for an average price of approximately $37.16, or a total of approximately $127 million under our second $500 million share repurchase authorization announced in August of 2017. We have approximately $373 million remaining under this authorization.

We expect to continue to opportunistically purchase shares of HD Supply stock in 2018 through open-market purchases under a 10b5-1 plan based on market conditions. Including the completion of our initial $500 million share repurchase authorization, we have purchased a total of 19.4 million shares of HD Supply stock for an average price of approximately $32.39, or a total of approximately $627 million. Through these share repurchase programs, we have reduced our outstanding share county by approximately 9.5% since the first quarter of 2017.

As to the end of the first quarter, our net debt to adjusted EBITDA leverage is 2.6X within our targeted range of 2-3X. We invested $19 million in capital expenditures in the first quarter of 2018.

On page 8, we provide first quarter 2018 monthly sales trend performance, as well as the 2017 comparable. In February 2018, we delivered sales of $391 million, an increase in average of daily sales of approximately 11.7% versus February 2017. In March 2018, we delivered sales of $423 million, an increase in average daily sales of approximately 12% versus March 2017.

Organic sales growth in the same period was 7.5%. In April 2018, we delivered sales of $575 million, an increase in average daily sales of approximately 17.7% versus April 2017. Organic sales growth in this same period was 10.3%. In both years, there were 20 selling days in February, 20 selling days in March, and 25 selling days in April.

In May 2018, the first month of our fiscal second quarter 2018, ended May 27th, so we can provide our preliminary sales results. We will not comment on May results beyond sales. There were 20 selling days in both May 2018 and May 2017. May sales were approximately $488 million, which represents average daily sales growth of approximately 18.7% versus 2017. Organic sales growth for May was 10.6%. Average daily sales growth versus prior year by business was approximately 34.5% for Construction and Industrial and approximately 6.3% for Facilities Maintenance. Construction and Industrial's organic sales growth for May was approximately 16%.

On page 9, we share our perspective on our second quarter 2018 guidance. For our second quarter 2018, we anticipate net sales to be in the range of $1.535 billion to $1.595 billion adjusted EBITDA to be in the range of $235 million, and $245 million and adjusted net income per diluted share to be in the range of $0.92 to $0.97. Our adjusted net income per diluted share range assumes a fully diluted weighted average share count of approximately 185 million. At the midpoint of the ranges, our second quarter net sales and adjusted EBITDA translate into approximately 16% growth and approximately 15% growth, respectively. On an organic basis, the midpoint of our second quarter 2018 sales range represents growth of approximately 8%.

For the full-year, we are raising our 2018 guidance. We now expect net sales to be in the range of $5.82 billion to $5.94 billion, adjusted EBITDA to be in the range of $832 million to $862 million, and adjusted net income per diluted share to be in the range of $3.11 to $3.27, which does not include any additional share repurchases for the remainder of 2018. Our adjusted net income per diluted share range assumes a fully diluted weighted average share count of approximately 185 million.

At the midpoint of the ranges, our full-year net sales and adjusted EBITDA translates into approximately 15% growth and 16% growth, respectively. On an organic basis, the midpoint of our full-year 2018 sales range represents growth of approximately 8%.

On page 10, we reiterate our end-market outlook for 2018. As previously detailed, we believe the MRO market will continue to grow approximately 1% to 2%. The non-residential construction end market will continue to grow low to mid-single digits, and the residential construction market will continue to grow approximately mid-single digits. These specific end-market estimates imply an approximate 2% to 3% end-market growth estimate for HD Supply's end markets in 2018.

On page 11, we summarize and consolidate our second quarter and full-year 2018 outlook views. To summarize, the teams are intensely executing across the Company and are focused on achieving our financial and operational goals. I'd like to thank you for your continued interest in HD Supply and I'll now turn the call back over to the operator for questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, if you have a question at this time, please press * then 1 on your touchtone telephone. If at any time your question has been answered or you wish to remove yourself from the queue, please press the # key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated.

Our first question is from Robert Barry with Susquehanna. Your line is now open.

Robert Barry -- Susquehanna International Group -- Analyst

Hey, guys. Good morning.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Good morning.

