Earnings Call Transcript - FERG Q1 2023

Operator, Operator

Good morning, ladies and gentlemen. My name is Daisy, and I'll be your conference operator today. At this time, I would like to welcome you to Ferguson's First Quarter Conference Call. All lines have been placed on mute to prevent any interference with the presentation. At the end of the prepared remarks, there will be a question-and-answer session. I would now like to turn the call over to your host, Mr. Brian Lantz.

Brian Lantz, Host

Good morning, everyone, and welcome to Ferguson's first quarter conference call and webcast. Hopefully, you've had a chance to review the earnings announcement we issued this morning. The announcement is available in the Investors section of our corporate website and on our SEC filings web page. A recording of this call will be made available later today. I want to remind everyone that some of our statements today may be forward-looking and are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Additional information on these matters is also included in our earnings announcement and in our Form 10-K available on the SEC website. Any forward-looking statements represent the company's expectations only as of today. In addition, on today's call, we will also discuss certain non-GAAP financial measures. Please refer to our earnings presentation and announcement on our website for additional information regarding those non-GAAP measures, including reconciliations to the most directly comparable GAAP financial measures. With me on the call today are Kevin Murphy, our CEO; and Bill Brundage, our CFO. I will now turn the call over to Kevin.

Kevin Murphy, CEO

Thank you, Brian, and welcome everyone to Ferguson's first quarter results conference call. On the call today, I'll cover highlights of our Q1 performance. I'll also provide a more detailed view of our performance by end markets and customer groups, before turning the call over to Bill for the financials and our outlook for fiscal year 2023. I'll then come back at the end to share some thoughts on how we're executing our strategy, particularly as it relates to acquisitions, and conclude with some closing remarks before Bill and I take your questions. The first quarter saw our teams deliver another strong performance. We'd like to express sincere thanks to our associates for their remarkable efforts to serve our customers, helping to make their projects simple, successful and sustainable. We've continued to leverage our consultative approach, our scale, our global supply chain, and our strong balance sheet to support our customers' projects. This drove 17% revenue growth, as we appropriately managed and passed through price inflation. We were disciplined with cost to ensure strong profit delivery, with adjusted operating profit increasing 13% and adjusted earnings per share increasing 18%. We've declared a quarterly dividend of $0.75 per share, implying a 9% increase when annualized over the prior year, as we transition away from historical semiannual dividend distributions. Our balance sheet is strong, and we continue to execute our strategy of investing for organic growth, consolidating our fragmented markets through acquisitions, and returning capital to shareholders. On the M&A front, we were pleased to welcome one acquisition during the quarter and two subsequent to quarter end. I'll touch on acquisitions in more detail later, but these bring annualized revenues of approximately $270 million. We're proud of these results, which came in as we expected, and we're confident in the strength of our business model as we go forward. Turning to our performance by end markets in the US, demand remained robust across our markets with growth moderating slightly as we came up against increasingly challenging comparables. We continue to take share across both residential and non-residential end markets. Residential, which comprises just over half of our US revenue, saw solid growth. While new residential growth has started to slow, repair, maintenance and improvement has been more resilient. Our residential revenue grew approximately 15%. The pace of non-residential growth eased from quarter four due to tough comparables, but grew by 20% over the prior year with broad growth across commercial, civil, and industrial end markets. As we've discussed previously, we will continue to focus on maintaining our balanced end market mix, and while we expect growth rates will fluctuate over time, we seek to maintain this healthy balance. Turning next to revenue growth across our largest customer groups in the US. All customer groups saw growth in the quarter despite challenging comparables. Residential trade grew by 15% and building and remodel grew over 20% with strong repair, maintenance and improvement activity. HVAC where the majority of our business serves the residential end market grew by 18% with a two-year stack of 41%, while residential digital and commerce grew very modestly against a strong comparable as we've seen a slowdown in the do-it-yourself consumer. Waterworks continued to deliver very strong revenue growth of 27% driven by price inflation on top of a prior year comparable of 50%. The commercial mechanical customer group continued to grow and within other non-residential industrial, fire and fabrication, and facility supply businesses saw strong growth. It's through these nine customer groups that we achieve broad and balanced end market exposure. In aggregate, this allows us to serve our customers' needs in a more holistic way and bring more value to the total project. Let me now hand over to Bill, who will take you through the financials in a little more detail.

