Fastenal Company

Greetings and welcome to the Fastenal 2020 Second Quarter Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If you would like to ask a question at any time, please press star 1 on your telephone keypad. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Ellen Stoltz. Thank you, ma'am. You may now begin.

Welcome to the Fastenal Company 2020 Second Quarter Earnings Conference Call. This call will be hosted by Dan Fornes, 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 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, 2020, 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 Fornas.

Thanks, Ellen, and good morning, everybody, and thank you for taking time this morning to listen in on the fast earnings call. Before I start, I'd like to mention two milestones in Fastenal this week, and I want to go to the start, end, in case I would be negligent and miss it. Dave Donahue today celebrates 40 years with Fastenal, and Dave, I want to say thank you and congratulations. Not far behind, Dave, is Lee Hine, who will celebrate 35 years with Fastenal tomorrow. Hey, Rodney, if you're listening, I would mention you as well, but you're only at 20 years, and so in 10 years, I'll mention you on the call. Surround yourself with great people, people better than yourself. Be willing to learn to change and be comfortable with trusting others and you will find success. And I'm pleased and I'm really proud of the FastFont team for what we accomplished this quarter. First off, the team was successful in sourcing hard-to-find safety products. and bringing this product to our existing customers, but of equal importance, maybe greater importance to new customers, customers we don't traditionally do much business with. And I'm thinking of hospitals and first responders when I talk about that group. The team was also successful in lowering our cost structure. It's really a combination of our model simply working the way it works. One item that assisted us this quarter was is we've enjoyed great growth over the years. We are a promote from within organization. That means you're finding new talent every day in the organization. And the best way to do that, at least the best way that we've found, is you have constant relationships with four-year state colleges, two-year technical schools. And you find folks every day to come work for us part-time. And so we have a fair number of full-time students that work for us Part-time. Well, as you can appreciate, in the spring of 2020, with all the schools closing, we lost some employees. We fully expect and we are maintaining contact with that group because we want them back when they're back in school. But in the short term, that helped us a little bit on managing the P&L, and you see that shine through on our FTE numbers. Again, that's the model working as it should work in an environment like this. And the final piece, and that is if you truly believe in a decentralized decision-making structure, you can move faster than anybody else in the marketplace. And I think that was demonstrated this quarter in both our ability to move quickly on rating expenses, but also to move quickly on finding sources of supply of critically needed safety products. And if there's anything that you take away from this quarter or when we think back to this quarter in the years of Fastenal, trusting others is probably the most important lesson. It's probably one of the greatest legacies that Bob Curlin has given to this organization. I'm going to be redundant here for a second. I'm flipping to the second bullet in the flipbook. And, you know, our five priorities through the quarter was trust and fairness. Trust each other, be fair with each other, support each other. And if somebody needs to be home with a child today or a parent or something else, be flexible with that person's schedule. If somebody has a person in their household that has, is particularly susceptible to the negative aspects of COVID-19, be mindful of that and conduct yourself accordingly in our branch, in our support area, wherever you are within the organization. And maintain a safe environment for our people. That includes our people's family and for customers and their families. Customers allow us to come into their business every day to fill vending machines to stock product on a production floor or in a bin stock. We have an obligation to them as well to maintain a safe environment. Support the people directly involved in the pandemic. They're the heroes here. Be there to support them. Make sure you're reaching out to them to see what they need and be creative in finding solutions for them. Sustain a supply chain of critical products for our regular customers as well. They are the fabric of our society. And if you think about the infrastructure of this nation or the planet or you think about the things that you need in your day-to-day life, we supply the folks that make that product for you. and they need a safe and resilient source of supply. The other suggestion I gave to the folks, and this is probably a bad talking, was maybe shut off the TV and get off social media. There's more garbage there than value, unfortunately. Talk to each other. Talk to your customer. Solve problems. That's the task of the day. Going down on page three, the effects of this PPE surge, and Holden will touch on it in more detail, but the effect of this surge notably shows up in our lower gross margin. Safety products is not the higher gross margin product. And our task in the quarter was getting product to market quickly. Sometimes that meant flying product that should be on a ship. Sometimes that meant using third-party transportation to move it in a different fashion. It's not an inexpensive proposition, but it brought the product to market quickly, and that was more important in this environment. And you see this show up in our gross margin. I believe that will recover as we move into the third quarter. The faster sales, daily sales, the hub picks and the vending dispensers, and more to that vending dispensers in a second, point to a bottoming of the environment we operated in in April and improved trends