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Greetings. Welcome to the SiteOne Landscape Supply, Inc. First Quarter 2021 Earnings Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, John Guthrie. John, you may begin.
Thank you, and good morning, everyone. We issued our first quarter 2021 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 projection. 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.
Thanks, John. Good morning and thank you for joining us today. Following a very strong fourth quarter and an excellent year in 2020, we are very pleased to report even stronger results in the first quarter of 2021, getting us off to a tremendous start for the year. We have seen the stay-at-home and outdoor living trends continue to benefit landscaping, repair and upgrade, coupled with a strong housing market and steady commercial activity, all supporting robust demand for professional landscaping services. At the same time, our exceptional teams continue to overcome the labor and product supply challenges associated with a very strong market, delivering better value to our customers and suppliers than ever before. We believe this has allowed us to gain market share on top of the overall market growth. Further, we continue to add terrific companies to SiteOne, all local market leaders with the best teams in the industry. As a result, we are delivering outstanding value to all our stakeholders and gaining strength at the same time. Stronger together works and I could not be prouder of our team or more confident about our future. I will start today's call with a brief review 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 first quarter financial results in more detail and provide an update on our balance sheet and liquidity position. Scott Salmon will discuss our acquisition strategy and then I will come back and review some of the trends that we are seeing in our end markets and address our outlook for the remainder of the year before taking your questions. As shown on Slide 4 of the earnings presentation, we have grown our footprint to more than 580 branches and 3 major distribution centers across 45 U.S. states and 6 Canadian provinces. We are the clear industry leader, yet we estimate that we only have about 13% share of the very fragmented $20 billion wholesale landscaping products distribution market. Accordingly, our remaining growth opportunity is significant. We have a balanced mix of business with 59% focused on maintenance, repair and upgrade, 27% focused on new residential construction and 14% on new commercial construction. We are also the only national full product line wholesale distributor in the market. Our balanced end market mix, broad product portfolio and geographic spread give us multiple avenues to grow and more ways to add value for our customers and suppliers while providing important resiliency in softer markets. Turning to Slide 5. Our large and local strategy combines the scale, resources and capabilities of a large world-class company with the passion, deep knowledge and entrepreneurialism of our local teams in order to deliver superior value and differentiate us from the competition. While we have come a long way in building SiteOne, we're still in the early to middle innings of developing our full capabilities across all our product lines. And so we remain highly focused on our commercial and operational initiatives to 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, EBITDA margin expansion and acquisition growth. If you turn to Slide 6, you will see that our strategy is working. Over the last 5 years, we've been able to deliver consistent organic growth, strong acquisition growth and solid EBITDA margin expansion while investing heavily in SG&A to build our IT, category management, supply chain, finance, marketing, operational excellence and acquisition teams as well as our underlying systems infrastructure, including our digital capability. While work remains to be done on building our systems infrastructure, our field support teams are largely in place. And each year, our teamwork and synergies across SiteOne improved, along with our ability to leverage our infrastructure investments. We can see this in our increased market share gains and organic growth and in our improved operating leverage. Going forward, we will continue to build and leverage our capabilities to accelerate performance for all stakeholders. You will also note that we have now completed 60 acquisitions across the irrigation, agronomics, nursery and hardscapes product line during the last 7 years, with 4 so far in 2021. We only acquire well-run companies. And so all of these acquisitions are already high-performing companies before joining SiteOne. With them, we added significant capability and tremendous talent, and we have learned many lessons that can be applied to future acquisitions. Our acquisition pipeline remains very robust and we have significant potential to continue growing through acquisitions for many years to come. In summary, our strategy is working. We are still early in our execution and you will see us get stronger every year as our key initiatives gain more traction. Slide 7 shows the long runway that we have ahead in filling in our product portfolio, which we aim to do primarily through acquisition, especially in the nursery and hardscapes categories. Nursery and hardscapes operations require larger sites and significant local expertise. And so these product lines cannot just be added to most of our existing branch locations. 