The Fastenal Company's 2023 second quarter earnings conference call is being hosted by Dan Florness and Holden Lewis. The call is proprietary and is being audio simulcast on the Internet. No recording, reproduction, transmission or distribution is permitted without Fastenal's consent. A replay of the webcast will be available until September 1, 2023. Dan Florness has a message to share before discussing Fastenal matters.

Bob Kierlin offered the narrator the opportunity to join Fastenal in an unconventional way as Chief Financial Officer. The narrator met Colleen Quad, Bob Kierlin's sister, and was sad to hear of her passing earlier in the year. Van McConnon, Fastenal's first employee, was also very welcoming to the narrator when they joined. The narrator warned the team that 2023 was going to be a challenging year, with the second and third quarters being particularly tough to get through.

The company's earnings rose 4.5% but sales growth decelerated due to softer manufacturing activity. Operating expenses grew 4.1%, which was not a good combination for leveraging earnings. The second quarter was difficult because of two tax payments, and usually for every dollar in earnings, the company generates $0.60 to $0.70 in operating cash flow.

Fastenal has seen strong cash flow this year due to the working capital needed to fund receivables and inventory. The company has made strategic investments in inventory to ensure their customers are not let down in their supply chain. Additionally, Jeff Watts, a 27-year employee, will now oversee all of Fastenal's sales efforts across the planet.

Terry Owen has been appointed Chief Operating Officer and Jeff has been appointed to a leadership role. The company has taken steps to improve labor and inventory productivity, but the number of Onsite signings has been impacted by COVID, dropping from 362 to 356 last year. The company has an internal goal of 400 Onsite signings per year, and leadership changes in the past two months may have caused some distraction.

FMI Technology and E-commerce are both growing for the company. Onsite goals for the quarter are 100 and FMI Technology goals are 100 per day. The company has seen market share gains and 40% of sales went through the FMI platform in the second quarter. E-commerce grew 45% in the quarter, which is historically not a strong suit for the company.

The web portion of the company's business has grown significantly since 2015, when it was only 2% of sales. Now it is 6.5% of sales, and is on a 12-month run rate of about $7.5 billion. This growth has been accelerated by the events of the last few years, such as people working remotely and ordering more online. The digital footprint of the company has also grown, from 47.9% of sales a year ago to 55.3% of sales in the second quarter of 2023. Despite this, industrial production has slowed down, leading to smaller transactions.

FASTStock, an Android device used to scan orders, has grown from 11,100 scans per day in January 2022 to 16,300 scans per day in June. The average order size was $258 in January 2022 and dropped to $246, then to $222 in June. This is likely due to the decline in activity in the industrial marketplace and possibly a little bit of deflation. The device was rolled out across the company by June 2020, which was accelerated due to COVID.

Dan discussed the rollout of two new apps, the order pad and FASTScan. The order pad is an internal-facing device that will allow personnel to take orders, search for products, and respond to customers in real-time. FASTScan is an external-facing app designed for smaller customers that will allow them to scan products and transmit orders. Both apps are expected to be released in August and, depending on the success of the order pad, it may be rolled out in a customer-facing app next summer.

In the second quarter of 2020, despite tax payments, cash conversion was at 100%. In the second quarter of 2023, daily sales increased 5.9%, with manufacturing customers growing 10.4%. Pricing contributed 190-220 basis points to growth, but it has declined from the second quarter of 2022 and first quarter of 2023. This trend is expected to continue in the second half of 2023.

In the second quarter of 2023, operating margin was 21%, down from the prior year, and gross margin was 45.5%, down 100 basis points. This was due to product and customer mix, with wider sales growth of non-fasteners and Onsite growth over non-Onsite growth. Freight was favorable, with record revenues allowing for leverage of the captive fleet, reduced external freight providers, lower fuel expenses, and reduced shipping costs. However, higher organizational or GAAP expenses stemmed from a smoother and more predictable supply chain.

In the second quarter of 2023, the impact of price cost on gross margin was immaterial, and leverage from lower incentive compensation was offset by deleveraging of occupancy costs and other expenses. This led to a 50 basis point negative impact on GAAP expenses, and other expenses such as IT spending and FMI devices grew. The Blue Team also did not adjust spending quickly enough to the slower macro environment, leading to a 4.6% increase in EPS from the second quarter of 2022. Operating cash was 101% of net income in the period.

