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Edited Transcript of SITE earnings conference call or presentation 31-Jul-19 12:00pm GMT

Q2 2019 SiteOne Landscape Supply Inc Earnings Call

ROSWELL Aug 1, 2019 (Thomson StreetEvents) -- Edited Transcript of SiteOne Landscape Supply Inc earnings conference call or presentation Wednesday, July 31, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Doug Black

SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO

* John T. Guthrie

SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary

* Scott Salmon

SiteOne Landscape Supply, Inc. - Executive VP of Strategy & Development

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Conference Call Participants

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* Alexander Rocco Maroccia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Damian Karas

UBS Investment Bank, Research Division - Associate Director and Equity Research Associate of Electric Equipment & Multi-Industry

* David John Manthey

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Keith Brian Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Matthew Adrien Bouley

Barclays Bank PLC, Research Division - VP

* Michael Benjamin Eisen

RBC Capital Markets, LLC, Research Division - Senior Associate

* Ryan James Merkel

William Blair & Company L.L.C., Research Division - Research Analyst

* Stephen Edward Volkmann

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the SiteOne Landscape Supply, Inc. Second Quarter 2019 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce you to your host, Mr. John Guthrie. Thank you. Please go ahead.

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [2]

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Thank you, and good morning, everyone. We issued our second quarter earnings press release this morning and posted a slide presentation to the Investor Relations portion of our website at investors.siteone.com.

I am joined today by Doug Black, our Chairman and Chief Executive Officer; and Scott Salmon, Executive Vice President, Strategy and Development.

Before we begin, I would like to remind everyone that today's press release, slide presentation and the statements made during the 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 the 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, we 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 in the slide presentation.

I would now like to turn the call over to Doug Black.

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [3]

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Thanks, John. Good morning, and thank you for taking the time to join us today. The second quarter turned out to be very challenging from a weather standpoint. After a good start in April, we experienced increased rains in May and June versus the prior year in 8 of our 11 regions and in particular in Texas, New England and the Midwest. The combination of bad weather and site labor inhibited our organic sales growth.

We also faced tough a year ago comparables as May and June were our strongest growth months in 2018 with 8% and 9% organic daily sales growth respectively. As a result, we achieved only 1% organic daily sales growth for the quarter.

With that backdrop, I was very pleased that we continued to expand our gross margin and our EBITDA margin during the quarter while adding 3 more terrific companies and producing excellent cash growth from operations. These results demonstrate both the excellent execution by our team and the resiliency of our business model.

With a healthy underlying market, a continued robust pipeline of acquisitions and easier organic growth comparables in the second half, we expect to achieve our performance and growth objectives for the year.

I will start today's call with a brief review of our unique market position, our strategy to deliver long-term performance and growth and some highlights from the quarter, including how our initiatives are contributing to our results. John Guthrie will then walk you through our second quarter financial results in more detail and Scott Salmon will cover our acquisition strategy. At the end of the call, I will discuss the trends we are seeing in our markets and address our outlook for the second half of the year.

As shown on Slide 4 of the earnings presentation, we have grown our footprint as the largest and only national wholesale distributor of landscaping products to more than 540 branches and 3 major distribution centers in the United States and Canada. We began the year with approximately 11% share of the wholesale landscaping products distribution market and are 4x larger than our nearest competitor and larger than 2, 3, 10 combined.

As a wholesale distributor, we benefit from the fact that the landscape market is quite fragmented, with over 3,000 suppliers trying to reach approximately 500,000 residential and commercial landscaping contractors. We serve the market with a robust offering of approximately 120,000 product SKUs. Our size and scale, entrepreneurial and customer-focused culture, broad product range and balanced mix of business across maintenance, repair and upgrade and new construction end markets give us agility in the landscaping market and provide multiple avenues for profitable growth.

We continue to expand our full product line offerings across our MSAs and build our commercial and operational capabilities, which increase the value that we provide to customers and suppliers and give us competitive advantage.

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 themes 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've added 6 businesses so far this year, all of which have expanded our product lines and increased our talent and capabilities in those markets. 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 improve profitability.

To fully realize the benefits of our strategy, we must have best-in-class commercial and operational capabilities. To do this, we are focused on strict initiatives. Of these initiatives, category management and pricing are the most advanced. Supply chain and salesforce performance are in the middle innings. And marketing and e-commerce and operational excellence are still in the very early innings. We expect our commercial and operational initiatives to help improve the value that we deliver to customers and suppliers, expand our margins and accelerate our organic growth throughout the cycle.

