SiteOne Landscape Supply Inc

NYSE:SITE

Earnings Call Transcript 2019-Q3

[Operator]

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

I would now like to turn the conference over to your host, John Guthrie, Chief Financial Officer.

Please go ahead, sir.

[John Guthrie, executive]

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

[Doug Black, executive]

Thanks, John. Good morning, and thank you for joining us today. As we expected, the good weather in the third quarter, balanced with a very challenging weather in the second quarter, providing our customers with increased workdays and allowing them to complete some of their backlog of jobs. Accordingly, we're able to deliver a strong 7% organic daily sales growth, which puts us on track to deliver mid-single-digit organic daily sales growth for the full year. Further, we achieved good EBITDA margin expansion and strong free cash flow during the quarter as our teams continued to execute our initiatives and as our acquisitions performed to plan. Finally, we added 2 more terrific companies to the SiteOne family and another one at the start of the fourth quarter. Overall, it was a solid quarter and the results demonstrate both the excellent execution by our team and the strength of our business model. With a healthy underlying market, continued execution and a strong contribution from acquisitions, we expect to achieve our performance and growth objectives for the year.

I will start today's call with a brief overview of our unique market position, our strategy to deliver long-term performance and growth and some highlights from the quarter. John Guthrie will then walk you through our third quarter financial results in more detail, and Scott Salmon will cover our acquisition strategy. At the end of the call, I will discuss some of the trends that we are seeing in our markets and address our outlook for the balance 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 with more than 550 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 through 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 the 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 we provide to customers and suppliers and give us significant 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 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 excellent talent to our teams and expand our branch network across the U.S. and Canada. We've acquired 8 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 6 initiatives. Of these initiatives, category management and pricing are the most advanced. Supply chain and sales force performance are in the middle innings, and marketing and e-commerce and operational excellence are still in the 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 long term. Overall, we are still in the middle and early stages of many of our initiatives, and so we remain well positioned to make steady progress towards our stated mid-term adjusted EBITDA margin goal of 10%.

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 approximately 50 of our targeted 230 major markets, primarily due to the lack of nursery and/or hardscape 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 highlights from our third quarter performance, as shown on Slide 8. Overall, we grew net sales by 13% in the third quarter with a nice balance of 7% organic daily sales growth and 7% growth from acquisitions. Our organic sales growth strengthened throughout the quarter, with September being our strongest month. Furthermore, we saw good organic daily volume growth come through at 5% with the remaining 2% due to price inflation. We have mentioned before that the weather moves volume around from quarter-to-quarter, but tends to average out during the full year. The second and third quarters of this year are a good example of this. On a year-to-date basis, we are now at 4% organic daily sales growth.

Our gross margin in the quarter was flat at 33% on a year-over-year basis, which was in line with our stated expectation, given the very strong gross margin outcome in the third quarter of 2018. Year-to-date, our gross margin is up 80 basis points with solid base business improvement and significant benefit from acquisitions. We continue to see benefit from our gross margin initiatives, which include pricing, category management and supply chain. We expanded our adjusted EBITDA margin by 40 basis points in the third quarter due to strong organic growth, good SG&A leverage and good acquisition performance. I was very pleased that for the second quarter in a row, our base business SG&A increased by only 3% on an adjusted EBITDA basis, despite our ongoing investments in siteone.com, barcoding and our new transportation management system. On a reported basis, we achieved 90 basis points of SG&A leverage as a percentage of net sales.

Going forward, with siteone.com, barcoding and operational excellence, all expected to improve our SG&A productivity. We believe that we can continue to achieve SG&A leverage with reasonable organic sales growth. Even with the strong sales growth in September and higher inventory levels to support a robust fall season, we achieved excellent free cash flow in the quarter by further leveraging our DCs and improving our inventory efficiency. At this point, we expect free cash flow to exceed net income for the full year. We also made good progress on our initiatives during the quarter. With siteone.com, we successfully piloted pay online with our customers and are in the process of rolling this improved capability out across the country. We also made further progress on our images and data and on the Spanish version of siteone.com, which we plan to complete by the end of the year.

