HD Supply Holdings Inc. (HDS) Q2 2020 Earnings Call Transcript

HD Supply Holdings Inc. (NASDAQ: HDS) Q2 2020 earnings call dated Sep. 09, 2020

Corporate Participants:

Charlotte McLaughlin — Investor Relations

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Bradley Paulsen — President, HD Supply Facilities Maintenance

Evan J. Levitt — Senior Vice President, Chief Financial Officer and Chief Administrative Officer, HD Supply

Analysts:

Nigel Coe — Wolfe Research, LLC — Analyst

Keith Hughes — Truist Financial — Analyst

Hamzah Mazari — Jefferies — Analyst

Joao Carvalho — Barclays — Analyst

Deane Dray — RBC Capital Markets — Analyst

David Manthey — Robert W. Baird — Analyst

Ryan Merkel — William Blair — Analyst

Chris Dankert — Longbow Research — Analyst

Andrew Obin — Bank of America Merrill Lynch — Analyst

Michael McGinn — Wells Fargo Securities — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the HD Supply Second Quarter Earnings Conference Call. [Operator Instructions]. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Ms. Charlotte McLaughlin, Investor Relations. Thank you. Please go ahead.

Charlotte McLaughlin — Investor Relations

Thank you, Jimmy. Good morning, ladies and gentlemen and welcome to the HD Supply Holdings 2020 second quarter earnings call. As a reminder, some of our comments today maybe forward-looking statements based on management’s beliefs and assumptions and information currently available to management at this time. These beliefs are subject to known and unknown risks and uncertainties, many of which maybe beyond our control, including those detailed in our periodic SEC filings.

Please note that the Company’s actual results may differ materially from those anticipated and we take no obligation to update these statements. Reconciliations of certain non-GAAP financial metrics with their corresponding GAAP measures are available at the end of our slide presentation and in our 2020 second quarter earnings release, which is available on our IR website at www.hdsupply.com.

Joe DeAngelo, our CEO will lead today’s call with Brad Paulsen, President of Facilities Maintenance providing further color around market trends. Evan Levitt, our CFO will provide additional information on our recent financial performance. There will be an opportunity for Q&A. For those participating, please limit your remarks to one question and one follow-up if necessary. Thank you for your continued interest in HD Supply.

And with that, I will now turn the call over to Joe DeAngelo.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Well, thank you, Charlotte. Good morning, everyone. Thank you for joining us today for our second quarter 2020 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.

Turning to Page 3, I will begin this morning by offering our sympathies and support to everyone affected by Hurricane Laura in Louisiana and Texas and those who continue to be affected by the COVID-19 pandemic.

HD Supply will continue to lead by living our unwavering commitment to protection and safety of our associates and their families. And I want to thank the entire team, especially our front-line drivers and branch and distribution center teams who’ve risen to the daily challenges and safely operate in this time of adversity to continue to help our customers and local communities thrive. I’m always amazed and proud of their dedication and spirit.

Our second quarter performance has dramatically improved from the end of the first quarter. Our Facilities Maintenance team has done an incredible job by anticipating the needs of our customers as they move to safely restart operations. Our merchandising, sales and marketing teams have led the way in training and communication of how to reopen with confidence.

We have provided the critical products we believe are needed to operate safe, living and working environments, including disinfectants, sanitizers, personal protective equipment and touchless products. Our teams continue to deliver on our customer promise despite the difficulty, in sourcing COVID-19 related product, durable goods shortages and transportation and shipping delays. Our performance improved throughout the second quarter building on the momentum that we reported back in June.

Sales while down 4.4% year-over-year for the quarter improved sequentially each month of the quarter for both businesses. We are encouraged by our second quarter and August performance and we are confident they we’re earning market share, performing better than our underlying markets across all of our sales verticals.

We continue to generate strong free cash flow of $190 million during the quarter. We paid down our revolving credit facility in its entirety and we ended the quarter with a combined liquidity of nearly $1 billion, an increase of $198 million from the end of the first quarter of fiscal 2020. Brad and Evan will provide more color around our second quarter performance later on the call.

I would now like to turn to the second half of the year. Within our Facilities Maintenance business, our Multifamily, health care and institutional verticals, all delivered positive sales growth during the month of August, the first month of our fiscal third quarter. And our hospitality business was down approximately 14% compared with hospitality industry trends down close to 50%.

We are confident that we’re earning share across our sales verticals as our customers search for the most reliable vendor partner that can help them keep business running and keep their associates and their customers safe. We have every expectation to maintain and expand the market share gains we have realized thus far in 2020, and we expect that our end markets will continue to improve throughout the remainder of the year.

However, we recognize that there may be additional volatility as COVID-19 continues to be addressed. Due to the uncertainty, we will continue to withhold guidance for the third quarter and full year of fiscal 2020. In June, we spoke about being on track with the planned separation of our businesses into two separately traded public companies.

In fact, we were targeting a third quarter 2020 spend of Construction & Industrial business when we were approached by Clayton, Dubilier & Rice regarding their interest in acquiring the business. After negotiation and discussion with our Board of Directors, we determined that the sale of the company will be in the best interest of our shareholders and associates. The sales process progressed rapidly and on August 11th, we announced the sale of our Construction & Industrial business for a purchase price of $2.9 billion.

We expect net proceeds from the transaction after taxes and transaction costs to approximate $2.5 billion. Proceeds will be used to repurchase shares of HD Supply, pay down existing debt, pursue our M&A strategy within the MRO living space market and continue to invest organically in our business with near-term capital expenditures estimated at 2% of annual revenues. We are incredibly excited about the sale. The speed with which we were able to act allows us to focus all of our attention on accelerating the growth of our Facilities Maintenance business and further differentiating the customer experience we provide.

