Q4 2019 Earnings Call
Greetings and welcome to the Fastenal 2019 annual and fourth quarter earnings Conference call.
At this time, all participants are in listen only mode.
A brief question answer session will follow the formal presentation.
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Please note this conference is being recorded.
At this time I'll turn the conference over to your host Alan itself Assistant Controller, Alan you May now be gets.
Welcome to this ethanol company 2019 annual and fourth quarter earnings Conference call. This call will be hosted by Dan Florness, Our President Chief Executive.
The call last for up to one hour and we'll start with a general overview of our annual and quarterly results and operations for the remainder of the timing open for questions and answers today's conference calls a proprietary fastenal presentation is being recorded by so no recording reproduction transmission or distribution of today's calls permitted without fastenals consent. This call is been audio simulcast on the internet.
Yeah, the Fastenal Investor Relations home page that stirred up fast and all dot com.
A replay of the webcast will be available on the website until March 1st 2020 at <unk> <unk> Central time.
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 that we undertake no duty to update.
It is important to note that the company's actual results may differ materially from those anticipated sectors 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 like to turn the call over to Mr. Dan for.
Thank you everyone and thank you everybody for joining us for our fourth quarter earnings call.
You know Oh last.
We'll be filing our Pan report here in the early part of the first half February and so last weekend dose drafting the letter to shareholders employees for inclusion in that and report.
Yeah, and one of the out through the basins contained in that letter.
As a comparison of 2019 2015.
Because when I was.
When I'm running that letter I typically will pull back and we read a few letters and one reason you do that is so you're not to repetitive. Another reason to do that to see what observations jumped out at the time.
Back in 2015, we started out the year with an eye PMI index, a 52.6% that's the average in the first three months to the rest we dispose back then I'm not sure if there's been adjustments to the P. my sense that.
We ended the year, just just shy of 49 I believe was 46.
Yeah in 2019, we started the year nobody <unk> 50, 55.4 in first quarter.
In Q4, we were at 47.9, so and we've been sub 50.
So since August .
If I look at it using an internal benchmark or an internal yardstick.
And I looked at our top 100 to customers in this group represents about 25% of our revenue historically.
In the first quarter of 2015 about 72% of those 100 customers were growing.
By the fourth quarter that number was 49%.
And given our size what relationship with each of these customers the change and trends and I went to like that is usually more about their underlying business then.
Fastenal, gaining or losing market share with that customer.
If I look at that same statistic in 2019, we started the year at 81%.
We finished the year at 57 again, it's looking at the percentage of our top 100 customers that are growing with us and I think that's a great barometer on the marketplace.
Yes, I ate yesterday in our board meeting one of our directors asked if you're looking at Q4 and the question was looking for my comments, you're sticking to go lives on 2019 in general, but when you go for a great on the quarter.
And what have you might be on it it's that kind of thought I looked at them I said, you know what I'd give it a b.
And the biggest reason for the D. is we did not leverage our earnings in other words are operating income growth was less than our sales growth.
Yeah, I, just can't give an aid or that performance Oh, so I agree that it'd be.
However, if I look at our team leaders throughout Fastenal and the execution of the team throughout the organization.
I think given the up given the subdued.
Activity has indicated externally the PM in PMI index.
As well as internally in our top 40.
Top 100, I believe the I believe the blue team executed well in fourth quarter.
Our December as you all know for Reed not release December was was it was a tough month, we grew 1%.
The mid week holiday over over Christmas was not our friend.
The January and yeah.
It's been doing that's been a pass all for 24 years.
And that means I have done just shy of 100 earnings calls.
And there's one thing we don't do we don't talk about current month in the current monk I'm going to break that rule.
January started with a mid week holiday.
I'm, not Thursday, and Friday, the second third.
Well, it's not our friend and we really haven't recovered from that and I expect at this point January will feel a lot like December .
I don't know that means will be 1%.
But I think it's going to feel like December did our sales team.
It's adamantly opposed to that they see reasons why.
We'll do better and.
Time will tell I hope I genuinely hope they prove prove my expectation wrong at this juncture dimont, but I'm just sharing that.
[noise] this has absolutely no bearing.
On my thoughts for February .
For for 2020 in General time will tell what the economy is is going to is going to provide for us and what headwinds are traded or tailwinds are created.
But but December ended with mid week holiday in January started with one so I wanted to make that observation.
I'm flipping over to Oh Holden Flipbook.
The.
You know the for the I've I've touched on that second bullet, we're really talk about a you know December weakness and up in the impact of the holiday timing.
You know despite everything that's going on in my comment about.
My belief in the blue team and the and being impressed by they're executing ability, we leveraged our operating cost and fourth quarter.
We continue to focus on controlling our costs.
Not as a means just for the expense.
But to put us in a position where we can continue to invest in our growth drivers.
Because we still have incredible opportunities for growth, we have a relatively small marketshare and I truly believe we have a better supply chain model for our customers.
The as we've talked about last quarter.
Moderation challenges of inflation, and terror and tariffs and our ability to manage through it has stabilized the price cost.
Holden violated rule last quarter and that he talked about his expectations for gross profit I suspect you won't do that again.
But what time will tell but up but one observation I'd have for everybody listening to this call.
Don't get caught up in them and new show.
The real issue in Q4.