Slide 6 shows SiteOne's history and the results from our strategy so far. We are proud of our track record of performance and growth over the past several years even as we have been investing heavily in our IT, category, marketing, supply chain, finance, operational excellence and acquisition teams as well as in our underlying systems' infrastructure, including e-commerce. We are seeing these investments yield results in 2019 and we expect to see benefit from our initiatives over the next several years even as we continue to invest for the longer term.

Our strong gross margin expansion and cash flow in the second quarter is a good example of our initiatives paying off. Both of these outcomes are directly attributable to our new distribution centers, which allowed us to aggressively buy ahead of price increases and more efficiently manage our inventory. Overall, we are still in the middle and early innings of many of our initiatives, and so we remain well positioned to make steady progress toward our stated midterm adjusted EBITDA margin goal of 10% plus, with continued expansion expected in 2019.

Turning to Slide 7. We remain focused on the large opportunity that we have to fill in our full product line capability in every major U.S. and Canadian market. As the graph shows, we have the full product line capability today in only about 50 of our targeted 230 major markets, primarily due to the lack of nursery and/or hardscapes branches. We will continue to fill these in by acquisition while also penetrating new markets and improving our market position through the acquisition of well run irrigation and agronomic distributors.

I will now discuss some of the highlights from our second quarter performance, as shown on Slide 8. We achieved 9% overall sales growth in the second quarter, with 1% organic daily sales growth and 8% contribution from acquisitions. As I mentioned before, the second quarter organic sales started well with 5% organic growth in April, but then it soften in May and June due to the especially wet weather.

In our southern regions, where weather was similar to 2018, we saw mid-single-digit organic sales growth for the quarter. However, in Texas, New England and the entire Midwest, where weather was especially difficult, we saw flat to slightly negative organic sales growth.

Keep in mind that we are operating in a very labor constrained market and so the amount of dry days will continue to have an impact on our organic sales given the inability of our customers to make up the work in the short term. The good news is that we believe the market is still very solid and our customers have plenty of work to do in the second half. Additionally, weather in any particular month tends to balance out during the year, and with our broad geographic and product exposure and the difficult weather we had in the second half of last year, we expect organic sales to balance out accordingly.

We continued to make progress expanding our gross margin in the second quarter with a 90 basis point increase to 34.3%. Acquisitions contributed to our improvement, but we were also able to improve our base business gross margin through excellent management of price versus cost and through our opportunistic inventory buys. We were also able to achieve a 20 basis point improvement in the EBITDA margin with only 1% organic sales growth in the quarter. We achieved this while still investing in bar coding, e-commerce and operational excellence as our teams tightly controlled their expenses.

Our acquisitions slightly enhanced our adjusted EBITDA margin during the quarter. We achieved excellent cash flow in the quarter as we continued to further leverage our DCs and improve our inventory efficiency. Overall, we made good progress despite the challenging weather. We also made good progress on our initiatives during the quarter. Our bar coding pilot in 40 branches has been successful and we have improved our system effectiveness since going live.

We have seen excellent results for our customers with bar coding, in many cases cutting their time in our locations by 50%. We are very excited about the customer service and associate efficiency benefits that will be possible as we roll out bar coding across SiteOne during the remainder of the year and in the first half of next year.

Similarly, we made good progress with our online portal siteone.com, improving our images and item descriptions and creating the capability for our customers to pay online. We are on track to have customers pay their account online in the third quarter and have the Spanish version of siteone.com complete by the end of the year. A very large number of landscape workers, supervisors and owners are Spanish speaking and a Spanish version of siteone.com will improve the experience for these important customers.

We believe that the combination of these exciting new capabilities will increase customer adoption, help separate SiteOne from our competition and facilitate deeper and broader market penetration.

Lastly, in the second quarter, we took the initial steps to pilot and roll out a new transportation management system or TMS. This system will help optimize the imbalance freight of products into our branches and better manage delivery of products from our branch network to our customers. We are excited about the customer service and costs benefits that we can achieve from this new capability.

We continue to execute on our acquisition strategy with the addition of 3 companies during the second quarter and 1 company at the beginning of the third quarter. We are excited to bring aboard these high-performing companies, which add terrific talent to SiteOne and expand our product offering and footprint.

