Fastenal Company

Greetings. Welcome to the Fastenal Company second quarter 2019 earnings results conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone today should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I would now like to turn the conference over to Ellen Stultz with Investor Relations. Ms. Stultz, you may now begin.

Welcome to the Fastenal Company 2019 Second Quarter Earnings Conference Call. This call will be hosted by Dan Flournas, our President and Chief Executive Officer, and Holden Lewis, our Chief Financial Officer. The call will last for up to one hour, and we'll start with a general overview of our quarterly results and operations, with the remainder of the time being open for questions and answers. Today's conference call is a proprietary Fastenal presentation and is being recorded by Fastenal. No recording, reproduction, transmission, or distribution of today's call is permitted without Fastenal's consent. This call is being audio simulcast on the Internet via the Fastenal Investor Relations homepage, investor.fastenal.com. A replay of the webcast will be available on the website until September 1, 2019, at midnight Central Time. As a reminder, today's conference call may include statements regarding the company's future plans and prospects. These statements are based on our current expectations, and we undertake no duty to update them. It is important to note that the company's actual results may differ materially from those anticipated. Factors that could cause actual results to differ from anticipated results are contained in the company's latest earnings release and periodic filings with the Securities and Exchange Commission, and we encourage you to review those factors carefully. I would now like to turn the call over to Mr. Dan Flournus.

