Ferguson, the leading distributor of plumbing and heating products, reported a slight decline in revenue for its second quarter, citing a challenging market environment. The company announced adjusted operating profits of $520 million and adjusted diluted earnings per share of $1.74, representing an 8.9% decrease from the previous year.
Despite the softer performance, Ferguson (FERG) remains optimistic about the second half of the fiscal year, expecting improvements backed by solid open orders and daily sales trends. The company's guidance for fiscal 2024 forecasts steady revenue and an adjusted operating margin between 9.2% and 9.8%. Ferguson plans to continue its growth strategy through organic expansion, dividend growth, strategic acquisitions, and returning capital to shareholders.
Key Takeaways
- Ferguson experienced a 2.2% revenue decline in Q2 due to market deflation.
- Adjusted operating profit hit $520 million, with adjusted EPS at $1.74, down by 8.9%.
- The company anticipates a stronger second half, bolstered by open orders and sales trends.
- Fiscal 2024 guidance remains unchanged, expecting flat revenue and a 9.2%-9.8% operating margin.
- Investments between $400 million and $450 million in CapEx are planned, mirroring last year's spending.
- Ferguson aims to capitalize on growth opportunities, particularly in nonresidential sectors and digital business.
Company Outlook
- Ferguson's fiscal 2024 revenue is projected to remain flat, with an adjusted operating margin forecasted between 9.2% and 9.8%.
- The company's strategy focuses on organic growth, dividend sustainability, market consolidation through acquisitions, and shareholder returns.
Bearish Highlights
- Q2 faced weaker sales than expected due to an extended holiday season and challenging weather.
- The industrial segment saw a 6% year-over-year decrease.
- The digital business is currently facing challenges, particularly in the RMI residential sector.
Bullish Highlights
- Ferguson expects improvements in the second half of the fiscal year, with stabilizing commodity prices and slight increases in finished goods prices.
- Growth is anticipated in the second half, especially in nonresidential sectors and major capital projects.
- The company is confident in the strength of their markets and expects to capitalize on growth opportunities.
Misses
- Revenue declined by 2.2% in Q2, and adjusted EPS decreased by 8.9% compared to the previous year.
Q&A Highlights
- CEO Kevin Murphy emphasized growth expectations in the second half, particularly in nonresidential sectors.
- The company is focusing on opportunities in the data center sector and collaboration with customers for total package solutions.
- Ferguson's M&A strategy is robust, with a focus on expanding capabilities in Waterworks and HVAC.
- The company has closed four acquisitions year-to-date and has a healthy pipeline of deals.
Ferguson's second quarter earnings call revealed a modest decline in revenue but maintained a steady outlook for the fiscal year. The company is poised to invest significantly in capital expenditures, echoing the previous year's spending, and remains committed to its growth strategy.
Despite the downturn in the industrial segment and challenges in the digital business, Ferguson is confident in its market strength and the potential for improvement in the latter half of the year. With a solid balance sheet and a flexible business model, the company is well-positioned to navigate the current market conditions and seize growth opportunities, particularly in the nonresidential sector and through strategic mergers and acquisitions.
InvestingPro Insights
Ferguson's recent financial performance, as reflected in the second quarter results, indicates a challenging period for the company. However, the InvestingPro Data and Tips highlight some key aspects that might be of interest to investors and stakeholders:
InvestingPro Data:
- The company's market capitalization stands at a robust $41.27 billion, suggesting a significant presence in the market.
- Ferguson is currently trading at a Price/Earnings (P/E) ratio of 23.55, which has adjusted to 21.31 over the last twelve months as of Q1 2024, indicating a potential reassessment of its earnings capability.
- Despite the slight revenue decline reported, the company's revenue over the last twelve months as of Q1 2024 was $29.51 billion, with a gross profit of $8.935 billion, reflecting a gross profit margin of 30.28%.
InvestingPro Tips:
- Analysts have noted that Ferguson is a prominent player in the Trading Companies & Distributors industry, which could signal resilience and potential for recovery in challenging market conditions.
- The company's liquid assets surpass its short-term obligations, providing it with a stable foundation to manage its financial commitments and invest in growth opportunities.
Investors looking for more in-depth analysis and additional InvestingPro Tips for Ferguson can explore the 10 more tips available at https://www.investing.com/pro/FERG. To get an extra 10% off a yearly or biyearly Pro and Pro+ subscription, use the coupon code PRONEWS24.
Full transcript - Ferguson Plc (FERG) Q2 2024:
Operator: Hello, and welcome to Ferguson's Second Quarter Results Conference Call. My name is Adam, and I'll be coordinating your call today. I'd now like to turn the call over to Brian Lantz, Vice President of Investor Relations and Communications. The floor is yours. Please go ahead.