In summary, despite the challenging weather in the final 2 months of the second quarter, we are pleased with our progress on many important fronts. We expect to pick up additional momentum in the second half as we work tirelessly to increase the value that we create for our customers and suppliers, deliver strong financial results and invest in our capabilities for the future.

Now John will walk you through the quarter in more detail. John?

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [4]

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Thanks, Dough. I'll begin on Slide 9 with the income statement for our second quarter results. We reported a net sales increase of 9% to $752 million in the second quarter. During the quarter, we had 64 selling days, which was unchanged compared to the prior year period.

Organic daily sales grew 1% in the second quarter as unfavorable weather negatively impacted sales volume. Organic daily sales for agronomic products, which includes fertilizer, control products, seed, ice melt and equipment, grew 2% for the quarter and 4% year-to-date. Agronomic product sales remained steady due to a strong economy and price increases.

Organic daily sales for landscaping products, which includes irrigation, nursery, hardscapes, outdoor lighting and landscape accessories, grew 1% for the quarter and 1% year-to-date.

As Dough mentioned, 8 out of 11 regions experienced more rain this quarter compared to the prior year period, with the greatest impact in Texas, New England and the Midwest. The Southeast, including Florida, had a slightly dryer spring and generated solid results.

Prices increased 3% year-over-year for both the quarter and year-to-date as cost increases from suppliers have been passed through by the market. We expect year-over-year pricing to increase approximately 2% during the second half of the year as we will be lapping some of the price increases from last year.

With regards to tariffs and the impact on the second half pricing, we have seen a few midyear price increases from suppliers, but nothing substantial.

Acquisitions contributed approximately $58 million or 8% to net sales growth for the quarter. Gross profit increased 12% to $258 million in the second quarter, while gross margin expanded 90 basis points to 34.3%. The improvement in gross margin was attributable to acquisitions which are carrying higher gross margins than our base business, opportunistic purchases of inventory and improved pricing.

As a reminder, it was in the second quarter of last year that the pricing caught up with the largely freight-driven cost increases in the market. While we are certainly pleased with the gross margin results this quarter and for the first half of 2019, we are expecting gross margin to be flat for the remainder of the year as much of the improvements from pricing and early buys have been fully realized. Product mix did not impact gross margin during the quarter.

Selling, general and administrative expenses, or SG&A, increased 15% to $167 million in the second quarter. The increase is primarily due to operating expenses from acquisitions. SG&A as a percentage of sales increased 110 basis points to 22.2%. The increase is attributable to acquisitions which are also carrying higher SG&A compared to our base business, a onetime increase in stock-based compensation, higher health care costs and general wage inflation, all combined with our modest organic growth.

Acquisitions were the largest contributor accounting for over 1/2 of the 110 basis point increase. In the second half, we expect to achieve SG&A leverage on an adjusted EBITDA basis as a result of stronger organic growth, moderating health care costs and the absence of onetime expenses.

For the second quarter of 2019, our effective tax rate was 23.0% as compared to 18.9% for the second quarter of 2018. The increase in the effective rate was primarily due to a decrease in the amount of excess tax benefit from stock-based compensation. Excess tax benefit of $2.9 million were recognized for the 3 months ended June 30, 2019, compared to $6.0 million for the 3 months ended July 1, 2018. We expect our 2019 effective tax rate will be between 26% and 27% excluding discrete items such as excess tax benefit.

Net income was $64.7 million in the quarter, up approximately 3% compared to the prior year. The increase was primarily attributable to net sales growth and improved profitability, partially offset by increased tax expense due to reduced excess tax benefit.

Our weighted average diluted share count was 42.7 million for the second quarter compared to 42.6 million for the second quarter of the prior year. The increase reflects option exercise activity during the last 12 months.

Adjusted EBITDA increased by 11% to $114 million compared to $103 million for the prior year period. Our adjusted EBITDA margin was 15.2%, a 20 basis point increase as the benefit of gross margin leverage was partially offset by higher SG&A.

Now I would like to provide a brief update on our balance sheet and cash flow statement, as shown on Slide 10. As a reminder, we adopted the new lease accounting standard during the first quarter of 2019. Total operating lease liabilities as of June 30 were $216 million with corresponding right of use assets. Of the total operating lease liability, $46 million is reported as a current liability and is reflected in our net working capital, which was $536 million for the quarter.

