Fastenal Company

Greetings and welcome to the Fastenal 2020 Third Quarter Earnings Results Conference Call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If you would like to ask a question during today's conference, 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 of Fastenal. Thank you, ma'am. Please go ahead.

Welcome to the Fastenal Company 2020 Third 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 will 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 December 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 Flournus.

Thank you, Ellen, and good morning, everybody, and thank you for joining us for the third quarter earnings call. Before I start with a flipbook, just thought I'd share a few thoughts. We do some simple things at Fastenal. We find great people. We ask them to join, and then we give them a reason to stay. One of the enjoyable aspects of my role here at Fastenal is in the fall of each year, I send a letter to all of our 25-year employees, all of our 15-year employees. And then we typically, with the 25-year employees, we celebrate them at our national meeting held in December of each year. Obviously, this year won't be held in person, but it's a great opportunity to recognize great service to the organization and folks that saw the reasons compelling enough that they've spent much of their adult life in the If I look at the third quarter of this year, we actually have six people I get to work with each and every day that hit a milestone in their employment with Fastenal. So back in July, Lee Hine celebrated 35 years with Fastenal. Rodney Hill, a little bit later in the month, celebrated 20 years. Rodney Hill, for those of you who don't know who he is, he's our senior vice president in our national accounts team. In August, we had two employees celebrate an anniversary. Again, these are folks I work with. Holden Lewis, who you'll hear from shortly, hit four years. But on top of that four years, a wealth of knowledge, because many of you know that he spent a good chunk of his career in the Southside community. And when I stepped out of that role, I wanted to bring somebody in who I'd known for years, who I was really impressed with their body of work. And Holden's been with us now for four years in August. Bill Drozdkowski, many of you have heard that name before. He's our leader in our Western United States Business Unit. In August, he celebrated 25 years. I remember the first time I met Bill, I was traveling in southern Minnesota. He was working in our Elbert Lee, Minnesota branch. My first impression of meeting Bill was I didn't realize we hired 16-year-olds. And today, he's a key leader in our organization, and again, covering the Western United States business. Here in September, John Soderberg, our executive vice president of IT, had a milestone celebrating 27 years with the organization. And this coming Saturday, Renee Weiskopf, our EVP of HR, will celebrate 32 years with the Fasten organization. Now, four of these six people I just mentioned grew up in the organization on the sales side. Seems inappropriate for a sales-minded, sales-centered organization. and they bring a wealth of experience and knowledge to the table. I touched on Holden a few minutes ago. I'd say Renee is probably the person I listen to the most. If we make great decisions on HR, it's because I listened to Renee that day. If I look at decisions that I wish I had to do over, it's usually because I didn't listen to Renee that day. The one other item I'd share is in that group of 25-year employees, this year has its first non-American Our Canadian business celebrated 25 years last fall and I look forward to seeing Darrell next time we meet to congratulate him on that milestone. I did single him out in my letter that goes in our annual holiday box of goodies that goes out to employees in December. In the July call, we talked a bit about the steps we took back in the early months of the year as we were listening to our team in Shanghai. on what they were learning firsthand from COVID-19. And we talked about what we did in March and that was we locked down our locations. We closed the front door of our branches. We asked our customers to call ahead. We'd have the product ready for them. We are a supply chain partner for our customers. Most of our sales go out the back door of our branch and we deliver it to our customers' facilities. So by letting us on their premises, they're placing a trust in us and we wanted to honor that trust. Here's a quick recap of information that I've been sharing on weekly and monthly basis with our employees as we progress through this COVID-19 era. We never shut down as an organization. I think everybody knows that. 94% of our population, because of their role, don't have the ability to work remotely. They might work in a branch or on-site. They might work in a distribution center. They might drive a truck. They might work in our manufacturing division. They're in some role that requires them to be present. If I look at that population, in the months of March to May, we were seeing two to five cases per week. And at the end of May, we had 41 cumulative cases within the FASTER organization. Now, we have roughly 21,000 employees, so that was two-tenths of 1%. In the month of June, as some businesses were coming back to work and there was a little more activity, we saw our case count on a weekly basis jump quite dramatically, and we were seeing about 14 cases per week. At the end of June, cumulatively, we were approaching 100. We had 97 cases, which is a half of a percent of our 21,000 people. July saw it increase a little bit more, 16 cases per week. In August, 20 cases per week. September, we saw an interesting change in that trend. We dropped to about 17 cases per week. And at the end of the quarter, cumulatively, we've had 344 cases within the Fastenal Blue Team family. Again, if I did my math right, and these aren't audited numbers, these are my notes, that's about 1.6%, 21,000. In the first week of October, we saw the case count come in at 14. Again, positive trend. I have no idea what our trends will be in October, November, and December, and as we enter the new year. But I do know our group of employees have been taking responsible steps to protect themselves, their families, and their customers they serve while