Greetings, and welcome to the Fastenal 2020 Third Quarter Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Ellen Stolts of Fastenal. Thank you, ma'am. Please go ahead.

Welcome to the Fastenal Company 2020 third quarter earnings conference call. This call will be hosted by Dan Florness, our President and Chief Executive Officer; and Holden Lewis, our Chief Financial Quarter. The call will last for up to one hour and will 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 the 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 Web site until December 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. Dan Florness.

Thank you, Ellen, and good morning everybody and thank you for joining us for the third quarter earnings call. Before I start with the flipbook, I just thought I'd share a few thoughts. We do some simple things at Fastenal. We find great people. We ask them to join and then we give them a reason to stay. One of the jovial aspects of my role here at Fastenal is in the fall of each year, I send a letter to all of our 25-year employees as well as our 15-year employees. And then we typically with the 25-year employees, we celebrate them at our national meeting held in December of each year. Obviously this year won't be held in person, but it's a great opportunity to recognize great service to the organization and folks that saw the reasons compelling enough that they've spent much of their adult life in the Fastenal organization. If I look at the third quarter of this year, we actually have six people I get to work with each and every day that hit a milestone in their employment was Fastenal. So back in July, Le Hein celebrated 35 years with Fastenal. Rodney Hill, a little bit later in the month, celebrated 20 years. Rodney Hill, for those of you don't know who he is, he's our Senior Vice President in our National Comms team. In August, we had two employees celebrated anniversary. Again, these are folks I work with. Holden Lewis, who you'll hear from shortly, hit four years. But on top of that four years, a wealth of knowledge because many of you know that he spent a good chunk of his career in the sell-side community. And when I stepped out of that role, I wanted to bring somebody in who I'd…

Great. Thanks, Dan. Flipping to Slide 7. Third quarter 2020 sales were up 2.5%. Like last quarter’s strong sell-through of safety products offset weakness in our traditional manufacturing construction customers. Sales of safety products are up 34%. Sales of state and local government and healthcare customers grew 131% in the period and this certainly includes sales related to COVID mitigation. However, we're also seeing restocking, pre-stocking and share gains as we received follow-on orders from customers that we added in the second quarter. As a result, we're not characterizing strength here in the third quarter as surge as the reasons behind our customers buying have become much more varied. We do view this favorably, however, as it affirms our belief that we will be able to retain relationships that began in the chaos of the second quarter. That is likely what allowed us to outperform our original expectations for safety growth in the third quarter. All other products declined 4.2% including fasteners, which declined 6.9%. This represents deceleration in rates of decline as the economy has reopened and production has rebuilt following the disruptions of the second quarter. In fact, we saw sequential low single digit improvement in both hub picks and vending dispenses in each month of the third quarter, suggesting gradual but steady gains in the underlying business conditions. At this time, we believe customer activity levels are down mid single digits from pre-pandemic levels. As it relates to the near-term outlook, I think everyone understands that coronavirus is still with us but at this point customers are navigating around the issue without having to close operations. As a result, business activity continues to trend steadily, albeit gradually upward. Against the backdrop of multiple months of better than 50 readings in the PMI and an RVP commentary about…

Thank you. The floor is now open for questions. [Operator Instructions]. In the interest of time, we do ask that you please limit yourself to one question and one follow up before rejoining the queue. Our first question is coming from David Manthey of Baird. Please go ahead.

Hi. Good morning, guys.

Good morning.

I have kind of a long-term question here just to reorient on the growth drivers of the business. Could you update us on how you see the total available market for vending and onsites relative to where you are today? And then a little bit more near term, if you could just give us an update on the LIFT initiative to get some pretty good early returns on the pilot programs and I'm wondering if you're moving forward with those more broadly yet?

Yes, so a few things there. I'm going by memory here, Dave. I think what we've talked in the past about is we believe there's around 15,000 – there's potential for about 15,000 onsites based on what we know today. And what we know today is largely confined to North America. And that's a number we've talked about internally. I hope that’s a number we've talked about externally in the past and Holden’s not giving me a dirty look. But suffice it to say it's a really big market and the reason it's so big is, because of our frugal cost structure, we can find success in an onsite doing $100,000 a month, doing $150,000 a month where most of the marketplace struggles with the onsite model when you get below 250,000, 300,000 a month. Putting one person in an office and doing sourcing is not an onsite in our mind. An onsite is you’re there engaged in their business. But we're able to find success in a lot more places. The vending, suffice it to say, I personally believe the numbers over 1 million but I don't know how much over 1 million and I don't know if I'm a [indiscernible] put into figuring that one out. The wild card on vending is historically vending was about putting in a vending box. And because we were reliant on a third party for vending, it was a separate system from everything else we did. But there's places where we have vending where bin stock works. But we want to illuminate the supply chain. So what we're doing now after acquiring it is we're building the technologies together. So some places we’ll use vending and some places we’ll use a bin stock that has replenishment automation in it. In other words,…