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 the first quarter performance highlights as shown on Slide 8. We delivered a record 41% net sales growth in the first quarter, with 32% organic daily sales growth and 7% net sales growth added through acquisition. We are seeing very robust demand so far in 2021 across all our product lines, customer segments and geographies, supported by very strong residential repair and remodeling activity, and a strong new residential construction market. Interestingly, commercial activity has been solid so far this year and seems to have stabilized. On top of the market growth, we believe we are gaining share in all our product categories as our category management, operational excellence, sales force performance, marketing and digital initiatives gain strength. Through these initiatives, we are improving our product portfolio, customer service, partnership capabilities and our customers' awareness of our capabilities. As a result, we are attracting new customers and gaining wallet share with existing customers. As I had mentioned, we have seen the strong sales continue so far in the second quarter, though we expect the rate of growth to moderate during the remainder of the year. As you can imagine, with this kind of growth, our suppliers are struggling to keep up with demand and product supply is very tight across most product categories. Additionally, there is an acute shortage of trucking capacity to bring product to market. All these factors have put a lot of stress on the industry supply chain. Fortunately, this is an area where we have built significant strength and I'm very proud of the SiteOne supply chain and transportation teams for overcoming these challenges and keeping our branches well supplied so far to support our growth and enable us to gain market share. Our gross margin was down 10 basis points during the quarter as we built up inventory for the year, worked through the supply chain and transportation constraints, and managed cost inflation and pricing. We saw particularly high inflation in freight and in a few product lines like PVC pipe and copper wire during the quarter. That said, our teams did a great job managing product costs relative to the market and we saw a minimal negative impact on our gross margin. We remain confident in our ability to improve gross margin for the full year with private label growth, growth with small to mid-sized customers, and the continued execution of our supply chain and category management initiatives. On the SG&A side, we achieved fantastic leverage as our teams worked hard to service the strong demand while also managing cost exceptionally well. Like most companies in our industry, we are challenged in ramping up our field teams this year and so our associates have had to be very productive and creative in serving our customers. In this environment, our recent investments in MobilePro, our transportation management system or TMS, and in siteone.com are paying off. We remain focused through our operational excellence initiatives on helping our associates to be more productive through better systems and technology so that they have more time to do what they do best, help our customers to win. I would also comment that our field support associates who are working from home have been tremendous. And we have learned a lot about how to help them be more productive, while also supporting their work-life balance. As we return to the office environment in the coming months, we believe that we can develop a hybrid work structure that will be a win-win-win for our associates, our customers and for SiteOne. In this way ironically, the COVID experience has made us a stronger company. Overall, we will continue to invest in our systems and processes to create a better place to work for our associates, build competitive advantage with our customers and suppliers, and increase our SG&A leverage in the coming years. The combination of strong organic sales, excellent SG&A leverage and good contribution from acquisitions allowed us to deliver record adjusted EBITDA growth for the first quarter and improve our adjusted EBITDA margin by 610 basis points. We are excited that we now expect to achieve our 10% adjusted EBITDA margin milestone for the full year in 2021. On the acquisition front, we are off to a great start with 2 deals in the first quarter and 2 deals completed so far in the second quarter. These companies are high performers, and give us excellent talent and capability for growth in their respective markets, while adding approximately $80 million or about 3% to our annual sales. With an experienced team, broad and deep relationships with the best companies in the industry, a very strong balance sheet and an exceptional reputation for being a good home for local companies, we remain well positioned to grow through acquisitions for many years to come. Overall, I am very proud of how our team has performed in this extraordinary environment to keep everyone safe, serve and support our customers, deliver outstanding financial results and create tremendous value for all our stakeholders. We remain excited about both the short- and long-term opportunities to drive excellent performance and growth with our strong team and winning strategy. Now John will walk you through the quarter in more detail. John?
