Q3 2022 Fastenal Co Earnings Call
Press Star Zero on your telephone keypad as a reminder, this conference is being recorded I would now like to turn the call over to Taylor Ranta, a fastener company. Thank you you may begin.
Welcome to the Fastener company in 2022 third quarter earnings Conference call will call will be hosted by Dan <unk>, Our President and Chief Executive Officer, and Holden Lewis, Our Chief Financial Officer, the call will last for up to one hour and we'll start with a general overview of our quarterly results and operations with the remainder of the time being opened for questions and answers today's conference call is a proprietary fashion presentation.
Speaker 1: So I P I.
<unk> and is being recorded by basketball no recording reproduction transmission or distribution of today's call is permitted without bathhouse concert with housing audio simulcast on the Internet via the fastener Investor Relations homepage investor about basketball Dot Com a replay of the webcast will be available on the website until December one 2022 at midnight Central time as a reminder, today's comps.
This 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 companys 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 <unk>.
Good morning, everybody and thank you for joining us for our third quarter earnings call.
The.
We had a good quarter.
When I look at the performance of the team.
Speaker 2: Greetings and welcome to the fastenol 2022 third quarter earnings results conference call. At this time, all participants are listen mode. The question-and-answer session will follow the formal presentation. Anyone to require operator assistance during the conference? Please press start zero on your telephone key Pat. As a reminder, this conference is being recorded. I would now like to turn the call over to Taylor arana, a fastenol company. Thank you, you may begin.
Proud to be a member of the team.
16% daily sales growth that we experienced in the quarter, we were able to translate that into 19%.
<unk> profit growth.
And ultimately we were also able to translated into strong operating cash flow growth, we grew our cash flow of 54%.
From the third quarter of 2021 in the third quarter of 2022.
Speaker 3: Welcome to the fma company 2022 third quarter earnings conference call. This call will once of advan warning are presentident and ief Executive Officer and holding new our Chief Financial Officer. This call will after for up to one hour. We will start with a general overview of ourquarly results and operations, with the remainder of the time we open for questions and answers. Today's conference call is the proprietary fma presentation and is VIE recorded by basma. Yet recording reproduction, transmission or distribution of today's call is permitted without asma consent.
And the expansion of our ability to generate.
Operating cash.
Relative to our level of earnings we haven't been able to to delay.
Lay claim to that for.
Over a year and a half I believe you have to go back to prior to 2021, where you can see that.
And it was it was really great execution throughout the organization and the fact that supply chains have become a bit more stable.
That doesn't mean, they've they've become easier it just means they become more stable and you can you can rely on what youre seeing in your level of safety stock doesn't need to be quite as deep.
As far as customer demand that was stable throughout the quarter now September two 7% sequential growth versus August .
Does lag the way we look at the historic pattern and history would say, we should be up 3% to 4%.
The real driver of that is if you look at the storms that hit the south Eastern United States Hurricane Ian.
Late in the late in the quarter and essentially pushed some business out of September and into October .
The storms likely reduced our sequential DSR by about half a percent.
And so you can do the math on what it would be if thats added back in but.
We see it as stable demand.
And.
And the next bullet touch on the fact that we are preparing for a softer 2023, so I thought I'd share some thoughts on what does that mean now.
Now first off I remember back in the fall of 2015.
I believe it was a Tuesday morning don't quote me on it but the day before we had our board meeting and I learned to after that board meeting that I had been selected as the next.
Didn't see or pass it on.
And it was a pretty tough environment for.
Not just the organization, but for industrial.
Entities in general.
And the next day.
Yeah.
During the Q&A section section.
Was the <unk>.
Probably a little more animated than I, typically am and I commented on what I thought the state of the economy in the next day my wife the info.
Informed me that I was on the front page of the Wall Street Journal, but because I open my mouth.
So we're not in that kind of environment, we're not as something where I'm going to proclaim something but.
But we are preparing for a softer 2023 and.
And a lot of that centers on two things. One one is something that has nothing to do with 2023. If you had been on the call ahead, an hour or two hours ago with our our leadership around the planet.
I've talked I gave them the typical October tuck.
And that is we are a seasonal business.
And if you look at history history says between September .
In December .
Our daily sales typically drop off 12%, 13% and I'm going back to the time before before Covid.
And even before some of the tariff period I'm going back to the 2017, and 16 and 18 numbers and just looking at sequential patterns and that should not be a surprise to anybody listening to this that.
Business that operate in northern North America things chunk of revenue in North North America.
After you get past Canadian Thanksgiving and get to the U S. Thanksgiving to Christmas the business slows down we're preparing ourselves for that.
When we're talking about 2023, it's really about a lot of the numbers, we're seeing and again they are not numbers that are unique to Ireland.
Looking at industrial production and Holden will touch on some of that here later, but looking at industrial production and what some of the.
Forecasters are predicting.
But the most important feedback that we focus on is what is what are our regional and district leaders.
Hearing from their customers as far as their confidence going into 2023 and not to be honest with the group that confidence isn't strong it's not hey, the sky is falling but the confidence is very very cautious and we're preparing for that type of environment and that means that.
Youre very thoughtful about where you invest.
We're very thoughtful about not getting ahead of yourself now we've signed a lot of onsite this year and that gives us resiliency going into next year and I'll touch on that in a second.
But.
But what it means is you staff for the things you know.
But you don't get ahead of yourself on staffing for the things you don't know.
And thats the mindset, we have going into 2023, whereas a year ago and two years ago, we were staffing for both.
And and and it's just a bit of caution in the air.
Last week I was traveling in Europe , My first trip outside North America since before the pandemic.
You know it's.
There is something about human beings, even this human being is the social creature.
And Theres, a theres a certain energy you get.
And a certain report you can get in a level of communication interest you can get by meeting people in person and it was a wonderful trip I spent some time with our folks that what we call <unk> hub, which is which is our distribution facility up in the Netherlands.
And most of our European leadership, we're there for that for that discussion and then I travelled down to northern Italy, primarily Lombardi area of northern Italy and met with our team there.
What stands out is the last time I was visited this group was in 2000 fall 2017.
How the group has grown just into your numbers, but grown in talent and business acumen was really impressive and despite all the stuff that's going on in Europe over the last three year actually of the globe, but then more specifically Europe in the last 12 months.
