SiteOne Landscape Supply, Inc. Q3 FY2022 Earnings Call

Greetings, and welcome to the SiteOne Landscape Supply, Inc. Third Quarter 2022 Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John Guthrie, Executive Vice President and Chief Financial Officer. Thank you, John, you may begin.

Thank you, and good morning, everyone. We issued our third 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 this 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.

Thank you, John. Good morning, and thank you for joining us today. We are pleased to continue our positive momentum during the third quarter, with solid growth in net sales and adjusted EBITDA despite the strong comparable growth and outsized gains in gross margin that we achieved in the second half of last year. We are also very pleased to add seven new high-performing companies to SiteOne over the last four months, bringing our total number of acquisitions completed year-to-date to 14. All these companies have talented teams and terrific customer relationships and expand our product lines and market presence in their respective markets. Through the execution of our commercial and operational initiatives, and through acquisition, we continue to build SiteOne as a world-class market leader for the long term and deliver consistent performance and growth in the near term. While we are seeing some early signs of softness in the residential market, we feel confident that we will finish 2022 well, and enter 2023 from a position of strength with our well-balanced business, strong balance sheet, exceptional teams, improved capabilities, and robust acquisition pipeline. Overall, we expect to continue gaining market share and achieving strong performance and growth in the years ahead. 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 third quarter financial results in more detail and provide an update on our balance sheet and liquidity position. He will also comment on our recently announced share repurchase authorization. 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 630 branches and four distribution centers across 45 U.S. states and six Canadian provinces. We are the clear industry leader, over five times 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 acquisition, 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. I would note that our balanced business mix will be very important as we navigate through 2023 and seek to overcome the expected softness in new residential construction. 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 have come a long way in building SiteOne and executing our strategy over the last six 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 fills 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’ve built a strong track record of performance and growth over the last six 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’re still building and investing, and we remain confident in our ability to gain market share and continue driving all three of our value creation levers going forward. You will also note that we have now completed 78 acquisitions across the irrigation, lighting, agronomics, nursery, hardscapes, and landscape supplies product line since 2014, with 14 completed so far in 2022. We only acquire well-run companies, and so all of 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 having a good year this year on the acquisition front, and our pipeline of potential deals remains robust, with significant opportunity to continue growing through acquisition for many years to come. Slide 7 shows the long runway 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 third quarter performance highlights as shown on Slide 8. We achieved 18% net sales growth in the third quarter, with 12% organic daily sales growth and 6% net sales growth added through acquisition. The organic daily sales growth was driven by 17% price inflation, partially offset by a 5% volume decline, which was an improvement from our 11% volume decline in the second quarter. Price inflation has proven to be more durable than we had previously expected, though it has begun to steadily decline over the last four months. At the same time, our volume improved during the quarter and is down low single digits in October. Overall, we believe that we are outperforming the market in terms of sales volume with our strong teams and focused initiatives. Gross profit increased 14%, and our gross margin declined 120 basis points to a very healthy 35.2%, as we did not repeat the exceptional gains from last year when prices were rising rapidly. We expect gross margin to be lower than last year, again in the fourth quarter, but modestly improved for the full year due to our strong gains achieved in the first half of this year. As we move into 2023, we will face gross margin headwinds like those we had originally expected for this year. However, we expect to achieve underlying improvements in gross margin through our initiatives to mitigate some of those headwinds. On the SG&A side, our operational initiatives and disciplined cost management were offset by lower volumes, elevated fuel and wage expenses, and our continued investments in marketing, digital, and operational excellence. Our acquisitions of hardscapes and landscape supplies companies also contributed to the SG&A increase as a percent of sales as these businesses operate with a higher gross margin and higher SG&A percentage. Accordingly, SG&A as a percentage of net sales increased by 110 basis points to 26.2%. The combination of good organic sales growth and a solid contribution from acquisitions allowed us to deliver adjusted EBITDA growth of 6% despite the gross margin and SG&A headwinds that we faced during the quarter. Adjusted EBITDA margin declined by 140 basis points to 12.3% during the quarter, reflecting these challenges. Overall, aside from the short-term fluctuations, we remain focused on driving underlying improvement in our adjusted EBITDA margin with the goal of 13% to 15%.

