SiteOne Landscape Supply Inc

NYSE:SITE

Earnings Call Transcript 2022-Q2

[Operator]

Greetings, and welcome to the SiteOne Landscape Supply Second Quarter 2022 Earnings Call. [Operator Instructions].

I would now like to turn the conference -- the call over to you, Mr. John Guthrie, Executive Vice President and Chief Financial Officer for SiteOne Landscape Supply.

Thank you. You may begin.

[John Guthrie, EVP, CFO & Assistant Secretary]

Thank you, and good morning, everyone. We issued our second quarter 2022 earnings press release this morning and posted a slide presentation to the Investor Relations portion of our website at investors.siteone.com.

I'm 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, Chairman & CEO]

Thanks, John. Good morning, and thank you for joining us today. We were pleased to continue our positive momentum during the second quarter with solid growth in sales and profits, despite strong comparable growth from last year and spring weather headwinds in our northern markets.

Weaker volume in these markets was more than offset by stronger price realization across all markets, coupled with good contribution from acquisitions. We are also very pleased to add 7 new high-performing companies to SiteOne over the last 4 months through acquisition, building our foundation for future performance and growth.

As we enter the second half of the year, we expect prices to contribute less to organic daily sales growth and volume to improve versus the first half of the year against weaker comparisons. Taken all together, with our strong teams, improved capabilities and robust acquisition pipeline, we expect to continue gaining market share and achieve another very good year of performance and growth in 2022, while building our company for the future.

I will start today's call with a brief overview of our unique market position and our strategy for long-term performance and growth, followed by some highlights from the quarter. John Guthrie will then walk you through our second quarter financial results in more detail and provide an update on our balance sheet and liquidity position. Scott Salmon will discuss our acquisition strategy, and then I will come back to address our latest outlook before taking your questions.

As shown on Slide 4 of the earnings presentation, we have grown our footprint to more than 620 branches and 4 distribution centers across 45 U.S. states and 6 Canadian provinces. We are the clear industry leader over 5x the size of our nearest competitor, yet we estimate that we only have about a 15% share of the very fragmented $23 billion wholesale landscaping products distribution market.

Accordingly, our future growth opportunity is significant. We have a balanced mix of business with 64% focused on maintenance, repair and upgrade, 21% focused on new residential construction and 15% on new commercial and recreational construction.

As the only national full product line wholesale distributor in the market, we also have an excellent balance across our product lines as well as geographically. Our strategy to fill in our product lines across the U.S. and Canada, both organically and through acquisitions strengthens and reinforces this balance over time. Overall, our balanced end market mix, broad product portfolio and good geographic coverage offer us multiple avenues to grow and more ways to create value for our customers and suppliers, while providing important resiliency in softer markets.

Turning to Slide 5. Our strategy is to leverage the scale, resources, functional talent and capabilities that we have as the largest company in our industry, all in support of our talented, experienced and entrepreneurial local teams to consistently deliver more value than our competitors to our customers and suppliers.

We've come a long way in building SiteOne and executing our strategy over the last 6 years, but we are still in the third or fourth inning of our overall development as a truly world-class company. Accordingly, we remain highly focused on our commercial and operational initiatives to further build our capabilities and improve the value that we deliver to customers and suppliers.

These initiatives are complemented by our acquisition strategy, which builds in our product portfolio, moves us into new geographic markets and adds terrific new talent to SiteOne. Taken all together, our strategy creates superior value for our shareholders through organic growth, acquisition growth and EBITDA margin expansion.

If you turn to Slide 6, you can see that we have built a strong track record of performance and growth over the last 6 years with consistent, organic and acquisition growth and good EBITDA margin expansion.

Note that we have done this while investing heavily in our teams and in new systems and technologies to build the foundation for SiteOne and to create superior capabilities for our customers and suppliers. We are still building and investing, and we remain confident in our ability to gain market share and continue driving all 3 of our value creation levers going forward.

You will also note that we have now completed 72 acquisitions across the irrigation, lighting, agronomics, nursery, hardscapes and landscape supplies product lines during the last 8 years, with 8 completed so far in 2022. We only acquire well-run companies, and so all these acquisitions were already high-performing companies before joining SiteOne. After they join us, we together enjoy the benefits of our combined commercial and operational capabilities.

Acquisitions are also a key source of new talent and ideas, and therefore, they enhance our competitive advantage as we grow. We're off to a strong start to the year, and our acquisition pipeline remains robust with significant potential to continue growing through acquisition for many years to come.

Slide 7 shows the long runway that we have ahead in filling in our product portfolio, which we aim to do primarily through acquisition, especially in the nursery, hardscapes and landscape supplies categories. We are well networked with the best companies in our industry and expect to continue filling in these markets systematically over the next decade.

I will now discuss some of our second quarter performance highlights as shown on Slide 8. We achieved 12% net sales growth in the second quarter with 8% organic daily sales growth and 4% net sales growth added through acquisitions. The organic daily sales growth was driven by 19% price realization, partially offset by an 11% volume decline. With 26% organic daily sales growth in the first half of last year, driven primarily by volume, we expected volume growth to be negative for the first half of this year.

In addition, we had less favorable weather in our northern markets this year than last year, which significantly affected our growth in those markets. Accordingly, organic daily sales growth were flat during the quarter in our northern markets, stretching from the Northeast across to the Pacific Northwest, including Canada.