Brian Lantz: Good morning, everyone, and welcome to Ferguson's second quarter earnings 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. 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. Including the various risks and uncertainties discussed in our Form 10-K available on the SEC's website. Also, any forward-looking statements represent the company's expectations only as of today, and we disclaim any obligation to update these statements. 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: Thank you, Brian, and welcome, everyone to Ferguson's second quarter results conference call. On the call today, I'll cover highlights from our second quarter performance, I'll also provide a more detailed view of our performance by end market and by customer group before turning the call over to Bill for the financials then come back at the end and give some closing comments before Bill and I take your questions. Our associates have continued to execute well, going above and beyond to serve our customers, helping to make their projects more simple, successful and sustainable. In the quarter, we saw a modest revenue decline of 2.2%, largely driven by 2% deflation in a challenging market. We delivered solid gross margins and appropriately managed costs while preparing for our seasonally stronger second-half. Adjusted operating profit came in at $520 million, with adjusted diluted earnings per share of $1.74 down 8.9% against last year. Over the three years since fiscal 2021, this represents sales growth of 35%. Adjusted operating profit growth of nearly 50% and adjusted diluted earnings per share growth of nearly 60% for the second quarter. Looking forward, open orders and sales per day trends support our expectation of improvement through the balance of the fiscal year against easing comparables. Our views on fiscal 2024 guidance are unchanged. Bill will walk you through this in more detail shortly. Turning to our performance by end markets in the United States. Net sales were down 2.2% as end markets remain challenged. Trends in new residential housing starts and permit activity improved slightly in the quarter, while repair, maintenance and improvement work remains soft. Our residential revenues, which comprised just over half of U.S. revenue, declined 4% during the second quarter, representing a sequential improvement from Q1. Non-residential markets show comparative resilience Commercial and civil infrastructure activity held flat in the quarter against strong comparables with industrial down 6% against an outstanding 24% comparable. Overall, Net sales in nonresidential declined by 1% during the quarter, the good levels of nonresidential bidding activity and expect improvement through the second half. While we expect growth rates will fluctuate over time, our intentional balanced end market exposure positions us well. Moving to our customer groups in the United States. Residential trade plumbing declined by 2%, an improvement from double-digit declines over the three quarters as we begin to lap easier comparables and new residential markets begin to stabilize. Any indicators such as new residential permits and starts have recently seen modest improvement, and we expect further improvement in future quarters. HVAC growth continued. Rising 1% against a 10% prior year comparable. We will continue to build on the strength of our residential trade plumbing and HVAC customer groups in service of the growing dual trade contractor. Residential Building and remodel revenues declined 4%, similar levels to the first quarter with continued pressure on repair, maintenance and improvement. Residential digital commerce declined by 13% with consumer demand remaining weaker. Waterworks revenues were flat. Hitting activity is healthy across our broadly diversified business mix, including residential, commercial, public works, municipal, meters and metering technology and wastewater treatment plant. Soil stabilization and urban green infrastructure. The commercial mechanical customer group grew 1% as we continue to see our customers pivot towards work such as data centers and major capital projects. Our industrial, Fire and Fabrication and facility supply businesses delivered a combined net sales decline of 3% against a strong 17% growth comparable. Our breadth of customer group allows us to bring value to the total project while also maintaining a broad and balanced end market exposure. Now let me pass to Bill to cover the financial results in a bit more detail.
Bill Brundage: Thank you, Kevin. And good morning, everyone. Second quarter net sales were 2.2% below last year. Manic revenue declined 3.7%, partially offset by acquisition revenue of 1.5%. Pricing environment was similar to the first quarter with approximately 2% deflation driven by weakness in certain commodity categories as we lap strong comparables, while finished goods pricing has remained slightly positive. Gross margin of 30.4% was up 20 basis points over the prior year, driven by strong pricing and product strategy execution from our associates. We are appropriately managing the cost base with SG&A stepping down more than $40 million from Q1. We're balancing targeted cost control actions and productivity initiatives with continued investment in core capabilities for future growth. Adjusted operating profit of $520 million was down $62 million or 10.7% lower compared to prior year. Adjusted diluted earnings per share of $1.74 was 8.9% lower than prior year, with the reduction due to lower adjusted operating profit, partially offset by the impact of our share repurchase program. Our balance sheet remains strong at 1.1 times net debt to adjusted EBITDA. Moving to our segment results. Net sales in the U.S. declined by 2.2% with an organic decline of 3.7%, partially offset by 1.5% contribution from acquisitions. Adjusted operating profit was $525 million, delivering an adjusted operating margin of 8.2%. Canada net sales were down 3.7%, with an organic decline of 3.3% and a 0.4% adverse impact from foreign exchange rates. Markets have remained challenging, and we saw similar trends to that of the U.S. Adjusted operating profit came in at $9 million. Turning to our first half results. The year is progressing as expected. As we set out at the beginning of the year, we expected to operate against a challenging market backdrop, particularly in the first half of our fiscal year against strong revenue and adjusted operating