The second quarter of 2023 was challenging, but the company was still able to reduce debt and improve their accounts receivable and inventory. Net capital spending is expected to be at the low end of their range, and they are continuing to make structural improvements to their business. They have little control over end market demand, but are expecting better cost comparisons and tighter cost control in the second half of 2023.

In the second quarter, labor productivity was at a record high and there was significant strategic flexibility in inventory and improved return on capital. This allowed the company to outgrow the market. Regarding price contribution, the company expects moderation in the second half of the year. The CFC program experienced growth of over 50% in the current quarter compared to the previous year. There was no specific information provided on the Focus 5 initiatives.

Holden Lewis and Dan Florness discussed the PMI indicator, which suggests that the second half of the year will be weak, and the digital transformation of FMI, which is currently 40% of their business and could reach 65%.

The business is becoming more efficient through the use of new platforms, allowing them to engage with customers more and grow the business faster. This is highlighted through the example of their RFID program, which can help solve problems for customers. This was demonstrated when an employee saw the potential of the program and was amazed at the solution it could provide. This technology is also celebrated by employees who have been with the company for 40 years.

Holden Lewis explains how Fastenal uses RFID chips to help customers with their pallet replenishment. This makes the process more efficient and customers love it, which helps Fastenal to win business. He also notes that this technology helps to reduce the overall cost of operations, making Fastenal more competitive in the marketplace and allowing them to gain more market share.

Dan Florness visited a customer who had contacted them in 2020 and needed help. The customer had been staffing the Onsite 24 hours a day, but the company found that staffing it 10 hours a day would provide better service and be easier to recruit for. Chris Dankert asked how SG&A spending and investment would trend in the second half of the year, to which Holden Lewis replied that they were investing in IT and FMI to provide wise investments for growth.

The company is looking to rein in expenses related to travel and other non-sales related expenses, and increase part-time hours to reflect the current environment of slower growth. This has had a 10 basis point impact on profits, and a 450 basis point impact on margins. To offset this, incentive compensation is being lowered. Dan Florness has also said that everyone will be receiving lower pay in the next 12 months due to earnings growth.

Holden Lewis stated that the company has increased their investment in IT, adding 50 people to their Bangalore tech center and 100 people in January. This is to create a digital footprint and increase sales productivity. Normal seasonality should be expected, but at a more muted rate.

Holden discussed the seasonality of the business, expecting muted results against history for the next couple of quarters, and the wildcard being the cyclical element of seasonality related to fasteners. Ryan Merkel asked if Holden could adjust SG&A fast enough to hold operating margins flat year-over-year in the second half, to which Holden did not provide an answer.

Holden Lewis and Josh Pokrzywinski discuss the need to reduce SG&A costs by $2-3 million through tighter control of headcount and expenses. They also discuss the impact of reversing inflation on customer-facing elements and margin profiles.

Dan Florness discussed the changes the company had to make in 2021 and 2022 due to sky high container costs, which the shareholder base was supportive of. He also mentioned the company's plan spend and unplanned business, and how the company has been working to build technology and supply chain systems to better serve the remote and multiple location buyers. Lastly, he mentioned the difficulty in offsetting the tariffs and inflation during the period of tariffs.

The organization has been able to use the pricing review tool (PRT) to remain price cost neutral during periods of inflation and deflation. Additionally, the organization has been able to reduce inventory from 185-190 days to 135-140 days by strategically managing branch inventory and improving velocity. This reflects the organization's ability to manage multiple tasks at once, despite the pressure of the pandemic.

Dan Florness comments on the competitive landscape, noting that there is inflation in product costs, transportation costs, and labor costs, and deflation in container costs. He also mentions that their total cost of ownership approach allows them to have intelligent conversations with customers and make better choices. Holden Lewis adds that there was also a benefit from the lack of availability of product in 2020 and 2021, but as the supply chain normalizes, the marketplace will also normalize.

Holden Lewis states that product margins for fastener products are stable, and that while there are contracts requiring some adjustment based on end markets, this is not having an adverse impact on their overall profitability. He also mentions that they have agreements with certain large customers on imported product.

Fastenal provides a buffer for their customers to ensure product is delivered when needed. They often take on new customer relationships where they manage inventory and can illuminate what the customer has in their inventory. They have seen cases where there is an excessive amount of inventory due to an uncoordinated effort from multiple suppliers.

The speaker explains how they were able to help a customer manage their 14 months of inventory without product sales, through an arrangement with them. They also mention that this is an example of an inefficient supply chain and thank everyone for attending the earnings call.

This summary was generated with AI and may contain some inaccuracies.