Thank you, Ellen. Good morning, everybody. Before I start, I just want to share a thought with the group. And I had the distinct pleasure of my 23 years at Fastenal to have worked with some really fine people. And two of them I'll mention, our original CEO, Bob Curlin, and his successor, Will Overton, two individuals that I think were stellar in the role and I learned a tremendous amount from. And not only were they great at their role. They're really good people. I remember back in, I believe it was 1998, October, and our business growth dropped in one month, about a third. We went from 27% growth. We dropped 10 points. I think we went from 27 to 17. Don't quote me on that, but I think that's what it was. And we did six simple things. And if you want to, if you're a CEO out there and you want to know six things to do in a time like this, these are really useful. The first thing you do is you take a step back. You revisit your long-term priorities. These priorities should center on your goals or something's wrong to start with, but you take a look at your priorities. And that's step one. Step two is you remind everybody about these priorities and you remind everybody, hey, we keep doing these things. 20 years ago, that was opening branches because we were spreading across North America. Today, it's executing on our growth drivers. Step three, you take a step back and you identify those things that are really, really important to your long-term success, but you pull back on that a bit. And you explain to everybody why. And a good example of something that we're pulling back, back in late May, I sat down with Renee Weiskopf, our head of HR, and Peter Gettinger, our head of our professional school business, and I said, you know what, we need to pull back expenses and we need to do it in a bunch of places. We need to pull back our instructor-led programs for the second half of the year because we need to pull back the travel expenses. So if you're an airline right now or a hotel in Winona, Minnesota, or one of our distribution centers, you will lose some business in the next six months because we pulled back about 40% of our instructor-led trainings. And the team didn't react with anger, didn't react with fear. They reacted with resiliency. And now maybe they had some fear in their stomach. Maybe they had some anger in their stomach, but they didn't let that show. And they immediately identified with some of the resources they would be freeing up, what could they do that helps Fastenal in the short term and long term. And they identified some courses they're going to develop. Most of our courses are delivered online. We identified an abrasives course, a metalworking course, a blueprint reading course, an ISO quality course, several new Courses relating to Lean and Six Sigma. Now, my guess is there aren't anybody on this call that's signing up to take those courses. But they're really important to our employees and to our customers. And that's something that you do when you do tradeoffs and you pull back expenses in the short term. Really important thing. There's no organization or individual, in the case of me, that believes in education more. But in the short term, you pull back because we don't have the dollars to pay for it. Step four. You also identify those activities that don't support your long-term priorities or that, quite frankly, aren't really that necessary in the first place. Fortunately for us, we're pretty frugal. So we don't have many of those, but we are human beings, so you always develop some. And those you just stop, and you stop today. The third thing you do is you communicate this throughout your organization. You create normalcy in your organization. You remove fear and replace it with resiliency. And then step six, you repeat that communication to everybody, and you repeat it again and again, and you build resiliency in the organization. Six really simple steps, but they're really effective. In a time when all of a sudden your business has slowed down and you're not sure how long. I feel comfortable we're taking market share, but the business has slowed down. Had a call with our regional VPs at 7 this morning. Actually, Holden did. I chimed in at the tail end of it. I talked to them about a number of things we're doing right. I also talked about them on aspects of the corridor that don't fall into normalcy, where our execution faltered. And gross margin is one that stands out. You know, to be honest with you, last fall, we thought we had a really good plan to address some of the inflation we were seeing in the, you know, there's been tariffs now in place on steel-based products for a year, on fasteners since late last fall. and felt we had a really good plan coming into the year, how to approach it. I often encourage our team to think big about the business. Unfortunately, on that front, I fell shy on where we were last fall in that we had a good plan coming into the year. We didn't have a great plan. And part of where we faltered was the resiliency part. We didn't prepare our team for a bunch of things coming their way. We prepared them for that big wave coming in, It was tariffs that were direct. That's an easy one to identify. That's an easier one to go after. It's not easy to take it downstream, no pun intended, but it is easier to go after. We also prepared them for some of the things that would be coming from our suppliers in the U.S. that import product and resell it to us. Not as easy to identify, but relatively easy. And I think on those two fronts, we did a relatively good job. We realized in the process we were going to share some of it with our customers. We were going to share some of it with ourselves. We are a supply chain partner. Our customer is not a means to an end for us. We're not a business that just sells products and the customer goes away and we don't really care what they do with it. We are a supply chain partner, and that's what we represent to our customer. Where we failed, though, is there wasn't just a couple waves coming in. There was a bunch of riptides, too. And those riptides came from a bunch of different directions, and we weren't ready for that. And as a result, and Holden will touch on a little more detail about that, we lost some gross margin. To me, that's the thing that stands out in this quarter that is troubling from the standpoint. If the economy slows down, the economy slows down. If the economy expands, the economy expands. You react to both. We did not execute on gross margin. And as a result, a statement I made to this group, I believe it was back on the January call, where I said, when I look at Fastenal, and I'm describing it to our folks internally, you know, when we're a $10 billion company, I believe a 46 gross margin is a reality that we can achieve. I believe a 24% operating expense is a reality we can achieve, and we should aspire to an operating margin of around 22%. I believe it then, I believe it now. I didn't think I'd be sitting there six months later talking to you about a quarter where we just put up gross margin at 46 and change. 46.7, I believe, is the number. And in that regard, we have some work to do as we go into Q3. I'll go to now the flipbook. The sales growth slowed about 8%. It's our first sub-10% reading in nine quarters. We continue to realize double-digit growth through vending and onsites, and our national account customers are growth drivers, if you will. Our fourth growth driver, construction, did weaken as we got deeper into the quarter. Not exactly sure what's driving all of that at this time. But overall, our activity in the end markets we serve slowed as we stepped into the quarter. I don't know if it continued to slow during the quarter, but it did slow as we stepped into the quarter, and I'll let Holden touch more on that in a few minutes. There were a few milestones in the quarter, and one that occurred right after the quarter that I'll touch on as well. The first milestone was we installed our 100,000th, that's a hard thing to say, vending device during the quarter. We have a little over 85,000 vending machines now. We have another 15,000 that we lease to some customers where they use them for check-in, check-out. So 100,000 of them out there. I'd like to personally thank Oshkosh Corp., and specifically their Pierce Manufacturing Facility in Appleton, Wisconsin. They were an early adopter, I should say an early guinea pig of our vending program back 11, 12 years ago. Continue to have a great relationship with that organization, and they added machine number 100,000 in early June. And they had the opportunity to go over there and and thank them in person. It worked out really well because they're based in Appleton, Wisconsin. My father-in-law, Gus, lives about 10 miles away in Neenah. So I didn't need to get a hotel that night. But I had a chance to learn a little about their business. And what they do is pretty special. They make fire trucks. Beautiful product. Late in the quarter, we signed on-site number 1,000. I think that's a big accomplishment. It took us quite a few years to get the branch number 1,000. It took us a lot less time to get to onsite 1,000. I'm not at liberty to share with you the name of that customer right now. I believe we're announcing it in a day or two. You need to get all the formalities worked out, but I'd like to thank them incognito for onsite 1,000. I think we're at 1,026 right now. A third milestone occurred. It's not in the flipbook, but yesterday, and it wasn't even in the quarter. Yesterday, our facility in Connecticut, Wallingford, Connecticut, Holochrome, Back in 2009, we acquired Holochrome. They were in the process of being shut down. Within two years of the acquisition, we moved them from an 80-year-old facility that was rather tired into a newly renovated facility. But Holochrome Manufacturing started back in 1929, kind of an odd year to start, given what happened in the next decade. But they celebrated 90 years of operation yesterday. My congratulations to the team at Holochrome. They've been a great addition to the Fastenal family. Price realization, as I've alluded to, has been insufficient to fully offset the tariffs and general inflation we're seeing. We're seeing it in a bunch of fronts. Obviously, the direct impact of tariffs, but the indirect through companies we buy from. Some pass it on in different ways. Some spread it across all products. Some apply it strictly to tariff-related products. Nonetheless, it's created a lot of supply chain inflation. In the short term, we've not been able to realize the price to fully pass that along. We have taken further price adjustments going into the third quarter. We will, as a supply chain partner, share some with our customer. We will absorb some of it. But we plan to claw back the gross margin degradation that came beyond just customer mix in the current quarter. As a result, we struggled to obtain leverage. We did get operating expense leverage. The flipbook talks about that. The only disagreement I'd have with the flipbook is that's looking at operating expense to sales growth. I think of operating expense to gross profit, dollar growth. And in that regard, we did not lever. But I think the team did a good job of managing operating expenses in the second quarter. We are dialing them down as we go into the third. On the next page, I don't need to read these all individually. What I can say as it relates to our growth drivers, the team did a great job continuing to take market share. We just need to continue to do a great job on executing the business. With that, I'll turn it over to Holden.