SiteOne Landscape Supply, Inc. (SITE) Q3 2016 Earnings Report, Transcript and Summary

Good afternoon ladies and gentleman, thank you for standing by. Welcome to SiteOne Landscape Supply Third Quarter 2016 Earnings Conference Call. All participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I’ll now turn the conference over to your host, Pascal Convers, Executive Vice President of Strategy and Development for SiteOne Landscape Supply. Thank you, you may begin.

Thank you. Good afternoon everyone. We issued our earnings press release this afternoon and posted a slide presentation to the Investor Relations portion of our website at investors.siteone.com. We will be referencing the slides during this call. I am joined today by Doug Black, our Chief Executive Officer, and John Guthrie, our Chief Financial Officer. Before we begin, I would like to remind everyone that during this call, SiteOne Management may make certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about future expectations, anticipation, beliefs, estimates, forecasts, plans and prospects. Such statements are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in the company’s earnings release posted on the website, and providing in our Final Prospectus, as filed with the Securities and Exchange Commission. The company does not undertake any duty to update such forward-looking statements. Additionally, during today’s call, the company will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of adjusted EBITDA to net income calculated under GAAP can be found in our earnings release, which is posted on our website, and in our Form 10-Q, which we filed with the SEC today. I would now like to turn the call over to our CEO, Doug Black.

Good afternoon and thank you for taking the time to join us today. I would like to start today’s call by briefly reviewing our strategy, followed by highlights from our third quarter results. I will then pass the call along to John Guthrie, who will walk through our financial results in more detail. Pascal will provide an update on our acquisition activities, and finally I will come back to provide comments on our outlook, before opening up the line for your questions. I will start on slide 4 of the earnings presentation and address our strategy to grow and improve the business. Our strategy is to combine the scale advantages and capabilities of a large company more than four times larger than our nearest competitor with the passion, deep knowledge and entrepreneurialism of our local teams in order to deliver superior value to both our customers and our suppliers. This value is augmented as we acquire leading local and regional companies and the very fragmented landscaping products, wholesale distribution market, thereby filling in our product portfolio, adding terrific talent to our teams and expanding our store network across the U.S. and Canada. We believe the combination of these will allow us to gain market share both organically and inorganically in order to accelerate our growth and profitability. In the third quarter we grew next sales by 10% despite slower than anticipated markets, which is evidence of our strategy network. In addition we have the opportunity to expand our margins as we execute our commercial and operational excellence initiatives focused on pricing, category management and supply chain. In the third quarter we continue to see good results from these initiatives expanding our year-over-year gross margin by 180 basis points and adjusted EBITDA margin by 150 basis points. Turning to slide 5, we are pleased with our financial and operational performance in the third quarter, as we delivered solid overall results for the three months ended October 2, 2016. We grew net sales by 10% year-over-year to $445 million with good contributions from acquisitions complementing our organic growth. Organic revenue increased by 2% in the quarter, lower than we had anticipated. John, will address the specifics here, but in summary we saw three major trends; hot and dry weather affecting the nursery product line, flatter year-over-year pricing, and some softness in construction which is being dampened by a pervasive shortage of labor. All that said, organic growth did improve modestly from 1% in July to 3% in September. I would note that among our five commercial and operational initiatives the two focused on organic share growth which our sales force performance and marketing are in much earlier stages of development than our margin expansion initiatives. We continue to develop these two initiatives and we would expect them to begin to contribute more meaningfully to our organic growth in 2017. Gross margin expanded by 180 basis points to 31.1% in the third quarter as we continue to benefit from our ongoing operational improvements primarily in pricing and category management. We expect continued benefits from our commercial and operational initiatives for the next several years. Adjusted EBITDA increased by 30% to $44 million and margins increased by 150 basis points year-over-year to 9.8%. We are very pleased with our strong EBITDA margin expansion despite lower than anticipated organic growth. Lastly we continue to execute our acquisition strategy, but the acquisition of Bissett in Long Island, New York in August; Glen Allen in Richmond, Virginia in September; and Loma Vista Nursery just last week, all three providing us with expanded product line positions in their respective markets. With that, I will now turn the call over to John Guthrie to walk through the financials in more detail.