Bill Brundage, CFO

Thank you, Kevin. And good morning or afternoon, everyone. Net sales were 16.6% above last year, with growth rates slowing through the quarter as expected. Organic growth was 12.7%, with price inflation stepping down from Q4 to Q1 to 15%, indicating a small volume decline in the quarter. Acquisitions contributed 2.7% to revenue with a further 1.5% from an additional sales day, partially offset by a 0.3% adverse impact from foreign exchange rates. We were pleased to deliver gross margins of 30.5% in line with Q4 but down 80 basis points over the prior year as expected. This was driven primarily by strong prior year comparables during a period of rapid commodity price inflation and supply chain constraints. Tightly controlled costs partially offsetting the year-on-year gross margin decline enabling us to deliver adjusted operating margin of 10.9%. Adjusted operating profit of $864 million was up $97 million or 12.6% over the prior year. Adjusted diluted EPS grew by 18% driven principally by the growth in adjusted operating profit as well as the impact of our share buyback program. Our balance sheet remains strong at one times net debt-to-adjusted EBITDA. Moving to our segment results, the US business delivered another solid performance. We continue to take market share with net sales growth of 17.4%. Organic revenue growth of 13% was bolstered by a further 2.9% growth from acquisitions and 1.5% from an additional sales day, delivered adjusted operating profit of $845 million, an increase of $93 million or 12.4% over the prior year, with operating cost leverage driving an 11.2% adjusted operating margin. Turning to our Canadian segment, the business performed well with organic revenue growth of 8.2% as we lapped a 13.9% prior year comparable. One additional sales day added 1.5% to revenue growth but adverse foreign exchange rates reduced revenue growth by 6.1%. Total revenue growth was 3.6%, similar to the US non-residential end markets performed better than residential in the quarter. Adjusted operating profit of $33 million was $1 million below last year, including a $2 million adverse impact from foreign exchange rates. Turning to cash flow, we take a disciplined approach to cash generation. It continues to be an important priority and quality of our business model. Adjusted EBITDA in the quarter was $912 million. As expected our working capital investment of $357 million was lower than the prior year, as we have begun to reduce inventory as supply chain constraints start to ease. Inventory was down approximately $100 million during the first quarter. We generated $501 million in operating cash flow, an increase of $510 million over the prior year. We continue to invest in organic growth through CapEx, principally invested in our market distribution centers, branch network, and technology programs. As a result, free cash flow was $408 million, an increase of $470 million over the prior year. Our balance sheet position is strong with net debt-to-adjusted EBITDA of one times. We continue to target a net leverage range of one to two times and we intend to operate towards the low end of that range through the cycle to ensure we have the capacity to take advantage of growth opportunities as well as to maintain a resilient balance sheet. We allocate capital across four clear priorities. First, we're investing in the business to drive above-market organic growth. I previously mentioned on the cash flow side our organic investments were driven by a combination of working capital to support our growth and CapEx investments, which are broadly split between our market distribution center rollout, technology investments in both front-end customer-facing capabilities as well as the modernization of our back-end systems and investments in our branch network. Second, we continue to sustainably grow our ordinary dividend. We previously announced our intention to transition from a semiannual dividend to a quarterly dividend and have today declared a $0.75 per share dividend. This implies an increase of 9% when annualized over the prior year, reflecting our confidence in the business and cash generation. Third, we're consolidating our fragmented markets through bolt-on geographic and capability acquisitions. We purchased three businesses since the start of the fiscal year bringing in approximately $270 million of incremental annualized revenues. While the pace of deal activity in the market has slowed, we maintain a good pipeline of potential deals, and we remain focused on executing our consolidation strategy. Finally, we remain committed to returning surplus capital to shareholders, principally through share buybacks when we are under the low end of our target leverage range. During the quarter, we returned $366 million to shareholders through share buybacks, reducing our share count by approximately $3 million. This leaves approximately $600 million outstanding on the share repurchase program at the end of the quarter. Turning last to our view of fiscal 2023 guidance, which remains unchanged; we expect to deliver low single-digit revenue growth for the year driven by continued organic market share gains and the benefit of completed acquisitions on top of markets which we expect to decline in the low-single digits. We expect growth rates to continue compressing as we move through the year, driven by increasingly difficult comparables, a reduction in inflation, and deterioration in market volumes. After stepping up adjusted operating margins by 230 basis points over the last two years, we envision some normalization and have provided a range of between 9.3% to 9.9%. We expect interest expense to be between $170 million to $190 million. Our adjusted effective tax rate should stay broadly consistent at approximately 25% and CapEx is expected to come in between $350 million to $400 million. So to summarize, the business is performing well, and we remain focused on executing our strategy. We believe the combination of our strong balance sheet and flexible business positions us well for the remainder of the fiscal year.