providing a much-needed supply chain to the marketplace. With those 14 cases, cumulatively we're at 358. Again, that's as of last week. At that time when I received the report, we had 21 people currently out. And the typical duration we're seeing is about 15 days, so about two weeks' worth. If I go to the flipbook, we talk a little bit about our daily sales. So while it's not on the sheet, in Q2, we grew 10.3%. In Q3, that reduced 2.5%. Operating income in Q3 grew 2.9%. Our incremental margin was in the mid-20s. Really pleased with those numbers from the standpoint of when I think of safety, safety provided us a bridge between where the economy was prior to COVID-19 as the economy shut down and where it is today. So it's been providing us a bridge. If I look at discrete business pieces of our Fastenal business, fasters and safety, as we've talked in prior calls, make up about half of our revenue. In the second quarter, our fastener business, our oldest product line, our most mature product line, our product line that really links to what's going on in the industrial world, sales dropped 16%. In Q3, that improved to negative 7%. Safety products grew 116% in the second quarter. It came back out of the stratosphere and grew 34%. in Q3. And if you look at all the remaining products that aren't fasteners or safety, they contracted about 8% in Q2, about 2% in Q3. And so the trends are telling me the environment we operate in is healing itself, is improving. And again, safety has provided an incredible bridge as we've gone through this. Earlier I mentioned great people. When I Think of the last six months. I'm really impressed our ability to adapt really quickly to the new normal. Incredibly impressed with our ability to successfully manage costs and how we're holding each other accountable. In fact, this afternoon I have a call with a subset of our regional leaders. I have another call scheduled tomorrow where we're going to talk through elements of our P&L where they're not pleased with us and us being Dan and Holden and the folks that support them because our expenses grew a bit more than theirs. Actually, our expenses didn't improve as well as theirs did. And some things I'm going to share with them are profit-sharing contribution that goes to the entire organization. It's based on our level of profitability. Q3 to Q3 is up 40%. I'm personally proud of that. It means we're finding success together and we're sharing that together. We made a big acquisition of technology back in the first quarter in March. So in both Q2 and Q3, we have a sizeable amortization expense that's now in the numbers. We introduced mobility across the organization. We deployed just under 8,000 devices in the last nine months. So that's an expense that went from zero to something that's not zero. It's a million-dollar-plus increase. of investments we're making to improve the long-term health of the business. We found great success, interestingly enough, in our ability to sell clearance items, clearance products, products that have been on our shelf, whether they're in our branch or distribution center. And this isn't COVID products. This is stuff that we've accumulated over time. We saw an incredible jump from Q3 to Q3, like 200%. It's a small number. But we're finding success. We're resourceful in this marketplace. As you can expect, our purchasing of inventory, we did a great job with inventory. Our purchase discounts we earned are less this year than they were a year ago. And so I'll be having that conversation with our team. But we hold each other accountable. And that's how you successfully manage expenses in an organization. Most importantly, when I think of great people, we've retained the talent of our organization. in ways many other organizations haven't had the ability to do. And our safety sales played a role in that, and I'm proud of that. But we continue to invest in the future. Our training has actually expanded in a COVID era. Even though we don't have our instructor-led training at all this year, our online training and our virtual instructor-led trainings, our school of business, our Fastenal School of Business, did an incredible pivot And our folks in the field are embracing it in incredible ways. Earlier I mentioned we deployed almost 8,000 mobility devices, and we created a more efficient platform for providing service to our customer. I believe in the last six months we've widened the moat that Fastenal enjoys by demonstrating the following in the marketplace to our customers. We're a great supply chain partner. We solve problems, and we invest to deliver. And, you know, we have a great group of analysts that have historically covered us. And I'm not saying that to ingratiate myself to the analyst community. I'm saying that because it's a fact. I was reading one of the – a couple of the analyst reports that came out earlier this morning, and I asked Holden about it. And in there I saw where we have $30 million of slow-moving PPE inventory. You know, we made a big investment in products to support the marketplace in the early part of this year. If you're in our supply chain team, if you're in our forecasting team, he's done a great job. And I think there are folks in our organization that are looking at our PPE inventory and say, geez, we have a bunch. And they're scared about it, nervous about it, is probably a better word. And I look at it and say, this $30 million of inventory, our sales in Q2 surged dramatically. The inventory that's explicitly in this, and the reason I know these numbers, I was talking to our board about it yesterday. Our sales of these products that we have this inventory on, from Q2 to Q3, the quantity of our sales went up 18%. So this isn't something that all of a sudden there was a big need for in Q2, and that need's gone away, and Fastenal's sitting with all this inventory. Based on the sales in Q3, we do have months of supply. Frankly, In today's chaotic world, I consider that an asset, not a problem. And it will support us as we move through this. And I'm happy we have it. So if you need three-ply mats, give us a call. Because the marketplace needs them, and I'm glad we have them. Moving on to the surge activity, as Holden mentioned in the flipbook, it did ease. However, pandemic products continued to contribute to high sales, as mentioned earlier. Safety