Thanks, Doug. Now turning to slide 6 in our third quarter 2016 results. We reported net sales of $445 million, an increase of 10% compared to $405 million in the third quarter of the prior year. We grew organic sales by 2% for the quarter and by 5% year-to-date. As Doug mentioned, we did see some softness in this quarter relative to what we have seen year-to-date. Our customers however continue to be optimistic, and our project services group reports a growing pipeline of commercial job leads. Irrigation, nursery, hardscapes, and landscape accessory grew 4% organically for the quarter and 8% year-to-date. These products have continued to benefit from strength in residential and non-residential construction in addition to the repair and remodel market. Among these products, nursery was an outlier in the third quarter, posting a 4% decline in sales as the hot dry weather across Texas and East Coast negatively impacted the planting season. Excluding nursery sales, organic sales growth for these products would have been 5% for the quarter. Agronomic product sales which includes fertilizer, control products and grass seeds was down 1% for the quarter and it’s flat for the year. Agronomic sales started the quarter down, as the softness we saw in the second quarter continued in July before recovering in August and September. Overall, pricing was up 40 basis points for the quarter, compared to a 160 basis point improvement for the first half of the year. We are seeing pricing pressure on products that have a commodity component to them such as fertilizer. Acquisitions for the third quarter contributed $34 million or an additional 8% to our sales growth. On a year-to-date basis, acquisitions have contributed a $127 million or an 11% to our overall growth rate, which combined with our organic growth resulted in total sales growth of 16% year-to-date. Gross profit increased 17% to $138 million, compared to $118 million during the same period last year. Gross margin was 31.1% for the third quarter of 2016, compared to 29.3% for the same period in 2015, a 180 basis point expansion. Improvement in pricing and category management were the main contributors to our gross margin expansion. We are still in the early innings of these initiatives and we expect to continue expanding our gross margin for the next several years. Mix did not have a significant impact on margin for the quarter. Selling, general and administrative expenses increased to $108 million from $98 million in the same period last year, while SG&A as a percentage of net sales, was 24.2% flat year-over-year. The increase in SG&A was primarily attributable to our acquisitions. Net income in the third quarter was $50 million or $0.36 per diluted share, compared to an $11 million during the same period last year. The weighted average common shares outstanding used in the earnings per diluted share calculation was $41million. The increase in net income for the third quarter was attributable to an increase in net sales and continued margin improvement. This was partially offset by increases in SG&A associated with acquisitions, and higher interest expense from our increased debt levels borrowing our dividend recapitalization. The effective tax rate for the quarter was 41.8%, up from 39.4% for the prior year. The increase in the tax rate was due primarily to nondeductible IPO related costs during 2016. Adjusted EBITDA increased 30% to $44 million compared to $34 million for the prior year period. The improvement reflects a strong gross margin performance and a good contribution from acquisitions. These were also the primary drivers in the 30% increase in adjusted EBITDA to $123 million from $95 million year-to-date. As a reminder, we define adjusted EBITDA as excluding pre-acquisition acquired EBITDA. Now I’d like to provide a brief update on our balance sheet and cash flow statement, as shown on slide 7. Net working capital increased to $383 million for the nine months ended October 2, 2016, versus $297 million as of January 3, 2016. This increase in net working capital reflects both our seasonal build, and the impact of our acquisitions. Net debt at the end of the quarter was $419 million, which yields a leverage ratio of 3.1 times, our LTM adjusted EBITDA of a $135 million. We made progress this quarter lowering our leverage ratio and working towards our longer term target of two to three times. Cash flow from operations was a negative $3 million for the quarter and $9 million for the nine months, compared with $32 million and $45 million for the same period of 2015. The reduction in operating cash flow year-to-date reflects the timing differences, and increase in the working capital to support the growth of the business, primarily in accounts receivable and the favorable impact in 2015 from the change in the timing of our annual bonus payment. We made investments of $17 million for the quarter including $15 million for acquisitions and $2 million for capital expenditures. This compares to $39 million in the third quarter of 2015 of which $36 million was for acquisitions and $3 million was for capital expenditures. Our capital structure and our ability to generate cash provide us the flexibility to execute our growth strategy, including the funding of our acquisitions. I will now turn the call over to Pascal for an update on SiteOne’s acquisition strategy.