Robert Barry -- Susquehanna International Group -- Analyst

Congrats. Very nice start to the year. I was just curious on the top line. Anything in particular that you're cautious on? Just looking out? I mean, the guide for Q2 is at 8. Out of the gate, you're at 10.5. I think the comp in June is actually a nice bit easier, a little harder in July.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Nothing in particular that we are concerned about. The team is operating well. We've got a lot of momentum, but we are just getting into the start of selling season. So, we look forward to continuing the momentum and selling season will tell the story.

Robert Barry -- Susquehanna International Group -- Analyst

Got it. Then just wanted to follow-up on the rebar comment about seeing that pressure start to abate in the second half. Just curious what are the underlying assumptions behind that view and how much of seeing that abatement do you think is in your control?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Robert, we're a little ahead of the curve in terms of impact of tariffs on the steel markets because we've been seeing them since the first quarter of 2017. So, as we get into the back half of 2018, we're anniversarying quite a bit of the drop in margins we've already seen and the increase in tariffs. So it's nothing that we haven't already seen, nothing that we don't know how to operate in this type of environment. In terms of how much is under our control, we will control everything that we can. We'll stay disciplined. We'll buy intelligently. We'll manage our inventory properly. But we will stay competitive with the market. So, we do expect to see some additional pressure through the first half. I don't think that pressure goes away entirely in the second half, but it begins to ease.

Robert Barry -- Susquehanna International Group -- Analyst

Got it. I know last quarter you'd speculated that the mills might respond to these tariff regimes by actually shifting some production to other products, maybe even helping rebar pricing. Any signs of that behavior starting to materialize?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Too early to tell, Robert.

Robert Barry -- Susquehanna International Group -- Analyst

Yeah, OK. Thank you.

Joseph J. DeAngelo -- President, Chief Executive Officer

Thank you.

Operator

Our next question is from Julian Mitchell with Barclays. Your line is now open.

Ronald Weiss -- Barclays Capital -- Analyst

Good morning, guys. This is Ronnie Weiss on for Julian.

Joseph J. DeAngelo -- President, Chief Executive Officer

Good morning.

Ronald Weiss -- Barclays Capital -- Analyst

The Q1 operating leverage pretty solid at 1.5X. I guess the updated guidance still implies somewhere in that 1.1 range though, and it doesn't seem like rebar investments are drastically stepping us as we move through the year. So, is there anything kind of one-off to call out of why the operating leverage would be a bit lower the remainder of the year than it was in Q1?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Yeah, Ronnie. We did have the benefit of the $7 million of one-time cost that were incurred in the first quarter of 2017. So we had an easier comp from a cost perspective in the first quarter. I'll also point to the Facilities Maintenance strong gross margin performance in the first quarter, 110 basis points of improvement in gross margin. We think we can continue to defend our gross margin and perform well on gross margins. But we are not forecasting an additional 110 basis points of improvement throughout the year. That improvement was also partially aided by mix, as HVAC got off to a slow start because of the cool weather in April.

Ronald Weiss -- Barclays Capital -- Analyst

Got it. Then just a quick follow-up on the A.H. Harris dilution to gross margin, 30 basis points for the quarter. Should we be thinking about that kind of steady throughout the year or should it step down a bit?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

That will be pretty steady throughout the year. That's simply a mix issue of the acquired business versus the consolidated business.

Ronald Weiss -- Barclays Capital -- Analyst

Okay, great. Thanks, guys.

Joseph J. DeAngelo -- President, Chief Executive Officer

Thank you.

Operator

Our next question is from Evelyn Chow with Goldman Sachs. Your line is now open.

Evelyn Chow -- Goldman Sachs -- Analyst

Good morning, guys. I was hoping to start maybe with a question on SG&A leverage. Specifically, in CNI, noting that you guys achieved really good EBITDA margin expansion, despite gross margins being down so significantly. What kind of actions are you taking there and what is the expectation moving through the rest of the year?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Evelyn, leveraging's fixed cost is a big part of or business model. As you know, in distribution, as you get denser and deliver more to existing customers, your cost per unit goes own. That's your cost to serve per unit goes down. When you generate strong double-digit 14% organic growth, you get that type of leverage. Now, at a more modest growth rate of 300 basis points in excess of market, we can still get leverage, but not quite at that rate.