That business is 80% bigger than what it was in 2019 and Thats.
Telling the story in U S dollars, if I lump it in local currency and be closer to 90.
And I think back to when I was there which was two years earlier, we havent tripled in size, but we're pretty close to it.
And so it's really a powerful story about the marketplace around the planet has.
Identified and fast on what is special about fast over the years and I'm glad to say that we're replicating that with our team in Europe .
The one thing that.
It is a positive.
Quite what it looks like in the numbers, it's a positive and that is the pre pandemic margin profile of the business has has reemerged and back in 2016, and 17 and 18, when we were really <unk>.
Telling the story of how we thought our growth was going to change in the future and those will be much more onsite driven.
It changes the profile of the gross margin, but it also changes the profile of your operating expenses and we felt over time that was a great trade off because ultimately it's about.
The level of profit and return you can generate.
And is this a faster way to grow in a better way to develop your talent and the special in the marketplace. We thought it was.
It was.
It was explaining how those dynamics work.
Mixed driven lower gross margin did occur in the quarter.
Strong expense leverage also occurred very much in line with the story, we're telling five years ago.
And I am pleased to say that after a period of time, where are our operating margin was kind of stuck.
Within 20, or 30 basis points of 20% for a number of years.
Year to date, we've been able to break out of that and move it up to 21% or actually slightly better.
So very very pleased with that and then finally I touched on it earlier really impressed on the former CFO . So looking at our cash flow statement for the last couple of years, you'll stop for holding it was tougher down too and I'm really pleased to tell you when I look at the cash flow statement.
That for the first time in a you know.
Quite a few quarters six seven quarters.
I can look at the year over year numbers and say, it's improving our cash flow is improving and.
And I believe it has staying power because I look at the things we're doing to create the environment, that's allowing us to create it and the tools, we are deploying to maintain it and elevated even more we've never been in a better position to improve our ability to generate cash.
Flipping to page.
Four of the flip book onsite signings softened a little bit during the quarter 86.
So total on active onsite is 567 up about 15% from a year ago.
Our goal for the year of 375 to 400 remains intact.
Given where we are in it.
Early part of October we expect in the lower end of that range.
F&I technology, we signed 50 187 weighted devices Thats about 81 per day.
A year ago, we signed 75.
I'd be lying to you if I didn't say I'd like that number would be closer to 100.
And in at least starting with a nine.
But.
Getting good execution, what really stands out is the what's happening with that business from the standpoint of the revenue per device how is expanding nicely.
From what we'd seen the fast Ben element of it.
We're putting up really impressive numbers one of the things I shared with our our board yesterday is if you look at that discrete number of signings per day couple.
A couple of years ago, one of those signings.
With a fast Ben today's 15th and so its rapidly expanding throughout the organization and really impressed with the way our teams in the field have embraced the technology and the way our customers like the technology too.
You look at E Commerce daily sales through Oh, excuse me and our goal for the year of 21 to 23000.
Our unit equivalents per fast been investments signings remains intact.
Finally daily sales for E Commerce rose, 50% and.
E Commerce is an interesting one because for years I think back to when I stepped into this role.
E Commerce was about five 5% of our sales.
And it had been stuck there and it was stuck in purgatory.
And because it wasn't how we went to market. We're a service organization, we're not a catalog centered organization or E Commerce company or a service where supply chain partner and part of it was we had to admit to ourselves thats, what we are and that's a beautiful thing.
And then how do we play though those strengths and so we've really I believe found a way to make this part of our business.
In the quarter, we hit.
$5 million, a day going through e-commerce.
And it wasn't too many years ago that we were starting out in that journey, so really impressed with the team and finally, our digital footprint.
You've talked about that.
It's really about.
Widening the moat.
Illuminating supply chain for our customer and making supply chain more efficient for both ourselves and our customer.
I am pleased to say that.
We've grown that to 49, 5% of sales in the third quarter.
Versus $43 seven a year ago.
And we've talked about our plan our goal to hit 52% of our sales running through digital footprint sometime in 2022, that's still our goal in fact in the month of September .
We came in at 49.9.
Percent. So if you would excuse me a second I'll just round it up and say 50% of our business is now the digital footprint and we see that continuing to grow as we move forward.
The other piece in this is touching back in I didn't touch on it with the E Commerce, a second ago.
Is not just to have our numbers improved but one thing we always look at internally is our level of participation in other words how much.
Is everybody doing not just a few leaders in the organization.
So if I go back to 2018.
17% of our branches.
Had more than 10% of their sales and e-commerce.
Two years later in 2020 that number had grown to 25% of our branches had more than 10% of their sales in ecommerce.
I am pleased to say in the third quarter of 2022 50.
52% of our branch and onsite locations.
Excuse me of our branch locations and over 10% of their revenue in E Commerce.
This 18% that we had in the third quarter isn't coming from a few it's coming from a lot of activity throughout the organization, which means it's becoming part of our DNA and that's how we found success in vending a decade ago. How we found success in on site over the last five six years and what we're seeing in e-commerce today.
With that I'll turn it over holding great. Thank you Dan.
I'll start on slide five.
Total and daily sales increased 16% in the third quarter of 2022 growth did decelerate by 200 basis points from the second quarter of 2022 and September DSR growth is below the historical norm.
However, a lot of that was due to comparisons price contribution in the period was 110 basis points below the second quarter, which we expected relative.
Relative to the second quarter of 2022, we also saw difficult government comps that cost us about 20 basis points foreign exchange cost us about 10 basis points and the impact of Hurricane Ian on our Atlantic coastal region cost us about 20 basis points.
As well as 50 basis points in September .
At the same time, we experienced robust 22, 6% daily growth and our manufacturing end market 18, 2% daily growth in our fastener product line and 28% growth in national accounts.
<unk> VP feedback kind of more had a few more pockets of forward looking caution sprinkled in but overall they also judge business activity in the third quarter. There had been very similar to the second quarter, which we believe is a fair characterization of the period.
Pricing contributed $550 to 580 basis points to growth in the third quarter of 2022 moderating from the second quarter as we began to grow over the pricing actions that started in the third quarter of last year.
While many commodity indexes have recently fallen from their peaks global supply chains are filled with product were costing reflects the higher commodities of a number of months ago. It will take several quarters for lower cost product to find its way to the point of views and we continue to see supplier letters seeking to recover these costs.