Gross margin improved 210 basis points to 37.9% for the quarter, as we continue to benefit from proactive inventory management during this high inflation period. For the first half, gross margin is also up 210 basis points to 36.1%. As a reminder, we had previously thought that gross margin would decline this year without the benefits of price realization that we achieved primarily in the third and fourth quarters of last year. We still expect gross margin to be lower in the second half than last year, but given our strong start and the persistent inflation, we now expect modest improvement in gross margin for the full year 2022.

On the SG&A side, our operational initiatives and disciplined cost management were offset by lower volumes, higher-than-expected fuel and wage expense and our continued investments in marketing, digital and operational excellence. Our recent acquisitions of hardscapes and landscape supply companies also contributed to the SG&A increase as a percent of sales, as these businesses operate with a higher gross margin and a higher SG&A percentage.

Accordingly, SG&A as a percentage of net sales increased by 160 basis points to 22.4%. We expect SG&A leverage to improve in the second half. The combination of good organic sales growth, gross margin improvement and solid contribution from acquisitions allowed us to deliver adjusted EBITDA growth of 16% for the quarter and expand adjusted EBITDA margin by 60 basis points to 18.2%.

Overall, we remain focused on improving our adjusted EBITDA margin as we grow by executing our commercial and operational initiatives and capturing synergies with acquisitions.

In terms of our initiatives, we have continued to make good progress this year. On the gross margin side, we continue to grow with small customers, drive private label growth and improve our inbound freight costs through our Transportation Management System or TMS initiative.

As price realization runs its course this year, we expect these initiatives to allow us to continue driving steady gross margin improvement in the years to come. We also have several initiatives aimed at improving our customer experience while making our teams more efficient, thereby increasing organic growth and improving our SG&A leverage.

MobilePro helps automate branch transactions, while allowing our associates to serve customers from anywhere on the branch site. We can serve customers quicker and more accurately, especially at our larger nursery and hardscapes sites, and our branch associates are more efficient, a win-win. We have recently enhanced the functionality of MobilePro and solved some of the connectivity problems. So our progress in rolling this out across SiteOne has accelerated. By mid-2023, MobilePro should be broadly deployed across SiteOne.

We also are currently rolling out DispatchTrack, which allows us to manage our outbound deliveries to customers and proactively update customers on their delivery status by text. DispatchTrack is a terrific improvement to our customer experience and has set us up to start managing our outbound fleet more efficiently within each MSA. We expect to benefit from these efficiencies in 2023 and beyond.

Additionally, we continue to make great progress with siteone.com as we have added substantial new functionality and capabilities to the site. With these improvements, we are seeing improved customer adoption and increased activity as we move into the second half of the year.

Finally, we are executing numerous other operational excellence initiatives that are focused on enhancing our customer experience and improving our associate efficiency. These projects range from how we answer our phones during the busy parts of the day to how we organize and staff our branches, to how we bid and quote commercial projects. We now have a full-time team in each major line of business, working with the field to isolate pain points and then develop and implement solutions across the company.

In total, we have ample opportunity to improve our customer experience and increase our operating effectiveness and efficiencies, while expanding gross margin in the years to come. On the acquisition front, we added a record 6 high-performing companies to our family during the quarter and 1 more since the quarter closed, bringing the total to 8 so far this year. These companies provide us with excellent new talent and capabilities for growth in their respective markets, while adding approximately $125 million in trailing 12-month sales to SiteOne. Our development teams remain very active in 2022, and we expect to continue adding strong companies to SiteOne in the coming months.

With an experienced and recently expanded team, broad and deep relationships with the best companies, a strong balance sheet and an excellent reputation as the acquirer of choice, we remain well positioned to grow consistently through acquisition this year and for many years in the future. In summary, we are executing strongly in the current environment to build our teams, execute our initiatives, deliver value to our customers and suppliers, add new companies and achieve excellent performance and growth. As we look ahead to the second half, we are confident in our ability to deliver another strong year in 2022.

More broadly, as we look ahead to 2023, which will likely be a tougher year, we remain very confident in our capability to navigate through any market conditions and expect to both outperform the market and with our strong balance sheet, continue to build our company for the future.

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

[John Guthrie, EVP, CFO & Assistant Secretary]

Thanks, Doug. I'll begin on Slide 9 with some highlights from our second quarter results. We reported a net sales increase of 12% to $1.22 billion in the quarter. There were 64 selling days in the second quarter, which is consistent with the prior year period.

Organic daily sales increased by 8% in the quarter, driven by price inflation in response to rising product costs, partially offset by dampened volumes resulting from higher prices, moderating economic conditions and unfavorable weather in our northern markets.

Acquisitions continued to perform well, contributing approximately $45 million or 4% to our second quarter net sales growth. Scott will provide more details regarding our acquisition strategy later in the call.

Geographically, we saw a wide variation in organic sales growth in the second quarter. In the Sun Belt market, we saw solid organic daily sales growth of 17%, but in northern markets, stretching from the Pacific Northwest to the East Coast, we saw no organic daily sales growth. These markets, which faced a tough 24% comp from last year, were negatively impacted by the slow start to the spring and unfavorable weather compared to the prior year. Overall, 7 out of our 9 regions, including all northern markets, had more rain in Q2 2022 compared to a very dry Q2 2021.

Organic daily sales for agronomic products, which includes fertilizer, control products, ice melt and equipment, increased 7% for the second quarter due to strong price inflation resulting from rising product costs, partially offset by reduced volumes from unfavorable weather and higher prices. Prices for agronomic products like fertilizer and grass seed have risen dramatically over the past year. And while price inflation has been an overall net positive to sales growth, we believe the higher prices for products like fertilizer have reduced the short-term demand as our customers feel with constrained maintenance budgets.