With the Construction & Industrial sale expected to close in October, I want to thank John Stegeman and his entire team for the leadership and service, HD Supply shareholders, associates and customers. Over the past ten years, our Construction & Industrial business’ sales have nearly tripled, and adjusted EBITDA has grown nearly 30-fold.

We believe that this transaction will allow the Construction & Industrial team to continue to profitably grow their business, and we wish them the best of luck. I will conclude by highlighting our team’s continued commitment to our communities. During the third quarter, we donated an additional $6 million of inventory to those in need including organizations providing shelter for victims of domestic violence and those in need of transitional or affordable housing.

We are proud of our HD Supply associates’ dedication giving best during uncertain times. I will now turn the call over to Brad Paulsen who will provide an update on our Facilities Maintenance business.

Bradley Paulsen — President, HD Supply Facilities Maintenance

Thank you, Joe and good morning. I’d like to start by thanking our team of nearly 6,000 associates for their hard work and commitment to delivering incredible service to our customers across the United States and Canada. We continue to prioritize the health and safety of our associates and to date have had no meaningful disruptions to any of our distribution centers, call centers or leadership development center. This has allowed our teams to be there for our customers and provide the level of support they require to confidently reopen and safely operate their living space properties.

Turning to Page 4, we saw a steady improvement in our performance throughout the second quarter despite continued pressure in our end markets. Our sales recovery took a significant step forward in August, the first month of our fiscal third quarter by delivering year over year preliminary sales growth. The focus for our customers during the second quarter was the safe reopening and operating of their living space properties. This focus led to continued increases in demand for safety in the infection control product along with essential MRO items like appliances, HVAC and water heaters.

Our broad product assortment, competitive pricing and excellent sales and service execution were key drivers to each of these categories growing faster than the Company average. We continue to be encouraged by the initiation of deferred maintenance by our customers but have seen demand for less critical MRO items such as hardware, electrical and lighting recovered slower than the previously mentioned categories as properties are executing their highest priority maintenance needs first.

We do believe this is a short term trend and expect all of our MRO categories will return to normal demand levels as properties execute more of their deferred maintenance backlog. Our property improvement team made solid gains throughout the quarter despite operating in an environment where unit turn demand was down significantly year over year. We believe the property improvement market will remain below prior year levels for the remainder of 2020 and into 2021 as they continued this moderate recovery.

I was especially proud of the responsiveness and the execution speed our team demonstrated to provide the support our customers required during the quarter. Our category management and supply chain teams partnered closely with our supplier partners across the globe to ensure product availability on the key products needed to reopen living space facilities.

Our marketing and customer training groups responded quickly to the challenges facing our customers and developed helpful online tools and virtual training to provide critical know how to help with the safe operations of their facilities. And finally, our sales team and drivers provided incredible on site support to ensure each property had what they needed to provide a clean and safe living environment to its residents. These efforts along with many others across our organization resulted in our team recording one of the highest ever Voice of the Customer scores during the quarter.

Moving on to Page 5, I will now discuss our performance across our four sales verticals. Our multifamily business saw a significant performance improvement throughout the second quarter with July and August delivering positive year over year sales growth despite facing the headwinds associated with lower summer unit turn demand.

This vertical’s recovery was driven by consistent year over year order growth and strong sales execution that accelerated our average order value improvement as deferred maintenance was gradually initiated. We continue to be encouraged with the rate at which properties welcome our sales team back on site and residents becomes more comfortable with maintenance professionals entering their living space.

The hospitality industry continues to show signs of improvement with the latest year-over-year growth in revenue per available room numbers reading better than minus 50% for the first time since March.

Our hospitality team has done an outstanding job providing best-in-class sales support and service to our customers, which has resulted in clear market share gains. We have every intention of retaining this customer share and are fully committed to supporting our hospitality customers recovery, which we think will extend well into 2021. We are also excited to announce our newest supplier partnership with Ecolab, the global leader in water, hygiene and infection prevention solutions and services.

This partnership will position our team to better provide the products and solutions our hospitality and healthcare customers supplier [Phonetic] to clean and sanitize their properties. Our health team delivered a solid quarter despite seeing some of the lowest all-time resident occupancy rates in senior care living facilities. I applaud our team for pivoting quickly in the COVID environment and providing the service and solutions needed by their customers.

This quarter we have also shared the results of our institutional vertical, which is now in similar size to health care in terms of sales. Our institutional vertical primarily serves military housing, housing authority and student housing customers who have similar MRO needs as our multi-family vertical. This team has performed incredibly well throughout the COVID crisis delivering approximately 2% growth during the second quarter and 14% in August.

It is clear that our value proposition is a good fit for this customer segment, and we look forward to expanding our presence in the sales vertical. I’m very encouraged by our improved results through August. Our team has made tremendous progress and it remains fully committed to supporting our customers and our communities during this recovery.

With that, I will now hand the call over to Evan.

Evan J. Levitt — Senior Vice President, Chief Financial Officer and Chief Administrative Officer, HD Supply

Thank you, Brad and good morning everyone. I’d like to start by addressing our announcement made on August 11th in regards to the sale of our Construction & Industrial business. We currently expect the sale to close by the end of October subject to regulatory approval. The results of our Construction & Industrial business will be reflected as a discontinued operation beginning in the third quarter of 2020 including the month of August.

We are excited about the ability to completely focus on our Facilities Maintenance business which has always been our most profitable and highest return business. We expect to use the estimated $2.5 billion net after tax and transaction cost proceeds from the sale of our Construction & Industrial business to pay down debt, fund M&A opportunities within the MRO living space market and to repurchase the stock of HD Supply, which we continue to believe is attractively priced.

Turning to our second quarter results on page 6, net sales decreased $72 million or 4.4% to $1,552 million in the second quarter of fiscal 2020 as compared to $1,624 million in the second quarter of fiscal 2019. Gross profit decreased $37 million or 5.8% to $596 million for the second quarter of fiscal 2020 as compared to $633 million for the second quarter of fiscal 2019.

