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Edited Transcript of CNM.N earnings conference call or presentation 13-Sep-22 12:30pm GMT

Q2 2022 Core & Main Inc Earnings Call Sep 14, 2022 (Thomson StreetEvents) -- Edited Transcript of Core & Main Inc earnings conference call or presentation Tuesday, September 13, 2022 at 12:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Mark R. Witkowski Core & Main, Inc. - CFO * Robyn Bradbury Core & Main, Inc. - VP of Financial Planning, Analysis & IR * Stephen O. LeClair Core & Main, Inc. - CEO & Director ================================================================================ Conference Call Participants ================================================================================ * David Emerson Ridley-Lane BofA Securities, Research Division - VP * David John Manthey Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst * Elizabeth Ann Langan Barclays Bank PLC, Research Division - Research Analyst * Jamie Lyn Cook Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research and Analyst * Kathryn Ingram Thompson Thompson Research Group, LLC - Founding Partner, CEO & Director of Research * Patrick Michael Baumann JPMorgan Chase & Co, Research Division - Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Hello, and welcome to the Core & Main Q2 2022 Earnings Call. My name is Alex, and I will be coordinating the call today. (Operator Instructions) I will now hand over to your host, Robyn Bradbury with Core & Main. Robyn, please go ahead. -------------------------------------------------------------------------------- Robyn Bradbury, Core & Main, Inc. - VP of Financial Planning, Analysis & IR [2] -------------------------------------------------------------------------------- Thank you. Good morning, everyone. This is Robyn Bradbury, Vice President of Finance and Investor Relations for Core & Main. I am joined today by Stephen LeClair, our Chief Executive Officer; and Mark Witkowski, our Chief Financial Officer. Steve will lead today's call with a brief business update, followed by an overview of our recent acquisitions. He will then discuss our confidence in the resilience of our business and the demand for our products and services. Mark will then discuss our record second quarter financial results and full-year outlook followed by a Q&A. We will conclude the call with Steve's closing remarks. We issued our fiscal 2022 second quarter earnings this morning and posted a presentation to the Investor Relations section of our website. As a reminder, our press release, presentation and the statements made during this call include forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. Such risks and uncertainties include the factors set forth in our earnings press release and in our filings with the Securities and Exchange Commission. Additionally, we will discuss certain non-GAAP financial measures, which we believe are useful to assess the operating results of our business. A reconciliation of these measures can be found in our earnings press release and in the appendix of our fiscal 2022 second quarter investor presentation. Thank you for your interest in Core & Main. I will now turn the call over to Chief Executive Officer, Steve LeClair. -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [3] -------------------------------------------------------------------------------- Thanks, Robyn. Good morning, everyone. Thank you for joining us today. If you're following along with our second quarter investor presentation, I'll begin on Slide 5 with a brief business update. I am pleased to report another record quarter as we continue to build on our momentum, achieving strong growth in both net sales and adjusted EBITDA. This is a remarkable accomplishment considering the challenges we faced from weather and flooding during the quarter, continued supply chain challenges and our strong performance in the same period last year. Our teams are leveraging our best-in-class capabilities and executing at a high level to support our customers, suppliers and communities. We can continue to execute our strategies to drive above-market growth while navigating ongoing supply chain constraints and inflation. Strong demand and constrained manufacturing capacity supported elevated prices and caused continued project delays during the second quarter. Supply remains constrained for many of our product categories. However, we are beginning to see capacity free up for certain products. And while it is possible that commodity prices could moderate at some point, we expect the demand for our products to remain resilient, causing market prices to moderate at a slower pace than other industries. In addition to strong pricing in the quarter, we continue to drive growth from both higher volume and M&A. Our customers remain busy, and we continue to experience healthy demand across each of our end markets and product lines. Municipal repair and replacement activity remains strong and continues to benefit from healthy municipal budgets. Bidding, backlog and order activity are all trending favorably across municipal end market, giving us confidence and demand through the end of the fiscal year. As a reminder, municipal repair and replacement activity makes up roughly 40% of our net sales. We are encouraged by the strength in many pockets of nonresidential development as suburban communities expand, which increases the demand for our water works, storm drainage and fire protection products on these projects. We have continued to experience softness in certain metro areas in both the East and West Coast, which has impacted our volume of fire protection products, and we expect that to remain the case for the balance of this year. Despite the softness in these metro areas, we expect nonresidential activity to be positive, given our backlog and bidding activity. Residential volume was healthy through the second quarter, and