in both May and June. I don't think there's anything new there for folks that are looking at our monthly numbers, but just wanted to share that. We added two charts to this quarter's discussion. And with 100,000 vending devices deployed across 25 countries, I think we probably have a good view into what's happening in real time as it exists. So the first is looking at product dispenses and because I don't want to be in a situation where the analyst community is asking for numbers from now into infinity. We indexed everything back October to 100. But it's really about looking at a machine out there or a group of machines that's dispensing 100 items per day and what are the trends of that population. And as you go through, and the reason we chose October is to cut off, it was well before the start of COVID-19. So the gold line you see is a combination of the last four years of history. And you can see some points that move around. So you see the Thanksgiving drop-off. You see a little surge before Christmas, and that's probably related to a lot of – we have a bunch of customers in the e-commerce world, and there's probably a bunch of activity that spikes up there. You see a drop-off around Christmas and New Year. January and February kind of tread water. And you see, based on history, that if we start at 100 – we'll have 103 dispenses come early March. This year, we were at 105. A couple weeks later, you see the noise that's around Easter, but you also see the direct impact of COVID-19. You see a dramatic shift as that blue line drops and bottoms out in mid-April at 76 relative to the 100 dispenses we were doing back in October. As we move into June, you see that 109 is about the number we'd expect before the dip that occurs around July 4th. This year, we're at 93, so about a 600 basis point delta. And you'd see by fall, we would expect to be at about 113. If you have maybe some nominal inflation in there, that would tell me our vending business is growing about 14% a year. Looking to the next page, Now we're looking at it not from a how much is dispensing, but how many unique users are accessing the machine. Again, using that logic of 100 unique users last October, you can see a little fluttering around Thanksgiving. You see, obviously, the drop-off around Christmas. History would say we should be at about 104 people accessing instead of 100 come early March. That's primarily a result of we're adding new devices every month, and And so you get the growth because of that. This year, we are actually at 106, 107. And then again, you see the little fluttering around Easter, but you see the dramatic drop off because of COVID-19. And we bottomed out at about 85. The marketplace has since recovered. We're at about 101. It's treading water, as you can see, through much of June. But history says we should be at about 109. So about an 800 basis point delta. And then come fall, we peak out at about 119. We start a new cycle again as we go into the new year. This is more in my mind about people and employment. The reason I shared this number internally, I think it's good for us to understand where we are in the marketplace. And you can see the very conservative stance we're taking in managing the expenses in the business. And we intend to continue that as we go into Q3 2020. because it's still a weak, very weak environment. Holden will touch on that in a little more detail. Fortunately for us, we were able to find additional business in the second quarter and make some lemonade out of loans. Switching to page six in the flipbook, our vending and onsite signings bottomed in April. I don't think there's any surprise by that. They did improve in both May and June. Vending and onsite is critical for us. That's two of our principal growth drivers. And they really allow us to build. They don't maybe have the same type of impact in the last 90 days or even the next 30 or 60 days. The vending does. But the onsite is about building that momentum for growth as we go into the tail end of this year and into 2021. And so we're very, very attuned to getting signings back because we We need that for market share gains as we go into the future. We signed 40 onsites in the quarter. You know, our goal coming in, internally, our discussion is all about how close can we get to 100 per quarter. Holding that share numbers in the past, we've since pulled those numbers for the year. But I'm pleased to say that of the 40 we signed in the quarter, 20 of those were in June. So at least we're exiting the quarter with some positive momentum. but it's still at a lower level. If you look at vending, 100 is the same mantra, but there it's not per quarter. It's how close do we get to 100 signings per day? Last few years we've been in the 80s, and we moved into the 90s, and then over time moved into the 100s, or moved north of 100. That dropped off in March as well. April was pretty low. We gained some traction in June. We signed 69 per day, so we're almost back to 70. It's still at a lower level than the last few years, but it's telling me that we can engage with customers in this kind of environment. You just have to be a little more creative with how you communicate and how you tell the story. Finally, e-commerce sales grew about 13.5% in the second quarter. They were climbing as we went into May and June. One thing that hurt our e-commerce numbers during the quarter is we put in place a very strict allocation process. for our COVID-19 products. Think masks, think face shields, think thermometers, sanitation products, et cetera. So that we essentially shut that product off from buying electronically and you had to call the branch or call your contact to source that because that was our best means to manage our supply chain of that product so we had a stable supply for everybody and could hold back the urge to hoard. With that, I will turn it over to Owen. Great. Thanks, Dan. I'll start on slide seven. Second quarter 2020 sales were up 10.3%. It was a quarter that was marked by two really distinct trends, both evolving from the social and business efforts to manage the COVID-19 pandemic. The first trend was the weakening