Industrial tools, materials, and facilities maintenance supply organization HD Supply (NASDAQ:HDS) issued results for its fiscal second quarter on Sept. 10. While the company's revenue and earnings fell within previously issued guidance, its forecast for the entire year was found wanting by investors, as shares declined 4% in the trading session following the report's release. Below, we'll review the quarter and the specific issues that have limited HD Supply's ability to generate financial momentum this year. Note that all comparative numbers in this article are presented against those of the prior-year quarter.

The raw numbers

Metric Q2 2019 Q2 2018 Change
Revenue $1.62 billion $1.60 billion 1.3%
Net income $135 million $131 million 3.1%
Diluted earnings per share $0.80 $0.72 11.1%

Data source: HD Supply Holdings.

What happened with HD Supply this quarter?

  • The organization's top-line result, as seen in the table above, hit the low end of a forecasted range of $1.62 billion to $1.67 billion, which was shared with investors last quarter. Net income also fell nearer the lower end of the company's anticipated band of $131 million to $142 million. Earnings per share (EPS) landed at the midpoint of an expected range of $0.77 to $0.83.
  • Facilities maintenance revenue rose by 1.2% to $830 million. Management attributed the slight growth to colder weather during the quarter, which impacted HVAC (heating, ventilation, and air conditioning) sales, as well as the rollout of an automated fulfillment process in the company's Atlanta distribution center. Problems originating with the automation vendor caused HD Supply to temporarily resume manual order fulfillment during the summer. According to management, automated fulfillment has resumed and is now running smoothly. Together, the weather and fulfillment issues shaved an estimated 150 to 250 basis points from facilities maintenance sales during the quarter.
  • Construction and industrial net sales improved by 1.8% to $795 million. While the company is benefiting from numerous multiyear projects in the construction industry, spread over a variety of sectors, industry activity has generally decelerated during 2019 due to cooler weather in the spring and summer, as well as from a dearth of skilled labor.
  • Gross margin was unchanged at 38.9%.
  • Adjusted EBITDA slipped less than 1% to $244 million.
  • After quarter-end, on Sept. 1, HD Supply acquired Houston-based maintenance, repair, and operations (MRO) provider Presto Maintenance Supply. Presto booked sales of $15 million in 2018; terms of the deal were not disclosed.
An electrician works on repairing an elevator lift mechanism.

Image source: Getty Images.

Management's perspective

In addition to the impact of moderating construction industry growth this year, HD Supply has faced earnings volatility due to the current tariff environment, as I discussed last quarter. During HD Supply's earnings conference call, CFO Evan Levitt offered a counterpoint to these external headwinds, pointing to the distributor's generation of $562 million in free cash flow over the last 12 months. Levitt also discussed positive aspects of the company's balance sheet and capital allocation strategies, burnishing the investment thesis on HD Supply:

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 2 to 3 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.

Looking forward

Management continues to display wariness regarding the effect of import tariffs with the back half of the year in sight. Due to this caution and expected softer revenue from construction industry supply sales, the company trimmed full-year fiscal 2019 earnings projections on Tuesday. Sales are now expected to range between $6.1 billion and $6.2 billion, against the previous projection of $6.25 billion to $6.35 billion. Full-year net income is slated to land between $450 million and $472 million, versus last quarter's predicted range of $474 million to $504 million. Finally, diluted EPS has been trimmed to a range of $2.68 to $2.81, from an initial expectation of $2.77 to $2.95.