Gross profit was 38.4% of net sales for the second quarter of fiscal 2020, a decrease of approximately 60 basis points from 39% for the second quarter of fiscal 2019. I will discuss the change in gross margin during the business unit discussion. Adjusted EBITDA decreased $6 million or 2.5% to $238 million for the second quarter of fiscal 2020 as compared to $244 million for the second quarter of fiscal 2019.

Adjusted EBITDA was 15.3% of net sales for the second quarter of fiscal 2020, an increase of approximately 30 basis points from 15% in the second quarter of fiscal 2019. On Page 7, I will discuss the specific performance of our individual business units in more detail. Net sales for our Facilities Maintenance business were $761 million during the second quarter of fiscal 2020 as compared to $830 million for the second quarter of fiscal 2019.

The sales decline was 8.3% as compared to the second quarter of fiscal 2019. Adjusted EBITDA decreased $17 million or 11.4% to $132 million for the second quarter of fiscal 2020 as compared to $149 million for the second quarter of fiscal 2019. Adjusted EBITDA was 17.3% of net sales for the second quarter of fiscal 2020, down approximately 70 basis points from 18% for the second quarter of fiscal 2019.

Facilities Maintenance gross margin declined by 120 basis points for the second quarter of fiscal 2019. The decline in gross margin rate was primarily a result of a shift in product mix with an unfavorable impact of approximately 90 basis points and to a lesser extent, a highly competitive environment with customers carefully monitoring maintenance budgets.

Our improving sales performance is being led by appliances, HVAC, janitorial and safety categories, currently generating strong double-digit growth. These product categories are in high demand and we are working tirelessly to ensure adequate supply to support our customers reopening activities.

However, all four of these product categories have margins lower than the Company average. The more traditional break-fix MRO categories of electrical, lighting, hardware, faucets and window coverings continue to see a decline in year-over-year demand. The maintenance involving these items is deemed less critical in the current environment and is being deferred as customers tighten their budgets and limit tenant interactions.

We continue to believe that these categories will recover, albeit at a slower pace as deferred maintenance is worked and as unit turns improve. Moving to the Construction & Industrial business, net sales for our Construction & Industrial business were $793 million during the second quarter of fiscal 2020 as compared to $795 million for the second quarter of fiscal 2019.

The sales decline in the second quarter of fiscal 2020 was 0.3% as compared to the second quarter of fiscal 2019. Adjusted EBITDA increased $11 million or 11.6% to $106 million for the second quarter of fiscal 2020 as compared to $95 million for the second quarter of fiscal 2019, reflecting both enhancement of gross margin rate and disciplined cost control.

Adjusted EBITDA was 13.4% of net sales for the second quarter of fiscal 2020, up approximately 150 basis points from 11.9% for the second quarter of fiscal 2019. During the second quarter of fiscal 2020, Construction & Industrial’s gross margins improved approximately 30 basis points as compared to the second quarter of fiscal 2019.

Gross margin was benefited by favorable year-over-year rebar margins and the mix of product categories, including the sale of safety products, which are higher margin category for our Construction & Industrial business. Turning to Page 8, in the 12 months, we generated — in the last 12 months, we generated $645 million of free cash flow, an increase of 15% year-over-year.

In the second quarter of 2020, we generated $190 million in free cash flow. We invested $12 million in capital expenditures in the second quarter of fiscal 2020, and we continue to estimate our ongoing annual capital expenditure requirements to be approximately 2% of annual sales although our expectation for fiscal 2020 is to spend less in light of the COVID environment.

In the second quarter, we paid cash income taxes of around $36 million. This included payments made in July for the first and second quarters of 2020 as the CARES Act provided for a deferral of the estimated first quarter income tax payment until July. Our effective tax rate for the second quarter was approximately 25%. We expect that our ongoing effective tax rate will be approximately 26%.

As of August 2nd, 2020, HD Supply’s combined liquidity of $995 million, was comprised of $71 million in cash and cash equivalents and $924 million of additional available borrowings.

During the second quarter, we repaid all outstanding borrowings on our revolving line of credit. We have increased our liquidity by $367 million from the start of the year entirely through operations, demonstrating our ability to generate strong cash flow even in a challenging economic environment.

We have not entered into any new or expanded any existing credit facilities during fiscal 2020. Our net debt to adjusted EBITDA leverage is 2.1 times. We did not purchase any shares in the second quarter under our most recently authorized $500 million share repurchase program. The full $500 million authorization remains available for us to execute.

As I stated, we intend to use a significant portion of the cash proceeds from the sale of our Construction & Industrial business for share repurchase activity. Our strong liquidity of nearly $1 billion and current repurchase authorization enables us to begin repurchasing shares prior to the close of the construction and industrial sales.

On Page 9, we provide second quarter 2020 monthly net sales trend performance as well as the 2019 comparable. In May of 2020, we delivered sales of $431 million, a decrease in average daily sales of approximately 7.3% versus May of 2019. In June of 2020, we delivered sales of $495 million, a decrease in average daily sales of approximately 4.8% versus June of 2019.

In July of 2020, we delivered sales of $626 million, a decrease in average daily sales of approximately 2% versus July of 2019. There were 19 selling days in May, 20 selling days in June and 24 selling days in July of fiscal 2020 and fiscal 2019. August 2020, which ended August 30th, was the first month of our fiscal third quarter 2020 and we have provided our preliminary sales results. We will not provide information on August results beyond sales.

Combined, Preliminary Net sales in August of 2020 were approximately $518 million, which represents a year-over-year average daily sales decline of approximately 0.7%. Preliminary August year-over-year average daily net sales by business segment was an approximately 1.1% growth in Facilities Maintenance and an approximately 2.5% decline in Construction & Industrial. There were 20 selling days in both August 2020 and August 2019.