Excluding the lease liability, working capital for the quarter would have been $582 million, $65 million or 13% increase over the prior year's second quarter result. The increase primarily reflects the additional working capital associated with our acquisitions.

Cash flow from operations was $37 million in the second quarter, a significant improvement compared to $12 million in the prior year period. The increase in cash from operation was primarily attributable to improved working capital management and a smaller increase in receivables due to modest organic growth.

We made cash investments of $29 million for the quarter compared to $23 million for the prior year period. The change reflects increased acquisition investment during the quarter.

Net debt at the end of the quarter was $622 million and leverage was 3.3x our trailing 12-months' adjusted EBITDA, which is an improvement compared to 3.5x at the same point last year and 3.6x during the first quarter. The decrease in leverage reflects our increased profitability. Our long term year-end leverage target is 2x to 3x net debt to adjusted EBITDA. We continue to expect leverage to be in the upper half of that range at year-end.

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 Scott for an update on SiteOne's acquisition strategy.

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Scott Salmon, SiteOne Landscape Supply, Inc. - Executive VP of Strategy & Development [5]

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Thank you, John. As shown on Slide 11, 41 companies have joined the SiteOne family since the beginning of 2014. They added 216 branches to SiteOne and represent approximately $853 million in sales on a trailing 12-month basis.

We have made good progress accelerating our pace of acquisitions over the past 5 years and have closed 6 acquisitions through early July, representing approximately $73 million in trailing 12-month sales.

Now as we turn to Slides 12 through 15, you will be able to find information on our 4 most recent acquisitions. On April 5, we acquired Landscape Depot Supply, a leading distributor of hardscapes and landscape supplies with 3 locations in the Greater Boston and Massachusetts markets. Landscape Depot Supply complements our existing branch network in the Greater Boston market and significantly strengthens our hardscape and landscape supply business there.

On April 24, we acquired Fisher's Landscape Depot, a leading distributor of hardscapes and landscape supplies with 2 locations in Western Ontario. Fisher's Landscape Depot was a natural fit with SiteOne as they add hardscapes and landscape supplies to our existing product offerings in Ontario.

On May 22, we completed the acquisition of Stone & Soil Depot with 3 branches in the Greater San Antonio market. Stone & Soil Depot bolsters our product offering in Central Texas by adding natural and manufactured stone products as well as landscape supplies to our existing irrigation, agronomic, nursery and landscape lighting product lines in that region.

And in the third quarter, on July 3, we acquired the wholesale distribution business of LH Voss Materials Dublin and its affiliates, Mt. Diablo Diablo Landscape Centers and Clarks Home & Gardens, with 5 locations across the East Bay in Northern California focused on the distribution of hardscapes and landscape supplies to landscape professionals.

As we turn to Slide 16, we continue to see a significant opportunity to grow profitably through acquisitions, which allows us to move into new markets, expand our presence in existing ones, broaden our product offerings and add outstanding talent to our team.

Our pipeline remains robust, and with 6 acquisitions year-to-date, our M&A strategy has solid momentum and we continue to build our reputation as the buyer of choice in the industry.

We would like to thank all the leaders of SiteOne, who continue to be 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 expect to close additional acquisitions throughout the year, which should contribute to our growth in 2019 and beyond.

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

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [6]

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Thanks, Scott. I'll wrap up on Slide 17. We continue to see 2019 as a year where we bring together many of our initiatives that we have been working on in order to accelerate our market share gains, adjusted EBITDA margin expansion and cash flow generation even as we continue to launch new exciting initiatives like e-commerce and operational excellence. We will also continue to add terrific companies to our family through acquisition.

The second quarter was certainly challenging from a weather standpoint, which limited our organic growth. However, through solid execution, we are still well positioned to achieve our 2019 objectives with reasonable weather during the rest of the year. Our team is stronger than we have ever been, and as we face various headwinds and market challenges, we continue to gain experience and strength.

In terms of markets, we are still seeing good demand across all of our end markets and our customer backlogs are robust, especially given the limited work days this spring. We anticipate that the market will be steady during the remainder of the year.

Our customers remain very constrained on labor and so as we stated at the beginning of the year, the number of work days available will be an important factor in our organic sales growth during the second half.

Overall, given our balanced mix of business and broad geographic coverage across the U.S. and Canada, coupled with our improving capabilities to gain market share, we believe that we can achieve mid-single-digit organic daily sales growth in the second half of 2019. This level of organic daily sales will support EBITDA margin expansion for the year.