And I might chip in a couple of things, Dave, first on the market size. The numbers that Dan cited were numbers that we sort of derived some time ago. We haven't necessarily updated them on a regular basis, but we do touch base with the owners of those businesses and there's not a belief that anything has changed in terms of that opportunity. In fact, when you hear Dan describe the performance that we have in some of the educational facilities and government facilities, that was not a market that was envisioned in the original study. And so we're seeing – in addition to the opportunity exists in the original study, we're seeing expansion of the potential applications. As it relates to the LIFT performance, right now, we still got relatively few. I think we will ramp up the rollout on that based on the performance. And so we don't have a lot of sort of longstanding metrics that we can hang our hat on. But in our oldest one, we did see things such as the dollars per FTE in those regions get better and the signings improve in that region and quite frankly the service level as measured by the number of returns improve. And so, yes, I think you're right. The initial data from the initial rollouts of the LIFT have been encouraging enough that I think you'll see us put more of those in the market in their various capacities and forms, and perhaps accelerate that in the coming 18 months.

Perfect. Thanks, guys.

You bet.

Thanks, Dave.

Thank you. Our next question is coming from Nigel Coe of Wolfe Research. Please go ahead.

Thanks. Good morning. Thanks for the question. Just wanted to kind of dig back into the inventory reductions and also the tight lid on employee hiring. Given the sequential improvement we're seeing and the optimism perhaps from the field, how long can you restrain employee costs so aggressively going forward and inventories as well? That's my first question.

Yes, on employee costs, remember that restraining of those expenses really is not a function of what we do [indiscernible]. It's really a function of the decisions that are being made by the individuals in the field that are running their businesses, whether that be a branch, a district or a region. So I don't want to give you the impression of a degree of control that we don't by choice exercise in our culture and our model. The reality, Nigel, is the reason that we protected our talent the way we did through what certainly initially looked like it was going to be a pretty nasty downturn was specifically so that we'd be able to move quickly when conditions allowed, and with demand sort of getting gradually better and with our customers increasingly reengaging in conversations about growth drivers, in many respects that moment has come. And as a result, we fully expect that much as we saw in September, we saw an uptick in FTE relative to what we'd seen the month before, I wouldn't be surprised if you continue to see some of that. Travel expenses, I wouldn't be surprised, again, if you saw that come up from where it's been. And so the answer is difficult to answer because we don't control coming out any more than we control going in. Those are decisions made locally. And the field has made great decisions about it going in and we trust that they're going to make fantastic decisions about it coming out that's going to allow us to be both disciplined with expenses, because let's not forget we're going into a volume challenge seasonal period and we're all aware of that. But I think they're going to be able to exert a great deal of discipline over…

We call that a good problem.

That's a good problem.

Okay. Thanks.

Thanks, Nigel.

Thank you. Our next question is coming from Ryan Merkel of William Blair. Please go ahead.

Hi. Thanks. First off, Dan, you mentioned the investment in mobility. Just talk about what your vision is for how this is going to help sales and customer service. And then I'm curious what the early feedback has been?

Yes, I’ll give the vision from the team because I do more listening to them than talking at them. Part of it is just to ease things that are basic. So think of when I make a delivery, historically, I print off a bunch of packing slips at the branch and I take them with me and I get those signatures on the packing slips and I bring them back, I file them away. And if there's something that doesn't get paid and I need a proof of delivery at some point in the future, I'm digging through a file cabinet. Now we have signature capture. And now that doesn’t mean we always get a signature because sometimes the person doesn't want to touch the device in a COVID world, so we're working through that but it's – that's a whole bunch of back office – streaming the back office function which that brings no value to our customer supply chain. It's figuring out how to tap into that. Another one is, when I'm out visiting a customer going to – when I'm going to the vending machine, now that we own the technology that is the vending machine, our mobility device talks to the vending machine. And so we're not working with a keyboard -- a really obtuse keyboard on a vending machine to do inventory transactions. We have the device in our hand and it's talking to our point of sale system; incredibly efficiency enhancement. We're using mobility with our LIFT facilities. So I can fill machines and transmit it to the point of sale that it's filled and it automates a lot of processes behind the scene. Another one is if I'm out talking to a customer and they have a question about something, I actually have…

All right, it's very helpful. Thanks. And then secondly, I guess maybe for Holden, I was hoping you could quantify the safety surge in dollars for 2020 that may not repeat in '21. I have my estimate, of course, but I just want to sanity [ph] check it.