We have seen a steady improvement in our end markets. However, as Brad pointed out, we expect a relatively slow improvement in the hospitality and property improvement markets throughout the remainder of the year and into 2021. We will continue to strive for outgrowth in all of our end markets and we intend to retain for the long-term market share gains earned during the pandemic.

However, at this time, we will not be providing formal guidance. We believe there is still too many uncertainties as a result of the COVID-19 environment. We will continue to share what we see in our business and in our markets, but we will not provide specific guidance until we see more stability.

Looking ahead, as a simpler one line of business Company, we are committed to enhancing our industry-leading return on invested capital and free cash flow generation, as well as demonstrating consistent sales and earnings growth. Our number one priority continues to be the health and safety of our associates and their families, as well as our customers. We will continue to support our customers and communities by providing the critical products and services needed to maintain their facilities, care for their residents and operate and maintain safe job sites and work environments.

I’d like to thank you for your continued interest in HD Supply, and I’d now like to turn the call over to the operator for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions]. Our first question comes from Nigel Coe with Wolfe Research. Your line is now open.

Nigel Coe — Wolfe Research, LLC — Analyst

Thanks, good morning. Recognizing there’s still a lot of uncertainties and you know, you obviously have no guidance. But the improvement in FM sales in July, August back to growth is very encouraging. Is there anything kind of unsustainable within those results that might kind of sales back into negative territory in the back half of the year? And I’m thinking here but maybe hospitality could pull back from where it was in August. And perhaps a safety surge will kind of help in building [Phonetic] and get prepared, you know, is there anything that leads you to believe that maybe that’s — that positive growth might not be sustained through the back half of the year?

Bradley Paulsen — President, HD Supply Facilities Maintenance

Nigel, good morning, this is Brad. When we look back in the quarter, our kind of success equations was pretty straightforward and the fact that we really focus on providing the service that our customers are going to require there. It was probably the most challenging time they’ve seen in the last decade, at least. And we never pulled back on our service or sales support until we had a relatively very, very strong product availability and incredibly consistent next day execution, and positioned ourselves as, what I call the safest, most dependable option in our space.

And because of that, we were able to generate positive order growth through the quarter. Which to me is the signal that we’re picking up customer share. And then what we also saw is the end market starting to improve. They didn’t get all the way back to great, but they started to improve, and our customers started tackling some of that deferred maintenance.

So between the order growth that we saw, the really strong sales execution to help accelerate that Average Order Value Recovery, it was easy to see where it is, easy to see why we saw that improvements through the course of the quarter. Now, when we look at the rest of the year, we’re certainly moving forward in a very cautious manner. Some of the things that we’re watching from a macro perspective, and you have a couple of them occupancy and hospitality and healthcare especially hospitality post Labor Day, I think everybody has seen there has been a nice improvement with summer travel, but now that kids are back in school, we’ll see how that plays out.

And then, healthcare, you know, healthcare continues to have pretty serious headwinds as far as people leaving senior care living facilities. We feel really good overall, though, I would tell you about our ability to drive growth in our break-fix business. I mean, it’s generally about 80% of our sales and the team — all of our non-hospitality verticals has really done an exceptional job again in a really, really tough environment.

You know, the last headwind that I would call out is property improvement as I shared in my prepared remarks, and definitely feel like that’s going to continue to be down year-over-year. In our last call, I said we’ve lost a lot of the kind of prep windows as far as getting on site, bidding out the jobs, and now we’re at a point where there’s just less people moving. So less opportunity unit turns and that’s over 10% of our business, that’s going to be another headwind that we’re going to have to deal with.

But I’d tell you, overall, I couldn’t be more proud of the team’s execution in support of our customers during the past quarter.

Nigel Coe — Wolfe Research, LLC — Analyst

Great. Well, thanks Brad that’s a very helpful information. And then my follow-on question is really around the FM on a go-forward basis. I’m thinking about the leverage, right now you’re 2.1 times, your range is 2.2 times to 3 times. FM is a higher-margin business, it’s got outstanding returns on capital. How are you thinking about the leverage ratio for FM on a go-forward basis?

Evan J. Levitt — Senior Vice President, Chief Financial Officer and Chief Administrative Officer, HD Supply

Yes. So Nigel, the 2 times to 3 times as you know is a net debt to EBITDA ratio. Obviously with the sale of construction and industrial, we will receive quite a bit of cash over the coming months. And so, on a net debt to EBITDA basis, we will be well below the two to three times until we can deploy that cash. We outlined on the call that we expected to deploy that cash. We will pay down some debt, some gross debt, and then we’ll also look to fund our M&A opportunities and repurchase stock. A good portion of the cash proceeds will be used to repurchase stock and that will be over time.

So we’ll be below or at that — the bottom end of that two to three times net debt to EBITDA for a period of time here. Looking longer term, we still think that 2 times to 3 times is about the right range where we want to be. Certainly we are comfortable at the higher end of two to three times with the predictable cash flow of our Facilities Maintenance business as evidenced by the cash flow we were able to generate in the first half of this year. But we also are not afraid to keep some dry powder to remain opportunistic for opportunities that present themselves or that we want to pursue.

Nigel Coe — Wolfe Research, LLC — Analyst

Okay. Thanks, Evan.

Operator

Thank you. And our next question comes from Keith Hughes with Truist. Your line is now open.