Our sales fell off a bit more than we expected and we have an incredibly large.
Cost trucking fleet that operates and whether we're bringing one pallet or three fourths of a pallet product to a branch we're running a truck it's still a stop.
And that de Levered more in the fourth quarter than we expected.
Well to add little to the two that pain.
Our freight revenue also weekend.
That's a short term execution issue.
If I would attribute to anything I think there's a bit of fatigue and your organization from all the tariff and pricing in inflation energy that we had we had expelled in the in the summer and fall months and I think it showed up in our fourth quarter. That's it that's an execution issue on on fast on and that's on me.
But don't get caught up in the militia of other gross profit attempt to the percent toward 20 basis points. It de leveraging of the freight network.
And that happens always in the fourth quarter. This year was a little bit more acute.
[noise] slipping to the case for a full of slip book.
On sites, we signed 362 for the year.
Our our stated goal was 375 to 400 came in just shy of that we ended the year with 1114 active sites about a 25% increase from end of last year sales growth. What this group and this is excluding transferred sale. So this is looking at Peterborough. So if we have a 30000 other customer that told.
Well the brand should we go on site, it's looking at dollars above 30.
Was up in the low double digits I ask you get appreciate.
Our more mature on sites, we didn't see some degradation and that's a sign of the economy.
Going to 2020, our goal remains 370 or 400, we're really excited about this growth driver in our business.
Oh, one market locations were 3228.
Versus 30 121 at the end of last year.
We close or converted 36 locations traditional branches. We also closed 26 on sites in the fourth quarter now.
Probably raises a few questions in many of your eyes.
Here's here's a couple of things the always keep in mind Belfast and all.
Some organizations prefer only showing pretty pictures.
Some all organizations only prefer talking about good thanks.
We talk about the real we talk about the the things that that the change we address today's issues today one of the one of the things the team at Fastenal has learned to live with over the last five years is every year I share with them.
What I consider my top 10 suggestions on life things that I learned from a.
From friends and family as a kid.
And and that includes and where I grew up family was also your neighbors.
It includes a teachers and coaches else blessed to have in a in my life. It also includes the people you associate with in your adulthood starts with your spouse sense. Your kids it but it also extends extends the friends and associates you come across.
Number five on that top 10 list is make great decisions.
Share the reason why and start today.
If we have an onsite location, where that customers businesses downsized, maybe they close that facility.
Maybe the economics don't work and we decide to take that relationship it little bit back into the branch that's not a sign of failure.
That's a sign of wisdom.
That's a sign of saying how are we allocating our resources and what's the best resource allocation for our customer.
For our next customer for our people.
And for our business and I consider those decisions to close an onsite that doesn't meet the requirements.
To be a good decision provided we don't think it's an recover in reasonable timeframe.
Exiting an onsite doesn't mean you don't come back.
Doesn't mean, you lost customer relationship it just means the economics for being on site.
Aren't holding true right now you take a step back.
I think that's a great decision and we will make those decisions every day.
From a bending perspective, we signed 50 144 devices in the fourth quarter.
Essentially inline with our and 21 857 for the year essentially in line with our goal of 22000 devices.
Our installed base ended up at 89 937.
An increase of about 11% from last year and our product sales through those devices were up in the low double digits.
In the order of avoiding confusion or one year, we celebrated vending machine number 100000. This.
This 89 937 includes machines that are principally.
Producing product sales, we have another 15000 devices out there that are leased out to customers for check in checkout purposes, just to clarify that finally ecommerce our sales grew at a at 25%.
Q4 to Q4 for the full year, we were up 32.
And this includes a 35% increase or their national account customers.
The way, we think about e-commerce .
It's about making our business a little bit more efficient every day.
Because.
As our supply chain partnership with our customer growth most of our business activity is coming from.
Spending from bins docs.
There were where the customer really isn't ordering the product and we keep step in deeper and deeper into the business. Today. Those two pieces are about 30% of our revenue I believe in the future that number will more than double as a percentage of our business has become Lauren and in trends that our customers business. This is really a reflection of.
Stuff the customers order outside of that supply chain window, the nonrecurring stuff with that I'm going to turn it over Holden great. Thanks, Dan Good morning, I'll, just jump right into slide number five.
Total sales were up 3.7% in the fourth quarter, which included a particularly poor December grows. The just 1% December was affected by holiday timing it extended customer shutdowns, but even setting. These aside business activity was generally soft throughout the quarter. This was reflected as well in the macro statistics with the leading U.S. purchasing managers index.
Averaging eight contractionary 47.9 in the fourth quarter and printing a 47.2 in December .
Yes, industrial production swung to a decline of 1.1% in October and November manufacturing was up 5.1% heavy equipment lag that 1.4% growth with weakness as well in oil and gas metals and transportation.
Construction was up 3.1% in the fourth quarter consistent with the third quarter.
Larger construction customers again outgrew smaller ones. So we have seen a moderation in the rate of contraction in those smaller customers.
In the fourth quarter 2019, we sustained the pricing that was implemented and realized in the third quarter of 2019 as a means of offsetting general inflation and tariffs clearly things could change, but as we enter 2020 weaker end market demand and a more encouraging tone around trade policy has reduced inflationary pressure.