margin comparables. Net sales were 2.5% below last year, with an organic decline of 4.4%, partially offset by an acquisition contribution of 1.9%. Gross margin was 30.3%, down 10 basis points as our associates have been disciplined in managing prices through a period of commodity price deflation. We have managed labor and nonlabor expenses throughout the year, balancing the near-term market demand environment against expected growth in upcoming quarters. Adjusted operating profit of $1.3 billion was down 10.6% compared to the prior year, delivering a 9.0% adjusted operating margin. Adjusted diluted EPS of $4.40 was down 9.7%. I believe the business is well positioned as we head into the second half with improving market demand and the cost base in good shape. Next, the business continues to generate strong cash flows. Inventory positions normalized as we exited last fiscal year and we have returned to our normal historical seasonal working capital trends with a modest outflow in the first half of the year. Interest and tax outflows were slightly lower than last year, due to the timing of tax payments, resulting in strong first half operating cash flow of $863 million. We continue to invest in organic growth through CapEx, investing $192 million in the first half. As a result, we generated free cash flow of approximately $700 million. Moving to capital allocation. Our balance sheet position is strong, with net debt to adjusted EBITDA of 1.1 times. Target (NYSE:TGT) a net leverage range of 1 times to 2 times, and we intend to operate towards the low end of that range through cycle to ensure we have the capacity to take advantage of growth opportunities as well as to maintain a resilient balance sheet. Allocate capital across four clear priorities. First, we're investing in the business to drive above-market organic growth. Previously mentioned, we invested $113 million in working capital and $192 million in the CapEx during the first half, principally focused on our market distribution centers, branch network and technology programs. Second, we continue to sustainably grow our ordinary dividend. Board declared a $0.79 per share quarterly dividend, a 5% increase 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 are pleased to welcome associates from secure vision, grow supply and hard way appliances during the first half. Our deal pipeline remains healthy, allowing us to continue to execute our consolidation strategy. Finally, we are committed to returning surplus capital to shareholders when we are below the low end of our target leverage range. returned $250 million to shareholders via share repurchases during the first-half, reducing our share count by approximately $1.5 million and ended the period with $285 million outstanding under the current share repurchase program. Now let's turn our attention to the remainder of the fiscal year. As Kevin outlined earlier, current open orders and sales per day trends support our expectation of improvement through the balance of the fiscal year against easing comparables. I believe we are well positioned for our upcoming seasonally stronger second half. As a result, our view of fiscal 2024 guidance remains unchanged. We believe revenue will be broadly flat for the year. Here, we assume end markets declined in the mid-single-digit range. We expect to outperform these markets by approximately 300 to 400 basis points. Sales from completed acquisitions which we expect to generate just over $600 million in revenue and the benefit of one additional sales day landing in the third quarter. Overall, while we saw modest deflation in the first half, we are assuming a broadly neutral pricing environment for the full year as a whole. Continue to provide a range for adjusted operating margin between 9.2% to 9.8%. I expect interest expense of approximately $190 million to $210 million. Our adjusted effective tax rate is expected to be approximately 25% this year and we expect to invest between $400 million to $450 million in CapEx, similar levels to last fiscal year. So to summarize, we had solid execution in the first half and our views on fiscal 2024 guidance are unchanged. And remain focused on execution and believe the combination of our strong balance sheet, flexible business model and balanced end market exposure positions us well. Thank you, and I'll now pass back to Kevin.
Kevin Murphy: Thank you, Bill. Let me again thank our associates for their unwavering dedication to serving our customers, helping to make their projects more simple, successful and sustainable. We are pleased with our execution in the first half. Business is well positioned as we anticipate firming demand. And as Bill set out, our fiscal 2024 guidance is unchanged. As we look forward, we are well positioned with a balanced business mix between residential and nonresidential, new construction and repair, maintenance and improvement. We have an agile business model and flexible cost base that allows us to adapt to changing market conditions. Our cash-generative model allows us to continue to invest for organic growth, consolidate our fragmented markets through acquisitions and return capital to shareholders and to do this while maintaining a strong balance sheet, operating at the low end of our target leverage range. We have consistently executed on these priorities and supported a long-term track record of outperformance and disciplined deployment of capital. Scale and breadth allows us to leverage our competitive position across our customer groups in order to benefit from emerging multiyear tailwinds in our end markets. Remain confident in the strength of our markets over the medium and longer term and expect to capitalize on these growth opportunities. Thank you for your time today. Bill and I are now happy to take your questions. Operator, I'll hand the call back over to you.
Operator: Thank you. [Operator Instructions] Our first question comes from Matthew Bouley from Barclays (LON:BARC). Matthew your line is open. Please go ahead.
Matthew Bouley: Hey, morning everyone. Thank you for taking the questions. You all mentioned current open orders and sales per day supporting second-half improvement. I guess what exactly are you seeing around orders and daily sales and maybe help if you can kind of help us with the cadence of growth through fiscal Q2? How did January trend with weather and all that? And kind of what are you seeing quarter-to-date? Thank you.
