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HD Supply Holdings, Inc. (NASDAQ:HDS)

Q2 2013 Earnings Conference Call

September 10, 2013, 08:00 AM ET

Executives

William P. Stengel - Senior Vice President, Strategic Business Development and Investor Relations

Joseph J. DeAngelo - President and Chief Executive Officer

Ronald J. Domanico - Senior Vice President and Chief Financial Officer

Analysts

C. Stephen Tusa Jr. - JPMorgan

Hamzah Mazari - Credit Suisse

David Manthey – Robert W. Baird

Joseph Ritchie – Goldman Sachs

John Inch - Deutsche Bank

Allison Poliniak-Cusic – Wells Fargo

Dean Dray - Citibank

Matthew S. McCall – BB&T Capital Markets

Ryan Merkel - William Blair & Company, LLC

Operator

Good morning. My name is Simi and I will be your conference operator today. At this time I would like to welcome everyone to the HD Supply 2013 Second Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions).

Mr. Will Stengel you may begin your conference, sir.

William P. Stengel

Thank you operator. Good morning ladies and gentlemen and welcome to the HD Supply Holdings 2013 second quarter conference call. A copy of the second quarter earnings press release can be found on the Investor Relation tab of the company’s website at www.hdsupply.com

Joe DeAngelo, Chief Executive Officer will lead today’s call and provide an overview of our second quarter results. Following Joe’s remarks Ron Domanico, SVP and CFO will provide a second quarter financial overview. Joe will then provide closing remarks followed by Q&A.

Please note that some of the information you will hear in today’s discussion will include forward-looking statement within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements are subject to known and unknown risks and uncertainties many of which maybe beyond our control. We caution you that the forward-looking information presented is not a guarantee of future events and that actual events 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 registration statement on Form S1 as amended that was declared effective on June 26, 2013 and those described from time-to-time in our -- in HD Supply Inc.’s other filings with US Securities and Exchange Commission. 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 metric please see our earnings release press release.

For Q&A, please limit your remarks to one question and follow-up if necessary. We want to be able to provide an opportunity for as many people as possible to ask a question. We appreciate your cooperation and thank you for participating on the call.

With that I’ll now turn the call over to Joe DeAngelo.

Joseph J. DeAngelo

Well, thanks Will. Good morning and thank you for joining us today for our 2013 second quarter earnings conference call, our first quarterly earnings call as a publicly traded company. This is a very exciting time for our 15,000 associates who work hard every day to deliver customer success and value creation.

During our IPO roadshow we had the opportunity to talk or meet with many of you on today’s call. For those of you new to the company, since our IPO we look forward to having an opportunity to talk with you in the near future. We appreciate your support and stake in HD Supply.

To frame our first earnings call I’m going to spend a moment discussing several key investment themes that are important to understand our company and more importantly that excite us about company’s full potential. First, the company is built on our trusted local executions. We deliver that trusted local execution with our market product knowledge, customer relationships that are based on reliability of service and supplier alignment based on performance.

Our knowledgeable and talented associates, deep product offerings, the workflow integration between approximately 15,000 suppliers and more than 500,000 customers make it an integral part of the value chain. While we have a large scale and strengthening national footprint at our core, we are a local business, providing local market expertise through local presence and direct customer access.

Second, we have market leading positions in each of our primary business units with a 7% market share in approximately $110 billion highly fragmented industry. Scale matters in our business. We believe we have large opportunities to enhance our leadership position. We’re in the very early innings of capturing our full potential.

Third, we’re diverse in that we have steady growth in maintenance requiring operations, plus exposure in infrastructure and construction end markets which offer sequential overlapping growth. We are well positioned to benefit from recoveries in our residential and non-residential construction markets as well the increased pent-up demand in infrastructure.

And lastly, we’re intensely focused on controllable execution that delivers profitable above market growth. We execute five key growth strategies including increasing our share of wallet by selling more to existing customers, introducing new products and services, and acquiring new customers, expanding the channels to reach our customers such as e-commerce and catalog, and opening new locations.

We believe our controllable execution drives profitable above market growth, operating leverage and return on invested capital. We run these five plays over and over again to get better investments.

With this framing as a strategic overlay I’d like to discuss some highlights of our second quarter performance. Sales grew by 10% versus the prior year to $2.3 billion, driven by our high return growth initiatives.

Gross margin improvement and SG&A productivity translated to adjusted EBITDA of $218 million which represents growth of 14% compared to a year ago. All of our primary business units including Facilities Maintenance, Waterworks, White Cap and Power Solutions continued to deliver revenue growth in excess of market driven by controllable execution.

We delivered 12% sales growth in our facilities maintenance business, over 9% of our growth is organic. In our Waterworks business, we delivered 14% sales growth, nearly 10% of this growth is organic. We grew organically by over 9% in White Cap and nearly 4% in our Power Solutions business. We’re executing our growth strategies and see continued opportunities for further organic growth enhancement.

We achieved this performance despite softness in some of our end markets, in particular non-residential construction and municipal spending which I’ll discuss further, plus the negative impact from weather and cooler weather which affected outdoor construction activity as well as reduced demand for our HVAC products.