For barcoding, we are continuing to roll this out and now have mobile customer checkout capability in 60 branches. We are achieving excellent efficiency improvements for our customers and our associates with barcoding and plan to aggressively implement mobile checkout in another 150 branches before the spring season starts next year.

Finally, we moved into full development mode with our transportation management system during the third quarter and are excited about the inbound freight savings and the outbound customer delivery benefits that we expect to achieve with this new system in 2020. We expect all of these initiatives to increase the value that we deliver to customers and suppliers while helping us to expand our adjusted EBITDA margin and drive organic sales growth in 2020 and beyond.

We continue to execute on our acquisition strategy with the addition of 2 companies during the third quarter and 1 company at the very beginning of the fourth quarter. We are excited to bring aboard these high-performing companies, which add outstanding talent to SiteOne and expand our product offering and footprint. Note that our acquisitions year-to-date have been smaller in size, averaging approximately $10 million in sales each. The average revenue for companies currently in our pipeline of potential deal is $15 million to $20 million. And so, like the weather, we would expect this to average out over time. Our current backlog of deals would support this belief.

In summary, we delivered strong result in the third quarter and are pleased with our progress on many important fronts. We continue to work hard to increase the value for our customers and suppliers while delivering strong financial results and investing in our capabilities for the future.

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

[John Guthrie, executive]

Thanks, Doug. I'll begin on Slide 9 with the income statement for our third quarter result. We reported a net sales increase of 13% to $653 million in the third quarter. During the quarter, we had 63 selling days, which was unchanged compared to the prior year period. Organic daily sales increased 7% in the quarter and 4% year-to-date. Organic daily sales for landscaping products, which includes irrigation, hardscape, nursery and landscape accessories, was strong, growing 8% during the quarter and 4% year-to-date. Landscaping product sales benefited from favorable weather and strong demand due in part from the backlog of work, resulting from the challenging weather we had in the first half of the year.

In a reversal of last quarter's results, 9 of 11 geographic regions had fewer rain days in the third quarter of 2019 compared to the third quarter of 2018. Organic daily sales for agronomic products, which includes fertilizer, control products, seed, ice melt and equipment remained steady, growing 3% for the quarter and 4% year-to-date. Prices increased 2% in the quarter compared to the same period in 2018 and 3% year-to-date as the cost increases from suppliers have been passed through by the market. We expect year-over-year pricing to increase 1% to 2% for the fourth quarter, resulting in a 2% to 3% increase for the full year. With regards to tariffs and pricing, we do not expect to see any additional impact during the rest of the year. Acquisitions contributed $39 million or 7% to net sales growth for the quarter. Gross profit increased 13% to $215 million in the third quarter. Gross margin remained flat at 33% for the quarter, which was in line with expectations. We faced a tough comparison to Q3 last year and most of the improvement from pricing in early buys were fully realized in the first half of the year. Product mix did not impact gross margin during the quarter. Year-to-date, we've increased gross margin 80 basis points to 33.1%. Selling, general and administrative expenses, or SG&A, increased 9% to $165 million in the third quarter. The increase in operating expenses was primarily attributable to acquisitions as SG&A growth for our base business was only 3% year-over-year on an adjusted EBITDA basis. SG&A as a percentage of sales decreased 90 basis points to 25.3%, reflecting good expense management and operating leverage.

For the third quarter of 2019, our effective tax rate was 21.9% as compared to 7.4% for the third 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 benefits of $2.2 million were recognized for the third quarter of 2019 compared to $6.3 million for the third quarter of 2018. We expect our 2019 effective tax rate will be between 26% and 27%, excluding discrete items that has excess tax benefit.

Net income was $34.6 million in the quarter, up approximately 16% compared to the prior year. The increase was primarily attributable to the sales growth and improved profitability partially offset by increased income tax expense. Our weighted average diluted share count was 42.8 million for the third quarter compared to 42.7 million for the third quarter of the prior year. The increase reflected option exercise activity during the last 12 months.