In addition, some of our largest agronomic markets are in the north and the combination of the wet weather and a late spring resulted in some lawn care operator reducing rounds of agronomic product applications.

Organic daily sales for landscaping products, which includes irrigation, nursery, hardscapes, outdoor lighting and landscape accessories, increased 9% for the second quarter due primarily to price inflation as prices for products like PVC pipes and drainage remain elevated compared to the prior year.

Price inflation continues to play a major role in the organic daily sales growth for both landscaping products and agronomic products. We estimate price inflation contributed 19% to our organic daily sales growth for the quarter. While we have started to see signs of relief in some of our most volatile products like fertilizer and copper wire, price inflation has been greater and more persistent than we originally expected. We still expect price inflation to moderate in the second half of 2022 as we start to comp last year's price increases, but we expect the magnitude of the reduction to be less than we originally forecasted.

Conversely, we expect volume, while still healthy, to be less than we originally expected as it appears we have come off peak levels due to the combination of weather, higher prices and general economic uncertainty. As we look out to the rest of the year, we expect these trends to continue.

Gross profit increased 19% to $461 million for the second quarter, and gross margin increased 210 basis points to 37.9%. Gross margin during the quarter was positively impacted by supply chain initiatives, price realization and contributions from acquisitions. We continue to expect a gross margin decline in the second half of 2022, as our gross margin improvement initiatives such as private label and small customer growth are more than offset by the loss of the price realization benefit that we experienced last year. However, the amount of the reduction will be less than our original expectations due to the persistent price inflation.

Selling, general and administrative expense, or SG&A, increased 21% to $273 million for the second quarter. SG&A as a percentage of net sales increased 160 basis points to 22.4% due to increased operating expenses supporting our growth, cost inflation and the impacts of acquisitions.

We continue to make investments in our initiatives, including marketing, digital and MobilePro, which we believe will enhance the customer experience and improve the efficiency of our operations. We are also seeing the impact of inflation in SG&A as costs for salaries, fuel, travel and general branch operations have all increased this year.

Finally, our most recent acquisitions have positively impacted our gross margin, but also negatively impacted SG&A due to their higher operating cost structure.

For the second quarter, we recorded income tax expense of $44.8 million compared to $36.8 million in the prior year period. The effective tax rate was 24.2% compared to 23% for the 3 months ended July 4, 2021. The increase in the effective tax rate was due primarily to a decrease in the amount of excess tax benefits from stock-based compensation. We realized $2.4 million in excess tax benefits for the 3 months ended July 3, 2022, compared to $4.8 million for the 3 months ended July 4, 2021.

We recorded net income for the second quarter of $140.7 million compared to $123.5 million for the prior year period. The improvement was primarily driven by our strong sales growth and gross margin improvement.

Our weighted average diluted share count for the second quarter was 45.8 million, which is comparable to the prior year period. Adjusted EBITDA increased by 16% to $222 million for the second quarter compared to $191 million for the same period in the prior year. Adjusted EBITDA margin, reflecting our gross margin improvement, increased by 60 basis points to 18.2%.

Now I'd like to provide a brief update on our balance sheet and cash flow statement, as shown on Slide 10. Net working capital at the end of the second quarter was at $885 million compared to $624 million at the end of the same period prior year. The increase in net working capital is primarily attributable to higher receivables resulting from our strong sales growth and an increase in inventory, reflecting supply chain uncertainty, cost inflations and strategic purchases ahead of cost increases from our suppliers.

Net cash provided by operating activities during the second quarter was $95 million compared to $138 million for the prior year period. The decrease is primarily due to the increase in working capital to support our growth. We made cash investments of $104 million for the quarter compared to $36 million for the same quarter last year. The increase in cash investments reflects our increased acquisition activity during the quarter.

Net debt at the end of the quarter was approximately $436 million compared to $257 million at the end of the prior year period. The increase in net debt reflects higher borrowings to fund the increase in working capital and our acquisition investments.

Leverage at the end of the second quarter increased to 0.9x our trailing 12-month adjusted EBITDA compared to 0.7x at the end of the second quarter of 2021. The higher leverage reflects the increased net debt. Our target net debt to adjusted EBITDA leverage range at the end of the year is 1x to 2x.

At the end of the quarter, we had liquidity of $228 million, which consisted of $50 million of cash and approximately $178 million in available capacity under our asset-based loan or ABL facility. On July 22, after the close of our second quarter, we amended our ABL facility increasing the size to $600 million from $375 million and extended maturity to July 2027 from February 2024. With this amendment, we increased liquidity by an additional $225 million.

In summary, our priority from a balance sheet perspective is to maintain our financial strength and flexibility without sacrificing long-term growth or market opportunities.

I will now turn the call over to Scott for an update on our acquisition strategy.

[Scott Salmon, EVP, Strategy & Development]

Thanks, John. As shown on Slide 11, we acquired 6 companies during the second quarter and 1 company since the end of the second quarter, bringing our total to 8 for 2022, with a combined trailing 12-month net sales of approximately $125 million. Since 2014, we have acquired 72 companies with approximately $1.35 billion in trailing 12-month net sales added to SiteOne.

