SiteOne Landscape Supply Inc (SITE) 2018 Q1 法說會逐字稿

Greetings, and welcome to the SiteOne Landscape Supply, Inc. First Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Pascal Convers, Executive Vice President of Strategy and Development and Investor Relations. Thank you, sir. You may begin.

Thank you, and good morning, everyone. We issued our first quarter earnings press release this morning 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'm joined today by Doug Black, our Chairman and Chief Executive Officer; and John Guthrie, our Chief Financial Officer.

Before we begin, I would like to remind everyone that today's press release, the slide presentation and statements made during this call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. Such risks and uncertainties include the factors set forth in the earnings release and in our filings with the Securities and Exchange Commission.

Additionally, during today's call, the company will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. A reconciliation of these measures can be found in our earnings release and the slide presentation on our website.

I would now like to turn the call over to our Chairman and CEO, Doug Black.

Thank you, Pascal. Good morning, and thank you for taking the time to join us today. Though the start of our spring season has been delayed this year from March to April, we are seeing it come through now and remain optimistic about the underlying market demand and the strength of our company as we build on the progress that we made in 2017.

I will start today's call with a review of our unique market position, our strategy to deliver long-term performance and growth and our progress over the past 4 months.

John Guthrie will then walk you through our first quarter financial results in more detail, and Pascal, will address our acquisition strategy. Finally, I will discuss our outlook for 2018 before taking the questions.

I'll start on Slide 4 of the earnings presentation. SiteOne is the largest and only national wholesale distributor of landscaping products with a footprint of more than 500 branches across The United States and Canada, and a 10% share of this $18 billion highly-fragmented market. We now have 3 major distribution centers up and running to support our branch network with product and logistical advantages. We are the only distributor of scale who provides the full range of products and services that professional landscape contractors and maintainers need. This full-line product capability gives us competitive advantage and provides a nice balance across maintenance, new construction, and repair and upgrade end markets.

Turning to Slide 5. Our strategy combines the scale, resources and capabilities of a large world-class company with the passion, deep knowledge and entrepreneurialism of our local teams in order to deliver superior value to our customers and suppliers. We further drive this strategy by acquiring leading local and regional companies to fill in our product portfolio, add terrific talent to our teams and expand our branch network across the U.S. and Canada. We believe the combination of these efforts will allow us to gain market share, both organically and inorganically, in order to accelerate our growth and profitability.

Our strategy is enhanced through the execution of our 5 commercial and operational initiatives listed here, which help to improve our value to customers and suppliers, expand our margins and accelerate organic growth. Overall, our market position, capabilities and strategy allow us to create value for our shareholders in 3 complementary ways through organic growth, margin expansion and acquisition growth.

Since we're still in the early innings of implementing our strategy, we believe that we can leverage all 3 of these areas to create significant value for many years to come.

Slide 6 illustrates SiteOne's history and our strategy in action. Following the spin-out from Deere & Company at the end of 2013, we developed a vision to be a company of excellence for our associates, customers, suppliers, shareholders and communities. We then developed a detailed strategy to do this, leveraging our industry leadership position and the uniquely attractive aspects of the wholesale distribution market for landscaping products. Since then, we've been hard at work building our company, transforming our culture and executing our strategy.

As you can see from our financial results, our strategy is working with strong organic and inorganic sales growth over the past 3 years and adjusted EBITDA margins that remain on track for our stated milestone of 10%-plus.

Turning to Slide 7. An important part of our story is that we are still at the very beginning, and we have only just begun to implement our strategy. This includes filling in our full product line capability in every major U.S. and Canadian market. The graph shows that we only have the full-line capability today in 45 of our targeted 225 major markets, primarily due to the lack of nursery and/or hardscape branches. We plan to add the majority of these branches through acquisition in order to also bring in the local talent and both the customer and supplier relationships required to win in these markets. Additionally, we will continue to penetrate new markets and improve our market position in irrigation and agronomics through acquisition. In total, we have approximately 250 high-quality acquisition targets identified among the over 1,000 estimated wholesale distributors in the market in order to help build our company and increase our market share over the next 10 to 15 years.

This acquisition growth will complement our organic market share gains. Within the context of our strategy and evolution, I will now shift to our first quarter performance on Slide 8.

We achieved 11% overall net sales growth in the quarter despite adverse weather conditions that delayed the start of the spring season by approximately 3 to 4 weeks. We would typically see the season start during the second half of March. This March, we experienced more snow, rain and colder weather than last year in all of our key markets except California, Arizona and Florida. Through February, our organic daily sales growth was 6% with pricing up 1%, a very healthy start to the year.

With the delay in spring, however, March organic daily sales were down 2% and so we only achieved 3% organic daily sales growth for the full quarter. As we look into the second quarter, the adverse weather trends from March continued through the first half of April, but we've seen spring kick into full gear in the second half of April. With a strong underlying market, we expect sales for the remainder of Q2 and the rest of the year to be robust.

Our gross margin contracted by 90 basis points to 29.2% in the first quarter due to a combination of the new revenue recognition standard, expenses related to our distribution center rollouts and a slightly less favorable product mix driven by the spring season delay. We expect these 3 factors to be tailwinds during the rest of the year.