Evelyn Chow -- Goldman Sachs -- Analyst

Got it. That makes sense. Maybe just a higher level strategic question. You've been operating the HDS portfolio now with FM and CNI integrating Harris. As you've been operating the entity as it stands today, how would we think abut he synergies between the two businesses and are you finding areas where maybe the go-to-market has been changing or evolving?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Your question is synergies between A.H. Harris and HD Supply?

Evelyn Chow -- Goldman Sachs -- Analyst

Or rather, between CNI and FM.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Okay, so certainly the two businesses, we share talent across the two businesses. We also share market knowledge across the businesses. So, we seen in the Construction and Industrial business a lot of the earlier reads on the environment, on the marketplace, on construction of multi-family housing units, and then we support those housing units through maintenance with our Facilities Maintenance business. Then obviously all the back-office support functions that you would expect that we share leverage from IT to tax benefits, those types of support functions.

Evelyn Chow -- Goldman Sachs -- Analyst

Okay. Thanks, guys.

Joseph J. DeAngelo -- President, Chief Executive Officer

Thank you.

Operator

Our next question is from Ryan Merkel with William Blair. Your line is now open.

Ryan Merkel -- William Blair -- Analyst

Hey, thanks. Good morning and again, congrats on a great quarter.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Thanks, Ryan.

Joseph J. DeAngelo -- President, Chief Executive Officer

Good morning, Ryan.

Ryan Merkel -- William Blair -- Analyst

Two question on FM, if I can. First, have you seen suppliers raising prices or have you been successful holding back the price increases?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Ryan, we do see some modest price increases. It's not across the board. It's really kind of category by category. There's variability. I wouldn't say that it is an across-the-board inflationary environment that we're seeing right now. Where we do see that pressure for increase in costs, we do push back the mixture that it is justified and the cost increase from the vendor is real or the cost increase that the vendor is incurring is real. We make sure that we are not taking that cost increase before others. In many cases, we're able to take it after. We look at that very closely.

We do think that if we do see a pickup in inflation and the market moves, we'll move with the market. But our focus right now is on providing our customers with compelling value and offsetting some of the price increases we're foreseeing because right now most of the price increases we're seeing are in freight and labor that we've been able to offset through productivity to ensure that we continue to provide our customers with great value.

Ryan Merkel -- William Blair -- Analyst

All right. Bottom line, it sounds like you're not worried about price cost as it relates to product inflation?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

The team's doing a great job making sure that we have that aligned and balanced.

Ryan Merkel -- William Blair -- Analyst

Perfect, OK. Secondly, maybe for Joe. It's great to see the FM sales and margin expansion. Can you just give us summary of what is now going right and why you're confident that we can sustain this performance?

Joseph J. DeAngelo -- President, Chief Executive Officer

Yeah, well I think all the investments we put in are paying off. I think it's been absolute focus and discipline around ensuring we're investing in our selling channels and all the enabling functions. We'll give you a good look at that on investor day, when we showcase that. But I think all the investments we've been putting in are paying off exactly the way we thought they would.

Ryan Merkel -- William Blair -- Analyst

Great to hear. Thanks. See you next week.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Thanks.

Operator

Our next question is from Karen Lau with Deutsche Bank. Your line is now open.

Karen Lau -- Deutsche Bank -- Analyst

Hi, good morning, everyone.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Good morning, Karen.

Karen Lau -- Deutsche Bank -- Analyst

Good morning. Joe and Evan, you guys talked about how labor cost is impacting your businesses on the cost side. I was wondering if you can talk a little bit on the top line impact as well. Because there are a lot of labor shortages going on in the construction market and then obviously material costs are going up for that market as well. I'm just curious on your view and have you heard anything from you customers about kind of whether those costs would have some impact on future activity. I realize you remain very upbeat on the market and you had very strong results in CNI. I'm just curious what you're hearing and if those would have any impact on your pricing for that business as well?