Turning to Slides 12 through 18, you will find information on our most recent acquisitions. On April 22, we acquired BellStone Masonry Supply with a single location serving the Fort Worth, Texas market. BellStone distributes hardscapes and bulk landscape supplies and builds upon our December 2020 acquisition of Alpine Materials, which also supplies hardscapes products.

On April 28, we acquired Preferred Seed, a leading supplier of agronomics products to landscape contractors in Upstate New York with 1 location in Buffalo.

On June 17, we completed our acquisition of Across the Pond, a wholesale distributor of hardscapes and bulk landscape materials with 1 location in Huntsville, Alabama. This acquisition expands our current presence in the market and our product offering to include hardscapes and bulk landscape supply.

We completed our acquisition of Yard Works, an industry leader in the distribution of bulk mulch and soil on June 22. With 13 locations across Central Virginia, the addition of Yard Works extends the strong market position we established earlier this year in Northern Virginia with the acquisition of JK Enterprises.

On June 30, we acquired Prescott Dirt, a distributor of landscape supplies and hardscapes with 2 locations in Prescott and Prescott Valley, Arizona.

On July 1, we acquired ¦ A&A Stepping Stone, a leading wholesale distributor of hardscapes and landscape supplies with 4 locations in Sacramento, California. The addition of A&A establishes a leading hardscapes and landscape supplies platform in the growing Sacramento market.

And lastly, on July 22, we acquired River Valley Horticultural, a wholesale distributor of nursery, hardscapes and irrigation products with a single location in Little Rock, Arkansas. River Valley establishes a nursery platform for SiteOne in Central Arkansas.

These acquisitions add terrific talent to SiteOne and move us forward toward our goal of providing a full line of landscape products and services to our customers in all major U.S. and Canadian markets.

Summarizing on Slide 19, our acquisition strategy continues to create significant value for SiteOne. The recent expansion of our team has both improved our capacity to source and complete acquisitions and also improve the quality and effectiveness of our integration of these new companies and teams.

Our team of over 60 former owners together with our experienced field leadership create an unrivaled, down to earth, and make it happen culture at SiteOne, which in turn makes us the acquirer of choice for family businesses. Our laser focus on landscape distribution gives these entrepreneurs tremendous confidence that when they join SiteOne, they are joining the long-term market leader who will provide their associates with strong support and nearly endless opportunities for career growth and success across North America.

Heading into the second half of 2022, we are pleased with our M&A momentum and the ongoing strength of our pipeline. We have a highly capable team, an excellent reputation and a strong balance sheet to fund our acquisition strategy in both strong and challenging market conditions.

Taken together, these elements give us confidence that we will add more outstanding companies to SiteOne across the U.S. and Canada throughout the rest of 2022 and for many years to come, as we build SiteOne's capability to provide more value to our customers and suppliers.

I want to thank the entire SiteOne team for their passion and commitment in welcoming the newly acquired teams when they joined SiteOne. Their leadership and efforts are the key to our long-term success in building our company.

I will now turn the call back to Doug.

[Doug Black, Chairman & CEO]

Thanks, Scott. I'll wrap up on Slide 20. Following our spring season, which, as we mentioned, was significantly weather affected, we've developed solid momentum as we move through the summer and into our important fall season.

Volume has been less negative in July than in the second quarter, and sales growth has remained in the double digits due to continued price realization. As we lap last year, as John mentioned, we expect price realization to moderate, but we also expect volume to strengthen versus easier comparable growth from 2021. Our customers continue to have solid backlogs of work, and we expect them to remain busy through the end of the year. Overall, the market should provide a reasonable environment for us to execute our commercial and operational initiatives and drive further growth in sales and profits in the second half.

In terms of end markets, we are beginning to see some slowdown in residential new construction, which comprises 21% of our sales. With home price inflation and higher interest rates, homebuilders are seeing less demand and are being more cautious in terms of new starts. We would expect this softness to continue with moderate declines versus prior year.

On the contrary, new commercial construction representing 15% of our sales, has remained strong with healthy bidding activity and large backlogs. Note also that early phase material shortages in concrete and building components have delayed the landscaping phase of new commercial projects, which, in turn, has dampened near-term activity but increased the backlog of work for our customers.

Major repair and remodel, which comprises 27% of our sales, has also remained strong with only a few parts of the country developing some softness. Typically, in a downturn, major repair and remodel has proven to be more durable than new construction, and we expect that to be the case both this year and in 2023. Note that low unemployment and high home values both support the major repair and remodel market.

Finally, the maintenance end market, which comprises 37% of our sales, has remained steady. Again, as John mentioned, our end customers have somewhat fixed dollar budgets for maintenance. And so with the rapid price inflation in products like fertilizer and seed, maintenance customers tend to cut back wherever they can to get through the year.

Looking forward, as prices in these products come down and budgets are adjusted, we should expect volume to recover as customers focus on the longer-term health of their landscaping. Overall, maintenance dollar demand has remained steady, and we expect that to continue.

In total, we expect our end markets to provide a reasonable foundation for us to execute our strategy and gain market share, as we deliver higher value to our customers and suppliers. Accordingly, we continue to expect to achieve high single-digit organic daily sales growth for the full year of 2022, mostly driven by price inflation.

As mentioned, we now expect our gross margin to be slightly higher than last year, offset by SG&A, which will also be slightly higher than last year as a percent of sales.

Accordingly, we expect our adjusted EBITDA margin to be similar to 2021. In terms of acquisitions, as Scott mentioned, we have a strong pipeline of high-quality companies and look forward to adding more of these to the SiteOne family during the year.