our bidding activity and backlog remain positive. Recently, we are beginning to see a few geographies where residential lot development project scopes are becoming smaller in size as developers assess the current market environment and the reduction in housing starts. As we look across the balance of the year, we believe the trend could continue, particularly if the Fed takes additional actions to combat inflation. As a result, we believe we could see softening in residential lot development at some point. While the near-term prospects for the residential end market remains uncertain, we continue to believe the current undersupply of housing relative to household formation provides for a multiyear secular growth trend. As you can see, our teams are delivering strong results in the dynamic environment. We have a resilient business model and a leadership team capable of navigating through various economic cycles. We remain confident in the long-term stability of our business and the end markets as roughly 50% of our net sales is driven by nondiscretionary repair and replacement activity. The diversified nature of our end markets, customer base, product offerings and geographic footprint provides better stability for our business relative to other distributors operating on a smaller scale. Lastly, we remain active in M&A, driving sustainable growth through acquisitions. During and subsequent to the quarter, we closed the Earthsavers Erosion Control and Inland Water Works Supply acquisitions and signed a definitive agreement to acquire the municipal waterworks division of Trumbull Industries. I'll discuss each of these businesses in greater detail on Slide 6. Earthsavers Erosion Control operates 3 branches in Northern California and is a full-service distributor of geosynthetic materials, including straw wattles, erosion control blankets and a broad array of geotextile products. For over a decade, Earthsavers has been a leading and preferred resource in the California, Nevada and Arizona markets and the surrounding areas. Inland Water Works Supply is a single-branch, full-service distributor of water and wastewater products, based in Southern California. With a focus on personal service and attention to detail, Inland Water Works Supply has proven itself to be a supplier of choice in its local market for 70 years. This strategic acquisition will allow us to better serve our combined customer base, alongside a highly experienced and passionate team. The municipal waterworks division of Trumbull Industries is a distributor and private label provider of specialized branded accessories and tools in the water and wastewater industry. Operating for more than 100 years and with 4 branches in Ohio and Pennsylvania, this team has built a long-lasting customer relationship through their industry expertise and unparalleled service. We expect that the acquisition of Trumbull will accelerate our private label initiative as we look to broaden their reach throughout our existing branch network. Each of these acquisitions provide us valuable talent and unmatched capabilities in their respective markets, collectively adding approximately $95 million of annual net sales. We remain active on the M&A front this year, and we expect to continue acquiring and integrating companies in the coming quarters. As an experienced integrator and with a respected reputation as the acquirer of choice in our industry, we are well positioned to grow sustainably through acquisitions for many years to come. Now turning to Page 7. I'd like to spend a few minutes discussing our confidence in the resilience of our business and the demand for our products and services. Our nation's water and wastewater infrastructure is aging and the need for maintenance and repair is growing. Municipal repair and replacement demand has exhibited stable growth over the long term due to the consistent and critical need to replace aged water infrastructure. However, due to the limited availability of funding, the pace of investment has lagged the need to upgrade water systems throughout the U.S. In 2020, the average age of water and wastewater pipes was 45 years, up 20 years from 1970. There are approximately 300,000 water main breaks every year, representing the equivalent of a water main break every 2 minutes. On average, municipalities lose approximately 16% of their treated water on an annual basis due to leaks. An estimated $2.2 trillion is required for repairs and upgrades over the next 20 years to close the growing water infrastructure gap, which would more than double the historical growth rate in water and wastewater investment. In recent years, access to capital, increased utility rates and necessity have increased municipal investment in water. Municipalities appear to be taking a more active role in repairing and upgrading their water and wastewater systems, and our business is well positioned to benefit from these dynamics. We expect that funds from the Infrastructure Bill will begin to strengthen investments in municipal water infrastructure repair in 2023 and beyond. Another demand trend we anticipate persisting through the next economic cycle is growing response to extreme weather events. Cities across the country are investing to mitigate the impacts of extreme weather events like those we've seen this summer related to tragic flooding across the U.S. As the frequency and magnitude of flooding events increases, our customers continue to demand more robust storm drainage infrastructure and treatment plant solutions. Our national distribution network and access to specialized products makes us well positioned to support these growing needs. To wrap up my prepared remarks, I'm proud of how our team has come together to deliver these fantastic results. Earlier this year, we talked about our focus areas for fiscal 2022, executing on our key growth strategies, deepening our competitive advantage