Kevin Murphy: Good morning, Matt. Yes, thank you for the question. This is Kevin. I'll take the being portion and maybe then Bill can sprinkle in some detail around what we're experiencing. And as we said previously, the second quarter is always our seasonally weakest quarter from a revenue perspective. And if you look at how we progressed through the second quarter. The top line was a bit more pressured than what we would have expected, really given what was an extended holiday season for the trade professional and some January weather impact that was a bit more challenging than, say, years past. But generally speaking, the year is progressing as we expected, and that second quarter progressed largely as we expected. If we look forward, the bidding activity that we've got out there from our Waterworks group all the way up through residential trade plumbing and the like, and the open order volume that we have, sales per day trends against what are some easing comparables really do support what we think is going to be improvement throughout the balance of the year.
Bill Brundage: Yes, Matt, we've seen that improvement start to play through in the early part of the second quarter. So in February, organic growth was about flat, which with -- when you add in the acquisition impact that would lead to slightly positive total growth for the month. So again, supporting our confidence level that growth is improving and will improve as we move through the second-half.
Matthew Bouley: Perfect. Very helpful. Second one, the deflation of 2% in the quarter, it sounded like that was all commodity. I think you said finished goods was slightly positive. And so to get to your full year guide of broadly neutral inflation, are you starting to see any kind of incremental finished goods inflation and price increases to support that or is it really just kind of the year-over-year comps as you get to the second-half, kind of what takes inflation positive in the second-half to get to your guide?
Bill Brundage: Yes. So back to your point, about 2% deflation both in Q1 and Q2, largely driven by commodity deflation commodities were down, call it, low to mid-teens in the quarter. And those finished goods, as we expected, are still slightly positive in terms of year-over-year inflation. Think a couple of things as we roll through the second-half leads us to believe that, that deflation will improve. First and foremost, we are continuing to roll over, not just easing revenue comparables, but easing inflation comparables. And in fact, we'll start to roll over our first month of commodity deflation as we step out of the third quarter and into the fourth quarter. We've seen some stability broadly in those commodity prices over the first half of the year. So assuming that, that stability continues, that commodity deflation should lessen as we move throughout the second half. And again, we would expect finished goods inflation to be in that more traditional low single-digit range. So that leads us to believe that we'll have improving deflation moving back towards inflation in the second-half. But of course, predicting commodities is difficult. So as we're guiding broadly neutral pricing for the full-year, there's some range of possible outcomes around that full year guide.
Kevin Murphy: Yes. Matt, as we've discussed in the past, the commodity-based product basket that we have is going to and has moved at different rates and has had some puts as well inside of that. And so as we're sat here today, we've seen some signs of stabilization. We've seen some resin price increases playing through inside the marketplace. And then we've seen some stabilization from a steel pipe perspective. So we feel more confident about that. And as it relates to finished goods, we've talked traditionally about the annual spring price increase season. And although it hasn't been as ubiquitous as in the past, we have seen major product categories announcing price increases that give us some degree of confidence as we go into that second-half.
Matthew Bouley: Great, thanks Kevin, thanks Bill, good luck guys.
Kevin Murphy: Thanks Matt.
Operator: The next question is from John Lovallo from UBS. John, your line is open, please go ahead.
John Lovallo: Good morning guys, and thank you for taking my questions as well. The first one is you guys do have a pretty agile cost structure. I think it's highly variable around 80% to 90% incrementals are generally kind of 10% to 13-ish percent. Now recognizing pricing was a bit of a headwind in the quarter. Why were decremental margins so high close to 40%.
Bill Brundage: Yes, John, thanks for the question. As you think about the second quarter, again, in our seasonally lightest quarter and as Kevin mentioned, there's a bit more pressure on the top line. So that has a bit of an outsized impact on bottom line operating leverage when you get a bit more pressure from a top line perspective, the fixed cost nature of our business, even though we have a good variable cost structure in that seasonally later quarter plays down a little bit more from a decremental perspective. But as we take a step back and think about the overall cost structure, we are pleased that the cost did step down from Q1 into Q2 as we think about labor costs, which is certainly our largest component of our cost base, we manage very closely full-time equivalents and headcount as the primary input to that labor cost. If I look at where full-time equivalents are as we exited Q2, we're down slightly still year-over-year on volumes that were effectively flat for the quarter. So the teams are doing a really nice job managing those input costs, and we've really positioned that cost base for what we expect to play through in the second half and into next fiscal year, which is an improving growth environment. So given the fact that our associate base is the intellectual capacity and capability of the organization. We want to make sure we have the right associate base to take care of that future growth. So feel good about where the cost base is. Yes, it put a little bit more OpEx pressure in Q2. But as we look forward, we believe we're in the right place.