Our acquisitions are performing very well, and we continue to improve our ability to integrate them into our company. Accordingly, we expect acquisitions to contribute strongly to our performance and growth in the remainder of 2022 and the years ahead. With all these factors in mind, we are increasing our expectations for fiscal 2022 adjusted EBITDA to be in the range of $440 million to $460 million, which represents year-over-year growth of 6% to 11%. This range does not factor any contribution from unannounced acquisitions.

In closing, I would like to sincerely thank all our SiteOne associates who continue to amaze me with their passion, commitment, teamwork and selfless service. We have a tremendous team, and it is an honor to be joined with them as we deliver increasing value for all our stakeholders.

I would also like to thank our suppliers for supporting us so strongly and our customers for allowing us to be their partner.

Operator, please open the line for questions.

[Operator]

[Operator Instructions]. The first question comes from the line of Ryan Merkel with William Blair.

[Ryan Merkel, William Blair & Company]

I wanted to start with the comments that higher price is hurting growth. Can you just unpack what you mean there?

[Doug Black, Chairman & CEO]

Yes. I think there, Ryan, we're referring particularly to the maintenance piece of our business. As we described earlier, the maintenance budgets are fairly fixed, both maintaining facilities, et cetera. And when prices go up to the extent they have, they use some short-term tactics to get through and save here and pinch there, seed, fertilizer, et cetera.

When prices revert back, they come back and go back to maintaining the long-term health of their properties, right? So there is some price elasticity in that market. And given the significant run-up in prices, we're seeing some of that softness. So that's what we're referring to in terms of kind of price-driven demand dynamics.

[Ryan Merkel, William Blair & Company]

Okay. Saying that will correct itself as some of the commodity prices come down?

[Doug Black, Chairman & CEO]

Right. That's traditionally what we see is that, prices come back down, they're able to spend and use the volume that they need to maintain what they're trying to maintain. So that tends to correct. So you could call that an upside for possibly for next year on the volume side.

[Ryan Merkel, William Blair & Company]

Got it. And just to be clear, weather was the biggest impact to growth in the quarter or was it the higher prices because you listed that first in the press release, so I just wanted to clear that up?

[Doug Black, Chairman & CEO]

Yes. Yes. I mean the price is kind of a more minor component. Obviously, the weather was a big impactor. And we saw that improve. April and May were particularly difficult. And we exited the quarter at 8%. The volume was down 11% for the quarter. We exited at 8% down. We're seeing kind of 5% to 6% down in July. So that's kind of corrected.

And really, all of that dynamics going on in those northern markets from the Northeast across to the Pacific Northwest, including Canada, as we mentioned, those were flat, while we saw a 17% growth in the Sun Belt.

So -- and when I say flat, flat overall, including the price increase. So it was a pretty difficult spring versus a very good -- the weather was very good last year. So we had that dynamic going on.

[Ryan Merkel, William Blair & Company]

Okay. That's helpful. And then it looks like volumes will be down low single digits, maybe mid-single digits in the second half, which is an improvement. So is that -- well, improvement from 2Q. Is that just easier to compare and weather more normal?

[Doug Black, Chairman & CEO]

Right. If you look at last year, the first half was driven almost, primarily by volume of our growth. And remember, we had 22% growth for the full year, 11% volume growth, pretty much all that volume was in the first half. And then the second half was flat to slightly up last year. And so obviously, you've got that easier comp. And so we would expect to -- volumes to continue to strengthen, be less negative, if you will, in the second half as we move through the third and fourth quarter.

[Ryan Merkel, William Blair & Company]

Got it. Maybe just lastly on gross margin. The guidance implies a run rate of about 34% in the second half. I know you're not guiding to '23, but is 34% a fair run rate as we look forward, there's a lot of questions out there and distribution land about where gross margins will settle out in '23 and when inventory profits come out of the numbers? Any help there would be appreciated.

[John Guthrie, EVP, CFO & Assistant Secretary]

I think if you look at our guidance in the beginning of the year, it had kind of a baseline of 34%. I think that, that certainly will give more as we get closer, but that certainly was in our guidance at the beginning of the year from that standpoint.

[Doug Black, Chairman & CEO]

And that was the low end, I mean, we guided 34% to 34.5%. And that's where we thought it would reset this year, Ryan, and that's probably where we think it would go when you get -- when the price piece goes out. Keep in mind, however, that every year, we do acquisitions, and we're doing a lot of hardscapes and landscape supplies acquisitions.

Those come in at a higher gross margin, also higher SG&A, similar EBITDA range. So you've got that factor. So if you take a couple of years of that, you got to factor in some improvement there just through acquisitions when it comes to gross margin.

[Operator]

The next question is from Stephen Volkmann with Jefferies.

[Stephen Volkmann, Jefferies]

My question is around your comment, Doug, that '23 is setting up to be a tougher year. So I guess maybe that's something around residential, but I don't want to put words in your mouth. So maybe just a little bit of detail about sort of big picture how you're thinking about '23?

And then the follow-on there at the same time is what's the playbook for a tougher year? Is there work you can do on SG&A or do you think acquisition activity can accelerate? Is there inventory reduction? Just kind of what are the moving pieces in a "tougher year?"

[Doug Black, Chairman & CEO]

Right. No, thanks for the question. The context of a tougher year, I'll take it market by market. Obviously, let's start with new residential is 21% of our sales. It's likely that new residential could be softer than it is this year, right, and that would be a headwind.