Our ongoing initiatives to improve gross margin remain on track, and we are optimistic about our ability to improve gross margin as we look out over the full year.

On the initiatives front, I am pleased to announce that we achieved 2 operational milestones since our last call. First, all 3 of our distribution centers are now up and running and successfully supporting our branches. The last of these 3 are DC in Carlisle, Pennsylvania just outside of Harrisburg, started serving branches in March. We're very pleased with the performance of our DCs and the new dimension that they have added to SiteOne in terms of product availability and logistical performance.

Our supply chain teams and field associates have done a fantastic job ramping these up, and we look forward to reaping the rewards for many years to come.

Second, in March, we launched the pilot of our new e-commerce platform, the new SiteOne.com, which allows our customers to order product and schedule pick up or delivery, all from their phone, tablet or computer. As you're aware, our e-commerce portal has been in development for over 18 months, and we're very excited that it has gone live in select test markets. We plan to pilot the new site and then begin a countrywide rollout during the second half of this year. We believe this new capability will position SiteOne as the clear leader in service efficiency for our customers and suppliers.

We believe that these investments and others that we're making to build our company will deliver tremendous competitive advantage in our fragmented market and support accelerated performance and growth for years to come.

Adjusted EBITDA was a negative $5 million for the quarter, compared to $1.2 million in the first quarter of last year, driven primarily by the delayed spring season and reduced gross margin.

SG&A, which includes acquisitions and key investments, is on plan.

On the acquisition front, we've gotten off to a great start in 2018 with 3 excellent acquisitions closed during the first quarter and one company added in April. Among these was the strategically important Atlantic Irrigation acquisition, which significantly strengthens our irrigation business along the East Coast. Overall, our acquisition activity continues to ramp up nicely, and you can expect to see more deals closed during the remainder of the year.

In summary, as we've mentioned before, the timing of our spring and fall seasons can swing sales between quarters, but with our broad product and geographic diversification, these swings typically average out during the full year. While managing through this challenging quarter, I'm very pleased with how we have moved the foundation of the company forward to support strong performance and growth in 2018 and beyond.

Now John Guthrie will walk you through the financial results for the quarter in more detail. John?

Thanks, Doug. I'll begin on Slide 9 with the income statement for our first quarter results. We reported a net sales increase of 11% to $371 million in the first quarter. During the quarter, we had 64 selling days, which was unchanged compared to the prior year. As Doug mentioned earlier, organic daily sales grew 3% in the first quarter. Organic daily sales were directly impacted by the snow, rain, and colder weather in most of our markets. 5 out of our 10 geographic regions experienced negative organic sales growth due to the weather. We saw weaker sales not only in the northern markets due to snow, but also in the southeast due to colder temperatures and more rain this year compared to last year.

Organic daily sales for landscaping products, which includes irrigation, nursery, hardscapes, outdoor lighting, and landscapes accessories grew 4% as the fundamental demand in the repair and upgrade in new construction end markets remained strong. The western market saw especially strong growth in irrigation products, which benefited from both the strength in the economy and the drier conditions.

Nursery sales, which are primarily located in Eastern half of The United States, were down significantly due to the late spring. Organic daily sales for agronomic products, which includes fertilizers, controlled products, ice melt and equipment grew 1% in the first quarter, driven by strong sales of ice melt, which were up almost 70%.

Organic sales through February were up significantly due to the snow and the resulting increased demand for ice melt. However, when the snow events were still occurring in late March and customers had to delay their first lawn care applications, sales of agronomic products declined.

Pricing increased by 1% year-over-year, driven by cost inflation in our products. We expect this trend will continue and be a minor tailwind of 1% to 2% for the rest of the year.

Acquisitions contributed $28 million to net sales in the first quarter for approximately 8% to our growth rate.

Gross profit increased 8% to $109 million in the first quarter, while gross margin decreased 90 basis points to 29.2%. Gross margin contracted year-over-year as a result of higher supply chain cost from the rollout of the distribution centers, the adoption of the new revenue recognition standard and some negative changes in product mix brought on by the late spring.

Supply chain costs increased approximately $3 million or 70 basis points, driven by the startup of the new distribution centers and increased freight cost. These results were in line with plan, and with the startup behind us, we expect the new DCs will positively contribute to performance going forward.

The adoption of the new revenue standard resulted in an approximately negative $2 million or 50 basis points impact to gross margin in the quarter due to the timing on the recognition of the revenue and expenses associated with our customer loyalty reward program. The revenue and expenses, we recorded this period, would historically have been spread out over the course of the full year. The late spring caused the shift in product mix, which negatively impacts gross margin by approximately 10 basis points. We saw a strong sales growth of ice melt, which has a lower gross margin and weaker sales of nursery products, which have higher gross margins.

Selling, general and administrative expenses or SG&A increased by 16% to $132 million in the first quarter. And SG&A as a percentage of sales increased 160 basis points to 35.5%. The increase in SG&A as a percentage of sales was primarily attributable to our growth from acquisitions combined with the seasonally lower sales volume in the first quarter. In addition, we're continuing to make investments in the company to support the rollout of our e-commerce platform.

