Fastenal Company

Greetings and welcome to the Fastenal 2020 Annual and Q4 Earnings Results Conference Call. At this time, all participants are in listen-only mode. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Ellen Stoltz. Please go ahead.

Welcome to the Fastenal Company 2020 Annual and Fourth Quarter Earnings Conference Call. This call will be hosted by Dan Flournas, our President and Chief Executive Officer, and Holden Lewis, our Chief Financial Officer. The call will last for up to one hour and we'll start with a general overview of our annual and 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 March 1, 2021, 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 Flournas.

Thanks, Ellen, and good morning, everybody, and thank you for joining us for the Q4 2020 earnings call. I might not be on my A game today, and I point that out only because Typically when I do this call, I'm very fortunate that I have a moderator in the background, and that is my wife, who listens and will text me if I'm speaking too fast or too rapidly or if I'm going too long. And some of you might say she needs to step in sooner. But today I think she's probably online trying to see if she can convert her Packers season tickets into two tickets for Sunday's game. Time will tell. But if I go off on tangents, I apologize for that. I'd like to start with recapping our board meeting yesterday, our discussions with leadership early this morning as we were able to share our earnings and our progress a little bit more broadly within the organization, and a bit of the video that we share with the 20,000-plus employees within Fastenal. And one is a more somber piece, and that is, as we've done in prior quarters, just want to share some COVID statistics with our shareholders, because we can talk about a lot of things, but we have to start with the most important, and that is we were not immune, if you will, to the effects of COVID on the health of the Fastenal Blue Team family. Through September, and I've previously shared this information, we had 344 cases of COVID within the FASTA organization. In the month of September, we were averaging about 17 new cases a week. In October, and as we progressed into the fourth quarter, we experienced what was experienced, generally speaking, throughout the markets when we operate. Our case count increased dramatically in the October, we had 27 cases per week, a 10 increase over the 17 in September. So 106 cases. So through October, we had cumulatively 450 cases within the Fastenal family. That number essentially doubled in November. In November, we had 430 cases, 86 per week. In December, we started to see that trend down, but still quite high at 60 per week. 238 cases. So cumulatively through the end of the year, we had 1,118 cases within Fastenal. That's just over 5% of our population of employees. When you consider the fact that our business and the way we operate doesn't afford us the ability to remove ourselves from society, 93, 94% of our employees are in roles that involve day-to-day interactions with other human beings, whether that's at our branch or on-site locations, working in a distribution center, working in manufacturing, driving a truck. So we didn't have that luxury. And the fact that our number, I believe the U.S. population, if what I read is accurate, we're just over 7% of the U.S. population has had COVID, and we're at about five. So I believe our team has done a really nice job of exercising common sense and trying to protect themselves and those around them every day and being mindful of the anxieties that exist in society. When I think of 2020, I also think of things that we did from the perspective of things we did to improve our moat, to widen our moat, to improve our business as we move into 2021 and beyond. And I think one of the first things is we demonstrated to the market and we demonstrated to ourselves, perhaps, a bit of our problem-solving ability. Our growth drivers demonstrated their value, and value from the standpoint of it's a special way to engage with our customer. And because of the vending devices we have deployed, Because of the onsites we have deployed, because of the way we engage with our customer, when most people were turned away at a customer's door, our folks were allowed to enter. And they were allowed to enter because we were stocking bins. We were filling vending machines. We were staffing the support infrastructure of their business from inside their facility. And that was a special place to be in a special relationship with And because of that, we saw the success that we did in Qs 2, 3, and 4 on our ability to react and serve that marketplace in a unique way. The other pieces we demonstrated to a whole new group of customers. Maybe it's something that's special about FAFSA at all. The other thing that I reminded our teams and I reminded our board is we're coming into a weird year. We're forced to pivot, and that's a great thing. We look forward to this pivot versus the last. But the optics of the year are abnormal, and I just sort of want to remind the analyst community of that. I don't recall in my 25 years with Fastenal, it might have happened, maybe it happened back in the 90s or 80s or 70s, I don't recall a year where we entered and we're going to be down two business days. And as all you know, that's an important ingredient in our ability to grow and leverage the business. So in Q1, we will lose one business day. Q2, we don't lose any business days or gain any business days, but we have some weird comps because of the extreme surge we saw in safety sales in Q2 last year. Q3 is a normal quarter, if you will, in that it's a push on days. And then Q4, we lose a business day. So it's a 253 business day year versus 255. I just want to point that out. When you read the document and you hear our conversation, we'll touch on some things about the Apex transaction that we did back in March. And I'm really, really excited about what that means as far as our ability to broaden and illuminate how we serve our customer. And Apex is the the technology that underpins our vending platform. And we have the largest industrial