was up 34%. Growth drivers improved. The signings improved from Q2 to Q3. Sales is about what happened today. Growth drivers and momentum with growth drivers is about what happens tomorrow. Our tomorrow improved from Q2 to Q3, and I feel really good about that. We're not back to the hundreds, and the hundreds is, Our stated internal stretch goal that we put in place last December obviously got thrown out the window in March when the world kind of – didn't kind of, when the world shut down. But our stated goal is can we get to 100 signings of vending devices a day? Can we get to 100 signings of onsites per quarter? And that's what we've invested in infrastructure to support because we think that's a sign of great engagement with customers and a great ability to take market share. They did improve from Q2 to Q3. Lastly on that page, Holden talks about a conservative capital structure. Basically, we have a great balance sheet, and that great balance sheet improved in the quarter. One of the things I said to Holden back in March, and the finance team in general, Holden, Cheryl, and the entire team, I said, you know, what distribution businesses do in environments like this is we're not investing in working capital the same way. And we actually become a cash generator because we harvest some working capital. And I'm really impressed with our supply chain team, our finance team, our district and regional leaders on what they did to produce the cash flow of this year. And so if I look at it in nine months, because then you take out some of the noise of the cash, the tax payment deferrals from Q2 to Q3, nine months in, Our earnings are up 8.3%. Our operating cash flow is up 32.2%, $190 million increase over last year. We pulled back some CapEx, and our free cash flow, operating cash minus CapEx, is up 62% year over year. And there is a little lift in there because there's about $19 million of Social Security tax that's deferred until next year. Absent that, the 32 and 62 goes to 29 and 57. My compliments to Holden, Cheryl, the team. Great job. And it means we have a balance sheet that's ready to support our users. Flipping to the vending, dispensers information that we shared last quarter. Again, most of this you saw last quarter. You see the dip over Thanksgiving. You see the impact of Christmas and New Year. You see the impact... of Easter in early April. And you see where history says we should be by the end of March and where we were by the middle of April. You saw there was some recovery, but as of June, the blue line, which is current, versus the gold line, which is history, or yellow, depending on the quality of your monitor, we were 15 points below where history says we should be. By the end of September, that 15 points is now nine. We're not back to where we should be, but the health is better. And once we got into September, I'm pleased to say we are above where we started last October. Again, not where we should be, but a great performance. And vending is really about consumption of products in the marketplace. It's a great real-time indicator activity. The next page is about unique users. Here you get a little more noise because the way we calculate it, if you have a business day out, so you get the Thanksgiving noise, the Christmas, New Year noise, Easter. You see where we would have been in that March timeframe. You see where we bottomed out in mid-April at 85 and where we ended the quarter. So at the end of the quarter, we were eight points down. Right now we're seven points down. We continue to narrow the gap. This is about employment activity. The first one is dispensing. This is employment. I'm really glad we have a vending business, not just for what it gives us in visibility, but the fact how it helps us grow. And it gives us a reason and our customers a reason to allow us to keep coming in their facilities. And that's one of the ways that we're really entrenched in the business of our customers, and you see it shine through in this type of environment. Final page I'll talk to in the flipbook is page six. As mentioned earlier, our signing activity is still below where we were pre-pandemic, but it's making a comeback. On-site, we signed 62 in the third quarter, and I feel really good about the momentum of that. We need that momentum to come back to support us in the future. That's future growth. One thing I shared with our board of directors yesterday that I thought was an interesting development. And that is, if you look at government business, historically a relatively small piece of our business. Obviously, it became a more sizable piece of our business in the second quarter. We're getting onsite traction in the government world, too. So at the last September, 25 of our onsites were with governmental entities. That might be a K-12 school district. That might be a college or higher ed school. That might be something else in the government sector, but 25 of them. By March, that had grown to 29. At the end of September, we have 35. That's a 40% increase in on-site business with government customers. It tells me that some of that government business we picked up is going to be sticky. And 60% of that occurred in the last six months. And I don't know about the rest of you, but I've never seen government move real fast in a lot of things in life. This is incredibly fast-paced change when I look at that business. College higher ed, 56% increase over last year. We actually, in the third quarter, signed our first healthcare onsite. Don't know what that means for the future, but it is an interesting development. The rest of the information, I think it's pretty straightforward in the reading. You know, in March, our e-commerce sales, and so when we look at e-commerce sales, Even though vending is e-commerce in a way, we don't include that in our number, but it is a digital sale. This is still constrictly at EDI and web orders. For the first time ever in March, that popped over 10% of our sales. In the second quarter, it dropped back because most of the COVID surge was not going through EDI. It was reacting, engaging directly face-to-face with customers from a safe distance. In August and September, our e-commerce as a percentage of business, again, popped over 10%. And for the quarter, we were over 10%. With that, I'll set up and turn it over to Holden.