Joseph J. DeAngelo -- President, Chief Executive Officer

I think you've had a period of time now where the construction markets have been tight on labor and so this isn't kind of a new issue that has just emerged. I think the thing to note is when you are an expert in the space, we can work with our customers to make sure that their job stays on time. If there is a shortage there, we can certainly recommend products that require less labor to be able to execute. So that's why a complete solution and somebody onsite every day with you can make a big difference. Our ability to keep those job sites running as an integral part of that construction cycle is really important. So look, where it's tight, we'll do whatever it takes to make sure that we work hand-in-hand with our customers to make sure that their jobs are not delayed because of any particular tightness. Right now, we haven't experienced anything that's been dampening demand out there and I don't anticipate anything that working well with our customers would dampen the demand out there.

Karen Lau -- Deutsche Bank -- Analyst

Okay, sounds good. Thank you.

Joseph J. DeAngelo -- President, Chief Executive Officer

Thank you.

Operator

Our next question is from Luke Junk with Baird. Your line is now open.

Luke Junk -- Robert W. Baird & Co. -- Analyst

Good morning, guys.

Joseph J. DeAngelo -- President, Chief Executive Officer

Good morning.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Good morning.

Luke Junk -- Robert W. Baird & Co. -- Analyst

First question, Evan. Just wondering if you can bridge the CNI EBITDA versus prior year? In other words, what was the underlying operating leverage of the business plus the dollar contribution from A.H. Harris and specific to the acquisition, just wondering if things are tracking to your expectations thus far and any qualitative observations you can share a few months in here?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

The business is tracking to our expectations. We believe it performed similar to the guidance that we gave coming in to the year, particularly on sales. It is difficult for us, Luke, to give you an EBITDA number for A.H. Harris or the impact on operating because we're already integrating the two businesses. So, we're already sharing resources and, in fact, some sales that are made by an A.H. Harris salesperson will be fulfilled by the HD Supply branch and vice versa. So very difficult for us to break that out and because of that, we're not going to do that. We will provide you with an estimated impact on the sales line so that you can see what the organic sales growth is versus the total sales growth but it would be too speculative to do it on the EBITDA line.

Joseph J. DeAngelo -- President, Chief Executive Officer

I would tell you the integration with the CNI team and the Harris team has been spectacular. The teams are really working well together. Tremendous excitement about how we can bring the best of the best of both models and make our existing model better. The Harris team has been really excited about joining the team and being able to have the opportunity to earn more.

Luke Junk -- Robert W. Baird & Co. -- Analyst

Great. Then second question, staying on CNI. Just curious what you're seeing in terms of the bidding environment today? Especially as it relates to what continues to be obviously a more aggressive approach in the market from your standpoint. Any particular areas of the country or specific trades where you feel like you're getting better-than-average gains here?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

We see strong performance across the country, across all market team priority districts. We grew up as a West Coast business, so we do have a bigger market share on the West Coast. But we're excited about the East Coast as well. The A.H. Harris acquisition really helps us grow our business on the East Coast and serve our customers better. In terms of being more aggressive on bidding, I wouldn't necessarily characterize it as more aggressive on bidding. I'd characterize it more as a change in the mix of the jobs that we're working on. The larger jobs tend to be more competitive because they're well known and everybody wants to be on them; they're high-profile jobs. We're certainly taking our share of those jobs.

Joseph J. DeAngelo -- President, Chief Executive Officer

I'd say if you look at the size of the job in every priority district, these are big jobs. They all span multi-year execution. So, we're really pleased across the country there are major jobs happening and we don't see any gap.

Luke Junk -- Robert W. Baird & Co. -- Analyst

Great. Very helpful. Thank you.

Joseph J. DeAngelo -- President, Chief Executive Officer

Thank you.

Operator

Our next question is from Deane Dray with RBC Capital Markets. Your line is now open.

Deane Dray -- RBC Capital Markets -- Analyst

Thank you. Good morning, everyone.

Joseph J. DeAngelo -- President, Chief Executive Officer

Good morning, Deane.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Good morning, Deane.

