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.

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.

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…

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 [ph] 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…

[Operator Instructions] Our first question for today comes from Matthew Bouley of Barclays.

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?

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.

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?

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.

Our next question comes from Jamie Cook of Credit Suisse.

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.

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 [ph], 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.

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?

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.

Our next question comes from Kathryn Thompson of Thompson Research Group.

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.

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.

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 [ph]?

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.

Our next question comes from David Manthey from Baird.

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?

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.

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?

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.

Our next question comes from Joe [ph] from Deutsche Bank.

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?

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.

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?

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 Instructions] Our next question comes from Patrick Baumann of JPMorgan.

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.

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.

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?

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…

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.

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?

That's a fair way to do it, yes.

Our next question comes from Andrew Obin from Bank of America.

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.

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.

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?

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.

We currently have no further questions. So I will hand back to Steve LeClair for any further remarks.

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.

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