Kevin Murphy: And John, just to reiterate a little bit of what Bill said, we do feel good about where the cost base is as we prepare for what we believe to be an improvement through the balance of the year. If you think about what the volume outlook looks like inside of our residential trade plumbing business, which has been a pressured part of the business, both new construction as well as repair maintenance and improvement. They've done a great job of going out and taking market share. They've grown in volume and pounds for PVC pipe even though the pricing environment has been down in the mid-20% range while at the same time, holding gross margin. So keeping those teams engaged and prepared for what we think is an improving outlook in the second-half is quite important. So we're pretty positive about what the team has done in terms of expense management.
John Lovallo: That's helpful. Thank you. And then on the Industrial segment, in particular, down 6% year-over-year, understanding the comp was tough at around 24%. Just curious, I mean, the first quarter faced a similar comp it was actually up, I think, 3% year-over-year in the quarter. So was there anything particular in the quarter outside of the tough comps that challenged industrial?
Kevin Murphy: Yes, John, there's nothing that we would point to right now. You've got some timing issues that are out there. I talked about little bit of an extended holiday season. I talked about a little bit of weather. We typically don't like to talk about weather, but it did have an outsized impact with branch closures. But if I look at what's building behind that industrial environment, the backlog is solid. Especially in that major capital projects area. We've talked historically about that mega project trend. When you look at together, our industrial, our Waterworks, commercial, fire and fabrication and HVAC business coming together. That's where we're seeing a good tailwind on from an open order perspective and are positive about what's coming in the second-half.
John Lovallo: Great. Thank you guys.
Kevin Murphy: Thank you.
Operator: The next question comes from Philip Ng from Jefferies. Philip, your line is open. Please go ahead.
Philip Ng: Hey Kevin, looking at your non-res business, certainly some puts and takes on the heavy side. Clearly, you're upbeat about that. like commercial could be a little softer, but just kind of help us unpack in the back half. Do you expect growth and the bidding activity you're seeing in some of these mega projects, do you expect that to kind of ripple through in the second half? And conversely, have you seen light commercial bottom out here?
Kevin Murphy: Yes, Phil, thank you for the question. And we do see growth in the second half. Again, we do see open order volumes picking up across that nonresidential space from Waterworks through commercial through industrial and through fire. When you look at what's out there, we've said that those major capital projects, specifically those like onshoring and reshoring sustainability trends, fiscal stimulus aided they're going to take a bit longer. We're seeing that play out. I mean, much like we saw with the Infrastructure Act and how that plays through our Waterworks business. It's just taking more time both in terms of release as well as in project delays that we may see during the normal course of construction. There are also some tailwinds that we're really starting to capitalize that are in the current market. If you think about AI and what the data center impact is, those are very good projects for us across multiple customer groups. And we're seeing it play out very similarly to the way in which we're seeing mega projects play out. And that is across customer group collaboration with the owner, the general contractor to make sure that Ferguson is a valuable partner on the job for the contractor as well as the owner. And so we're bullish on what that looks like in the second half, and that's starting to play in today.
Philip Ng: Kevin, you beat me to the punch, I was going to ask you what percentage of your business on data centers is your non-res business just because it's very much involved with that AI dynamic. But any color on the data center portion of your business for non-res?
Kevin Murphy: Yes. For me, the color is that it's very much like that mega project or a major capital project landscape. Number one, they are good profit pools that are growing, and it's a unique time in the construction environment for our country. But maybe more importantly, it offers us that unique opportunity to come together and multiple customer groups for the owner, the general contractor, as well as for the contractor that's actually doing the install. And so coming together on water, commercial, industrial fire, HVAC is proving valuable. We're seeing that play out and in fact, we've made some good investments in how we can approach that part of the construction environment uniquely as to where we used to just bid that work as individual customer groups really coming together and offering a total package.
Philip Ng: Appreciate all the great color, thank you.
Operator: The next question comes from David Manthey from Baird. David, your line is open. Please go ahead.
David Manthey: Thank you. Good morning, everyone. First question for Kevin maybe. On slide five, when you look at your U.S. end markets in the second quarter, they're mostly flattish year-over-year, give or take. After this quarter, which of these end markets leave you more encouraged for the second half of the year and on which ones are you more cautious following recent results?
Kevin Murphy: Thanks, Dave, for the question. If I start at the residential side, as we're sat here today, we're looking at an RMI or repair, maintenance and improvement residential market that is a touch softer than what we would have expected at the beginning of the year, Leer is calling for a down market, call it, in that mid- to high-single-digit area for the calendar year. But the residential new construction market, we see as a bit more positive, especially in the single-family side of the world. We think that multifamily, although it's been supportive for the business as we've delivered product to the market. It now starts to get a bit more challenged because there's been a lot of product that has entered the market from a multifamily perspective. But single-family starts and permit activities give us a more bullish tone. On the non-res side, as I talked earlier on the call, the major capital project work and the data center work gives us some really good outlook for the second half. And so I'd say there's some balanced optimism as we go into the second half. There's a balance in terms of how we're lapping comparables from prior year. And so it plays to that, again, balanced business mix. On one note on that multifamily side, we are seeing good activity levels in high-rise multifamily, especially down in unit was down in Florida. And so we're bullish on that multifamily high-rise work, but maybe a bit more pressured on the core multifamily side.