In terms of our initiatives, we have continued to make good progress this year. On the gross margin side, we continue to grow with our 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 and in 2023, we expect to improve gross margin through these initiatives in the years to come. We 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 us automate our branch transactions, while allowing our associates to serve customers from anywhere in the branch site. We can serve customers quicker and more accurately, especially at our large nursery and hardscape sites, and our branch associates are more efficient, a win-win. We enhanced the functionality of MobilePro this year and have accelerated our rollout. By the end of 2023, MobilePro should be broadly deployed across SiteOne and part of the way that we do business. Dispatch track allows us to manage our outbound deliveries to customers and proactively update customers on the delivery status by text. Our customer feedback on Dispatch track has been very positive, and we expect all parts of SiteOne to be fully utilizing this new capability before the spring season next year. We have also recently completed the two-year development and rollout of our new Salesforce customer relationship management system, which is designed to help our outside sales and sales support associates to better serve our medium to large customers. Going into next year, we plan to leverage this new capability to deliver more value to our customers and drive more intentional and consistent market share gains through our sales force. During the last two years, we significantly strengthened our digital team, and they, in turn, have accelerated our progress with siteone.com. Our field associates and customers are becoming more comfortable with the site as we have improved the ease of use and functionality to help landscape contractors run their business more efficiently. We will continue to add features to siteone.com and are excited to leverage it more fully in 2023 and beyond to bring market-leading value to our customers and gain market share. In addition to our technology-driven initiatives, we also now have a full-time operational excellence team in each major line of business, working with the field and with our newly acquired companies to isolate pain points and develop and implement operational solutions across the company. These solutions improve our associate efficiency and our customer experience to help us achieve adjusted EBITDA growth and improved adjusted EBITDA margin. Overall, we have ample opportunity to improve our customer experience and increase our operational effectiveness and efficiency, while expanding adjusted EBITDA margin in the years to come.

On the acquisition front, we matched our record performance from the prior quarter, adding six high-performing companies to our family during the third quarter and one more since the quarter closed, bringing the total to 14 so far this year. These companies provide us with excellent new talent and capability for growth in their respective markets, while adding approximately $175 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, strong balance sheet, and an exceptional reputation as the acquirer of choice, we remain well positioned to grow consistently through acquisition this year and for many years in the future.

Moving to Slide 9, we are pleased to publish our third annual ESG report, which highlights the progress that we are making in delivering value to all our stakeholders. It is important to understand that our objective here at SiteOne is to build a company of excellence, one that creates exceptional value for our associates, customers, suppliers, shareholders, and communities. So we do not view ESG as a separate initiative. To the contrary, these ESG enhancements are fully aligned with our overall vision and so they come naturally to us. Overall, we are pleased with our progress. But as mentioned before, we still have a lot of opportunity to improve across all facets of our business over the coming years. In summary, we continue to execute our initiatives and deliver excellent performance and growth despite the near-term headwind and uncertain economic outlook. As we look ahead to 2023, we now believe that inflation will be more persistent, which will help mitigate the softer residential market and continued pressure on volume. Overall, we remain confident in our ability to navigate through any market conditions, outperform the market, and continue to build our company both organically and through acquisition. Now John will walk you through the quarter in more detail.

