Fastenal Company

Greetings and welcome to the Fastenal 2022 Third Quarter Earnings Results Conference Call. At this time, all participants are in a listen-only mode. The 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 Taylor Ranta of Fastenal Company. Thank you. You may begin.

Welcome to the Fastenal Company 2022 Third Quarter Earnings Conference Call. This call will be hosted by Dan Fornik, 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 December 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 Portnitz.

Good morning, everybody, and thank you for joining us for our third quarter earnings call. You know, we had a good quarter. When I look at the performance of the team, I'm proud to be a member of the booth team. The 16% daily sales growth that we experienced in the quarter, we were able to translate that into 19% operating profit growth. And ultimately, we were also able to translate it into strong operating cash flow growth. We grew our cash flow 54% from the third quarter of 2021 to third quarter of 2022. And an expansion of our ability to generate operating cash relative to our level of earnings We haven't been able to lay claim to that for over a year and a half. I believe you have to go back to prior to 2021 where you can see that. It was really great execution throughout the organization and the fact that supply chains have become a bit more stable. That doesn't mean they've become easier, it just means they've become more stable and you can rely on what you're seeing in your level of safety stock. It doesn't need to be quite as deep. As far as customer demand, that was stable throughout the quarter. Now, September's 2.7% sequential growth versus August does lag the way we look at the historic pattern, and history would say we should be up 3.4%. You know, the real driver of that is if you look at the storms that hit the southeastern United States, Hurricane Ian, and late in the quarter and essentially pushed some business out of September and into October. The storms likely reduced our sequential DSR by about half a percent. And so you can do the math on what it would be if that's added back in. But we see it as stable demand. And in the next bullet, touch on the fact that we are preparing for a softer 2023. So I thought I'd share just some thoughts on what does that mean? Now, first off, I remember back in the fall of 2015, I believe it was a Tuesday morning, don't quote me on it, but the day before we'd had our board meeting, and I learned after that board meeting that I'd been selected as the next President and CEO of Fasten On. And it was a pretty tough environment for not just the organization, but for industrial entities in general. And the next day, I... During the Q&A section, I was probably a little more animated than I typically am, and I commented on what I saw as the state of the economy. And the next day, my wife informed me that I was on the front page of the Wall Street Journal because I opened my mouth. So we're not in that kind of environment. We're not in something where I'm going to proclaim something. But we are preparing for a softer 2023. And a lot of that centers on two things. One is something that has nothing to do with 2023. If you'd have been on the call I had two hours ago with our leadership around the planet, I gave them the typical October talk, and that is we are a seasonal business. And if you look at history, history says between September and December, our daily sales typically drop off 12%, 13%. And I'm going back to the time before COVID. And even before some of the tariff here, I'm going back to the 2017 and 16 and 18 numbers. And just looking at sequential patterns, and that should not be a surprise to anybody listening to this, that a business that operates in Northern North America, a big chunk of revenue in Northern North America, after you get past Canadian Thanksgiving and get to the US Thanksgiving and get to Christmas, the business slows down. We're preparing ourselves for that. When we're talking about 2023, it's really about A lot of the numbers we're seeing, and again, they're not numbers that are unique to our lens. I'm looking at industrial production and Holden will touch on some of that here later, but looking at industrial production and what some of the forecasters are predicting. But the most important feedback that we focus on is what are our regional and district leaders hearing from their customers as far as their confidence going into 2023? And I have to be honest with the group, that confidence isn't strong. It's not, hey, the sky's falling, but the confidence is very, very cautious, and we're preparing for that type of environment. And that means that you're very thoughtful about where you invest. You're very thoughtful about not getting ahead of yourself. Now, we've signed a lot of onsites this year, and that gives us resiliency going into next year, and I'll touch on that in a second. But what it means is, You staff for the things you know, but you don't get ahead of yourself on staffing for the things you don't know. And that's the mindset we have going into 2023, whereas a year ago and two years ago, we were staffing for both. And it's just a bit of caution in the air. You know, last week I was traveling in Europe. It's my first trip outside North America since before the pandemic. You know, there's something about, you know, human beings, even this human being is a social creature. And there's a certain energy you get and a certain rapport you can get and a level of communication and intimacy you can get by meeting people in person. And it was a wonderful trip. I spent some time with our folks at what we call E-Hub, which is our distribution facility up in the Netherlands. And most of our European leadership were there for that discussion. And then I traveled down to northern Italy, primarily Lombardi area of northern Italy, and met with our team there. And, you know, what stands out is the last time I visited this group was in fall 2017. How the group has grown, just each year numbers, but grown in talent and business acumen was really impressive. And despite all the stuff that's going on in Europe over the last three years, actually the globe, but then more specifically Europe in the last 12 months, That