Thanks, Doug. I'll begin on Slide 9 with some of the highlights from our first quarter results. We reported a net sales increase of 41% to $650 million in the quarter. There were 65 selling days this quarter compared to 64 in the prior year period. Organic daily sales increased by a record 32% for the quarter due to strong demand as consumers are spending more time at home and investing in their outdoor living spaces. Organic daily sales for landscaping products, which include irrigation, nursery, hardscapes, outdoor lighting and landscape accessories, was strong again this quarter, increasing 29% compared to the prior year. Landscaping products are the products most closely tied to the repair and remodel end market, which is benefiting from homeowners upgrading their backyards and patio. Organic daily sales for agronomic products, which include fertilizer, control products, ice melt and equipment, grew 39% this quarter. Agronomic products benefited from increased demand in residential maintenance, an early start to the spring selling season, strong sales of ice melt in response to more winter storms, and increased sales of LESCO products through the retail home center channel. Geographically, all regions achieved double-digit organic daily sales growth. As Doug mentioned, we continue to see strong sales growth in the second quarter as our customers remain very busy. As a reminder, last year, due to the impact of COVID-19 related restrictions, we saw a negative organic daily sales growth in April and only 3% organic daily sales growth in the second quarter, but then sales recovered and we achieved double-digit organic daily sales growth in the second half of last year. So we have a less challenging sales comp for the second quarter and tougher sales comps in the third and especially fourth quarter. Prices increased 3% for the first quarter, which was at the high end of our previously expected range of 2% to 3%. We saw cost increases from our suppliers throughout the quarter with products like PVC pipe, copper wire and fertilizer, all reaching multiyear high. We are managing through the cost volatility and have adjusted our pricing accordingly. For the full year, we are increasing our expectation for price inflation to 3% to 5% as we're getting indications that some suppliers may push through additional price increases. Acquisition sales, which reflect the sales attributable to acquisitions completed in both 2020 and 2021, contributed approximately $33 million or 7% to the overall first quarter growth rate. We are pleased with the performance of our acquisitions and our overall deal pipeline. Scott will provide more details regarding our acquisition strategy later in the call. Gross profit increased 41% to $202 million for the first quarter, while gross margin decreased 10 basis points to 31%. We were pleased with how we maintain gross margin throughout the quarter despite product cost inflation and greater material handling expense, including almost $1 million of nursery losses resulting from the Texas winter storm, which represents approximately 15 basis points of negative impact on our gross margin this quarter. Selling, general and administrative expense or SG&A, increased 15% to $192 million for the first quarter. SG&A as a percentage of net sales decreased 670 basis points to 29.6%. The reduction in SG&A as a percentage of net sales reflects our excellent organic sales growth, combined with solid cost management. We expect the amount of SG&A leverage to moderate somewhat as we move into the primary selling season. For the first quarter, we reported an income tax benefit of $2.5 million compared to an income tax benefit of $13.5 million in the prior year period. The decrease in the income tax benefit is attributable to the increase in net income before taxes and the decrease in the amount of excess tax benefits from stock-based compensation. For 2021, we expect our effective tax rate will be between 25.5% and 26.5%, excluding discrete items such as excess tax benefit. We recorded net income for the first quarter of $7.4 million compared to a net loss of $17.5 million for the prior year period. The improvement was primarily driven by our strong sales growth and SG&A leverage. Our weighted average diluted share count was 45.7 million compared to 41.8 million in the prior year period. This increase was primarily attributable to our August 6, 2020 equity offering and the impact reporting net income for the first quarter this year and a net loss for the first quarter last year. Adjusted EBITDA for the first quarter was $34.5 million compared to a loss of $3.6 million for the same period in the prior year. Adjusted EBITDA margin, reflecting our SG&A leverage, increased 