Fastenal Company (FAST) Earnings Call Transcript & Summary

Greetings, and welcome to Fastenal's 2020 April Sales Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ellen Stolts, Assistant Controller.

Welcome to the Fastenal Company April 2020 Sales Results Conference Call. This call will be hosted by Holden Lewis, our Chief Financial Officer. The call will last for up to 30 minutes, and we'll start with a general overview of our April sales results, 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 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. Holden Lewis.

Great. Thank you very much, and good morning, and thank you all for joining. Just so you know, this will not be a regular event, but I have talked with many of you about how, in periods of unusually high volatility, it might be appropriate to provide a little bit of extra color. When we reported our first quarter results on April 14, we discussed how our regional vice presidents were anticipating results being potentially 15%-plus down, and how, to that point, we were tracking down 10% to 11%. This morning, we posted a daily sales growth rate that was up 6.7%. I don't believe that investors are accustomed to such dramatic swings in our short-term results, and so did feel that a brief call might be appropriate. Safety products were up 120% versus last April. This was entirely a function of what I would call surge orders: expedited PPE intended for critical users as part of the response to COVID-19. If you exclude the safety category, our daily sales in April would have been down 16.4% led by a 23% decline in fasteners. And it would be fair to say that safety, excluding the surge orders, would have been down to a comparable degree. Our manufacturing and construction customers, which were both down nearly 16%, have been severely hobbled by actions taken to fight the coronavirus. However, some of our traditional customers, such as food processing, would be considered critical and were actively sourcing PPE from Fastenal in the period. While sales to state and local governments and health care customers, which are typically less than 5% of sales, but were close to 10% of sales in April, was up 184%. April's results are a credit to the entire Blue Team, but particularly impressive has been the work of our sales, procurement, product and quality control professionals. It's not just about the raw numbers, it's also about Fastenal's ability to quickly pivot our efforts in order to play a critical role helping existing and new customers manage these difficult conditions. When I think about the month that just passed, several stories leap to my mind, which highlights the valuable role that we can play and do play to be a valuable supply chain partner. For instance, a large food producer that we deal with approached us to manage the logistics for KN95 masks from an overseas vendor that they had identified. Our international procurement unit, FASTCO, discovered while vetting that vendor that the math did not come close to meeting the filtration threshold expected by the customer. This allowed the customer to cancel the order without taking control of the masks, and we have since worked to find another solution for that customer. In another example, a large OEM engaged our Industrial Services division to assemble 170,000, what they call, back-to-work kits of masks, sanitizers and temperature gauges. Hundreds of Fastenal employees came together to get this done in less than a week, allowing the customer to bring employees back. And our safety teams were able to pivot to critical needs customers getting product to over 450 medical, health care and hospital customers that had bought little to no product from Fastenal in the past. In fact, the surge orders that we experienced in April where a product of more than 11,000 accounts that had not bought safety products from Fastenal in 2019. We bring this energy and creative problem-solving to customers daily even when there's not a pandemic, but we're especially proud of the nearly 22,000 Blue Team members during a time like this. Now it seems appropriate to address certain other dynamics that are relevant to the second quarter, though with the caveat that conditions remain really volatile and visibility into the second half of 2020 is nonexistent and so will not be addressed on this call. In terms of underlying business activity, there is the expectation that they will improve from April as the U.S. economy begins to reopen, though to what extent is not clear, and we certainly do not anticipate a return to anywhere near the pre-COVID levels. Further, while surge orders in May might not be quite at the level of April, they should remain meaningful in the period. What happens to both our regular way and surge business in June and the back half of 2020 will be heavily influenced by future policies around COVID response, the pace and degree of economic reopening, the strength of a post-COVID economy and changes, if any, in workplace practices around safety and social distancing. At this time, it is simply impossible to know how these variables are going to settle out, and so a very wide range of outcomes remain in play. Where our growth drivers are concerned, especially on-site and vending signings, we're seeing the poor environment that we anticipated at the time of our first quarter call. Again, we do not believe this has any bearing on the long-term effectiveness of our model. But in the short term, the energy of our customers has shifted to immediate needs over long-term planning. I don't plan on being more specific at this time, but did want to give a bit of directional color there. It's not clear how long this dynamic will persist. On margins. In the first quarter call, we expressed caution over the trend in gross margin based on a number of factors. The most important was a sharper shift in mix toward lower-margin customers and products, which was plainly evident in April. Safety, which was 18% of sales in 2019, was closer to 35% of sales in April, while fasteners fell from roughly 34% of sales in 2019 to around 25% in April. A similar dynamic played out in our end markets and our large customer and small customer splits. We believe these shifts are event-driven and temporary, but also more dramatic than we may have envisioned a few weeks ago. A lot of the safety product was also sourced and moved outside of our traditional supply chains, which does weigh on gross margin. Further, much of the product was shipped direct and in bulk as opposed to on our trucks and through our network, which means we expect freight revenues to have worsened with our core customers and to have less efficient utilization of our trucking fleet. Other areas of the business, such as manufacturing, is also likely to be underutilized and deleveraged in the current environment. As a result, notwithstanding the higher volumes, the gross margin picture remains very challenging. On the other hand, the greater-than-expected volumes and solid labor management by field leadership should allow for better leverage of operating expenses than might have been expected at the time of our first quarter earnings call. The current environment continues to pressure profitability. However, the magnitude of impact to operating margins in the second quarter of 2020 may not be as great as originally anticipated. On our first quarter conference call, we got the dynamics that produced our April results right. What we did not expect was the degree to which those dynamics would play out. Visibility, particularly from June to the rest of the year, is minimal. Whether our sales grow or decline in the second half of the year depends on the state of the industrial economy and our expectations for the sorts of surge orders we saw in April. Unfortunately, we don't have visibility into either item at this time. But as the April starting point is significantly different from what we expected only 2 to 3 weeks ago, we felt this call to speak to the broader investment community was appropriate. That's all that I have for my prepared remarks. So operator, in the time we have left, I'm happy to take a few questions.