Kevin Murphy, CEO

Thank you, Bill. We continue to drive ongoing end market outperformance while investing to build on our competitive advantages for the longer term. Our strengths and our strategy translate to long-term value. First, we hold leading positions in large, growing, and fragmented markets, with approximately 75% of our revenue generated from our number one or number two market positions last year. Our supplier base is fragmented, our customer base is quite fragmented, and our competitor base is also highly fragmented with more than 10,000 small and medium-sized mostly privately held competitors. And while there are macroeconomic headwinds on the horizon, the markets we compete in have historically grown above GDP. Secondly, our scale delivers sustainable market outperformance. On average, we delivered 370 basis points of U.S. organic market outperformance over the past five fiscal years. We're confident in our ability to continue to outperform by leveraging value-added solutions that help make our customers' complex projects simple, successful, and sustainable; a supply chain that delivers breadth and depth to our customers where and when they need it; and a suite of digital tools that offer our customers an omnichannel experience and our people, leveraging long-standing relationships within the supplier and the customer communities. As I talked about earlier, we complement this organic growth model by consolidating our fragmented markets with consistent bolt-on acquisitions, driving 2.2% incremental annual revenue growth from acquisitions in the past five fiscal years. All of this has produced a long-term track record of outperformance and cash generation by a dedicated team with long-term experience in the business. As we discussed, acquisitions are a key part of our growth algorithm, allowing us to continue consolidating highly fragmented markets. We acquire companies at attractive multiples and then leverage our scale to drive revenue, gross profit, and operating cost synergies to generate strong returns. Our strategy targets two types of acquisitions; geographic which allow us to expand and fill in our existing geography, consolidate our markets, and bring in associate expertise and customer relationships. We have a repeatable process that allows us to quickly integrate these acquisitions and leverage our scale to generate these synergies. Capability acquisitions, in which we bring in new products or services, associate expertise, and customer relationships that we can then leverage across our platform, opening up these products and services to our more than 1,700 locations and 1 million customers to rapidly expand that offering. In both cases, while we're acquiring physical assets such as locations, trucks, and inventory, the real value we gain is from the talented associates, their expertise, and the customer relationships that they have. Therefore, we spend a lot of time ensuring we have a good cultural fit and align values to make sure we have a successful acquisition. And as we present our company to potential targets, we believe that we're the acquirer of choice in our industry and that we offer those associates access to the best platform and capabilities in the industry and a proven ability to grow their careers far beyond their existing opportunities. One of the principal focus areas of our acquisition strategy is HVAC, particularly as we look to better serve the more than 65,000 dual-trade plumbing and HVAC contractors across North America. This year we've already added two great examples. Airefco is a leading regional HVAC distributor operating from 11 locations in the Pacific Northwest. Trading since the 1950s and operating with a strong service ethic, Airefco is very well-aligned with the culture of Ferguson. We're pleased to welcome the 191 associates who partner closely with the customer base to help make their projects more successful while also maintaining strong relationships with Carrier as well as various other vendor partners. Marino is another distributor of HVAC equipment and parts with five locations across the New Orleans metro and Gulf Coast areas. This accelerates our geographic expansion in Louisiana and Mississippi while strengthening our relationships with key vendors in the region. The HVAC area continues to be an attractive space for acquisitions due to the estimated $70 billion of highly fragmented market, and we'll continue to use our strategic initiatives within this customer group on both organic and inorganic fronts. To close, let me again thank our associates for their remarkable efforts to serve our customers. The result was a strong start to the fiscal year building on our market-leading positions and our key strengths while investing in the future of the business. We are well-positioned with a balanced business mix between residential and non-residential, new construction, and RMI. We have a flexible business model and a cost base that allows us to adapt to changing market conditions, and we're maintaining a strong balance sheet operating at the low end of our target leverage range. Despite slowing end markets and more challenging comparables, we continue to position ourselves to outperform fundamentally solid longer-term end market demand. Thank you for your time today. Bill and I are now happy to take your questions.