Keith Hughes — Truist Financial — Analyst

Thank you. There has been a lot of on again, off again talk on stimulus for consumers. It really impacts the lower end consumers, which will be more in your multifamily occupancy. Are you hearing anymore commentary from your multifamily customers about rising delinquency on payments, that impact on spending? Any sort of big picture view on that market you could give would be helpful?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

So Keith, we’ve certainly seen a slight uptick in the timeliness of rent payments that’s been well published throughout the second quarter and then in August, in particular the most recent data that we’ve got available. Rent recollections were down about 200 basis points year over year. So we continue to monitor this. You’re correct that much of the stimulus that was put in place by the Federal government in the first half has run its course. There is some additional unemployment benefits.

It varies state-by-state at this point and there is on again off again talks with Washington, so we don’t know whether anything will come out of that. We do monitor it very closely. This is likely a headwind that we’re seeing in the property improvement business that Brad previously mentioned. Certainly, customers will tighten their maintenance budgets and look at discretionary spend which property improvement is a discretionary spend in that type of environment.

That being said, we’ve been relatively pleased thus far with the reaction of our customers, as well as the quality of our own receivable portfolio. As you know in the first quarter, we took a charge to increase the conservativeness of our reserve for bad debt. We think that was still appropriate and we still hold on to that additional reserve. But to this point we’ve been very pleased with the quality of that portfolio, but we’re monitoring it just like you are as you indicated that we could see some additional headwinds in the back half of the year with less government stimulus.

Bradley Paulsen — President, HD Supply Facilities Maintenance

You know, the other thing that I would add to that, I mean, this has been a day to day, week to week, month to month conversation with our customers really since the onset of COVID. And, we’re at a point now where maintenance needs to be done. I think Evan’s right. I mean, people are going to be very cautious to see what’s around the corner. But this work needs to be done and when we talk break-fix versus unit turns, we’re very optimistic about what break-fix will look like going forward. And I think the next few months again, there is going to be a week-to-week review, but in all the customer conversations I have been having, and I have been having quite a few, the way that they have been framing it, yes, it’s a point of caution, but it’s actually turning out much better than they thought it would three or four months ago. So it’s still full steam ahead. We’ll watch it closely and continue to provide that service to the customers as they execute that deferred maintenance.

Keith Hughes — Truist Financial — Analyst

Okay. Thank you.

Operator

Thank you. Our next question comes from Hamzah Mazari with Jefferies. Your line is now open.

Hamzah Mazari — Jefferies — Analyst

Hey, good morning. Thank you. You had referenced using some of the proceeds from C&I for M&A in the FM business. Are there any verticals outside of the ones that you’re in today that are attractive, that may have synergies with your existing end markets? And maybe touch on also how valuations look like for assets as well?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Yeah. Evan and I will — we’ll tag team this question. I would say in our core markets that we’re in, today we operate in very fragmented markets. We view that as a great opportunity for us to be active in M&A going forward. We feel like we’re the natural acquirer given the skills that we have and the customer relationships that were in place. And I would say that description applies to all of the verticals that we operate in today. We feel like there is a number of different fantastic opportunities in front of us. As far as new channels, Evan, I will throw that your way so you can discuss that.

Evan J. Levitt — Senior Vice President, Chief Financial Officer and Chief Administrative Officer, HD Supply

Yes. So certainly, Hamzah, we’re looking at acquisition opportunities within our existing channels, but we do look for opportunities to enhance our position not necessarily in new channels, but with new products, or new service offerings to our existing customers to better serve them. We also look for opportunities where we can become more integrated with our customers’ workflow, so that we can be more relevant to them.

So it is a wide variety of the type of acquisitions that we may be looking for. And in all cases we look for value, so you asked about value. In general, we would look to do an acquisition for a multiple lower than that which we trade at, and then look to pay down that multiple further through synergies. So we’re going to buy a company that we think we can add value to and improve, either through acceleration in growth, reduction in cost, or acceleration in or enhancement of margin.

Then we also look for reverse synergies where is there an acquisition target that does something particularly well that either we don’t do today or don’t do as well as we would like that we can learn from and expand that know how across the balance of our business. So hopefully that gives you a little bit of color about — around the type of acquisitions that we’re looking for.

Hamzah Mazari — Jefferies — Analyst

That is very helpful and just my follow up question just on FM. Could you maybe comment on how much urban exposure you have within that segment? I know you generally stay away from high rise buildings, but I would have thought that the break-fix type work would have picked up a lot more with reopening trends, because it doesn’t seem like a massive ticket item. I realized you touched on hospitality as being depressed and that’s sort of apparent, but just any color you can give. Would you have thought this would have picked up a bit earlier? And then just any thoughts on your urban exposure within FM? Thank you.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Yes, so Hamzah we don’t specifically break out urban versus suburban, or rural exposure. However as you implied, our sweet spot is really in — is outside of the city centers in the suburban parts of the country. So we do have some customers that we support in New York City or Chicago in the high rise and mid-rise areas. But that’s not our sweet spot. Our sweet spot is the garden style apartment complexes two to four stories multiple buildings in a complex.

As far as your question on maintenance picking up, we are starting to see it pickup and improve. Much of the demand that we’re seeing in appliances and water heaters that has become a break-fix item with people staying at home, kids at home, those appliances are getting used more than ever. And so they are requiring repair and replacement as a break-fix item. Items that may have historically been required a next day repair, broken blinds in the living room, dripping faucets. Some of those repairs are waiting more than a day as our customers prioritize what needs to be done first. And as tenants become more comfortable allowing a maintenance professional, a professional into their living space.

And so that is improving. Folks are becoming more willing to allow somebody into their living space, but it’s not back to normal.

Hamzah Mazari — Jefferies — Analyst

Got it. Thank you so much.