business is 80% bigger than what it was in 2019. And that's telling the story in U.S. dollars. If I left it in local currency, it'd be closer to 90. And I think back to when I was there, which was two years earlier. We haven't tripled in size, but we're pretty close to it. And so it's really a powerful story about the marketplace around the planet has identified in Fastenal what is special about Fastenal over the years. And I'm glad to say that we're replicating that with our team in Europe. You know, one thing that is a positive, despite what it looks like in the numbers, it's a positive, and that is the pre-pandemic margin profile of the business has reemerged. And back in 2016 and 17 and 18, when we were really telling the story of how we thought our growth was going to change in the future and it was going to be much more on-site driven, It changes the profile of your gross margin, but it also changes the profile of your operating expenses. We felt over time that was a great trade-off because ultimately it's about the level of profit and return you can generate. It's just a faster way to grow and a better way to develop your talent and be special in the marketplace. We thought it was, but it was explaining how those dynamics would work. Mixed-driven lower gross margin did occur in the quarter. Strong expense leverage also occurred, very much in line with the story we were telling five years ago. And I'm pleased to say that after a period of time where our operating margin was kind of stuck within 20 or 30 basis points of 20% for a number of years, year-to-date we've been able to break out of that and move it up to 21% or actually slightly better. So very, very pleased with that. And then finally, I touched on it earlier, really impressed. You know, I'm a former CFO, so looking at our cash flow statement for the last couple years, it was tough for Holden. It was tough for Dan, too. And I'm really pleased to say when I look at the cash flow statement that for the first time in, you know, quite a few quarters, six, seven quarters, I can look at the year-over-year numbers and say it's improving. Our cash flow is improving. And I believe it has staying power because I look at the things we're doing to create it, the environment that's allowing us to create it, and the tools we're deploying to maintain it and elevate it even more. We've never been in a better position to improve our ability to generate cash. Flipping to page four of the flipbook, onsite signings softened a little bit during the quarter, 86. So total active onsites is 1,567. up about 15% from a year ago. Our goal for the year of 375 to 400 remains intact. Given where we are, and it's in the early part of October, we expect to be in the lower end of that range. FMI technology, we signed 5,187 weighted devices. That's about 81 per day. A year ago, we signed 75. I'd be lying to you if I didn't say I'd like that number to be closer to 100, and at least starting with a nine. But we're getting good execution. What really stands out is what's happening with that business from the standpoint of the revenue per device, how it's expanding nicely from what we've seen. The fast bin element of it, we're putting up really impressive numbers. One of the things I shared with our board yesterday is if you look at that discrete number of signings per day, a couple years ago, one of those signings, Today it's 15, and so it's rapidly expanding throughout the organization and really impressed with the way our teams in the field have embraced the technology and the way our customers like the technology too. You look at e-commerce, daily sales through, oh, excuse me, and our goal for the year of 21 to 23,000 unit equivalents for Fast Spin and Fast Spin signings remains intact. Finally, daily sales for e-commerce rose 50%. E-commerce is an interesting one because for years, I think back to when I stepped into this role, e-commerce was about 5.5% of our sales. It had been stuck there. It was stuck in purgatory because it wasn't how we went to market. We're a service organization. We're not a catalog-centered organization. We're an e-com company. We're a supply chain partner. Part of it was we had to admit to ourselves that's what we are, and that's a beautiful thing. And then how do we play to those strengths? And so we've really, I believe, found a way to make this part of our business. In the quarter, we hit $5 million a day going through e-commerce, and it wasn't too many years ago that we were starting out in that journey, so really impressed with the team. Then finally, our digital footprint. We've talked about that. It's really about... Widening the moat, illuminating supply chain for our customer, and making supply chain more efficient for both ourselves and our customer. I'm pleased to say that we've grown that to 49.5% of sales in the third quarter versus 43.7 a year ago. And we've talked about our plan, our goal to hit 52% of our sales running through the digital footprint sometime in 2022. That's still our goal. In fact, in the month of September, we came in at 49.9%. So if you would excuse me a second, I'll just round it up and say 50% of our business is now the digital footprint, and we see that continue to grow as we move forward. The other piece, and this is touching back, and I didn't touch on it with the e-commerce a second ago, is not just have our numbers improved. But one thing we always look at internally is our level of participation. In other words, how much is everybody doing, not just a few leaders in the organization. So if I go back to 2018, 17% of our branches had more than 10% of their sales in e-commerce. Two years later in 2020, that number had grown to 25% of our branches had more than 10% of their sales in e-commerce. I'm pleased to say in the third quarter of 2022, 52% of our branch locations had over 10% of their revenue in e-commerce. So this 18% that we hit in the third quarter isn't coming from a few. It's coming from a lot of activity throughout the organization, which means it's becoming part of our DNA. And that's how we found success in vending a decade ago, how we found success in onsite over the last five, six years, and what we're seeing in e-commerce today. With that, I'll turn it over to Holden. Great. Thank you, Dan.