These variables have supported stable product price levels in the marketplace.
Overall, the third quarter of 2022 reflected stable demand stable price levels, but tough comparisons at this time, we don't have a reason to believe that those conditions will change in the fourth quarter of 2022, However, as always our visibility into the future is limited and the uptick and caution that our regional vps of receiving from their customers while far from universal.
There's still notable and something we need to watch.
Now to slide six.
Operating margin in the third quarter of 2022 was was 21% up from 25% in the third quarter of 2021 our.
Our incremental margin was 24, 5%.
Gross margin was 45, 9% in the third quarter of 2022 down 40 basis points from the third quarter of 2021.
This quarter's results had a lot of moving pieces. The first piece I'll address is price cost, which relates specifically to fasteners and was a negative 30 basis point impact on the period.
Over the past 15 months the Blue team has done a remarkable job defending our profitability in an environment, where fastener costs are rising as much as 30% at this stage of the cycle. The marketplace is less receptive to further price increases even as higher cost product is still being imported.
As I indicated earlier product pricing in the marketplace is stable and there are tenuous signs of product inflation easing.
The timing of product flows suggest that while price cost may remain negative for a couple of quarters. The magnitude is likely to moderate going forward.
The second piece impacting gross margin as a write down this time of nitrile gloves, which pulled gross margin down 20 basis points.
This is very similar to the glove write down we had in the first quarter of 2021.
Quicktime masks, alright mask write down.
We had in the in the first quarter 2021 in that it derives from decisions that we made during the pandemic to support our customers and with the stresses of the pandemic waning the value of our inventory relative to the market became inflated.
We believe this is a discrete events specific to the third quarter.
The third piece was customer and product Mitch mix, which was 40 basis points dilutive based mostly on relative growth from our national accounts and onsite customers, which I believe everyone understands is an anticipated byproduct of our growth strategies.
These three impacts were partly offset by continued strong growth in freight revenues of 36%, which is narrowing losses related to maintaining our captive fleet.
And leverage of organizational expenses is higher volumes absorbed overhead.
We achieved 110 basis points of operating expense leverage in the third quarter of 2022, the largest contributor to this leverage was occupancy expenses, which reflects our branch rationalization.
We also achieved leverage over employee related costs due to primarily lower healthcare expenses and to a lesser degree moderating annual growth in total compensation expense.
We also leverage other operating expenses lower bad debt expense, lower general insurance costs, and higher asset sales being only partly offset by higher selling related transportation costs, driven mostly by higher fuel prices.
Putting it altogether, we reported third quarter 2020 to EPS of <unk> 50.
Of 17, 4% from 42 in the third quarter of 2021.
Turning to slide seven.
We generated $258 million in operating cash in the third quarter of 2022 or approximately 91% of net income in the period.
Theres still trails the conversion we might normally expect in the third quarter, reflecting the ongoing impact of steps, taking with working capital to support our customers. However, this was the first time in six quarters that our conversion has improved year over year.
As product availability in our hubs has reached our goal we have been able to slower inventory build even as improvement in the supply chain has allowed us to slightly shortened domestic and import ordering cycles.
These factors should improve cash conversion rates in future periods.
Year over year accounts receivable was up 17% on strong customer demand and an increase in the mix of larger key account customers, which tend to have longer terms.
Inventories rose 19, 8% continuing to reflect on an annual basis strong customer demand higher inflation and our hub inventory build however, and improving supply chain and moderating inflation impact contributed to a sequential improvement in our days on hand from 161 days in the second quarter of 2022 to 150.
Seven days in the third quarter of 2022 this continues to trend.
Roughly 10 days below the pre pandemic level. Despite the challenges of the last 15 months, which reflects increasing and sustainable efficiencies in how we manage our inventory.
Net capital spending was $44 million in the third quarter of 2022, mostly flat with the third quarter of 2021 year to date net capital spending was $121 million up 13% due mostly to increased spending for <unk> hardware hub automation and upgrades and it equipment.
We are reducing our 2022 net capital spending to a range of $170 million to $190 million down from $180 million to $200 million.
This reflects slightly lower F&I spending slightly lower vehicle spending on continued availability issues and higher asset sales.
We returned cash to shareholders in the quarter in the form of a 178 million in dividends and $95 million of share buybacks.
I'm a liquidity standpoint, we finished the third quarter of 2022 with debt at 14, 9% of total capital up from 11% in the third quarter of 2021% and 13, 7% in the second quarter of 2022.
With that operator, we'll turn it over to Q&A.
Yes.
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Please while we poll for your questions.
Okay.
Our first questions come from the line of David Manthey with Baird. Please proceed with your questions.
Good morning, Hi, Dan hold and how you guys doing.
Good morning, Dave.
Dave.
Good.
So.
As you're thinking about gross margin into 2023.
<unk> remains flat like you say it is right now.
Margins gross margins that has come under pressure as you cycled through rising cost of goods sold because of your FIFO inventory method in.
On slide five you see the material prices started to decline while market prices remained flat I'm just trying to understand how youre thinking about gross margin here and where those lines intersect.
So as you know through most of this cycle, we have been fairly flat from a price cost standpoint, and that reflected our ability to to kind of match the cadence of our price increases with how we're seeing cost come through.
As you pointed out we have a long supply chain and.
We're at the point now where.
On one hand pricing levels are stable, but we're still seeing some product come through that was bought months ago that was at a higher cost in the marketplace, that's impacting us and that's where the 30 basis point drag from price cost sort of evolve to in Q4.
But what we're also seeing is that and you look at the same the same indices. We do right I mean, we're starting to see that material costs things like steel have come off from prior peaks.
And what we are therefore seeing is as product is now getting on boats in Asia and it won't be here for months and months right and won't flow through our supply chain. It takes time.
Youre starting to see that the inflation in those in that product.
Has begun to come off in fact, if I think about September .
September and August cost levels of product that we're purchasing was fairly flat. So first time, that's been true in a long time.
We've been seeing sequential increases as things that flowed through this is the first time that we've seen that number flatten out.
And so I think that what that tells you is that.
We were a little bit shy of all of the cost and our pricing actions.
We had that that impact us in Q3.
Is that does that.
<unk>.
Less inflated or not inflated product begins to work through several quarters from now.
With price levels being where they are that should all stabilized. So we had a.