Deane Dray -- RBC Capital Markets -- Analyst

Evan, I'd like to have you go back to your comment related to price cost, where you said you try not to take cost increases before others. I think you suggested that you have this power in the market or at least influence where you can get from suppliers an early read on price increases coming through so you can turn around and get those price increases from your customers and kind of, you know, manage that lag effect. Is this the strategy? How successful have you been? What's baked into your assumption for the second half?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Yeah, certainly that's an advantage that we have, Deane, with our market presence. More so than the market presence, I talk about it as the relationships we have with our supplier base. So, we've got good partners in our supplier base that we stay close to that help us understand what's happening in the marketplace from a cost perspective, as well as a perspective of what new types of products are coming to market and are going to be introduced. Being the larger player in the space gives us the advantage to partner with those vendors and make sure that we're getting the best programs, the best product, the best pricing, and the best sales support from the vendor community.

Joseph J. DeAngelo -- President, Chief Executive Officer

Being the best with the vendor's innovation is most important because that brings us productivity to our customers and our customers constantly need to get better. We're an integral part of that by unleashing that innovation with the supplier first.

Deane Dray -- RBC Capital Markets -- Analyst

Great. Also on pricing, it was interesting that the FM catalog this year does not include prices. I think that's for the first time, but you do have this new app where customers can use their smartphones to scan products. Just maybe give us a sense of how that rollout has been, the reception for customers. Am I correct that it's around 80% of customers do not pay a list price?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

About 80% of our sales in the Facilities Maintenance business is pursuant to some type of national contract. And so the list price in the catalog isn't necessarily relevant to them. But yeah, the tools that we're introducing, we're introducing them very thoughtfully so that they work together. As you point out, this is the first year that we removed all pricing out of the catalog. We've been moving in that direction over the last several years. As you can imagine, and as our customers expect, it's difficult to hold price for a full year. In many cases, when we're changing that price, we're taking it down versus up to be competitive in the market and to provide good value to our customers. But the tools do work together.

So, you can scan any item within the catalog through the HD Supply app and get your price, your contracted price. But the teams have worked incredibly hard. The pricing teams have worked incredibly hard to make sure that we are protecting our margin and providing compelling value to customers.

Deane Dray -- RBC Capital Markets -- Analyst

Got it. Just last quick question as a follow-up to Rob's question on the rebar. It sounds like you don't want to go toe-to-toe with the steel mills here. Is the strategy to go toward more specialty rebar, special sizes, and what kind of opportunity is that for you?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

We've been doing that over the last several years, so we've gotten away from delivering truckloads of rebar. What we generally sell are odd-lot quantities or even more so, a fabricated rebar, so it's bent or shaped to customer specifications, so we're adding value to the rebar itself. It distinguishes us a bit from a steel mill selling a full truckload of steel and enables us to claim a little more value because we're adding value to the product.

Deane Dray -- RBC Capital Markets -- Analyst

Got it. Thank you.

Joseph J. DeAngelo -- President, Chief Executive Officer

Thank you.

Operator

Our next question is from Patrick Baumann with J.P. Morgan. Your line is now open.

Patrick Baumann -- J.P. Morgan Securities -- Analyst

Hey guys, good morning. Thanks for taking my call.

Joseph J. DeAngelo -- President, Chief Executive Officer

Good morning.

Patrick Baumann -- J.P. Morgan Securities -- Analyst

A quick question just going back to Ryan's question on FM. Just curious what you're seeing from a sales perspective there. It looks like the out performance versus the market is as good as it's been for a long time here. Right now, I'm counting like 400 to 500 basis points in the quarter versus market that you said what's up 1 to 2, I think. It looks like May sustain this and it even picked up into a much tougher comp. Just curious, is there anything to call out here from a category or market perspective? Did the market really tick up in May or is it just what you said, traction on those investments you've been making?

Joseph J. DeAngelo -- President, Chief Executive Officer

I think we're earning those investments. We're seeing the payback from those investments we've made. Across the board, I think, with every size of customer and every type of customer, every category, we're experience the winning that we've invested in.

Patrick Baumann -- J.P. Morgan Securities -- Analyst

Okay. Then maybe along those lines, any update on the competitive environment from the Home Depot, Lowe's, Ferguson's of the world or any others that are making noise these days?

Joseph J. DeAngelo -- President, Chief Executive Officer

It's been pretty consistent. They're out there, relatively transparent. The playbook really hasn't changed.