We recorded a net loss of $17 million for the first quarter compared to a net loss of $10.5 million for the prior year period. Our net loss for the quarter is attributable to the seasonality of the business as well as the continued investments in the company.

We recorded an income tax benefit of $10 million in the first quarter of 2018 compared to an income tax benefit of $8 million in the prior year period. The effective tax rate was 37.5% for the first quarter compared to 42% for the prior year period. The enactment of the 2017 tax act was the primary driver of the lower effective tax rate, which was partially offset by an increase in the excess tax benefit pursuant to ASU 2016-09. We currently expect our 2018 effective tax rate will be between 26% and 27%, excluding ASU 2016-09 and other discrete items.

Our weighted average share count was 40 million shares, an increase of 452,000 shares year-over-year due to the employee option exercises.

Adjusted EBITDA was negative $5 million for the first quarter compared to $1 million for the same period in the prior year. On an adjusted EBITDA basis, we normally record a loss through February, and the strength of March largely determines whether we post a profit for the quarter. In both 2014 and 2015, we recorded losses during the first quarter. In 2016, we had a very mild winter and recorded a profit. And last year, we were basically breakeven. The weather this year was worse than last year, and as a result, our first quarter looks more like 2014 and 2015.

Now I'd like to provide a brief update on our balance sheet and cash flow statement as shown on Slide 10. Net working capital increased 16% from the end of last year to $460 million as of April 1, 2018. The growth in net working capital primarily reflects the increase in inventory and receivables attributable to the seasonality of our business, the rollout of the new distribution centers and our acquisitions.

Cash used in operations was $41 million in the first quarter compared to $55 million in the prior year period. The improvement in operating cash flow for the quarter was primarily attributable to increased collection of accounts receivable. During last quarter's call, we mentioned how the timing and terms of our fourth quarter sales resulted in an increase in year-over-year receivables. The pickup in this quarter reflects a collection of those receivables. We made cash investments of $55 million for the quarter compared to $59 million for the prior year period, the reduction reflects a slightly smaller investment in acquisitions during the quarter.

Net debt at the end of the quarter was $559 million and leverage was 3.7x our trailing 12 months adjusted EBITDA, which is flat with the prior year period. As a reminder, our leverage typically peaks at the end of the first quarter due to the working capital build prior to the spring selling season.

Our leverage target for the end of the year is 2 to 3x net debt-to-EBITDA.

In summary, our capital structure continues to provide us with 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 Doug mentioned earlier, acquisitions play a key role within our overall growth strategy as we continue to fill a significant whitespace. As shown on Slide 11, we have now acquired 26 companies since the beginning of 2014, we added 162 branches to SiteOne, and contributed $650 million in sales on a trailing 12-month basis.

We are off to a great start this year and have made good progress accelerating our pace of acquisitions from 4, in 2015; to 6, in 2016; to 8, in 2017; and now 4 more through the first 4 months of 2018, representing a $100 million in last 12-month sales.

Now as we turn to Slide 12 through 15, you will be able to find information on the acquisition we completed so far this year. In January, we acquired Pete Rose, a leader in the distribution of natural stone and hardscape materials in one location in the Greater Richmond, Virginia market. The Pete Rose dedicated hardscape is a standard complement to our existing operations with a full range of irrigation, agronomics and nursery products and allows SiteOne to offer a complete one-stop shop to Richmond customers.

In February, we completed the highly-strategic acquisition of Atlantic Irrigation, which is the leading supplier of irrigation products along the East Coast with 33 locations in 12 U.S. states and 2 Canadian provinces. Atlantic Irrigation brings a talented team to SiteOne with an excellent reputation and a strong history of customer focus and growth. Combination of our 2 companies makes us the clear irrigation leader in the East, and provides good purchasing synergies as well as cross-selling opportunities.

In March, we closed the acquisition of Village Nurseries, the leader in the distribution of nursery and related products to landscape professionals with locations in the Greater Orange, Huntington Beach and Sacramento, California markets. Through Village Nurseries, SiteOne adds nursery products, which we did not have in those markets to our existing irrigation, agronomics, hardscape and landscape lighting product lines and allows SiteOne to offer a complete one-stop shop to our customers in California.

In April, we acquired Terrazzo & Stone Supply, a leader in the distribution of natural stone and hardscape materials with locations in Bellevue and Marysville, Washington.

Terrazzo adds natural stone and hardscapes to our existing irrigation, agronomics and landscape lighting product offerings in the Seattle metro market.

As we turn to Slide 16, we continue to see a significant opportunity to grow profitably 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 outstanding talent to our team.

Our pipeline remains robust, and with 4 acquisitions year-to-date, our M&A strategy is gaining momentum, and we continue to build a reputation as the buyer of choice in the industry. We would also like to thank all the leaders of SiteOne who are great ambassadors working hand-in-hand with our development team to help SiteOne attract the best companies to join us in the future. While the timing of acquisitions cannot be fully predicted, we have strong momentum and expect to close additional acquisitions in the next few months, which should contribute nicely to our growth in 2018 and beyond.