If we look at new commercial, new commercial has been strong. The backlogs are good. The bidding activity is good. So we actually feel pretty solid about new nonresidential and that's 15% of our sales. We model 27% of our sales, our model has been strong. We expect that to be, I'd call it, solid, but the growth could be less than this year. We don't know, but we'd expect it, it could be a little bit softer.

And then we look at maintenance, maintenance tends to be steady in any kind of market. And in fact, as I mentioned, volume-wise, there might even be a little upside if commodity prices come down, think of it as maintenance budgets in a dollar sense are stable, right?

So if commodity prices come down, then volumes could come up and offset. So when you take all that together, we're not here to call to 2023 yet, but we think it certainly is -- it doesn't look like it's going to be a terrible year, but being cautious and realistic it could be more difficult than this year.

The other thing that's happening in this year is obviously we have this price realization, right? And we don't expect that next year, right? So in essence, we'll have to deal with the missing price realization. You've got gross margin that we thought was going to reset this year, that would happen next year. So those dynamics are going on. So when you add that up, it would be a more challenging year than our record year this year. I mean we're going up on a terrific year that we had last year.

How we deal with that? When we go into markets or in periods where, say, volumes might be declining or things or we've got headwinds, we're going to still drive through with our commercial operational initiatives which are going to help improve our gross margin. Also, they're going to help our SG&A leverage, right? So that's a natural benefit for us.

We're going to be prudent about if markets are soft in particular parts of the country, which is likely to be, it's likely not to be a kind of a broad softening, then we know how to pull back in those markets. We can -- labor is a big part of our SG&A, and we can trim the team and stop hiring and do fine in terms of trimming the team and bringing that in.

And then, of course, we've got acquisitions, which you mentioned, which we plan to continue to invest in all types of markets. So that's going to fill in some of that. So that's how we would see the end markets. We really have 1 end market, roughly 21% of our business that's likely to be softer.

The others seem solid. And then we've got lots of, I guess, arrows in our quiver to respond to those market types, headwinds that we get. And acquisitions are always going to be there to kind of keep us growing, keep building the foundation and mitigate some of that. So we feel good about our company and our ability to perform really whatever -- however the market reacts next year.

[Stephen Volkmann, Jefferies]

Got it. Okay. That's super helpful. Just a quick follow-on, on the pricing, since you mentioned it. Do we get positive impact of carryover pricing in '23 or do you think that sort of deflation in certain kind of products might kind of offset that? Just how should we think about inflation in '23?

[John Guthrie, EVP, CFO & Assistant Secretary]

Well, we'll have to see. Obviously, it's been more persistent this year than last year. We were, if you remember, in our original guidance, in the second half of this year, we were thinking some of the commodities that might come off more dramatically.

I think, still just looking long-term, there is the potential for that what we will call roughly 20% of our business that reprices fairly regularly. Some of that may come down in the future, might be expected with regards to fertilizer and PVC pipe to the ones we've talked about a lot.

We don't -- some, I think, fertilizer in the second half of this year will come off of its peak, but they'll be elevated at a pretty high level kind of compared to where we were 2 years ago. We're seeing copper wire come off, some of those prices weaken a little bit right now.

But how far they come down I think we're going to have to see as we get closer to the year. But there's certainly -- some of the items peaked, I think, in the second quarter and are coming down a little bit, and that's built into some of our guidance.

[Doug Black, Chairman & CEO]

We do think that the other 80% will be -- kind of be solid, and it will hold, we might get additional price increases there, but we feel good about that other 80% being kind of solid, holding. Obviously, manufacturers will continue to monitor costs and -- but the other 80% really has been in catch-up mode, and we would expect that to continue.

[Operator]

The next question comes from the line of David Manthey with Baird.

[David Manthey, Robert W. Baird & Co.]

First off, John, I don't know if you gave it, but price and volume breakdown across agronomics and landscape products, if you could provide that to us?

[John Guthrie, EVP, CFO & Assistant Secretary]

We don't split it out completely like that. I think it would be fair to say based upon what Doug mentioned, what we're seeing with regards to agronomic products that it's greater in that line than it is in the landscape products and what I mentioned is kind of the fixed volume component.

[David Manthey, Robert W. Baird & Co.]

Okay. Yes, fair enough. And then definitionally here, when you talk about the 27% that's major repair and remodel what do you think in terms of discretionary versus nondiscretionary in that business? How much of that is sort of responding to something? And how much of it is just deciding you want to do a project? And related, when you talk about new construction specifically, are you talking about selling into a structure that was just built or could that also be someone who's putting in a new outdoor kitchen that never had one before. Just definitionally, if you could help us with those?

[Doug Black, Chairman & CEO]

Right. So to take the latter, new construction is a home that's just built, right? The new kitchen in the backyard, that's major repair and upgrade. We would classify those major repair and upgrade.

When you look at the major repair and upgrade, we get asked a lot, what's discretionary and what's nondiscretionary? I think that's -- we could debate that all day. But I think what's more important and what drives it. And typically, what drives it is jobs, home equity and those kind of things.

And there is a degree of housing turnover, right, that when new homes are sold or whatever the new owner comes in, wants to do something different, right? So those are the drivers. And it's actually a strange, when we're talking about next year and maybe new res going down and a recession, et cetera, but with low unemployment, I haven't been in many recessions with low unemployment.