vending platform on the planet, and it's a great platform. A lot of our other systems were disjointed from that because it was a captive platform. And so it allows us to broaden where we can bring supply chain knowledge and visibility to. And we're now referring to that as the FMI suite of things, Fastenal Managed Inventory. Within that are three distinct components, and Holden did a nice job illuminating it, I think, in the press release, and we'll talk about it today. But in that is FastBend, which is our vending platform, as we've talked about for years. The second component is FastBin, that's B-I-N. And that's a suite of bin technology It's not restricted access like you see in a vending machine. It's open access, but it's for a lot of things like fasteners or pipe fittings or things like that. But it's smart in the standpoint the system tells us when it's hungry and needs to be fed, and we don't need to have a person go check it. Or worse yet, our frequency of checking it means we have a bin that runs out. And it allows us to lean down inventory and illuminate the supply chain for our customer over time so it's a better supply chain. but it's also more efficient from a labor productivity supply chain. The third component is what we call fast stock, and that is we deployed, as you all know, a tremendous amount of mobility technology. Now, we've had a platform in the past, but that platform was very transactional-based. This is more system-based and allows us, again, to illuminate for the customer what they have in their facility, which is more efficient for the customer, more efficient for us. So we'll talk about that in combined, but take nothing away from the individual components of vending, which is a great element to enhance growth and engagement with our customer. We're just broadening it because the APEX transaction allows us to do that. If I move into Holden's flipbook, and I'm on page three, our daily sales grew 6.5% in the quarter. The team did a great job of managing our operating cost throughout 2020, and it was exemplified in the current quarter, and we produced operating earnings that were double-digit, 10.6%. Safety, as we've talked about on numerous prior calls, and I suspect continue to talk about in the calls as we enter 2021, because COVID is not behind us, but safety has been an outperformer for years. Largely because it's a product line that meshes really well with our fast vend, our vending platform. So despite safety being a little bit less than 20% of sales, it's produced for the last several years about 26% of our growth. But the contribution swelled to 156% in 2020. And as I touched on when I was first talking, It highlighted our problem-solving culture in the marketplace, and I believe this should open up new customer and end market opportunities to us in the future, and Holden will touch a little bit on that in his talk. Customer engagement on growth drivers has improved. However, as you saw in 2020, it ravaged our ability to sign because the In an environment where you're working really hard to protect your employees, maybe the last thing you want to do is all of a sudden, hey, come on, folks. It's fascinating. We love what you're doing. Why don't you come and move in with us? It introduces a variable that many folks in a year like 2020 don't want to introduce, and you saw that show up in our signing numbers, and I'll touch on that more in a few minutes. The APEX purchase I touched on already, utilization of e-commerce took a big step up in 2020. As I mentioned, commercialization of our FASBEN and deployment of mobility, I believe, will really evolve our model, evolve our ability to be efficient. Because one thing that's really critical in this path, we've talked about this for four or five years now, what's really critical is we're going much deeper into what we call our key accounts group, much deeper into a large customer. And the gross margin profile, because of customer mix and product mix, changes. And then it's incumbent upon us to allow the natural leverage to shine through. In other words, if you're doing more dollars, you have more places to spread your expense. But also to become more efficient. And that's what all these things tie to. The last piece is our branch model. We've evolved it. And we'll touch on this in the months to come. But there's two distinct models. Fastenal branch models that have emerged in 2020. One is what we refer to as the CSB, the Customer Service Branch. And that's the traditional branch that many of you are familiar with, where there's a showroom in front, there's a walk-in element to our business. Still, most of it's going out the back door, but it's a more traditional. That's about half of our branch network today. During 2020, and actually we've been testing this within a handful of regions for the last two, three years, we have what's referred to as the CFC, the Customer Fulfillment Center. Think of it as a branch where we close the front door and the marketplace almost liked that better, or we're able to operate more efficiently, and maybe we should keep it closed, or maybe it's closed to a to everything other than a will call or a pickup or maybe on a regular account base. And it allows everybody to go out the back door and most of our revenue to go out the back door. And that is about half our branch network right now. And those are the things that are driving improvements to things like e-commerce that I'll touch on in a few minutes. The last thing is, and I want to put a call out. I'm sitting here at a table with Holden Lewis and Cheryl Lasowski. our chief financial officer and our chief accounting officer. Different circumstances allow folks to shine in different ways. And our team was able to shine this year from the standpoint of solving problems in supply chain for customers. Holden and Cheryl and the entire team was able to shine in that we produced an amazingly strong cash flow in 2020. And it put us in a position late in the year, similar to what we've seen in prior occasions where we had some extra cash. We didn't see a need for that in our investments of the future. And we paid out a supplemental dividend late in the year. So my compliments to everybody on that as well. On page four, I started sharing this slide, I believe it was back in July. And this is looking at dispenses for vending. I think it's a way for us to illuminate for you, our shareholder, what we're seeing in underlying trends. So if we index everything to 100, and these are weekly snapshots of dispensers going through those 95,000 plus vending devices in 25 countries. History would say if we're at 100, we should be at 103 by early March. And the reason I call out that data point, that's right before the world shut down. This year we were running two points ahead of that. We were at 105. And as the economy shut down, So did the dispensing activity at our vending devices, and it dropped 29 from 105 to 76. By the end of June, history would say we should be at 109. 