Thanks, Doug. I’ll begin on Slide 10 with some highlights from our third quarter results. We reported a net sales increase of 18% to $1.1 billion in this quarter. There were 63 selling days in the third quarter, which is consistent with the prior year period. As a reminder, we have 60 selling days in the fourth quarter of this year, which is one less than the fourth quarter of last year. Organic daily sales increased by 12% in the quarter driven by price inflation, resulting from product cost increases from our suppliers, partially offset by lower volume resulting from higher prices and softening economic conditions. Acquisitions continued to perform well, contributing approximately $57 million or 6% to our third quarter net sales growth. Organic daily sales for landscaping products, which includes irrigation, nursery, hardscape, outdoor lighting, and landscape accessories, increased 15% for the third quarter due to price inflation as prices for products like PVC pipe and drainage remain elevated compared to the prior year. Organic daily sales for agronomic products, which includes fertilizer, control products, ice melt, and equipment, increased 5% for the third quarter due to price inflation resulting from rising product costs, partially offset by reduced volumes from higher prices. Prices for agronomic products like fertilizer and grass seeds remain elevated, and we believe these higher prices have reduced short-term demand as our customers deal with constrained maintenance budgets. Geographically, we continue to see variation across markets. In the Sun Belt, we saw solid organic daily sales growth of 15%, while in the Northern more seasonal market, we saw organic daily sales growth of only 8%. The lower sales growth in the northern markets is attributable to less favorable weather and a greater percentage of agronomic product sales. Price inflation continues to play a major role in organic daily sales growth for both landscaping products and agronomics products. We estimate price inflation contributed 17% to our organic daily sales growth for the quarter as we continue to see elevated prices on a year-over-year basis. We expect, as we compare to last year’s price increases, the impact of price inflation on our organic daily sales growth will moderate through the remainder of 2022. However, based on the cost increases already made this year and the anticipated cost increases from some key suppliers in the fourth quarter, we believe pricing will remain a positive contributor to growth through the remainder of this year and into 2023. On the volume side of the growth equation, results for the third quarter were negative, but improved in comparison to the second quarter. Volume growth was negative 5% for the third quarter compared to negative 11% for the second quarter as we benefited from more favorable weather and more reasonable comps. For the remainder of fiscal year 2022, we expect volume to continue to improve, though remain negative. Gross profit increased 14% to $389 million for the third quarter. Consistent with our expectation, gross margin decreased 120 basis points to 35.2% as the large price realization benefits achieved in the third quarter of 2021 were not repeated. Selling, general and administrative expense, or SG&A, increased 23% to $289 million for the third quarter. SG&A as a percentage of net sales increased 110 basis points to 26.2% due to increased operating expenses supporting our growth, cost inflation and the impact of acquisitions. We are experiencing the impact of inflation on SG&A as the cost of wages, fuel, travel, and general branch operations have all increased this year. In addition, our acquisitions have positively impacted our gross margin but also negatively impacted SG&A due to their higher operating cost structure. The impact of acquisitions accounted for most of the increase in SG&A as a percentage of net sales this quarter. For the third quarter, we recorded income tax expense of $22.9 million compared to $19.1 million in the prior year period. The effective tax rate was 23.8% compared to 19.3% for the third quarter of 2021. The increase in the effective tax rate was due primarily to a decrease in the amount of excess tax benefit from stock-based compensation. We realized $1.9 million in excess tax benefits in the third quarter compared to $6.5 million for the prior year period. We recorded net income for the third quarter of $73.3 million compared to $80 million for the prior year period. The decline in net income was primarily due to the lower gross margin and higher SG&A expense. Our weighted average diluted share count for the third quarter was 45.8 million, which is comparable to the prior year period. Adjusted EBITDA increased by 6% to $136 million for the third quarter compared to $128 million for the same period in the prior year. Adjusted EBITDA margin, reflecting our lower gross margin, decreased 140 basis points to 12.3%.

Now I’d like to provide a brief update on our balance sheet and cash flow statement, as shown on Slide 11. Net working capital at the end of the third quarter was $869 million compared to $715 million at the end of the same period in the prior year. The increase in net working capital is primarily attributable to higher receivables resulting from our strong sales growth and increased inventory due to cost inflation, supply chain uncertainty, and strategic inventory buys ahead of price increases. In the third quarter, we saw inventory start to come down due to improved product supply and normal seasonality. As product availability and lead times from our suppliers have improved, we no longer need to carry as much inventory in our distribution centers and branches. We expect this trend to continue in the fourth quarter and into next year. Net cash provided by operating activities during the quarter increased to $136 million compared to $67 million for the prior year period. The improved cash flow was primarily due to the actions we took in the third quarter to reduce working capital. We made cash investments of $66 million for the quarter compared to $15 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 $377 million compared to $208 million at the end of the prior year period. The increase in net debt reflects higher borrowings to fund our acquisition investments and increased working capital. On July 22, we amended our asset-based loan or ABL facility by extending the maturity to July 2027 from February 2024 and increasing the size to $600 million from $375 million. As a result, we increased our liquidity at the end of the quarter to $515 million, which consisted of $63 million of cash and approximately $452 million in available capacity under the ABL facility. Leverage at the end of the third quarter increased to 0.8x our trailing 12-month adjusted EBITDA compared to 0.5x at the end of the third quarter of 2021. The higher leverage reflects our increased borrowings resulting from acquisition investment and increased working capital. Our long-term year-end target net debt to adjusted EBITDA leverage range remains 1 to 2x.