That said, we remain focused on our controllable execution. We believe our high return growth initiatives continue to drive above market growth. During the quarter we also continued to make investments for future growth across each of our five key growth strategies. For example, our facilities maintenance business added associates to increase share of wallet, expanded distribution center locations to support sales growth.

Our Waterworks business expanded and accelerated their sales training program while continuing investments in strong drainage, meters, plant works and fusible plastics. Our Power Solutions business added associates to support category management and marketing initiatives opened a new location to capture oil and gas opportunities, plus executed branch expansion adding low voltage where we had an existing high voltage presence.

And our White Cap business added new sales associates to capture more wallet share, launched a new dedicated safety product catalogue and opened a new location in Texas.

Turning to our end markets we’ve been -- we see emerging signs of growth in the residential market sector in our White Cap and Waterworks business. We are seeing strong demand in Texas, Austin and Houston in particular for both the single family multi-family markets. We believe we are strategically positioned to continue to benefit from this uptick and expect this positive momentum to continue.

In the non-residential market we are experiencing softness and not yet benefiting from any significant tailwind. We are however seeing pockets of non-residential activity in our White Cap business in certain regions on a project-by-project basis. For example in Boston the commercial market is picking up with strength coming from apartment and condo shortages and water front university construction projects.

Despite the pockets of activity broader-based growth in these end markets are slower to take shape than originally forecast. We believe general softness in the non-residential end market could continue for the remainder of 2013.

Infrastructure spending has also been slower through the summer. Municipal spending continues to be impacted by economic and budget uncertainties. Similar to the non-residential markets we are seeing pockets of municipal activities, for example during the quarter our Waters business saw increases in automated meter projects in Texas and Alabama.

In our Power Solutions business we are seeing an increase in transmission project as our electrical utility customers upgrade portions of their ageing infrastructure. We are also encouraged by legislation around creative financing solutions to release significant pent up demand to improve our water infrastructure. However we do not expect a significant increase in these end markets through the remainder of 2013.

The MRO end markets continue to grow at a measured and steady pace during the quarter driven by increases in occupancy in the multi-family and hospitality industries. We expect this trend to continue.

In short we are focused on operational excellence and controllable executions. We are investing in our future growth. We continue to outpace the market and we are poised to take advantage of the anticipated market upturn in construction and municipal spending, together we think it's a very powerful mix.

I am now going to turn the call over to our Chief Financial Officer, Ron Domanico for a financial review of our second quarter performance.

Ronald J. Domanico

Thanks, Joe. I would also like to thank everyone for being on today’s call.

I am going to provide an overview of our overall financial performance for the second quarter of fiscal 2013, talk about our financial performance in our primary business units, provide some commentary around our favorable tax position and outline guidance for the fiscal year 2013.

We reported net sales of $2.3 billion for the second quarter, an increase of $198 million or 10% compared to the second quarter of fiscal 2012. Gross profit increased by $67 million or 11% to $661 million compared to $594 million for the same period last year.

The increase in gross profit driven by our Facilities Maintenance Waterworks and White Cap businesses was primarily due to sales growth from high return growth initiatives market volume and product mix. Gross margin was 29.3% of net sales, an increase of approximately 50 basis points compared to 28.8% of net sales for the second quarter of fiscal 2012.

Operating income increased by $47 million or 46% to a $150 million compared to a $103 million in the same period last year. The improvement was due to higher net sales and gross profit and a reduction in amortization expense.

Adjusted net income was $36 million, an increase of $33 million compared to the second quarter of fiscal 2012. As background we define adjusted net income as net income from continuing operations adjusted for cash income taxes paid, less amortization of acquisition related intangible assets other than internally used software, less any goodwill and intangible asset impairments and other items considered unusual or non-recurring in nature.

Adjusted EBITDA, which is a primary metric for us, increased $26 million or 13.5% as compared to second quarter last year and $57 million or 17.5% in the first six months as compared to the same period in 2012. The increase in adjusted EBITDA in the second quarter of fiscal 2013 was driven by Facilities Maintenance, Waterworks and White Cap.

On year-over-year basis gross profit and adjusted EBITDA were negatively impacted by the change in contract terms in the Crown Bolt agreement with The Home Depot as a result of our contract expansion. The new seven year exclusive contract through January 2020 adjusted pricing levels and eliminated the volume guarantee as compared to the original contract.

The second quarter and first six months of fiscal 2013 included a reduction of adjusted EBITDA of $6 million and $12 million respectively as a result of this new agreement. Loss from continuing operations was $72 million, which included a $46 million loss on the extinguishment and modification of debt associated with the redemption of our subordinated notes from the IPO proceeds.

Loss from continuing operations for the second quarter of 2012 was $56 million. Excluding the loss on the extinguishment of debt loss from continuing operations improved $30 million as compared to the same period last year.

Revenues for our Facilities Maintenance business was $638 million, up $67 million or 12% compared to $571 million from the second quarter of fiscal 2012. Adjusted EBITDA was $125 million, up $16 million or 15% versus $109 million in the comparable period a year ago. Overall, it was a strong quarter for this business.

