Fastenal Company

Greetings and welcome to the Fasten All 2021 Annual and Fourth Quarter Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the call over to Ellen Stultz of Fasten All Company. Thank you. You may begin.

Welcome to the Fastenal Company 2021 Annual and Fourth Quarter Earnings Conference Call. This call will be hosted by Dan Flourness, 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 1st, 2022 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 Florna.

Thank you, Ellen, and good morning, everybody, and thank you for joining us on our fourth quarter earnings call. Before I start, I always... like to make sure my mind is cleared of things so I can focus on the quarter, and I thought I'd share a personal story, and that is a little after five this morning, I received a text from my wife. Her father, Glenn Gustafson, also known as Gus, had passed away at the age of 90, and there wasn't a trip that he made to Winona. He lived in eastern Wisconsin just south of Green Bay. There wasn't a trip that he made to Winona where he wouldn't tell me how many fastener trucks he met on the road, or he wouldn't beam with pride when he would drive by Pierce Manufacturing in Epsom, Wisconsin, see those shiny fire trucks, knowing that the blue team with a whole bunch of vending machines were inside that facility helping Pierce manufacture those fire trucks. This will be my first earnings call in 26 years where I won't be able to share tidbits of it with us after the call. And just want to let Gus know I love you and you will be missed. And rest assured, the Packers will figure out a way to win this weekend with Elia. With that, a bit on the fourth quarter. So our sales, we grew about 13% in the fourth quarter. We had one less business day, so we grew almost 15% on a daily basis. And the quarter was gaining momentum as we went through it, with December growing at 16.5%. We leveraged our income statement and our operating margin grew almost 14%. And the quarter really reflects strong underlying demand, good execution on pricing, improved product availability in our supply chain, and in full disclosure, probably the benefit of fewer holiday-related shutdowns that would be typical for this period. It often gets a little bit dizzying trying to make comparisons in 2021 to the prior year, given all the wild COVID swings. So I thought I'd share a few vantage points by looking at a two-year comparison. When we started the year, Q1 was up just over 8% from two years earlier. And that was a reflection of a weaker environment, a lot of uncertainty. I'm pleased to say that as we went through the year, that picked up. In second quarter, on a two-year basis, we were up just over 10%. In the third quarter, on a two-year basis, we were up 13%. In the fourth quarter, we were up 20%, and if you look at it on a daily basis, we were up almost 22%. So very pleased with how the year was strengthening within our business as it progressed. Our gross margin recovered from 2020 as we expected, and it's Down from 2019, as we expected, as Holden has shared on earlier calls, the way we're growing the business and the way the mix is changing does cause our gross margin to decline over time. Again, it's a mixed function. But it also causes our operating expenses to drop over time. And we think it's a very effective way to grow the business for our customers, for our employees, and for our shareholders. On a two-year basis, our operating profit grew faster than sales, which really speaks to greater productivity that I touched on a moment ago and very effective cost control on the part of the blue team throughout the organization. When we talk and look at the impacts of COVID-19 and how we think about it on a future basis, We now consider COVID-19 to be merely an ongoing element of our global business environment. And like all of society, we have to learn how to live with it. The first step for us is recognizing it for what it is. It's a serious virus, but our approach is not one of fear and chaos. It's an approach of sharing the facts with our customers and our employees. what we're doing and how we're handling it day to day. I can share with you at the end of last year, cumulatively we've had 3,400 cases within the Fastenal family over that almost two year period. Since year end, that 3,400 has grown to 4,000 as we've had about 600 cases in the first two weeks of the month, about 400 of those occurring last week. If patterns In January, mirror what we saw after Thanksgiving in the United States, I would expect our numbers to drop off in the next couple weeks and to move back to kind of that 40, 50 to 60 cases per week that we've seen before. And time will tell if patterns repeat themselves. Again, the biggest focus that we've had is sharing facts with our employees. We have renovated aggressively our facilities. the air handling to make the air cleaner in all of our facilities, quite frankly, not just for COVID, but for flu season in general. And it's one way of addressing the comfort for everybody in the business. The gross driver details are laid out on page five, and we continue to see expansion in sales through our digital footprint, which was 46.4% of sales in the fourth quarter versus 37% in fourth quarter 2020. Again, on page four, this is just a comparison to 2019. Thought it would be helpful for folks looking at the call. And what emerges for me is a business that exits this two-year period stronger as an organization than we entered this two-year period. And I think which bodes well for our business as we move into the future. And one thing I think that's probably understated in these comparisons, when you're looking at the sales growth and our operating income growth, in other words, how did we