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.