The 30 basis point drag in Q3, I think in Q4, perhaps in Q1, there'll still be some of that but I don't expect it to get worse, I think it'll be basically at or better than that level and then by the time you get into the middle part of next year, we're going to see some of that product that looks like it's moderating in terms of cost coming back into our system.
Alright hold and thanks for the color I appreciate it sure.
Sure.
Thank you. Our next question comes from the line of Jay <unk> with <unk> Research. Please proceed with your questions.
Good morning, everyone.
Good morning.
Just on the non <unk>.
Construction site.
It seems like sales have slowed a little bit there.
Cautious comments on the release just curious I'm sure there is.
Storm impacts in September there, but just curious what youre hearing from.
From the field in terms of trends in that market I'm, sorry in particular regions or verticals.
Sandra.
Better yes.
I think I think there could be a few things that are playing out in construction.
One is as you said.
It probably wasn't our friend as it relates to the most recent months.
In certain parts of the southern markets.
But I think Theres a few other things playing out.
We tend to be a little bit later in the construction cycle as opposed to being early in the construction cycle, because we don't really supply a lot of the high volume high bulk, but very low margin type of product we tend to come in as the project is proceeding.
And we sort of step in to sort of fill in.
Fill in spot buys that they might need for product or supply sort of folks who are involved. The later stages of the project with their with their reflective vest and things of that nature. So I think that there is an element of timing so as we get further away from the pandemic.
And more projects that restarted coming out of it get deeper into it I think that tends to favor us from a cycle timing standpoint. So there may be some element of timing that's in there.
I think the other element of it though is recall we.
We have altered our branch model.
In certain respects in that branch model has used to be very much an open showroom for people to come in and buy a lot of product.
In many respects, we've reduced the size of that showroom and.
Tried to get a lot of that walk in business to go online.
And in many cases thats been successful again, you see the E. Comm business is growing the way. It is a part of that is because of that.
But at the same time, a lot of construction business tends to work in the front door and I wouldn't be surprised if our shift to focusing on.
Larger key accounts, which includes by the way larger construction accounts.
I wouldn't be surprised if.
Some of the walk in business, we might normally have entertained in our branches.
Isn't does as prevalent in our model today as it was then and so I think those are probably the variables that are impacting that.
The other one would be the fact that and this isn't unique to this quarter or this year, but over a number of years, we have reduced physical number of locations.
As a placement, but that has doesn't have a lot of relevancy to what we're seeing right now in the patterns.
Okay. That's helpful. Congrats good.
Good luck guys.
Thanks.
Thank you. Our next question is come from the line of Chris Dankert with loop capital markets. Please proceed with your questions.
Hey, good morning, guys. Thanks for taking the question.
We've talked about this in the past I guess, given the very high sales growth in kind of a necessary preoccupation with finding and sourcing alternative products and repricing.
Some of that starts to moderate does that mean, we can refocus more on sites and can kind of help drive some of that.
These kind of more organic growth initiatives.
Was that part of the productivity improvement in the SG&A leverage we saw in the quarter here I guess.
Yeah.
The stability in the supply chain.
Removes an incredible distraction to the entire organization because.
If we don't have product.
Either we don't have product on the shelf in our distribution centers or where we're having difficulty locating product.
The fallback for everything is our branch and onsite.
They are the first line to the customer.
And if a customer need something they will find it but the thing is from a time standpoint it.
It takes them more time to source and locate.
Then it takes to push a button on your computer and requested from your distribution Center.
So the energy losses there.
And that energy is coming back and so that puts us in a position where we can grow the business.
We can we can we can grow our intensity and we don't and we can leverage the payroll side better because you don't need to add people as fast because all of a sudden that that burden time is disappearing from your day and again. This is proposed to the branch and the onsite and <unk>.
It does provide pro Av less tension environment too.
Yes, I don't think that you can underestimate the amount of energy that has been diverted over the last 15 months towards conversations with customers about raising prices.
As opposed to conversations about increasing what we can do for them and how we can solve an additional or incremental levels of challenges that our customers may have as all of that normalizes I think that our conversations will shift from.
Playing defense to playing offense to an even greater degree than it has been and I think that that's useful and I think that is going to help on the productivity side.
If we werent doing the things that we were doing to prioritize the digital footprint to rethink kind of the structure of our physical footprint.
And how we prioritize our time.
I think that we would have we would have been much much more challenged and then we turned out to be.
Thank you both so much of the color.
Sure.
Thank you. Our next question comes from the line of Tommy Moll with Stephens. Please proceed with your questions.
Morning, and thanks for taking my questions.
Good morning.
We appreciate the insight you gave.
Our vps in terms of some of the cautious comments that you've picked up there and I was curious if we could maybe go one level deeper.
To what extent does that caution applied to the manufacturing end markets.
Or are you picking up anything different there versus construction and maybe some of the others tied to consumer that have been weak even earlier this year I appreciate it.
Yes, I think that the elements of manufacturing.
Faces capital spending a commodity markets being stronger than manufacturers that are touching consumer markets.
<unk> has persisted to some degree for the last two quarters and it existed in September as well so that still is a thing.
That hasnt changed.
But I think that the feedback that we're getting from the RVP and again, it's not universal Theres. Some RV piece I said no things are really still good right. So I'm, taking sort of a.
Our holistic consensual view from some 20, plus individuals and not all of them are seeing weakening markets, but I'm seeing a few more comments from a few more people and it's not about specific markets. It's just about the mindset.
And the outlook of the customers generally speaking.
Has gone from.
I'm just trying to get this massive backlog worked through two yes, my backlog is pretty good, but I'm not a little bit concerned about the orders right and so I can't related to specific markets.
It's been true in the consumer side. The fact that it's ticking up I assume means that there's been some change in the customer sentiment on some level and thats, probably a little bit more broad than simply the the.
Consumer side of things, but but again I want to emphasize and because we don't have a lot of visibility.
It's not universal I mean, we're not we're not facing a salesforce and a customer set that is.
That has seen a major inflection.
It's just the tone of some of the conversations have taken out a little bit more of a cautious cautious tone.
That's helpful. Thanks Holden.
Two a more strategic question around on sites.
Are we through most of the access issues that you faced at the peak of the pandemic, where you can now get the access you need to have those conversations and then to the extent you are and that we do enter into a recession that spilled over into the industrial economy.