leverage and how did we improve the business, the three-month period on a two-year basis is actually slightly understated in our strength because we have one less business day. And when you do $25 million a day, a lot of that gross profit flows right to the P&L, and that 25.9% operating income growth would have been meaningfully stronger. Flipping to page five, you know, Holden, I've been stealing his thunder in recent weeks based on a comment he made to an investor on a call I participated in some months back. And he said, you know, in 2020 and 2021, our customers asked Fastenal for different things than in prior years. You know, if you look at prior years, our customers were increasingly asking us to move in with them and be on-site and provide resources right in their facility rather than from a few miles away. They also asked us to deploy technology to help their businesses be more efficient. Initially, it was vending. Now it's a combination of vending bins and what we call fast stock, our mobility application, or more broadly, our FMI technology. But it's really about... helping customers be more successful inside their facilities. As you see from these jagged charts, our on-site signings and our FMI device signings have been meaningfully impacted by COVID over the last two years. However, we feel our opportunity for the future is unpainted by this, and if anything, it's strengthened because the definition of who's a potential customer has expanded dramatically during this time frame. So the one thing that I think should jump out, because of our brand's footprint, one thing that for us has always been a relatively small piece is the e-commerce component within our technology platform. And I'm pleased to say that our customers are embracing that more and more, and that's partly a function of the times, and maybe it's partly a function of us embracing it too, But our web sales were up almost 50%. Our EDI was up 47.8 in combined. It was up about, e-commerce was up 48% in the fourth quarter of 2021. Page six is a new chart I asked Holden to put in. And it stemmed from a question one of our directors had in preparation for the board meeting. It was really looking at the fact that, you know, we've closed a lot of branches over the last six, seven years. And where do you see that going to? And most of those closures have really occurred in our most mature market, the United States, and to a lesser degree up in Canada. But in those two markets combined, we've seen the same pattern. So our branch network peaked out in that 2013 timeframe. At that point in time, if you had started in one of our branches and would have hopped in a vehicle and drove 30 minutes, our network – would have touched about 95% of the U.S. manufacturing base. I don't have that exact statistic for Canada, so you bear with me, please. But today, that number is about 94% as we've rationalized our network. And we believe that ultimately our branch network in the U.S. and Canada will be about 1,450 locations. So there's a few more to consolidate. And that would be about a 93.5% coverage rate on the manufacturing base in the United States. As I mentioned on the previous page, our business has evolved, and one of those elements is e-commerce. So in March of 2020, we broke 10% of sales going through e-commerce for the first time in our history. As we exit 2021, that number is now 15% of sales. As I mentioned on the previous page, from Q4 to Q4, our volume in e-commerce is up about 48%. And in that two-year period from Q4 of 19 to Q4 of 2021, so going back to before COVID started, we are up 105% in our e-commerce business. And it's really a reflection of our customer base is embracing this way of ordering products from us. But our thrust is first and foremost, With FMI technology, if there's a discernible pattern to the usage of this product within a customer's facility, most businesses, most distribution businesses focus on how do I make that an electronic order? We look at it and say, well, if there's a discernible pattern, why are you even ordering in the first place? Your supply chain partner should make it available when you need it. And that's what our FMI technology is all about. With that, I'll switch it over to Holden. Great. Thanks, Dan. Turning to slide seven, as indicated, our sales were up 12.8% in the fourth quarter of 2021. On a same-day basis, sales were up 14.6%, which includes up 16.5% in December. The period still had difficult COVID-related comparisons, with government daily sales down 35.7% and safety and janitorial products being up only 3.5% and down 3.5%, respectively, in the fourth quarter of 2021. As a result, we believe total growth in the period understates the strength we are seeing in our traditional manufacturing and construction customers. Daily sales for our fastener products increased 24.2%, and if we look at sales excluding the COVID-affected safety and janitorial products, our daily sales would have been up 21.1%. Outside of government and warehousing, this strength was experienced broadly across our end markets, consistent with macro data points such as the PMI and industrial production. We believe the period was also boosted by fewer holiday-related shutdowns and somewhat improved availability of non-fastener products. Pricing contributed 440 to 470 basis points to growth in the fourth quarter of 2021, up from 230 to 260 basis points in the third quarter of 2021. This reflects good execution on actions taken during the year to mitigate cost inflation. Higher costs will remain a challenge in the first half of 2022. While certain metals prices seem to be plateauing for the moment, most remain at high levels. Products imported into our hubs in the first quarter of 2022 will have a higher cost, and shipping costs continue to rise. We do not currently have any broad pricing events queued up for the first quarter of 2022, but we'll be addressing specific product and product categories, particularly fasteners, to offset higher costs expected in the first quarter. We expect hub product availability to improve in the first quarter of 2022 and be more stable through the year, which should be a benefit to our customers who are still struggling with availability. However, this reflects shipment timing and our willingness to procure a supply of products several months longer than normal. The supply chain otherwise remains strained. Labor markets remain tight, though we have seen some improvement in our ability to hire in markets with less restricted on-premises recruiting policies. Now to slide eight. Operating margin in the fourth quarter of 2021 was 19.6%, up 10 basis points versus the fourth quarter of 2020. Our dynamics in the quarter mimicked the full year, with gross margin rising off of 2020's product-driven low margin and operating expenses being deleveraged as costs reset off of 2020's artificially low level. The gross margin was 46.5% in the fourth quarter of 2021, up 90 basis points versus the fourth quarter of 2020. This relates to two items. First, we experienced strong absorption of overhead and on strong product demand and growth. This exceeded our expectations largely due to the strong accelerating volumes in the period. Second, our safety product margin improved as lower margin COVID-related PPE was a smaller proportion of total safety sales versus last year, and the margin on those products increased. The impact of product and customer mix in the fourth quarter of 2021 was immaterial, as the favorable effect of strong fastener growth nearly matched the negative effect of relatively fast onsite growth. As the gap between fastener and non-fastener growth narrows, as seems likely in 2022, this drag is likely to widen to 40 to 50 basis points. Higher pricing continued to largely match higher costs, yielding a neutral price cost in the fourth quarter of 2021. Our fourth quarter 2021 exit rate and first quarter 2022 plans suggest pricing will remain elevated in the first half of 2022 and sustain a neutral price-cost relationship. The increase in gross margin was partly offset by operating expenses growing faster than sales. This primarily relates to cost resets, which are typical of the first year of any recovery, but exacerbated in 2021 due to the unique COVID-related cost restraints that existed a year ago. To provide perspective, in the fourth quarter of 2021, we had four SG&A cost reset categories, incentive pay, health insurance, fuel, and travel. Where spending collectively increased 35%, and which produced about 120 basis points of deleverage in the period. On the remainder of our costs, most notably occupancy, as we continue to rationalize the branch network, and IT as we leveraged our strong growth, we achieved 40 basis points of leverage. What should not be lost is the degree to which we improved our operating expense leverage from 2019 to 2021, as detailed on page 4 of this presentation. The first quarter of 2022 will still have COVID-related comparisons, albeit moderating, aside from last year's mask write-off, but comparisons will mostly normalize in the second quarter. At that point, provided volumes remain healthy in 2022, moving past the initial reset year, combined with continued productivity gains from further penetration of our digital footprint and our branch initiatives, should generate improved SG&A leverage. Putting it all together, we reported fourth quarter 2021 EPS at 40 cents, up from 34 cents in the fourth quarter of 2020. Now turning to slide nine. Operating cash flow was $156 million in the fourth quarter of 2021, down 51% year-over-year and representing 68% of net income. For the full year, operating cash flow was $770 million, down 30% and representing 83% of net income. We continue to believe our model produces a conversion rate north of 100% of net income. Additions to working capital caused us to fall short of this goal in 2021. Year over year, accounts receivable was up 17%. This reflects strong customer demand and a shift from PPE buyers last year and toward traditional customers this year that slightly blended up days outstanding. Inventory was up 13.9%, though about 80% of that was from inflation. Growth in product per stock remains modest given supply chain constraints. the rate of sell-through as product becomes available, and ongoing efforts to clean out slow-moving hub and branch inventory, close branches, and shift our stocking focus in the field. We have a considerable amount of imported product in transit, and we expect to see product availability, particularly for fasteners, improve in the first and second quarters. In the current environment, where product availability is a key differentiator, we view our investments in working capital as an effective means of utilizing our balance sheet to support customer service and growth. We finished the fourth quarter of 2021 with debt at 11.4% of total capital, down from 12.9% at the end of the fourth quarter of 2020. We utilized roughly $25 million of our $700 million revolver, so we have ample liquidity continue to be available. Net capital spending in 2021 was $148 million. In 2022, we anticipate net capital spending in a range of $180 million to $200 million. This increase is committed to both upgrading and investing in new automation at a couple of hubs, higher spending on FMI devices to support expected higher signings, and additional manufacturing capacity. That is all for our formal presentation. So with that, operator, we'll turn it over to you for questions.