Operator, Operator

Thank you. Our first question today is from Matthew Bouley from Barclays. Matthew, your line is open. Please go ahead.

Unidentified Analyst, Analyst

Good morning. You have Elizabeth Landan on for Matt today. I was just wondering if you could talk a little bit about your guidance with the low single-digit growth? Are there any changes to your underlying expectations within your end markets specifically, within residential or commercial? And if you have any details on your expectations for inflation or the cadence throughout the year, that would be really helpful?

Bill Brundage, CFO

Yes. Good morning, Elizabeth, this is Bill. Thank you for the question. Really, if you think about how Q1 played out for us, it was really right in line with our expectations. And as Kevin said in his prepared remarks, we're expecting those growth rates, both inflation and volume, to compress as we step through the year, and that's exactly what we saw in Q1. So as we finished, really in line with our expectations, really no change to that full year guidance and full year outlook. If you think about what's embedded in that, we have talked about the fact that we expect inflation rates to compress. Inflation was about 15% in Q1; that stepped down through the quarter. We would expect that to lap those tougher comparables as we step through the year, and likely for the full year inflation ending up in the mid- to high single digits for the full year, with volume then also stepping down in the year and ending in the high single to low double-digit volume decline. You add that up together, that comes back to our market decline expectation in the low single digits for the full year. And then, we expect to continue to outperform those markets, plus the tail of acquisitions gets us to our low single-digit revenue growth guidance for the full year. So really no change, but hopefully that frames the underlying assumptions for you.

Unidentified Analyst, Analyst

Thank you. That's really helpful. And as far as the channel dynamics go, are there any verticals in which you're kind of seeing more or less destocking or any excess inventory in certain groups?

Bill Brundage, CFO

We're not seeing a large amount of channel destocking with our end customers. What we have absolutely done is focused on bringing our inventory levels down, and you saw that in Q1, reducing our inventories by about $100 million as we started to see our vendor supply chain constraints improve and product availability improve. We've talked about some of the areas that still remain pressured from a supply chain perspective like HVAC, like high-end appliances, like ductile iron pipe on the Waterworks side. There are still some pressure in those product categories. But as things have generally improved, we are starting to ensure that we bring our inventory levels down and you should expect that to continue through the year. But we're going to remain really mindful of the current market dynamics. And if need be, use our flexible balance sheet and our balance sheet strength to ensure we have proper product availability.

Kevin Murphy, CEO

Yes, Elizabeth, this is Kevin. To build on that, with some exceptions, we didn't see a pull forward of demand in shipment activity. We did see a pull forward during supply chain pressures of ordering activity. And to Bill's point, we have done a good job of reducing inventory, by reducing committed inventory inside of our systems for good projects and getting our customers' ordering patterns back to a more normalized place.

Unidentified Analyst, Analyst

Thank you very much.

Operator, Operator

Thank you. Our next question is from Mike Dahl from RBC Capital Markets. Mike, your line is open. Please go ahead.

Unidentified Analyst, Analyst

Hi. It's actually Chris calling on for Mike. Thanks for taking our questions. Just going back to the implied market volume outlook for the full year '23 guide, the high single-digit low double-digit decline. Could you help break that out, how you're thinking about the split between new residential, RMI, non-res, kind of how that all baked into that outlook?

Bill Brundage, CFO

Yes, certainly, expecting more pressure on the new residential side of our business. Remember, new residential is only about 18% of what we do. In terms of price and volume, we are expecting new residential to be down high single, low double digits. On the residential RMI side, we expect that to hold up better. We expect in total again price and volume, that to be down low single digits for the year. And then on the non-residential side, there's some more strength there and particularly as we look out further ahead with some of the support offered from some of the government programs that will likely play in towards the end of our fiscal year and into fiscal '24. But we expect non-residential to be up slightly for the year from a market perspective. You put all that together, that gets us our implied negative market of low single-digit decline for the year.