610 basis points to 5.3%. Now I'd like to provide a brief update on our balance sheet and cash flow statement as shown on Slide 10. Net working capital at the end of the first quarter was $539 million compared to $521 million for the prior year period. The increase in net working capital is attributable to additions from new acquisitions and higher receivables resulting from our strong sales growth. Cash used in operations decreased to $46 million for the quarter compared to cash used in operations of $66 million for the prior year period. The improvement was primarily driven by our increased profitability. We made cash investments of $46 million for the quarter compared to $51 million for the same quarter last year. The decrease in cash investments reflects slightly lower spend on acquisitions this quarter compared to the prior year period. Net debt at the end of the quarter was approximately $355 million compared to $650 million at the end of the prior year period. The reduction in net debt reflects proceeds from our August 2020 equity offering and our strong operating cash flow. Leverage at the end of the quarter decreased to 1.2x our trailing 12-month adjusted EBITDA compared to 3.2x at the end of the first quarter of 2020. The lower leverage reflects a reduction in net debt as well as our improved profitability. Our target net debt to adjusted EBITDA leverage range at the year-end is 1x to 2x. As a reminder, we lowered our target leverage range from 2x to 3x to 1x to 2x to increase our financial flexibility and allow us to execute our acquisition strategy in all market environments. During the quarter, we took advantage of our strong financial position, lower leverage and favorable market conditions to refinance our term loan. In the refinancing, we extended the maturity of the term loan to 2028 and reduced the interest rate by 75 basis points to LIBOR plus 200 basis points. At the end of the quarter, we had liquidity of approximately $377 million, which consisted of approximately $33 million cash on hand and approximately $344 million in available capacity under our ABL facility. In summary, a priority from a balance sheet perspective is to maximize 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 11, we acquired 2 companies in the first quarter and 2 more companies since the quarter finished with combined trailing 12-month net sales of approximately $80 million. Since 2014, we have acquired 60 companies with over $1.1 billion in trailing 12-month net sales. Turning to Slides 12 through 15, you will find information on our most recent acquisition. On February 17, we acquired Lucky Landscape Supply, a wholesale distributor of nursery products to landscape contractors serving the greater Houston market from a single location. This is our fourth dedicated nursery branch in Houston and expands our full line capabilities in this important market. On April 1, we acquired Arizona Stone and Solstice, establishing a leading hardscapes platform with 9 locations across the rapidly growing Arizona and Nevada market. This complements our existing lines of business and doubles our footprint in Arizona. On April 30, we acquired Timberwall Landscape & Masonry Products, expanding our leading hardscape position in the greater Minneapolis market established in Q4 of 2020 when we acquired Hedberg Supply. Also, on April 30, we acquired Melrose Irrigation Supply, extending our leading irrigation presence in Florida by adding 6 locations across South Florida. Melrose brings a great team and excellent new locations to serve the growing Florida market. Summarizing on Slide 16. Our acquisition strategy continues to create significant value for SiteOne, and our pipeline is strong and expanding across all geographies and lines of business. We are excited to be partnering with the highest performing companies in the industry and bringing outstanding new talent to SiteOne. Our field and functional support leaders, along with our strategy and development team continue to build strong personal relationships every day with the mini [ entrepreneurs ] we hope to bring in to our family when the timing is right for them. The decision to sell a family business may only happen once in a lifetime, and we are truly honored and humbled each and every time an owner chooses to join our family. I want to thank all the highly successful entrepreneurs who have joined SiteOne as well as the entire SiteOne team. Their passion and commitment to making SiteOne a great company continues to be the key ingredient, which allows us to successfully add terrific new companies and associates, and provide tremendous value to our customers, suppliers and communities. I will now turn the call back to Doug.