From a product standpoint, non fasteners continued to lead but did decelerate with 5.1% growth in the third quarter, while they're more cyclical fastener line was up 1.8% from a customer standpoint national accounts were up 8.2% in the quarter was 57 of our top 100 accounts growing no national account sales actually contracted in the period, just 54% of ARPU.
Branches growing into fourth quarter.
November and December can be difficult months from which to draw conclusions about the future and that is certainly the case. This year. However business conditions, clearly remains sluggish and the feedback from our regional leadership remains cautious on the early part of 2020.
Remains our intention to take advantage of this environment to continue to invest in our growth drivers even as others pullback.
Now to slide six.
Our gross margin was 46.9% in the fourth quarter down 80 basis points versus last year. This annual decline is primarily a function of product and customer mix. The 30 basis points declined sequentially was in line with normal seasonality, though we were a bit shy of our expectations that gross margin would be at least 47%. This is primarily a trivial.
The freight as Dan commented on.
Well the cost of maintaining our captive truck fleet is fairly stable quarter to quarter, our ability to charge for freight to partly offset those cost can vary depending on market conditions in the fourth quarter of 2019, our freight sales declined 7.5%, which resulted in less absorption of our fleet costs than anticipated.
With our pricing sticking from the third to the fourth quarter and with weakening demand, causing inflationary pressures to moderate price cost was not a meaningful variable one way that your other affecting gross margin in the fourth quarter of 2019.
Our operating margin was 18.7% in the fourth quarter down 30 basis points year over year, we believe the blue team did a good job controlling expenses as SDMA as a percentage of sales of 28.2% was better by 60 basis points at a record low for a fourth quarter.
However, as we have commented before given our attention to continue to invest in growth drivers, even as conditions slow it will be difficult to defend the operating margin when growth eases into the low single digits, our inability to leverage occupancy cost in the fourth quarter of 2019 or a perfect example of this with current growth not being sufficient to produce leverage over the vending investments.
Driver market share gains.
Looking at the other pieces of S. DNA, we achieved 2030 basis points of leverage over employee related costs, which were up 2.4%. This was largely due to reduced ft growth of 1.4% combined with lower performance based compensation the period.
The current environment, we would expect further low single digit growth going forward.
We realize 30 or 40 basis points of leverage over general corporate costs with lower bad debt expense and the absence of certain legal and structural expenses incurred in the fourth quarter of 2018, offsetting I hire I T spending in the fourth quarter of 2019, putting it all together, we reported third quarter 2019 S 31 cents up 5.44%.
From 29 cents in the fourth quarter 2018.
Turning to slide seven looking at cash flow, we generated 252 million an operating cash in the fourth quarter or 141% of net income higher earnings combined with lower working capital needs produced the cash flow full year cash conversion was 107%.
Net capital spending in 2019 is 240 million exceeding our targeted range of 195 million to 225 million the sources of higher capital spending in 2019 vending trucks and hub capacity were planned the overshoot related to our addressing a number of facilities in 2019 as a means of managing a sharp increase in our volumes over the.
Past three years at a couple of those facilities simply coffee more to complete than we anticipated.
In light of weaker macro conditions, we expect net capital spending of 180 million to 205 million in 2020.
We paid nearly 500 million in dividends in 2019 and increased our dividends for the first quarter of 2020 by 13.6%. We finished the quarter with debt at 11, and a half or set of total capital below last year, 17.8%.
Inventories were up 6.9% in the fourth quarter of 2019, nearly three quarters of this growth related inventory to support Onsites hub inventory growth slowed sharply a function of both deliberate effort to reduce inventory as well as weaker demand while field inventories were slightly down.
Setting aside the impact of demand we believe there remains further opportunity to improve our inventory days in 2020 <unk>.
Accounts receivable grew 3.9% in the fourth quarter of 2019, the slowest rate of rent increase in more than three years, which largely reflects slowing demand.
Mixing customer behavior will likely continue to influence a our days in 2020, but our expectations being flat to slightly higher days. We believe these factors will continue to produce good operating and free cash flow in 2020.
That's all for our formal presentation, so with that operator, we'll take questions.
Thank you at this time will be conducting a question answer session.
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Thank you and our first question is coming from the line of Ryan Merkel with William Blair. Please proceed with your question.
Hey, Thanks, good morning, guys.
Good morning warning.
So first off in terms of price capture you said it was consistent with last quarter. So I just want to confirm does this mean pricings up 90 to 120 basis points, and then sort of a related question I recall that you thought you'd get some incremental price into fourth quarter did this not materialize and why was that.
That's the case.
No so what I, what I would say is if if.
You know the impact of price in the fourth quarter is probably the neighborhood of 70 to 100 basis points, there, which would have backed off a little bit for where Q3 was but again much as we saw much of the year that reflected having to grow above some increases from last year. If I look at the overall price level in our business in fourth quarter.
It was slightly up from where we were in a in the third quarter.
So we look at the the overall pricing activity from Q3 and for the most part I would characterize Q4 is living up with our expectations as it relates to the price side.
Okay.
So the bottom line and I was maybe picking up there was maybe a little price pressure starting to materialize, but that doesn't seem to be the case just yet.
We we aren't seeing price pressure materialize now what were commenting on has more to do with inflation remember what we've said as we've had two things affecting us over the past 12 months. One was the generalized inflation. The second was the tariffs and frankly, the generalize inflation was a much more significant impact on US then done the tariffs work what we are seeing.