In terms of acquisitions, Scott and his team have done an excellent job building and converting our pipeline and we feel good about our ability to add more companies during the remainder of the year.

Taken all together, we reaffirm our adjusted EBITDA guidance for the year to be in the range of $193 million to $207 million, which represents 10% to 18% year-over-year adjusted EBITDA growth.

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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from David Manthey from Baird.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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First off, I was wondering if could tell us the organic daily sales growth in May and June and any early read on what the trends look like in July?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [3]

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Obviously a significant weather impact there. We have seen the weather normalize in July. Right now, in July, we're running at about 4%, but that is increasing as we've gone through the month. So we feel good that we're seeing that mid-single-digit level come back to us and that's what we think we'll see during the second half.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

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Okay. Doug, I think you cut out there at the beginning. What did you say for May and June?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [5]

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Yes, May and June we're flat -- slightly negative in May.

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [6]

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Negative.

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [7]

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And flat in June.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [8]

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Okay. And John, could you tell us the number of selling days in the third and fourth quarter just for the math?

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [9]

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Yes, I believe it's 63 and 61. 63 in Q3 and 61 in Q4.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [10]

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Got it. And then on OpEx. Just to confirm, you said you can get leverage on SG&A in the third and fourth quarters. You also referenced some onetime costs I believe in the second quarter. Could you give us some more detail on that?

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [11]

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Well, there's 2 onetime costs and we were referencing really the first half of the year. On an adjusted EBITDA basis, we did have a legal settlement we mentioned in Q1. That was a onetime that wouldn't be repeated. And then on a GAAP basis, in addition, in the second quarter, we had a onetime increase in stock comp that obviously wouldn't be reflected on adjusted EBITDA but did impact our GAAP earnings.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [12]

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Okay. But leveraging both 3Q and 4Q you're saying?

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [13]

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Yes, we have a forecast in both of those. And I think it's important to remember is what really hit us in Q2 was the organic growth. Our SG&A on an adjusted basis was less than 3% growth in the base business in Q2 and it would have only been 1% if we wouldn't experience higher -- a large increase in health care cost during Q2. So we feel comfortable that with organic growth coming back down -- or increasing and maintaining what we've been doing in our base business that we'll be able to achieve SG&A leverage in the second half.

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Operator [14]

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Your next question comes from Damian Karas at UBS.

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Damian Karas, UBS Investment Bank, Research Division - Associate Director and Equity Research Associate of Electric Equipment & Multi-Industry [15]

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I would like to ask you about the gross margins. I think you make some similar comments to the first quarter that you kind of realized most of the gross margin improvement for the year, but second quarter came in obviously above your expectations there. I'm just wondering if you could maybe parse out the relative impacts of -- on the gross margin side. You had mentioned acquisitions, the opportunistic inventory buys and the improved pricing. And why you kind of think you'll flatline now this time?

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [16]

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So a little over 1/2 of it is due to acquisitions. And then the remaining is really kind of price/cost, which I would lump together, and the opportunistic buys and with regards to the pricing. I mean we think we'll be roughly flat rest of the year. Acquisitions could contribute positively. We had a really strong Q3 in gross margin last year with regards to that.

So we feel -- we saw some acquisitions coming in, as we discussed. That could move that up or down. But in general, we feel definitely kind of the early buys had played themselves out really through -- and midway through the second quarter most of those gains were complete.

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [17]

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And just a comment. In the second half if acquisitions do increase that number, it tends to increase the SG&A as well, right? So as we see it today, we're calling it flat. We think we'll get good SG&A leverage if acquisitions come in the hardscapes and the nursery acquisitions tend to be at higher gross margin and higher SG&A. You can see those figures move. But overall, the EBITDA improvement is the important part and that's the important part of the forecast.

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Damian Karas, UBS Investment Bank, Research Division - Associate Director and Equity Research Associate of Electric Equipment & Multi-Industry [18]

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Okay. That's helpful. And then just touching back on the daily organic sales and the underlying growth. It seems like volumes must have been kind of down low singles if you're still realizing about 3 to 4 points of price and you alluded to that kind of being about plus 2 points of price in the back half. So is that the right way to think about it? You probably had about a mid-single-digit weather impact in the second quarter from a volume standpoint and now you're looking at more sort of low single-digit volumes and plus the 2 points of price the rest of the year?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [19]

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I think that's a fair characterization of it. And the volume is really -- if you really think about it, a lot of that we believe will be a potential catch up on the demand that wasn't satisfied in the second quarter.

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Damian Karas, UBS Investment Bank, Research Division - Associate Director and Equity Research Associate of Electric Equipment & Multi-Industry [20]

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Okay. And it sounded like from Doug's comments that, that catch up, you just kind of expect it to be gradual and you're not really seeing sort of pent up resurgence here in early 3Q?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [21]

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That's correct. I mean we believe it will be steady. The demand is there. But it's not going to pop, if you will, given the constraints with regards to our customers and their labor.

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Operator [22]

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Your next question comes from Stephen Volkmann from Jefferies.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [23]

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A couple of quick ones here. I guess I'm just trying to think about the impact of the acquisitions coming in with higher growth margins and higher SG&A. And it sounds like, Doug, what you're saying is that the potential acquisitions in the pipeline have similar dynamic in terms of higher gross margin and higher SG&A. So I just wanted to kind of confirm that.

And then just -- if you could just explain. Would you expect the majority of your acquisitions to kind of come in that way? And why would they have higher gross margins than your base business kind of an ongoing basis?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [24]

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All right. Yes, great question. We have different types of business that comprises SiteOne. The irrigation and agronomics side of our business tends to run at kind of reasonable gross margins and lower SG&A. And then you have the nursery and hardscape side of our business, which is heavier trucks, more labor intensive in the yards, has higher operating cost. And so those businesses tend to run at higher gross margin and higher SG&A.

And if you look at our acquisitions -- and more our fill in is occurring across the country -- we do acquisitions in irrigation and agronomics and we've done those this year, but the majority of our backlog and the majority of our fill in is at nursery and hardscapes. So that's come in at about the same EBITDA level. And in the second quarter we saw that, that the acquisitions slightly improved our EBITDA margin. So they're right there with us, a little bit ahead. But because they were mostly nursery and hardscapes, they come in at the higher gross margin and higher SG&A.

So we'll continue to see that as we build out our nursery and hardscapes. We feel like we can improve that SG&A over time. They join our family and we create efficiencies there. We also feel like we can improve the gross margin. But the nature of those businesses is higher on both sides of that equation. It tends to be very similar when you come down to the adjusted EBITDA level.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [25]

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Okay. Great. That's helpful. Thanks. And then can you just give us a quick sort of feel for the 50 end markets where you have the full product line offering? How did those perform in the quarter relative to growth and margin? And just what good looks like -- how good was that during the quarter?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [26]

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Right. Good question. In general, our full product line markets tend to be our higher performers in terms of putting the full package together, leveraging the full might of SiteOne, getting efficiencies out of our branch associates and our area associates, sales and management. And so they tend to run at a higher EBITDA margin and they tend to be our good -- the better performers.

In a quarter like we had in the second quarter, it's really about weather. So in general, that's true. But the weather really affected the second quarter. So we saw on the second quarter is areas of the country that had normal weather, the Southeast, et cetera, they performed quite well and those tend to be more of our full product line markets. Areas of the country where -- the 8 regions where we had really tough weather, whether it's a full product line market or still is not built out really didn't matter. They had a tough time growing. But in general when we see that full product line come together, it just gives us the full synergies and allows us to operate at a more profitable, more successful level.

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Operator [27]

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Your next question comes from Ryan Merkel at William Blair.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [28]

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So my first question. Doug, maybe just remind us about the comparison in August and September because my memory is the comparisons get a little bit easier.

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [29]

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Yes. I mean John can pull up the specific figures. But really the strongest month last year were May, June and let's call the first half of July. And so as you get into August and September...

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [30]

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It is 5% and 3%.

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [31]

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Yes, they settle down to 5% and 3% respectively. So if you remember, September was interrupted by a couple of hurricanes. October and September were kind of -- were weather affected last year. So we do feel like the comparables are quite reasonable and we would expect with reasonable weather this year to be in that mid-single-digit level of growth for the second half.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [32]

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Okay. That's what I thought. And then I just wanted to follow up on the gross margin outlook for the second half. Do you -- are you meaning to say that you expect gross margins to be flat sequentially for the rest of the year from the second quarter? Or are you talking year-over-year you expect gross margins to be flat?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [33]

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We expect year-over-year gross margins to be flat. So -- yes.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [34]

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And then just lastly on 2019 guidance. Should we be thinking more towards the midpoint or do you still think the high end is achievable at this point?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [35]

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We always craft for guidance towards the midpoint being the mean expected. Obviously, there's a lot of things that could sway that to the high end, there's things that could sway it to the low end. So I think the best read would be midpoint and that's the way we think about it.