New growth initiatives contributed approximately $36 million of the year-over-year increase. Net sales in the second quarter were also positively impacted by favorable market conditions in the multi-family and hospitality segments and by approximately $30 million from the acquisition of Peachtree in June, 2012.

Organic sales growth was 9.4% as compared to the second quarter of 2012. Revenues for our Waterworks business was $601 million, up $74 million or 14% compared to $527 million in the second quarter of 2012. Adjusted EBITDA was $50 million, up $11 million or 28% compared to $39 million in the same period last year.

Growth initiatives contributed approximately $52 million of the year-over-year sales increase. The December 2012 acquisition of Water Products contributed net sales of approximately $25 million. Organic sales growth was up 9.5% compared to the second quarter of 2012.

Revenue for our Power Solutions business was $456 million, up $16 million or 4% compared to $440 million in the same period prior year. Adjusted EBITDA was $18 million, down $2 million compared to $20 million in the second quarter of 2012.

While we continue to outperform markets the decrease in Power Solutions adjusted EBITDA was driven by an increase in selling, general and administrative expenses as compared to the same period last year due to the increased net sales and investments in growth initiatives including category management and marketing.

Revenues for our White Cap business was $336 million, up $29 million or 9% versus $307 million in the second quarter of 2012. Adjusted EBITDA was $24 million, up $6 million or 33% compared to $18 million in the same period last year. Growth initiatives contributed approximately $21 million of year-over-year sales increase.

From a CapEx perspective we continue to have low requirements and spent $32 million in the second quarter primarily for new locations, IT system enhancement and facilities maintenance. From a balance sheet perspective we have no material bank debt maturities until 2017, no note maturities until 2019 and we have significant liquidity of $946 million at the end of the second quarter of fiscal 2013.

The IPO net proceeds of approximately $1 billion were used to redeem all of the 10.5% senior subordinated notes saving approximately $100 million a year in interest expense.

We continue to evaluate our options to economically reduce our debt balance while at the same time focusing on adjusted EBITDA growth. During 2012 $516 million of customer relationship intangible assets became fully amortized and were removed from the balance sheet. Amortization expense which had been averaging approximately $244 million per year for the past three years is expected to decline to $135 million in fiscal 2013 $105 million in fiscal 2014 and $40 million in fiscal 2015.

We have favorable tax asset that includes significant gross federal net operating loss carry forwards of approximately $2.3 billion. That includes the second quarter of fiscal 2013 net losses. Our future cash tax payments could be significantly reduced by the utilization of NOL carry forwards.

We anticipate our fiscal 2013 revenue to be in the range of $8.550 billion and $8.750 billion; adjusted EBITDA in the range of $755 million and $775 million and adjusted net income per share in a range of $0.52 to $0.64.

Our fiscal 2013 adjusted net income per share range assumes a fully diluted weighted average share count of 172 million. As Joe described we are focused on controllable execution to drive profitable growth in excessive markets whatever market growth might be and we believe we are very well positioned for the long-term recovery in our industry.

I would like to turn the call back to Joe DeAngelo for closing remarks.

Joseph J. DeAngelo

Thanks, Ron. In summary we are very pleased with our performance this quarter as we delivered growth in excess of market across all of our businesses. Current market outlook for our second half of fiscal 2013 is below our original expectations. We’re continuing to enhance our competitive position in large highly fragmented markets that offer significant opportunities for growth.

We believe our markets have long-term potential and we are intensely focused on controllable execution that is delivering results. We’ve built a culture around always getting better and faster driven by best performance translation. We are in the very early innings of the game and we’re excited about our full potential.

Thanks again for your participation in today’s call, we’ll now open the call up for questions.

Question-and-Answer session

Operator

Thank you. (Operator Instructions). Our first question comes from Stephen Tusa of JPMorgan. Your line is now open.

C. Stephen Tusa Jr. - JPMorgan

Hi, good morning.

Joseph J. DeAngelo

Good morning.

C. Stephen Tusa Jr. - JPMorgan

Just a question around the linearity of the quarter and I guess how your sales trends were May and in June and July and then maybe just little bit of a comment on what you’re seeing so far or what you’ve seen in August?

Ronald J. Domanico

Hi, Steve it’s Ron Domanico. For the quarters you saw our sales were up 9.6%. In July they were up 8.9%. So we did some tail-off at the end of the quarter. And as Joe mentioned in his comments it was due to two factors, mainly a weaker market than we anticipated primarily in non-resi and municipal we had seen earlier in the year those markets up slightly and in the second quarter it looked like those markets were flat at best.

The second that Joe mentioned was the impact of weather. We had one of the wettest and coolest second quarters in record of history. What that impacted our outside businesses, specifically Waterworks, White Cap like a few others. And it also impacted our faculties' maintenance business and our HVAC side

In total we believe the second quarter was impacted negatively by about $40 million in weather and the impact I talked about on the market side was probably about $70 million, again the non-resi and the muni piece.