It is when some of the a the activity around tariffs of late in Miss with the overall a slower demand level. Some of those inflationary pressures that they're part of our business for the past 12 to 18 months have begun to moderate.
But that shouldn't be read to suggest that we havent a you know maintained our pricing that we.
Achieved in Q3, because we have.
I'll just add a slight color to that when I first off there's always price pressure.
That's that's a constant in life and that it it's intense now.
If I, if I, if I, but I believe that comment again any quarter.
The one one element that does exist in the fourth quarter that does exist in the first quarter is.
Keeping the facts straight and the confusion at a minimum and what I mean by that is.
We've talked in prior calls and we've talked internally.
Continuously.
About the the tariff and anti dumping duties that are out in the marketplace. You have a to 32 anti dumping as it relates to steel and aluminum that was put in place.
And then you have the thrill one tariffs so the thrill, one tariffs and and and I get an update on this every two weeks.
And even that's not enough in many ways because there's a there's so many pieces that are flying around.
I suspect if I'm in a branch in Fastenal I'm I'm, having a customer talking to me in December and saying Jeez you get all the the tariffs were just.
Eliminated.
No. The list for B that never went into effect that was had been postponed was cancelled on December 13th but that number went into effect and that was largely consumer goods. So that the impact of that is less than our world. Then the next kind of might be well list I thought it went from 15 to seven and a half.
Well I.
It was just announced that list for a is going from 15 to seven in the house and its taking through that piece I'm for us the bigger one was frankly lifts three nothing's changed unless three so our biggest challenge internally.
He is to make sure that an individual on a branch branch manager.
District manager, a regional leader a national accounts person.
He is familiar with these pieces as as as what I just laid out.
Because when you're familiar with the facts you can have a discussion if you're not it's very difficult to have a discussion about it so that price pressures there primarily because of all the noise and confusion that can come into the marketplace.
And a lot of the misinformation that can float around.
But the fact is for be never went into effect for Aon has just announced that its dropping.
And and Ah, but three less three as to where the is where the dollars are at least for our marketplace West one of the unless it was two or less meaningful.
Yeah. That's helpful color you I think we're all started interested to see how that realizes it tariffs are removed what happens with pricing such but I guess TBD on that.
And then on the on site you mentioned the closings and you mentioned the economics I'm curious is the reason for the worst economics do the slowing economy or is this more the local team didnt assessed the opportunity correctly and this is something you can fix.
I, but I think it's typically economic I'm sure. There's examples of ones that are that we that we decided either up to.
To.
Pull it back because it didn't materialize as what we thought keep in mind I I know and I've used. The example, before I remember traveling with the district manager several years ago.
And he had an onsite that when when we were driving to the onside. He said yeah and this this individual knows as much about onsite has anybody in our company.
It is based in Wisconsin, and he said.
He said you know I'm I'm thinking of this one and I'm not really serve as a good idea or bad idea, but here's why did it he talked about going onsite.
Talk about what the relationship was any talk about where he thought he can get into.
And he thought he can get it to 75000, a month, which is a small on site for us, but he's had a real Frank discussion with the customer.
That that you know what I'm only going to go to staff at this many days a week, but again the freedom to move the branch a little further north in Oh, It was a better location for the branch.
There he was looking and saying if it doesn't work out I pull that back into the branch as it turned out he got up to 75.
And a couple months later is something message and said Hey, we picked up some OEM parts and we're going to get it over 100.
That change occurred because the customer loved what we're doing.
And they figured out ways to buy more from us.
Doesn't always happen and so sometimes you might have one where you're going in on onsite and you think you can get attacks and if you find out that you can only get halfway there that 30 got the 80, but you can't get to 130 any pull it back I don't consider that failure. We took a 30000 other relationship through the 80 rabbit and we're having a frank discussion with the customer.
It's easier for us to service that from the branch.
Consider that we're engaging with that customer wants when and if that's one of the 26 I'm fine with that.
I'll add a little color to that as well, but I think looking at the causes of the closures. This quarter. There were really no differences versus the ones that we covered with the last quarter right. So it's all sort of the same reasons and we have to remember that in those as Dan alluded to some of those are simply taking business that we had an onsite and moving it to a branch.
So as I said, we didn't see anything different in sort of the character of those closures.
And I think you have to think about the larger installed base. Yeah. Once you get to a certain level you do review that base for Underperformers and again, a data, saying I think thats a healthy a healthy transition, but I think you should also think a little bit about the culture of the business. I mean, if you think back to vending I think we started that initiative in 2009, it really began to get get legs and.
2011 in and in 2016, we sort of went through and we looked at all the machines, we put in and said so this machine really be here right and that year, we had a higher than normal sort of removal rate than we had seen in previous years as we sort of evaluated the installed base and you know we're in fifth year.
Oh, this onsite push and I think that our culture in some respects is just sort of find these growth drivers run fast grab ground and clean up a little bit later and at the end of the day, what you're seeing right. Now is we built a good installed base. We're evaluating what we have the churn has gone up a little bit.