[Operator Instructions] Our first question today comes from Hamzah Mazari of Jefferies.

This is Ryan Gunning on for Hamza. Just real quick, with the safety business, are sales to any one particular end market or a few end markets? Or is it largely government business?

Well, what I would say is I think it's through a lot of end markets, right? And one of the things that I tried to call out there is if I think about the surge orders that we achieved in April, those orders were spread across over 11,000 different account numbers in the company. Some of those account numbers didn't previously exist. Some of them may have existed, but had never bought safety products before, at least in 2019, from Fastenal. And if I look at those top 10 -- let's say the top 10 out of those, I mean, we're looking at a number of different state and local governments. If -- but we also see within that top 10, customers -- commercial customers that haven't done business with us before and there's also customers that have done business with us before, but have never bought these types of PPE product. And so if I think about the surge orders, in particular, that we saw in April, what we would expect to see in May, are there some large orders in there? Certainly, there are. But I think more impressive and really getting to the job that was done by our folks in the field was just the sheer number of accounts that were buying products and for whom we were solving certain critical problems. And really, it tells you that those surge orders are not built on a single customer or even a handful of customers. Those surge orders are built on the 2,200 branches we have in the field, the 1,100 on-sites we have in the field, the corporate structures that we've built that allows us to contribute to solving problems, not for 1 customer or 10 customers, but for dozens of customers, and in fact, hundreds of customers, whether they be hospitals or government customers or customers we know or customers we haven't had a chance to know yet. I think that those surge orders were built on more than a few customers. That's what the numbers tell me.

The next question is from David Manthey of Baird.

Yes. First off, I'm trying to understand your discussion of the safety margin. Should we assume that these safety sales will be a several hundred basis point drag on the second quarter overall, but a less negative impact on pretax?

Well, I think what we're -- the problem is it's really difficult to say, right? We still have 2 more months in this quarter to play out. Like I said, we have some visibility perhaps into how May might play out, but we really have none in terms of how June is going to play out. And so I'm deliberately, Dave, trying not to be overly explicit about this. I think it's too early to do so. I mean 3 weeks ago, we didn't think we'd be up 6.7% in April, right? This is a rapidly changing environment. I think what I'm trying to convey -- I can see where the consensus is and I can see what the expectations of The Street is. What I'm trying to convey is that the gross margin -- what we see with respect to mix is probably going to have more of an impact on gross margin than we perhaps would have anticipated 3 weeks ago. But that the additional volumes is also going to allow for a little bit better leverage than maybe we would have anticipated a couple of weeks ago. Net-net, there's still pressure on overall levels of profitability, but it may not be quite the same degree that we -- or that I think investors were expecting when we spoke last -- 3 weeks ago. I think that's what I'm trying to convey without being overly explicit about the number, right? I mean essentially, the reason I wanted to have this call is because the starting point is different than we might have thought it would be 3 weeks ago, but the overall dynamics are still in play. I think the conditions are still challenging, particularly outside of the safety business. I think that margin pressures are still there. It's just that with what we've seen in April, I think that the starting point is somewhat higher than what investors were expecting a few weeks back. And that's what I'm trying to convey without being overly explicit. There's just too many open questions remaining for the next couple of months and certainly the rest of the year.

Okay. Fair enough. And then just quickly, you told us at the quarter that 120 on-site locations were closed. Can you give us an update on that figure?