and building on our foundation of long-term profitable growth. We've made great progress in each of these areas and continue to position the company for success. I will now turn the call over to our Chief Financial Officer, Mark Witkowski, to discuss our second quarter financial results and full-year outlook. Go ahead, Mark. -------------------------------------------------------------------------------- Mark R. Witkowski, Core & Main, Inc. - CFO [4] -------------------------------------------------------------------------------- Thanks, Steve. I'll begin on Slide 9 with some highlights of our second quarter results. We reported a net sales increase of 43% to $1.86 billion for the quarter. The increase was due to price inflation in response to rising material costs, mid-single-digit volume growth driven by a combination of market growth and share gains and contributions from acquisitions. We outperformed our end markets in the second quarter due to our industry-leading product availability and the execution of our product, customer and geographic expansion initiatives. Acquisitions continue to perform well, contributing approximately 5% to our second quarter net sales growth. [Material] costs continued to increase throughout the quarter, though we are starting to see the frequency and magnitude of cost increases slow. As a result, we expect price contribution to moderate in the second half of the year as we anniversary the rapid price increases from a year ago. Gross profit increased 54% to $501 million in the second quarter, and gross profit margin increased 190 basis points to 26.9%. Gross margin was positively impacted by strategic inventory investments ahead of announced price increases, a favorable pricing environment, our gross margin enhancement initiatives and accretive synergies from acquisitions. As we've discussed for the last several quarters, we have targeted initiatives in place to continue driving sustainable gross margin expansion, including private label through global sourcing, pricing initiatives and procurement optimization. We're in the early innings of executing on these initiatives, and we see a long path of sustainable growth ahead. Selling, general and administrative expenses increased approximately 20% to $230 million in the second quarter. SG&A as a percentage of net sales declined 240 basis points to 12.4%. The decline was due to our ability to leverage our fixed costs on the increase in net sales in addition to the timing of one-time costs in the prior year associated with the accounting for equity awards. Interest expense in the second quarter was $17 million compared with $37 million in the prior year. The decrease was primarily due to the redemption of the 2024 and 2025 senior notes. Our effective tax rate in the second quarter was 17.3% compared with 24.6% in the prior year. The year-over-year reduction reflects certain fixed tax expenses and permanent differences decreasing as a percentage of pretax income. The effective tax rate for each period reflects only the portion of net income that is attributable to taxable entities. We recorded adjusted net income for the second quarter of $169 million compared with $61 million in the prior year. The improvement was due to our strong sales growth, gross margin improvement, SG&A cost leverage and lower interest expense, partially offset by an increase in income taxes. And preparing adjusted net income, we exclude the effects of noncontrolling interests as we evaluate and manage the business as a whole. Adjusted EBITDA increased approximately 79% to $277 million compared to $155 million in the prior year. Our adjusted EBITDA margin improved 300 basis points to 14.9% due to our strong net sales growth, gross margin improvement and leveraging our cost structure on the increase in net sales. Now I'd like to provide a brief update on our cash flow and balance sheet on Slide 10. Net cash used to fund operating activities during the quarter was $23 million, an improvement of $32 million compared with the prior year. The improvement was primarily due to higher profitability and lower cash interest, partially offset by higher receivables from our strong sales growth and an increase in inventory, reflecting supply chain uncertainty, inflation and strategic investments ahead of supplier cost increases. We continue to carry portions of our inventory longer than expected due to elongated project timelines and to ensure product availability to support our customers. These dynamics could reduce a portion of the working capital unwind we typically expect to see in the second half of the year. Net debt at the end of the quarter was $1.627 billion, the increase in net debt from the prior year reflects higher borrowings to fund the increase in working capital and our recent M&A activity, coupled with lower cash balance. Despite the increase in net debt, our leverage improved to 1.9x, attributable to an increase in adjusted EBITDA. As part of our debt refinancing in July 2021, we correspondingly entered into a 5-year fixed interest rate hedge on our senior term loan with a notional value of $1 billion to lack in the LIBOR rate at 74 basis points. As of July 31, the cash value of the hedge was $65 million. On July 29, we amended the terms of our credit agreement governing the ABL facility to increase the aggregate amount of commitments by $400 million to $1.25 billion. And at the end of the quarter, we had nearly $1.1 billion of liquidity, consisting of excess availability under the asset-based lending facility, which is net of $142 million of borrowings and approximately $9 million of outstanding letters of credit. While we expect to generate strong operating cash flow over the next 6 months and beyond, we believed it was prudent to expand the borrowing capacity of our ABL to support anticipated business growth and to give us additional flexibility to pursue growth opportunities as they arise. We have a capital allocation plan that consists of balanced investments in growth. Our priority is to maintain our financial strength and flexibility without sacrificing long-term organic and inorganic growth opportunities. We will continue to invest in greenfields and acquisitions to grow our market share or enhance our operating capabilities. We will also evaluate other capital deployment options as we generate strong cash flow, including the potential for share buybacks and debt reduction. I'll wrap up on Slide 11 with a discussion of our outlook for the remainder of the year. We've sustained great momentum through our spring and summer selling seasons, and our customers remain busy with healthy backlogs. We expect overall end market demand to remain positive, even as rising interest rates, inflation, supply chain disruptions and labor shortages persist. As Steve mentioned previously, we are beginning to see a slowdown in new residential construction in certain geographies. With rising interest rates, we could see a slowdown in lot development more broadly. However, our residential bidding activity and backlog currently remain positive. As a reminder, the residential end market makes up roughly 20% of our net sales. Municipal repair and replacement activity, which makes up roughly 40% of our net sales, has remained strong. Repair and replacement demand has historically been resilient through economic cycles, and we expect that to continue through the next cycle, especially as funds from the Infrastructure Investment and Jobs Act make their way into our end markets. Our expectation is that we may not see incremental demand from the Infrastructure Bill until 2023 or beyond due to ongoing supply chain constraints and labor shortages. Nonresidential development, which makes up 40% of our net sales, also remained strong with healthy bidding activity and backlogs. We expect price contribution to moderate in the second half of the year as we anniversary the price increases from a year ago. If demand softens, providing relief to our supply chain, it is possible we could see the cost of commodity-based products come off peak levels at some point in the second half of the year. Taken all together, we now expect 26% to 32% net sales growth for fiscal 2022, excluding the contribution from acquisitions that have not yet closed. We expect gross margins in the second half of the year to be sequentially lower than the first half, in part due to the moderating commodity prices and less inventory profits. With these factors in mind, we are raising our expectation for fiscal 2022 adjusted EBITDA to be in the range of $840 million to $890 million, representing year-over-year growth of 39% to 47%. We expect to convert roughly 45% to 60% of adjusted EBITDA into operating cash flow for the full year. Our expectation for operating cash conversion is less than what we guided to last quarter due to strong demand and supply chain constraints, resulting in our decision to continue investing in inventory. In closing, we have a resilient business model and a leadership team capable of quickly adjusting to changes in the market. We are strategically positioned with multiple paths of sustainable growth. We remain focused on executing at a high level, delivering value to our customers, suppliers, communities and shareholders. At this time, I'd like to open it up for questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Our first question for today comes from Matthew Bouley of Barclays. -------------------------------------------------------------------------------- Elizabeth Ann Langan, Barclays Bank PLC, Research Division - Research Analyst [2] -------------------------------------------------------------------------------- So you have Elizabeth Langan on for Matt today. I just wanted to kind of touch on the updated guide. Would you be able to give us maybe a little bit more of a breakout of what you're embedding in price and volume and if you have any details on the general cadence of that through the third and fourth quarter of the year? -------------------------------------------------------------------------------- Mark R. Witkowski, Core & Main, Inc. - CFO [3] -------------------------------------------------------------------------------- Yes, sure. Thanks for the question. As we've guided towards the second half, volume for the second half, we expect to be flat to slightly down, primarily coming off of really strong comps in the prior year. Second-half price contributions, I'd say, would be in the low to mid-teens with acquisitions contributing another couple of points. So ultimately, full-year volume, low to mid-single digit; full-year pricing, low to mid-20% range and acquisitions approximately 3 points of contribution. -------------------------------------------------------------------------------- Elizabeth Ann Langan, Barclays Bank PLC, Research Division - Research Analyst [4] -------------------------------------------------------------------------------- Okay. That's really helpful. And would you be able to touch on what you're seeing in regards to inflation currently? And if there are any categories that are specifically seeing normalization or the ones that are kind of holding price? -------------------------------------------------------------------------------- Mark R. Witkowski, Core & Main, Inc. - CFO [5] -------------------------------------------------------------------------------- Yes, sure. I think as we expected throughout this year, we did anticipate some of our commodity-based products would start to stabilize. We are starting to see supply chain in certain of those areas start to free up a bit. And at the same time, some of our non-commodity products, which we really saw kind of lagging in price, start to come through during the quarter. And I'd say that non-commodity piece was really a surprise to the upside for us in Q2, and we really see that sustaining through the second half of the year, which is, again, part of the raise in the guide. -------------------------------------------------------------------------------- Operator [6] -------------------------------------------------------------------------------- Our next question comes from Jamie Cook of Credit Suisse. -------------------------------------------------------------------------------- Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research and Analyst [7] -------------------------------------------------------------------------------- I guess my first question, you noted some slowdown on the residential side, talking about lot development and I think some slowdown on the East and West Coast. Can you just sort of give a little more color on sort of what you're seeing there and how that's impacted, if at all, your sales forecast? So I guess that's my first question. -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [8] -------------------------------------------------------------------------------- Yes. Sure, Jamie. What we've seen generally is that some of the major metro areas in the East Coast and West Coast have just taken a pause in some of the nonresidential and commercial construction. So we're seeing that hit in our fire protection products that's been -- we've seen that coming. That isn't really new, but we've really seen strong performance in a lot of the other areas, certainly in the Midwest that's kind of picked that up. So overall, for the year, we still feel we've got positive outlook in regards to what we're seeing with commercial construction, nonresidential. From the residential piece, we've seen pockets where for the land and lot development phases are being put in place here, shortening the scope and -- in terms of the land development that's happening in a lot of these areas. We're seeing that in certainly areas in the [Sun Belt], through Florida and Texas, where that's starting to take shape. And again, we're -- our backlog looks strong in there. The outlook looks good for us and what we're seeing -- we're just seeing some of the sizing and scoping of the development be scaled down as builders look some of the challenges associated with interest rates and the housing market itself is just -- they're looking at how that's going to shape up for them. -------------------------------------------------------------------------------- Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research and Analyst [9] -------------------------------------------------------------------------------- Okay. And then just a follow-up question. I think last quarter, you talked about 50 to 100 bps of temporary margin benefit in your guidance. I think it was tied to strong pricing, but can you just provide an update on if that's changed at all, like what your assumptions are? -------------------------------------------------------------------------------- Mark R. Witkowski, Core & Main, Inc. - CFO [10] -------------------------------------------------------------------------------- Yes, Jamie. Now we've got another quarter in where we've been able to continue delivering on some of our gross margin initiatives that we've got, in particular, with some of the private label work, our accretive acquisitions that we did last year. We saw a continued benefit come through there, in particular with some of the Erosion Control products that we're now expanding. So we've seen some nice increases associated with that. That 50 to 100, I think, still is a temporary benefit, we believe, just due to the pricing environment, and there's continued ability to buy ahead of these cost increases is still there. But I'd look at that kind of off the first-half margins that we've been able to deliver just due to continued execution on the initiatives that we've got. -------------------------------------------------------------------------------- Operator [11] -------------------------------------------------------------------------------- Our next question comes from Kathryn Thompson of Thompson Research Group. -------------------------------------------------------------------------------- Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO & Director of Research [12] -------------------------------------------------------------------------------- And not to beat a dead horse on guidance, but just a couple of clarifications, and I appreciate the color you've given so far. Three quarters of the top line growth has been driven by pricing in the first half of the year. As you look at your second-half guide, how much of that is driven by the favorable pre-buy price increases and mix? I mean this is kind of on the pricing bucket, how much does that contribute versus some of your other core initiatives that you've been working along? And really kind of part and parcel with that, what are the levers for the margins that we should take into account, understanding that you had guided for sequentially lower? But what are the primary components for that understandable sequential deceleration of gross margins. -------------------------------------------------------------------------------- Mark R. Witkowski, Core & Main, Inc. - CFO [13] -------------------------------------------------------------------------------- Yes, Kathryn, just to try to unpack that a little bit on the top line as we look out into the second half, the guide is really to see continued stability with our non-commodity-based products. We do expect some softening of some of the commodities, in particular, PVC, that's been a pretty large element of the price increases that we've seen come through. So we're assuming some of that kind of dials back as the supply chain frees up, potentially here in the second half. And then from a gross margin perspective, again, no real major mix impacts there, but we do expect to see some of those inventory profits become less as we get into the back half of this year, and I'd expect more of that pressure kind of later in the year, just based on kind of what we're seeing to date. -------------------------------------------------------------------------------- Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO & Director of Research [14] -------------------------------------------------------------------------------- Okay. And as far as the coast, once again, I note that earlier and then the Q&A for non-res swing a little bit. Is it more in bid activity? Or is it in projects that were slated to start are now delayed? Or is it just -- give a flavor of what that means? And then based on your prior experience, how does this deal versus prior periods where you've seen a [pause]? -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [15] -------------------------------------------------------------------------------- Yes. I would say, most of what we're seeing are project delays that are happening and occurring right now, most part for the commercial construction piece impacting our fire protection projects. I would say, this has not given us a lot of concern at this point, just given the nature of the type of projects that we're seeing out there that are on the slate. So we've been through this before, certainly went through some of the store in COVID, where some of these areas were impacted temporarily, where construction was paused. So that's generally what we're seeing. The condition across the rest of the country has been really quite strong. So we're encouraged by that. And so we're not too alarmed. This was -- we certainly have been seeing that coming. And bidding activity across the rest of the country still looks very strong. -------------------------------------------------------------------------------- Operator [16] -------------------------------------------------------------------------------- Our next question comes from David Manthey from Baird. -------------------------------------------------------------------------------- David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [17] -------------------------------------------------------------------------------- First off, I was wondering if you could broadly discuss the relative growth rates of the municipal markets during the quarter and the momentum you're seeing there, you kind of touched on resi and non-res already? -------------------------------------------------------------------------------- Mark R. Witkowski, Core & Main, Inc. - CFO [18] -------------------------------------------------------------------------------- Yes, David, thanks for the question. Just -- I would say in general, as you think about our end markets for the quarter, in the first half, I'd say, municipal has been really strong, relatively speaking, just from a volume perspective, I'd say, kind of in that low to mid-single-digit range and muni is typically an area that's kind of low single digits. So really, really good volume coming out of that. Non-resi, I'd say next, just again, good strength, broadly speaking, though there are some pockets where we saw some weakness and then kind of residential, third, just lower due to some of the scoping. -------------------------------------------------------------------------------- David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [19] -------------------------------------------------------------------------------- Okay. Could you talk about the municipalities and how they're dealing with inflationary spikes? Is there some kind of a shift going on here from upgrades to chasing brake fix-type business? And what I'm getting at is, do you think there's any sort of project deferrals because of budget limitations, just stemming from these inflationary spikes that we're seeing? -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [20] -------------------------------------------------------------------------------- David, we're not really seeing a lot of project deferrals due to the inflationary nature of the products themselves. We are seeing some projects being tabled due to availability of product and the long lead times associated, particularly large diameter type water main replacement, things along those lines, where the lead time for that pipe could be anywhere from 6 to 9 months. So we have seen some deferral of those projects until better availability of those specialty type, the products are -- it becomes more available and timely. But for the most part, municipal has just been incredibly steady as we've gone through here. We've seen a lot of work being done on the repair and replace. We're seeing a lot of good treatment plant being done, new expansions of water and wastewater treatment plants as well, too. So it's really been across the board. And then very strong outlook, and bidding activity has been incredibly strong. -------------------------------------------------------------------------------- Operator [21] -------------------------------------------------------------------------------- Our next question comes from Joe [Alicemeyer] from Deutsche Bank. -------------------------------------------------------------------------------- Unidentified Analyst, [22] -------------------------------------------------------------------------------- I just wanted to be clear on the municipal end market commentary. I think implicit in a lot of what you're saying is that you're not seeing any benefit yet from the Infrastructure Bill. I know, on the last quarter call, you mentioned the potential to see earlier benefits from that at the supply chain eased. But given the prepared remarks and the answer to the prior question, it sounds like it's definitely not going to be a benefit until '23, and that doesn't explain the increase in the guide, correct? -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [23] -------------------------------------------------------------------------------- Yes, correct. I think that's the way we're looking at it right now. We're just not seeing a lot of projects utilizing those funds at this point. Again, through second quarter, everything has been pretty strong. We believe that if something were to happen where residential should start seeing some type of decline that some of that we may see more capacity being allocated into municipal and that could drive and support some of the residential declines. But up to this point, we just haven't seen that yet. -------------------------------------------------------------------------------- Unidentified Analyst, [24] -------------------------------------------------------------------------------- Okay. Great. And then just shifting gears to geo erosion. I know you've said it's roughly a $5 billion market subsegment within your addressable market. What kind of CAGR could that grow at? Do you have a share target in mind, something maybe in line with your overall company average? And if it's maybe more or less, what will contribute to that difference? -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [25] -------------------------------------------------------------------------------- Well, we just see a lot of avenues to continue to grow that model. We are very underpenetrated in that in our business, overall. It's a very complementary product to our existing customer base as well and fits in really strongly with what some of our core strengths are with local expertise and local specifications. So we're going to continue to grow that. We see multiple avenues to do that organically and continuing to expand the capacity of our distribution network on this in addition to, as you saw with our most recent acquisition this last quarter continue to fill out a lot of the geographies out there to increase the supply. So just a really nice acquisition for us that helps complement our prior ones in L&M supply, and that's been primarily through the East Coast, up and through the Midwest, and now having these 3 locations out in the West Coast really help support that business, and we'll continue to grow it. -------------------------------------------------------------------------------- Operator [26] -------------------------------------------------------------------------------- (Operator Instructions) Our next question comes from Patrick Baumann of JPMorgan. -------------------------------------------------------------------------------- Patrick Michael Baumann, JPMorgan Chase & Co, Research Division - Analyst [27] -------------------------------------------------------------------------------- I just want to dig into that 50 to 100 basis points of temporary benefit in the gross margin, I suppose, now you're saying it's off of the first-half run rate, which is around 26.5%. And I'm just curious, what gives you confidence that the temporary benefit is more than that? Can you talk about your visibility to, I guess, your core performance improvement, since, I guess, pricing really took off versus kind of what you've seen in terms of inventory profits over that period? I think you were kind of run rating at a 24.5%, 25% type of gross margin before this inflationary period. So any additional color on that would be helpful. -------------------------------------------------------------------------------- Mark R. Witkowski, Core & Main, Inc. - CFO [28] -------------------------------------------------------------------------------- Yes. Thanks, Pat. Thanks for the question. Yes, in terms of some of the margin initiatives that we've talked to you about previously, I mean, we've seen now continued improvement in those areas here now for several quarters. So we've got those well tracked, and we continue to see expansion there, in particular, moving more product now through private label and then now having really 4 full quarters now of sustained gross margin accretion that we've seen come from some of the acquisitions that we've done and then the related synergies associated with those. So recognizing that we still have benefit in there associated with buying ahead of some of these cost increases that have come through, but we've also seen some product categories where we've actually seen pricing start to stabilize a bit and have seen the margin reaction associated with those. So it's allowed us to better really identify what we think that benefit is on a product category, which ultimately gives us confidence to know how these other products could react if they're -- the cost side starts to stabilize a bit, and we don't have that same level of opportunity to pass that price-through. So that's best estimate at this point, but given the sustained quarters we've now had with those margins, we think that's still 50 to 100 holds. -------------------------------------------------------------------------------- Patrick Michael Baumann, JPMorgan Chase & Co, Research Division - Analyst [29] -------------------------------------------------------------------------------- That's encouraging and helpful. Appreciate the comment. And then can you provide some additional color on the pipeline for acquisitions, like the types of multiples you're seeing, the types of prospects, I mean, should we continue to expect bolt-on type deals? And then in terms of that $95 million of M&A revenue you highlight on Slide 6, is that all now added to the guidance or just a portion? And if it's just a portion, just curious kind of in rough terms, what percentage of that is now included in the guidance? -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [30] -------------------------------------------------------------------------------- Yes. I'll start first with the M&A pipeline. So as you've seen, we continue to find really strong businesses out there. It is still an incredibly fragmented market. We do consider ourselves the acquirer of choice, and we've got a lot of experience