Thanks, Scott. I'll wrap up on Slide 17. As mentioned, we've seen very strong demand trends continue in April across all product lines, customer segments and geographies. Given our customers' current backlog of work and the underlying positive development that we see in the economy and in residential construction, we expect favorable demand trends to continue through the remainder of the year. As a reminder, last year, we had negative growth in April, which was heavily impacted by COVID-19 restrictions. As the restrictions were removed, we saw some recovery in May and then very strong double-digit growth in June through December. As such, we expect our current growth to begin to moderate in May and then settle into a much lower growth rate in June through the end of 2021. We do, however, expect the growth to be positive in the second half, supported by higher inflation and solid demand. In terms of end markets, we would expect maintenance, which comprises 41% of our business to be steady during the remainder of the year with low to mid-single digit growth. We have terrific capability and great momentum in maintenance with our market-leading LESCO brand. And so we are confident in our ability to perform in a steady market. Residential new construction and major repair and upgrade, which comprised 27% and 18% of our business respectively, are expected to remain very strong. While growth will certainly moderate against higher comparable sales, our customers have deep backlog in residential and do not plan to slow down. These markets will be constrained by labor, weather and possible supply shortages. Lastly, the commercial market, which represents 14% of our business has remained surprisingly solid this year so far. And the weakness that we anticipated earlier in the year has not developed. Our Project Services group is bidding on more jobs than they did at this time last year, and our customers' backlogs are solid, both supporting growth in the second half. Accordingly, we believe that we will see a stronger commercial market than we had originally forecast for the second half of the year. Taken all together, we expect to achieve low double-digit organic daily sales growth for the full year 2021, which would be a record level of growth for SiteOne. Additionally, we will continue to execute our commercial and operational initiatives, which we believe will yield good gross margin improvement and SG&A leverage, leading to solid adjusted EBITDA growth and margin expansion. We are excited in that we now expect to achieve our 10% milestone for adjusted EBITDA margin in 2021. In terms of acquisitions, as Scott mentioned, we currently have a very strong pipeline of high-quality companies and look forward to adding more of these to the SiteOne family over the remainder of the year. Our acquisitions are performing very well, and we continue to improve our ability to integrate them into our company, improve our customer value and create synergies together. Accordingly, we expect acquisitions to contribute strongly to our performance and growth in 2021 and the years ahead. Taken all together, we are raising our fiscal 2021 adjusted EBITDA guidance to be in the range of $300 million to $320 million, which represents year-over-year growth of 15% to 23%. This range does not factor any contribution from unannounced acquisitions. This compares to our prior estimate of $275 million to $292 million. In closing, I would like to sincerely thank all our SiteOne associates who continue to amaze me with their passion, commitment, teamwork and selfless service. We have a tremendous team and it is an honor to be joined with them as we deliver increasing value for all our stakeholders. I would also like to thank our suppliers for supporting us so strongly and our customers for allowing us to be their partner. Operator, please open the line for questions.
[Operator Instructions] Our first question is from Ryan Merkel with William Blair.
And very nice quarter overall. So first off, EBITDA this quarter was well above even my most optimistic expectations. You usually break even or lose a little money in this quarter. So Doug, help us understand how you made $35 million this quarter? And then was there any revenue pulled forward from the second quarter?
Yes. I think it just gets down to the organic growth. When you see organic growth like that, it ends up looking like a second or third quarter. And so it just gets down to the rapid growth that we saw really across all regions and all product lines. And the other thing is that our teams. We are struggling to ramp up, if you will, labor wise. We fill out our teams as spring hits. And it's a battle out there. Our customers are fighting at them and we're fighting at them. And so you get the combination of really good leverage on a, let's call it, a thinner team and then the strong sales. Now our teams will fit out and we'll get less leverage as we go through the year. But those were the big factors in having that profitable -- a strongly profitable first quarter. In terms of pull forward, we really don't feel like that's a big factor. It's been -- spring did hit a little early and the weather was favorable. We did have the storms in the winter. So we sold a lot of ice melt. So if you saw our maintenance product, very strong. And so we really don't feel like that's a big factor. It could always be somewhat of a factor, but it wouldn't be a huge factor that we think would materially affect the second and third quarter. John, anything to add to that?
No, I think you hit on it. You've hit the key points.
Great.