So together we believe the uncontrollable in the quarter were approximately $110 million top line translating to approximately plus or minus $10 million in EBITDA.

C. Stephen Tusa Jr. - JPMorgan

Okay and then and so for the second half of the year I guess the implied growth rate is I guess kind of in line. How did you think about positioning the second half of the year? And then obviously some of those things or maybe they don’t and may be they do what kind of normalization in those dynamics you expect for the second half or how do you position yourself for the second half?

Ronald J. Domanico

So Steve if you look at the way we’ve positioned the guidance range, if things carry forward kind of flush with those two big markets for us then we'd be in the midpoint of the range if they trend upward from that and we’ll be at the high end and obviously if they trend materially down then we'd be at the lower end of the range, I believe. I think right down the middle is the positions we are seeing at the moment.

C. Stephen Tusa Jr. - JPMorgan

And weather?

Ronald J. Domanico

And the weather we didn’t take into account plus or minus either way.

C. Stephen Tusa Jr. - JPMorgan

All right okay and then one last question. How was the outgrowth in the quarter from initiatives? I mean, anyway to talk about what happened with the spend and related benefits from that?

Joseph J. DeAngelo

Well the benefits they are $198 million that we increased. Ron went through the benefits by business. We had around $22 million of sales increased. So over 60% of our growth was growth that we went out there and earned. So that was controllable execution. And then if you look at our expense we didn’t change our expense trend trajectory.

And so what we went in to the year with what we’ve plan to spend for the quarters we continue to spend and our intend would be to do that going forward so stay all over the investment and the high return growth initiatives I gave you a few examples of those.

And then from our EBITDA contribution it was obviously a very materially contribution for the $26 million we were up, our controllable growth was $80 million of that.

C. Stephen Tusa Jr. - JPMorgan

Great, thanks for the detail, I appreciate it.

Operator

Thank you. Our next question comes from Hamzah Mazari of Credit Suisse. Your line is now open.

Hamzah Mazari - Credit Suisse

Good morning, thank you. The question is just on the balance sheet given some of these end markets are slower for you, how are you thinking about the balance between growth initiative spend and paying down debt? Is the strategy is still to build EBITDA to delever and how should we think about that?

Joseph J. DeAngelo

Hi Hamzah, the strategy hasn’t changed at all for two reasons. Number one we continue to have significant opportunities to invest in our high return initiatives and that investment level is continuing as it has in the past and will continue. The second part of that is as you are aware that the premium to take out the remaining debt on the balance sheet is quite expensive and we continue to evaluate that on an ongoing basis.

But for the short term the investment will be in the high return growth initiatives and we will de-lever through the growth in adjusted EBITDA. That being said the debt notes begin becoming callable in April of 2015 and as you are also aware as the term debt is callable immediately without penalty.

So we do have alternatives but right now the primary use of the cash will be reinvestment in these high return initiatives that have returns in excess of our weighted average currently and well on excess on our weighted average cost of capital.

Hamzah Mazari - Credit Suisse

Great and just a follow up question on the White Cap business. Could you may be give some color on how that business is different now and managed differently versus pre-recession? I mean if I look at your sales last year you did $1.1 billion, that's only 30% off from what you did in '06 it seems like, and the cycle really hasn't begun for you, so maybe if you could talk about how that business is different and then where exactly are you levered within that business to non-resi, because it seems like some of your publicly traded competitors saw somewhat of an acceleration in August but I realize that non-resi exposure differs among distributors, so maybe if you could touch on that please.

Joseph J. DeAngelo

Yeah, those are great questions. So this is -- our white cap business is completely re-tooled business. If you look at the leadership team that we have in place with John Stegeman leading that business. We have a combination of folks that were acquired with the White Cap businesses that are just rock stars, JJ Jackson, Bob Jacoby, Brian Bilderback and they are the core of understanding those business and markets.

Obviously John knows how coming from Ferguson and building that into a very large business, a growth business. And then we brought in world class talent that had background in other world class competitors in our peer group, Ian [Heller] and [Rob Tank] are examples of that. And so, what we have is a team that's configured to drive the non-res construction business in a completely different competitive direction than what we had in the past.

In the past we had, in the 2006 primarily, West Coast-based business. Now we have a homogeneous business that continues to grow up through across both coasts and across the country. And we have an execution team that of a world class category management, marketing and field execution. So it’s a very different business.

So we’ll catch our peak, as you observed, much, much sooner than the market peaks. And it is a non, non-residence, I mean that’s really to look at our residential business within White Cap the strength in the residential business where we have an engineered structural product in residential which happens to be on the West Coast. We have seismic activity down through Florida where you have hurricane activity and other Gulf Coast hurricane activity.

So think of that as a real non-res oriented business and that’s why you see bit more impact on this, but very different business operating model taken the investment what we had and being very additive to it from the best of what we saw in our peer group.

Hamzah Mazari - Credit Suisse

Okay, great. Thank you so much.

Joseph J. DeAngelo

Thank you.

Operator

Thank you. Our next question comes from David Manthey of Robert W. Baird. Your line is now open.