2020 wasn't historic in that regard. We were at 93, so we were down 16 still from that 29 drop-off in March and April. By the end of September... History says, hey, it should be 112. We were 104. So that negative 16 is now a negative 8. And we always ignore the last couple weeks of December because the world kind of shuts down because of the holidays. So if you look at the week just before that, history says, yeah, it should be about 121. We're at about 115. We're still down. A piece of that is economic activity. A piece of that is we didn't sign as many vending devices because we weren't able to move in with as many people as we'd like to. And we're down six. The next page, this is dispenses. The next page is unique users. So how many people are coming to work at these customers? If there's 100 employees coming in every week back in October of 2019, history would say, because we've signed some more machines, that should grow to 104. This year we were at 107 in early March. Well, when those businesses shut down and weren't using as much, it's because they didn't have as many employees. the number dropped 22 and it dropped from 107 to 85. The history says by the end of June, we should be at 109, we're at 101, we're down eight. By the end of September, we should be at 115, we're at 109, we're down six. By that week before Christmas, we should be at 123, we're down 119, negative four. In the employment front, That negative four is probably more about we didn't sign as many devices. So people are coming back to work and you're seeing in their underlying numbers, but the activity is still subdued. And the one thing I did point out on page four, and I apologize for that, a few of the blips you see in early July, that's obviously July 4th week. In late November, that's obviously Thanksgiving week. Going to page six, onsites. We signed 36 in the quarter. Again, really, really choppy year. So we signed, you know, our goal coming into the quarter is 375 to 400. We're coming into the year, excuse me, with 375 to 400. It slowed in March. So in first quarter, we signed about 85. Second quarter, it was 40. Came back a bit in Q3 at 62. In many ways, Q4 was a more chaotic environment than Q2 was. In that case surge, I talked about our own surge internally, and we only signed 36, so 223 for the year. But holding included in the flipbook and included in our write-up, our mindset is the same. The market, we believe, will support us signing 375 to 400 a year. Conditions need to open up to allow us to do that. I don't want the investment community to read from what we said here. Oh, things are back to normal. Everything's hunky-dory and we're going to do 400 signings. This is going to play out in Q1 and Q2 and as we go on into the year, the way the economy and the marketplace and the COVID environment will allow it to happen. You saw how it played out in 2020. We don't have a crystal ball. We're not the burning bush. We can't tell you what's going to happen. What you can tell is we believe the marketplace likes what this onsite is about and is open to that onsite. And it's really about engagement with the customer. The onsite signings are just a marker in time of what that engagement is translated into. But we're very bullish on the fact that onsite proved its value in 2020. Vending, I talked earlier about the whole FMI concept. That's meant to provide better information to the investment community, not to confuse the issue with the vending and bins and all that kind of stuff. So read it as this is an outgrowth of the Apex transaction. E-commerce, 38% growth in the fourth quarter of 2020. In March, we broke 10% of our sales being e-commerce for the first time ever. And I'm pleased to say that Despite the fact that the surge actually hurt it because most little surge orders, actually almost all of them, are outside of e-commerce. That's people in a chaotic fashion getting product from us, and a lot of that's over the phone. But despite all that, for the first time in our history, e-commerce is more than 10% of our revenue. And, again, that's e-commerce measured the way this community measures it. I personally think that's an inaccurate way to measure it because, again, I think 20% of our revenue being vending is e-commerce. I think 7% to 10% of our revenue being bins and fast stock is e-commerce. But it's better than e-commerce because the customer doesn't have to order it. That's the best digital flow there is. And then the final being this 10% that truly is e-commerce. With that, I'm going to turn it over to Holden because I don't have my text from my wife telling me to shut up. Great self-control, Dan. All right. Good morning. Flipping over to slide seven. Fourth quarter of 2020 sales were up 6.4 percent annually. That's an acceleration from the third quarter. Holiday timing was favorable this year, but even so, the overall tenor of the marketplace continued to improve during the period. Sales of safety products were up 34.6 percent, driven by growth to state and local government and healthcare customers, which was at 98.3 percent in the period. This continues to be some blend of COVID mitigation, PPE restocking and pre-stocking as well as share gains. The most encouraging data point is that 28% of the accounts that bought PPE from us for the first time in the second