Patrick Baumann -- J.P. Morgan Securities -- Analyst

Got it. Then last one for me, just on gross margins. How do you see them trending for the year now, given the 1-2 strength in FM? I'm just curious do you see them as kind of stable this year or down or up a little bit? How do you see that playing out?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

From a Facilities Maintenance we certainly see that stable to potentially up into 10 or 20 basis points here. I certainly wouldn't bake in 110 basis points of improvement the rest of the way. The team does a terrific job through category management, taking cost out wherever we can, being as efficient wherever we can. But it is hard work out there. We've said it in the past that a flat gross margin in this environment is good execution. We truly believe that. A flat gross margin is really good execution. The execution we had in the first quarter was terrific by the team. Again, it was aided a little bit by mix. So, the team's going to continue to work hard. We'll defend our margins and maybe squeak out some modest growth in gross margin, but that's what I plan for the rest of the year.

Patrick Baumann -- J.P. Morgan Securities -- Analyst

Okay. Thanks a lot, guys.

Joseph J. DeAngelo -- President, Chief Executive Officer

Thank you.

Operator

Our next question is from [Inaudible] with Macquarie. Your line is now open.

[Inaudible] -- Macquarie Group -- Analyst

Good morning, thank you. The first question is just on the FM business. Your FM business is pretty concentrated on multi-family, hospitality, healthcare. Just curious if you can get bigger in other areas and whether that's attractive and then along those lines, is the service component an opportunity for you guys? I know it's sort of 10% of the FM business, but any thoughts there?

Joseph J. DeAngelo -- President, Chief Executive Officer

I would say the verticals that we're in are the ones that we have the opportunity in, we've scoped out and we're expert in, so we're going to continue to grow within that. There's plenty of room with the market that's over $50 billion and certainly when you look at the service opportunity of installations and property improvement overall, that's clearly a nice growth area for us that is typically self-performed today by the customers. So, our ability to package that in and be the expert there is something that we'll continue to focus on and grow. All those areas are growing well. So, we're very pleased with that we're executing across the board in all our verticals and across the board in the property improvement within those verticals.

[Inaudible] -- Macquarie Group -- Analyst

Great. Just a follow-up question for Evan. It looks like free cash flow conversion just as a percent of EBITDA is around 59% for this year. I know you touched on inventory a little bit in your earlier remarks. Is that a normal run rate for you guys going forward or did that step up? Thanks.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Yeah, the way we look at cash flow is we look at a 75% conversion pre-tax, pre-interest. Because tax and interest bounce around a bit for us as we've improved our capital structure, and tax will change as we become a taxpayer. So we look at a cash conversion, pre-tax, pre-interest, 75% of EBITDA, and then subtract cash paid for taxes and interest. This year, cash paid for taxes will be 10% to 12%, cash paid for interest about $120 million.

[Inaudible] -- Macquarie Group -- Analyst

Great. Thank you.

Operator

Our next question is from Ryan Cieslak with Northcoast Research. Your line is now open.

Ryan Cieslak -- Northcoast Research -- Analyst

Hey, good morning, guys. Great start to the year. My first question, just going back to the FM sales in the months of April and May. I think you guys had highlighted some slower sales in April as relates to HVAC and just wondering maybe what that impact was and did that actually then pick up in May as part of the acceleration in the sales growth during the month of May?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Yeah, certainly in May we saw a more return to normal of the HVAC business. The month of April, I'd say the impact to the Facilities Maintenance business of a slow start to the HVAC season, somewhere around 100 basis points.

Ryan Cieslak -- Northcoast Research -- Analyst

Okay. That's helpful, appreciate it. And then thinking about your updated full-year guidance, certainly the top line trends continue to move in the right direction and it seems like exceeding your expectations. How do you guys think about or maybe give some color if you can on what you're assuming from a cost perspective as it relates to rebar, wages, and freight? Is there some incremental assumptions in terms of headwinds there that you guys are currently assuming within your guidance?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

In terms of rebar, we are assuming additional pressure on gross margin rate. So, we've been seeing that all along. We've got the expectation that pressure continues at about the current rate through the second quarter and then gradually eases. We do have expectations for increasing labor costs. We're seeing about 3% year-over-year increase, so it's not unmanageable. We manage that by ensuring we continue to get more efficient with our labor, both in the distribution centers and our drivers. We continue to see increases in freight costs, but we're better able to manage that than most since we operate our own delivery fleet. As you deliver more to your existing customers, as you grow and you're able to dense in your deliveries on a truck, your delivery cost per unit drops. So that's how we offset the increase in freight cost and fuel cost.