Great. Thanks, Dan. Flipping to slide seven. Third quarter 2020 sales were up 2.5%. Like last quarter, strong sell-through of safety products offset weakness in our traditional manufacturing and construction customers. Sales of safety products were up 34%. sales to state and local government and healthcare customers grew 131% in the period, and this certainly includes sales related to COVID mitigation. However, we're also seeing restocking, pre-stocking, and share gains as we receive follow-on orders from customers that we added in the second quarter. As a result, we're not characterizing strength here in the third quarter as surge, as the reasons behind our customers buying have become much more varied. We do view this favorably, however, as it affirms our belief that we will be able to retain relationships that began in the chaos of the second quarter. That is likely what allowed us to outperform our original expectations for safety growth in the third quarter. All other products declined 4.2%, including fasteners, which declined 6.9%. This represents deceleration in rates of decline as the economy has reopened and production has rebuilt following the disruptions of the second quarter. In fact, we saw a sequential, low single-digit improvement in both hub picks and vending dispenses in each month of the third quarter, suggesting gradual but steady gains in the underlying business conditions. At this time, we believe customer activity levels are down mid-single digits from pre-pandemic levels. As it relates to the near-term outlook, I think everyone understands that coronavirus is still with us, but at this point, customers are navigating around the issue without having to close operations. As a result, business activity continues to trend steadily, albeit gradually upwards. Against a backdrop of multiple months of better than 50 readings in the PMI and an RVP commentary about customers reengaging in growth at driver discussions, conditions are encouraging. Remember that we are entering the low volume and holiday-impacted fourth quarter, which can always introduce a bit of unpredictability. Still, it's good to see some degree of normalization settling in. Now to slide eight. Gross margin was 45.3% in the third quarter of 2020, up 80 basis points sequentially and down 190 basis points versus the third quarter of 2019. The most significant factor in the third quarter behind the annual decline is low margins for COVID-related safety and Janssen products. In contrast to the second quarter, when this pressure was a byproduct of inefficient supply chains and our own speed in sourcing products, pressure in the third quarter is from two different sources. First, for certain products, demand continues to outpace supply and costs have begun to rise. We began addressing these products with price actions beginning late in the third quarter. Second, other products like three-ply masks and disposable respirators are oversupplied and prices have declined. We believe this will correct itself based on the sell-through of these products out of our inventory. However, this process may take until the second half of 2021. Collectively, COVID-related safety in Janssen was about 14% of sales in the third quarter, and the gross margin was down mid to high single digits on that group of product. The remaining declining gross margin is for mixed and cyclical and organizational factors, such as rebates, deleveraging of certain fixed costs, higher import costs, et cetera. Aside from specific lines associated with COVID, the pricing environment is stable. This decline in gross margin was slightly more than offset by leveraging of SG&A and higher sales of PP&E, which produced 200 basis points of operating expense leverage over the third quarter of 2019. 6.3% lower FTE at the end of period and lower bonuses as a result of the weaker environment generated very strong leverage of employee expenses, while lower travel expense, lower fuel costs, and continued tight control of operating expenses generally enabled leverage of other operating costs. The result was an operating margin of 20.5%, up 10 basis points, and an incremental margin of 24%. Putting it all together, we reported third quarter 2020 EPS of $0.38, up 3.5% from $0.37 in the third quarter of 2019. Now turning to slide nine, we produced $289 million of operating cash flow in the third quarter of 2020, representing 131% of net income and up 12.3% from the third quarter of 2019. This strong cash generation is despite having paid $104 million of taxes deferred from the second quarter as part of the CARES Act and is attributable to higher earnings and farming working capital in the period. Accounts receivables up 2.1%. We did collect the $75 million in surge-related balances that existed at the end of the second quarter, though follow-on orders from some customers simply replaced surge balances with regular-weight balances. As a result, receivables increased largely in line with sales. Receivables quality remained excellent. Inventories were down 1%. $50 million in COVID-related stock at the end of the second quarter was around $30 million at the end of the third quarter, and we will continue to work down this balance over the next few quarters. Meanwhile, the combination of weak demand and efforts to streamline our inventories translated to declining inventory at our branch locations and moderating inventory growth in our onsites and hubs. Our net capital spending range for 2020 remains $155 million to $180 million. We achieved record net income and record operating cash flow over the first nine months of 2020. This allowed us to acquire the assets of Apex, deploy significant resources to secure critical products, and carry working capital for customers during the chaos of the second quarter, and return $480 million to investors in the form of dividends and share repurchase. At the same time, net debt is just 2.5% of total capital, and substantially all of our revolver remains available for use. We retain ample capacity to pay our dividend, finance working capital as demand improves, or take advantage of any other business opportunity that may arise. That is all for our formal presentation. So with that, operator, we will take questions.