David Manthey – Robert W. Baird

Hi. Good morning everyone. First question is on the outlook, if you could talk qualitatively about it. If you could just talk about where in that outlook your expectations changed for the second half, are you still expecting some weakness in non-res and muni for example? And if you could talk about underlying growth in which business units do you see sort of accelerating or decelerating as you move through the end of this year excluding your growth initiatives?

Joseph J. DeAngelo

Yes. So, what we had in the outlook is we had the MRO business as steady and pace growth. And so you can see that in that business the vacancy rates are very low, the occupancy rates are very high in hospitality and we continue more of the same as just steady metered growth on that. And we’ll continue to outperform the market with that as we have in the past.

Also in the residential market we saw a little bit of sag in residential when there was some interest rate concern and we think that stabilized back. So we think that’s about 25% lower this year as we go forward.

And then what we did is we did take a flat outlook on non-res and on municipal, primarily given what we had seen in the July timeframe. We really saw some adjustments there kind of flowing through. What we believe will happen as we go forward is that the residential strength will carry the non-res strength forward but we believe that we’ll wait until 2014 to really be meaningful to us.

And we also believe that the municipal will have a longer gap than that and will probably be flattish to up a little next year and then have a strong recovery going into ‘15. So we believe we’re going to see some nice sequential overlapping growth for our business unit but primarily municipal and non-res where we took and aligned with more recent market forecast.

David Manthey – Robert W. Baird

Okay. Thanks Joe. And then in terms of inflation or deflation, are you seeing anything anywhere, if there is any expectation or movement in those items going forward that you could discuss relative to your outlook?

Joseph J. DeAngelo

Yeah, we’re not seeing anything meaningful relative to the outlook and we’re not expecting anything meaningful.

David Manthey – Robert W. Baird

Great, all right. Thank you.

Operator

Thank you. Our next question comes from Joseph Ritchie of Goldman Sachs. Your line is now open.

Joseph Ritchie – Goldman Sachs

Hi. Good morning everyone.

Joseph J. DeAngelo

Good morning, Joe.

Joseph Ritchie – Goldman Sachs

So maybe we can talk a little bit about since this is your first earnings call, you can talk a little bit about that decision making and the process in determining your guidance. And so maybe start there did you start bottoms up, was there, what are your thoughts relating to the market and initiatives if you could walk us through some of those discussions that’ll be helpful.

Ronald J. Domanico

Yeah so to establish the guidance range, we started with the market we just worked our way back. Sorry, it was a bottoms-up where we start with markets, we had assumptions going in the year those assumptions were modified as Joe said previously primarily in non-residential and muni taking those down.

We then look at the percentage of our business is driven by just the market growth. We then on top of that have share gains which are driven by our high return growth initiatives. So it’s a layered build Joe from the market on up.

Joseph J. DeAngelo

And it's consistent with our planning process, I am sorry I joked for a second there but I mean Joe, our standard planning practice is if you think to look at the market every quarter, being able to take a look at our higher return growth initiatives and the execution, layer those over the top and then put that forward as far as we have good visibility and that's the way we created the midpoint in the range and worked our way to the high point or lower point on the range.

Joseph Ritchie – Goldman Sachs

Hey and so it sounds like for the quarter specifically it sounds like the growth from the initiatives came through. But maybe then you can talk then a little bit about the visibility of the forecast particularly is it relates to the following year the ’14 and ’15?

I take a look at consensus expectation ahead of the quarter and folks were forecasting a 13 % growth, 12% growth and we were looking at back half growth, call it 2% to 7%. So just help us understand your confidence in getting to the longer term growth trajectory?

Ronald J. Domanico

So if I just take it market by market, I think for the MRO business that's rock solid they continue to have a solid growth trajectory, GDPS if you will and then we obviously outperformed those markets pretty heavily in the past several quarters, and so we intend to do that going forward.

If you look at the residential market I think you know there is a bandit going around that certainly the external forecast today stepped up pretty handedly up to like a $1 million in 2014 and up to $1.5 million in '15 and '16. Our view on that is that really should be 20% to 25% growth, so certainly that those huge steps we believe it’s going to be a more moderated and protracted and therefore lengthened residential.

If you look at the non-residual following that, if you look at the external market forecast for non-res going into next year they are right there between 8% to 14% from '14 it's up to 20% on '15, 16% in '16 and we believe that the high single digit is kind of the way we forecasted that going forward and that will follow.

And then I think the municipal as I said we think that’s kind of flattish to up a little next year and then I think there is significant opportunity for that to grow in '15 and beyond and so that's the way that we view it and that's consistent overly with what the external forecasts are associated with that.

I think the key to us has been in all cases we are driving our high return growth initiatives, we have outperformed the markets that we see and that we’ll consistently across the long range forecast year-over-year growth 300 basis points to 500 basis points greater than these markets that we participate in.

And we look this year unrolls and we have businesses that will grow on our forecast that are in the consensus between 300 basis point to 900 basis points growth market still. So I think it’s pretty well directed.