Okay. It's helpful. And then secondly, you mentioned April is tracking well. I know it's easy comp. If I just use normal seasonal lift in the 2Q, I get mid-teens or better organic growth. Is there any reason that we wouldn't see typical seasonality into 2Q and then even through the whole year?
Yes. We feel like we'll get the usual seasonality. So that's a good assumption.
Our next question is from David Manthey with Baird.
So yes, following on to Ryan's question, typically the first quarter is breakeven or loss on an EBITDA basis and clearly, really strong result here. And then relative to the guidance, which looks like it's up $25 million to $28 million, should we assume that when you put up the initial guidance range in your mind, you had already assumed there was EBITDA profitability in that first quarter? And I guess what I'm asking here is, are you increasing the outlook for the second through fourth quarters? Or are you just upping the guidance for the first quarter beat and then mostly maintaining the outlook for the remainder of the year?
I think I would characterize it as the latter. We were -- the increase in guidance primarily reflects the outperformance in Q1. There's still a lot of the season to play and we're really going into our selling season. While I think we're probably more optimistic now than we were when we gave initial guidance, we have not substantially changed our outlook other than for the first quarter be.
Yes. Okay. And then second, on gross margin. You noted the handling expense increase. Could you talk about TMS and update us there and then discuss private label and the mix of nursery hardscapes, the usual suspects as it relates to gross margin? I think previously, you had said you expect to increase gross margin for the full year 2021. And I'm just checking in on the puts and takes there.
We still think that we're very optimistic that we're going to continue to expand gross margin this year. The major items -- and we were actually very pleased with how we ended up for the quarter only being down 10 basis points. We did lose almost a $1 million of nursery product in Texas this year. That's about 15 basis points. And obviously, I think one of the things that's different is price inflation was stronger than we originally thought. So we've managed through that. I think we've got a good handle on it now, but there was a -- it was a battle for our teams throughout the quarter as they're both honoring our customer commitments, but also seeing the cost increases exceed what we had originally forecast. On top of that, David, we're seeing very strong private label growth. We're extremely happy with that. We're seeing really good growth with our small and midsized customers, not just sales, but the customer count going up. So -- and then the other category initiatives as we're driving nursery and hardscapes and higher gross margin products. All those are on track. And so we feel -- that's what gives us confidence. In addition to the -- we feel like we're in good shape on price costs. The other factors are still full steam ahead for this year.
Our next question is from Matthew Bouley with Barclays.
Congrats on the results. I just wanted to follow-up on the margin side actually because I think if I'm doing the math right, the guide implies a decline in EBITDA margins just for the balance of the year, following the strong start. And you just touched on gross margins improving year-over-year. So basically, if you could reconcile that, is it just that moderation in SG&A leverage you spoke to, perhaps pulling in some extra investments, sort of all of the above? Or just what else can you give us on reconciling that?
We haven't completely, what I would say, given up on achieving EBITDA margin growth. We are going to face some higher expenses in SG&A. As Doug mentioned, we're staffing up to realize the increased demand. We do expect to -- gross margins to improve in the second half. And then there will -- potentially depends on how Q4 goes, that will be probably the most challenging just from our standpoint also that we have faced a tough comp from a sales perspective in Q4.
Okay. Second one on the M&A side. If I look at Phoenix and South Florida, obviously large construction and housing markets. On the slide, I mean, it seems like you have a pretty healthy scale in those markets. Are those type of markets where you've got 10 or 15 branches, does that get you near the kind of desired local market share with a full line offering? Or is there still even more to come in places like those markets? And just broadly, what are you thinking on just kind of the next areas of white space you're looking to fill?
Yes. I think you bring up a good point. If you look at our 4 acquisitions year-to-date, it shows the diversity and strength of the pipeline with 2 hardscape distributors and irrigation and in nursery and all across the country. But that's always a factor, Matthew, the market share we have in any market. But in -- there are still parts of Florida where we have very strong market share in irrigation, but there's still pockets where we might be able to grow. And Arizona, Nevada, where we -- Arizona Stone was, is such a fast-growing market as well that I still believe we have opportunities in really all of our lines of business. And looking forward, I think what you'd see is the continued -- the go-forward pipeline is similarly diverse just like our acquisitions year-to-date across geography and lines of business.