Excuse me. Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tonal indication line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Once again, that is star one to register questions at this time. In the interest of time, we do ask that you please limit yourself to one question and one follow-up before rejoining the queue. Our first question is coming from David Manthe of Baird. Please go ahead.

Hi. Good morning, guys. Good morning. I have kind of a long-term question here just to reorient on the growth drivers of the business. Could you update us on how you see the total available market for vending and onsites relative to where you are today? And then a little bit more near-term, if you could just give us an update on the Lyft initiative. I think you had some pretty good early returns on the pilot programs, and I'm wondering if you're moving forward with those more broadly yet.

Yeah, so a few things there. I'm going by memory here, Dave. I think what we've talked in the past about is we believe there's around 15,000. There's potential for about 15,000 onsites based on what we know today. And what we know today is largely confined to North America. But that's a number we've talked about internally. I hope that's a number we've talked about externally in the past. Holden's not giving me a dirty look. But suffice it to say, it's a really big market. The reason it's so big is because of our frugal cost structure, we can find success in an onsite doing $100,000 a month, doing $150,000 a month, where most of the marketplace is struggles with the onsite model when you get below $250,000, $300,000 a month. You know, putting one person in an office and doing sourcing is not an onsite in our mind. An onsite is you're there engaged in their business. But we're able to find success in a lot more places. The vending is, the vending, suffice it to say, I personally believe the number is over a million, but I don't know How much over a million? And I don't know how much energy I'm going to put into figuring that one out. The wild card on vending is historically vending was about putting in a vending box. And because we were reliant on a third party for vending, it was a separate system from everything else we did. But there's places where we have vending where a bin stock works. But we want to illuminate the supply chain. So what we're doing now after acquiring it is we're melding the technologies together. So some places we'll use vending and some places we'll use a bin stock that has replenishment automation in it. In other words, we know how full the bin is. We know how either through RFID technology or infrared technology or some other technology. And so Suffice it to say, it's an incredibly big market. I believe between vending and bin stock, it could address 70% of the true spend that exists in the marketplace. And so you can size it on that based on a device that does, you know, between $1,000 and $2,000 a month in business. But that yields for a number. The final point, and Holden, remind me on the final point. Lyft. Lyft. Lyft. Lyft. And for those of you that aren't familiar with what LIFT is, the acronym stands for Local Inventory Fulfillment Terminal. And the way we're approaching it initially, it's a terminal that replenishes vending, but it could replenish other things, such as bin stocks in the future. We had some pilots. We have a handful of pilots we did. The first one was in Phoenix, Arizona, but we've added since then. The only thing that's changing, well, first off, The initial results are really positive because it allows us to become more efficient in replenishment of vending. It also pushes us to make the model better. And what I mean by that is a greater standardization of products going into the vending because we're replenishing multiple machines, multiple branches, multiple business units out of one facility. And so we're doing some aggregation. What we're really doing now is the movement is we're moving more and more of the lifts we're doing in the next 12 months into distribution centers to make it part of our distribution network, but really excited about the potential there, and we're moving forward on it.

And I might chip in a couple things, Dave. First, on the market size, you know, the numbers that Dan cited were numbers that we sort of derived some time ago. We haven't necessarily updated them on a regular basis, but we do touch base with the owners of those businesses, and there's not a belief that anything has changed in terms of that opportunity. In fact, when you hear Dan describe the performance that we have in some of the educational facilities and government facilities, that was not a market that was envisioned in the original study. So we're seeing, in addition to the opportunity that exists in the original study, we're seeing an expansion of the potential applications. As it relates to the Lyft performance, You know, right now, we still got relatively few. I think we will ramp up the rollout on that based on the performance. And so, we don't have a lot of sort of longstanding metrics that we can hang our hat on. But, you know, in our oldest one, we did see things such as, you know, the dollars per FTE in those regions get better and, you know, the signings improve in that region. And quite frankly, the service level is measured by the number of returns improve. And so, Yeah, I think you're right. The initial data from the initial rollouts of the lift have been encouraging enough that I think you'll see us put more of those in the market in their various capacities and forms and perhaps accelerate that in the coming 18 months.

Okay. Terrific. Thanks, guys. You bet. Thanks, Dave.

Thank you. Our next question is coming from Nigel Coe of Wolf Research. Please go ahead.

Oh, thanks. Good morning. Thanks for the question. I just wanted to kind of dig back into the inventory reductions and also the tight lid on employee hiring. Given the sequential improvement we're seeing and, you know, the relative optimism perhaps from the field, how long can you restrain employee costs so aggressively going forward and inventories as well? That's my first question.