On October 20, 2022, our Board of Directors approved a share repurchase authorization for up to $400 million of our common stock. The share repurchase authorization does not have an expiration date and may be amended, suspended or terminated by the Board at any time. As shown on Slide 12, we believe this new repurchase program complements and provides balance to our existing capital allocation strategy. Our primary goal with regards to capital allocation is to invest in our business, including the execution of our acquisition strategy. We are also committed to maintaining a conservative balance sheet as demonstrated by our target leverage ratio. To the extent we have excess capital after achieving these objectives, the share repurchase authorization will provide us the mechanism to return capital to our shareholders. 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.

Thanks, John. As shown on Slide 13, we acquired six companies during the third quarter and one company since the end of the third quarter, bringing our total to 14 for 2022 so far, with a combined trailing 12-month net sales of approximately $175 million. Since 2014, we have acquired 78 companies with approximately $1.4 billion in trailing 12-month net sales added to SiteOne. Turning to Slides 14 through 20, you will find information on our most recent acquisitions. 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 established as a nursery platform for SiteOne in Central Arkansas. On August 11, we acquired Cape Cod Stone, a wholesale distributor of hardscapes product, with one location in Orleans, Massachusetts. Cape Cod expands our natural stone product offering to our New England customers. On August 12, we acquired Linzel Distributing, a wholesale distributor of outdoor lighting and landscape supplies with one location in Hamilton, Ontario, Canada. The addition of Linzel expands our product offering with our Eastern Canadian customers. On August 18, we acquired Jim Stone Company of Louisiana, a wholesale distributor of natural stones and other hardscape products. Jim Stone’s three locations extend SiteOne’s hardscape product offerings across all Southern Louisiana. On August 31, we acquired Stone Plus, a wholesale distributor of hardscapes and landscape supplies with three locations in Northeast Florida, significantly expanding these product lines into new markets in Florida. Also on August 31, we acquired Kaknes Landscape Supply, a wholesale distributor of nursery products with one location in Naperville, Illinois, a suburb west of Chicago. Kaknes further strengthens our growing nursery presence in the Chicago market. And most recently, on October 13, we acquired Madison Block & Stone, a wholesale distributor of natural stone, pavers, and landscape supplies with one location in Madison, Wisconsin. The addition of Madison extends our hardscapes product offering into a new market. These acquisitions, led by strong entrepreneurs, add excellent 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 21, our acquisition strategy continues to drive significant value for SiteOne. Our team of over 70 former owners, together with our experienced field leadership, create a dynamic and exciting culture, which makes us even more attractive to owners considering a transition of their family business. Our laser focus on landscape distribution gives these entrepreneurs tremendous confidence that when they joined 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. 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. We are confident that we will add more outstanding companies to SiteOne across the U.S. and Canada throughout the rest of 2022 and for 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.