And with that, I'd like to turn the call back over to Doug to discuss the outlook.

Thanks, Pascal. I'll wrap up on Slide 17. Overall, we are confident that we can deliver another year of excellent performance and growth for the full year 2018 as we move past our seasonally weakest period. The underlying market trends remain positive across residential and commercial new construction, repair and upgrade and maintenance. We continue to execute our commercial and operational initiatives, which we believe will allow us to gain market share, achieve good organic growth and further expand our adjusted EBITDA margin.

Lastly, as Pascal mentioned, our acquisition pipeline remains very active, and we anticipate 2018 being a good year in terms of adding great companies to SiteOne.

Accordingly, we continue to expect adjusted EBITDA to be in the range of $180 million to $192 million in 2018.

In closing, I would like to acknowledge all of the SiteOne associates, who continue to create significant value for our customers and suppliers. We have a tremendous team, and it is an honor to be joined with them as we build a company of excellence for all of our stakeholders.

Operator, please open the line for questions.

(Operator Instructions) Our first question is coming from the line of David Manthey with Robert W. Baird.

First question for John, on the gross margin. The change in accounting seemingly pulled expenses into the first quarter. So are we to assume that all else equal, that change would have a positive impact on the gross margin percentage in quarters 2 through 4?

That is correct. The dollar amount over the course of the year, the change in accounting for the full annual year will have no impact at all on our performance. It's just really accelerating certain expense in the first quarter and that leaves 2, 3 and 4 as improvement.

Okay. And then, just to close the loop on the gross margin. The inventory level you show on the balance sheet now, I assume, reflects the 2 new distribution centers being fully stocked. Could you talk about any potential impact there from better rebates or purchase discounts, freight in, other things that you will get benefits from? And should we just continue to assume that you'll have a more balanced year between gross margin improvement and SG&A leverage overall?

I think, in general, just to speak on the supply chain that we really view this as a positive going forward. And really, there's 3 things that we're really trying to accomplish here with our new supply chain strategy. One is, we're taking control of the freight. So we all know what's going on in the freight market, and by managing it directly, and contracting directly with suppliers or with freight providers in our markets we can better negotiate the contracts. Two, that really allows us and the DCs really play a major role on this, is it allows us to pick the best mode of transportation. Previously, everything went over the roads, and now, we can go intermodal because we have larger quantities shipping into the DCs. And then I think the third item and really kind of the real value created by the DCs is the fact that we can consolidate loads and overall reduce our freight cost. And think of it as all of these suppliers originally shipping directly to half truck loads or pallet quantities to stores, by them shipping directly to our DCs and that's us almost cross-stocking and shipping back full truck loads out to our stores, we really optimize their overall freight cost that we experience. So our whole supply chain strategy is really allowing us to gain better control on rather than being a cost taker really managing this cost directly.

And so just applying on top of that. So what you're seeing in the first quarter is the dilution effects of ramping up the DCs, charging them with product, you also see that in inventory levels. The remainder of the year that becomes a tailwind, but in terms of helping us to achieve better gross margin, but also on the inventory side to be able to work our inventory down throughout the system. So -- and to address the second part of your question, so we still see very good EBITDA margin expansion in 2018, primarily driven by gross margin though we expect to see some SG&A leverage as we go through the full year and as our SG&A gets leveraged through our more meaningful quarters, which are 2 and 3 and then in part 4.

The next question is coming from the line of Ryan Merkel with William Blair.

So want to start with a couple of questions on sales. So it sounds like April is tracking well. Doug, I think you said sales are robust. Could you just give us a little more color there?

Yes. So in the first half of April, we saw the same adversity that we saw in March, quite frankly. But in the second half, we really see now that the season kicks into gear, and as you know, we are still snowing up till mid-April in North and Midwest. But we're seeing the season start, it's kicking into full gear. And we really do -- the underlying market is quite strong. Our contractors have very large backlogs. They got lots of work. They're itching to get out of the year now that the year has really begun. You can see the growth coming through. So we do think we will make up those sales that got pushed and end up with a good solid year for organic growth.

And just a follow up on that. Just help us how does it work? Do you make up most of the lost sales in the second quarter or do you make that up over the course of the year?

We think due to the fact that the delay was so long, it was 3 to 4 weeks, that some of that makeup will probably spill into quarter 3. But we would expect the majority of that makeup to be in the second quarter. So it will play out during the full year. As you know, labor is tight and so there are some constraints there. But we would expect the majority of that to be made up in Q2, but some of it will, we would predict, move into Q3 as well.

And then just lastly, I'll pass it on. Is anything lost for the season when you get a slow start like this?

It really depends kind of how the season develops, kind of when the summer starts, et cetera. But we have -- I've been here 4 years, John Guthrie has been here a long time, these weather delays or swings really do tend to average out. And so there's nothing that we see today that would cause us to feel we've lost any year. I mean, the treatments are going in. The contractors are optimistic. And they've -- some large contractors take vacation in the summer. A lot of them have already taken their vacation. While the season was slow and they don't plan to take vacation in the summer. So they can move things around to adapt to the year. And we feel, at this point, looking at the year, we would predict that we'll get those sales back.