Yeah, on employee costs, remember that restraining of those expenses really is not a function of what we do in Winona. It's really a function of the decisions that are being made by the individuals in the field that are running their businesses, whether that be a branch, a district, or a region. So I don't want to give you the impression of a degree of control that we don't, by choice, exercise in our culture and our model. The reality, Nigel, is The reason that we protected our talent the way we did through what certainly initially looked like it was gonna be a pretty nasty downturn was specifically so that we'd be able to move quickly when conditions allowed. And with demand sort of getting gradually better and with our customers increasingly reengaging in conversations about growth drivers, in many respects that moment has come. And as a result, We fully expect that much as we saw in September, we saw an uptick in FTE relative to what we'd seen the month before. I wouldn't be surprised if you continue to see some of that. Travel expenses, I wouldn't be surprised again if you saw that come up from where it's been. And so the answer is difficult to answer because we don't control it coming out any more than we controlled it going in. Those are decisions made locally. And the field has made great decisions about it going in. And we trust that they're going to make fantastic decisions about it coming out that's going to allow us to be both disciplined with expenses, because let's not forget we're going into a volume challenge seasonal period, and we're all aware of that. But I think they're going to be able to exert a great deal of discipline over their cost structure because it makes sense for them to do so and they've shown ability to do it, while deploying the resources necessary to take advantage of the opportunities that are reopening again. And that's probably how I'd answer that question. I hope that gives you something you're looking for. As it relates to the second question on inventory, you know, inventory kind of reacts the same way, right? When demand is weak, inventory naturally can come down as customers naturally need less of it. And when demand gets better, then it goes the other way. And so there certainly is a – if demand gets better and we would welcome that, then that would come with some improvement in inventory as well. Now, that said, I'll tell you, we're doing a lot of things to get better at managing our inventory, one of which is we're really moving product through our internal supply chain really smoothly today, right? We've gone through a period where we've been closing branches. We're addressing slow-moving product, you know, which is sort of historical product that we've brought into the business over years. You know, we have different types of model stockings that we're – you know, engaging with. And that's required us to move product through the supply chain at an accelerating rate. And whether it goes store to hub, hub to hub, you know, hub to customer and branch, we've really made the movement of that product much smoother and at a higher velocity than I think what we've seen before. And that's an improvement. We've introduced budgets on inventory to the field that I think that they try to operate to, which has been an improvement. We're working with supplier partners to really time shipments better. As you know, we have a long supply chain. And so if we can get those shipments timed better, that actually works for us. And, you know, obviously we've been a little bit more aggressive with non-performing inventory, such as you saw in some of that clearance stuff. So, you know, we're doing a lot of things that I think will continue to lead to an improvement in our days on hand over time. But if demand gets better and the on-site signings we accelerate, that's going to put some need into the inventory again.

We call that a good problem. That's a good problem. Okay. Okay, thanks, Hope. Thanks, Ida.

Thank you. Our next question is coming from Ryan Merkle of William Blair. Please go ahead.

Hey, thanks. First off, Dan, you mentioned the investment in mobility. Just talk about what your vision is for how this is going to help sales and customer service, and then I'm curious what the early feedback has been.

Yeah, I'll give the vision from the team because I do more listening to them than talking at them. part of it is just to ease things that are basic so think of when I make a delivery historically I print off a bunch of packing slips at the branch and I take them with me and I get those signatures on the packing slips and I bring them back and I file them away and if there's something that doesn't get paid and I need a proof of delivery at some point in the future I'm digging through a file cabinet now we have signature capture And now that doesn't mean we always get a signature because sometimes the person doesn't want to touch the device in a COVID world. And so we're working through that, but that's a whole bunch of back office, streaming the back office function, which that brings no value to our customer supply chain. And it's figuring out how to tap into that. Another one is when I'm out visiting a customer, When I'm going to the vending machine, now that we own the technology that is the vending machine, our mobility device talks to the vending machine. And so we're not working with a keyboard, you know, a really obtuse keyboard on a vending machine to do inventory transactions. We have a device in our hand, and it's talking to our point-of-sale system. Incredibly efficiency enhancement. We're using mobility with our lift facilities. So I can fill machines and transmit it to the point of sale that it's filled, and it automates a lot of processes behind the scene. Another one is if I'm out talking to a customer and they have a question about something, I actually have the means to answer the question. I don't need to write it down, get back to the branch, look up at my point of sale system, and call them back. I can answer it on the spot. I can order it on the spot, for that matter. And so it allows you to do a lot of things right now, just like a cell phone. Think of that. efficiency that brings to almost every human being on the planet today. I can take care of something right now rather than writing it down and making a phone call when I get back to a phone. So it allows us to do a lot of things, and it allows our team to be more mobile. In a COVID environment, being more mobile is great because I don't need to go back to the branch at the end of the day, along with everybody else, and congest up an area because everybody has to work on the same terminal. The The other piece, it allows us to illuminate for the customer when deliveries are made, when our schedule is coming, and so our customer has greater visibility to their own supply chain, something that was difficult to do in the past. And the final one is because we're getting orders in earlier in the day, our distribution center can be picking orders we get at 10 o'clock at 10 in the morning, not at 6 in the evening because that's when the order was entered when they got back to the branch at 5 o'clock. on the East Coast or 5 o'clock in the central time zone. It allows you to move work up. If we could pick earlier today, our trucks can leave earlier today, and more of our branches get a truck by 6 or 7 in the morning rather than 7 or 8 in the morning. So it does a lot of downstream efficiencies.