Unidentified Analyst, Analyst

Understood. That's helpful. And just turning to the pricing outlook one more time. Are you seeing any price elasticity in the marketplace today from these increases, given the outlook of pretty significant volume declines to materialize the next quarter? What are your guys' thoughts on kind of maintaining the price on the non-commodity side? And then in terms of the commodity normalization, how are you guys factoring that into your outlook?

Kevin Murphy, CEO

We don't anticipate any catalysts for further significant price inflation. Looking ahead, just under 15% of our business involves commodities. We expect some movement in the commodity market, although we believe different commodities will not behave uniformly. For instance, we are seeing some pressure on carbon steel and stainless steel, while pricing levels for PVC, polyethylene, cast iron, and ductile iron remain fairly stable. We do expect some changes in commodity prices. However, on the finished goods side, there hasn't been any notable impact. We believe there are solid foundations supporting current pricing levels, partly due to the labor costs that manufacturers face. In summary, we haven't observed any noticeable changes in price elasticity as demand for new residential construction has begun to slow.

Unidentified Analyst, Analyst

Understood. Appreciate the color.

Kevin Murphy, CEO

Thank you, Chris.

Operator, Operator

Thank you. Our next question today is from Kathryn Thompson from Thompson Research Group. Kathryn, your line is open. Please go ahead.

Unidentified Analyst, Analyst

It appears Kathryn has disconnected. I'll move on to the next question. Our next question is from McClaran Hayes from Zelman & Associates. McClaran, please go ahead. Your line is open.

McClaran Hayes, Analyst

Hey, good morning. I wanted to get a bit on the non-res side of your business. Have you guys seen any leading indicators of weakness there, whether it's project delays or cancellations?

Kevin Murphy, CEO

Thanks, McClaran. We have seen some, albeit very small, delayed activity on some of our commercial build-out activity. It hasn't been very large, and it's been spotty in different geographies. What we are energized by is again some of the larger scale projects as we look to non-residential, things like electric vehicles, battery, LNG, pharma, semiconductors, even normalized activity like refinery turnarounds, downstream chemical, and mining activity. Those projects generally take a bit longer. So as we expect, we'll see some softening in new residential construction. We also believe we will see those projects start to take hold as we go through our fiscal year 2023 into the spring and summer. And as we look at those projects in particular, those are good projects for our company as a whole, as we take a more One Ferguson approach toward that owner, engineer, architect, general contractor to bring all the customer groups of Ferguson together on the project and on the site. So we've seen a touch of slowing in some areas of knock-on build-out commercial nothing discernible, but a good level of activity in what we would call megaprojects as we go forward.

McClaran Hayes, Analyst

Got it. Thanks, that's helpful. And then on the M&A environment, I think you noted in your prepared remarks that the pace of deal activity has slowed a bit, but clearly, you've still been able to get deals done. Have you begun to see any change in sellers' expectations as they're looking out for 12 months and they may be sharing a similar outlook to you?

Bill Brundage, CFO

Yeah. We've seen, McClaran, we're still seeing to our point earlier a pretty good pipeline in terms of what we maintain and still good deal activity, as we look out into the future, at least through the rest of this fiscal year. I think what you're seeing from a seller expectation perspective is, as maybe there's a bit more cloudiness on the horizon from a potential recessionary environment perspective, you are seeing valuation expectations certainly looking back 12 months and facing valuation on what could be considered peak profits for some of these potential acquisitions. And so we're maintaining quite a bit of discipline as we think about value and valuation, but really a bit of slowing in the marketplace, but nothing significant in terms of our pipeline.

McClaran Hayes, Analyst

Got it. Thanks. Best of luck.

Kevin Murphy, CEO

Thanks, McClaran.

Operator, Operator

Thank you. Our next question is from David Manthey from Baird. David, your line is open. Please go ahead.

David Manthey, Analyst

Yeah. Thank you. Good morning, everyone.

Kevin Murphy, CEO

Good morning, David.