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Operator [36]

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Your next question comes from Keith Hughes at SunTrust Robinson Humphrey.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [37]

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You had talked earlier in the prepared comments about some SG&A leverage in the second half. Is that going to come from leveraging acquisitions, cost cuts? Any sort of feel and any kind of magnitude of what you think that will look like?

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [38]

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I think it's going to come from just managing our expenses closely, as we really did in the second quarter, and then the fact that we expect SG&A leverage on kind of just -- we continue to manage our expenses at the low levels in our base business and there is some recovery in organic growth, but we should be able to achieve pretty meaningful SG&A leverage.

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [39]

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Yes, in terms of cost out of acquisitions, it takes 2 to 3 years to really -- I mean in the first year of an acquisition, you keep the team. It's business as usual. "Welcome to SiteOne." You get them acclimated to our company, et cetera. And then in years 2 and 3 is when you really start taking that SG&A out. So there's a -- SG&A take out of acquisitions would have been acquisitions we did last year. So there is some of that. But acquisitions we're doing this year, that SG&A doesn't get affected until years 2 and 3.

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Operator [40]

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Our next question comes from Michael Eisen from RBC Capital Markets.

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Michael Benjamin Eisen, RBC Capital Markets, LLC, Research Division - Senior Associate [41]

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Just following up on some of that SG&A commentary you just provided and thinking of the back half of the year some of the investments you guys are making. When can we start to see a more meaningful improvement of SG&A on some of the investments like bar coding, the transportation systems, the mobile app? And what level of growth do you guys need to see in the back half of the year to be able to get that SG&A leverage?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [42]

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Well, starting with the second question first. The mid-single digit that we've signaled, that we think we're going to get mid-single-digit organic growth is what we're expecting and we're expecting SG&A leverage with that. So that's the level. Obviously, if it comes in low single digit as it did in the second quarter, we won't get that leverage.

In terms of the initiatives, they're all ongoing this year. And if you remember -- our initiatives in the past have been more gross margin focused. The ones that you mentioned, the e-commerce, the bar coding and the TMS, those are going to really impact our SG&A. But we're looking at next year before we start to see the full benefits of that. Obviously, we'll be rolling out bar coding this year and next year, but we will get the benefit of that next year.

TMS we'll be rolling out right at the end of this year and in the next year, so we'll get some benefit, but not the full benefit of that. Siteone.com, we're very excited about the improvements we're making there. It's allows customers to now pay on account online, the Spanish version. And so we expect the adoption of that to increase as we really push that hard toward the end of this year and in the next year and that will help.

So we expect to see benefits of those showing up in SG&A next year and obviously for the next several years after that. That's when we really start to drive it down significantly.

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Michael Benjamin Eisen, RBC Capital Markets, LLC, Research Division - Senior Associate [43]

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Got it. Helpful. And then transitioning over to -- the cash flow you guys generated in the quarter was definitely stronger than we anticipated. I mean it looks like a lot of it from working capital management. Can you talk to what some of the initiatives you guys are driving there and what you expect to be -- where you expect to be able to improve in the back half of the year?

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [44]

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We're going to -- we've been working hard at improving our inventory turns I would say with regards to focusing on the key SKUs that drive our business and very judicious in our inventory levels with regards -- have plenty of those inventories that have been also moving out or moving SKUs. I think we've also been better at buying relative to last year with regards to buying the right amount of inventory and the payment of those terms with regard to that inventory improving year-over-year. Receivables continue to be relatively strong. The business is still good. Bad debts still very good. So expect to see some improvement there also this year.

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Operator [45]

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Our next question comes from Matthew Bouley from Barclays.

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Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [46]

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So I wanted to ask just on the volume side. Obviously, you guys have been having success on the pricing side and then volumes were a bit softer, which you attributed to weather. But you have been pushing price and you've seen some additional inflation from the tariffs. I mean are you sensing that the competition is pushing price as well? And accordingly, what's your sense of kind of your share position and volumes versus the market at this point in light of these price increases that you're pushing?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [47]

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Yes. When we raise prices, it's with the market. And it is very important for us to be competitive and we're competitive out there. And our competition is also out there and so we go head-to-head with them, but we remain very competitive at all times. The market in general is pretty rational, pretty responsible about passing through manufacturer price increases and I think that's what you're seeing. The manufacturers raised price. They did at the end of last year and early this year. Those were well announced and those went into the market.