Our next question is coming from the line of Keith Hughes with SunTrust.

Let me ask a little bit of a longer-term question. On Slide 7, it shows a good representation of where you are, I believe it says there's 45 markets where you're in full-line product offering. But within those 45, how many markets are you structured with the market presence in all 4 major product groups that you want to be and it's kind of a model for what the other big MSA's would look like?

Right. That's a very good question, Keith. We have a full-line in those 45 markets. However, there is nuances to the lines of business. For instance, in agronomics, while we're in the market, we really want to be in the market in 2 different ways, in the major markets, let's say, the top 80 -- 80 to 100 markets. We have our smaller stores, we call bolt stores that are out in the neighborhoods, but we also benefit from having agronomic hubs, big locations in the metro area like Atlanta or Dallas, Fort Worth or Charlotte, North Carolina, where we can do full truck load in and out on an agronomic basis, and we can also house erosion control products and other products that are bigger and bulkier. So that's a nuance to the agronomic coverage in a market. If you take all the nuances together, we have structurally what we need in only a handful of markets, let's call it 3 to 5 markets where we have all the pieces. We have full coverage in 45. So actually the opportunity structurally is a bit more than we're showing here. It's kind of complicated nuances, but to answer your question specifically, if we said how many markets do we have, everything that we want, it would be a handful. So there is tremendous opportunity, I think, is the punch line, for us to build out and create that kind of optimal structure to be the one-stop shop in the market, significant competitive advantage over all of our competitors with the tools and resources that our associates need to win.

And you talked in (inaudible) about the opening of the 2 distribution warehouses, I think that brings you to 3 now. Is that going to be enough? Or let me ask it this way, as you look at your growth plans in the future, how long will you be able to -- how many years will you able to support the business out of 3 or are we going to see more of those come out at some point in the future?

Right. Great question. We really think the 3 get us out to the next 3 to 5 years. I mean, it does cover us and it covers us very well. I think as we become a bigger and bigger company, let's say, $5 billion or $6 billion company, we might add a fourth, say in Dallas Fort Worth or somewhere in the center of the country. But we clearly don't need a dozen of these. It's -- if anything, we'll add a fourth in the next 3 to 5 years, but the 3 really gets us where we need to be. And just to clarify these DCs are very large, they support the whole business. The agronomic hubs that I was talking about before that we need in the various markets are quite a bit smaller and we would put them in kind of as the market develops over time.

The next question is coming from the line of Nishu Sood with Deutsche Bank.

So the 70 bps of distribution center impact in gross margins, could you please -- just go into a little bit more specifically how much of that was just a part of the launch process? And how much of it might be recurring on an ongoing basis?

We do not expect on a bps basis that for the rest of the year that it would be a negative drag. I mean -- when we look at our plan, we saw kind of the rollout this year that over the course of the full year to be slight negative -- negative on gross margin, but that was all really realized in Q1. And over the rest of the year, really the advantages of what we did in Q1 should play out with regards to that.

Got it. Got it. Okay, so the 70 bps was really mainly a 1Q event, it sounds like. Okay.

Yes.

The distribution centers, obviously in the past and we've spoken about this before, there is risk associated with the implementation of distribution centers, and I know, obviously you folks have planned, and obviously well aware of that. Where are we at in the risk spectrum at this stage? With the opening of the Pennsylvania Center, are we now past that kind of risk zone? Is it smooth sailing from here? Or is there still further work to be done in terms of making sure everything goes smoothly?

That's a great question, Nishu. Obviously, smooth sailing is all a relative term. But we are well past the high-risk phase. When we did the first DC last year at Fairburn, we used that to work out most, if not all the bugs, in the system. And if you remember, we also implemented our JDA replenishment system at the same time. So last year would have been the year where if things were going to go wrong or we're going to have big problems, we would have those. We -- like any new implementations, we overcame minor struggles, and it's new, so we had to do a lot of training with the field, et cetera. But we really worked all that out last year. We did a lot of retraining, this winter, which was very valuable. And I would say that the California and the Pennsylvania DCs, those startups have gone very, very well. And so we're quite pleased with where we are. I think we are in a zone now of fine-tuning and reaping the rewards and substantially past the risk phase, which was really last year.

Got it. Got it. Good to hear. And just finally on inflation. John, you mentioned to expect 1% to 2% inflation effect. I believe you're referring to revenues in terms of that? Clearly across the broader building and construction space, inflation has been a dominant theme. Can you just kind of dig into that a little bit more? What are you folks, specifically seeing? I mean, obviously, your exposure is to the traditional source of inflation that a lot of other companies in the construction sector are seeing are different. So what are you folks specifically seeing? Freight might be the one that folks might be kind of cross apply to you folks as well. So, maybe, if you can dig into that a little more, please?