David Manthey: Yes. Thanks for that detail. A quick one for Bill, mathematically if we think about the new M&A deals that you've announced and the roll-off of prior acquisitions, what percentage contribution to growth should we expect in the third and fourth quarters?
Bill Brundage: Yes, Dave, if you look at the first half, we delivered just under 2%, just under $300 million worth of acquisition contribution. And given the deals we've recently announced, we'd expect a similar dollar amount in the second half. So somewhere just south of that range, roughly $600 million of full year revenue contribution would be our expectation at this point.
David Manthey: Got it. Thanks guys.
Bill Brundage: Thanks Dave.
Operator: The next question comes from Ryan Merkel from William Blair. Ryan your line is open. Please go ahead.
Ryan Merkel: Hey good morning. Thank you. I wanted to ask on gross margins, really solid result this quarter. Can you remind us of gross margin seasonality as we think about modeling 3Q? And any reason not to use normal seasonality?
Bill Brundage: Yes, Ryan. I mean, seasonality really doesn't play a large factor. It doesn't have a large impact on gross margin swings. I mean it's sometimes as we approach the larger seasonal months in the summer calendar, we'll get actually a touch of pressure there just given the HVAC growth in our business and the Waterworks growth in our business in those seasonal months, which tends to have slightly lower gross margins, again, similar operating margins. But in general, in that low 30% to 35% range is kind of our expectation and where we've delivered over the last several quarters.
Ryan Merkel: And just a follow-up there, if inflation turns positive. Is that a help or to your gross margins as we think about the second half?
Bill Brundage: We don't expect inflation to move at a pace that would have a big impact on gross margins. Certainly, as we lap those comparables and as we've talked about we still expect low single-digit inflation on finished goods, that would be helpful from a revenue perspective, but I wouldn't expect a large gross margin impact without some significant short-term moves in commodity prices, which we don't expect sitting here today. But again, that's a little bit difficult to predict and call.
Kevin Murphy: Ryan, what we are pleased with is as we've been going through this period of commodity-based product deflation, the hold and to achieve the kind of gross margin levels that we have is very encouraging, especially as, as I've indicated earlier, we've taken market share and actually grown volume inside of some of those commodity-based products held in produced good gross margins even in a falling price environment. As we look forward to what we should experience this year, we start to get back to, again, a more normalized pricing environment, where you see annual price increases playing through on finished goods. And this year may be a bit more choppy than years past, but generally speaking, that's where we get back to utilizing our product strategy and charging for the value that we provide to get long-term sustainable gross margin expansion can call it, that 10 basis points to 20 basis point environment.
Ryan Merkel: Got it. That's helpful. And just for my follow-up. Anything to think about for March and April, when we think about last year in terms of modeling, I know there was some weather last March. Just curious if the comparisons get a little bit easier and if there's anything to think about?
Bill Brundage: Yes. It's difficult to predict what the weather impact would be, Ryan. But certainly, the comparables continue to ease as we step through Q3 into Q4. We had our first negative organic growth, organic decline of about 2.4% last year, Q3, and then that went down to about 5% organic decline in Q4. So the comparables do continue to ease a bit as we march through kind of month by month through the end of the fiscal year.
Ryan Merkel: Perfect. Thank you.
Bill Brundage: Thanks, Ryan.
Operator: The next question comes from Mike Dahl from RBC Capital Markets. Mike, your line is open. Please go ahead.
Mike Dahl: Good morning. Thanks for taking my questions. First question, just looking at kind of category performance. Digital has been soft even as we've gotten against easier comps, I think, double-digits off of comping off a double-digit decline and you're now down to about 8% of sales from 10%. Obviously, that at least partially with your comments around RMI, but just wondering if you can give a little more color there and give us an update on how you're planning to invest and expand the digital effort here?
Kevin Murphy: Thanks, Mike, for the question. When you look at that digital piece, it was the most affected in terms of a pull forward of demand during that COVID lockdown period. And you're right, the RMI side of the world is a bit more challenged on the residential portion of the business. And so the customers that, that is really going after and targeting is that light decorative pro and that project-minded consumer. And so there's probably the most pressured when we look at that residential space. If you think about consumer balance sheets and again, where they are spending their money on experiences versus say, some light renovation on the home, that's where we're seeing the pressure. If I look at where we're going to take this business going forward, where we get really energized is how we pair what we think are really unique assets together for an omnichannel experience. Because if you look at the digital business, especially built with Ferguson, that's a unique digital experience for that project-minded consumer and that like record to Pro and the tools that are there from a technology perspective are starting to really enable that building and remodel business through the showroom bringing together a best-in-class experience for bricks and mortar with a consultative experience in person, together with a best-in-class experience digitally and a great project tool. So as we look forward, that's really where you're going to see those businesses come together and where we should see that growth.
