SiteOne Landscape Supply, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended July 1, 2018; comparative periods ended July 2, 2017. Unaudited. Amounts are in millions except per-share data.
Business context and reporting period
SiteOne is a wholesale distributor of landscape supplies serving professional customers through more than 520 branches, primarily in the U.S. Sales are seasonal and typically strongest in the second and third quarters. The company reported results amid substantial acquisition activity, including seven acquisitions completed in the first half of 2018.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $687.8 | $608.6 | $1,059.2 | $943.6 |
| Gross profit / margin | $229.9 / 33.4% | $202.4 / 33.3% | $338.4 / 31.9% | $303.3 / 32.1% |
| Operating income / margin | $85.8 / 12.5% | $77.1 / 12.7% | $65.2 / 6.2% | $65.2 / 6.9% |
| Net income / margin | $63.1 / 9.2% | $44.2 / 7.3% | $46.1 / 4.4% | $33.7 / 3.6% |
| Diluted EPS | $1.48 | $1.07 | $1.08 | $0.82 |
- Q2 sales rose 13%; first-half sales rose 12%. Organic daily sales increased 5% in Q2 and 4% in the first half. Acquisitions contributed $48.4 (8%) to Q2 sales growth and $76.3 (8%) to first-half growth.
- First-half operating cash flow was negative $28.4, versus negative $31.7 a year earlier. Cash used in investing was $78.1, including $67.3 for acquisitions and $8.0 for property and equipment. Financing provided $107.0. Ending cash was $17.1.
- At July 1, cash was $17.1; working capital was $516.6. Gross debt was $584.0, comprising $236.6 under the asset-based credit facility and $347.4 under the term loan; reported debt net of issuance costs and discounts was $573.1. Capital lease obligations were $14.7.
- ABL availability was $84.0, down from $162.0 at December 31, 2017. ABL interest rates ranged from 3.85% to 5.75%; the term loan rate was 4.85%. The company reported compliance with debt covenants.
Material changes versus the prior comparable period
- Q2 gross margin edged up 10 basis points, attributed primarily to category management initiatives. First-half gross margin declined 20 basis points, reflecting higher freight and supply-chain costs, new distribution centers, and customer-loyalty revenue timing under the new revenue standard.
- Operating expenses rose 15% in both Q2 and the first half, outpacing sales growth; the company cited additional staffing and costs for acquisitions, e-commerce, and supply-chain initiatives. Operating expenses as a share of sales increased in both periods.
- First-half operating income was unchanged at $65.2 year over year, while net income increased. Lower tax expense drove much of the improvement: the first-half effective tax rate was 8.9%, versus 35.7%, reflecting the 2017 Tax Act’s lower corporate rate and $9.0 of excess tax benefits.
- Interest and other non-operating expense increased to $14.6 for the first half from $12.8, due to higher debt levels and interest rates. Debt increased as the company funded acquisitions.
Outlook, commentary, risks and unusual items
- No specific full-year revenue or earnings guidance is provided. Management expects cash from operations and available ABL capacity to be sufficient for operations, expected capital expenditures, and debt service over the next 12 months.
- Management cited strength in repair-and-upgrade and construction markets; agronomic product sales also benefited from a later spring, price increases in response to cost inflation, and stronger ice-melt sales in the first half. The company continues initiatives targeting procurement, pricing, inventory planning, freight efficiency, and branch productivity.
- Key risks include seasonality and adverse weather, construction-market cyclicality, product-price inflation and supply availability, inventory and working-capital demands, acquisition integration, labor and operating-cost pressures, competition, and substantial variable-rate debt. ABL borrowing capacity depends on eligible receivables and inventory; covenant breaches could restrict borrowing or accelerate debt.
- Interest-rate swaps covering $174.0 of notional term-loan borrowings are scheduled to become effective in March 2019 and mature in June 2021. Counterparty failure could eliminate the intended hedge benefit. The company also noted provisional accounting for some Tax Act effects.
- Environmental remediation liabilities were estimated at $3.8, with company exposure capped at $2.4 under an indemnification arrangement; a $1.4 indemnification asset was recorded. No material litigation was reported.
- Four acquisitions completed after quarter-end were described as not material and not expected to significantly affect the consolidated financial statements. The company expects adoption of the new lease standard in 2019 to significantly increase lease-related balance-sheet assets and liabilities; income-statement effects were still being evaluated.
Most important facts for investors to verify
- How much sales and earnings growth is organic versus acquisition-related, and whether acquired businesses deliver expected integration benefits.
- Whether seasonal working-capital outflows, especially receivables and inventory, convert to operating cash later in the year, and how ABL availability changes.
- The impact of higher borrowing and interest rates on debt service, liquidity, and covenant headroom.
- How much of the unusually low first-half tax rate and higher net income reflects recurring operations versus tax-law effects and excess share-based compensation tax benefits.
- Whether margin and cost trends improve as freight, new distribution centers, and strategic investments affect results; also monitor weather and construction-market demand.