We're passing along in the revenue numbers most of the cost inflation that we're seeing. And so when I say 1% to 2% on a revenue line, that's also representative on somewhat of the cost line. And so our plan is, and I think the market is pricing that -- prices that into our business. And so, if we -- a lot of other industries in building products they're seeing much higher inflation rates. And we're not expecting that or forecasting that. If we did see something like that, I think we would raise our pricing revenue number to cover that. But right now, the 1% to 2% coverage is what we're expecting on cost inflation also.

Just to be specific about freight. Obviously, freight costs are going up. Freight is up about 10%. For us, it's about 5% to 6% of our sales, so if you take in on a total, its 5% of our cost -- I'm sorry, so if you take in on the total, that's about half, as 50 basis points on cost. So that gives you a feel for how much of that 1% to 2% is freight. So freight is a significant factor. As John mentioned, we are now in control of more of our freight, and I think what you're seeing with us is that we're managing freight down as freight is inflating. And so our -- the impact to freight to SiteOne is a bit lower than say other more mature players because we've got all these new ways of making freight more efficient. And so it certainly is a headwind and it's a part of our overall forecast of cost, but we also have ways of mitigating that.

The next question is coming from the line of Samuel Eisner with Goldman Sachs.

So, maybe, just following up on that freight point. I just want to better un--, maybe, just go back to John your comments. You're saying that the DC investments, the 70, 80 basis points associated from that are kind of episodic or onetime. Yet, Doug, you just said that the freight inflation is about 10% year-on-year. I calculate that as being 30 basis points of a headwind. So I'm just trying to understand what's actually episodic versus actually ongoing impact to the gross margins going forward?

Well, I think from a gross margin standpoint, normal inflation is passed along and price offsetting it. And so it's not necessarily a headwind from a gross margin percentage basis. What you saw in Q1 was a lot of excess -- extra costs related to the startup combined with the 70 basis points. We're in a very low sales volume period before the spring. So that plays in sort from a percentage standpoint. But we plan on the cost of our supply chain to be -- it has a minor headwind for the full year and that was really built into our plan at the beginning of the year. And most of that cost was really incurred in the first quarter, where I would say a negative headwind to our margin targets.

So just to resummarize, the normal freight -- or the freight inflation that we're seeing, the 10% inflation, we are passing that on, and we just see that as normal course, and we pass that on into the market. The freight was front-loaded. The DC cost of dilution was kind of front-loaded into the first quarter. And that becomes a tailwind for the rest, it kind of balances out through the year to become a net -- very slight headwind, but call it net breakeven and those are the things that are going on with gross margin.

Got it. That's helpful. And, maybe, following up on some of the comments on the full-line offering. It sounds like there is a pretty large opportunity there. I was wondering if you could talk through some of the examples that you guys have had of actually creating full-line offerings when you add hardscapes, when you add nursery. What -- how big do customer wallets grow from, is it 2x, is it 3x, is it only up 10%, 20%. Just trying to understand really the kind of 1 plus 1 equals something larger than 2 equation for when you guys ultimately expand from single line to multiline?

Right. We've been filling in markets. I think when we first got here, the number of markets where we had full-line was about 25. And so we've actually filled in about 20 markets. We have been at it 2 or 3 years. So you can see the rates, it takes a while to get the markets filled in. And if you think about a typical contractor that's doing construction, you look at the market, nursery is 40% of the market; and hardscapes is 15%; maybe 15%, 20% of the market irrigation; 15%, 20% agronomics, et cetera. And so if you look at the product mix of the market, that mimics what our contractors are using. So when you add nursery and hardscapes, which are big parts of the market, you become a much more important supplier to that customer. If you're only providing them irrigation or even irrigation and agronomics before, you maybe had, let's say, kind of 20% to 30% or 40% of their share of wallet when you add nursery and hardscapes. Now you become a much bigger player for that customer. So it's a powerful effect. We see in our full line markets that we're more profitable than our other markets partly because you become more important for this customer, you become more of an important partner, more intimate, you get to know them better, they get to know us better, and we can add more value to them. But also, because you have economies of scale that are local in a market so your sales force, your General Manager, your area infrastructure, if you will, is spread out now over a lot more sales and it gives you those local economies that give you that higher EBITDA percentage. So it works both for the customer, but also for the economics of our business.

Okay. And maybe just, lastly, on the e-commerce pilot. Just any sort of cost that you guys are putting in that we should be aware of? Any early successes? I mean, it sounds like obviously -- maybe it hasn't even been rolled out, so we're not sure of the efficacy yet, but any sort of expenses that we should be anticipating here in the back half of the year as you roll this out?

Well, we called that out, I think in our fourth quarter call, that we are going to spend about $5 million on e-commerce this year. Last year, we spent $2 million to $3 million. I think it was $3 million in total on e-commerce. So it's kind of a couple million more. That year-over-year spend was $1 million in the first quarter, more than last year. So you look at the remaining part of the year, let's call it $4 million against $3 million, so we'll have an additional $1 million spend versus what we spent last year on e-commerce during the remainder of the year. So the biggest effect of that additional investment was in the first quarter where we had the least amount of sales, you'll see the rest of the year had much less dilution. And the pilot is going very well. We're fulfilling orders. We're seeing the customers use the site to do their quotes and to check pricing and all the things that we would expect them to do. It's still early, early days, but so far, it's been a smooth pilot, and we're very, very excited to spread this across the country, and take our service to a new level for the customers, and with our relationship with our suppliers. So we're really excited that it's finally in action, and we're able to use it to start gaining market share.

