Fastenal Company (FAST) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to the Fastenal presentation. I'm Ryan Merkel from William Blair's Research Department. Before we begin, I need to remind you that a complete list of disclosures and conflicts of interest is available on our website. With us today is Dan Florness, President and CEO. We also have Holden Lewis, Executive Vice President and CFO. Fastenal is a leading North American distributor of fasteners and MRO across the manufacturing, construction and government. Fastenal has a unique business model that gets great people close to customers. With that, let me throw it over to you, Dan, for opening remarks.

Thanks, Ryan, and thanks, everybody, for joining us today. I just have a handful of slides that I want to flip through, and then we can turn it over to Q&A. And run through the proverbial, here's the legal disclaimer helps me for anything I'm about to say. And this slide, for those of you that perhaps watched our webcast for our annual meeting. This was a slide I used at that point in time. And it's a slide that was put together by Jeff Hicks, who leads our -- who's a -- almost a 30-year employee. I think he's at 27 years. He was a long-serving district manager down in the Indianapolis market, with an early adopter in his business unit of vending. And several years ago, asked Jeff and his family to move to Winona and lead our vending initiative because we wanted to bring somebody into that had been -- that had really worked with it from a district perspective. And at our employee show back in December, he shared a slide that was very similar to this with our leadership and I love the depiction it had. And the pie chart you see on the left looks at our business in 2019. About 20% of our revenues, we did just over $5 billion of revenues, so just over $1 billion of that went through a vending device of some sort. And on top of that, about 10% of our revenue is a bin stock, where we track an active planogram, our branch personnel go in and are replenishing that bin stock. It might be for OEM passers, it might be for some MRO parts. So about 30% of our business goes through those 2 discrete channels. And we involve them together because they're close cousins. The one might be, in the case of vending, a highly automated with restricted access, but they're both about point-of-use supply of parts. The other 70% of our sales are outside that world. And what Jeff was laying out for our leadership is really to think about where is the business going. And some of the things we're doing, what the thought process is, and he really looked at the expansion of both vending and bin stock as we become a deeper and deeper supply chain partner to our customer, he really believes that when we're a $10 billion company, for example, he believe 70% of our revenue will go through a vending or bin stock. He also believes the line between the 2 will start to blur in that we're currently in -- well, we have introduced and are deploying more and more bin stock that has technology embedded into it to really serve as a gas gauge, if you will, to what the business looks like. We believe that positions our -- us Fastenal, whether it's through our traditional branch or on-site model to be the premier supply chain partner, whereas the remaining 30% is products outside the more repetitive products that are sourced periodically by the customer. And everyone have a great offering, a great value proposition and a convenient source for our customer to gain the product. If you think about the acquisition that we did in March, where we bought the Apex Vending Technology platform that we've been operating on for the last 12 years, we bought both the technology and the access to its supply chain. Part of the logic of that was it allows us to meld the vending and bin stock in an ecosystem, whereas, historically, we didn't have that opportunity because it was 2 distinct systems. The second -- and I suspect folks listen to this presentation for different reasons. Some of you perhaps are listening to it to learn more about the Fastenal business model or perhaps you're listening to it -- through the presentation or through just general Q&A, you might learn a little bit what the tone of the marketplace is. This is something that I've been looking at. And again, Jeff Hicks, the individual I was talking about a second ago, he provides that -- this on a weekly basis. And it's week-by-week snapshots of activity going on in our vending machines. So we have just shy of 100,000 vending devices deployed with customers across 25 countries, most in the U.S., Canada and Mexico, and quite frankly, most in the U.S. And there's 2 distinct lines here, the top line is looking at unique users that accessed vending in that particular week. The bottom line, the black line, is the average number of dispenses per calendar day. And I stress calendar, a lot of our reporting is business day. Vending machines are on 24 hours a day, 7 days a week. So we have activity all 7 days. It can vary. So we measure it based on calendar day when we're looking at this because business day gives you a lot of unnecessary noise. So if I look at -- just going back to October, you can see that black line going along, and the scale has been a minute on purpose. I don't want a new statistic that you're going to be asking for. But I think looking at the trends and understanding the trends is really important in this environment. So if I look at the back to October, you see it slowly growing. You see a little peak, that's Thanksgiving, that's just the impact of removing the Thanksgiving calendar day, and we're dividing by 6 instead of 7. You can see over Christmas and New Year, that time frame, the business can shut down for a few days, and you see the drop-off, it normalizes again. And you do see a little bit subdued of a level. Now that is probably because historically, our business is stronger in October and November than it is in January and February. And -- but you see it slowly trickling up. And