Yes. The -- when we checked in again in mid-April, we had seen that number expand fairly meaningfully. And I would say if we were looking at 120 at the time, it probably expanded to more in the 160 to 175 range. If I think about where it ended in April, it has actually declined from that peak a little bit. And as we go into May, I think the expectations are that you're going to begin to see additional openings happen. So I suspect that we have probably seen the peak of the closings and going by the commentary from the RVPs, I think the expectation is that the underlying business conditions in May should be better than where they were in April, although they should still be significantly below what was the case just as recently as February. So -- and again, I think that's consistent with a lot of what you read and see about people trying to open up and finding ways to kind of bring people back more safely, and as that happens, you would expect that you would see some more of these on-sites open up. Now it's not just about whether an on-site is closed or not closed, right? I mean because we can talk about that number, but the number of RVPs that also comment, look, x percentage of them are running at less than 50% capacity. It's really difficult for us to express the full impact of what's occurred. But what does appear is that we've probably seen sort of the peak in terms of that closing, if you will. I think that it probably gets better as you roll through May. But I would expect that you're still going to -- however May turns out in terms of the underlying economic activity, we would still expect it to be meaningfully below where we were just as recently as February.

Next question is from Nigel Coe of Wolfe Research.

Holden, great decision to do this call, thanks. It's been really helpful.

Thank you.

Look, I just want to go back to -- you're not going to express gross margin targets given the uncertainty. But just curious, in the past, you talked about mix differentials between different product lines. And in the past, you talked about 30 to 50 bps, I think, and that's gone a little bit high in recent year. But how does the drop ship nature of these products, what kind of mix pressure does that create between traditional telephone sales and what we're seeing right now?

Well, I'm not sure that the drop ship nature of it necessarily is related to the mix element. I think the drop ship nature is probably more reflective of the fact that, in many cases, we're procuring product in a way that's different than we typically do within our supply chain, right? And in this environment, we're engaging vendors that may not be typical vendors, right? So we're getting to know them, they're getting to know us. We're entering into transactions that we haven't traditionally entered into. We're finding ways to expedite the shipping of that product because of the critical need for it, et cetera. And so I'm not sure that the drop ship nature of what we're doing today is really caught up in the mix conversation. But what I said in the prepared remarks was that it's not the way we traditionally manage our product and it does come with a slightly lower margin on those products than we might otherwise expect to see if we were managing through our traditional supply chains where we simply maximize the efficiency of those, right? So I think that -- maybe I'm misunderstanding the question, but I think you're mixing 2 concepts. Mix, obviously, is just related to how much of each we sell compared to the other, and you can kind of see what that is doing. But the issue of drop shipping has a lot more to how we're navigating supply chains. And -- but I do think that it's going to wind up having an impact on the gross margin outside of the mix impact.

Okay. Fair enough. And my follow-up is can you just comment on the run rate of safety through the month? Clearly, 120% growth compared to 30-and-change in March suggests that it saw a pickup towards the end of the month. Have you seen that trend continue?

What I would say is we talked about kind of the back order quantities when we spoke at the first quarter conference call, I would tell you that we've seen the total amount of back order quantities continue to rise. As we've had customers that continue to approach us to seek out solutions to their problems, it's opened up additional opportunities for us to purchase additional products. So yes, I mean, clearly, we didn't see 3 weeks ago the degree to which safety was going to grow in the month. And so it clearly expanded as the month went on. But I will tell you that there's still a lot of momentum around being able to procure product and still a lot of demand from customers for us to be able to do so. So this is not a situation where the surge orders were specific only to April. Like I said, I think you go out into June and beyond, it's impossible to know what that's going to look like. But I think if we look at May, based on what we know today, I don't know that those surge orders will be at the level that we saw in April. But there's going to be a meaningful amount of surge orders that we would expect to see in May as well.

The next question is from Josh Pokrzywinski of Morgan Stanley.

Just following up on one of the earlier comments you made on this kind of return-to-work kits. Is the surge kind of push that you're seeing from customers because they're reopening or because it's a hard time securing PPE last month and earlier and now they're kind of broadening their sources of supply. I'm just trying to connect that to the comment that on-sites are starting to slowly reopen again. Like it sounds a little bit like a return to work if you read the tea leaves the right way, but I don't want to overstate it.

