Q2 2023 Fastenal Co Earnings Call
Yes.
Good morning, and why.
So faster than all of 2023 second quarter earnings Conference call. At this time, all participants are in a listen only mode.
A question and answer session will follow the formal presentation. If anyone should require operator assistance during the call. Please press star zero on your telephone.
As a reminder, this conference is being recorded.
I would now like to hand, the call over to Taylor Ranch, a fast one.
Company. Thank you you may begin.
Welcome to the Fastener Company 2023 second quarter earnings Conference call. This 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 open for questions and answers today's conference call. The proprietary fast my presentation.
<unk> and is being recorded by <unk> no no recording reproduction transmission or distribution of today's call for a minute without asphalt consent, that's causing audio simulcast on the internet via the fastener Investor Relations homepage investor top ethanol dot com a replay of the webcast will be available on the website until September one 2023 at midnight Central time as a reminder, today's conference call.
<unk> will include statements regarding the company's future plans and prospects. These statements are based on our current expectations and we undertake no duty to update them. It is important to note that the company's actual results may differ materially from those anticipated factors that could cause actual results to differ from anticipated results are contained in the company's latest earnings release and periodic filings with the securities and exchange.
Commission and we encourage you to review those factors carefully I would now like to turn the call over to Mr. Dan Florida.
Good morning, everybody and thank you for our second quarter earnings call.
Before I start on the personal.
Personal matters I'd like to share our message.
When I joined the past now.
Back in 1996.
One of the things that was unique in my joining is that Ah I stepped into the role of Chief Financial Officer, Bob Kurland offered me the opportunity and.
And so I joined in an unconventional way and that idea.
Start at the branch or in a.
Distribution Center and work my way up through the organization and sometimes when you joined that an organization that promote from within <unk> not sure what kind of reception Youll get when you joined.
One of the first people I met was.
Colleen quite those bumps Kirtland sister, she had retired and in our retirement she worked for fastball few years in sales support.
One of the <unk>.
Nice ladies I ever met and we lost culling earlier this year.
To her children and grandchildren, you have my condolences and and as well to Bob on the loss of your sister.
What a wonderful Lady and we were all blessed to Noah.
We started back in 67, so our five founders aren't.
Aren't in their Twenty's anymore.
And van Mcconnon Henry Mcconnon.
He goes by van.
He was our first employee in fact I think that's how he earned his stake in fast now and yeah yeah.
Well with that stake and I'm proud of them.
He lost his wife Wilma earlier in the year and the same message.
Van was could not have been more of a welcoming person to me when I joined the organization.
And here's my condolences on the loss of his other swipe this spring.
With that I'll move on to the onto the personal quarter.
Second quarter 'twenty through this challenging quarter.
Last fall when we or last December when we had our our leadership meetings and are planning discussions for for 2023.
The ISI had weakened.
We knew that 2023 was going to have some slugging aspects to it.
We werent, we caution our team second quarter, and third quarter, and we tough quarters to get through and prepare yourself.
Prepare your teams.
From the standpoint that we're going to have to manage our expenses really well, we'll have to keep all of our heads screwed down the right way because.
There has been.
It's been an interesting number of years between tariffs and COVID-19 and congested supply chains and inflation and all of this stuff, there's always noise noise noise noise.
We're going to we're going to experience some degree of experience for number of years and that's a slowing economy.
And prepare for what that means and get the muscle memory back but.
But it was a challenging quarter our earnings came in at two <unk> are rising.
Rising four 5% softer manufacturing activity.
Let our sales daily sales growth to decelerate, we grew five 9% in the second quarter.
We did not leverage as an important element of our business.
Our sales grew five 9%, but as we're cycling through some mix changes in the hole and touch on a little more detail. Our gross profit dollars grew about three 6% and our operating expenses grew $4, one and I'm not real good with math, but I know thats not a.
Good combination if you want to leverage your earnings.
The.
And one of the elements is we didn't anticipated softening quite as much as it did.
And that $4, one needed to be little bit lower we didn't adjust our variable cost quite quickly enough.
As we've seen in prior.
Timeframes when the economy is weakening and it affects our ability to grow the high amount of working capital on our balance sheet.
Really can't influence our ability to generate cash and given my given my old roles My old role as CFO second quarter is a painful quarter for us typically because we have two tax payments and when youre a profitable organization in the operate a lot of business the United States you pay a lot of income tax.
And so second quarter hit us really hard.
And normally we for every dollar in earnings we generate 60 to 70.
And operating cash flow.
I don't recall us ever having a second quarter, where we generated more cash operating cash flow than earnings perhaps Holden will cite an example, where we did but.