Short story is look we are in the very early inning of recovery, this recoveries are only choppy with the entire start but we think, we know where to track them, market-to-market we’ve seen Houston for example where res picked up and non-res followed and we see markets where res picking up like Miami but non-res hasn't fallen yet but it will and that's kind of think we also know that we are in the very early innings of our high returns growth initiatives.

So in all cases we believe that we are right in the strike zone of good recovery for us. I mean it’s very moderated sequentially for us and it's right on the strike down for our execution that we’ll continue to ramp up.

Joseph Ritchie – Goldman Sachs

Thank you appreciate color.

Operator

Thank you. Our next question comes from John Inch of Deutsche Bank. Your line is now open.

John Inch - Deutsche Bank

Thanks, good morning everyone. Morning, so and I want to go back to, firstly a clarification when you guys are talking non-resi and municipal markets being flat are you talking about sequentially or year-over-year because your guidance sort assumed 4% to 5% growth in the second half after doing 11%. So I am just, I am trying to understand just that, then obviously you have got this issue of compares right.

So that's year-over-year, so I think if you said 50% of the growth in the quarter so that would have been over six percentage points of growth was kind of driven by your own growth initiatives. Now you’re assuming that’s the kind of that second half growth really slows dramatically you’re effectively sort of suggesting that the market for you kind of on a blended basis doesn’t grow in that 4%,

I guess my question is kind of how much of the 4% to 5% is coming from your own growth initiatives versus what you think the market is assuming?

Ronald J. Domanico

John, it’s Ron. I just want to remind you that part of the complication we had in comparison with prior year for the second half has to do with two things. Number one in fiscal 2012 we had a 53rd week, we have that about every five years.

So the growth rate that you are referencing when you back that out of course that’s on an annualized basis 2% on half basis 4% difference. And so that will make it look much more lined up.

The second thing is that as I mentioned in my comments the new agreement with Crown Bolt and Home Depot that has a very large impact in the fourth quarter. We said in Q2 with $6 million year-to-date $12 million EBITDA impact, that number goes up to approximately it will be another $6 million in Q3 but in Q4 it’s going to be closer to $26 million, $27 million versus prior year because that was the quarter that you recognized the volume short fall which is going away for fiscal 2013.

But the main thing is just adjusting for that 53rd week in fiscal 2012 you’re going to get a growth rate that’s more in-line with Q2 on an organic basis.

John Inch - Deutsche Bank

Okay. So your assumption for muni and resi non-markets, so from kind of I am assuming like up low single digits first half to zero for the second half, is that a fair characterization?

Ronald J. Domanico

That’s correct.

John Inch - Deutsche Bank

Okay. And then just lastly what was the impact of price, was there any net realized price benefit on your top line and kind of how do you see the pricing environment because obviously some of your distributor peers are talking about more difficult pricing kind of as a backdrop are you seeing that?

Joseph J. DeAngelo

John it was a, we had two stories there, the first commodities were down specifically PVC, ductile iron, some copper that was offset by price realization and our non-commodity was the bulk of our portfolio. But net-net in the second quarter it was plus or minus zero for pricing excluding the commodity impact it would have been favorable somewhere 150 to 200 bips.

John Inch - Deutsche Bank

All right. Thank you very much.

Operator

Thank you. Our next question comes from Allison Poliniak of Wells Fargo. Your line is now open.

Allison Poliniak-Cusic – Wells Fargo

Hi, good morning guys. On the gross margin, obviously solid performance there, how sustainable is that number going forward, I know there is a lot of moving parts for that number?

Ronald J. Domanico

We think we’re very locked on our gross margin, as far as we grow we’ve got very rigorous schedules in terms of how we price in the marketplaces and also we’ve got very good category management strategy in terms of how do we compete with the growth every category from a gross margin standpoint. So we feel very good about that profile.

Allison Poliniak-Cusic – Wells Fargo

Okay. And then just some of your comments on the infrastructure side I think you talked about some changes in funding but it doesn’t sound like you are seeing, you are going to see any impact of that in terms of revenue in ’14 until ’15 in terms of market growth. Can you just expand on those comments there?

Joseph J. DeAngelo

Sure so if you look at the Water Infrastructure in the U.S. there a couple of builds -- that are hung up on less inflation but they are pretty good builds as the Water Infrastructure Finance and Innovation Act which is a direct [knock up] for transportation act they did in the late 90s, which just allows municipalities to be able to access funding at treasury rates and that would be one that would make many of these projects very, very manageable versus multi-year bonds to be able to do that.

There is also a bill out there called the Water Infrastructure Now act which allows the public private funding to be able to do that. And some states like Texas that do some of that themselves are really growing their water projects I mean there is a lot of need within the water registry there's six billion gallons a day that are lost, that a product that’s certainly no matter what you pay for water that’s one way you can get very economical price and we’ve seen those happening in Texas and Alabama, most recently with a couple of them.

But there are money constraints that we need a mechanism at the federal level or at the state levels where they control to be able to help make that happen. And we believe those will be coming and they are good builds that are proving self-relative to transportation. And the infrastructure gets more and more stressful and find a way to be able to do that. So that’s what I was specifically referring to.