We took advantage of early buys obviously to -- using the DCs to enable us to improve our gross margin. But in terms of taking care of our customers and keeping the price competitive in the market, we do that market by market, and that's a must in order for us to gain market share and be the supplier choice for our customers.

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Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [48]

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Okay. Thank you for that. And then secondly, as kind of you just alluded to, I think you also said earlier that there was some modest increases from the suppliers related to the tariffs, but not significant. Is there any additional opportunity there for -- or have already seen it for you guys to have some of that pre-buying benefit like we saw in the first half again?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [49]

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With regard to midyear price increases, they've been so minimal. I would not expect them to materially impact what we're -- what's going on in the market. We'll have to watch towards the end of this year to see where most of the suppliers and manufacturers in the marketplace would push through prices at the beginning of the calendar year. And we'll -- as we get closer, we'll see where our tariffs are heading and whether there's going to be additional price increases next year. But with regards to suppliers pushing through right immediately additional midyear price increases, we aren't seeing that other than a couple of handful, which are not material.

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Operator [50]

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(Operator Instructions) Our next question comes from Alex Maroccia from Berenberg.

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [51]

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I'm just having some trouble reconciling the adjusted EBITDA guidance you put out. Last quarter you mentioned that to hit the high end of that target, you would need high demand and good weather for the remainder of the year. But given that the weather didn't hold up in Q2 and EBITDA came in a bit lighter than expected -- and additionally, EBITDA is typically about 2/3 of the first half EBITDA if you look at second half EBITDA historically -- what's going to be providing this $100 million bridge between H1 EBITDA and the high end of the guidance?

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [52]

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Yes, I'm not sure -- we'll have to go back and check the math there. But if you look at the shortfall in Q2, it was $4 million, $5 million in EBITDA in dollar terms. And so we were quite -- and so to have 1% organic growth and being able to hit EBITDA, that's only -- that much of a miss to us was quite pleasing to see. And so it's all to play for, for the rest of the year. With reasonable mid-single-digit growth, as we mentioned, gross margins that are similar to last year, with a good SG&A leverage and acquisitions coming in quite frankly and performing quite well, we certainly feel the range is quite doable.

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John T. Guthrie, SiteOne Landscape Supply, Inc. - Executive VP, CFO & Assistant Secretary [53]

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Certainly, the high end of the range requires -- what would require a complete recovery, which we haven't, of the sales volume that we've missed in the first half of the year to get to the top end of the range, which isn't -- we're not missing…

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [54]

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Yes. No, that makes sense. And then the second question is more for Scott. What geographies are you targeting in the acquisition pipeline currently and should we expect a greater number of hardscaples in the latter part of the year similar to the first half? I'm just trying to think about the GM benefit we might see and conversely the increase in SG&A.

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Scott Salmon, SiteOne Landscape Supply, Inc. - Executive VP of Strategy & Development [55]

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Right. Well, I guess I'll start -- our overarching strategy is to look at the top 200 MSAs across the country and trying to build out our product line across those. And when you factor in the -- the timing of any specific acquisition can't be determined. We're not targeting any specific geographies other than executing on that strategy of filling out our product line across MSAs.

As Doug had mentioned earlier, our market share in hardscapes and nursery is lower. So statistically speaking, our pipeline has more of those opportunities available. So it's more likely than not that we will do more hardscape and nursery acquisitions going forward. But also as Doug mentioned, we continue to find good irrigation and agronomic opportunities in the marketplace.

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Operator [56]

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Thank you. There are no further questions at this time. I would like to turn the floor back over to Doug Black for closing comments.

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Doug Black, SiteOne Landscape Supply, Inc. - Chairman of the Board & CEO [57]

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Okay. Great. And thank you all for joining us today. We very much appreciate your interest in SiteOne. I'd like to thank again our team for all the good work in the second quarter and for being a terrific team to work with as we move forward and build a company of excellence.

We appreciate everyone's interest in SiteOne and we're excited about the longer-term growth and profitability that we can achieve as a company. Thank you very much.