quarter of 2020 bought from us in the fourth quarter. And they tended to be the larger opportunities. So this continues to reinforce that we have gained share and increased our growth prospects with state and local government and healthcare customers that's going to carry into 2021. Non-safety products were up 0.3% annually, accelerating versus the third quarter of 2020. Janitorial products, driven by the same trends as safety, were up 30.3%. More cyclical verticals remained negative in the fourth quarter of 2020, but generally saw moderation in the rates of decline. In fact, fasteners and material handling edged into growth territory in December. Improving macro data is producing better trends in core markets, particularly manufacturing, which grew 1.7% in the fourth quarter of 2020. We don't have a lot of visibility, but our regional VPs remain optimistic that activity will continue to improve. The exception to this normalization is our growth driver signings. COVID continues to negatively affect labor markets and supply chains, but our customers are operating around those conditions. We believe that absent COVID, the market will support 100 vending signings per day and 100 onsite signings per quarter. However, lack of access to facilities and decision makers in light of COVID protocols is delaying new commitments. The challenge that is carrying into the first quarter of 2021 and makes it difficult to determine when signings activity will return to potential. Now to slide eight. Gross margin was 45.6% in the fourth quarter of 2020, down 130 basis points due to product and channel mix, relative growth of lower margin COVID products, and organizational factors such as further clearance, lower vendor rebates, and overhead deleveraging. Gross margin was up 30 basis points sequentially in a quarter that more commonly sees a decline. Relative to the third quarter of 2020, we saw the revenue share of lower-margin COVID-related products decline by 200 basis points, even as the margin on those products improved by 200 basis points on selective pricing actions taken in the quarter. We also experienced more favorable shipping and fleet costs in the period, largely from having rationalized our weekly routes earlier in the year. Strong growth and continued tight control of costs generated 210 basis points of SG&A leverage to produce an operating margin of 19.5% of 80 basis points year to year. Nearly half this leverage came over labor costs as our record fourth quarter sales were achieved with headcount that was down mid-single digits versus last year. Labor productivity improved meaningfully in the fourth quarter and full year of 2020, and we will look to sustain this in 2021. We also leveraged occupancy on lower branch count and vending costs, as well as other expenses on tight control of travel, lower freight costs as we rationalized our branch pickup fleet, and lower insurance costs. Our incremental margin was 31%. If you put it all together, we reported a fourth quarter 2020 earnings per share of 34 cents, up 9.6% from 31 cents in the fourth quarter of 2019. Turning to slide nine, we produced 321 million of operating cash flow in the fourth quarter of 2020, representing 164% of net income. For the full year, we produced $1.1 billion of operating cash flow, or 128% of net income. Weak demand freed up cash and working capital, and we did benefit from $30 million in CARES Act-related deferred payroll taxes and about $20 million in payables that moved from the fourth quarter of 2020 to the first quarter of 2021. However, we also believe we are taking steps to be more productive with working capital. Accounts receivable were up 3.7%, with growth related to higher sales mitigated by improved collections, with past dues down 23% year over year. Inventories were down 2.1%. We have taken steps to make it easier to move inventory internally to get it where it can best be used, which has been particularly useful as we have closed branches and migrated other branches to a leaner inventory model. We put energy into clearing older stock from our branches and hubs. As a result, branch inventory was down nearly 8% at year-end, while on-site and hub inventory was up just low single digits. Net capital spending was $158 million in 2020, the lower end of our $155 to $180 million range. In 2021, we expect net capital spending to be $170 million to $200 million, with the increase over the prior year being a combination of catch-up maintenance spending following tight spending controls in 2020 and as well as higher spending for a non-hub facility project in Winona to support our growth. Record net income and operating cash flow in 2020 allowed us to acquire the assets of Apex, deploy significant resources to secure critical products and carry working capital for customers, and return $855 million to investors in the form of dividends, including a special dividend in December and share repurchase. At the same time, net debt is just 5.1% of total capital and substantially all of our revolvers available for use. Now, before turning it over to Q&A, there's one change to reporting I wanted to discuss, and Dan alluded to this. The bin stocks have long been used in distribution to hold product in customer facilities. Over the last few years, we have taken these bins and we've equipped them with scales or sensors that turn them into digital tools that provide product visibility, continuously monitor those products, and generate fulfillment efficiencies. These fast bins complement vending, expand the products that can be digitally managed, and round out our fast, non-managed inventory or FMI offering. And we anticipate commercializing them more aggressively in 2021. As a result, in 2021, we will replace reporting on vending signings with weighted FMI signings. This is going to convert each vending device and fast bin device into a standard unit based on the target output of our fast 5,000 vending machine, which is 2,000 a month. and combine that into a single data point. In 2020, our weighted FMI signings were 15,724. In 2021, we are targeting 23,000 to 25,000 weighted FMI signings. With that, operator, we'll take questions.