It's down from Q from Q3, and frankly, I think we're expecting a lower rated churn in 2020, we'll see how that plays out but in the end what you wind up getting much as he did with vending is a great business, where we're ahead of the field in terms of being able to implement it and it contributes to gaining market share and we're looking at this very much the same way the other thing.
To your point about you know opportunity.
This past quarter, the onsite team to actually sampled 400 locations I'm not sure. What is 400 those are but they wanted just to get to the same question that you're asking and you know these were.
Recently sized EUR 400 on sites in terms of the average, but they found that in the products that we currently deal in.
There's still more than two times the revenue potential than than we already have in those onsite and again these are smaller on sites.
So the potential.
It is if we don't see any diminishment in the potential for this business and I think what you're seeing us transition to I would say is historically consistent with how we execute our growth drivers is leading to have a great business.
Makes sense. Thanks, that's it on yep.
Our next question is from the line of Robert Barry with Buckingham Research. Please proceed with your question.
Hey, guys good morning.
Good morning did you say you're could you how much the freight was a headwind to gross margin.
It.
It probably impacted us by 10 to 20 basis points relative to the expectations and you think it now that just goes away or that persist as long as the sales growth is low single digits.
Well I think as long as sales growth is low single digits, there's going to contribute some pressure there for sure and that's not new and that's not necessarily unexpected I think Dan also talked about you know we just have some focus to bring to that right. We spent a lot of effort in the last 12 months on.
Pricing discipline on the product side of our business and the degree to which you've seen us not really have to talk about price cost is a direct result of the success of that right. We've been able to mitigate some of those inflationary pressures, we need to bring some of that discipline to the freight side of it as well and that's going to be a focus in a goal for 2020.
And the degree to which it is or is not a drag.
Well it will depend on our level of success, but again.
You know, we always have to put this into perspective, we're talking about 10 to 20 basis points now we want those tend to 20 basis points right, but you know we're not talking about 100 basis points of riskier 150 basis points. On then we're also talking about something which is related to an asset that being our captive fleet, which is a huge.
<unk> competitive advantage for us.
So there are things that we have to do better. Its you know the focusing on that what will be something we do in 2020, we do have to address the that the market that doesn't make it easier, but there's some things that we can do for self help standpoint, and yeah, that's probably I would characterize the situations freight.
So rob the only element I'd add to that is.
Part of it is is about yearoveryear growth the part of its about sequential.
So if you think about where we were in October to November December the de lever that occurs because you have this infrastructure to support that going to falls off history has shown where January is relative to October and depending on what the start of Janney, where we'll be in that and that normal.
Landscape will still come into play, but but it but once you were emerged from that that slowdown that you get around the holidays and you get further away from that and the dollars climb back then that then that de lever that occurs from our our distribution our trucking freight they're talking fleet.
That dissipates because.
We are we not only oh want that tend to 20 basis points back message to our team is excited here is when we expect to get it back.
At this point don't don't forget seasonality as well right again, the crux of the issue is that you have relatively stable costs in your fleet you know it and seasonality is you get into Q2 in Q3, you get a seasonal uptick as well just naturally so.
He is right part of this reflects simply the the seasonal nature exacerbated by the cyclicality.
That is an element of it but we're going to work on next executing a better as well got it I guess bigger picture you know where do you see price cost going from here. It sounds like if the non tariff inflation was actually the bigger piece and we're seeing commodity deflation.
I don't know how do you think about the puts and takes because I think you said the tariff inflation will peak in Twoq, you, but if you're seeing some meaningful commodity deflation like steel I mean could you see price cost I don't know even be modestly positive see any line of sight to that or how should we think about it tracking.
Hey, Rob I'll make a deal with yet [laughter]. If you can tell me what what tariffs are gonna do in the next six months I'll tell you what I think our reaction is going to be I've had numerous times over the last year, where I have a discussion on Friday and by Monday, what we just talked about it completely changed into discussion became a relevant.
So I'm going to respectfully decline to answer that only because.
I don't I don't know sometimes from week to week in month to month, what's going to happen with tariffs in it. It makes it you know the economy I can look at trends and look at prior years and fast on like at least give up.
And in form thought I'm tariffs, we really can't yeah.
All I know as we focus every day.
On setting the best light weekend for our customers on building the best supply chain for our customers and where where appropriate moving sources of supply and that we've done quite aggressively and less to.
10 to 15 months.
And the only thing that I'd, probably add add to that is.
Over the past six to nine months the pricing teams the way they've been sort of structured the work they've done to sort of surface a lot of our challenges the tools that they deployed to to allow us to react to events.
We're in a far better position today than we were a year ago to manage whatever happens right. So to the extent the parents go up or go down we'll be able to adjust to that in the way that we promised our customers that we would and that would be with an eye towards maintaining that price cost dynamic.
Inflation deflation and again you know <unk>.
Well, how sad to see how that plays out but I think that it really is it's the other side of the same coin right I mean I'm many of our national account contracts have terms in it better that are linked to specific steel price indices or what have you into those conversations get had in the end to question that you know.
We have to deal with with our customers is what's the right action.
To again be able to neutralize the impact on gross margin, we're not trying to take advantage of our customers.
But the same time, we're just looking to what to deploy the tools that we developed over the last few months last couple of quarters odds it to essentially neutralize the impact and that would be the intention, but again love to see how things play out as the year goes on.