Thank you, John. As many of you know, acquisitions played a key role within our overall growth strategy. As shown on slide 8, we have now acquired 13 companies since 2014, and we continue to see a significant opportunity to create superior value for SiteOne through acquisitions, which allow us to move into new markets, expand our presence in existing ones, broaden our product offering, and also, very importantly, add market-leading talent to our team. We talked on our last call about our position of Bissett Nursery and Bissett Equipment Company, which complement our existing business in the agronomics, irrigation and outdoor lighting product line, and we believe make us the largest and only supplier of a full landscaping product line to green industry professionals in the Long Island, New York and New York City markets. Now as we turn to slide 9, you can see some details on our acquisition of Glen Allen Nursery which occurred after our last earnings call and is another great example of our ability to identify an acquired local market leaders. In this case, Glen Allen provides SiteOne with a leading nursery presence in the Richmond market and allows us to offer a full product line to our local customers. In addition, as we turn to slide 10, late last week we closed on the acquisition of Loma Vista Nursery which has two landscape distribution centers in the Kansas City market with a focus on nursery products and hardscapes. Loma Vista established SiteOne as the number one supplier of nursery products in the Kansas City market and enables SiteOne to offer a full suite of products for our Kansas City customers. We have now closed five acquisitions for the year which contribute $155 million of annualized sales to SiteOne. Our pipeline remains robust and our M&A strategy is accelerating as we continue to build a reputation as the buyer of choice in the industry. While the timing of acquisition cannot be fully predicted, we have additional acquisition that we expect to close during the winter and will contribute nicely to our 2017 growth. And with that, I would like to turn the call back over to Doug to discuss our outlook.

Thanks, Pascal. Overall, we are pleased with our third quarter results and our performance so far this year, as we have managed through volatile weather patterns, flatter product pricing and industry labor shortages. In terms of outlook, we remain positive on the underlying trends for the market, so we have seen some modest softening. Our customers have good backlogs and we are seeing steady levels of commercial bidding. Based on these trends and our customer feedback, we expect the market to continue to grow in 2017. As we look to the fourth quarter, we were up against the difficult comparison as we experienced unusually mild weather last year, and that is not likely to repeat itself this year. So assuming a normal winter, we would expect organic daily sales growth in the fourth quarter to be roughly flat. Note that because of the extra week of sales in the fourth quarter of 2015, our overall organic growth in the fourth quarter will be negative. Taken all together for the full fiscal year 2016, we’re updating our guidance and now expect adjusted EBITDA to be in the range of $132 million to $135 million, representing a year-over-year growth of 24% to 27%. In closing out 2016 and moving into 2017, we’re even more excited about our future as we continue to implement our margin expansion initiatives, as organic sales growth initiatives begin to contribute more meaningfully, and as we ramp up our acquisition activities. We have an attractive growing industry that is well balanced and lends itself to wholesale distribution. We are the clear leader in the industry and the only national consolidator with significant competitive advantage. And we have a winning strategy to leverage these advantages in order to deliver superior value to both our customers and our suppliers thereby creating value for our shareholders. Most importantly, we have a terrific team, both in the field and at the center with the ability to execute our plans. Overall we’re well positioned to deliver significant value to all stakeholders in the years ahead. In closing, I would like to acknowledge all of the SiteOne associates who have worked tirelessly serving our customers and who have made us successful to this point. Operator, please open the line for questions.

Thank you. At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from David Manthey from Robert W. Baird.

Hi, good afternoon guys. You may have alluded to this during the preamble, but could you give us an idea of what your growth was – your organic growth within irrigation, hardscapes and lighting as sort of a proxy for the non-weather impacted areas of your business? If it’s hot and dry I would assume that wouldn’t impede and probably would help your ability to sell those types of products and contractors to get those in.

Right. If you take our construction products without nursery, they grew at 5% in the Q3, and again, that’s about what we expected. Remember, we had about a flattening and pricing of about 1%, our pricing was up about 160 basis in the first half, it was up only 40 basis in the third quarter. So if you take that, which we really saw that across all product sectors, but the core growth of the construction products without the weather affected nursery was 5%, which we feel is solid.

Okay. And the pricing trend, when you say 40 basis points, that’s year-over-year, so pricing is still positive, it’s trending closer to zero. When you look at trends in nitrogen and fertilizer and things, do you assume that 2017 will be a year of flatness or deflation possibly?

Well, we have seen the deflation, and again, you’re correct, we’re still seeing price increase but it’s just smaller than it was before. We’re going to see that continue through the fourth quarter. It’s anybody’s guess on what commodities are going to do next year. So if commodities to drop further, then we’ll get further pressure on pricing. Our sense is that going into 2017, we’ll see kind of stable commodities, and so overall we’ll probably see more normal inflation, maybe the low end of normal. But we think the pressure should ease a bit in 2017 as commodities stabilize and normal inflation kicks in on the other product lines.

All right. Thanks, Doug.

Thank you.

Our next question is from Nishu Sood from Deutsche Bank.

Thanks. About the fourth quarter sales trends, you laid it out flat on a daily basis; but with the extra week in 2015 expected to be negative. Wondering if you could help us to understand that, how should we think about in your business, what percentage impact that might be? So what are you expecting overall for sales?