Operator

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

Joao Carvalho — Barclays — Analyst

Hey, good morning, everyone. This is Joao Carvalho on for Julian. Maybe digging deeper into some of the gross margin dynamics you talked to within Facilities Maintenance. You mentioned a competitive environment is kind of serving as a headwind right now. How much of that is sort of attributed just to the broader environment now versus some of the market share gaining efforts that you guys have kind of talked to on the call? And sort of how are you balancing trying to capture more share with kind of maintaining these margins and then sort of pricing and all that’s kind of baking into that?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Yeah. So to unpack it a little bit for you, as we shared, the category, the unfavorable category mix is a headwind of about 90 basis points of the 120 basis points total. We’re also seeing about 20 basis points of tariff headwind where we haven’t completely anniversaried the tariffs from last year as of the end of the second quarter.

Favorably impacting the margin rate is the mix of hospitality. So hospitality is a lower margin vertical for us. It is still down even in the month of August about 14%, and that’s about a 40 basis points to 50 basis points of benefit in the margin, the margin walk, or the margin change. And the difference is primarily that the competitive environment and ensuring that we’re priced right everyday and offering compelling value to our customers.

Joao Carvalho — Barclays — Analyst

Perfect. And then is there any update on kind of e-commerce? I know you mentioned sort of last quarter that 75% of sales are kind of on digital platforms and so on. Any kind of additional puts and takes there, or sort of any headwinds or tailwinds that that might generate?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

No. That continues to be a real strength for our business. We continue to invest in both our web platform and our app. I have received really fantastic feedback from our customers as far as saving them time and money and giving maintenance time back to the maintenance professional. So no headwinds. And like I said, definitely it’s something that we’re viewing as a competitive advantage.

Bradley Paulsen — President, HD Supply Facilities Maintenance

Yeah. I also think the digital integration you’ve done with the customer to help them reopen, so the webinar has been sold out and the ability for you to provide these value via the knowledge on how to do this right I think has been highly integrated highly digitized.

Joao Carvalho — Barclays — Analyst

Wonderful. Thank you.

Operator

Thank you. And our next question comes from Deane Dray from RBC Capital Markets. Your line is now open.

Deane Dray — RBC Capital Markets — Analyst

Thank you. Good morning, everyone. I was hoping to circle back on hospitality again, and just to make sure I have the numbers right. They’re down 14% for FM versus down 50% for the industry. So you made it sound like this was all share gains which would be terrific, but if you could provide us some more context there on the dynamics.

Have competitors shut down? Are you, do you have an edge in providing more services? And then, is there any benefit from — and this was part of Nigel’s question, some one time like replenishment that came through in the quarter that would have skewed that number favorably. So can we start there please?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Sure, sure. So you hit the nail on the head. You know, and as I said in my first answer, we haven’t pulled back in our service or support to our customers especially the hospitality customers. And I would say that is not the case for other competitors across the business. And I think when you pair that with strong in stock position and the ability to deliver consistent next day service really across the country, it attracted a lot of new customers that we weren’t doing business with.

So, while we saw a relatively good performance from orders, order increases, average order value didn’t increase all that much through the course of the quarter which isn’t a surprise. Now there were certainly pops through the quarter as people prepared for different summer holidays and things of that nature. But we really view this as our team providing a level of service that wasn’t being matched our competition and because of that we picked up on market share.

Now as far as, did we see any initial surge in orders, we’re still kind of dissecting that as you can imagine the last three months and last four months excuse me, in hospitality have been unlike any that we have seen over the last five years to six years, but what we are seeing in customers that we didn’t do business with at a great level are now coming to us and asking to — are asking to provide services in product that we just hadn’t done in the past. And then with existing customers, I would say it’s slow but steady improvement, nothing that would tell us that the recovery is going to be shorter than what we expected.

But what we are really watching is what happens, like I said earlier post Labor Day, I think that’s going to be really interesting to see both from a select service and a full service and see how that customer returns back. We are still certainly in the camp of, it is going to be mid to late 2021 before we see hospitality return to normal levels.

And hopefully that answers your questions.

Deane Dray — RBC Capital Markets — Analyst

It did. That was really helpful color and some of the competitive dynamics. So I appreciate that. And then the second question is on the C&I divestitures. So, first of all congratulations. It looks like a favorable outcome for everybody and you’re putting it in strong hands with — the business in strong hands with Clayton, Dubilier. But just the — Evan, maybe you can take us through expectations regarding taking out stranded cost, what the timing of that would be, and especially for the third quarter modeling purposes, I know you’re not giving guidance, but how much residual expense might still be in the reported results, operating results and what’s the plan there? Thanks.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Yeah. Thanks Deane. So our expectation is still that the incremental or stranded cost is about 30 basis points to 60 basis points of revenue. We do expect to recover that over time as we grow, as we leverage fixed cost and as we become more efficient.

So, over the next 12 months to 24 months, I’d hope that we would recover that 30 basis points to 60 basis points of incremental cost or stranded cost. But that 30 basis points to 60 basis points is real and we will see it in the third quarter, as a reminder to everybody that third quarter is the first quarter where we will show the Construction & Industrial business as a discontinued operation.

Deane Dray — RBC Capital Markets — Analyst

Great. And just lastly, just a comment, look, this has — have been unprecedented times here and Joe and the team, I just think your organizational response has been really impressive, you guys are really on the frontlines, and how you have adapted and responded and I specially appreciate hearing how you supported the community with donating the PP&E, so just wanted to add my congrats. Thanks.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Thanks. We are very proud of the team. Thank you.

Operator

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

David Manthey — Robert W. Baird — Analyst

Thanks, good morning. Along the same lines on standalone FM, have you given any thought or can you give us any guidance in terms of the split of depreciation and amortization and what that might be for the standalone FM business?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Sure. I can give you a little bit of a color on that Dave. So, facility or standalone post split, we will see depreciation amortization of — one moment here about $70 million to $80 million a year.

David Manthey — Robert W. Baird — Analyst

Okay. Thank you. And second, could you describe the status of the information systems, infrastructure at FM when you think CRM, finance, HR, WMS, are all of the systems 100% consistent and stable at the FM business today or do you have some projects that you need to work on?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Well, our core system within the Facilities Maintenance and what will be RemainCo is SAP, that is a stable platform that we have operated for many years and we will continue to operate. The work that we’re doing right now relative to the separation is more on the back office functions, our HR and payroll systems currently on PeopleSoft. And we do need to — it’s is a shared platform right now with Facilities Maintenance and Construction & Industrial. And so we are working on separating this.

But by and large, our systems are stable. We’ve been on them for a number of years. We’re always making enhancements and improvements to them. But we will be doing so in bite-size chunks so that we are able to adequately test and have fallback position should we have any issues with any changes or improvements within.

David Manthey — Robert W. Baird — Analyst

Great, thanks Evan.

Operator

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

Ryan Merkel — William Blair — Analyst

Hey, thanks for fitting me in. I guess first off thinking about FM longer term because of the pandemic are you planning to make any changes to the business model in terms of how you go to market, product assortment or technology?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

You know, I would say the one big change that we have made is really building out our safety and infection prevention product assortment. Pre-COVID we really didn’t have a business that address that, our category management team has done a — just a miraculous job in adding a number of new suppliers, hundreds of new SKUs, and all that really positioned us to be the one-stop shop for all those products and that is important because I don’t think that demand is going to go away. I think it may evolve over time, but I think that’s going to be a big part of our business going forward.

Ryan Merkel — William Blair — Analyst

Yeah, I agree. Okay.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

I would also say that certainly customers today would prefer less interactions, and so one truck that has everything on it is a big deal and we’re going to really make sure as we remarket and relaunch FM that we can do everything for you and it is best for you if we do everything for you.

Ryan Merkel — William Blair — Analyst

Yeah. Also a good point. Okay. Second question, I know you’re not giving guidance and this is frankly hard to answer. But, how should we think about FM market growth potential until the economy fully reopens? Is flat a reasonable outlook for the next couple of quarters or with pent-up demand could the market return to low single-digit growth?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Yeah. So Ryan, we’re always striving to outgrow the market and we think we are doing that significantly right now. It is difficult to estimate where the market is today, and where it’s headed, particularly with the hospitality market as Brad discussed. We saw some nice improvement in hospitality over the course of the second quarter, as we saw leisure travel pickup. So we saw folks taking their summer vacations, driving rather than flying, but still traveling close to home and staying away from home.

Our business travel has not picked up like leisure travel has. So post Labor Day, that’s the nature of Brad’s discussion around potential headwinds in the back half. Difficult to say when that will come back, I think the markets will still be down in the second half, again we will make every attempts to outgrow the market. We were able to deliver a positive comp in August. It is our intention to continue to improve as the — over the course of the year. But it may not be every month. We may have a setback here and there, as we are still in very uncertain environment and the virus is still with us and unpredictable.

Ryan Merkel — William Blair — Analyst

Yeah. Understood, very helpful. Thank you.

Operator

Thank you. Our next question comes from Chris Dankert with Longbow Research. Your line is now open.

Chris Dankert — Longbow Research — Analyst

Hey, good morning guys. Thanks for taking my question. I guess one year on here, obviously the Atlanta DC operating very well, but just can we speak to customer recovery in the region? Is that where we wanted to be a year on? What’s the opportunity to kind of still kind of recapture some of that lost share in that specific region just any thoughts on that dynamic.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

So we are definitely pleased with the recovery that we’ve seen in that market, absolutely applaud the leadership with [Phonetic] that DC have really turned it around in a really short period of time and providing what I consider is best in class service for the customers in that region. Our efforts to recover and also take share or earn share in that market is never over, and we are going to have that mindset every day and every month going forward.

Chris Dankert — Longbow Research — Analyst

Yeah. Fair, fair. And I guess circling back to Ryan’s question a bit, as we move into you know, hopefully growth mode here in FM, are there any additional initiatives to highlight beyond that safety build-out? Are we talking about headcount expansion? Is it geographic build-out? I mean, I understand there is competitive intelligence issues here, but just any additional growth initiatives that you would be able to call out here?

Bradley Paulsen — President, HD Supply Facilities Maintenance

We’re — it’s a great question and we certainly have that plan, we’re probably not going to share it in full detail on today’s call. But I think the first thing that we can do and I mentioned it earlier in the call is really establish ourselves as the safest, most dependable option in our space. And if you talk to our customers, dependability is their number one need and nothing really comes close to that.

So, our ability to do that on a consistent level and there’s a lot that goes into that. It’s easier to stay hard to do. And if we can do that on a consistent basis, we’ll absolutely pick up share at a property level. I’ve also been really open in saying that we’re going to aggressively pursue new national accounts customers. We think we’ve got a value proposition that is very unique for them. And we have seen great success really over the last, I would say nine months to ten months in that activity.

And we’re going to continue to invest in the business. As Evan called out, both Evan and Joe called out 2% of our revenue would go into investing into the core business to continue to improve our value proposition. So, I’m really excited to see the business evolve certainly in the second half and as we move into 2021.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Yeah. I think you are seeing a very nice just natural extensions at every place [Phonetic], so that consistent investment bite-sized chunks to be able to make a difference. And I think you are seeing that really read through in the VOC that you posted through the pandemic. So I think, clearly being the safest and most reliable option out there is, is core and there’s just a ton of share to gain by doing that.

Chris Dankert — Longbow Research — Analyst

Understood. Thanks so much guys and best of luck into the fall here.

Bradley Paulsen — President, HD Supply Facilities Maintenance

Thank you.

Operator

Thank you. Our next question comes from Andrew Obin with Bank of America. Your line is now open.

Andrew Obin — Bank of America Merrill Lynch — Analyst

Yes, good morning.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Good morning.