Should that accelerate decision, making around on sites does it put a hold on a lot of those decisions are.
No impact really.
To the extent your businesses and in.
In the Americas or in Europe .
Access is completely there.
To the extent your business is in Asia, particularly.
China part of Asia.
<unk>.
Very very restricted.
Unfortunately for US 99% of our revenue is in the areas that access is really good.
As far as the.
You know.
History has shown when you're.
When you are.
Really busy sometimes decision process has slowed down a little bit because you just don't have that time.
The change from a strategy standpoint, you don't change that and that and that could hurt the onsite.
A little bit weaker environment.
Probably helps our ability because we're bringing at the end of the day.
Our onsite model is about a more efficient model for supply chain.
And there is a there is a.
Noted cost advantaged from the standpoint of when.
When we're in there we have the tools to provide the supply chain in a way the customer can.
Generally speaking our <unk>.
Average or a slower environment is probably a little bit helpful.
One thing to bear in mind, we just answered a question related to how we have to spend what is a limited limited amount of energy right and how we're looking forward to shifting from from spending a lot of energy on playing defense enable to put a lot of energy into playing offense and it's really very similar to our customer set right. I mean, if you have a fairly stable environment.
It's not that difficult to predict and plan and take on an implementation process that that can be fairly involved as youre getting these things set up.
If youre in an environment, that's cascading frankly, either cascading lower or cascading higher.
And your energy in an organization is being spent on managing those inflections and those significant changes than your ability to spend a lot of energy on an implementation process becomes a challenge so.
I would probably suggest that there is a great case to be made for on site.
When people are trying to be cost conscious and working capital conscious and Thats certainly is the case in a downturn, but it would depend on the magnitude of what you're talking about I would say at a modest downturn, we probably are in a better position to be able to sell what we do.
If if you have dramatic growth or dramatic downturns, I think that our customers energy can be moved into other other things.
All very helpful. I appreciate the time and I'll turn it back.
Thanks, Thank you.
Thank you our next questions come from the line of Chris Snyder with UBS. Please proceed with your questions.
Thank you.
I understand the commentary that fast that this fastener price cost drag will narrow over the next few quarters as lower unit costs will flow through the P&L, but I guess my question is how should we think about fashion or price into our revenue forecast for next year is the expectation that price will holds or that twice.
We will go down, but maybe not to the same level as the cost deflation you are expecting.
The.
Yes, as you know we have.
I think 55% to 60% of our business today is national accounts.
And those are contracts pieces of business many of those contracts have terms and conditions and at which.
When raw material costs go up we can adjust them when they come down we need to adjust as well so.
As we get to the point, where our costs are beginning to reflect.
Less inflation.
And that sort of thing that I would fully expect that they are going to be customers that we're going to have to make good on contractual terms and so I think you would see pricing decline in those circumstances.
Now bear in mind of course.
Bear in mind of course that even within contract relationships or spot buys and things like that that aren't going to be as reactive to the contract terms and of course, we do have a significant amount of business that isn't necessarily contract.
That may not be as responsive either and so.
I think there'll certainly will be cases, I think our responsibility is to make sure that we reduce price as we see our cost coming down that will be our goal.
And then have the same conversations with with our customers that we had on the way up.
No really appreciate all that color and then I'll hold it.
Prior commentary you made about.
You said unit costs. So the price I guess you guys are paying from the producers.
Flattened out in August and September really for the first time since the pandemic.
I guess my question is.
Is that faster.
Boston is down and everything else is still kind of inching higher or is it kind of really across the board.
Cost of funding I will just ask again, just with a property or something a bit different of a cap on the trajectory there.
Theres not a meaningful difference at this stage of the game, whether it be fasteners or other things.
It's not there's not a meaningful delta between those things.
Bear something in mind.
I think that I think that we're at a point, where we're seeing a little bit of a change in the market, but it's very early and we actually are still when I talk about how the boats are still filled with products that are fairly expect that are expensive from price levels existed months ago. We're still receiving letters from suppliers that are asking for price increases on certain products because of that.
FIFO effect on their own supply chain right. So.
Let's.
It's an exciting it's an exciting change I suppose but we have to see some we have to see some string of these trends before we can.
Start thinking about what actions need to be taken.
Part of it Chris.
Comes from what was the ultimate cause of the inflation, if you think of the product.
I'll speak to factors, but I think it would be true to anything.
There is a there is a cost of the underlying steel.
There's a there's a cost of the energy to convert that underlying steel to the finished product.
As you know that cost of that energy.
Has only gone up and that's not coming down.
The next piece is the cost of the <unk>.
The human capital to human resources to be involved in that.
In that endeavor of converting it.
Transporting of running it through distribution.
That has appreciated as well and thats not coming down once once once.
Our cost element there increases it has incredible sticking power.
The third one is is the physical cost of moving it.
That cost has moderated I mean, it had gone from it had gone ridiculously high it has moderated.
And but I don't see that coming back.
And so if you look at those four pieces there is really one of the four.
That you can see that you can just looking at it mechanically and see yes, there's opportunity for that in the future, but with the cost of the energy the cost of the people and the cost to move it.
But.
Are those are what they are and they really don't deflate.
Yes, no no real increases on that was probably the Genesis of the question on fasteners and it just feels like if you look at those cost buckets. The one that is deflating, the most as metal, which fasteners are more exposed to that and then the other product lines.
Really appreciate all that color.
Thank you. Our next question is come from the line of Ken Newman with Keybanc capital markets. Please proceed with your question.
Hey, good morning, guys.
Good morning.
So I just had a follow up question on the non res side of the business I appreciate that the operating strategy for that business, maybe a bit different.
Prior cycles, but.
Is it fair to assume that the 505 or 65 basis points of price that you said on the quarter.
Is that equally weighted across all your served end markets I guess.
I'm ultimately trying to get to whether volumes in non res were down call. It four 5% or September or is that not really a fair assessment.
Yeah, and I guess, the Frank answer is I don't know the answer to that question.
We don't have it broken down.
Price cost elements by end market.
So I just don't have a good answer for you.
Theres nothing that would lead us intuitively to say there'd be a difference.
Yes.
<unk> made at the same steel whether youre selling it into a construction application or manufacturing applications same same underlying raw material right.