Allison Poliniak-Cusic – Wells Fargo

Perfect, thank you.

Joseph J. DeAngelo

Welcome.

Operator

Thank you. Our next question comes from Dean Dray of Citi Research. Your line is now open.

Dean Dray - Citibank

Thank you. Good morning everyone. I know you’re not in the quarterly guidance business, but since this is the first -- third quarter that we all will be modeling, is there anything you’d want to call out in particular about comp issues, either year-over-year or sequential, the change in The Home Depot arrangement, anything that you provide for color would be helpful there.

Ronald J. Domanico

Dean, one thing I need to call out is the provision benefit for income taxes. And as you’re probably aware, in years when you switch between net income and net loss on a quarter-by-quarter basis, the IRC is very complicated. So that in situations like Q2, where we had net loss, we would actually record a tax provision so in expense.

Going forward in Q3, we anticipate net income and we’re actually going to have a tax benefit there somewhere in the area of $10 million favorability in Q3. And then, as Q4 is seasonally a smaller quarter as it always is historically, that will switch back to a net loss situation and the tax would actually be a provision of $14 million.

So understanding that will help with the adjusted net income calculation and also the adjusted net income per share calculation.

It -- the Crown Bolt growing up with The Home Depot described previously in Q3 versus prior year will be about a negative $6 million all the way through the P&L, so sales, gross margin, EBITDA. In Q4, it’s going to be around $26 million-$27 million, again $6 million on the pricing side, the balance having to do with the elimination of the shortfall payment in fiscal 2013.

Joseph J. DeAngelo

And then of course you have the 53rd week for the fourth quarter.

Ronald J. Domanico

That -- last year was $137 million in revenue, $15 million in EBITDA, plus or minus.

Dean Dray - Citibank

Great, that’s helpful. And then from my follow-up, we’ve had a lot of discussion here about expectations that a municipal upturn might get pushed out to 2015. But as it pertains to Waterworks, I just want to make sure we’ve calibrated this correctly. How much of waterworks is actually municipal spending? And then, within that how much is project-based as a new project, new project funding versus MRO, which we might consider more break and fix.

My sense is that the break and fix, the MRO side of waterworks, municipal spending is much higher.

Joseph J. DeAngelo

Yeah, I think when you look at it it's about half of our business and it’s probably a break, we’re not really precise on break-out half in half relative to what the municipal break and what's the project oriented, which you know is obviously very lumpy. The one point I’d make on Waterworks is that Waterworks obviously has peaked with a lot of residential content and we believe we see the emerging signs of that content coming forth in our 2014 execution as these developments read off. And this offset is helpful for us.

Dean Dray - Citibank

Great, thank you.

Operator

Thank you. Our next question comes from Matt McCall of BB&T Capital Markets. Your line is now open.

Matthew S. McCall – BB&T Capital Markets

Thanks, good morning everybody.

Joseph J. DeAngelo

Hi, Matt.

Matthew S. McCall – BB&T Capital Markets

So on the initiatives, may be, again since this is the first call and I know Joe, you hit some of the areas of focus. But maybe review the specifics of some of the high growth initiative spending and remind us what is in the guidance and then the assumed impact on your margins on the year-over-year basis. And then following, I guess as a follow up any tweaks that you’ve made since we’ve last had an update on some of those initiatives?

Joseph J. DeAngelo

Yeah, I say relative to the high return growth initiatives we really have tweaked it a lot, so there is no material differences to what we ended the year with and what we expect to spend and get out of either share of wallet with existing customers, new products and services, new customer acquisition and new locations. So we have moved things around materially based on what we’ve seen.

I think as we previously discussed the share of wallet initiatives and new products and services are the highest payback initiatives and the ones that we have the most investment in, they drive a large portion of the increased sales and almost all of the increased EBITDA. The new customers and the new locations typically tend to be flat, may be a little bit dilutive when you start them out and they kind of buy their way into it.

And so when you think about it is we consistently go into the year with an SG&A profile or some capital profile and a CapEx profile that we are going to execute relative to our high return growth initiatives. We review those in detail every month to make sure that they are tracking the way we expect to do and do a sharing process across the company to drive acceleration and so we get traction and then hit those bumps and then we are very focused on how much EBITDA accretion and sales growth accretion that we get out of those and make sure that we get the pay back that we’ve mentioned.

So I gave a few examples but in real simple term share wallet is all about tracking net few sales counts to come to the team and driving a higher concentration of the efforts in the sales accounts we have so they work on those accounts and they had a great more and driving the tools associated would be able to make that happen we are running that plan in all the businesses.

The new products and services typically for the products for the businesses that we have a catalog cycle for like facilities maintenance and now White Cap we’ve launched new products to be coincident with that catalog cycle for White Cap in this case, we launched a catalog cycle in the spring, we are also in the process of launching one in the fall.