Okay. Just lastly could you say have December rocking that'll flow battery on that Hey, Rob yes, Okay towns.
Yeah no problem, okay. Thanks, guys.
Yep.
Our next question is turned in line if David Manthey with Baird. Please proceed with your question.
Hey, guys morning.
Oh over the past couple of years. Your your gross margins pretty consistently been down 100 basis points year over year, and some of that secular or some cyclical I'm just as we look ahead to 20 Twond. He gets the decline is less than that what would be the factors you would see this is driving.
Better outcome.
Yes, So I think there's there's two things to think about next year in terms of big big sections, and assuming that the price cost dynamic remains neutral.
As it has been the last couple of quarters.
And that's obviously a depend on anything that occurs that we have to react too, but we don't know what that looks like they told me know today.
I think that's with the slower.
Small customer business, where we have fairly good margins, you know and expectations for growth on the on site I think you're looking at mix, probably being a 50 60 70 basis points drag next year.
Now that could change depending on the relative growth between the small customer in the large customer, but that's that seems like a decent range to me.
I think because that we also have to think just about the cadence of the price trend from 2019 right I think in the first half we did not do a great job addressing inflation and addressing terrorists, especially the better job on tariffs, we did inflation, but the in the second half I think who did a very good job on that.
And I think that success will carry over into the first half a 2020. So you might ask an easier comps in the first half of 2020 before that sort of normalizes in the back half and.
I think those are the two big things to think about when you're thinking about how to model. Our gross margin next year and then you know yeah. I think those are the two big things to think about at this point.
The.
What I'd add is if if we're able to.
Shallow let out.
It's from things that we're doing.
Specifically inside the organization related to some of the products for example.
Were challenging and then this is ongoing.
These challenging our folks from the standpoint, if I think of our vending platform. So that's highly repetitive transactions.
How do we how do we channels much of the spend.
To our two too.
Just a select group of preferred branded suppliers.
And our own exclusive brands, our private labels from the standpoint, but it's not just about the cost of the product. It's about the cost of the whole supply chain because its product we have on the shelf if it's on the shelf our distribution centers operate more efficiently, our trucking network and our freight cost or more efficient our local labor costs.
Some more efficient and the first two of those three pieces impact our gross margin. The third obviously is an operating expenses the branch labor.
But it allows us to have a product offering in that machine or in our our ongoing supply chain offering.
Where we can offer a better price to the customer because our cost structure is inherently lower and that typically helps our gross margin. So we're sharing some of the benefit with the customer. So it's a win win scenario and we're driving more spend to our preferred suppliers.
Great. Thanks, guys.
Thank you.
Our next question is from the line of Nigel Coe with Wolfe Research. Please proceed with your question.
Thanks, Good morning, guys, great great color on the gross margins Hogan I'm just thinking about you know you know when we give quarterly guidance, we normally see gross margins among two pretty flat it feels like cubic here. This it sounds like that holds true Q1 20, aneek any come so that's.
Well a couple of things first I I would dispute the idea that I normally give forward guidance.
Dan commented on how we rarely talk about the current month in the current month, because you know it's hard pressed to know what what's going to play out until till it's all said and done but sometimes things are moving in a direction, where you deserve a little bit of guidance.
And for the last two quarters I've, given you a little bit of forward guidance on the next quarter, because we had a lot of moving pieces as it related to the inflation the tariffs or success around pricing et cetera, and you know when your second quarter gross margin is down I think it was 180 basis points. You know I think you all needed a little bit of guidance about what we were seeing in expecting it so I provided a little bit.
That color, but the idea that we usually provide that color I would disagree with that and I'm not going to get into that game now that frankly, I think most of these moving pieces are kind of stabilizing out. So I'm wondering moved by saw from that game until.
A future period, where there's a where there's a lot of volatility that you need a little bit of guidance on.
But you know you ask you about the seasonality you know it at this point if I assume that.
The trends in the back half of 2019 or sort of the ones that will carry over into 2020, we sort of a neutral price cost dynamic and then our usual mix piece and you know and all that I I you know I think that.
Judge what you think the seasonality is going to look like and I think thats a reasonably it.
That's a reasonable way to approach.
The cadence of the quarters.
Okay got I didn't mean from the was the amount, but thanks for the coming Hogan.
[laughter] just my questions around the attrition on your own side. So I'm just now that we've got so base of over thousands you know something some level of attrition is normal and should be expected I'm. Just curious if you. If you can think about what do you consider to be you know I.
CEO CFO , a normal rave attrition going forward as it is 2% the quota the right number so is it lower than that but maybe also can you just clarify the freight issue. It sounds like that's you know I understand the seasonality and on the absorption, but that that this sounds like it's more of a price and the you know obviously, we see an LTL.
Oh rates, obviously down I'm just curious if if we should be tracking price of freight volumes are the proxy for what's going on on that side of your business, but my real question is on the attrition on your insights.
Yes.
I'll touch on the onsite attrition and the cycle on my count as a third so I'll let.
Finally on sale will take through that one night, if I think of I'm going to answer it first in the context amending.
And then I'll transition to onsite. So if I go back a few years ago, Holden mentioned and and 16 number of vending machines were moving it actually started before that so in 2012, our vending really took off and we pulled out if you look at that number we had ended 2012 and I'm going to be pull out 2013. It was 20 some part.