Maybe it was 2009, but.
But.
That's a strong cash flow as we as we've ever seen for this time of year.
And it also and a chunk of it is from not just what's happening in the economy and the working capital needed to fund receivables and to fund inventory for growth.
In the last several years as supply chains are really getting congested.
Message.
Did I made very clear to our supply chain folks.
And our teams.
We have a covenant with our customer and that is worthy of a supply chain partner.
We will not let our customers down in their supply chain if that means we need an extra 15, an extra 30, an extra 45 days of inventory.
You don't get ahead of yourself, but we need to have inventory to support the business period.
And when when the ports on the West Coast of North America, we're getting congested.
The economy is turning back on everything was getting congested, we beefed up our inventory. We started we were harvesting that we were doing it in the first quarter were doing it this quarter I think the team has done a wonderful job. It means we have capacity now to look at our our balance sheet and say.
Where does it make sense to make strategic investments in inventory not saying theres stuff on the table right now, but that discussion can be had whereas a year ago and two years ago, we couldn't really even think about it because we were focusing all of our energy on something else.
In the second quarter, we made some leadership changes first off Jeff Watts Who's led our international who joined fast all back in 1996. So he has been here for 27 years and as and.
Started in our Canadian organization, when we were when we had just a handful locations in Ontario and.
He has led our international sales efforts since 2015.
And he will oversee all of our sales efforts across the planet.
And obviously, we know each other really well the team in the U S. Obviously international knows him really well because he has led that team for quite a few years, but the U S. Team is there is no stranger to a 27 year employee so we know each other well but.
I believe we will have greater coordination on our efforts and.
And Jeff has a very entrepreneurial approach to how he leads a business.
I welcome him and look forward to the success he is going to see.
Terry Owen Who's been our.
EVP operations role.
We formalized his role and that he is our chief operating officer and bullet was added kind of late in the process I found out yesterday as a team one that I should mention this since we had announced that this quarter and there is an error in our release I thought I'll, let you know.
Yes.
It's probably not material.
Two aspects of life, but it is Terry has been here 28 years.
I know you joined in June of 1999, if I do the math I think it's 24, so sorry, we didn't catch that are in our process.
But.
In conclusion cyclical factors aside the last several years, we've taken a lot of steps to improve both our labor and our inventory productivity and I believe this forums.
Excellent Foundation.
Our ability to generate long term share gains in the marketplace.
Switching to the next page.
Yeah.
On sites.
I'll state the obvious 86 onsite is a disappointing number.
Our aspiration internally.
Has been to drive that two two to 100 per quarter 400 per year Thats been our stated.
Abstract.
Mentioned internally.
Prior to Covid.
We hit 362.
And that was a ramp up from <unk> in 2015 to 176 to 270 to 336 to 362 per year. When Covid came along it really impaired our ability to sign on sites because the last thing you want when you're worried about people being around you is inviting a bunch of folks the blue shirts to come in and operate inside.
Four walls and so we saw that drop dramatically. We've recovered to about we did 356 signings last year, we broke 102 out of four quarters.
Perhaps some of the leadership changes we made in the last 60 days create some distraction perhaps were not as focused as we should be.
But that number needs to be 400, a year or more.
And right now we've adjusted our number we think it will probably come in similar to last year somewhere in the $3 <unk> and <unk>.
That said the fact that our on sites are up we are 15% more on sites in the year ago, That's a great number.
We're just not building the pipeline the way we need to.
Yes, if I my technology, that's a different story.
So our goal in onsite so the 100 a quarter, let's get there and then figure out how we how we take it a 110 120, but let's get to 101 same.
With <unk> technology, it's not a 100 a quarter its 100 a day.
And and I'm pleased to say.
In the fourth quarter excuse me the second quarter.
We did 106 per day.
And that's market share gains that is us going out and planting new flags in new locations to improve the supply chain for our customer.
Illuminate the supply chain for our customer and us being a great supply chain partner.
That's a huge positive.
I believe it tells me.
The marketplace is conceding this space to us maybe I'm wrong on that but I believe it is because we are so far out ahead of the marketplace.
Year to date.
I told the board yesterday.
With the 106 this quarter, we and our board meeting yesterday with 106. This quarter. We're at 100 year to date I Miss spoke we're actually at 99, but but I'm really pleased with what the group is doing there.
And.
The 39, 8% of our sales went through our <unk> platform in the second quarter News Flash. It was 40% in June So we hit the number we had 40% now we need to get the $45 50.
But continue to see really nice progress there e-commerce continues to grow handsomely for us.