Thanks, Scott. I’ll wrap up on Slide 22. As we finish 2022, we expect price inflation to remain resilient while continuing to moderate during the remainder of the year and into 2023. As mentioned, we are currently seeing low single-digit volume decline, reflecting the softer residential market. We expect organic daily sales growth to moderate along with price inflation as we move into 2023. 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 in 2023 versus prior years. In contrast, new commercial construction, representing 15% of our sales, has remained strong with healthy bidding activity and good backlogs. We expect this market to continue to be healthy in 2023. 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 typically been steady in past downturns. Accordingly, the maintenance dollar demand for our customers has remained steady, and we expect that to continue in 2023. 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. We now expect to achieve low double-digit organic daily sales growth for the full year 2022, mostly driven by price inflation. As mentioned, we continue to expect our gross margin for the full year to be slightly higher than last year, offset by SG&A, which will also be higher than last year as a percent of sales. We expect our adjusted EBITDA margin to be slightly below our record 2021 level. 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 expectation for fiscal year 2022 adjusted EBITDA to be in the range of $455 million to $470 million, which represents year-over-year growth of 10% to 13%. 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’s 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.

Our first question is from David Manthey with Baird.

Doug, when you were referring to gross margin in 2023, you said you expect underlying improvement. I just want to press on that word underlying quickly just to see what you mean by that relative to overall. And then it sounds like you’re saying that you feel the benefits from price costs have rolled through your inventories and are complete at this time. With stable pricing ahead, you’re saying that we shouldn’t see downside to gross margin. But if we do see more softness than you expect, we could see lower gross margin overall. Just any thoughts you could share there.

I’ll begin and then have John chime in. When I refer to underlying improvement, I’m talking about the significant gains we achieved from price realization in 2021, which we essentially repeated in 2022. We expected a reset of gross margin in 2022, but that didn’t happen due to a strong first half of the year. Now, we’re seeing gross margins that are lower than last year. We will finish 2022 slightly ahead of 2021, and we anticipate that reset in price realization for 2023. My point regarding underlying improvement is that aside from that reset, we expect to see continued gains in underlying gross margin. However, we will face a gross margin headwind due to the reset we anticipated for this year but didn’t see. John, do you want to add anything?

No. I think you've highlighted the key points. Looking ahead to the next three quarters, we will see effects this quarter and into the first half of next year, especially if we have a more stable pricing environment. However, we will face challenges from tough comparisons. We are working to offset that with the initiatives that Doug mentioned.

Got it. Okay. So yes, if we look back to like 2019, clearly, there’s improvement once we cancel out all the noise from the pricing. Okay. And then my second question is, are you surprised that landscape product volumes are holding up better than agronomics right now? And anything about the market you’re seeing today, does it change your view on maintenance holding up through a garden-variety downturn?

That's a great question. We're not surprised but we are pleased that the volumes for landscape products are showing improvement. Regarding the maintenance market, it's important to note that the budgets for maintenance are fairly fixed, such as those for golf courses or municipalities. Rapid price increases have put pressure on our customers. We've noticed customers are shifting to lower-cost products and reducing usage where possible, such as with fertilizers and seeds. This has resulted in reduced demand. However, we anticipate that this situation will stabilize over time as maintaining greenery and full usage becomes necessary again. Weather conditions in northern markets have not been favorable, which adds to the challenges. Nevertheless, we are optimistic about dollar demand as prices stabilize and budgets adjust to account for inflation going into next year. We believe there may be some upside in volume for the maintenance market next year. These are the trends we are observing in maintenance.

Our next question is from Stephen Volkmann with Jefferies.

Great. Maybe just to drill down a little more on this price thing, Doug, because that seems like it has sort of changed a little bit. Is there any reason that to expect at least kind of mid-single-digit pricing in ‘23 sort of from all the carryover, even if nothing else gets done, there’s been so much in ‘22, I assume the carryover kind of gets you there?

We would say the carryover right now is in the low to mid-single digits. Currently, we are experiencing some additional price increases, although they are much smaller than this year's. There is also some potential risk associated with commodities. Therefore, we are not fully prepared to finalize where pricing will stand at this moment, but I would estimate that the current forecast for carryover into next year, which will likely be higher at the beginning of the year than at the end, would be in the low to mid-single digits.

Okay. All right. And maybe sort of the corollary to that, what percent of your product do you think is sort of potentially going to see price declines that you’ll have to sort of pass through?