Right, but weather, whether or not the pricing behavior in those two markets are the same or different I. Just don't have a good answer for you on that.
Okay.
And then for my follow up here.
Onsite in the semi growth looks pretty solid in the quarter.
As you kind of think about past down cycles and elevated levels of uncertainty.
Is there a change in how you think about the rate of deceleration.
In the macro whether it's PMI or year over year industrial production versus the rate of change in onsite signings is that different from prior cycles, you think because the value prop is different or would you expect kind of similar versus past cycles.
Well, if you think about it historically, we can look at our established business and our business that was coming from new branch openings I'm going back 15, 20 years and I'll make this comment.
So you had this constant wave of pushing but.
We still sell into a cyclical end market.
And so where you have.
Where do you have a meaningful presence in a market.
You get headwind into <unk>, how much of that headwind is offset by the things Youre doing.
And on site is is a cousin to branch openings.
From the standpoint of <unk>.
I feel better about 2023, the fact that we've signed a whole bunch of on sites in the first month nine months of this year.
Because the customer activity at our existing branches at our existing.
Onsite.
Is going to be impacted by the economic cycle.
Just the reality of we have a customer spending $10000 with us and it goes to 11, it goes to 11% to nine it goes benign.
So it's how many new customers how many expanded relationships are you adding.
And.
I think a lot of comfort in the fact that we have a lot of pent up.
Growth market share gains.
In our in our Hopper right now because of all those onsite, we signed and because of the vending in the F&I devices that we've signed it gives you incredible ability to take market share and when we're looking at internally.
I look at it from the standpoint, okay, here's our peers our growth how much is the market giving to us.
And how much are we are we taking.
And the number you are focused on.
Is how much are you taking and what are you doing to take and then the the number thats how much is being given that's what you used to pull levers to manage the business.
Because obviously those are things that impact you and the other is things you impact.
That's helpful.
And I might be.
If you think about our value prop hasnt changed that much right. It's always been about getting really well trained.
People close to the customer and empowering them to make.
Decisions to solve customer issues and that has been the proposition that remains the proposition. The only thing that's changed is the tools, we have at our disposal to achieve that have gotten.
I have gotten better and more sophisticated advanced but the value proposition I think is change, but one thing that does excite me is as you do go on site as you do put in those bins.
Not only is there a greater ability to add value through data that I think becomes even more important when people are looking for how to how to become more efficient themselves, but it also ensures that we always have a reason to be there.
Speaker 4: And it goes to 11, itgoes to 11 of the host to nine it goes to design. So it's how many new customers, how many expanded relationships are adding and, I think, a lot of comfort in the fact that we have a lot of pent up grow growth, market share gains in our hopper right now because of all those Onsites be signed and because of the vending in the FMI devices that we've signed.
That onsite might be down 20% because of the market, but we're still there every day and we're looking for other opportunities to expand our ability to gain more business and when we were primarily branch driven.
We have to gain entrance to it and there might be people that are saying no. We're not time right now we're managing this and now we're there every day filling those bins that are that have.
Speaker 4: It gives you incrediblebility to take market share and when we're looking at it internally, we always look at it from the standpoint: OK, here's our growth, how much is the market giving to us?
A part of the digital footprint in the vending machines, and even onsite and I think that that's going to that's going to make our ability to gain market share resilient regardless of cycle. What do you think to that end do you think about when we're going through the pandemic.
Speaker 4: And how much are we, are we taking?
Speaker 4: And number you focused on is: how much are you taking and what are you doing to take? And then the number, that's how much is being given. That's what you use the pull leververs to manage your business.
A number of reasons why we found success one.
We didn't have it we just haven't seen that's pretty good at finding stuff.
And are really really focused on quality and so people could buy stuff from us and they knew it was what it was and they could trust that they were going to get it.
Speaker 4: Because you those are are things that impact you. The other is things you impact.
But because of our vending footprint because of all the bin stocks, we do because of all of those things that we've been doing for years to.
Speaker 4: elphan-t, California.
Speaker 4: And I might, if you think about our value proofp hasn'thas changed that much. Right, it's always been about getting really well trained people close to the customer and empowering them to make great decisions to solve customer issues, and that has been the proposition. That remains the proposition. The only be a changed. The tools we have in our disposal to achieve that have gotten, have gotten better and more sophisticated advance, but the value proposition i't think has' chang. But one thing that does excite me is, as you do go on site, as you do put in those bins.
To Holden's point about access granted.
We were getting into customers' facilities one of the reasons, we closed the front door of all of our branches.
We didn't want to be the weak link if this customer is studying on access they're building with letting us in well our building becomes an extension of theirs and we shut down access to that too.
And so it puts us in a unique spot of we still get to come in and get engaged.
As opposed to being an internet connection away or a phone call away.
Very helpful color I appreciate it.
Speaker 4: Not only is there a greater ability to add value through data, than I think becomes even more important when people are looking for how to how to become more efficient themselves, but it also ensures that we always have a reason to be there.that that on-site might be down 20% because of the market, but we're still there every day and we're looking for other opportunities to expand our ability to gain more business. And when we're primarily branch-driven.
Thanks.
Thank you our next questions come from the line of Nigel Coe with Wolfe Research. Please proceed with your questions.
Thanks, Good morning.
Well.
Okay.
At the risk of <unk>.
Beating a dead horse I do want to go back to the non res.
Because that's a topic of interest for a lot of investors here.
Against the fact that manufacturing is benefiting from the <unk> initiatives and.
Speaker 4: We have to gain entinterestance to it and there might be people are saying know we time right. Now we're managingthis and now we're there every day filling those bins that have have that a part of the digital footprint and the vending machines and even on site. I think that that's going that's going to make our ability to gain market. Share resilient regardless of cycle well you think for that and do you think about when we've going to the pandemic. The number of reasons why Ve found success one.
Yes.
Depending on size and less whereas you've clearly stated that non res is much more on stool. So I think the classification makes sense, but is there anything unusual happening in the normal category in terms of I don't know projects getting delayed.
Moving to the right.
Our customers are buying less.
And anything unusual ecolab over and above what you just described.
Speaker 4: We have have a team that's really the good at finding stuff and and are really really focused on quality, and so people could buy stuff us and they knew it was what it was and they could trust that they were going to get it. But because of our vending puts, because of all the bins stops to dobecause of all those things that we've been doing for years, to holding's point about access: granted, we were getting into customer facilities. one of the's, we cloed the front door of all of our branches.