David Manthey, Analyst

A couple of times on the call you mentioned DIY residential business versus pro contractor. And I'm pretty sure that the predominant percentage of your business is pro, but could you tell us approximately how much of it is DIY today?

Kevin Murphy, CEO

Yeah. Thanks, Dave. So about 6% of our business would be considered direct homeowner consumer business, so call it DIY or direct-to-consumer.

David Manthey, Analyst

Got it. Okay. Thank you for that. And then more broadly, here as we enter fiscal 2023, could you maybe update us on a few of your initiatives and strategies? You touched on a couple of these, but could you talk about the MDC rollout? You talked a bit about Durastar but maybe own brand initiatives more broadly. And then the One Ferguson approach that you just referenced maybe talk about some progress that you've made there and what you expect for fiscal 2023?

Bill Brundage, CFO

Yeah, Dave, in terms of the MDC rollout we maintained – we're right on track with that. As you know, we opened Denver and Phoenix within the last year. Houston is set to open in the next couple of months. So we're receiving product into Houston now. We'll begin shipping in the next couple of months. And then that will be followed by Dallas, Washington DC Metro area, and Nashville, which will come out over the next call it 12 to 18 months after that. So we're continuing that rollout really in line with that call it two to three per year, and that is clearly going to be a multiyear-phased approach for us.

Kevin Murphy, CEO

Yeah, Dave. And then when we think about owned brand, owned brand is a part of our overall product strategy, which our associates are going to help to guide a customer to the right product solutions for their project to make it successful, but also to guide them towards those products that will make it more unique for Ferguson and potentially be gross margin accretive for us as a company. As you remember last year, owned brand was a bit overshadowed in terms of its growth because of what happened in the commodity side of our business. As price inflation drove commodities, we saw the impact of our owned brand growth be minimized, which kept us in that 8% range. Even though last year, we had over $400 million in growth of our owned brand activity. That progress continued into our first quarter. We saw $170 million worth of growth in the own label side of our business, and that was driven – or that drove us up to about 9.5% of our overall revenue inside of Q1. It's good broad-based activity. M&A, where we're bringing on solid companies that we can leverage across our bricks and mortar, across our digital platforms, and then also organic expansion of categories where we believe that we can bring a good owned brand potentially through some of the M&A that we've already brought in play like Jones Stephens, like Signature Hardware and expand that across our bricks and mortar. So that's been a good success story during Q1. When we think about One Ferguson that's an extension of how we drive that consultative approach to make sure that that project is better, but we take it from the trade professional for the individual customer group, up to the general contractor and the owner. And again, as I said earlier, that's one of the energizing things around what's happening with non-res mega projects, as we're starting to get involved much earlier in the design process and construction process, to bring everything from underground water, wastewater, stormwater infrastructure up through commercial mechanical piping systems, HVAC, fire suppression, and the like to the non-res side again across a variety of those different end uses like electric vehicles, chips, and the like. So pleased with what that progress has been to date and what it can be as we go towards the end of fiscal 2023.

David Manthey, Analyst

All right. Thank you, Kevin. I appreciate it. Best of luck.

Kevin Murphy, CEO

Thank you, Dave. Take care.

Operator, Operator

Thank you. Our next question is from Kathryn Thompson from Thompson Research Group. Kathryn, your line is open. Please go ahead.

Brian Biros, Analyst

This is actually Brian Biros on for Kathryn. Thank you for taking our question. First one, can you talk about the activity you're seeing in the Waterworks segment? Activity there is give read-through for further activity. Just in general construction-wise seems project there are continuing funding their solids. Any further commentary on that segment would be helpful.

Kevin Murphy, CEO

Yes. Thanks, Brian. Waterworks' growth was good, 27% in the quarter. Felt good about the activity level. If I take a step back, what we're most pleased with from our Waterworks business is great balance across new residential construction, single-family and multi, public works infrastructure, commercial infrastructure, municipal spend, metering, metering technology, erosion control, soil stabilization, that broad mix has and will continue to serve us well. The activity levels are good. We're just now starting to see the Infrastructure Act start to play out. We think that tailwind plays out more as we get into calendar year 2023, and we continue to see good activity levels even inside of residential construction activity in terms of new multifamily projects being put in the ground. So generally speaking, still very supportive in terms of what that customer group looks like.