I would just add to that, like the fill in. If you look at Arizona, we have several locations, but we still have a ways to grow there in market share in irrigation because Horizon is very strong there. [ UGM ] is very strong there. And so it might look like we're -- we've got great coverage, and we're #1, but that's actually a market that we've got a lot of room to grow in both irrigation and agronomics. Arizona Stone adds to our -- the acquisition we did previously, and now we're the leader in hardscapes and landscape supplies there. So we're very happy and that's kind of a good example of our strategy, how we kind of build out over time these leadership positions and acquisitions are key to doing that.
Our next question is from Keith Hughes with Truist Securities.
Question is on inflation. You've raised your guidance on that earlier in the call. In terms of passing through that pricing, are you at the point now we don't see a drag associated with the inflation coming in your businesses? Have you gotten ahead of the curve, I guess, is my question as we head into the second quarter?
We do feel as if we're ahead of the curve there, especially -- as we went through the first quarter, we put in place new pricing to reflect the increases coming from our suppliers. And we think we got ahead of it at the end of the quarter and are well positioned for the rest of the year.
And final question. Doug, you talked about your raised expectations on your commercial business. Do you expect that to be solidly positive year-over-year in the second half of the year? Or is this quotation activity that's more focused on like '22?
Yes. When we started the year, we thought commercial would be down. And given what we see now, we actually do think it will be slightly positive in the second half. And we base that on the activity that we see. We have a Project Services group that does bid for our contractors that -- and their bidding is higher than it was at this rate last year. And last year, it dipped in April, but then it came back in May. And -- but we're still look like we're tracking above last year's rate. And the other thing is just talking to our customers. Our commercial customers feel good about their backlogs that they have going into the second half of the year. And some of them actually feel good going into 2022, which is interesting. So we think that the commercial market seems to be lagging and -- but slowly following a very strong residential market. And as you think about the suburbs where the residential are happening, that kind of commercial business lends itself more to landscaping than maybe intercity commercial, which has been strong over the last couple of years. So the mix is good for us as well. So long, long story short, we expect to be slightly up in the second half in commercial, which is terrific and more positive than what we would have thought about 3 months ago.
Our next question is from Mike Dahl with RBC Capital Markets.
My first question is just kind of follow-up on the guidance. And I think you mentioned that you still expect positive growth in the second half despite the tough comps. I was wondering if you could clarify. Do you expect positive growth in each of 3Q and 4Q? I know you have the selling day impact in 4Q. And also specifically on volumes, do you expect positive volume growth in each of 3Q and 4Q within the guide?
We're not specifying that level of detail. I would say, we will say we are more optimistic. The later you go in the year, the more uncertainty is. 4Q is going to be the toughest comp. It's also the smallest -- smaller than obviously, 3Q. And in addition, one thing just to model out is just on pure organic basis, not accounting for the extra days, we do lose a few days of sales in the fourth quarter. So Q4 will be more challenging than Q3, but we're not specifically calling out the difference between the 2.
Okay. Got it. Yes, that helps. And then I think you've talked about some of the moving pieces around margins. I was wondering if you could kind of specify, maybe with respect to freight, specifically, how much of a headwind do you expect freight to be. And have you started to implement anything like surcharges on freight?
We think we're trying to capture the freight costs like all costs in the cost of our product. From that standpoint, we're trying to manage it through it. Maybe a slight headwind, I would say, relative to where we thought we would be at the beginning of the year or what we've talked about with regards to gross margin, we think we can overcome it. But it could be a slight headwind. We are not implementing any additional freight surcharges or anything for our customers. Most of our freight cost is actually our delivered cost to customers. But we're trying to manage through that. But slight headwind, I would -- I guess, in summary, we think we can still achieve gross margin improvement in spite of that.