I don't think so.
But again I mean, given some of the things that I described being perhaps a little bit later in the cycle in terms of where we hit our sweet spot construction. Some of the changes we've made I'm just I'm just not sure. We're a great proxy for the overall non res market trends right.
But when a query the RVP.
Nothing, particularly special has come out of the discussion around around non res for us.
Speaker 4: We didn't want to be the weak link. If this customer is shutting down access their building to letting us in well, our building becomes an extension of theirs and we shut down access to that too. And so it puts us in a unique spot of we still get to come in and engaged, as opposed to being an Internet connection away or a phone call away.
Okay. No. That's that's frankly I want to make sure. That's the case and then when you when you say preparing for a soft.
293 into the back half of the year, perhaps what does that actually mean I understand maybe not hiring for growth.
Are you actively in the personnel managing down inventories managing managing discretionary costs are we in that phase yet.
Speaker 4: serreapple collored brggetit.
Speaker 5: Thanks.
And any any comments you have on <unk> gross margin.
Speaker 2: Our next question come from the line of Nigel a with Wolf research and perceed with your questions.
<unk> would be appreciated.
So nigel as far as the.
Speaker 6: Thank good morning and to October of as wellbecause at the risk of you know beaten in debt if do want to go back to the nonrise because that's that's a top of interest our investors. Here. Andi guess the fact that manufacturing is benefited from the the FMI initiatives and you know the defending on sites and all that whereas you clearly says that nonres is much more on stores. So I think the bcation makes sense but.
We're always in the phase of managing down costs, we're always in the phase of looking at everything and rationalizing everything every day.
And that does that just keeps us agile and fresh.
What it means is sometimes it is reminding everybody we've been we've been through.
You think of the last four or five years you had.
We were impacted.
Speaker 6: Is there anything unusual happening in that non-res category in terms of projects getting delayed or moving to the right, I don't know. Customers buying less anything unusual? Call out there, over and above what you just described.
Very directly by all the tariffs two years ago.
We along with everybody else on the planet was impacted by Covid.
We along with everybody else on the planet, we're impacted by supply chains being just narrowed up.
Speaker 4: I don't think so.
The only.
Speaker 4: But again, I mean, given some of the things that I described being perhaps of a little bit later in the cycle in terms of where we hitour weet, spot construction and some of other changes I made, I'm just I'm M not sure we're a great proxy for the overall nonres market trends. Right, But when I query the rbp, nothing particularly special has come out of the discussion around around nonres for us.
Benefit we had was we're better at on snarling that than anybody else in and part of that we were willing to do just with hard work. Some of that we were willing to do because we just know a lot of manufacturers a lot of potential suppliers.
And part of it we were willing to do because we were willing to use our balance sheet.
You think back to the spring of 2020.
I remember some of the appeals we were cutting for mass.
I sleep well at night, there were a few nights from kind of like Oh My God.
Speaker 6: Ok another. First there was want to make sure that's case. And then when, when you say prepare for a softter 2023 into the back up the perhaps, what does that actually mean? Understand, maybe not hiring for growth, but are you actively in the person of managing down inventories managing, managing sort discretionary costs? Are we in that phase yet? And any comes you have on four ky gross margins, a whole MO would be pushed.
And and.
And as we went forward if it's taken an extra 30 or 60 days to get product and all of a sudden we're adding to $250 million of inventory because that just mathematically what it what it takes because at the end of the day, we have a covenant with our customer where their supply chain partner and they will get it from us and they trust us to do that.
Now.
We've been in the process for some months of looking at that and saying, Okay. We now can rely on supply chains in a way we climbed six 912 months ago. So we can start dialing that safety stock down what you're seeing in cash this quarter.
Speaker 7: So So Nigel as far as the.
Speaker 7: We're always in the phas.
Speaker 7: Of managing Dun costs. We're always in the phase of looking at everything and rationalizing everything every day, and that that just keeps us as ile and fresh.
It's just the outcome of that.
Speaker 7: What it means is sometimes it's reminding everybody we've been, we've been through.
And so we arent squeezing the balance sheet and squeezing inventory because of what we're thinking for 2023.
Speaker 7: You know, you think of the last, you know four or five years you had.
We're removing layers of safety stock that we had added over the last few years and we're slowly removing.
Speaker 7: We were impacted.
Speaker 7: Very directly by all the tifis a few years ago.
You closed a bunch of locations and you changed your inventory lay out we had a lot of inventory that was positioned around the company.
Speaker 7: We along with everybody else on the planet, was impacted by COVID-19.
Speaker 7: howwe, along with everyveelse on the planet, were impacted by supply chains being just snarled up. The only.
Because we had a front room that we slowly are working our way out of.
And those two things is what gives me confidence on our ability to generate cash flow.
Speaker 7: Benefit we had was we're better at snarling that than anybody else, and part of that we were willing to do just with hard work.
The idea of preparing for 2023 is reminding everybody. What this isn't the time, we're giving raises this isn't the time, we're adding things that are discretionary. This is the time, we were saying to our field personnel.
Speaker 7: Some of that we are willing to do because we just know a lot of manufacturers, a lot of potential suppliers.
Speaker 7: And part of it we are willing to do because we were willing to use our balance sheet.
We have.
Speaker 7: You think back to the spring of 2020. I member some of the appeals we were cutting for mths. I sleep really well at night. There were a few nights I kind of like my cut.
Close to 300 onsite we've signed we.
We need to staff those.
We have locations that are growing we need to staff. Those are our head count became disproportionately out of kilter during the last three years, because our recruiting model.
Speaker 7: And as we went forward, if it's taken on extra 30 or 60 days, we get product in all of a sudden we're adding 2, two hundred and fifty million dollars of inventory, because that that's just mathematically what it takes, because that the other day we have a covenant with our customer.
A big chunk of what way, we recruit as we go into two year technical colleges and four year State colleges and we stated we say the young people come join US. We're 15 20 hours a week, let's get to know each other so that when they graduate they might decide that industrial distribution is right for them and we might decide they are right for us and Thats, how we had.
Speaker 7: We are their supply chain partner. They'll get it from us and they trust us to do that now.