We estimate that around 20% of our product has a commodity component. Some of that is already experiencing decreases from the peak levels, particularly with PVC pipe, which is a small portion of our sales, under 5%. We are monitoring these components closely. Looking ahead to next year, we do not anticipate that the 80% will remain flat, and while we won’t experience the significant increases seen this year, there may still be some upward pricing on that specific product, along with potential downward pressure on the 20% commodities.

Got it. Okay. And then just finally and I’ll pass it on, on SG&A., is there an opportunity in a sort of slower or maybe more normal environment? Is there an opportunity to get at some of the SG&A or maybe that just is the investment you need to keep growing?

Yes. Well, we manage SG&A closely while making investments. But certainly, if certain markets are down, then we can pull back; the majority of our SG&A is people cost, and we can staff appropriately for the market that we’re given in certain markets. We run our business very locally from that standpoint. So we have a lot of flexibility to adjust to specific market conditions as they come around. So I think the broad answer is, yes, we can manage SG&A as we see the demand trends developing in any particular market. John, anything you want to add?

Our next question is from Matthew Bouley with Barclays.

Regarding the new buyback authorization, I need to ask what it indicates about the M&A program. Does it suggest anything about private multiples or the implications for organic growth investments? Are we at a point where we are shifting to a slower pace, or is this simply a sign that our balance sheet now has the capacity to pursue all these options?

Yes, it’s very much the latter. Our strategy is in full swing. The acquisition program is quite strong, and we’re continuing to invest in the business. As you know, our target range of debt to EBITDA is 1% to 2%, and we’re operating below 1%. Therefore, it makes sense to consider utilizing our share repurchase authorization to return some capital if we have excess. As we become more profitable and manage our supply chain while conditions improve post-COVID, we anticipate strong cash flows. This is about allowing ourselves the flexibility to make decisions as they arise. We’re excited, as we believe we're in the early stages of our development as a company. We’re accelerating our strategy, focusing on investments, and we see the future pipeline of acquisitions as very promising.

Got it. That’s really helpful information. For my second question, I wanted to focus on the near term and the commentary regarding improving volume trends. You've indicated that Q3 was down less than Q2, and in October, it seems to be improving to low single digits. Could you remind us if the comparisons were easier and how that influenced the results? I know you mentioned some comments about gaining market share. Do you have any insights on how your growth compares to the market overall? Any additional details on what is contributing to the reduced volume decline would be appreciated.

Yes. The volume comparisons in the second half of the year were easier than in the first half, which contributed to our performance. The improvement from the second to the third quarter aligns well with these comparisons. It's encouraging to see that we're still improving, as this reflects our performance rather than just favorable comparisons. We believe we are successfully building our capabilities to capture market share, and we are monitoring information from our suppliers and analyzing our competitors. We feel confident that we are gaining market share, and we expect our ability to do so will continue to strengthen with our new technologies, the CRM system, enhancements to our sales force, and initiatives aimed at small customers. We have various strategies to expand our market presence, including our private label brands, LESCO and PRO-TRADE. As we approach 2023, which may present challenges, we are fully committed to seizing market share by enhancing customer experience and providing better value. We are optimistic about our trajectory and believe we are ahead of market trends, and we will continue to enhance our capabilities moving forward.

Our next question is from Ryan Merkel with William Blair.

I wanted to follow up on the volumes decline in 4Q. Is the main driver slower new residential construction? And if that’s the case, how much is it tracking down right now?

It’s challenging for us to determine exactly how much it's declining. We have reports indicating that starts are down compared to last year. The primary area of softness is in the residential new construction market. Although we are still at decent levels, builders are becoming more cautious, and our customers who serve builders are busier than before. However, the other markets remain strong. Overall, our customers are still active and have backlogs heading into next year. In the commercial market, our Project Services team is submitting more bids than they did at this time last year, and we have substantial backlogs. The commercial sector allows us to see further ahead, and we are well-positioned as we head into next year. Thus, we believe the main weakness heading into 2023 will be in residential new construction. We intend to leverage our full product line across all customer segments to work diligently on gaining market share to mitigate some of this weakness.

Got it. As a follow-up, are you seeing the consumer pullback on upgrade projects like patios, fire pits, outdoor lighting? Is that something you expect in ‘23?

There are two aspects to the consumer side. First, the retail, do-it-yourself segment, which is a small part of our business, is facing a softer market and sales are down slightly. On the other hand, the professional side remains robust. Professionals still have projects to complete, including larger backyard jobs for customers, and they have been managing backlogs. We continue to observe strong demand in the professional market. According to HIRI predictions, the professional remodeling market is expected to perform better than the do-it-yourself segment in 2023, which gives us some optimism for ongoing strength in that area.

That’s helpful. Okay. Last one for me, just back on the gross margin question. Is there any way to tell what you think the price/cost timing give back will be in ‘23, I think maybe you said 90 to 100 basis points in the past, but it would be helpful to get a little clarity there as we’re thinking about our 2023 models?

We’re not ready to give full guidance on 2023 yet. But that 90 to 100 basis points that we kind of talked about going into this year, that’s probably a pretty good start for next year just because the dynamic that we had in our model at the beginning of this year has really been at least pushed into next year from that perspective because of the strong price that happened in the first half of this year.

Our next question is from Mike Dahl with RBC Capital Markets.

Doug, I want to touch on volumes and ask a couple more questions. You mentioned there might be moderate declines in new construction, and it's clear that the build order trends have dropped significantly. Starts are decreasing as well. Could you provide some insight on what you mean by moderate declines? Could it be less impactful since you are entering towards the end of the process? Any information you could share on that would be helpful. Additionally, when I consider your comments, it seems like you might be anticipating a stable market for the next year. Can you share your initial thoughts on the blended volume?

We are not providing full guidance for next year. When I refer to moderate declines, it could represent a range as we experience a lag in starts. We anticipate that starts will decrease further next year, and we typically lag those by three to six months. This will likely soften the impact of SiteOne in 2023. However, new residential construction is expected to decline. While we can debate the specifics, we do not foresee any different trends than those you are reading regarding starts, and we will face a lag of three to six months on these numbers. For other markets, we will see how they perform, but we expect them to remain relatively stable. I'm not sure if that translates to flat or slightly down, and we will discuss that at the end of the year. One thing we will ensure is that we are prepared to gain market share and outperform whatever the market conditions are in 2023, and we are confident in our ability to do so. When everything is taken into account, we will provide more insight at the end of the year regarding our full-year expectations. Additionally, we would correlate the lag on starts more with completions than with starts, so you can use those figures to estimate next year's outlook.

Yes, that’s understandable. My second question is about commodity pricing and its dynamics. You've mentioned that prices have been steadily declining over the past four months. Can you provide any quantification on how much commodity prices have decreased during that time and what the year-on-year comparison looks like today?

I believe it's a bit early to provide a detailed breakdown. What we do know is that price inflation peaked in the first quarter of this year at just over 20%. This quarter, we experienced 17% inflation, and as we close out the year, we are still seeing double-digit increases year-over-year, though significantly lower than the 17% we discussed earlier. Looking ahead to the fourth quarter, we anticipate price realization in the low to mid-teens. Much of this will be compared to last year’s prices, and we are also seeing some reductions in commodity prices.

Our next question is from Keith Hughes from Truist.

A previous question on maybe was in the intro. You talked about you’re still getting some price increases coming in. I think they’re pretty small, but can you just talk about what products are raising price now? And I was interested in your comments on PVC about it rolling over, if you give any kind of magnitude of what you’ve seen so far on that?

We anticipate some price increases for certain irrigation parts and specific chemicals. These are not commodity products but rather high-end items that haven't fully experienced the benefits of increasing flows, as their prices have not risen as quickly. We will need to observe how pricing evolves in the first quarter of next year. However, our team is not indicating that we expect increases as significant as those from this year, but rather more modest and typical adjustments. Regarding PVC pricing, it appears we might see a decrease of around 10% to 15%.

Our next question is from Jeff Stevenson for Loop Capital.

Congrats on the nice quarter. I just wanted to talk more about the opportunity for inventory destocking moving forward now that material availability challenges have improved. Would you expect this largely to occur in the fourth quarter or could destocking continue in the early next year?

I believe the destocking will carry over into next year to some extent. There will be typical destocking associated with the seasonality of the fourth quarter, which is to be expected. This process may be quicker due to our excess inventory. We are a very seasonal business, and some products that are currently heavy in stock won't sell until spring of next year. Therefore, the inventory will likely be reduced over the next 12 months as we address this issue. We made progress this quarter and will continue to do so next quarter. Our goal is to achieve 4.5 inventory turns, and initially to reach 4 turns, which I believe is a realistic target for us next year.

Understood. That’s very helpful. And then since you mentioned it, I just wanted to get an update on the progression of siteone.com. Obviously, you’ve seen it as an opportunity to gain shares with small and midsized customers, maybe weren’t as in front of previously? And just wondered how successful that has been over the last year and kind of your expectations as kind of we move into 2023 of the potential share gain opportunities from siteone.com.

Yes. It's one of the tools we're using to stand out from our competitors. We’ve focused on enhancing functionality and user-friendly design, tailoring the tool to our customers' needs. We’re pleased with the progress we've made. We've seen sales activity double this year, albeit from a low starting point. We're excited about leveraging this tool more aggressively in 2023 to capture market share among smaller customers. It's also highly beneficial for our larger customers as it integrates with their systems, allowing them to order seamlessly. We've now integrated with QuickBooks, so invoices flow directly into their financial system. This year has seen some impressive developments that strengthen our position as a unique provider. We’ve made significant progress this year, and we expect this momentum to accelerate in 2023 given our team and the capabilities of the tool we now have.

Our next question is from Andrew Carter with Stifel.

I would like to ask if you can share the pricing for structural items compared to index price items for the quarter. I'm curious about the strong pricing trends we've seen. I understand that your pricing may reflect past conditions, but with Urea PVC and other indexes showing deflation, do you think there’s a chance that this significant index pricing cycle could be sustained, considering the structural factors for you and your competitors? I assume your competitors align with your pricing strategy.

I don’t think we have the specific breakdown at that level of detail on this call right now. It seems more like a blended number. From a structural perspective, I believe we need to be more competitive in the marketplace. Regarding the commodities we can maintain, I think it's not realistic to expect to hold prices significantly higher when commodity prices are declining. The market is quite orderly both when prices are rising and falling. Therefore, I believe we need to remain competitive in terms of pricing for those products. If the general market price is decreasing, we’ll have to adjust accordingly.

And just one final question. If I'm correct, there was a $15 million variance in the fourth quarter, which accounts for a 25% year-over-year EBITDA. Is there anything specific regarding that variance? Also, did the Florida hurricane cause any near-term disruption or create any opportunities in the fourth quarter?

I’m not exactly sure about the variance you’re referring to. Concerning the hurricane, we had to close our stores in Florida for just under a week. Overall, the impact was likely between $5 million to $6 million. Some of that we might recover, but most importantly, all of our employees came through the hurricane in good shape, and our stores sustained no damage; we just took precautions for safety.

Yes. I believe you are referring to the differences in our fourth quarter estimates compared to market expectations. It's important to note that the fourth quarter tends to be one of our weaker sales periods. During this time, various factors can influence our performance, including weather conditions and significant fluctuations in gross margins like pricing adjustments, especially with lower sales volumes. Therefore, there are no long-term trends to be concerned about in our fourth quarter performance. We expect to conclude the year on a solid note but must exercise caution when making predictions related to weather and margins, among other factors. We aim to enter 2023 from a strong position, ready to exceed market expectations and achieve favorable results. Hence, there's no need to interpret the discrepancies between our outlook and prevailing sentiments in the market.

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

Okay. Thank you. So thank you, everyone, for joining us today. We certainly appreciate your interest in SiteOne and look forward to speaking with you again at the end of the year, at the end of next quarter. Would like to take one last opportunity to thank our associates, our customers, and suppliers. It’s really a pleasure to be in business with such a great team, and we’re excited about our future. Thank you very much.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.