Well, I think we talked about second quarter – again when we think about surge, I'm really confining the dialogue to second quarter because I don't really know how you differentiate surge from market share gains from customers that are restocking post an issue or pre-stocking in anticipation – I don't know how to differentiate that in Q3 and beyond. And I believe last quarter we talked about 350 million to 360 million in surge revenue that one conclusion could be that it may not recur, but one thing I would point out and talked a little bit in my presented remarks or my prepared remarks was we are winning business. If I think just about healthcare and government, in the second quarter we had 5,400 accounts that we did not have in the first quarter. Now remember, in our system, an account is not a customer. A customer can have multiple accounts. But we have 5,400 accounts with customers in the second quarter in healthcare and government that we did not have in the first quarter. In the third quarter, of those 5,400, in July, 1,000 of them ordered again. In September, I think 850 of them ordered again, right? So that surge business of 350 to 360, will all of it replicate? I mean, we hope not, right? To some degree, we’d like this whole COVID thing to back off. But some of that is being replaced with regular way business with customers that we raised our profile with that we didn't have that we now do, and we’ll retain some of that. And so I suppose the quick answer is 350 to 360, but I don't think that the whole is going to be that big. But unfortunately, I'm not really sure what that is at this point. We're going to need more time to really sort of evaluate the data and understand the marketplace and how it evolves. I think that's just some perspective that's worth providing.

The other wildcard you need to at least consider is when does the activity we're seeing in Q3 and the activity we're seeing in Q4, when does some of that subside and we get to whatever our new normal of life in this world is? Is it people over the age of 70 wearing masks a lot? I don't know. Is it more sanitizing done or are we back in – two years from now, does it feel a lot like it felt a year ago? Only time will tell. Personally, what we’ve challenged our team to prepare themselves for is regardless of your opinion on when a vaccine may or may not be available and regardless of your opinion on how fast we can produce to provide vaccinations for the population that we have not just in this country or in this continent but in this globe is going to take time. And I feel sufficient to say to our employees we better plan on being in this kind of environment for at least through another 12 months. And how it tweaks and changes and goes up and down between now and then, time will tell. But that's where your head needs to be. And so if that's truly there, that tells me there's going to be a certain level of this extra layer of safety and janitorial products I believe for quarters to come.

And let's not forget as well, because obviously I know the point of the question and understand that. When we're copying against that product, we're also copying against the fastener business that was down 17%, 16%-17% in the same period that --

And 7% this quarter.

And 7% this quarter. So, I understand the point of the question, right? I mean, there certainly is a difficult comparison to be had in Q2, but just bear in mind that we have an easy comparison in fasteners if the market has come back at that point. And we do believe that we have picked up market share and so that 350, 360 doesn't just go away completely because we picked up business we didn't have in Q1 last year.

Yes, some great points, guys. Thanks a lot. I’ll pass it on.

Thanks, Ryan.

Thanks. Our next question is coming from Michael McGinn of Wells Fargo. Please go ahead.

Good morning, everyone. Thanks for the question.

Good morning.

I can start on the onsite. Historically, your branch onsite or consolidation efforts have been somewhat mirrored by onsite signings in those same markets or at least that's been my understanding. Given we're in somewhat uncharacteristic times, what is the net impact on your SG&A this year and maybe next year as the signings pick back up and you see a void left in those markets or anything like that?

The void in the markets related to SG&A from what?

So the branch consolidations, they're accelerating where onsite have decelerated. Historically, my understanding has been you maybe consolidate a branch and a couple of those large customers served by that branch are able to convert to an onsite. Now this is different. Does that maybe kick start things again in 2021?

So the first thing I would say is I wouldn't so explicitly tie branch closings to onsite openings. I can't rule out that there haven't been some branches that have been closed, maybe in small markets where there's very few customers because of onsites have gotten created. I think that probably has happened. But in general, they've been independent decisions. The decision to close a branch has more often been because it's a smaller branch that maybe the path is scaling and it doesn't look today like it might have looked five years ago, seven years ago when it got open. And the onsite decision is similarly somewhat independent. So I would be cautious about tying those two explicitly together that way. I think that they're more independent than you're giving credit for.