Brian Biros, Analyst

Got it. Thank you. And a follow-up question. I guess just on gross margin compression in the quarter, I think it was 80 basis points. You guys touched on this throughout the call. But I guess just to clarify is that purely a function of that price cost gap narrowing from the inventory pre-buy dynamic, or was there any actual pricing declines in other categories so far? Thank you.

Bill Brundage, CFO

Yes, Brian. There have been no pricing declines. As we mentioned earlier, we are still seeing price inflation and we haven't observed any significant price deflation, nor do we anticipate that in the short term. The 80 basis point decline year-on-year is primarily due to our performance last year when we faced significant commodity inflation. The gross margin of 31.3% that we achieved last year was essentially our peak gross margin, and we had anticipated that it would normalize as pricing stabilized on a sequential basis. We've noticed that compress over the last few quarters, but I'm very pleased with our 30.5% delivery in Q1.

Brian Biros, Analyst

Thank you.

Operator, Operator

Thank you. Our next question is from Will Jones from Redburn. Will, your line is open. Please go ahead.

Will Jones, Analyst

Thank you. A couple from me if I could please. The first just around your guidance, which I think implies a small sales decline for the remaining nine months of the year. Does that start in Q2, or is that more of a H2 issue against the tough comps do you think? And then maybe perhaps you could just talk around overhead, which I think grew around 14% year-on-year in the quarter given where headcount has been and like-for-like wage inflation we might have expected that to be slightly higher run rate of inflation. So could you just talk about some of the measures you're taking to keep that check please? Thank you.

Bill Brundage, CFO

I'll begin addressing those questions. You are correct that our guidance indicates a slight revenue decline for the remainder of the year in the low-single-digit range based on our Q1 results. I anticipate that growth will become more difficult as the year progresses due to increasing comparables. For instance, looking at the two-year period of fiscal 2021 and 2022, growth rates in Q1 were in the high 20s, which we expect to rise to the low 30s in Q2, and further into the low 40s in Q3 and Q4, driven by inflation and volume changes. Consequently, I expect those growth rates to continue declining as the year advances. To address this, we are ensuring that we take appropriate actions regarding our cost structure. As you mentioned, we have begun reducing headcount. We evaluate headcount based on full-time equivalent positions. Our approach begins with reducing overtime, then cutting temporary associates, allowing attrition to occur naturally, and finally implementing targeted actions where necessary. In Q1, we reduced full-time equivalents by approximately 400 from July through October, and we will continue to take targeted measures as we move into Q2 to effectively manage our cost base. You may have noticed that total cost dollars decreased slightly from Q4 to Q1, and we expect this trend to continue as we manage our business costs.

Will Jones, Analyst

Thank you. And just a follow-up there. A couple of your peers have talked about some of the extra costs they've incurred in the last couple of years when supply chains have been tight, in order to maintain service for their customers. And that if supply chains normalize, some of those extra costs, logistics and so on, might start to ease out. Is that something you experienced again you might get some benefit from if supply chains get better or not so much?

Bill Brundage, CFO

Yes. I mean, look, we certainly had some inflationary cost pressures over the last couple of years, but I would submit that those inflationary cost pressures are not decreasing yet. If you think about our cost base, well, you know it well, 60% is labor. We're still experiencing wage inflation in the mid to high single-digit rate. And so we're working hard to offset that, but we're still seeing cost inflation in other areas such as truck costs, rents, effectively everything that we buy is still impacted by some level of inflation. So, we don't see cost inflation pressures alleviating significantly, but we're working very hard to offset that.

Will Jones, Analyst

Thank you.

Operator, Operator

Thank you. Our next question today is from Gregor Kuglitsch from UBS. Gregor, your line is open. Please go ahead.

Gregor Kuglitsch, Analyst

Good morning. Thank you for taking my questions. I have a few inquiries. First, could you provide an update on your current trading status? Specifically, how does it compare to the 13% organic figure? I understand it may be showing a slowing trend. Secondly, regarding gross margin, you have previously indicated that it would be in the mid-30s, and that’s where you have landed. Do you expect this to remain consistent, or should we be aware of any factors that might affect gross margin in the upcoming quarters? Thank you.