Andrew Obin — Bank of America Merrill Lynch — Analyst

Just a question on FM, just as part of the HVAC I think was that lot of people are not paying rents, and so I understand how it works for them in certain verticals but just in your core multifamily vertical office buildings how is this dynamic sort of impacting your customers longer term capex plans, what kind of discussions are you having with them?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

So, it’s a conversation we have quite a bit. With our unit turn business being down, property improvement being down, we’re trying to get a pulse for how our customers are feeling about it. And again, as I shared, we’re having a lot of conversations with the customer. Right now the expectation is that work [Phonetic] is going to get done. Their mindset is rent delinquency is actually lower than they anticipated, and we’ll see how it plays out if there is a lack of a stimulus that would impact the second half. But right now, all communications that we’re receiving is capital investments will happen and at the very latest in 2021 some might even sneak into the fourth quarter.

Andrew Obin — Bank of America Merrill Lynch — Analyst

Well, that’s great news. And then of course I know you guys are divesting C&I, congratulations on the deal. Can you just give us I think you did it last time, just go over key markets, California, Texas, Florida, North-East, what are you guys seeing in terms of big market trends?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Specific to the construction business, Andrew?

Andrew Obin — Bank of America Merrill Lynch — Analyst

Yeah. Well, I think, I would — certainly happy to see it for the entire Company, but also specifically for C&I as well, yeah — [Speech Overlap]

Bradley Paulsen — President, HD Supply Facilities Maintenance

So maybe [Speech Overlap] I’ll take that.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

So, okay — well I’ll discuss the construction business first. So, certainly we are seeing a very localized trends within the construction business. It is a very local market. Certain markets continue to perform well like the Southeast part of the United States. We’re seeing continued strong demand in our infrastructure tech project, road and bridge, airports, a number of soccer stadiums being built around the country. And so these are in some of the markets like in Atlanta, like in Nashville, Chicago, Boston remain strong, other markets remain a little weaker. Folks that don’t have that infrastructure spend and maybe a little either slower to reopen or have additional constraints around a job site activity.

Well, a lot of job sites have resumed work. Many locations limit the amount of folks that can work on a jobsite at a time. So we’re seeing one or two trades on a job at a time and so that’s slowing the progress on those jobs. And so really it really isn’t very regional, regional impact market by market on the construction business.

As far as Facilities Maintenance, we are seeing nice improvement sequentially month-over-month, as we shared through August. I’d say right now that the eastern half of the United States is a little ahead of the Western half of the United States, in terms of recovery in our markets.

Andrew Obin — Bank of America Merrill Lynch — Analyst

That sounds amazing. Thank you very much congratulations on a great quarter.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Thanks Andrew.

Operator

Thank you. And our next question comes from Michael McGinn with Wells Fargo. Your line is now open.

Michael McGinn — Wells Fargo Securities — Analyst

Hi. Thank you everyone. Just going back to the average order size, I think this is the second quarter you mentioned this in your prepared remarks, is there any way to frame this from a year-over-year perspective and that may be how that leads into your freight and route density equation and the way you’re looking at maybe gross profit for invoice any commentary there would be great.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Yeah. So it certainly does put pressure on cost per delivery and even handling costs within our distribution centers. When you’ve got the same number of orders but there are smaller orders, there’s still an apparent level of cost that’s incurred to pick, pack, close out the order, load it on a truck, deliver it and then bill and collect it.

So, you are spot on that that does put pressure on the financial profile. The average order size has improved as we’ve moved through the year. It was down double digits earlier at the end of the first quarter and early second quarter. It’s now back down to single digit. So it is improving, but it is still below last year.

Michael McGinn — Wells Fargo Securities — Analyst

Okay. And then just on the margins, I think incrementals you mentioned last quarter you were targeting at 25% to 30% decremental range. I mean with the co-cost [Phonetic] now on the table, is that — is there a different target out there any updates that you can provide?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Yeah. It’s hard to provide that type of update given that August was up slightly up 1%, so we’re — when we’re around that flat mark, incrementals — or decrementals become less relevant. We do expect to see some continued pressure in gross margin. So we saw the 100 basis points plus gross margin pressure within Facilities Maintenance primarily because of mix.

That will likely continue at least into the third quarter as we continue to see the high demand categories being the categories whose margin is below the Company average. And so there will continue to be some pressure on operating margins as we work hard to offset that margin pressure. And the margin pressure related to mix we believe is short term that will recover. The competitive nature of the marketplace will continue.

Michael McGinn — Wells Fargo Securities — Analyst

Okay. And if I could sneak one more in regarding the multifamily market. You guys do a superb job meeting the needs of the class A professionally managed multifamily market. On the other hand, do you see a synergistic benefit of operating within a larger organization, and able to meet that class B or class C multifamily profit or are those spend characteristics too dissimilar from each other where it is a non factor?

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

I’d say, look we cover all the properties all the way through and we think that being a very focused business model is the best way to do that because we understand the needs and we understand the different varying needs based on their property economics. So, I think we can cover the full waterfront and we can cover it really, really well by being absolutely focused on just that living space market.

Michael McGinn — Wells Fargo Securities — Analyst

Appreciate the time. Thank you.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Thank you.

Operator

Thank you. And I’m showing no further questions in the queue at this time. I’d like to turn the call back to Joe DeAngelo, CEO for any closing remarks.

Joseph J. DeAngelo — Chairman of the Board and Chief Executive Officer

Well, thank you for your questions. Over the next couple of months, we will be focused on closing the sale of our Construction & Industrial business. We will also relaunch the HD Supply Facilities Maintenance story later on this year, which will focus on our strong record of return on invested capital and lay out our plans to continue as the distant number one distributor in our living space end markets. Please subscribe to our Investor Relations website and look for updates on the team for details. Thank you for your continued interest in HD Supply.

Operator

[Operator Closing Remarks]