The next question is coming from the line of Michael Eisen with RBC Capital Markets.

Just wanted to follow up on that previous question. When we're thinking about kind of broader picture, the different buckets you guys are using to generate towards that double-digit margin performance, how should we think about any incremental spending across the different categories coming through? And then should we think of a step down before a material step-up from things like the distribution center and the e-commerce platform going forward?

No, great question. No, we don't see a step down this year at all. We will -- our plan and our forecast would be to continue to march our EBITDA percentage upward. Last year, we were 8.3%, 8.4%, we're headed toward 10%. We think we will achieve 10%-plus in kind of 2019, 2020. And as we mentioned on the gross margin side, we do expect gross margin to expand this year. And on the SG&A side, even though we are investing in the company, we are also reaping the economies of scale on the base business. And that's enough to cover and give us some SG&A leverage for this year, which will increase in '19 and '20. And just to remind you, we've been building the head office and the corporate center and the field support teams. And largely that build is complete. And so we're starting to get the leverage on that as well. So we're still diluting ourselves building the company, making important investments for the future. E-commerce is one of those, barcoding is another one that we're going to invest in this year. But now we're at a point where the operating leverage of the business can cover, we can still get operating leverage on the SG&A side. We are still going to expand gross margins and keep our steady pace to the 10%-plus, and hopefully, beyond as we continue to garner new efficiencies, gain market share and perfect what we have started.

Understood. And that's very encouraging. And then, just transitioning quickly to the M&A side of the business. When thinking about your ability to execute the strategy, how should we think about the pace and kind of the human resource capacity you guys have as the business continues to go and then additionally, when you're looking at some of the conversations you're having here today, has anything changed in the marketplace, whether it be asking multiples, what you guys are seeing as interest rate concerns or any increased competition on the bidding front out in the market?

Yes, on the M&A side, Michael, we see a good acceleration, right. We did 8 acquisitions last year, and I would say, we should expect 10 to 12 this year. We've had a really good start, right. We've done 4 deals in 4 months, about $100 million TKM which is our goal -- subgoal, for the full year. So if you look at the full year, I would say, we did $150 million in 2016. We did $230 million in 2015. We would expect the year to finish somewhere in between, right. So we've got really good momentum. We've got several LOIs in place. We're making more offers. The pipeline is basically getting bigger quarter after quarter as expected. So it's a normal acceleration. The team is built to handle more than that. As you know, Doug and I, [prior] life used to do a lot more than 8 to 12 deals a year. So we built a team that could fully handle as many as 15, right. We don't expect to do 15 acquisitions a year, but that's the capacity that we have today. If we had to move to 20 deals a year, we would have to add some resources incrementally. And then, so very good momentum -- better momentum at this point, this year than we had last year, and a normal multiple, we haven't seen any shun, right. We're going to be -- we remain the -- I guess, the natural consolidator for the industry, the vast majority of our deals are exclusive, and I think when we look at the 26 acquisitions we made over the last 3.5 years, and the ones we're planning to make over the next few months, we really see SiteOne as a great home. So it's not just about the multiple or that kind of thing, it's also making sure that you can integrate correctly, and we've got we think a secret sauce, as far as integrating small, mid-sized, family companies into SiteOne. So really good momentum on that front, Mike.

If I can sneak in, just one more clarifying question. Your [guides] reiterating in the full year guide does not include any of those LOIs or the idea of additional M&A throughout the course of the year. Is that correct?

That's correct. It does not include future deals.

Our next question is coming from the line of Matthew Bouley with Barclays.

This is actually Marshall Mentz on for Matt. On private-label products, I don't think any real mention today. I was just curious where does that initiative stand?

Yes. So we announced our launch of our PRO-TRADE private-label lighting brand, which -- obviously, we have our LESCO private-label brand. In agronomics, we have Green Tech and Irrigation. We're excited to launch PRO-TRADE in the lighting space. It is going well. We did a couple of million sales last year, getting started. We've already done over $2 million in sales on PRO-TRADE and we would anticipate that we'll do say $10 million to $12 million of that this year. So that's a nice new line for us that's doing quite well, it has been very well received in the market. And then, we're planning other private label launches as we go through the year to be announced as we make them available to the market. But it's definitely a strategy. It's going well. We have some nice brands, and a lot of tailwinds. And private label tends to be a nice accretive initiative in terms of gross margin and EBITDA margins. So we're pleased with that as well.

Great. That's helpful. And then, maybe, one for Pascal, just another one on M&A. How do you -- when you're in the market for deals, how do you think about balancing entering new MSAs or markets versus kind of backfilling your footprint to address what you want to do to fill out product suites in given markets?