On to the devices, we pulled out because we've gone from a handful of.
District managers doing on doing vending to a big chunk of district managers doing vending and a big chunk of our branch is doing vending and you know we didnt really haven't Dal then what I should go and because it was a new industry we're creating.
And that 20, some number was 20 some number was 20 some percent the next year.
And then it dropped I think the 17 I don't have a stats in front of me, but but then it dropped to 16, we believe long term that numbers kind of settle in around 10% right. Now we're at about 14, so 14% of the installed base that 89000, we signed in two months ago I would expect.
I would get removed based on history in 2020, and our goal is can we get that down to 10.
If I looked at on onsite historically those back when we had a couple of hundred alone.
Very we'd put we'd we'd close about kind of year, that's about 5%.
I think if I spend elemer sitting here and Chris.
Leads our team that really drives in homes, our onsite model.
The team that that is involved with.
Evaluate our on site I think the number he typically thinks it is about is about 6%.
So how that plays out quarter to quarter is anybody's guess, but it's it's probably in that neighborhood history. Instead, it's gonna be it it's probably five.
A person is more informed to meet thinks it's going to be six.
And the interest Nigel and not encouraging people to ask one question with 12 parks will address your second question when we talk after the fact.
Okay. Thanks.
Yeah.
Our next question from the line of Hamzah Mazari It with Jefferies. Please proceed with your question.
Good morning. Thank you very much Oh My first question is a good morning.
Dan a number of years ago, you know you had something quarter pathway to profit and you know, 23% op margin, what's sort of the goal.
Maybe maybe you know do you view that as achievable still than any thoughts on that target as you look long term.
Yes that was pretty close to that one back in the day I'll I'll touch on that in fact, I talked about pathway to profit in this years.
Letter to shareholders, something a little bit more insight you can gain from that and if you're in a in the early February but.
The pathway to profit was about our branch network.
And about the fact that as our average branch revenue went from 70.
To 80, I'm talking about the revenue per month, so $70000 a month to $80000 amongst the 90 to 100 and beyond as that number went up we had a whole bunch of branches out there that we're doing a 120 150 200000, a month and we already know what the profitability as of that group. So we talked about in 2007 when we.
It is pathway to profit was you know we're opening fewer branches today.
Which means the dilution factors going to go away and the average revenue per month is going to keep climbing in assets climbing the inherent profitability of our branch based model will shine through we had a whole bunch of branches that were in deep into the twentys.
But you see a branch that does $50000 month doesn't have that kind of operating margin brand said does 70 or $80000 month doesn't have that kind of operating margin. So that that 23 is still true for our branch network, but branches represent about 70% of our business today. Another thirtys onsite for I'd say that numbers down in the upper teens.
From the standpoint, or where the profitability is there's still a pathway to profit element of it you know when we go from having 200 onsites that down to 2014 Dabbing just over 1100 onsite today.
That's a massive take off and so our revenue per onsite actually dropped because we opened so many new ones.
And and so we've been living through that for the last 40 years of that de leverage of our onsite business because our average revenue dropped.
We're approaching now an inflection point, where our steady state of how many were adding.
It's going to kind of neutralized and our revenue per onsite when we get later in the 2020 to 2021 is actually going to start inching up and so that will still come into play.
As as the mix changes I, but I see a path to an operating margin where do you have a 50 50 business of a branch and onsite in that low Twentys I've started number at 22%.
Time will tell if I'm right or from full of it, but but but you're the number you cite hamzah. It was really about the branch network, which is a subset of our business.
Guarded very helpful. My follow up question I'll turn it over is on freight how much of a cost advantage is your captive fleet and do you view that cost advantage as off starting execution risk.
Just any berard high level thoughts there. Thank you.
Well the cost advantages a constant so it doesn't offset excuse of risk execution risk stands on its own.
The cost advantage, we've always felt that.
You know running on a highly utilized trucking network, where you have products going by highly utilized I mean, there's probably going both directions.
The number we've often cited if you contrast, what it cost to move it on our trucking network versus shipping industrial products small parcel in industrial and shipping a relatively low value products small parcel is incredibly expensive.
And that's where the e-commerce robots and that's why they keep trying to build different types of networks to change that dynamic. We've often cited a relationship will tend to want.
That it's about it's about 90% cheaper.
But again, we're you know we're moving a relatively low product on a captive trucking network.
Third of our products. So if I look at a faster products, there's a big chunk of that product category that has secondary operations. So it isn't just ever moving it from supplier to the cut to the branch to the customer took from supplier to the customer with the onsite.
We might be sending that that that faster product out for a secondary operations. It's going to go get heat treated so that will get plated and what it means in our faster industry and the reason we built the cap in an effort to start with.
Is.
Many of our competitors because they're using a lot of LTL shippers and other parties don't have that advantage and so there their freight costs in many cases can become equal to if not greater than their product cost.
And so one of the reasons, we enjoy the gross margins were doing fasteners.
And the reason we built the trucking network is we've just built a better means we'll product around.
But execution risk.
There are just connected into standpoint.
Of standpoint of of what you're doing and what do you put your habits you behaviors everyday.
Well, that's what I think it's fair to say hamzah that the value that affords us because of our captive truck fleet.
It's well well in excess of.