And with housing, so it is a strange situation because there's low unemployment, everybody's got jobs. You still have this stay-at-home effect is in place. So you have a lot of white -- it's particularly white collar workers that are fully employed. They're living at home, they still want to do stuff at their home.

Their home value is up, so they've got plenty of home equity. So those typically drive strong repair and remodel. And so we'll have to see how it goes. But we're cautiously optimistic that repair and remodel will stay strong because of those factors, which I think -- we think are the drivers of that market. So we'll have to see. But certainly, the foundation is there, and we'll see how the market goes.

[Operator]

[Operator Instructions]. The next Question is from the line of Matthew Bouley with Barclays.

[Matthew Bouley, Barclays Bank]

Can I ask on the SG&A side? Yes, I know you mentioned several factors that drove sort of the deleveraging in the quarter despite the strong, I guess, price inflation you had. I'm curious, I guess, number one, if you sort of quantify those pieces that drove the deleverage and maybe if there's anything additional perhaps on the weather and staffing and incentive side that plays into that? And obviously, what I'm really getting at is sort of your view to the second half of the year and the ability to sort of improve the leverage side with SG&A?

[John Guthrie, EVP, CFO & Assistant Secretary]

Yes. So with regards to some of that SG&A, first, I'll say, acquisitions of the 160 basis points probably accounted for 40 to 60 of that increase in SG&A. Those are businesses that are coming in with higher basis.

And about 20 basis points of that, I would say, is -- would be removed on an adjusted basis. We had some onetime costs with regards to that. So I would say 40 kind of more through run rate on acquisitions and then 20 of it was the basis point.

Then with regard to it, I mean, wages probably made up of the remaining 90 to 100. Wages made up probably half of it, but we're seeing higher cost with regard to fuel in our delivery fleet. We've continued to invest in IT. We've continued to get our people out. Travel budgets are up with regards to that. So I would say those were the primary components. Fuel, I see some of our -- the investments in our initiatives and then just overall kind of wage inflation combined has driven up SG&A.

We do not think, in the second half, while we will say some, we're right now would be forecasting it to be not as great an impact as what you saw in the first half, though the acquisition component will probably carry, if not expand, with some of the -- our flurry of activity we've had most recently.

[Matthew Bouley, Barclays Bank]

Got it. That's great color. And then just a second quick one, just on customers and inventories. I guess this is kind of skewing to the medium-sized and larger sized customers. But I guess, to what degree are your customers able to hold sort of excess inventory? And do you suspect over these past few months that there was any overordering going on at customers that could now result in some destocking?

[Doug Black, Chairman & CEO]

No. I mean the capacity for them the whole inventory is not great. You do get some buying. We have EOP programs and stuff that were combined, can move around, but that's particularly in the early part of the year. So at this point, we wouldn't have a sense that there's significant inventory that our customers are holding or are sitting on. So yes, they're going to continue to buy kind of hand to mouth as they go through the rest of the year.

[Operator]

The next question is from the line of Keith Hughes with Truist.

[Keith Hughes, Truist Securities]

Yes. I just wanted to go back to some of the pricing questions. You talked about declines coming in some of the agronomic products. Are you starting to see prices in sprinkler pipe? Is it starting to come off and how quickly is...

[John Guthrie, EVP, CFO & Assistant Secretary]

We're not -- we are not seeing that in, I would say, irrigation, hardscape. We're not seeing really a significant reduction in our cost or anything being passed through to the industry right now.

[Keith Hughes, Truist Securities]

Okay. And that would -- would that apply hardscapes as well?

[John Guthrie, EVP, CFO & Assistant Secretary]

That would imply hardscapes as well. Almost all of our product lines other than the specifics on copper wire, I know is one that we've seen, and I think for fertilizer will be less of those two.

[Operator]

The next question comes from the line of Mike Dahl with RBC.

[Michael Dahl, RBC Capital Markets]

Doug, just wanted to ask on the second half volumes a little bit more. So less negative in the second half. It sounded like 2Q is the biggest issues were in the northern markets, but as you've gotten into July and then your expectations were still negative volume in the second half, has that broadened out across your markets in terms of volumes turning negative? Or is that still a broad comment around just not seeing the recovery in those northern markets?

[Doug Black, Chairman & CEO]

Yes. I think the northern markets have come back some, but they certainly aren't matching the strength we see in the Sun Belt. So we're just being cautious. Now it could be more positive, right, as things continue to develop because as I mentioned before, volumes last year were kind of flat to slightly up.

And we'll see how we do, right? We like the trends we see so far, as I mentioned, through June to July. We'll see how that continues. But the trend of the kind of the northern markets being softer than the south of the Sun Belt have continued, though we've seen some recovery in the northern markets. The southern markets have remained pretty steady in that kind of strong mode.

[Michael Dahl, RBC Capital Markets]

Okay. And my second question, just a follow-up on Matt's question around inventories. It seems like there's some destocking going on in the retail channel around certain products, obviously, retail would carry -- you carry a lot more in different products, but when you're looking at your inventory balances up a bit, some of that's M&A, some of that's inflation, but how are you thinking about managing your inventory as you go into year-end against what you've characterized us and discussed about potentially seeing a tougher 2023 trends?

[John Guthrie, EVP, CFO & Assistant Secretary]

We think our inventories will be coming down, just normal seasonality. I think one big thing to realize is it's because of the uncertainty in the supply chains and the lead time that were coming from the suppliers, every distributor, and ourselves included, had to bring in more inventory just because we weren't -- so there was so much great uncertainty on when we could restock. It's not a type of product issue, it's just we are carrying more because we didn't know when the next ship was coming or the next delivery was coming from our suppliers.