<unk> grew about 45% in the quarter.
For us this has been a different journey than other things because a lot of E. Commerce is unplanned spend if you think about our our F&I technology. That's all about planned spend that stuff youre using.
Daily Weekly every month in your business and it makes sense to stage it accordingly.
E Commerce, a lot of that is stuff that youre hopping onto order. So it's unplanned <unk>.
Historically, not a strong suit for us.
And I am pleased to say, it's growing to be a bigger piece of our business.
I mentioned, 45% the evi portion of it is up 37% and Thats typically larger customers.
Web portion of it can be larger small and thats up almost 70.
And to give you a magnitude of how thats changed and again, we're not great at this piece of the business.
But we can be.
With that said in.
In 2015, when I stepped into this role.
The web portion of it was less than 2% of sales than we were 383 9 billion. The company back then so.
About $75 million going through.
Web sales back in 2015.
In 2023 in the second quarter.
It was six 5% of sales so right now around a 12 month run rate of about $7 5 billion. So that's a business that's approaching $500 million.
And we're not that good at it.
But we can be.
So it's six five times bigger than it was a handful years ago and obviously, it's been accelerated by the events of last few years Covid is a perfect example.
What really accelerated as people do some people are working remotely. Some people are are ordering a lot more stuff electronically, we're seeing that in our numbers and we're getting better at it every day.
And when you push.
The <unk> technology in the E Commerce, together and you think about our digital footprint that was 55, 3% of sales in the second quarter of 'twenty three.
Was $47 nine a year ago.
We thought we could get to 65 this year, we've tweaked it to 60.
I don't know if I completely agree with our language there about fast stock conversions.
It's really part of it is the case of we're doing more and more every day.
But.
Some of the activity because a lot of the fast stock for example was going into fastener installs, it's going into OEM production areas, that's going to the MRO production.
And we're doing more transactions every day.
However.
The transactions are a little bit smaller because industrial production is slowing down in our business and so we might be doing more orders there just fewer of them.
Say you a few statistics.
In January of 2022.
Our fast stock we did 234000.
Scans.
Orders through for through a tool, which is 11100 every day. So our employees are going out with an Android device and scanning 11100 plan O grams every day and generating about $250 order actually it was closer to 260.
And and then in January of this year that 11100 had grown to 14700.
And between January and June that 14700 scans per day is now 16300, that's a combination of market share gains and conversion of.
Instead of going out with a yellow notepad, we're going out with an Android device and scanning bins.
And so that's that.
As a huge win in our system from efficiency, it's a huge win from a standpoint of ability to take market share.
But looking at the numbers.
Our average order size.
It was $258.
In calendar 2022.
In January that number had dropped to 246, so it was down about four 7%.
I think theres enough transactions going on there.
That's probably more a tone of the economy.
Than anything else because when youre doing 300000, a month, it's not it's not a mix thing.
Between January and June .
The 246 stellar order dropped about $2 22, so it's down $24, which is nine 6%.
It's primarily activity, that's declining and the industrial marketplace.
And there might be an element between January and June of a little bit of deflation because theres. Some fasteners in there, but it's but it's mostly about activity.
Just thought I would share those started to get into the weeds and I will share one last thing before I turn it over to Holden.
And that is.
Again, this fast stock tool, if Android device that we have out there.
In October of two excuse me in the fall in the summer and fall of 2019, we did a beta version out in the southern California of that device and worked through some bugs worked through some bugs and started rolling it out to regions late in the year with a planned two year rollout COVID-19.
Covid hit and we accelerate that rollout and we rolled it out across the company.
By June of 2020, So we had a six two year rollout in six months and today, that's about 12% of our revenue.
The.
In October of this year.
We plan to roll out what we call our order pad, which will be on the same device there'll be a customer internal facing device.
And use it in beta for.
In the October timeframe, if all goes well our goal would be to roll it out in Q4 and essentially it's it's.
It's a tool for our personnel when they are out visiting customer not only kind of take up of recurring order.
Easily take a customer asking for something where I can do a search on it and I can respond to the customer right in front of them. That's a capability. We've never had and we plan to we expect to have that by the end of this year for 2024.
The second piece is that as an internal facing out. We've also developed an external facing app called fast scan.
It's with beta customers right now.
Our goal is in August to have that out in the Apple store and the Google play for.
For customers, if they choose to download that and that would be a bin stock app for customers, primarily smaller customers or customers that might be a few hours from our facility in Montana or in Western Canada, where if.
They can do some bin bin stocks scans themselves transmit the orders so when we visit.
We aren't surprised by a stock out and it makes for a better supply chain for that customer base.
That will be again coming out in August and depending on what we are successfully find with our order pad. Our goal would be next summer to roll that out in.
In the customer facing App as well again, we're not great at the web portion of our business is to have $1 billion business within personal now, but we can be and we're building tools to do that because we think thats a better reaction to.
Some of the buying habits thats going on in the marketplace with that I will turn it over to holding great. Thanks, Dan.
One loose thread there perhaps to to pull a little bit last time, we had cash conversion of this level was actually in the second quarter of 2020 for those who don't remember the second quarter of 2020, there wasn't event occurring at the time that we now know as the pandemic.
But I really think it reinforces the point it took a once a century event.
To create a second quarter that despite several tax payments.
Produced.
Cash conversion in that 100% range and the fact that our teams were able to do that in a quarter, where thankfully there has not been anything remotely looking like a pandemic again I think it really gets to the the.
<unk> of the teams in and managing kind of the post pandemic environment.
Yes, but it does take it does take a condition of that store.
Jumping into the details on slide five of the deck daily sales increased five 9% in the second quarter of 2023.
Since March we have seen overall business activity moderate which culminated in June daily sales growth of up four 7%. The most meaningful change in trend has occurred in our manufacturing customers. This segment grew 10, 4% in the period, despite sustained sub <unk> and flat to negative industrial production.
This reflects the impacts of our investment in onsite and greater sales focus on key account planned spend which tends to be significant within manufacturing. Even so we did experience weaker sequential than may and June that represents a macro driven change from the long string of strong sequential sequential that we had from 2021 in February of this year.
Year.
As it relates to pricing that contributed 190 to 220 basis points to growth in the period declining approximately 470 basis points for the second quarter of 2022, and approximately 100 basis points from the first quarter of 2023.
This trend is not a surprise and will likely continue in the second half of 2023.
Other factors cited in recent quarters, specifically weakness among some large retailer customers lack of growth in our rest of world geography and contraction in our construction end market remained factors in the current quarter, but the dynamics around these areas were largely unchanged from prior periods. While we continue to pursue key account planned spend in construction this mark.
<unk> has historically had a disproportionate amount of smaller transactional spend where we are currently putting less emphasis.
We believe this shift contributes to manufacturing outgrowth, better labor leverage and better asset efficiency we.
<unk> experienced manufacturing driven weak sequential in three of the last four months regional leadership continues to characterize customer sentiment is cautious with greater scrutiny over operating and capital spending and some mention of slower or deferred orders.
As usual, we have limited forward visibility, but most indicators seem to be pointing to the immediate outlook remaining soft.
Now to slide six I'll.
Operating margin in the second quarter of 2023 was 21% down from 21, 6% in the prior year the incremental operating margin was 11%.
Gross margin was 45, 5% down 100 basis points in the prior year. This decline is almost entirely due to product and customer mix as we experienced widening sales growth outperformance of non fasteners over fasteners and of onsite growth over non onsite growth freight.
Freight was favorable to gross margin, reflecting record freight revenues that allowed for good leverage of our captive fleet.
Reduced use of external freight providers lower fuel expenses and reduced shipping costs. The benefits of freight were offset by higher organizational or GAAP expenses reductions of purchasing and shipping activities of imported products stemming from a smoother and more predictable supply chain relative to the year ago period caused higher prior period cost to be relief.
From the balance sheet to the P&L the.
The impact of price cost was immaterial to gross margin in the second quarter of 2023.
On the operating expense side, we produced 40 basis points of leverage which was not sufficient to fully offset the decline in gross margin.
This was due entirely to payroll expenses off which we experienced 60 basis points of leverage which was related to lower incentive compensation off last year's record level. This was offset by modest deleveraging of both occupancy costs and other expenses.
There are three distinct elements playing out in our operating margin in the second quarter of 2023 first I alluded to the GAAP expenses.
GAAP expenses had the convergence of a difficult comparison aggressive inventory reductions and shortening product order cycles. This alone was a 50 basis point negative impact and is unlikely to repeat buy anywhere near the same magnitude in the second half of 2023.
Certain expenses, such as 16% growth in it spending and 13% growth in cost for F&I devices represent planned and prudent investments in our business the impact of which is magnified by the slower sales growth environment.
Third the Blue team did not adjust spending quickly enough to the slower macro environment with variable cost for meals travel supplies, all increasing double digits also while lower incentive compensation produce leverage in the second quarter. We continue to have growth in head count and part time hours that exceed sales growth.
I would expect us to tightened this spending appreciably in the third quarter of 2023.
Putting everything together, we reported second quarter 2023, EPS of <unk> 52.
Up four 6% from <unk> 50 for the second quarter of 2022.
Turning to slide seven.
We generated $302 million in operating cash in the second quarter of 2023 or approximately 101% of net income in the period traditionally normal second quarters have a conversion rate of 60% 70% range. So this is a strong cash performance relating to a reduction in the use of cash for working capital versus the prior period.
This allowed us to reduce debt with debt ending at nine 4% of total capital in the second quarter of 2023 down from 13, 7% in the first quarter of 2022.
From 10, 9% in the first quarter of 2023, I apologize <unk> 37 in the second quarter of 2022.
Year over year accounts receivable was up six 1% largely tracking sales growth with the impact of mix due to faster growth from larger customers, which tend to have longer terms being offset by improved receivables quality.
Inventories fell 6%. This is a function of normalized supply chain, allowing us to unwind inventory layers. We had built up in late 2021 in early 2022 to manage that period's product bottlenecks that process will likely continue the likely to a lesser degree throughout 2023. It is also notable that our days on hand fell.
138, 5% a level not seen since 2002, which reflects improved velocity of inventory through our internal network a reduction of retail stock in branches and improvements in stocking processes, we have significant strategic flexibility and inventory at this point.
We have retained our range for net capital spending in 2023 or $210 million to $230 million, reflecting higher spending on hub investments lead equipment and equipment.
At the same time, we have deferred certain projects related to slowing demand that suggests our capital spending will be at the low end of the range.
The second quarter of 2023 was obviously challenging we expect to have better cost comparisons and to more tightly control those costs that we can effect in the second half of 2023, obviously, we have little control over end market demand in whatever direction that takes over the next six months will influence our profitability. However, these shorter term issues shouldnt cloud the structural improvements to our bid.
The second quarter saw record labor productivity, the creation of significant strategic flexibility in our inventory and further improvement in our return on capital as reflected on page nine of the Investor presentation. We believe we are positioned strongly outgrow the market, particularly as the industrial cycle stabilizes and improves with that operator, we will turn it over to begin the Q&A.
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Our first questions come from the line of David Manthey with Baird. Please proceed with your questions.
Good morning, Dan Holden I Hope you guys are having a great summer.
Thanks, Dave Good morning.
Yes, good morning.
I have a clarification and then one question a clarification Holden when you are on slide five when you were talking about price contribution. We said this will continue in the second half of 2003 and I'm wondering what you were referring to there first and then second.
Second the question I'm, hoping you can update us on Kpis relative to your cfcs and the focus five initiatives.
Sure. The clarification is we continue to expect moderation in the overall contribution from price in the back half really just a continuation of what we've been seeing over the past few quarters.
Okay.
That helps.
Yes, okay.
Up.
Yes.
The <unk> continue to experience very strong growth I believe in the second quarter. If you think about.
The books of business that are CSC or Hunter program has.
The growth in those books in the current quarter relative to what those books did the prior year, it's actually up north of 50%. So we continue to see good success in particular with the <unk> with the CFC program.
And I don't have specific numbers on the target $5 for you Dave.
CSC is to some extent have their own target five so I think you can get a sense of how that growth is occurring.
But.
<unk>.
Yes, I don't have specific target Pfizer the cst's continued to grow well in excess of our business and I think the <unk> are a manifestation of the same key account approach that the target Pfizer our feed into as well.
Got it that's helpful. Thank you.
Thank you our next questions come from the line of Michael Hoffman with Stifel. Please proceed with your questions. Thank you very much Dan and Holden.
The trend data that you share so generously can you.
And I guess you have limited port.
Toward visibility, but do you think youre hitting a bottom.
I guess I'll, just reinforce we have very little visibility.
To what the market is going to hold it here's what I'll say I've always respected the PMI as an indicator of future.
Activity levels I tend to think it has a forward look of three to five months.
I think we all know that the PMI in June hit 46, which is not a meaningful new loan with a new low Nonetheless, and I think that I think the.
Message that we gave to our people internally was that.
Would seem to suggest that the back half of this year is going to remain soft.
I don't have an indicator internally.
That would give you any real insight into what's going to happen in August September October .
October .
The PMI has always been a good indicator in the PMI remains relatively low and suggest in the back half is going to be weak and that's that's what we sort of take our Hughes off of.
Okay, and then on the digital transformation one of the things that.
I think I understand correctly is you tend to gain a greater percentage of wallet of the individual customer over the.
The lifecycle of that penetration.
How would you characterize where you are in that journey.
And how that's influencing some of the share gain.
You know.
I think so.
If you think about it.
The digital foot well I'll talk about the F&I component of the digital footprint is about 40% of our business and.
Internally the number we've always talked about is we think we can get that about 65%.
A good chunk of.
<unk>.
<unk> of that is is converting existing customers.
Two of the new platforms and it it allows us to share insights with our customers in ways that historically you can't it brings efficiency to the business and the efficiency isn't just for efficiency sake, which is nice.
To free up time to engage in the marketplace.
And.
So ultimately we see that time freed up as a means to grow the business faster because you can you can engage more.
The other pieces.
It's a separate in the marketplace there is.
We have a customer event, each spring, where we bring in thousands of customers and we meet with <unk> with suppliers engaged with different tools of the business and.
We are winning business because of the capabilities.
I sat in a customer discussion last summer.
And our National account person, who was speaking to.
Purchasing team from a bunch of locations within our.
Conglomerate and.
They were explaining how the how our RFID program worked.
And that's essentially a kanban system with an embedded RFID chip. So in that vein is empty instead of somebody somebody having to walk around and check things and find stuff and see what needs to be replenished.
That Ben has placed on the top shelf top shelf.
Simple RFID reader.
<unk> been 14 is empty, okay, I'm hungry I need to be fed and that's how our replenishment works and her response when she learned about it she looked at a person across the room and said you remember the issuance you she talked about four different manufacturing plants, where they struggled she said this things she asked a few questions Clare.
<unk> questions as you look to the person. This is unbelievable this would solve all of our problems.
And that's a light bulb that pops awful lot when people realize what this says I was visiting it employee down in Illinois.
Two weeks ago employee celebrating 40 years I drove them to spend the day with them and thank them for 40 years of service and he said he want to go visit a customer with me and unlike I'd love to.
And when we're in any should be something in his wallet. He pulled out a little less the size of a credit card and Thats whats that he said that's my RFID chip.
And I said, he said the customer you're going to I'm going to show you how we're using it in ways above and beyond just a kanban system. They are using it per pallet replenishment. So they go out they have a little envelope on the on the pallet rack and then they have a low carbon there it's a little plastic card within RFID chip, they grab that and they throw it in the top the top band on our on the Con.
<unk> system.
And it tells our branch we need another pellet of this product.
Not only is that incredibly efficient for us.
Our customer loves it the customer showed it to me.
Our folks loved it because they don't need the right stuff down and then call up passed on to bring another one over or wait for you guys. When you come here tomorrow to check it and realize you need to bring another one over we just tell you, but it's done in a matter of seconds.
That's that.
That's something a supply chain partner.
Does and we're great at planned spend and that is winning us business because when other customers come and tour that facility when theyre in the RF are a few process they see stuff like that and Thats, a separate or just like vending as a separated.
Sorry, I went a little long there, but I think it is helpful to sometimes use some examples and I might add as well that I think that those two actually interconnect in the sense that to the extent that it helps to reduce our overall cost of operations and it does that actually allows us more flexibility in bidding processes and I think it makes us more competitive in the marketplace.
Contributes to our ability to to win and gain market share as well. So it really plays as it plays really strongly in both our ability to leverage as well as our ability to grow.
In February I think it was February I was down in Indiana visiting.
Speaking to a group of branch managers and visiting with Randy Miller.
Our most senior regional Vice President.
And they asked me if I want to go up and visit a customer and the customer they took me too well it's a.
A large on site they.
They would contact us in the fall of I believe it was 2020 I might be wrong on the year, but I believe it was 2020.
And they need some help and we set up an onsite in there.
And.
The incumbent had been staffing the onsite 24 hours a day.
And our folks really studied the activity and said you know.
If we put out a handful if we put if we put our product in a handful of lockers in a way that we typically do it.
We could give you better service and staff at 10 hours a day instead of 24, and you would get better service than you were getting before and we'd have a better.
It would be easier for us to recruit we could ramp up faster the business because finding folks to work 24 hours. A day is sometimes challenging finding folks to work 10 hours, a day or 10 of our window.
You went at Sterne daylight is less challenging.
And again it was a case of that separated us.
Instance that I.
Visitors that customer had a great visit with them and they were showing me some of the stuff that we were doing that they just loved about our model.
Thank you very much.
Thanks.
Thank you our next questions come from the line of Chris Dankert with loop capital markets. Please proceed with your questions.
Hey, good morning, guys.
Good morning Holden.
Yeah.
It kind of a mid teens growth in it spend and Thats my investments.
Thinking about kind of SG&A spending and investment going forward can you kind of give us a sense for.
Could trend in the back half of the year, just kind of keep investing for growth here.
Yes, well.
I mentioned, the it and the semi spend because those were investments in our business that we're making that are wise investments to make and I don't necessarily anticipate.
We're making investments in those areas that we're going to pull pull meaningfully back in those areas.
Areas, we were talking about more has to do with you.
Expenses that we had for travel both sales and non sales and related type expenses.
When we think about how we're using our part timers and the fact that our among our part timers are up.
12% in June in a marketplace, where revenues were up less than five.
There's just a number of things that we talked about that are variable that we werent really treating those expense lines as though we're in an environment, that's growing at 5% and in the messages we need to we need to get there now what was the impact of that.
If I think about the.
If I think about the travel meals supplies et cetera that was about a 10 basis point impact on our business.
In terms of overall profit impact if I think about the increase in base pay that comes from higher absolute head count that comes from higher part time hours.
Those sorts of things.
That would have been about a 450 basis point impact to margin now that was offset by the fact that incentive compensation was down because last year was such a strong year relative this year.
But those are areas that as an organization, we need to we need to tighten up a lot of our behavior and patterns to reflect more of the environment that we're in and again I expect it will make progress on that in the third quarter.
On the add on and I'll put onto that as it relates to <unk>.
As when I stepped into this role back in 2015.
One of the one of the first things that I said to the board and I said to our team is.
Everybody is going to is going to get lower pay next 12 months, because we're going to because we're paid off of earnings growth as you read our proxy youll see how our compensation programs work, we're all going to take a pay cut because we are going to increase the investment in it.
And tap the senior leader, who has grown up through our branch network was a district manager was the regional Vice President had led our government sales our vending business and his name is John Soderberg I tapped him I said, John I know you know nothing about it.
Other than <unk>.
Apps you download on your Android device, but youre a great leader of people, we have great folks in our it group I don't think the connected well enough to the business and I think we're under investing and we increased our spend on it by 50 basis points in 2016, and we've held that number in there ever since.
And I told them, we will not sacrifice our investments in the short term if it's longer term.
We have to be pragmatic, but last year, we added 50 people.
Into our Bangalore.
Tech Center.
In January we added another 100 people, we're not there yet, but I suspect at some point in time, we will have more people in our India technology.
Technology group than we do in our four U S. Three U S technology groups.
And Thats and Thats, partly about availability of recruiting because we have great folks here, we can't handle pest enough.
But we will continue to make those investments and because we made those investments today, we have a digital footprint.
55, 3% of sales and the productivity gains over the last three years would not have happened without it.
So I think its wise investments, we will continue that.
Absolutely yes. Thank you so much for the color guys.
Thanks.
Yes.
Yes.
Thank you. Our next question is coming from the line of Ryan Merkel with William Blair. Please proceed with your questions.
Hey, guys, Hey, Brent good morning.
I had a couple questions on margins first off on gross margin how should we think about the rest of the year is normal seasonality the right framework for our <unk> and <unk>.
And I think in the first quarter, we sort of talked about.
Normal seasonality would apply but a bit more of a muted rate.
And I think that's still I think theres still appropriate I mean second quarter was down about 20 basis points from first quarter I typically think of it being down 30%.
<unk> is fairly typically flat with <unk> and I think that's a reasonable ballpark.
And <unk> is <unk> is usually down about 30 basis points from <unk>, and then again, maybe it would be a little bit more modest than that.
About.
Is it the mix question is still an open one right because the reality is in a week cycle your fasteners weaken more.
And that winds up sort of having a bigger impact on gross margin and mix than you would normally expect and you saw that this quarter just as you've seen in the past and so to some extent Ryan part of the question is what's going to continue to happen with the cycle and the gap between fasteners non fasteners and Thats a cyclical question I can't answer.
But if I think about.
The transportation piece of it.
I think thats going to continue to have a sustained beneficial impact for a number of quarters, if I think about sort of the.
The timing elements that the GAAP stuff that I talked about I don't think that that impact is as great in Q3 and Q4 as what we saw in Q2.
It will still be price mix neutral just as we were this quarter right. So when I put all that in together I think the seasonality is reasonable, but I would mute it against history for the next couple of quarters, That's my expectation and like I said the wildcard really in my mind is what happens to the cyclical element of seasonality related fasteners.
Yep.
Super helpful.
And then on Opex, holding you mentioned youre going to tighten that up a bit and then youre also going to invest in it.
For the long term, which I agree with.
Is there any metrics you can provide is there a goal for FTE growth in the second half.