A one quarter 10 or 20 basis points.
You know a lower result than we expected I'll be but yet you get huge dividends from the ownership of our captive fleets.
I'm going to dividends we research.
Great very well bank. Thank you very much.
Thanks.
The next question comes from the line of Josh present see with Morgan Stanley . Please proceed with your question.
Hey, good morning, guys.
Right.
They didn't want a few white if you my mind.
Commenting on how we should think about mix and you're kinda historical recoveries. Dan you went off talking about you know maybe the analog to 2015.
That you saw if I were to look at some more points in time, rather you know other periods, where you think it feels like today what is the mix on the way out is it that the onsites recover faster because our captive visit that the you know kind of the smaller customers are non national accounts, where there's higher mix recover.
For a faster just just trying to to calibrate how we should think about mix as markets you know eventually recover.
Yeah, so, but if if I think about you know my my comparison 2015 was more about just the trend in what we're seeing in the numbers. The you gather observation I'd make looking at 2015 is.
In 2019.
We started at a higher point and we finished at a higher point and I really attribute that to the success, we've enjoyed taking market share to faster clip and the backlog we have in energy I mean in the last three years, we've signed either renewals or new contracts rough about 1500, that's it.
Credible Terra we've been on and that build a certain level of just market share gains you get and up and so when I look at our relative outperformance to in 2019 versus 2015 in a similar PMI index scenario. It's it's what the team's done to engage with our customers and we have a mass.
The footprint.
So to the extent that a you know the percentage of our top 100 snaps back and it moves into the sixties the moves into the seventies.
Because of there's a there's a bit of a lift in the economy that piece will snap back pretty fast and our large account are.
Our accounts with a a contract relationship would would grow disproportionately faster because they have contracted disproportionately faster.
And but and that's it that's a shift that's just a reflection of recovery in the underlying market.
So I would I would expect that to play out the speed at which is going to be dependent on what the market's doing maybe holding that's more insight.
Yeah, I mean I think this is an area that I think can be over thought many times I mean, the fact is you know whether it's an onsite whether its non fasteners fasteners most of our businesses essentially all of our businesses are cyclical and so when you see an upswing that's fun talking about upswing by the way I hope it happens, but if you see enough.
Swing what happens is.
You see the growth rate at particularly our older on sites to get better.
Just as you see the growth rate in our smaller customers get better just as you see the growth rate in our fast as a non fasteners get better now.
Does non fastener growth coming out typically maybe outpace I'm, sorry, just fastener growth coming out outpaced non faster growth probably.
Just like you'd outpaces it going in you know, but if you look at page five and you kind of look at the non fastener fastener.
Lines.
There's not a difference in how they move right and they really move in the same direction.
The gap may narrower widen depending on the cycle, but as long as were successful with on sites as long as are successful of ending I don't think you're going to get a a period where mixed works in your favor frankly.
That's how the math works out this is always where I always feel a need as well however to point out that you know if mix is going to continue to work against us.
If we're successful or when we're successful whether on sites in vending and our growth drivers.
You have to remember that we get good leverage over SGN today, one piece of prospective I might offer you is if you think about our gross margin fourth quarter or 16 to fourth COVID-19, I think it's you know is down to something like 300, almost 300 basis points. If you think about our fourth quarter operating margin over that.
Same period of time, it's down 60.
There's inherent leverage and onsites, there's inherent leverage in the pathway to profit asked about earlier.
You know and so.
I wouldn't expect that mix is going to start pushing our our margins up.
Because I mean, I expect will be really successful that growth drivers I wouldn't conclude from that that our operating margins are at risk because there's inherent leverage ability in the growth drivers at the operating expense line as well.
So were not coming up on the.
Oh, so Josh someone else, we're coming up on the hours, so I'm going to unlock the.
So.
During the call to a close I'll just close with one one thought and that is.
And I often bring a personal touch into this I apologize for those people that are rolling their eyes right now, but last the last weekend I had the opportunity to go to a funeral.
Funeral for a very dear individual her name was Lillian Peterson, she was known as till two family and friends.
For me she was both in a way while she was a neighbors who was also my godmother.
Consider that family.
She she was 88 years old.
She's married to the two or husband for 67 years.
She and her husband had six children as you can appreciate the multiples that and grandchildren great grandchildren.
Lives My Oh, My Sunday School teacher, she was the give or have a great advice and affection. She was the a writer of many letters over the years, obviously, many letters from earn as that many others.
Said simply she was a second mom.
I alluded to earlier, the top 10, a suggestions I share with folks over the years and.
As I was that are at or funeral and hearing the story about her life and learning elements of things that I didn't know.
It dawned on me that three she was the incredible influencer on three of them.
A number eight on that lift is trust people.
My exposure, Bob Kirtland put a little later on that as that is incubating cherish ideas.
Number nine on that list is cherish embraced the special words say, please and thank you.
Always say you're welcome.
You are willing to say your sorry.
And show respect for all.
And finally.
Enjoy something outdoors in all four seasons, she loved the ride bikes you'd love to go for walks and she loved the cross country skin in the winter and if you look foolish enough to live in Wisconsin, and Minnesota, you'd better do all you better enjoy all four seasons.
I'll close on that note. Thanks, everybody. Thanks, everyone.
Thank you. This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation.