Fastenal Company

Hello, and welcome to the Fastenal first quarter 2022 earnings results conference call and webcast. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. 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, Investor Relations. Please go ahead.

Welcome to the Fastenal Company 2022 First 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 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 June 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 Flournas.

Thank you, Ellen, and good morning, everybody, and thank you for joining our Q1 earnings call. Before I start, I thought I'd just share a few tidbits from a conversation I had this morning with our our regional business unit leaders, our regional vice presidents, and our VPs of the business. And I started that by sharing last evening or late yesterday afternoon, my wife and daughter returned from a week-long band trip to Florida, marching band. And as with most high school trips, It involved a 26 – well, if you're coming from Winona, that is. It involved a 26-hour bus ride down last Wednesday and a 26-hour bus ride back. And I saw a bunch of haggard kids and a handful of haggard adults get off the bus yesterday at about 4 o'clock. And when we got home that evening, I was watching the video. I don't like to watch myself on video, but it's a necessary evil to make sure you – present as good a message as you can and present it in a style that isn't too painful to watch. And, uh, and my wife commented on it and I think she probably was commenting partly in fact, she was kind of tired from the bus ride. She thought it was a pretty under under inspiring video and she had no problem telling me that. And she said, you know, for the last two years you come home, you talk about things that people are doing at Fastenal, things you see from the leaders and everybody within the organization. and how impressed you are. And your video, you just had a great quarter, and your video doesn't speak to that at all. It sounds like you're in the middle of COVID. It's kind of disappointing. And after brushing my pride off, I got in this morning, and I let our leadership know just how damn proud I am of the quarter they just put up. But more important than that, of what they've done in the last two years and all the hard work, as we transitioned from tariffs to COVID and worrying about our own human safety and the safety of others to the surge in demand for products that pivoted into a supply chain globally that completely fell apart. And how did we manage through that to support our customers and their needs? And more recently managing through the chaos that is inflation. Frankly, the first bullet on the flip book says that has the statement good execution. There's a typo there. That should say great execution. I think the Fastenal Blue team did an unbelievable job in the last two years, and I think that extended into this quarter, and I'm really proud to be associated with them. I even, you know, yesterday in our audit committee call, we were picking on Holden a little bit. He's been kind of crabby lately. And, you know, it's kind of refreshing when you have a really good quarter and your CFO is kind of crabby and he was talking about our cash flow. And he wasn't pleased with it. And I said to him, I said, Holden, take a look at the last six years and look at our growth and look what our operating cash flow to earnings was in our strongest year. It was at 90, I think it was at 93%. I think that was first quarter of 2018, might've been 17. And, uh, and it costs money to grow a distribution business, and that money is spent in working capital, and that gets amplified when you have heavy inflation like we're seeing right now. So I'm glad you're irritated and irritable. I can't imagine being a lease right now when you come home from work, but thanks for what you're doing, but don't be too hard on everybody. So flipping to the book here, The net sales grew 20.3% in the first quarter. Our pre-tax profit grew 28. There was some amplifying effects. Last year's weather in the Texas and Oklahoma area in February hurt our sales, hurt the economy, quite frankly. And then we had a mass write-down. But adjusting for those, this is our strongest top and bottom line growth that we've experienced in a decade. You know, it's really been since we were recovering from the 08-09 in the 2011-2012 timeframe that we saw the growth that we're seeing right now. So really pleased with the performance. And in the last two years, so since the pandemic started, we've put in a lot of energy to deploy technologies and strategies to just improve our efficiency. And that surfaced really well because The environment has restrained our ability to add labor, add energy into the organization, but it hasn't hurt our ability to grow sales and also to continue the branch consolidation process that we started six, seven, eight years ago. So very, very strong performance there. The supply chains and labor markets remain tight. However, conditions have stabilized. We're getting more product on the shelf to support the needs, which makes the business less chaotic. And we are seeing an uptick in applications coming in, and I'm hearing it mostly anecdotally from our regional leaders, but they're seeing more and more people willing to come back into the workforce and apply for jobs. Part of that is probably a function of our number one recruiting area is four-year state colleges and two-year technical colleges. as they've come back in full force, that group of people are looking for opportunities for their future. Our international business reached a milestone. In the month of March, we exceeded $100 million in sales for the first time. And next week marks two steps towards