One of the things that gives us confidence there is we just have a very good transportation team that does a phenomenal job of working with our freight partners, managing costs and -- but more importantly, securing capacity in this kind of strong market where there's shortages. So we've got a very -- that would be a strength of SiteOne. And so that gives us the confidence that we can manage that. And then on the pricing side, as John mentioned, we're on top of the movements and obviously working and feel good about our ability to pass on any increases.
Our final question is from Alex Maroccia with Berenberg.
My first one is on acquisitions. Did you notice an uptick in calls from distributors looking to sell following the recent discussions around capital gains tax increases?
I would say it's -- there's so many factors that go into that decision that, that is one of many. I think I've heard it discussed some, but I wouldn't say that, that is someone who wasn't thinking of selling at all the uncertainty of the tax change hasn't driven them to full sell mode. But it is, I would say, it adds momentum within their decision process already.
Okay. Understood. And then second one is on back half of the year guidance. Taking into consideration the 3 items you outlined as potential sources of second half weakness, so labor, weather and supply issues, which one you think could provide the best upside if it doesn't come to fruition?
Yes. It's really -- I would just characterize them as labor, we know is a constraint. It's been a constraint. It continues to be a constraint. So I think that's a more predictable one and one that we and our customers seem to always figure out how to overcome and get some growth. Supply shortages, we have strong suppliers. They're working hard. We do a great job of kind of making sure that we secure volumes for our company. And so that one, I think is a risk, but also a somewhat manageable risk. Weather is the one that is not in our control, right? So if we got Tier 4 hurricanes or if winter comes early, that could be a probably a more material factor. So I would probably put that one. It's always a factor in our industry. And so of the 3, that's probably the one to watch more for.
Our final question is from Damian Karas with UBS.
Just had a follow-up question on the really strong profitability in the first quarter. I was just curious to what extent did the 1 week shift in the calendar kind of stretching into April, more of the spring season have an impact on the first quarter profitability?
I don't think it would be a huge impact. I mean, we've talked about a little bit, especially in the maintenance being in early spring, but we believe kind of the strong sales we saw throughout the quarter from that standpoint. And so maybe on the margin a little bit, but not huge with regards to the overall performance of the quarter.
Okay. Great. And then just on the capital allocation, how you're thinking about the balance sheet targeting sort of the 1 to 2x. Last year, you made that decision kind of in an environment where there was still a lot of economic uncertainty out there. Just where we are today, just wondering how you guys are thinking about that 1 to 2x and whether you have more flexibility to go kind of above those levels from here?
We do not anticipate that at all. We think the 1 to 2x is a good range to operate in. We think we're -- the strong cash flow we're generating from the business. We've got great opportunities on acquisitions. So we don't see ourselves going outside of that 1 to 2x anytime soon, whether this year or even over the next couple of years perspective. We're going to try to manage through there and execute our strategy, and we think we're in a good position from that perspective.
Yes. And that being said, if we had a large opportunity, which there's not many large opportunities in the landscaping is very fragmented. Or for some reason, we did more acquisitions. The 1 to 2 is designed that we could go above that if we needed to, strategically, right? It gives us strategic flexibility. It's also designed if we hit it in the future, if we hit a recession, we want to continue to be able to do deals. So the strategic flexibility is important for us. We would go above it to make important strategic moves or to continue investing in acquisitions if the times were tougher. But assuming normal times in a good, solid market and kind of normal course, it's a good range for us.
Ladies and gentlemen, we have reached the end of the question-and-answer session. I will now turn the call over to Doug Black for closing comments.
Thank you, and thank you all for joining us again today. It's such an honor to be able to build SiteOne, and we appreciate your interest and support as we move forward with our company. I do want to, before we close, just highlight that COVID-19 is still with us, and our thoughts and prayers go out to all those that have been negatively impacted by COVID-19, and we look forward to updating you again during our call in August. Thank you.
This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation. Have a great day.