HD Supply Holdings, Inc.

reclassification of prepaid rent and accrued rent balances outstanding at adoption into the ROU assets and the cumulative adjustment recorded to the opening balance of retained earnings. The cumulative adjustment, net of tax, recorded to the opening balance of retained earnings was $3 million. The Company’s finance leases are immaterial. The adoption of ASC 842 did not have a material impact on the Company’s income statement. The Company’s consolidated financial statements for the three months ended May 5, 2019 are presented under ASC 842, while comparative periods presented have not been adjusted and continue to be reported in accordance with the previous standard, ASC 840.

The Company elected the package of practical expedients for existing contracts permitted under the transition guidance within ASC 842, which includes not reassessing lease classification of existing leases, the historical assessment of whether contracts are or contain leases, and the determination of initial direct costs. The Company did not elect the hindsight practical expedient.

Many of the Company’s real estate leases contain charges for common area maintenance or other miscellaneous expenses that are updated based on landlord estimates. The Company determined these charges are variable non-lease components and did not elect the practical expedient to combine with lease components. Additionally, many of the Company’s transportation equipment leases require additional payments based on the underlying usage of the assets. Certain lease agreements include rental payments adjusted annually based on changes in an inflation index. Due to the variable nature of these costs, the cash flows associated with these charges are expensed as incurred and not included in the lease payments used to determine the ROU asset and associated lease liability.

In March 2019, the Company received a subpoena from the U.S. Securities and Exchange Commission (“SEC”) requesting information and documents from calendar years 2016 and 2017 relating to, among other things, the Company’s Facilities Maintenance business unit and to the allegations of the Amended Complaint described above. The Company is in the process of responding to the subpoena and intends to cooperate with the SEC’s investigation. We cannot currently predict the timing or outcome of this ongoing investigation.

Leases — In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, “Leases (Topic 842),” amended by ASU No. 2017-13, “Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842),” ASU No. 2018-01, “Leases (Topic 842) — Land Easement Practical Expedient for Transition to Topic 842,” ASU No. 2018-10, “Codification Improvements to Topic 842, Leases,” and ASU No. 2018-11, “Leases (Topic 842) — Targeted Improvements.” The amended guidance requires companies to recognize all leases as assets and liabilities for the rights and obligations created by leased assets on the consolidated balance sheet. ASU No. 2016-02 also requires enhanced disclosures that provide more transparency and information to financial statement users about lease portfolios. ASU No. 2018-11 allows entities an additional transition method to the existing requirements whereby an entity could adopt the provisions of ASU No. 2016-02 by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption without adjustment to the financial statements for periods prior to adoption.

Adjusted EBITDA as a percentage of Net sales decreased approximately 50 basis points in first quarter 2019 as compared to first quarter 2018. The decrease was driven by an increase in Selling, general and administrative expenses as a percentage of Net sales and decreasing rebar margins. SG&A increased in large part due to weak sales in February 2019 impacted by significant rain in California. The Company was fully staffed and incurred an increase in personnel costs as a percentage of Net sales due to the unexpected slow sales in February 2019. Rebar gross margin rates are declining due to an increase in steel costs impacted by tariffs and duties. We have increased our pricing of rebar to recover the increase in rebar costs, but not enough to maintain our gross margin rate, negatively affecting our overall margin rate, excluding the impact of non-organic A.H. Harris, by approximately 30 basis points in first quarter 2019 as compared to first quarter 2018. Rebar costs are stabilizing and we expect the unfavorable impact on gross margins to subside during second quarter 2019. Additionally, the acquisition of A.H. Harris negatively impacted gross margin by approximately 10 basis points in first quarter 2019 as compared to first quarter 2018.