normalcy in our world. One is our customer export, our selling events, is returning to an in-person format after two years of not occurring in person. And that will be Tuesday and Wednesday of next week. And then next Saturday, we'll hold our annual meeting in person after two years of the sanitized video or, you know, on-air version, which is, frankly, less than satisfying in a community like this where we get a good local turnout at the events. Flipping to... to page four of the book to compare some of the 2020 to 2022 periods. And this will be the last quarter that we put this table in because obviously as we exit this quarter and enter the new quarter, our two-year comparison falls square into the COVID period. So it becomes less than meaningful. But we thought we'd continue it as we've done the last three quarters. I think the only thing that should jump out on here at least for me, is the fact that our operating and administrative expenses have dropped from 26.7% of sales two years ago to 25.5% of sales today as we've worked to make the organization more efficient. And I'm really proud we were able to accomplish this during the distraction of the last two years. One item that's probably a little bit misleading in here, it shows our gross profit is actually flat in that two-year period. It's actually down slightly. January and February of 2020 were a bit higher. And as we entered the COVID period in March of 2020, we started selling bulk quantities of masks and things like that at a lower margin. And it actually pulled our margin down to 46.6. Just trying to express a little full disclosure there. Flipping to page five. When people get more confident where we are today and there's less chaos in the world and you're more comfortable engaging with others, we always felt that our growth drivers would see an uptick and we had to just get through this COVID period. Well, our onsite saw that uptick. We signed 106 in the quarter, finishing with 1,440. So we're up 12% from the number of active sites we had a year ago. And we continue to do the healthy business thing, and that is just like we've done with our branches over the last decade. You challenge every business unit, is that onsite performing to what you need it to be for both our customer and for us? You know, sometimes we run into situations where we take a customer that was doing $25,000 or $30,000 a month in sales in a branch, And we double that, or maybe we even triple that. But we get to the point where we kind of get stuck at a number. Let's say it's $70,000, $80,000 a month. We always have to evaluate what is the best solution there for the customer and for our ability to serve that business. And sometimes it's pulling it back into the branch. Sometimes it's the case the customer runs out of space for us. Sometimes, and we've seen this in the last six months particularly, we have some customers that are consolidating some of their operations And we've had a few onsites that have closed, but we pick it up somewhere else or it validates with an onsite we have somewhere else. But we think it's a great business and we're really pleased at what we saw in the first quarter with signings. And we're excited about that customer event next week and what it means to keep this thing going. FMI technology, it's about bringing better visualization and service ability to the point of use. It started with vending a decade plus ago, and we've expanded it with a bunch of other technologies. A year ago, we were signing 74 a day. This quarter, we signed 83 a day. We ended the quarter stronger than we started the quarter. And for onsites and for FMI, our plans, our goals for the year remain unchanged. So the FMI technology now represents 35.5% of sales. A year ago, it was 28.7, and two years ago, it was 26.4. We're going to keep driving that. E-commerce, 55.6% growth in the first quarter of 22. And like our international group, our e-commerce team also hit a milestone. In March, we exceeded $100 million in revenue for the first time. You know, it's not too many years ago. I think it was 2011 when we pointed out the fact that International was now 10% of the company, but still a relatively small piece. And e-commerce was something we dabbled in, but we really wasn't a thing. Times have changed in the last decade, and now both of them are $100 million a month businesses. Finally, if you roll up our FMI technology and our e-commerce, we talk about our digital footprint. We hit 47% of sales in the quarter. 39.1 a year ago, 34.9 two years ago. Our goal is to hit 55% of sales at some point later in the year. And we still believe that long-term that has the potential to be 85% of sales. And we're gearing our supply chain and have been gearing our supply chain to support that kind of business in the future. With that, I'll turn it over to Holden. Great. Thanks, Dan. So I'll be starting on slide six. Total sales increased 20.3% in first quarter 2022. If you adjust for the extra selling day in the period, sales increased by 18.4%. Both periods were impacted by adverse weather, and the net effect contributed 50 to 100 basis points to the growth in the period. I'm not going to recite all the numbers that are on this page because we basically experience consistent growth across all major product categories, our large and our small customers in most end markets. The main exception to this broad-based strength were government customers, which fell 6.2% year over year. But I would point out that they were up nearly 50% from pre-pandemic levels. And I think that really reflects sustained share gains across that customer set. So as always, our business does not carry a lot of forward visibility. but our field sales force continues to maintain a very