most of the gain over time is from deploying additional vending devices. Then you get to the middle of March, and you see just a drop-off. You see a little blip there at Easter Week, again, we're dividing by 6 because we take out the Easter Sunday. And then you see the patterns start to gain slightly as you go into May. You see the blip, that is Memorial Day, and then you see the week after Memorial Day. Now one of the questions I had of our vending team is when I look at that kind of floor around the Easter time frame, so mid-April, then I see it slowly gaining traction. Is that gaining traction because people are dispensing more stuff, but we still have fewer people working? In other words, they're using more PPE because it's a COVID-19 world. So the second statistic is looking at unique users that are accessing the vending in that given week, so you can see in the fall that slowly is growing again, it's slowly growing in connection with rolling out more vending devices. You see the number of unique users drop off because some folks might be shut down for Thanksgiving Thursday and then the Friday, the day after. So you see a drop-off. You see the unique users drop-off in late December around Christmas and New Year's, then you see it kind of revert to a normal, and it's trending up. And then again, you see an abrupt drop in mid-March. We see the same pattern where the floor appears to be the week around Easter, the week after Easter. And since then, it's been climbing. You see the drop-off in users in the week of Memorial Day. And then you see it pop up again, and it rose slightly again this week. It's not on the chart, but I do have the stat in front of me. It rose again slightly. So when I ask Jeff, what this tells him when he's looking at our activity? He says, the climb back up, if you look at the actual units, it's about at half the pace of the free fall from mid-March to mid-April. And you can see, based on your assumption where that line goes out to the future when you think we kind of get back to where we were in early March, time will tell if you're right or wrong, I'm not going to speculate. But I thought it might be useful to share this statistic because it tells me something about the world that we live in, our customer base coming back to work slowly once you get past mid-April And I suspect we'll continue to see some upticks as we go into June, and time will tell when we get back to normalcy. But I thought this might be a useful statistic to share from the standpoint of what we're seeing across a wide range of industrial and nonindustrial customers. The one thing that has stood true for me as I've gone through this, and we talked at length in April about how we've been leading the FAST organization, and quite frankly, the FAST organization being led by thousands of leaders throughout our network, but how we've approached the COVID-19 world. One of the things that we did back in March, we expanded our benefits program to provide an additional 2 weeks of time off for all employees, full-time and part-time, for COVID-19-related issues to get that out of people's head the concern of what might happen to them. But we ask them to start sharing stories, and we've shared a lot of stories across the organization in our weekly video updates on what's going on about different acts of courage. And on the lower left of this picture, this is the Penn Presbyterian Medical Center in Philadelphia, Pennsylvania. It is not a customer of ours. The father of one of the employees in this picture is a customer of ours, in an unrelated city, who had reached out to our local team, he'd been talking to his daughter, and he said, "This is a great medical center, but we're running out of supplies, and we can't get of hold of face shields." And this father reached out to us and said, "Can you get a hold of some face shields?" And the first reaction of our local team was, how many do you need? And within hours, we had them the face shields they needed, and they snapped this picture and send it to us. And I'm proud of the fact, while we're not a first responder or a provider of medical services, I'm proud of the fact that our organization in this time has been able to help people that work in that arena to make their world a little safer, right? Prior to that, they were sharing face shields and having to sanitize them every time. Now a person can have a face shield for their entire shift. The picture above it is in Brazil. This was another hospital that was not getting supplies and a bunch of customers pulled together and worked with us to get donations to that local hospital, and that's our employee in Brazil delivering those. The final one is a related story, we were -- what we -- our branch in Indianapolis had heard about the fire department not getting supplies. And even though that fire department is not a customer of ours, they called them up and they said, "What do you need?" And I'm pleased to say we were able to get them respirators to help them do their job because their regular supply chain, for whatever reason, had failed to provide the items they needed, they weren't able to source product. These stories and many, many more are symbolic of an organization. And as I touched on in this last slide, I think in many ways, the Fastenal organization is uniquely in a position to help in a time like this pandemic. We think locally. We make our decisions locally. We are a population of problem solvers. And that organization can think on its feet and react to a customer's needs locally. And to me, it marks the sign of a true supply chain partner, not just a fulfillment company whose -- who will get you what you ordered if it's on our shelf. We find out what you need, and if we don't have it on our shelf, we'll find it or we'll suggest some alternatives, and they come from human intuition of knowing the facts on hand as opposed to -- sorry, I can't help you and the website ends there. With that, I will turn it over to what questions we might have of either Holden or me. Thank you.

All right. Well, thanks for that intro. And certainly, Team Blue has done a great job because your safety sales have been nothing short of fabulous. But let me pick up on that. Do you think the safety surge is sort of over here, should we expect that to meaningfully slow in June and then over the coming months?

Yes, I would. I think what you're seeing is the marketplace -- the nature of the crisis is become somewhat more known, and I think buyers are able to be a bit more planned in how they approach the marketplace. I think that more product has come to the market as more manufacturers have come open, and perhaps added capacity. And I think more people, more suppliers have found those resources. And so when you lump all those things together, I think what you're seeing is a marketplace that is shifting from chaos to some degree of organization. And as a result, I think you're going to start to see those surge orders, which are, by definition, sort of expedited, very sort of purpose-driven types of orders begin to come down. And I think you're starting to see that already. The amount of surge orders in April and May were fairly consistent. May was perhaps a little bit better than I might have expected, but we always thought they'd be meaningful. I would not be at all surprised if the surge orders in June are, give or take, half of what they were in April and May. And I wouldn't be surprised if we roll into the third quarter and fourth quarter, we're not discussing surge orders. And now the question really is what is underlying business doing? And I think that becomes the conversation at that point. So yes, I think that we're beginning to see the unwinding of this phase of the crisis and our role in it, if you will.

Perfect. Yes, visibility is obviously still very, very low. Maybe talk about what are some of your more challenged end markets right now?

So I would call out probably construction is still a challenge, and that's one we're pretty visible on in the monthly releases, and that was down 10%, I think, in May. But we saw a pretty nice improvement in the month-to-month change in industrial, still negative, but it did improve versus where it was in April, and construction didn't show the same degree of improvement. So I think that's an area that's still weak. I would probably also call out metals mining and oil and gas. Metals mining is down probably more than 30% and oil and gas down more than 40%, and so it's still very much challenged there. As I said, industrial is still challenged. But we definitely, over the course of May, saw more and more of the industrial complex opening up. And the very crude way that we kind of looked at it, we talked about before on sites that are closed, however, the RVP defined that. And in -- at the end of May, the number of closed on sites was fairly small to the degree that I don't really think it's worth mentioning at this point. I don't think I'll ask the question in June. So we've seen a lot of opening up. Now opening up doesn't necessarily mean that they've gone back to 100% production capacity, right? But they've certainly increased from where they originally were, and you saw May activity in the industrial space, still weak. I think Dan talked to that on his discussion of the vending side, still weak but better in May than April. And frankly, based on the feedback from the Regional Vice Presidents, it wouldn't surprise me if June is better than May. But I would highlight, I think the expectation is that June will still be well below where we peaked in February.

Got it. Okay. I'm getting a lot of questions about gross margins. Obviously, the safety, surge kind of make things look a little wonky. Just tell us what are gross margins on safety products, national accounts and then what are margins on fasteners?

The -- typically, we view fasteners as being sort of a low to mid-50s type of margin. And we view nonfasteners as being a low to mid-40s on gross margin. And safety is perhaps in the lower end of that low to mid-40s, but nonetheless, sort of in that range. So I would use those as your benchmarks.

Perfect. Okay. So in a post-COVID world, where are some of the opportunities for Fastenal to be a winner long term versus some of the smaller monopods?

I think a couple of things will come to mind. One is, does it possibly expand the universe of customers out there? We've talked about government, state and local in the past, we've talked about some of the medical institutions here more recently. I do believe one thing that emerges is, I believe the marketplace -- and I'm talking explicitly about those end markets, understands a little bit more about what Fastenal is. Fastenal is -- and again, I don't want to keep beating this dead horse, but we're not just another fulfillment company that you can buy from. If you need more or if you need a supply chain partner, if you need somebody to help your supply chain be more resilient, we think we bring a better value proposition. And I believe the market will preach that a little bit more. And I'll read -- if I can find it here quickly, I'll read a quote that came from one of our government specialists in New York State, received this from one of his a County Director of Procurement. And here is what the e-mail says, "The County Director called and said, he now understood what we meant when we said we would like to be a partner, not just a transactional supplier. He thanked us for everything we are doing for them and that they have not seen the same support from their other supplier." And my guess is you'll have a bunch of folks that realize, "Hey, this is something different that Fastenal does." And I think a lot of our industrial customers have known it for years, perhaps they know it a little deeper now. I know Holden cited in his conference call in early May on April sales, the number of customers that bought safety products from us who had never purchased safety products from us in the past. So it wasn't that their volume went from x to y, their volume went from 0 to some number. And they are more aware that we do a wide range of products. They're more aware that we're a supply chain partner. Possibly some of them are aware that we do more than just fasteners and tools and so awareness is half the battle of expanding the universe of what you do. And I think we'll get some traction from that post-COVID-19.

What about the themes of onshoring back in China or e-comm, you see those as being a tailwind?

Yes, I might tackle that one first. I think from an onshoring standpoint, the agreement that we have with our customers is we're going to reduce the cost of their supply chain. If for some reason, the market shifts in such a way that the supply chain wants to exclude non-U.S. sources, first, I think there's a tremendous amount of work that has to be done to make sure that products that aren't made here today are made here. And that's a very long-term issue, frankly, that would need to be addressed in a scenario like that. I mean fasteners aren't produced in America today. But if you folded your arms, blinked your eyes and made that happen, in the end, we're going to go by what the customers tell us to do, and we're going to reduce the cost of that. So if the customer tell us we really need you to be sourcing from U.S. manufacturers, we'll do that, and we'll do it as effectively and in such a way that reduces cost as much as possible. So that's -- we view ourselves as a supply chain partner, and our customers can put some parameters around that. And we will reduce the cost as much as possible within the parameters that they put out there. Historically, they've allowed us a tremendous amount of freedom to determine how we were going to reduce the cost of their supply chain. And that's how we've built the structure that we've built and right now, there's no reason to think that, that's not going to continue to be the dynamic. But if it changes, we'll change with it. But our promise will be the same, which is that whatever the parameters are, we're going to reduce the cost of your supply chain for you. Dan, do you want to comment on e-comm or anything on that front?

I guess I'll touch on the question of supply chain as well. I think that's as much a society question as it is an individual business question. Because at the end of the day, I think people are going to be looking for the best value proposition. And sometimes that means low-cost production, sometimes that means more resilient supply that's physically closer because it provides comfort or it provides some type of derisking. If I think of some of the basic necessities of life, if we produce in -- on this continent, in this country, more than an ample supply of food. If we didn't, I think that would be a risk that society would have to decide, is that a risk we want to have. If our supply of drinking water was not something that we locally sourced, would that be a risk you'd want to have? For decades, our society had that risk in its energy supply. And that risk has largely been removed in recent years. A couple of things that jumped out when I think of discussions, whether you're in the media, in the print or video media is there's 2 things that really jumped out in this COVID-19. One was the fact that we don't produce a lot of our own supply of pharmaceuticals and what does society think that should change? Because that's the only way it's going to change. The other piece is we don't produce much in the line of PPE as it relates to mass. If you think about 3M had a lot of press, positive and negative, mostly positive in recent months because they were unique in that they make N95 masks in United States. I believe most of their production is in South Dakota, Nebraska. That production is here not because of the medical community, it's here because of the industrial community was using that production. 90% of that, I believe, it's 90% of that production went into industrial uses. Absent that demand over the last decade, there wouldn't be any domestic production to speak of. And so as a societal question of where should the supply chain be? But I think those questions are posed before where the source of fasteners are or the source of gloves or other things. Because you're looking at it and saying, "How critical is food, water or energy? The pharmaceuticals that keep our population healthier or the PPE that protects the folks in the medical community and the first responders?" In regards to e-commerce, I believe that's going to continue to grow, not just for finding product. But also because it's an easier means with which to communicate. Well, I think a lot of society has discovered over the last 60 days, 75 days that, in some ways, it's easier to have a meeting in a video conference than it is to have an in-person meeting. I know for our leadership, we have a monthly leadership meeting. And we have 3 individuals in that meeting that aren't physically based in Winona. We have the balance of the group is physically based in Winona. I suspect the 3 that are not in Winona feel more a part of that meeting when everybody is on a Teams meeting than they're dialed into a room, and they're looking at the PowerPoint on their slide, but they're trying to figure out if they're on the right slide or not during part of the discussion. And it makes for, I believe, a more productive meeting. I think we'll continue to have our monthly EVP meetings on Teams even after COVID-19 goes away -- or the social distancing aspect of COVID-19 goes away or at least subsides because I think it's more productive. That doesn't mean that video chats replace -- I'd much rather have this conference in a room where I can see the room because you understand if your message is resonating, and it's easier to take Q&A.