You’re going to see a 14 – last year we had a 14-week Q4 and this year we’re going to have a 13-week. So you do the math, it’s 6%, 7% reduction just from the loss of week of sales.

Got it. Last quarter we had talked about how the September and October pre-applications – I’m sorry, the late season applications were very important in kind of dictating the trends for the second half of the year. You gave a little bit of color on that in your commentary interquarter. So what have you seen in October? And if you could remind us please, is that just on the agronomics side or is that on the discretionary side as well? You’re basically making a call here on the cold weather, the potentially cold weather that’s coming up. Just trying to get a sense on what you’ve seen in the late season applications and how that plays out for the rest of the quarter?

Right. Yes, that’s a great question. As you know the first and second quarter balanced and there’s quite a bit of pull forward in the first, we had a weak second quarter in agronomics. And during the summer when we reported our second quarter earnings, we told you it was still a bit of a lull with those products, but we did see it come back. So if you’re looking at – we were looking at negative growth in July. That kind of normalized and we actually saw 3% growth in our agronomic products in September. So we’re happy with how that’s come back, and the applications did come through, and we’re seeing – price aside, price dampening aside, we’re seeing more normal growth in agronomics both September and October.

Got it. Thank you.

Our next question is from Keith Hughes from SunTrust.

Thank you. The yearly guidance implies that the fourth quarter EBITDA will be down a little bit. You discussed earlier one less week. Any other things going on in the quarter that are going to be affecting profits that would be one-time in nature?

Well, it’s really about the weather. Our last year, the fourth quarter was unseasonably warm well in to December, and so we don’t expect that to repeat. Our guidance assumes a normal winter if you will. And if the winter comes earlier, that’s toward the lower end. And if we have more of a year like we had last year, that’s toward the higher end. So that range really is all about the weather in November and December. We were hit a bit by Hurricane Matthew, but that’s factored in to the guidance already.

Just to be clear, the flat organic or flattish organic growth you’re expecting in the fourth quarter that would be accounting for one less week. Is that right?

No, the flat is on a daily basis. So again…

Yes.

Yes. So we’re flat on a daily basis, then when you’re missing the one week of sales, that takes you negative. And I believe that’s about $20 million of sales in that week that we’re missing.

Final question. The acquired volume in the quarter, did that meet your expectations? We don’t have a lot of details on the amount of revenue drop per acquisition.

Right. Overall our acquisitions are performing to plan. That being said in the third quarter they would have seen some of the same weather challenges obviously with shaman and the nursery, they would have seen the same trends. However, they’re performing strongly on an EBITDA level, so we’re quite happy with their performance overall, but they would have had the same revenue trends in general that you see in our base business.

Okay, thank you.

Our next question is from Chris Belfiore with UBS.

Hey guys, good evening. How are you?

Good evening.

Thanks, Chris.

Yes. Just a first question, just kind of on – you guys have been making pretty good traction on the gross margin side. The 180 basis points year-over-year, how much of that – can you kind of like break that out a little bit between like pricing and category management? And then also just kind of – are you seeing any potential like runway for more kind of action there taking anymore to the initiatives going forward?

Sure. With regards to gross margin, we saw benefit on both category and pricing during the quarter. And when we say pricing, I want to differentiate between overall pricing and pricing from a margin basis. But we saw, I would say we don’t completely split out but both of those were meaningful contributors to our improvement in gross margins for the year. And then just generally I think as we’ve talked about before we do feel especially going to each year we’re looking to optimize our margins and our initiatives while certainly category and pricing are the ones we’ve used the most over the past few years, the furthest along, really supply chain and some of our other initiatives we expect to further increase our margins going forward.

I would say – I would just add that we do have room on category and pricing. Those will go on a lower run rate going forward but as John said, then you see supply chain coming in to kind of keep the overall momentum. And a reminder that on the SG&A level, we do expect to start to get gearing on SG&A in the fourth quarter and that gearing will carry on for as we’ve done our corporate build and we leverage that going forward. So, we’ll have another lever helping us on the EBITDA margin going forward.

Yes, that kind of goes to my second question, it was kind of around the SG&A like with the acquisition that creeped up, it was a little higher than we thought. I mean, how do you guys think about that like kind of just going forward in terms of synergies when you guys acquire these companies in terms of how long you keep people with type 1 and how you kind of attack that? What are the plans for SG&A?

Typically – good question, Chris. Typically on the acquisition side it takes us 12 months to 18 months to extract what we call the fixed cost synergy, right. And so we’re still working on some of the SG&A synergy we had with shaman and as we close Blue Max and some others, this year they’ll continue. I think that’s the main reason why you see a little creep up early on. It’s not like purchasing. Purchasing is immediate synergy, SG&A. It’s a 12 months to 18 months mark to extract 100% of it. But in general, the acquisitions we do are about the same EBITDA as the company on average, number one. And then in some companies will have actually lower SG&A than others, we resource out of very – I guess, cost completed situation versus some other, and leverage again the SG&A is about the same as the company.

Go ahead.

I was just going to say, excluding acquisitions, we have largely finished our corporate build and believe that the investments we made last year in the field and going forward we’d expect to realize greater SG&A leverage with future sales.

Okay. Thanks a lot.

Thanks.

[Operator Instructions] Our next question is from Ryan Merkel with William Blair.

Hey, thanks. Good afternoon everyone.

Thanks. Good afternoon, Ryan.

So it sounds like the recent sales were below your expectations in the quarter was the hot and dry weather and slower new construction. Is that correct?

I would say the weather, the flatter pricing, and then some softness in construction and really it’s more of a tentative growth. I mean, we feel like new residential, new commercial still is very solid but there’s dampening effect that we’re seeing by labor in general. And so we think that’s dampened a bit. I wouldn’t call it soft but it’s tentative and it’s dampened versus the pop we may have seen in prior years.

Got it. So it was primarily the weather and you mentioned the lower pricing. That was something you knew about and called out last quarter. That wasn’t a net negative, was it?

No, no. We knew that was coming and that was part of the trend, but we did see that and talked about that when we reported last quarter.

Okay. And then it sounds like based on the commentary the weakness that we’ve seen the season was really a weather issue and not a change in the underlying demand in the industry. Is that fair?

I think that’s fair to say. When we pull our customers that they remain quite positive. They’ve got backlogs, our commercial bidding teams are seeing steady bidding and some markets were seeing commercial bidding pick up a bit. So we think the tailwinds are still solidly there. On residential side, we all know that’s got a way to run. So, yes, we think it’s more the weather, some dampness, some choppiness as we went through the season. But we’re still fairly positive about going into next year, 2017 having a good year.

And for 2017 should we expect mid-single digit industry growth sort of the same level that you’ve been talking about?

We’ll get more guidance on 2017 when we do our year end. But again, all we know is we see right now good backlogs, good steady bidding and we don’t think the trends will materially change as we head into next year.

Okay. Last one from me on M&A pipe line, it sounds like it’s fairly robust. Is the $100 million of M&A in 2017 sill a reasonable target? I know that’s a soft target but is that reasonable?

Yes, that is reasonable. As you’ve seen over the last two years, we’ve beat the target. And today I’d say that the M&A activities clearly accelerating, right? We’ve got a number of agreed LOIs that are in place right now. Some are expected to close before the end of the year. Some will close early next year. We are also discussing with on a few offers that we’ve made and we plan to make a few more offers before the end of the year. So we expect acquisitions to contribute very nicely next year and again beat that conservative $100 million guidance that we have.

Very good. Thank you.

Our next question is from Bob Wetenhall from RBC Capital Markets.

Good afternoon, this is actually Michael Eisen on for Bob today. I just had a quick question, you guys have mentioned in few times a slowdown in constructions being one of the key drivers the soft revenues performance this quarter. A number of other companies have also talked about this and talked about it as a temporary air pocket in demand and they see it reaccelerating into the fourth quarter in 2017. I was just wondering what you guys are using in your forecast for construction, both residential and non-residential for fourth quarter and for fiscal year 2017, so we can kind of get an idea of what your thinking and markets are going to be growing into next year. Thanks guys.

Again, a great question. And again, I think soft pocket tentative kind of dampen growth is a good way to describe the third quarter. We’ve talked about the fourth quarter which had unseasonably favorable weather last year and so we’ve got tough comps for the fourth quarter, but underlying growth is still there, it’s still there in new residential. It’s still there in commercial. And we think that underlying growth will certainly carry into 2017. And so that’s what we’re basing our forecast on.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. I’d like to turn the call back to Doug Black for closing remarks.

Yes, thank you. And I thank all of you for joining us again today. We appreciate your questions and we appreciate your interest in SiteOne. Again, we’re pleased with our performance and we’re very excited about our longer term growth and profitability potential for our company as we move into 2017 as we close out 2016. We look forward to reporting our full year results in March and look forward to touching base again at that time. Thank you very much.

This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.