All right. That's very helpful. Thanks. And then secondly, I guess maybe for Holden, I was hoping you could quantify the safety surge in dollars for 2021. That may not repeat in 21. I have my estimate, of course, but I just wanted to sanity check it.

Well, I think we talked about second quarter. And, again, when we think about surge, I'm really confining the dialogue to the second quarter because I don't really know how you differentiate surge from market share gains from customers that are restocking post-issue or pre-stocking in anticipation. I don't know how you differentiate that in Q3 and beyond. And I believe last quarter we talked about $350 to $360 million in surge revenue. That one conclusion could be that it may not recur, but, you know, one thing I would point out and talk a little bit in my presented remarks or my prepared remarks was, you know, we are winning business. If I think just about health care and government, In the second quarter, we had 5,400 accounts that we did not have in the first quarter. Now, remember, in our system, an account is not a customer. A customer can have multiple accounts. But we had 5,400 accounts with customers in the second quarter in healthcare and government that we did not have in the first quarter. In the third quarter, of those 5,400, in July, 1,000 of them ordered again. In September, I think 850 of them ordered again, right? So That surge business of 350 to 360, will all of it replicate? I mean, we hope not, right, to some degree. We don't want to – we'd like this whole COVID thing to back off. But some of that is being replaced with regular way business, with customers that we've raised our profile with that we didn't have that we now do, and we'll retain some of that. And so, you know, I suppose the quick answer is 350 to 360, but I don't think that the whole is going to be that big. But unfortunately, Ryan, I'm not really sure what that is at this point. We're going to need more time to really sort of evaluate the data and understand the marketplace and how it evolves. I think that's just a perspective that's worth providing.

The other wild card you need to at least consider is when does the activity we're seeing in Q3 and the activity we're seeing in Q4, when does some of that subside and we get to whatever our new normal of life in this world is. Is it people over the age of 70 wearing masks a lot? I don't know. Is it, you know, more sanitizing done or are we back in, you know, two years from now? Is it feel a lot like it felt a year ago? Only time will tell. Personally, what we've challenged our team to prepare themselves for is, you know, regardless of your opinion on when a vaccine may or may not be available, And regardless of your opinion on how fast we can produce, I mean, to provide vaccinations for the population that we have, not just in this country or in this continent, but in this globe, is going to take time. And I feel sufficient to say to our employees, we better plan on being in this kind of environment for at least through another 12 months. and how it tweaks and changes and goes up and down between now and then, time will tell. But that's where your head needs to be. And so if that's truly there, that tells me there's going to be a certain level of this extra layer of safety in janitorial products, I believe, for quarters to come.

And let's not forget as well, because obviously I know the point of the question and understand that. When we're comping against that product, We're also comping against a fastener business that was down 17%, 16%, 17% in the same period. And 7% this quarter. And 7% this quarter, right? So, you know, I understand the point of the question, right? I mean, there certainly is a difficult comparison to be had in Q2. But just, you know, bear in mind that we have an easy comparison in fasteners if the market has come back at that point. And we do believe that we have picked up market share. And so that 350, 360 doesn't just go away completely because we picked up business we didn't have in Q1 last year.

Yep. Some great points, guys. Thanks a lot. Pass it on.

Thanks, Ryan.

Thanks, Ryan.

Our next question is coming from Michael McGinn of Wells Fargo. Please go ahead.

Oh, good morning, everyone. Thanks for the question. Good morning. Good morning. If I could start on the on-site question. historically your branch onsite or consolidation efforts have been somewhat mirrored by onsite signings in those same markets or at least that's been my understanding given we're in somewhat uncharacteristic times what is the net impact on your SGA this year and maybe next year as the signings pick back up and do you see a void left in those markets or anything like that the

avoiding the markets related to SDNA from what? So I might have missed the question.

So the branch consolidations, you know, they're accelerating where onsites have decelerated. Historically, my understanding has been you maybe consolidate a branch and a couple of those large customers served by that branch are able to convert to an onsite. Now this is different. Does that maybe kickstart things again in 2021?

So the first thing I would say is I wouldn't so explicitly tie branch closings to on-site openings. You know, I can't rule out that there haven't been some branches that have been closed, maybe in small markets where there's very few customers because some on-sites have gotten created. I think that probably has happened. But in general, they've been independent decisions. The decision to close a branch has more often been because It's a smaller branch that maybe the path of scaling it doesn't look today like it might have looked five years ago, seven years ago when it got opened. And the on-site decision is similarly somewhat independent. So I would be cautious about tying those two explicitly together that way. I think that they're more independent than you're giving credit for.

The only place that you could make a link is roughly half of our branches, I think it's 55%, are in large metropolitan areas with more than half a million people. And so there is some connection, but it's not – think of it more as we open onsites in a market like Minneapolis-St. Paul, and we go directly engage with customers onsite. Over time, it might mean to serve the market in Minneapolis-St. Paul. Fewer branches makes sense because instead of having – you know, 30 or 40 branches in the market, we might have 15 to 20 branches in the market and 40 onsites. And so you're really morphing how you're approaching it, but it's more of a case of the one allowed the other to operate in a different fashion and more efficient.