of the economy due to stay-at-home measures and steps taken by companies to protect their workforce. This caused customers to operate at greatly reduced utilization and even shut down through parts of the quarter, something which particularly impacted our onsites. Conditions did improve as the quarter progressed, a pattern exemplified by our fastener daily sales, which declined 22.5% in April, 15.3% in May, and 11.4% in June. That same pattern was evident in the vending data that Dan discussed, as well as our distribution center picks. We believe demand in our traditional business is still 10 to 15% below first quarter levels, and we have seen some flattening in those trends in the last few weeks. The second trend was a surge in demand for certain products that were critical to governments, healthcare providers, and certain businesses in handling the pandemic. We estimate that surge sales of PPE, sanitizer, and other products contributed 350 to 360 million, or roughly 25 percentage points of growth in the quarter. These volumes, which drove 116% growth in our safety products and 260% growth in our government and healthcare business, more than offset weak underlying conditions in our traditional business. We've mostly sold through our pipeline of surge orders at this time. The near-term outlook remains difficult to project. The reopening of industry is occurring in fits and starts as customers reconstitute their workforces and their supply chains. and the trends in our internal metrics and a June PMI of 52.6 are encouraging. Further, while we do not expect a second quarter style surge in PPE and sanitizer products because the marketplace today is much better supplied, the recent increase in COVID-19 infections and expanded customer list in key industries should sustain some degree of safety growth. On the other hand, it is less clear how that increase in infections will affect the pace of reopening. I would characterize the tone in the field to be one of cautious optimism for the third quarter of 2020. Now to slide eight. Gross margin was 44.5% in the second quarter of 2020, down 240 basis points versus the second quarter of 2019. Roughly one-third of this decline related to mix, which was better than we would have expected at the start of the quarter. While the negative effects of product mix rose sharply, this was partly offset by customer mix as closures in April and May caused our onsites with lower gross margins to underperform total company sales. We expect these dynamics to reverse as conditions normalize. Roughly one-third of the decline in our gross margin related to lower safety margins, a byproduct of sourcing product quickly from nontraditional channels. This should be fully recovered, though it may take a couple of quarters as an oversupply of certain PPE particularly masks, is impacting margins for those products. The remaining decline in gross margin is from cyclical and organizational factors, such as rebates and deleveraging of certain fixed costs, with the exception of specific lines with unique supply-demand profiles, such as three-ply masks. The pricing environment is stable. This decline in gross margin was more than offset by leveraging of SG&A, which at 23.6% of sales was 320 basis points better than in the second quarter of 2019. Most of our branch network did not have meaningful surge orders and reacted to weakness in their traditional business by reducing FTE by 9.4%, mostly through a reduction in part-time labor of 15% and hours worked of 23%. This resulted in 240 basis points of leverage over labor in the second quarter. The remaining leverage was from tight control of costs related to travel, training, occupancy, et cetera, and produced an operating margin of 20.9%, up 80 basis points, and an incremental margin of 29%. Given still challenging macro conditions, we will continue to tightly control discretionary operating costs in the third quarter of 2020. Putting it all together, we reported second quarter 2020 EPS of 42 cents, up 16.7% from 36 cents in the second quarter of 2019. Turning to slide seven, operating cash flow of 251 million. Sorry, slide nine. I'm sorry, turning to slide nine. Those ending charts threw me. On slide nine, operating cash flow of 251 million in the second quarter of 2020 was 105% of net income. The increase in operating cash flow versus the second quarter of 2019 was due to 111 million in deferred taxes as part of the CARES Act and higher earnings. 104 million of the deferred taxes will be paid in the third quarter of 2020. Accounts receivable was up 7.5%, including approximately 75 million related to COVID that we believe will be mostly paid in the third quarter of 2020. Inventories are up 4.1%, including approximately 50 million related to COVID that we will work down over the course of the year. We deployed our balance sheet aggressively through the second quarter of 2020 to retain customer inventories while they were shuttered or operated at severely depressed levels, as well as to secure and move critical products quickly. Net capital spending in the second quarter of 2020 was $38 million, down from $67 million in the second quarter of 2019, which was expected given reduced needs for new hub capacity after the investments made in 2019, but also reflects lower vending and truck spending. Our capital spending range for 2020 remains $155 million to $180 million. We returned cash to shareholders in the quarter in the form of $143 million in dividends. From a liquidity standpoint, we finished the second quarter of 2020 with debt at 12.7% of total capital, up versus the fourth quarter of 2019 due to the March 2020 APEX asset acquisition, but below the year-ago level of 16.6%. We did convert our variable rate revolver debt to fixed debt under our master note agreement during the period, and as a result, we have about $660 million available on our existing credit lines. This leaves us with ample capacity to pay deferred taxes and our dividend, as well as to support the reopening of our customers or any COVID-related needs that may yet emerge. This is all for our full presentation, so with that, operator, we'll take questions.