Bill Brundage, CFO

Yes, Gregor, if we look at our organic growth rate, in Q4 we achieved about 20% organic growth, which decreased to 13% in Q1. This was a noticeable decline as we progressed through the quarter. By the end of October, we were seeing high single-digit organic growth, which has continued to decline as anticipated. For November, we're now in the low to mid-single-digit organic growth range, reflecting the challenging comparisons and the expected downward trend. Regarding gross margin, we were pleased to achieve a 30.5% gross margin. We previously mentioned that we expect this to remain in the range of 30% to 31% for the year, likely leaning towards the low 30% area. We will continue to manage this actively. As Kevin pointed out, we are focusing on our product strategy, particularly our owned brands, and managing our pricing in a dynamic market environment. While there are various factors that can influence gross margin, we are satisfied with our Q1 results.

Kevin Murphy, CEO

And Gregor, we'll continue to work hard to take price in the coming quarters. But if we think more along the medium term, we're going to consistently look to add value-added services that make the construction process more productive for our customers. We'll continue to add to that world-class supply chain to make product availability better for our customers, and we expect to see gross margins increase modestly over time, call it 10 basis points a year for the foreseeable future.

Gregor Kuglitsch, Analyst

Thank you. That was really helpful. Thanks.

Kevin Murphy, CEO

Thanks, Gregor.

Operator, Operator

Thank you. Our last question today comes from Harry Goad from Berenberg. Harry, your line is open, please go ahead.

Harry Goad, Analyst

Yes, good morning. Thank you for taking my questions. I have two, please. The first is a clarification on something you mentioned earlier regarding the inflation rate. You spoke about mid to high single-digit rates towards the end of the year. Can you confirm whether you are referring to that as an average for the full year 2023 or as the exit rate for full year 2023? My second question relates to the Capital Markets Day earlier this year, where you talked about a potential adjusted operating margin of 9.2%. Is that figure still applicable? I understand it falls below the low end of your guidance range, but can we consider it a worst-case scenario? Additionally, could you remind us why you believe it cannot drop below that level, and how has the efficiency of the business changed compared to two or three years ago? Thank you very much.

Bill Brundage, CFO

Yeah, Harry, the inflation rate that mid- to high single-digit expectation from a market perspective that was a full year average. Given the fact that we are at 15% in Q1 that stepped down through the quarter, and it's continuing to step down, that would be a full year average. In terms of the adjusted operating margin to your point, 9.2% is below the guidance that we've put out this year of 9.35 to 9.9%. We do believe that we've stepped up the operating efficiency of this business over the last couple of years, and that we can continue to operate in that range. If you think about part of the impact on that operating margin has been a step up in price. A good portion of that step-up in price has been on finished goods, which represents 85% of our product sales. And finished goods pricing as we've talked about in the past tends to be more sticky. So we don't see significant price deflation risk that would erode that operating margin below that 9.2%. With that said, you said a worst-case scenario. Certainly, if we got into a significant downturn, there are different scenarios that could play out, which we don't expect at this point. So we're very comfortable with the guidance for the full year. That remains unchanged, from what we said coming out of Q4, to land in that 9.3% to 9.9% range.

Harry Goad, Analyst

Okay, very clear. Thank you.

Bill Brundage, CFO

Thank you.

Operator, Operator

Thank you. This is all the questions we have time for today. So I'll hand back to Kevin for any closing remarks.

Kevin Murphy, CEO

Thank you, Daisy, and thank you all for your time today on the call. I'll end the way we began, with a thank you to our associates. Really a remarkable effort to serve our customers and make their projects better, more simple, successful, and sustainable. And we were very pleased with the quarter, with revenue up 17% operating profit up 13% and diluted EPS up 18. And so it came in really as we expected. And as we go throughout the year, albeit some macroeconomic headwinds particularly in new residential construction, we do believe we're extremely well positioned with the balance of our business mix and our business model, to continue to progress and outperform what are fundamentally solid longer-term end markets. So thank you very much for your time. Very much appreciate it.

Operator, Operator

Thank you, everyone, for joining today's call. You may now disconnect your lines. And have a lovely day.