Mike Dahl: That's helpful. And then shifting gears back on to kind of capital allocation M&A. It seems like there's been a significant uptick in broader M&A activity across virtually everything in distribution, manufacturing, a lot of things housing-related industrial related. Can you talk to Obviously, you closed the three acquisitions, but just the pipeline you're seeing kind of composition. Has that changed at all as you've gone through the past few months and any kind of medium to larger size things taking most? Or are you -- or would you still expect kind of similar cadence as we've seen?
Bill Brundage: Yes, Mike, I would say no significant change. Pleased with the four deals we've now completed year-to-date. In fact, we closed on our York West deal that we announced previously signing on. We closed on that late yesterday. So pleased to have those four deals this year. The pipeline is pretty healthy right now. Still full of those size deals that you would expect, just given the nature of our industry. So as we've talked about a lot in the past, 10,000-plus small- to medium-sized competitors out there that make a good robust and healthy pipeline for us for what we believe will be years to come. So I'd expect a similar cadence, nothing very large in the pipeline just given the nature of what our industry is. And that pipeline is still solid. We still focus on both geographic bolt-on and capability M&A you see us focusing on new capabilities inside of our Waterworks business, especially in areas like meters and metering technology, storm water management, soil stabilization and urban green infrastructure, and then you also see us focusing on expanding our HVAC capabilities so that we can best serve that dual trade HVAC and residential plumbing repair trade professional. We see that market growing. We see that contractor base growing, and we'd like to be uniquely positioned to take care of that customer as we go forward. And M&A is a big part of that landscape as we look to fill out our HVAC capabilities across the United States.
Mike Dahl: Thank you.
Operator: The next question comes from Kathryn Thompson from Thompson Research Group. Katherine, your line is open. Please go ahead.
Kathryn Thompson: Hi, thanks. Just a clarification from earlier in the Q&A. Could you remind us what percentage of cost of goods sold or commodity products and how has this balance changed today versus, say, three to four years ago?
Bill Brundage: Yes, Kathryn, today, commodities are roughly just under 14% of our revenue. if you went back pre-pandemic, we were more like 10%, 11% of revenue with rapid commodity inflation that increase as a percentage of our sales to up over 16% at 1 point. So we've started to normalize back kind of midway back closer to where we were pre-pandemic. And given where commodity prices are today, probably expect a similar range in terms of total percentage of revenue as we step through the second-half.
Kevin Murphy: And that will all depend, Kathryn, on how we progress through the next, call it, for five quarters as we start to see good nonresidential activity continue to play through. That will play through beginning with our Waterworks business, roll into heavy steel pipe usage inside of our commercial mechanical business. Some heavy steel usage inside of our industrial business as well as iron fabrication. So you may see that volume begin to increase even though price deflation is already largely set in through the group.
Kathryn Thompson: And we find that there are some building product categories with other companies that where you're able -- you're better able to pass through pricing on commercial projects then on residential. How does that play through for you in terms of pricing power, particularly taking into account larger scale projects that are a greater relative mix versus historic levels?
Kevin Murphy: Kathryn, I wouldn't say that our ability to pass through pricing is very different between residential and nonresidential inside of our business mix. Certainly, you have different pressure points that happen for long gestation period projects. But we generally play that through in conjunction with the contractor and the manufacturer as we're going through those projects. So there isn't a whole lot of different as we go through there. And as we said, we don't expect to have massive inflation or abnormal price inflation as we move to -- we do see finished goods having some positive movements from a pricing perspective and stabilization on the commodity side of the world.
Kathryn Thompson: Okay. And finally, last week, the largest annual residential construction and end market trade international builder show wrapped up. What if any trends can you share with us that could give just some additional broader color into that important residential end market for you?
Kevin Murphy: So if you think at the highest level, as we've talked, Kathryn by the way, that just ended, so I haven't gotten a complete download in terms of what the epiphanies were coming out of the show from our associates. But at the highest level for us in terms of market, again, we think that we're going to see good movement from a single-family residential start perspective as we're underbuilt inside of this country and existing home turnover is still pressured we think that multifamily starts to tail off. And on the remodel side of the world, we still believe that the high-end remodel side of the world is going to be a bit more resilient than, say, your core MI portion of the business, we're seeing that play out. If you look at the real core customer for our showroom business, that local high-end builder remodeler what we've seen is if they're doing, call it, 6 to 12 projects annually and their high-end projects. We're seeing them flip from new residential construction to more high-end total remodels, but their book of business is still pretty solid, and they feel pretty good about the marketplace. So generally, from a market perspective, that's what we're seeing. In terms of trends that are happening inside the product set, I'll defer to a bit later in the year as to what the takeaways were from KBIS either.
Kathryn Thompson: Okay, great. Thanks very much.
Kevin Murphy: Thanks, Kathryn.