Adjusted EBITDA increased 18% to $70.5 million compared to $60 million for the prior year period. Our adjusted EBITDA margin was 10.8%, a 40 basis point improvement from prior year.

Now I'd 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 at the end of the third quarter were $228 million with corresponding right-of-use asset. Of the total operating lease liabilities, $47 million are reported as current liabilities and are reflected in net working capital, which was $516 million for the quarter. Excluding these lease liabilities, working capital for the quarter would have been $563 million, a $50 million or 10% increase over prior year's third quarter amount. The increase primarily reflected the additional working capital associated with our acquisitions.

Cash flow from operations was $76 million in the third quarter, an improvement of $6 million over the prior year period. The increase in cash from operations was primarily attributable to improved working capital management. We made cash investments of $16 million for the quarter compared to $62 million for the prior year period. The change reflected a reduction in acquisition investment during the quarter, due in part to the smaller size of our acquisitions. Net debt at the end of the quarter was $566 million and leverage was 2.9x our trailing 12-month adjusted EBITDA, which is an improvement compared to last year's third quarter leverage of 3.3x. The decrease in leverage reflected our increased profitability combined with flat year-over-year debt levels. 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.

[Scott Salmon, executive]

Thanks, John. As shown on Slide 11, 43 companies have joined the SiteOne family since the beginning of 2014. They added 218 branches to SiteOne and represent approximately $865 million in sales on a TTM basis. We have made good progress accelerating our pace of acquisitions over the past 5 years and have closed 8 acquisitions so far this year, representing approximately $85 million in TTM sales.

Now as we turn to Slides 12 through 14, you'll be able to find information on our 3 most recent acquisitions. On July 3, we acquired Voss Materials with 5 locations across the East Bay in Northern California, focused on the distribution of hardscapes and landscape supplies to landscape professionals. On August 30, we acquired Trendset Concrete Products, a leading distributor of hardscapes products with a single location in the greater Seattle market. Trendset is a great fit with SiteOne, expanding our already strong hardscape business in Seattle. And in the fourth quarter, on September 30, we acquired Design Outdoor, a hardscape distributor with a single location in the greater Reno, Lake Tahoe market. This is a new market for us, and we are very excited to add them as part of the SiteOne family.

As we turn to Slide 15, 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 add outstanding talent to our team. Our pipeline remains very deep, and we continue to build our reputation as the buyer of choice in the industry. With 8 acquisitions year-to-date, more than a dozen current letters of intent and offers in negotiation and dozens of active nondisclosure agreements, our M&A strategy has solid momentum. 95% of our deal activity this year has involved exclusive negotiations with sellers. We believe the growing number of successful entrepreneurs who have joined the SiteOne family are a vital element to our continued success and position us to drive growth for many years across what remains a highly fragmented 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 during the remainder of the year.

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

[Doug Black, executive]

Thanks, Scott. I'll wrap up on Slide 16. We are pleased with our third quarter results and remain well positioned to achieve our 2019 objectives. Our teams are executing well and our initiatives are producing good results as we work to increase the value that we deliver to our customers and suppliers, accelerate our market share gains, expand our adjusted EBITDA margins, increase our cash flow and build our company for the future, both organically through new systems, processes and talent and through acquisition. We continue to benefit in the short-term from a solid underlying market and expect the market will remain steady during the remainder of the year, supporting mid-single-digit growth. Keep in mind that our customers remain very constrained on labor, and so the number of workdays available will be an important factor in our organic sales growth during the fourth quarter. So far, in October, the weather has been good, supporting our outlook for mid-single-digit organic sales growth. In terms of acquisitions, Scott and his team along with our field leaders, have done an excellent job in building and converting our pipeline of high-quality companies. As he mentioned, we currently have a very strong backlog of deals and feel good about our ability to add more companies during the remainder of the year and into 2020. Taken all together, as we enter the fourth quarter, we are maintaining the midpoint of our adjusted EBITDA guidance for the year at $200 million, but tightening the range from our original $193 million to $207 million to our new range of $197 million to $203 million, which represents a 12% to 15% year-over-year growth or 14% growth at the midpoint.

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]

[Operator Instructions] Your first question comes from the line of David Manthey with Baird.

[David Manthey, analyst]

First of all, so we understand the P&L dynamic ahead. I assume that you expect most of your operating leverage to come from SG&A from this point forward. Could you talk a little bit about your expectations on gross margin? I'm thinking over the next couple of years here, could gross margin, depending on pricing and mix, actually flatten out or go down a little bit in future years? Just some thoughts on the complexion of the P&L.

[John Guthrie, executive]

We think there is still opportunity available on gross margin. As Doug mentioned, with regards to TMS, one of our initiatives with regards to it, private label, another initiative we have going there is future opportunities. Certainly, if you look over our past history, gross margin has been a primary driver of our growth, but -- and we certainly think it will be much more balanced going forward. But there is still opportunity on the gross margin front going forward.

[Doug Black, executive]

Yes. Specifically, if you're looking at the fourth quarter kind of finishing out this year, we're probably more in the flattish, like we were in the third quarter, given the strength of the first half. But if you look ahead into future years, there is -- yes, we expect our EBITDA margin expansion to be pretty well balanced between gross margin improvement and SG&A leverage.

[David Manthey, analyst]

Okay. Okay. And then just quickly on acquisitions, the Trendset acquisition. Am I right in assuming that was about $2 million in contribution this quarter. And then Trendset and Design Outdoor, those both roughly that $5 million, $6 million, $7 million in annualized revenues?

[Doug Black, executive]

Yes. I think if you take them together, it was $10 million to $15 million of annualized revenue. And so you can do the math. Those are -- they're up in the upper northwest. And so you're going to get some seasonal aspects, not much contribution in the fourth and first quarter, most of their business in the second and third quarter.

[Operator]

Your next question comes from the line of Ryan Merkel with William Blair.

[Ryan Merkel, analyst]

A couple of questions. So first off, I just want to pick up on the October commentary, Doug. So is October tracking sort of 5% plus, just given you have good weather, and I think the comparison is still fairly easy? So maybe just a little color there.

[Doug Black, executive]

Yes. I mean, as we mentioned, October has gone well for us. So we think, as we stated, we're set up to hit that mid-single digit. September, as the third quarter evolved, September was the strongest month of the third quarter. We would probably anticipate that October would be the stronger month of the fourth quarter. So -- but overall, we're very confident that we can finish out the year strongly on organic sales.

[Ryan Merkel, analyst]

Got it. Okay. And then secondly, 7% organic growth is a pretty solid number. Just wondering, was this mostly boosted by an easy comparison last year? Or did you see some pent-up demand from the bad weather we had last quarter? And then maybe initiatives are starting to kick in and maybe there is an extra share gains in this quarter? Just trying to understand that strong 7% a little bit better.

[Doug Black, executive]

Right. No, great question. And it's difficult to bifurcate it completely, but we really think the underlying market that we're in right now is a mid-single-digit market. So to the extent that we outperform that, there is a bit of catch up. Weather wise, as we mentioned, the weather was net better in the third quarter of this year than it was last year. And then there is a bit of a share gain. We feel good about how we're evolving as a team. We get stronger every year, and we're gaining more market share this year than we did last year. We expect to gain more market share next year than we did this year. So I think that's how we think about it. The more we dissect the numbers, underlying market is mid-single digit, and weather can move that around up or down. And then on top of that, we have some share gain going on.

[Ryan Merkel, analyst]

Got it. That's helpful. Let me just sneak one more in on gross margin, just to clarify. I think fourth quarter has an easy comparison. And so should we expect margins still flat year-over-year? Is that what you're saying? Or is there still -- is there a chance that margins could be up year-over-year? Just a little color there would be helpful.

[John Guthrie, executive]

I think we would say that we think they'll be roughly flat. I mean there could be a little upside on that with regards to it as Q4 is not as tough a comparison as Q3 was. So there may be some upside, but we're thinking -- compared to especially relative to what you saw in the beginning of this year that margins will be a little -- it would be a minor, if it is up relative to what we saw in the first half.

[Operator]

Your next question comes from the line of Matthew Bouley with Barclays.

[Christina Chiu, analyst]

This is Christina Chiu on for Matt. My first question is on what you're expecting in acquisitions for the fourth quarter, noting that year-to-date acquisitions of $85 million are a bit lighter than previous guidance, comprising roughly 7% to 13% of annual revenue?

[Scott Salmon, executive]

Yes. We wouldn't see the pace as slowing. We have a very strong backlog, and we still expect to close more deals in 2019. Historically, as you said, we've acquired 7% to 13% of TTM sales, and we'd anticipate being on the low end in 2019. However, as with the weather and a lot of things seasonally, that would -- we'd expect that to balance out over the years and in 2020.

[Christina Chiu, analyst]

Got you. And then just operationally, given your focus on SG&A leverage, at what stage are you tracking on your investments in supply chain and marketing? And for the branches that have seen the rollout, have customers received some of these investments? And do you have an idea of the long-term effect?

[Doug Black, executive]

No, great question. In terms of our overall investment, we're now on kind of an even pace year-to-year. We're making investments constantly in building the business, but we made investments last year and in the year before. And so we're tracking along with those. In terms of the benefits, we're seeing very nice benefits with our barcoding, have the mobile checkout. We're getting customers in and out faster that makes our customers more efficient, and it makes us more efficient. So that's -- the early signs of that are very good. Keep in mind that we're still kind of in the pilot early rollout phase, so not enough data to be able to say, hey, we know -- and every branch is going to be able to achieve X, but we're -- let's say, we're very optimistic given what we've seen in the early parts of those pilots in terms of the benefits. Siteone.com, we're also still in the early phase, so hard to tell specifically. But we're excited about the specific efficiencies we see as customers adopt that and put that into their routine for them and for us. So still in the early stages, quite optimistic. We are tracking along to plan, and we feel very good that in 2020, '21, '22, those types of initiatives will help transform our company and with that, give us terrific leverage on the SG&A side and also help us to be a more consistent and more successful market share gainer on an organic basis.

[Operator]

Your next question comes from the line of Damian Karas with UBS.

[Damian Karas, analyst]

So John, you talked about October off to a solid start so far, pretty favorable weather. Could you remind us how much of the fourth quarter is, indeed, concentrated in October historically? And thinking about the 7% daily organic sales growth from the past quarter, would you be able to give us perhaps a little bit of a regional walk across the country on how that looked?

[John Guthrie, executive]

Yes. Well, we gather the data -- the specific numbers -- on the first question, let me just -- the second question. So I will say geographically, every region that was up across the country, the -- probably the strongest geographic regions were here in the south, partly because we did face some inclement weather, especially in September of last year. So from that standpoint -- but we were pleased that there wasn't any problems with any problems with any region being down during the quarter. And so we were pleased with good geographic growth across the base. With regards to the amount, about 45% to 50% of our sales is in October typically.

[Doug Black, executive]

That's the fourth quarter.

[John Guthrie, executive]

The fourth quarter.

[Damian Karas, analyst]

Great. That's really helpful. And a follow-up question is on SG&A. So you guys mentioned the 90 basis points of leverage there in the third quarter and did talk a little bit about kind of longer term, how you're thinking about that. But looking at the fourth quarter, is that kind of 90 basis points or thereabouts, how we should be thinking about the SG&A leverage? Are there any specific factors that you're expecting out of this year related to comps last year that would, perhaps, suggest otherwise?

[John Guthrie, executive]

Well, I think you can kind of back into the number from our guidance. But I think 90 basis points is, in general, going to be a little more difficult to achieve, just given the fact that we have, in northern markets, in November and December, you have a low sales volume. So you're really trying to manage that cost and a little of the uncertainty in the fourth quarter is really when the winter begins in the northern market as we manage it down. So the guidance kind of gives where SG&A will be and then from that perspective, it's tougher to give SG&A leverage without the sales volume in the northern markets.

[Operator]

Your next question comes from the line of Mike Dahl with RBC Capital Markets.

[Christopher Kalata, analyst]

This is actually Chris Kalata, on for Mike. So my first question, could you just talk to some of the puts and takes to your 4Q guide, given the performance this quarter and M&A backlog. I would think that would imply some upside there?

[Doug Black, executive]

Could you ask that again. You were cutting in and out.

[Christopher Kalata, analyst]

Sure. Can you hear me now?

[Doug Black, executive]

Yes, much better.

[Christopher Kalata, analyst]

Okay. So my first question, could you just talk to some of the puts and takes to your 4Q guide, given the performance this quarter and the M&A backlog. I would think that would imply some upside there?

[Doug Black, executive]

Yes. Well, at this point of the year, it's really about organic sales. So upside would be stronger sales, downside would be less sales. So that's the real factor that would provide any variance in the fourth quarter. We've got pretty good line of sight on our SG&A and on our gross margin. In terms of acquisitions, when you add acquisitions this late in the year in the fourth quarter, especially if they're in the north, they could lose money, right? Because they move into loss-making months in December. If they're in the south, they'll contribute a bit. So we never count on any kind of contribution. We'll -- they will contribute sales and working capital, but in terms of profits, you're not going to get much contribution late in the year from acquisitions.

[Christopher Kalata, analyst]

Got it. That makes sense. And then just for my second question, just on your pricing outlook. It looks like you're expecting a sequential decline next quarter. So I was wondering if you could provide some additional details on what's driving that? And then separately, it looks like the Department of Labor recently increased the national salary requirements for exempt employees. So I was wondering if you could maybe touch on that. And if you're expecting or seeing any impact to demand or pricing power as a result of that?

[Doug Black, executive]

No. In terms of pricing, I think, we're thinking 1% to 2%.

[John Guthrie, executive]

Yes. We've been running -- we started the year at 3% and then it would come down to 2%, and it's been trending down. I mean we've been, I think, between like 1.9%, honestly in September. And the general trend is because in Q4 of last year, we saw some major price increases, and we're starting to come across a tougher comp with regards to that, and that's all that's driving that down. So we were, honestly, really pleased this quarter because of the fact that the 7% was largely a volume growth and not just price.

[Doug Black, executive]

And just to clarify, that's 2% up, not 2% down.

[John Guthrie, executive]

Yes. Yes. We're not going down, but sequentially, the increase is going from 2% -- between 1% and 2% is what the expectation is.

[Operator]

[Operator Instructions] Your next question comes from the line of Alex Maroccia with Berenberg.

[Alexander Maroccia, analyst]

Just a couple for me. So typically, you've seen in the past, gross margins get a slight uptick from these hardscape acquisitions. However, year-over-year, you were flat, and you still had some hardscapes acquisitions in Q3. Was there anything pushing that gross margin number down in the quarter?

[John Guthrie, executive]

I think the biggest thing was we faced a tougher comp. I mean acquisitions did have a slight positive contribution, but we had a slight negative contribution from customer mix and some incentives from our suppliers, all expected with what we were -- with our outlook even from the beginning of the year.

[Doug Black, executive]

Yes. Just to add to context, remember, in 2018, we got behind in the base business on margin in the first half, and we had a significant catch up in the second half. So we're comping against that. This year, we had a significant improvement in the base business. As John mentioned, we were slightly negative in the third quarter. Fourth quarter is a bit easier comp. And so the acquisitions are what caused that to be flat. Going forward, we still expect acquisitions to increase our gross margin, given the mix of the hardscapes and nursery acquisitions.

[Alexander Maroccia, analyst]

Okay. Great. That will make sense. And then I was just interested to see that the Tahoe market, kind of your first new market over a year, nearly a year rather, do you think it's -- you'll be looking to acquire more in that market or organically in-fill it? And then how are you approaching some of these other greenfield markets around the country?