Speaker 7: We've been in the process for some months of looking at that and saying okay, we now can rely on supply chains in the way we clint six 9, 12 months ago, So we can start dialing that safety stuck down. What you're seeing in cash flow this quarter is just. It's just the outcome of that.
People, we still haven't corrected that mix.
And so we're going to be adding people in the field, but it's going to be disproportionate to part time.
And folks to staff our onsite.
And.
Part of when you are looking at a year like 2023 could be based on the tone out there.
Speaker 7: And so we aren't squeeing the balance sheet in squeezing inventory because of what we're thinking for 2020. -three.
You just remind people to what we're about.
Speaker 7: We're removing layers of safety stock that we had added over the last few years and we're slowly removing. You closed a bunch of locations and you change your, your inventory layout. We had a lot of inventory that was positioned around the company.
And with regards to Q4 I'll, just give you a sense of sort of how I see the moving pieces.
Product and customer mix is going to continue to be a drag is it. The same 40 bps is as it was in Q3 or is it 50 bps.
Or whatever that will be determined by the relative growth of national accounts versus non national accounts relative growth of the fasteners versus non fasteners, but.
Speaker 7: Because we had a front room that we slowly are working our way out of.
I don't necessarily expect that to.
Speaker 7: And those two things is what gives me confidence on our ability to generate cash flow.
I don't expect that 40 basis points to be less it could be slightly more.
Speaker 7: The idea of preparing for 2023 is reminding everybody what. This isn't the time we're given raises. This isn't the time where we're adding things that are discretionary. This is' the time we're sayaying to our field personnel.
I don't expect the write down of course.
I don't expect price cost to get worse, it could get it could get a little bit better frankly than what we saw in the third quarter.
Seasonality from a seasonal standpoint, its not unusual for the fourth quarter to be 30 bps lower than the third quarter and I think that that's reasonable and I think there'll be a little bit of a challenge on the on.
Speaker 7: We have close to 300 Onsites we've signed.
Speaker 7: We need to staff those.
Speaker 7: We have locations that are growing, we need to staf those. Our headcount became disproportionately out of kilter during the last three years because our recruiting model- a big chunk of what way we recruit- is. We go into two year technical colleges and for your state colleges and we say: we say that young people come join us, work 15, 20 hours a week. Let's get to know each other So that when they graduate, they might decide that industrial distribution is right for them and we might decide they're right for.
The organizational expenses, we had in some areas we had some difficult comps are going to come up against the fourth quarter. So.
Run all that math together.
I think normally you would expect seasonality to play through for about 30 bps in <unk>.
When you get all those those pluses and minuses all blended together it probably comes in down 20 to down 40 kind of range.
The.
We're about two minutes to the hour. So I'll just share a couple of closing thoughts.
One is holding talked briefly about the fourth quarter.
But also about some of the expense components that.
That are fixed or that are variable.
We're in a position where a lot more of our expenses are variable than we've ever been in for the last 50 plus years of our existence.
And that couldn't be more true than what we see today. If you take a step back go read our proxy and Youll see how people and fast at all are paid there is a lot of incentive comp at the branch level at the support level at the distribution level throughout the organization a pizza as it related to sales and gross profit growth.
Speaker 4: Sense sort of how I see the moving pieces. You know, product and customer mix is going to continue to be a drag. Is it the same 40 bps as it was in Q3 or is it 50 bps? You know, or whatever, that that will be determined by the relative growth of national account versus non national account, the relative growth of the fasteners versus non fasterss. But you know, I don't necessarily expect that to. I don't expect that 40 basis points to be less. It could be slightly more.
A piece of that is related to expense management, a piece of that is related to earnings growth.
It's no secret that for the year.
We will have pretty good earnings growth.
And if you.
Do you think a chunk a big chunk of folks are paid off that earnings growth.
Speaker 4: I don't expect the write down of coursese. I don't expect price costs to get worse. It could could get a little bit better frankly than what we saw in the third quarter season from a seasonal standpoint. It's not unusual for the fourth quarter to be 30 bits lower than then the third quarter and I think that that's reasonable I think there'll be a little bit of a challenge on on the organizational expenses we had in some areas we had some difficult. Comps are going to come up against the fourth quarter so.
I think and I'll put it set out to Dave Manthey coined this phrase I think 15 18 years ago about the shock absorbers in the fast in all expense model those shock absorbers.
Fully flex right now and what that means is.
Unfortunately, as an employee it means.
You'll probably get some contraction in pay and I'm an employee.
The unfortunate.
Dennis you had a pretty good 2022.
It puts us in a position to invest to grow the business in the future without cutting any any any muscle.
Speaker 4: youknowrun all that math together it is, I think normally it expect seasonality to to play through for about 30 bips and think when you get all those those pluses and minuses all blended together, it probably comes in down 20, down 40 kind of range.
You there are some things that just naturally contract if earnings growth contracts. So it puts us in a great position to do the thing that we've proven for decades, we could do quite well and thats take market share.
Speaker 7: The we're about actually going to through the hour, and so I'll just share a couple of closing thoughts. one is holding. Talk to these threely here about the fourth quarter and and, but also about some of the expense components that our fixed store that are variable. We're in a position where' a lot more of our expenses are variable than we've ever been in for the last 50 -plus years of our existence.
Thanks, everybody have a good day. Thank you.
Thank you. This does conclude today's teleconference. We appreciate your participation you may disconnect. Your lines at this time enjoy the rest of your day.
Speaker 7: And that couldn't be more true than what we see today. If you D take a step back, but green our proxy, and you'll see how.
Speaker 7: People and fast and all are paid. There's a lot of incentive comp at the branch level, at the support level, at the distribution level throughout the organization. A piece of that's related to the sales and gross profit growtha piece of that's related to expense management. A piece of that is related to earnings growth.
Speaker 7: It's no secret that for the year.
Speaker 7: We'll have pretty good earnings growth.
Speaker 7: And if you, you think trunk, a big chunk of folks are paid off that earnings growth, I think you I'll put a shut out. Dave mthy coined this phrase, I think 15, 18 years ago, about the shock absorbers in the fast and all expense model, those stock absorbers. They're fully flex right now and what that means is unfortune as an employee. It means you probably get some contraction and pay and I'm an employe. So that's the fortuneate. The Fortune is you a Ty good 2020 two.
Speaker 2: Thank you. This doesoug, conclues today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.