So a key part of the Fastenal story for a long time has been market share gains. And I would say, 500 to 700 basis points of outgrowth is basically what you achieve in most years. Vending has been wildly successful, on-site has been successful, there's more to go. So talk about bin stocking, that's a little bit newer. And if there's anything else you want to mention.

Bin stocking, we've been doing for years, we just don't talk about it. And what's really changing is we're better understanding how much we do. If you went to a given branch, you can ask them, hey, how many bin stocks you do and they can quickly raddle off, here are the customers that I deal with. But because there's no technology element to it, in many cases, we don't have any visibility in our system that we're doing at bin stock, other than the fact that there's a handful of skills that are highly repetitive. And so through mobility, we're getting better visibility to the bin stocks we do. In our bin stock, that 10% number, that's probably understated even today. It's higher than that, but we don't have visibility to it. But as the -- as our branch employees create planograms to track what we're doing and we introduce mobility to handle replenishment, we'll be able to better surface that information for our customer, and we'll be able to better manage that from the standpoint of supply chain and how we pick that and how we are more efficient with it, which ultimately lowers our cost to serve that business, which makes it more appealing for our branch employees to go out and find more of it because we make it easier to do. But I believe both vending and bin stock are really close cousins and they're kind of the same thing other than the one we have 24/7 visibility, and you can restrict who can get access to it. With the bin stock, with pipe biddings or fasteners or other types of product, the restricted access isn't as big a deal. You just don't want to run out, and you don't want to spend too much labor to keep track of it.

All right. And the final 1, 2 minutes here. Onsite, I think you've got this maturation curve where you're now getting to the point you have more mature, higher-margin Onsites being a bigger portion of the mix than the younger ones. Are we at that inflection point now? And how much upsize is there on EBIT margin, if so to quantify?

Yes. I always felt that 2020 was a bit of that inflection year, if you will, where you're going to kind of get the bottoming in the average Onsite size. And then 2021 and beyond, you're going to start to see an increase in the average unit size, and that would carry with it some leverage that would allow us to improve the margins. Today, our margins in that business are in the high teens, call it, 17% -- yes, 17%, 18% sort of range. We know that if you look at our oldest Onsites, we know that mature Onsites that are larger than where we are today, call it, $1.8 million, $2 million a year. We know that they can produce margins in the 20%-plus range. So now I'm not sure that we're going to get there in 2021, 2022, but I think that we begin the process of improving the overall profitability as the average size begins to increase, and I do think this is a bit of a transition year to that in 2020 or 2021. The question is going to come, what does this issue with COVID do? Does that defer that point a little bit, if you will? And then I'm not sure whether you're going to get some benefit just from Onsites sort of coming back relative to the push out of new units or whether the slowdown of new units is going to maybe make it a little bit quicker, it's really hard to say. But I do think that we are at essentially in an inflection point. And whether it's been pushed out 6 months or not, we're at an inflection point. And I think that the next, call it, 3 years of evolution in Onsites are going to be towards better profitability.

Well, that's exciting to hear. Unfortunately, we're out of time. But Holden and Dan, thank you so much, and thanks for everyone for listening. We'll talk to you soon.

Thanks for your time, Ryan.

Thanks, Ryan.