And so if we could get it, we wanted within our DCs or in our stores. What we've seen most recently is that those requirements and those lead times from suppliers will not -- nobody would say all supply chain issues have resolved themselves, but they're getting significantly better, almost across the board. So what we -- we normally have a seasonal takedown.

But in addition to what we're doing is we're taking out those extra lead times that cause that extra safety stock and that allows us to pull down inventories to more kind of what I would call our normal stocking level that is necessary to replenish our stores and our customers.

[Operator]

The next question is from Jeff Stevenson with Loop Capital.

[Jeffrey Stevenson, Loop Capital Markets]

Congrats on the nice quarter.

[Doug Black, Chairman & CEO]

Thank you.

[Jeffrey Stevenson, Loop Capital Markets]

So with eight acquisitions year-to-date, that's in line with the total number you did last year. And I'm just wondering what's driving the increased pace of acquisitions? Is there more motivated sellers in the market or is it some of the internal initiatives you guys have been doing?

[Scott Salmon, EVP, Strategy & Development]

Yes. Good question, Jeff. This is Scott. I don't think there's been any specific macro drivers that are pushing sellers to the exits. I think it has more to do, as we mentioned a few quarters ago, we intentionally strengthened our team to both increase our capacity to source and close deals. But equally as importantly, to improve our focus and execution of integrating companies after closing.

And those actions have played out very well for us on both fronts. Acquisitions, by their nature, can't be neatly forecasted, and so you can get some, call it, hot streaks and dry spells. But I think the bottom line for SiteOne is we have better capacity than we've ever had, and we feel really good about our strong momentum going into the second half and moving into 2023.

[Doug Black, Chairman & CEO]

Yes. And it is amazing how as we've added capacity of our quarters that go out and kind of find and talk to companies that, that we're still discovering as big we are and as ubiquitous as we are, we're still discovering great companies that kind of hidden gems, if you will. And it's just when you've got more folks out there, you tend to turn up more activity and so we're seeing some of that as well, as Scott mentioned.

[Operator]

The next question is from the line of Andrew Carter with Stifel.

[William Carter, Stifel, Nicolaus & Company]

One thing I wanted to ask about is you kind of, over time, mentioned that the hardscape locations nursery, the higher SG&A, but they're also higher margin. How do those items kind of index towards kind of the more discretionary aspects, new construction? And from a mix perspective, if you had some weakness in new construction, would that be difficult to kind of overcome kind of at the EBITDA level?

[Doug Black, Chairman & CEO]

No, great question. I'll take hardscapes first, which -- most -- if you noticed, most of our acquisitions are hardscapes and landscape supplies, that's very much pointed at the repair -- major repair and remodel market.

The landscape supplies part of that is really more maintenance, if you will, molds, soil, et cetera. So we love the fact that we're growing in those areas because they're really pointed at the more durable parts of the market. Nursery would be kind of more new construction. So that's a line there. But that's how those product lines play out.

[Operator]

The next question is from Damian Karas with UBS.

[Damian Karas, UBS]

Lot of ground covered. I appreciate all the details. Just a few follow-ups. Doug, you mentioned earlier, major remodels been more stable in past market downturns compared to new construction. I guess just thinking about trends from the last few years, hasn't repair and upgrade actually been a bit more of a growth driver than new construction for you? And I would think that, maybe just opposed to what you've seen in prior cycles?

[Doug Black, Chairman & CEO]

Right. No, I mean the professional repair and remodel market has been very strong, right? I mean there's no doubt about it. It's been a big driver of growth. My comment was on a traditional market and a traditional downturn. So if you go back to the great downturn or typical downturns, repair and remodel is going to come down roughly half of new construction.

But I don't think we're in a typical market, right? As I mentioned, we're in a low unemployment market and with high home values. And so those typically drive repair and remodel. So we'll have to see, but it certainly is a market that we embrace. The outdoor living trend is real.

COVID put real emphasis on that, but it's going to continue long term, stay-at-home lends itself to repair and remodel. So lot of things pointed at that sector that caused it to drive long-term growth. And so we like it, and we're going to continue to build that as a part of our end market portfolio.

[Damian Karas, UBS]

Understood. And just a follow-up on the price-sensitive portion of maintenance you spoke to. I would think you could only defer maintenance activity so long. So I guess, regardless of whether some of these prices -- ag prices start coming down, is there pent-up demand that simply needs to happen? I mean how long can those short-term tactics last?

[Doug Black, Chairman & CEO]

Right. No, you're right. And we would think on an annual basis that there is some pent-up demand there and some need to kind of catch up and go back to normal. So yes, we think there's potential upside there as we look forward possibly in the second half but into next year.

The spring, we did lose some rounds, I think, as John mentioned, and you don't get that back, but it's upside for the next year because if the weather is more normal next year, those applicators are going to go do those rounds. So yes, but I think there's some potential upside there that we'll see how it plays out, but that -- while it hurts us this year, there could be some upside for next year.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Doug Black for any closing remarks.

[Doug Black, Chairman & CEO]

Okay. Great. I know we're running over, but thank you all for joining us today. We really appreciate your interest in SiteOne. We're excited about our company, and we look forward to building it and working with you as we go forward. And we look forward to speaking with you again next quarter.

A final thank you to our great associates for doing such a great job of helping us build SiteOne. Thank you very much.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.