integrating in a lot of these businesses, whether they're traditional waterworks distributors or certainly the work that we're doing now in geosynthetics is just -- is ripe for consolidation. And we continue to see a really strong pipeline. The multiples we're paying have been in line with everything we've done so far at 6 to 9x adjusted EBITDA on a pre-synergy basis. And we typically can provide 2 turns of improvement on that, post synergies, with cost reductions. And certainly with our size and scale and purchasing arrangements help us to really bring in post-synergy, post-acquisition synergies. So the $95 million, Mark, I don't believe that was in... -------------------------------------------------------------------------------- Mark R. Witkowski, Core & Main, Inc. - CFO [31] -------------------------------------------------------------------------------- So yes, the Earthsavers and Inland, which have both closed, are in the guide. Trumbull has not yet closed, and our practice on that is going to not include those in the guide until we get to closing, which we expect during the third quarter. -------------------------------------------------------------------------------- Patrick Michael Baumann, JPMorgan Chase & Co, Research Division - Analyst [32] -------------------------------------------------------------------------------- Should we assume since it's like -- should we just assume kind of a percentage of sales based on branch count or something like that? -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [33] -------------------------------------------------------------------------------- That's a fair way to do it, yes. -------------------------------------------------------------------------------- Operator [34] -------------------------------------------------------------------------------- Our next question comes from Andrew Obin from Bank of America. -------------------------------------------------------------------------------- David Emerson Ridley-Lane, BofA Securities, Research Division - VP [35] -------------------------------------------------------------------------------- This is David Ridley-Lane on for Andrew. Did supplier delivery times get better as you went through the quarter? And I'm asking broadly. I know there's still shortages for, as you mentioned, the large diameter pipes and the chips for the smart water meters. -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [36] -------------------------------------------------------------------------------- David, it's been kind of interesting. We've certainly seen some lead times improve pretty significantly over this last quarter as supply has firmed up. One thing I would share with you, though, there's still a lot of extended lead times out there for many of our products. But I think nearly all of the manufacturers at this point have become more reliable in terms of their lead times and the accuracy of those, which has helped us to manage this process much better with our customers and all the way through the whole system. So I think we're kind of getting into a new normal here of normalizing some of these lead times, being able to have them be more reliable to support our projects and support our customers in this time frame. We've really started seeing that improved certainly in the second quarter. -------------------------------------------------------------------------------- David Emerson Ridley-Lane, BofA Securities, Research Division - VP [37] -------------------------------------------------------------------------------- Got it. And then I know you reiterated your view on when the U.S. infrastructure-related funds will show up. Just not to split hairs, but are the lead times sort of stabilizing the continued municipal advantage? Is that making you more or less optimistic about the impact for that in calendar 2023? -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [38] -------------------------------------------------------------------------------- I would say, we'll probably get a better feel for that in the next quarter here on how that firms up. It's just too hard to tell right now. We're just not seeing those infrastructure dollars really flowing through at this point. So whether it's lead time concerns or inflation, which we haven't seen just yet, that's causing some of these delays or those funds not to be utilized, we'll have a better feel, probably, for the next quarter. And then we do believe this is going to be a tailwind for us, particularly in 2023, and we'll just see how that shapes up in the next quarter. -------------------------------------------------------------------------------- Operator [39] -------------------------------------------------------------------------------- We currently have no further questions. So I will hand back to Steve LeClair for any further remarks. -------------------------------------------------------------------------------- Stephen O. LeClair, Core & Main, Inc. - CEO & Director [40] -------------------------------------------------------------------------------- Well, thank you all again for joining us today. It's a pleasure to have you on, and we hope that you're doing well. So we are extremely pleased with our second quarter performance and continue to focus on the controllable areas of our business. While the near-term environment remains dynamic with inflation, supply chain challenges and broader economic uncertainty, we are confident that the underlying demand trends, a robust M&A pipeline and strategic initiatives will position us to achieve sustainable growth in 2022 and beyond. Thank you for your interest in Core & Main. Operator, that concludes our call. -------------------------------------------------------------------------------- Operator [41] -------------------------------------------------------------------------------- Thank you for joining today's call. You may now disconnect your lines.