Operator: Our final question today comes from Patrick Baumann from JPMorgan (NYSE:JPM). Patrick, your line is open. Please go ahead.
Patrick Baumann: Well, hi. Good morning. Thanks for taking my questions. Just wanted to jump back to gross margins. You mentioned, I think, in the commentary that pricing and product strategy are drivers of expansion in the quarter. Can you just flesh out what you mean by that? Because on pricing, you're seeing deflation. So are you getting some price cost benefit? I think you said like discipline from your associates from a price perspective. And then on product strategy, is this own brand contribution? Is this -- or something else from a services perspective?
Kevin Murphy: Yes. Thank you, Patrick. And if we think about the pricing side of the world, one of the things that is most important from a customer service and a customer engagement perspective is consistent pricing across our network and across time. And so making sure that we have good solid matrix utilization as well as doing the right thing from a specialist pricing. As you know, we're a value-added and service-driven company. And so in some cases, upwards of 20% of our revenue can be nonstock specials. And so making sure that we're pricing appropriately for the project has an impact on our gross margin and that gross margin expansion. Additionally, from a product strategy perspective, we think that's probably our best avenue for overall gross margin. And yes, own brand is probably the highest expression of what that product strategy looks like because you have a product that's unique to Ferguson and one in which we are promoters of the brand and have a higher overall gross margin profile. But it's not just one brand. It's also the partner vendors that we have that we can grow faster than market for them that we can offer unique cost savings and we can drive value for them and have a higher overall gross margin profile. So it's really our sales associates, both inside now. Driving the right product for the job and the application for the customer and then secondarily, those that have the highest gross margin profile for Ferguson as a company. And that's the way we look at expanding gross margin over time.
Patrick Baumann: Makes sense. Helpful. And then on the -- my follow-up is on the commodity product pricing side. You mentioned some increase in resin as a good sign for PVC pipe, I suppose. I'm wondering if you could comment on any differences you're seeing in the smaller diameter like plastic water pipe for resi trade versus like the bigger exxameter stuff for the Waterworks business. You said something about like a 20% decline overall, I think. I'm just wondering if you could give any color on differences between the types of PVC pipe.
Kevin Murphy: And if you look at the commodity base basket of products that we have, again, it's PVC pipe, steel pipe, cast iron, ductile iron, copper tube. And so inside of that basket, we've said that they're going to move at different paces and potentially move quite differently. PVC is one of those. We've seen a bit more movement on the small diameter and plumbing PVC pipe than we have on large diameter and Waterworks PVC pipe. We've seen more stability. That said, resin price increases are going to affect both sides of that. And so although we've seen a bit more pricing pressure or deflation in plumbing, we do see that moving in a different direction as we're sat here today. So it really has had different movements across, call it, the first 2 quarters, especially this year.
Patrick Baumann: Helpful. And then if I could fit one more in here. I know I'm the last question, so I'm just going to fit one more in -- on the -- your MDC rollout, any update kind of on how that's going relative to your expectations? Like what are kind of the plans for this year from an MDC perspective? And any kind of financial metrics you could share with us on how it's impacting the business.
Bill Brundage: Yes, Pat, we're pretty pleased with our rollout to date. To date, we have 3 MDCs that are open, Denver, Phoenix and Houston, Houston being our most recent MDC that we've opened. And as we look at this year from a calendar year perspective, we'll open our first MDC in Canada in Toronto. We'll have Nashville come online later this calendar year. And then as we roll into next calendar year, Dallas and Washington, D.C. So the rollout strategy of, call it, two to three per year over the next several years is very much on track. Early reads on productivity levels are quite good and positive. As you know, we've got a lot of investment in automation within those warehouses. And just from a pure labor standpoint, we're getting 20% to 30% productivity out of those components of the warehouses. So good productivity, but maybe more importantly, from a strategic standpoint, what we're bringing is best same-day availability of inventory into these major metropolitan markets. And that's really improving customer service scores and product availability, fill rates and in-stocks in those markets. We think this is a real core component of our continued organic growth strategy over the next several years. So very pleased with the rollout to date, and we'll continue to march down that path.
Patrick Baumann: Great. Thanks a lot for the update. Best luck.
Bill Brundage: Thanks, Pat.
Operator: This concludes today's Q&A session. I'll now hand over to Kevin Murphy for closing remarks.
Kevin Murphy: Thank you, operator, and thank you all for your time with us today. We appreciate it more than you know. And again, I'll end where we started and to thank you to our associates there. Tyler's efforts to really make our customers' projects better because we were on the job with them. As I take a step back, we are pleased with how the year is progressing. It's generally progressing as we expected. And as we look forward to the second half, our seasonally stronger second half, we look forward to continued improvement as we lap some easing comparables. So again, thank you very much for your time, and we look forward to seeing and talking with you soon.
Operator: That concludes the Ferguson second quarter results conference call. I'd like to thank you for your participation. You may now disconnect your lines.
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