Yes. Well, and -- I'm only trying to report what we're seeing in real-time. I don't know -- it's much harder to know what's going to happen in the next 30 days. I think when we talked about the return-to-work, I think that was more a reflection of the creativity that many of our customers are trying to exercise in order to be able to bring employees back and work safely. And we're really able to mirror that creativity and be a part of those solutions, right? So I think that's what that story was meant to convey. In terms of whether that's something we're seeing everywhere, I think you're seeing a lot of things. Again, if I think about the hospitals and the first responders, the reason they're ordering product is really different from the reason why many of our commercial customers might be ordering product, right? And we're seeing a tremendous amount of demand from both of those. And so you're seeing commercial customers that are considered critical to begin with and never close down, but have to make sure that they can keep their people safe with -- via more requirements for masks and goggles and gloves and things of that nature. We're seeing customers that perhaps did shut down that are trying to find answers to how they can get back to work and bring their people back in. And we're participating in finding solutions in that respect. And then we're participating with the first responders and those folks who are just really dealing with the day-to-day issues of illness and things of that nature so that we can keep them safe as well and keep them doing their job. So I'm not sure that I could point out, Josh, a single trend. I think that there's a lot of people ordering products for a lot of reasons, and I'm not sure that I would say that one is getting an upper hand over another at this point.

The next question is from Chris Dankert of Longbow Research.

I guess if we look back, May has held flat or increased sequentially on an ADS basis versus April going back at least to the early 2000s and it sounds like you expect this track record to continue. I just want to be explicit that, that is kind of the snapshot as of today.

You know what, this is not an environment, Chris, I think, where the normal sequentials are necessarily at play. But again, if I think about the business in the context of those normal sequentials, what I would say is you have to factor in a number of things. The normal sequential always reflects what you see out of the macro: does the macro get better than what it was the prior month or worse than it was the prior month? And that's going to, to some extent, play a role in dictating what that sequential does. But -- then I think at this point, you also have the question of the surge orders. How many of those do you have, right? And that's going to wreak havoc with the sequential. So I don't think at this point that I mean I'm going to -- that I'm particularly comfortable with the idea of guiding on sequentials for May. I'm trying to provide a general landscape that you should be thinking of in terms, but you really need to think about not only the underlying economy, which impacts those sequential numbers but you have to be thinking as well about the trend on surge orders. And as I said, I'm not sure I would expect the surge orders to be quite at the level that we saw in April. But I think that they're going to be fairly meaningful. How meaningful? We still have a full month to figure that out.

Yes. April certainly broke that macro mold, hence, the question. And I guess just to follow up, that 22% number of customers growing in the month. I guess how does it compare back to the trough in, say, 2016 or '09?

I'll just take that one off-line. I don't know the answer to that question. Yes, Chris, I don't know the answer to give you, so I would have to go back and check that out.

The next question is from Steve Barger of KeyBanc Capital Markets.

This is Ken Newman on for Steve. Just curious, my first question was just any color on the growth by geographies and just any moving parts within those geographies that we should be aware about?

No. I think if you think about the geographies, I think the geographies are behaving as you would expect in light of the markets that are weak, right? Oil and gas is a poor market today. As a result, you would expect that our Mid-South and our Texan regions would be relatively weaker than other areas, and they are. I don't think that has anything to do with Texan or Mid-South, I think it has everything to do with the markets that are weighted towards those regions. Automotive is obviously an area to which we don't have a lot of direct exposure, but our indirect exposure would be meaningful in those areas where automotive is meaningful. And so I think you could expect that areas like our Michigan region and our Indianapolis region would also be weak because those markets have an impact on those. If you think about the coasts, the coasts are a little bit of a different beast because they tend to have more of the government-type business and things like that. And so I think that the coasts are probably doing somewhat better than some of those more traditional industrial markets. But again, I don't think that has anything to do with the region per se. I think it has everything to do with the end markets that those regions are concentrated within. And I think that the regions are behaving as you would expect, given what you're seeing out of end markets. And that's how I'd answer that.

That's very helpful. And then just a follow-up question. Just any color as to whether you expect to provide any historical data on safety just so that we have a better way to gauge comps and the impact of surge orders going forward.

No. I don't believe that we do. The -- we continue to report to you monthly kind of what our safety is doing. I think that we can have these conversations not in a formal call like this. This is sort of something we expect to do only this once. But we report to you kind of how safety is doing. I think that we'll be able to provide some color. But I don't see us breaking down the difference between surge orders and nonsurge orders. As I said in the prepared remarks, I think if you strip out the surge orders, safety was probably down pretty much consistent with the rest of the business. And I think that's probably the color that we're likely to provide. With that, operator, I think we've approached the 30-minute mark. One thing I did want to go back to Chris' question really quickly. Looking back at 2015 and 2016, the number of national accounts that we ultimately saw growing during that period of time, I think, bottomed at 41. So not near where we are today. I don't have that 2009 number at this point, but to give you a sense, obviously, 2015, 2016 was not on par with what you're seeing in the marketplace today. So operator, with that, I'll turn it back to you. I think the question period has ended, and we can close off the call.

Thank you, sir. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.