positive outlook about their markets. Pricing contributed 580 to 610 basis points to growth in the first quarter of 2022, reflecting actions taken over the last nine months to offset inflation. Input costs have mostly stabilized at high levels, with a few notable exceptions. For instance, higher nickel prices will flow through to stainless steel fasteners, while higher oil prices will affect the cost of fuel for our captive vehicle fleet and the cost of overseas shipping services. As described on this page, these are relatively smaller pieces of our business, which we believe we can adjust through targeted pricing on stainless steel fasteners and surcharges for transportation-related increases. Price contributions should remain high in the second quarter of 2022 before running into tougher comparisons in the second half of 2022. The last thing I'll say about the marketplace is it is still grappling with supply chain and labor constraints, as well as high prices for inputs and products. What is changing is we and our customers are more effectively managing this environment. This is reflected in higher growth driver signings and improving internal supply chain and relatively strong FTE additions in February and March. So while these disruptions persist, the chaos surrounding them has receded, resulting in a more predictable business environment. Now to slide seven. Operating margin in the first quarter of 2022 was 21%, up from 19.8% in the first quarter of 2021, and good for an incremental margin of 27.1%. While the absence of last year's write-down of masks favorably impacted the year-over-year compare, even adjusting for this, our incremental margin was a solid 24.4%. Gross margin was 46.6% in the first quarter of 2022, up 120 basis points versus the first quarter of 2021. Half of this increase relates to the absence of last year's mask write-down. The next largest contributor was safety product margin, which increased significantly, even excluding the effect of the write-down. In the year earlier period, we were still supplying COVID-related supplies to key customers under supply commitments that we had entered into at the start of the pandemic, which had lower margins. Those commitments have since expired, and COVID-related product margins have returned to pre-pandemic levels. A smaller contributor was a narrower loss on freight service to our branches, as strong daily sales growth in freight sales of 37% provided improved cost leverage. Our price-cost remained largely neutral to gross margin in the quarter. Product and customer mix was a roughly 10 basis points negative impact to gross margin, with drag produced by strong on-site and national account sales having a slightly greater impact than the positive effect of favorable fastener mix. Our operating leverage was modest in the first quarter of 2022, with an operating expense-to-sales ratio being 10 basis points better at 25.5%. We achieved 60 basis points of leverage over occupancy expenses related to a 10% reduction in our traditional branch count and the effect of what has been, to this point, relatively slow expansion of our vending installed base. We also achieved good leverage over employee base pay. While we are encouraged by the February and March growth in our FTE employee base, the tight labor market continues to produce FTE growth that is lagging sales. These areas were mostly offset by strong employee incentive payouts, higher profit-sharing expenses, higher health care costs, higher travel expenses, and to a lesser degree, rising fuel costs. If you put it all together, we reported first quarter 2022 EPS of $0.47, up 27.8% from $0.37 in the first quarter of 2021. Now turning to slide eight. We generated 230 million in operating cash in the first quarter of 2022, which is roughly 85% of our net income in the period. Traditionally, first quarter conversion rates exceed net income. However, a combination of robust customer demand, supply chain constraints, and high inflation put a premium on product availability and investment in working capital. As a result, we view the lower conversion rate as reflecting our commitment to supporting our customers. As supply chain constraints and inflation rates ease, We expect to see improved conversion rates as we go through the year. Year over year, accounts receivable was up 25.9%. This reflects strong customer demand and an increase in the mix of traditional manufacturing construction customers, which tend to have longer terms versus the prior year period. Inventories were up 22.6%. Inflation accounted for roughly two-thirds of the total increase. That's significant, but it is a decline from the fourth quarter of 2021 when inflation accounted for roughly 80% of the rise in inventory, and that is the result of an accelerating flow of physical products into our hubs, which is improving product availability and fulfillment rates. Net capital spending in the first quarter of 2022 was $33 million, up from $30 million in the first quarter of 2021, with increased spending for FMI equipment, hub automation and upgrades, and IT equipment. quarterly capital spending levels should pick up through the balance of the year as vehicle availability improves and hub projects advance. As a result, we continue to anticipate 2022 net capital spending in a range of $180 million to $200 million, which is unchanged from the prior quarter. We returned cash to shareholders in the quarter in the form of $178 billion in dividends. And from a liquidity standpoint, we finished the first quarter of 2022 with debt at 10.4% of total capital, down from 12.7 in the year-ago period and 11.4% versus the fourth quarter of 2021. Our revolver remains available for use. With that, operator, we'll turn it over for Q&A.