The only place that you could make a link is roughly half of our branches, I think it's 55%, are in large metropolitan areas with more than half a million people. And so there, there is some connection, but it's not – think of it more as, as we open onsites in a market like Minneapolis-Saint Paul and we go directly engage with customers onsite, over time it might mean to serve the market in Minneapolis-Saint Paul, fewer branches makes sense because instead of having 30 or 40 branches in the market, we might have 15 to 20 branches in the market and 40 onsites. And so it's really morphing how you're approaching it, but it's more of a case of the one allowed the other to operate in a different fashion and more efficient. So if you don't tie the openings and closings of the two together, does that change your question?

No, I'm all set. I'll take it a different direction from here. So given that you were able to take some early actions regarding stocking ahead of COVID and shown an aptitude for skating to where the puck is going, not where it is and also trying to remain as apolitical as possible, you've always paid your fair share of taxes and you've also benefited from fair and open trade. So looking into '21, what is the most important factor for your business in your mind?

I'll give mine and Dan can give his, but I think it's reaccelerating the growth driver activity. And again, part of that is simply when do customers reengage with us because that kind of shut down during the second quarter as our customers are dealing with some more pressing issues at the time. But those growth drivers is our key to what allows us to gain market share. And so when Dan talks about the hundreds, the hundred vending a day and the hundred onsites a quarter, I think sort of getting back to that level, give or take, of signings for our growth drivers is critical not only for 2021 growth, but probably more importantly for 2022, 2023, et cetera. We're built on growth drivers and growth and those are sort of core to it. So that's I think a very important element for us right now.

Michael, I love the way you asked the question. You have an apolitical question, looking for an apolitical answer. I only wish our media on both sides of the fence could do the same. And from my standpoint, we're a supply chain partner to our customers. We operate in the same environment, all of our peers do. We have no unique advantage or not – we have no unique advantage or are not uniquely hurt by anything that changes. We react to it. We reacted to COVID. Because of our decentralized nature, because of our true belief in people and giving them the freedom to make decisions, we just move faster because we're not looking – everybody isn't looking to somebody else to tell them what to do. We do and we support each other. And so if the trading patterns between nations on the planet changes, we will morph to that change just like our industry will and just like our customers will and the marketplace will, and I think our actions over the last several years in a tariff environment and now in a COVID environment demonstrate the sheer strength of the Fastenal distribution model as a supply chain partner to our customers.

Thank you. I appreciate the time.

Thanks. It is five minutes to. I think we have time for one quick question. Let’s do one more.

Our next question is coming from Hamzah Mazari of Jefferies. Please go ahead.

Hi. Good morning. Thank you for sneaking me in. My quick question is just at a high level if you could just compare what does the sales cycle look like today during COVID on onsites, I know you mentioned sort of 62 signings, but versus pre-COVID? Is the sales cycle just pushed out by a few months? Is it longer? Is it sort of an in-person type meeting you have to have? Just give us a sense of is there pent-up demand here from signings that were sort of midway through that got essentially closed due to COVID and will reopen? Just any thoughts high level as to the sales cycle?

Yes. I don't think the sales cycle is changed at all, assuming you can do a sales cycle. And what I mean by that is, there's some business – when times get crazy, some people kind of duck their head and say, okay, let's figure out who we are. It's status. It's kind of like in the movie Apollo 13 when everything's falling apart in the rocket going to the moon, okay guys, what’s the status? What do we have on the ship that works? And that's what a lot of companies go through is they kind of shut down and they say, okay, what are we doing? And Fastenal, we're going to give you the Heisman and say we can't talk today. So it's not that the sales cycle is drawn out, it might be the sales cycle doesn't occur. And so the real question is, when does it start to occur? One of the things that hurt us in 2020 on top of COVID is an outgrowth of COVID was we didn't have our normal customer expo in the spring, which is a great igniter for change because you get a chance to really engage with folks and you really are able to talk about what we are. We're not an e-commerce platform. We're not somebody you hop on and if we have it great and if we don't, you're kind of SOL [ph]. We are your supply chain and we’ll find stuff for you. And so we're slowly – our customers are willing to take that call even if it's a virtual call. It doesn't have to be in person. It's nice if it is, but it doesn't have to be. In some ways, we might move faster in a virtual world because we're not waiting for…

Ladies and gentlemen, thank you for your participation in today's event. You may disconnect your lines or log off the webcast at this time, and have a wonderful day.