I did mention we just launched the safety product catalog as a specific in the high growth high return area for us. And then for the new location we tend to lose in both in terms of greenfields and in terms of infields. So we take a very specific look at each market to determine do we have an infield opportunity to be able to make sure we capture more market share making easier for our customers to able to do business with us and lower our logistics cost.

And then we also have in that format we do expansions of distribution centers for facilities and maintenance or net new distribution centers like we just did in Burlington and Alabama and then greenfield activity is obviously net new like we did both for White Cap and that couple of examples we gave relative to the growth that we are seeing in that market and participation were the result of us standing up a new team and new branches up in that area.

Matthew S. McCall – BB&T Capital Markets

Thank you Joe and then Rob maybe one for you. I think you said pricing was a 200 basis point positive in the quarter. I think that if I heard that right were pricing trends in line and then what kind of pricing are you assuming in your guidance? I apologize if I missed it.

Ronald J. Domanico

Yeah Matt that was true for the non-commodity items. What I said was it was totally offset by the reduction in commodity items in the quarter specifically PVC, ductile iron and little bit on the tougher side. So net for pricing in Q2 was zero, it was flat.

Matthew S. McCall – BB&T Capital Markets

Okay and then what’s assumed in the guidance?

Ronald J. Domanico

Flat, I mean we will continue to as Joe mentioned as the pricing opportunities come often with the catalog cycles and but right now as the assumptions conservative going out forward that we’d be able to maintain what we’ve achieved year-to-date.

Matthew S. McCall – BB&T Capital Markets

Okay thank you.

Operator

Thank you our next question comes from Sam Darkatsh of Raymond James. Your line is open.

Unidentified Analyst

Good morning, this is Josh filling in for Sam. Thanks for taking my question. I wanted to dig into the growth initiatives a little bit more, could you quantify what the spending was on those initiatives in the quarter?

Ronald J. Domanico

So our SG&A for the quarter for the growth initiatives was $20 million and that was primarily half of that was in our share of wallets, sales from existing customers and then spread between the other ones.

Unidentified Analyst

Thank you. And could you talk about what you think that will shape for the balance of the year and how we should think about operating leverage, ex the growth initiatives?

Ronald J. Domanico

The spending on the growth initiatives is project by project but it's going to be pretty much inline on a quarterly basis going forward. We haven’t given any guidance other than that. Operating leverage as we talked previously our gross margin is approximately 29%, variable SG&A is 11%.

So the growth in leverage is a pull through of that 18% differential. Now that can swing up or down by the timing of these high return growth initiatives but again you are also need to factor in what we talked about previously on the 53rd week in the Crown Bolt agreement if we’re doing some modeling, especially in Q4.

Unidentified Analyst

Appreciate the color.

Operator

Thank you. Our last question comes from Ryan Merkel of William Blair. Your line is now open.

Ryan Merkel - William Blair & Company, LLC

Thanks for fitting me in, really appreciate it. So my first question I had is just little more product detail you called out HVAC as soft in the quarter, I was just wondering what the growth rate was there and then was there any other product categories that you had called out as been soft or weak?

Joseph J. DeAngelo

Yeah I wouldn’t call out anything except for HVAC and that was wholly dependent on the when the weather hits, certainly, the hit beyond the quarter was in terms of, that was the one that we had the impact on the category.

Ryan Merkel - William Blair & Company, LLC

Okay. And then just lastly the utilities market outlook, it sounds like the CapEx backdrop is getting a bit more cautious there, could you comment on what you’re expecting there over the next call it, six to nine months?

Ronald J. Domanico

Yeah I think for our utilities market it’s going to be a little bit different what the market's seeing and what we will see, it’s going to be a little bit different. We captured a number of these larger transmission projects and I think the CapEx for the utilities in total is kind of tempering itself and that but then this kind of net new for us, we will be seeing some decent growth in that, but not large enough to be material to what we’re driving as we go through.

But for our utilities market if you look at the base electrical consumption out there that is down significantly since the last prior quarters. So if you look at four-five quarters back the electrical consumption billions of kilowatts per day was 10.6, 10.7 and now its tracking in the 9.6, 9.5 range.

And so we do see that as driving a lower need for formation since we’re not putting up these lines, so the automation side we think it's coming down a little bit on the CapEx side we believe that we’re participating more probably in what leveling off of execution.

Ryan Merkel - William Blair & Company, LLC

Thanks for the color.

Operator

Thank you. And at this time I would like to turn the conference over back to our management for any closing comments.

Joseph J. DeAngelo

Well great. Thank you. Well in closing I would say we are in very early days of capturing our full potential. We are in differentiated large markets with very attractive long-term characteristics. And we are intensely focused on controllable execution to grow faster than our markets. We have very simple repeatable growth strategies that you will see we’ll continue to invest in. And that will drive profitable growth as we go forward. Thank you.

Operator

Thank you for participating in today’s HD Supply’s second quarter earnings conference call. This call will be available for replay beginning at 11:00 AM Eastern today through 11:59 PM Eastern on September 17, 2013. The conference ID number for the replay is 23111599. The number to dial in for the replay is 1855-859-2056 or 404-537-3406. Thank you for your participation. You may all disconnect.

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