Ryan Cieslak -- Northcoast Research -- Analyst

Okay, just to be clear, Evan. So you are assuming some incremental headwinds as relates to wages in freight into the back half of the year or the next couple quarters relative to your initial guidance you gave last quarter?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

No, I wouldn't say different than the guidance we gave last quarter. This was included in our full-year guidance from last quarter and included in our plan of what we expected in 2018.

Ryan Cieslak -- Northcoast Research -- Analyst

Gotcha, OK. The last one for me is I think you mentioned the non-res market in the first quarter, if I heard you right, was up 6%. Was that right?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

We're estimating the non-res construction market in the first quarter was up about 6%, yes.

Ryan Cieslak -- Northcoast Research -- Analyst

Okay. Then just how do you, so thinking about the outlook do you guys still have in that low single digit to mid single digit range, is that maybe some conservatism or is there something that you guys see out there that you're keeping an eye on versus maybe thinking maybe more at the higher end of that range versus the lower end?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

You're right. WE said low to mid single digits. 6% is on the higher end of that range. I still consider that a mid single digit, but also keep in mind it's the first quarter. The construction season really starts here in April and May. And so before we reevaluated our estimated growth rate of that market on a go-forward basis, we'd want to see it through the construction season.

Ryan Cieslak -- Northcoast Research -- Analyst

Okay, sounds good. Best of luck, guys.

Joseph J. DeAngelo -- President, Chief Executive Officer

Thank you.

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Thanks.

Operator

Our next question comes from Keith Hughes with SunTrust. Your line is now open.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Thanks. A question on A.H. Harris. At least part of their business is fabrication -- forming things of that nature. Are you going to be looking to do more acquisitions of that variety to complement the existing white cap?

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Yeah, Keith. Our legacy white cap business, we do fabrication within that business as well. You're right. We acquired additional fabrication capacity through the A.H. Harris acquisition and that is certainly a benefit to us. As we look at additional M&A, absolutely. We're looking for opportunities to either dense-in in a given market or to identify opportunities and specialties that we can leverage across our business. So, whether that's fabrication or an expertise in a particular product category, we'd be very interested in that.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Okay, thank you.

Operator

Thank you. I'm showing no further questions. I would now like to turn the call back to Joe DeAngelo for any further remarks.

Joseph J. DeAngelo -- President, Chief Executive Officer

Well, thank you for your questions. I would like to encourage those of you who have not signed up for investor day on June 21, to contact Charlotte McLaughlin and our investor relations team. We believe this is a great opportunity to meet our extended leadership team, learn more about our strategic and financial outlook, and have the opportunity to experience the HD Supply Facilities Maintenance growth investment showcase, as well as the HD Supply Construction and Industrial branch experience. In summary, on page 13, the team is focused and energized to continue to deliver on our customer, associate, and shareholder promises. Thank you for your continued support and interest in HD Supply.

Operator

Ladies and gentlemen, thank you for participating in today's conference. You may now disconnect. Everyone have a great day.

Duration: 58 minutes

Call participants:

Joseph J. DeAngelo -- President, Chief Executive Officer

Evan J. Levitt -- Senior Vice President, Chief Financial Officer

Charlotte McLaughlin -- Senior Manager, Investor Relations

Robert Barry -- Susquehanna International Group -- Analyst

Ronald Weiss -- Barclays Capital -- Analyst

Evelyn Chow -- Goldman Sachs -- Analyst

Ryan Merkel -- William Blair -- Analyst

Karen Lau -- Deutsche Bank -- Analyst

Luke Junk -- Robert W. Baird & Co. -- Analyst

Deane Dray -- RBC Capital Markets -- Analyst

Patrick Baumann -- J.P. Morgan Securities -- Analyst

[Inaudible] -- Macquarie Group -- Analyst

Ryan Cieslak -- Northcoast Research -- Analyst

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

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