Yes. The largest opportunities if you go back to that Slide 7, that Doug referred to earlier, is with the new product lines, the product filling, right. I mean, there are 80 markets where we're missing both hardscapes and nurseries. So for an M&A guy, its 160 deals potentially, your eyes are pretty bright. And then if you look, there's another 50 we're missing either. So that's about 200 acquisitions potentially to be done with the product filling, which is a very big priority. However, we still need, right, as Doug, was alluding to earlier, to get a stronger position even in the core product lines like irrigation and agronomics. So you will see some consolidation like we did with Atlantic this year, Hydro-Scape 2016, Green Resource in 2016, great agronomics company that joined us. So new MSA's is probably when you look at those 2 priorities, it'll be probably the last, because if you look at the footprint, the 180-plus MSA's where we are, it covers a fairly big piece of the population. However, from time-to-time, and as you buy a larger company, it might have branches in MSA where we don't have a presence, so that will come with it. And also, we are exploring a few deals where we don't have a presence in the MSA, and the company is doing really well, very profitable et cetera. So, yes, we will probably go from 180-plus all the way to 225 or something like that over time. But the priority is the product filling and making sure we've got the perfect structure to serve our customers in those metros. And it takes a lot of moves, right, several pieces of the puzzle, you need to put together to get that perfect structure or that great structure that we have for example today in Charlotte, Atlanta, Dallas, some other metros.

Thank you. And I guess, just kind of piggybacking on that. Does your rollout of the distribution center footprint help, if you do start to enter these new MSAs that are kind of off your footprint now. I guess, are you better able to serve those, does it make the process easier?

Yes, I would say that the DCs support our entire business to include acquisitions. So -- and just one bit of color to add to what Pascal said, since we are -- normally if you're green fielding and you're going into a new market, it's dilutive and it's somewhat risky. Since we're acquiring into these new markets we're acquiring the team, the relationship, the supplier relationships et cetera, so we get the same synergies that we get in existing market like he pointed out with the DC, with our purchasing power et cetera. But we get a ready-made team that's been in that market for 30 years. And so our acquisition strategy actually allows us to move into new markets quite readily teamed up with the right company, which gives us really good synergies, but the risk is no greater for us than if we're filling in an existing market. So that's an important factor we think that plays to our advantage with our acquisition strategy filling in these markets.

Our next question is coming from the line of Chris Belfiore with UBS.

I'll keep it brief, but just curious if you can kind of provide color, how you think the e-commerce and some other initiatives you guys are working on. I think there was stuff in terms of like field depending on where you guys were -- like the payment and taking orders out in the field. So how that might begin to offset some of the SG&A build as you continue to execute the acquisition strategy? And then just kind of tied to that, with regards to the cost takeout plan that you guys laid out a few years ago, where are we there? I mean, in terms of like what inning are we in, and like what's left to go there?

So to the first question on e-commerce, yes, we are excited that, that will aid us in becoming more efficient. By the way, it will make our customers a lot more efficient, and our suppliers a lot more efficient. So it's a win, win, win. But if you think about our SG&A, 65% or 70% of our SG&A is people related. And the majority of that is in the field, 80% of that's out in the field. So these tools that we deploy to include e-commerce that can make our store associate to more efficient, allow them to serve customers better and, spend less time on administrative type of stuff, looking at pricing and those kind of things is a huge facilitator, it's a huge enabler for us to drive our SG&A. and that's why we're so confident. I mean, we're making investments right now that are dilutive. And we're not yet seeing the benefit of the things that we've been working on to really drive SG&A efficiency. When we look out to 2019 and 2020, with e-commerce in place, with our operational excellence initiatives down the road a bit, our full team here has already been built. We can see very, very nice accretive operating leverage on our SG&A for many, many years to come. So we're in that period. As we've said, we're now in a year where we can overcome the dilution of investments and new tools with the efficiency of things that we've done over the last 3 years and with our team in place. And that will be accretive to EBITDA margin. As we go out in '19 and '20, you're going to see the SG&A side be much more of an adder to our EBITDA expansion. We're up in above 23.5% in terms of SG&A to sales on an adjusted EBITDA basis. We see driving that down into the low 20s. So there's a lot of leverage there to be had. You're not going to see a huge move in 2018. You're going to see a small move. But over the next 3 to 5 years, you will see us drive that cost efficiency in our business. So this is kind of the beginning. We're just piloting tool. We will get to settled in and implement it in the second half. But look forward to reaping the rewards of that and the other things that we're doing, supply chain and otherwise for many years to come.

We have no additional questions at this time. So I would like to pass the floor back over to management for any additional or concluding comments.

Okay. Thank you, and thank you, all again for joining us today. We very much appreciate your interest in SiteOne. Just to thank again all of our associates for doing a tremendous job, helping us build the company and get us to where we are today. We'd like to thank our customers and our suppliers. We are highly intent on causing our customers and suppliers to win as we grow our company. But for our investors, and shareholders, we appreciate your interest. We're excited about our long-term growth and profitability, and we look forward to our next call at the end of the second quarter.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation and you may disconnect your lines at this time.