So if you don't tie the openings and closings of the two together, does that change your question?

No, I'm all set. I'm just I'll take it a different direction from here. So given that you were able to take some early actions regarding stocking ahead of COVID and shown an aptitude for skating to where the puck is going, not where it is, and also trying to remain as apolitical as possible, you've always paid your fair share of taxes and you've also benefited from fair and open trade. So looking into 21, what is the most important factor for your business in your mind?

I'll give mine and then Dan can give his. But, you know, I think it's re-accelerating the growth driver activity. And, again, part of that is simply when do customers re-engage with us because that kind of shut down during the second quarter as our customers are dealing with some more pressing issues at the time. But, you know, those growth drivers are key to what allows us to gain market share. And so when Dan talks about the hundreds, the hundred vending a day and the hundred onsites a quarter, I think sort of getting back to that level, give or take, of signings for our growth drivers is critical, not only for 2021 growth, but probably more importantly for 2022, 2023, et cetera. I think we're built on growth drivers and growth, and those are sort of core to it. So that's, I think, a very important element for us right now.

Michael, I love the way you asked the question. You have an apolitical question looking for an apolitical answer. I only wish our media on both sides of the fence could do the same. And, you know, from my standpoint, we're a supply chain partner to our customers. We operate in the same environment all of our peers do. We have no unique advantage or are not uniquely hurt by anything that changes. We react to it. We reacted to COVID-19. Because of our decentralized nature, because of our true belief in people and giving them the freedom to make decisions, we just move faster because everybody isn't looking to somebody else to tell them what to do. We do, and we support each other. And so if the trading patterns between nations on the planet changes, we will morph to that change just like our industry will and just like our customers will. and the marketplace will. And I think our actions over the last several years in a tariff environment and now in a COVID environment demonstrate the sheer strength of the Fastenal Distribution Model as a supply chain partner to our customers.

Thank you. I appreciate the time.

Thanks. It is five minutes to, I think we have time for one quick question, if there's one more.

Our next question is coming from Hamza Mazzari of Jefferies. Please go ahead.

Hey, good morning. Thank you. Thank you for sneaking me in. My quick question is just at a high level, if you could just compare, what does the sales cycle look like today during COVID on onsites? I know you mentioned sort of 62 signings versus pre-COVID. Is the sales cycle just pushed out by a few months? Is it longer? Is it sort of an in-person type meeting you have to have? Just give us a sense of, you know, is there pent-up demand here from signings that, you know, were sort of midway through that got essentially closed due to COVID and will reopen? Just any thoughts high level as to the sales cycle?

Yeah. You know, I don't think the sales cycle has changed at all. assuming you can do a sales cycle. And what I mean by that is there's some business, you know how it is when times get crazy, some people kind of duck their head and say, okay, let's figure out where we are. It's status. It's kind of like in the movie Apollo 13 when everything's falling apart in the rocket going to the moon. Okay, guys, what's status? What do we have on the ship that works? And that's what a lot of companies go through is they kind of shut down and they say, okay, what are we doing? And fast on, we're going to get you to Heisman and say, we can't talk today. So it's not that the sales cycle is drawn out. It might be the sales cycle doesn't occur. And so the real question is, when does it start to occur? I mean, one of the things that hurt us in 2020 on top of COVID is, and outgrowth of COVID was, we didn't have our normal customer expo in the spring, which is a great igniter for change because you get a chance to really engage with folks and you really – are able to talk about what we are. We're not an e-commerce platform. We're not somebody to hop on and if we have it great and if we don't, you're kind of SOL. We are your supply chain and we'll find stuff for you. And so we're slowly, our customers are willing to take that call, even if it's a virtual call. It doesn't have to be in person. It's nice if it is, but it doesn't have to be. In some ways, we might move faster in a virtual world because we're not waiting for a resource to To be there, maybe somebody at the plant can't make a meeting, but they can if it's done virtually. And so in some ways, it might shorten the sales cycle. I do believe this. I believe it's expanded the demand because the marketplace is more appreciative of a great supply chain partner after the last six months than maybe they were in the past. And when I say expand, my example earlier was government. I think a lot of those folks would kind of look at us in the past and say – you don't do what? That's different, and we don't do different. And now they're looking at it and saying, we need to do Britain different. We need to embrace change. So I think it's expanded it. I see we're at about two minutes before, so I won't give you a follow-up, sorry. But Holden's available right after the call. I'd just like to close with my thanks to the Fastenal team for everything you've done, not just the last three months, but for the last six months, and frankly, for years. Many of you have been with us years, and you've seen us through good times and bad, and we find success together. I want to thank you, our shareholders, for participating today. And in closing, October 28th, my wife and I will celebrate 25 years, and Jen, thanks if you're listening. Have a good day, everybody. Take care.

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