[Doug Black, executive]

Well, I mean, good question. Yes, we always prefer to go into a new market with an acquisition. And so obviously, we cover most of the markets today, and we've got a lot of fill in to do within our existing markets. But we're quite happy when new markets come up. If you remember, we did acquisition, I think, it was earlier in the year and last year, Auto-Rain in Spokane, that was our first move in to Spokane. So every year, we're going to hit -- we're going to catch a couple of new markets when sellers are ready to sell in those markets, and it's certainly part of our strategy. In terms of Reno, Lake Tahoe, that's a pretty hot market. Lot of folks moving in, and so that's a terrific market to get into to help our overall organic growth.

[John Guthrie, executive]

And it also helps us expand that just -- it's hardscapes location, but also an opportunity to tap into those customers and also expand on the irrigation and mix side -- agronomics, side.

[Doug Black, executive]

Yes. That's a good point, John. I mean that's the beauty that we carry all the product lines. So if you get into a market with one of the product lines, you can follow with the others and create synergies there.

[Operator]

Your next question comes from the line of Keith Hughes with SunTrust Robinson Humphrey.

[Judy Merrick, analyst]

This is Judy Merrick on for Keith Hughes. In 2019, it looks like you had a fairly steady pace with your acquisitions, and they were mostly like hardscapes with higher gross margin, higher SG&A. Would you kind of expand the leverage benefits and SG&A to kind of work off the study pace next year? Or is that just more of a factor of the timing kind of made the diverse locations of these acquisitions?

[Doug Black, executive]

Yes. Just the dynamic is -- yes, so as we -- hardscapes and nursery companies run at a higher gross margin and higher SG&A. So as we acquire those -- a lot of our fill-in is nursery and hardscapes. And so as we acquire those types of businesses and bringing them into the company. When we get SG&A leverage on the base business, that SG&A leverage will be mitigated because you're bringing in a higher SG&A company. So on the gross margin side, our gross margin improvement is improved because you're bringing in higher gross margin. So if you take the base business, and you're getting a certain amount of SG&A leverage, certain amount of gross margin improvement. If you add hardscapes and nursery, your SG&A leverage is going to look less, and your gross margin improvement is going to be greater. And so that's the dynamic that we are seeing this year, and that's the dynamic, actually, we would expect in the next couple of years as we gain market share and fill in more aggressively with nursery and hardscapes. But the good part is they're all equally profitable. And so on a EBITDA, percentage basis, margin basis, there is really no effect. In fact, the companies that we're buying are right in line with where we are. So we're not diluting the overall business. We're just changing the nature of how to get there.

[Judy Merrick, analyst]

Got it. I understand that. And then just in your comments, you said most of the ones this year around -- roughly around $10 million sales, that the pipeline is maybe a little bit bigger. Is that more just a factor of what's available out there that you're seeing? Or just sort of timing of what you're looking at for next year in the size?

[John Guthrie, executive]

It really has to do with the timing of when sellers want to sell. We feel very confident about our backlog and everything from offers and negotiation to the number of NDAs we have out. We're -- again, we don't see any slowing in the pace or any change in the structure of the competition or anything. Over 95% of our deals that we've been working in 2019 have been exclusively negotiated.

[Doug Black, executive]

Yes. And so what you're seeing this year, as I mentioned in the earlier comments, the average companies that we've bought so far this year are $10 million. That's unusual, and so it's all about timing. So it will average out just like the weather that will average out. So if you look at our backlog today, we think the average company in our backlog is about $15 million to $20 million that we're going to be acquiring. So let's say, $17 million, $18 million should be our average. If you look at our average backlog today than we have handshakes or LOIs, it's net above that average, and we would expect that to average. The average won't stay $10 million. It will average back to the, let's call it, the $16 million to $18 million over a period of a -- couple of years or 18 months. So yes, our backlog today is net above average, which is logical balanced out with what's actually come through so far this year.

[Operator]

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

[Doug Black, executive]

Okay. Well, thank you very much for joining us today. We very much appreciate your interest in SiteOne and are very excited about our long-term growth and profitability potential for our company. I would like to take one more opportunity to thank our terrific associates that make everything possible. They're doing a great job, and we look forward to serving our customers, growing our suppliers and be enforced in the landscape industry for many years. Thank you very much.

[Operator]

This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.