Guess ultimately what I'm getting at is can you adjust SG&A fast enough, where you can hold operating margins flat year over year in the second half or is that maybe optimistic.
It will depend how aggressive we are.
The.
Part of the operating margin is going to be a reflection of the gross margin. So again I will perhaps cop out a little bit on your question about SG&A as a part of it part of the answer to your question is going to rest and what happens to the cyclical element of mix right.
Set that aside and just focus on the SG&A.
<unk>.
I think that the.
We need to reduce the cost in our SG&A relative to Q2.
By two 3 million Bucks and we need to do that through tighter control of head count through tighter control of those expenses.
And I feel comfortable that we'll be able to do that I think the organization is already sort of responding to the messages and responding to the natural signal of their growth slowing down.
So.
I do believe that we will.
Have better leverage opportunities in the back half again with the wildcard being what happens.
The underlying demand environment, and what impact does that have on fasteners related mix.
Got it thank you I'll pass it on.
Okay.
Thank you. Our next question is coming from the line of Josh.
<unk> <unk> with Morgan Stanley . Please proceed with your questions.
Hi, good morning, guys.
Good morning.
Also kudos to the operator for nailing the authentic pronunciation, there we don't get that.
I was going to ask that was pretty close.
Yes that was that was all country right there I like that.
Just maybe a higher level question for both of you obviously you've seen.
Huge wave of inflation supply chain tightness now going back the other direction at least with disinflation.
What would you identify Dan.
The biggest change you saw as a function of that and the biggest things that are changing now as those reverse could be customer facing could be kind of margin profiles of the business.
Deliberately a broad question, but just thinking yes.
Yeah.
Well I mean, the biggest change that we saw directly in our business from supply chain element was the fact that we had to add a heck of a lot of inventory and it was expensive inventory in.
In 2021, and 2022 container costs were Sky high we were doing a lot of things we were not going to let people down.
Fortunately, we have the balance sheet to do that and we have a shareholder base.
That.
That appreciates, we're judicious with with their capital.
But they were supportive of the move.
And they were confident that when the need.
For that extra layer of inventory subsided, we figure out a way to harvest that out of the balance sheet and.
And move forward, that's probably the biggest thing to how it manifests itself, obviously on our balance sheet and our cash flow statement, we talked about that earlier.
If I think about more broadly.
We are seeing changes in and it's one of the reasons I touched on a bit.
The.
The two elements of our business the planned spend.
I believe we have created over time, an incredible ability to serve that market.
And the unplanned unplanned where.
Where.
We're good at it we're not great at it.
And partly because we haven't built the system to support it.
Whether it's technology or supply chain and we've been busy building that the last several years and we talked about some of those pieces.
And we've seen success on what we've built but it's still a relatively small piece of business, but we are seeing that trend.
If a buyer is working remote two or three days, a week or covering a bunch of locations because the technology you can do a lot of things you Couldnt do in the past and you can do it easily.
They are buying in a different way.
And.
We need to make sure our systems.
Work for that different way.
I hope that's helpful.
Specific on pricing if you recall during the period of tariffs, we didn't do a great job.
Sort of offsetting all the tariffs and inflation that occurred during that period of time.
The organization kind of buckled down and developed since then what we call. The price review tool of PRT and I think what you've seen over the last few years in a period first of fairly significant inflation and now a period of perhaps modest deflation.
I think you've seen that tool in our organization's ability to.
Utilize it.
Result in a much better outcome.
There's the occasional blips here and there we didn't quite get all the inflation on faster so that's come back.
Fourth quarter, I think maybe we got a little bit behind on a certain area, but for the most part we've been able to be price cost neutral.
For the entirety of this period of inflation or deflation and I think it really is reflective of the organization's ability to deploy technology solutions to.
The problems that we run into every day.
The other thing that I would say is from an inventory standpoint.
We talked about how inventories dropped a lot because of the unwinding or sort of harvesting some of the investments but we.
We peaked from a days on hand standpoint between 185 to 190 days. We're currently sitting at $1 35 and 40.
That's not just because of buying inventory and then harvesting related pandemic that relates to a lot of things. The organization did in terms of how it views branches branch inventory strategically in terms of.
What's in our hub versus where should inventory be improving the velocity and I think the fact that we were able to improve the overall performance of our assets.
Even in an environment, where we're getting a tremendous amount of pressure because of the needs of the pandemic when it started and as it was fading really reflects the organization's ability to do more than one thing at once.
I think the organization can be proud of itself, how it's managed a lot of <unk>.
Lot of the things that have come up over the course of the past four five years.
Got it I appreciate that comprehensive maybe just a quick follow up.
As you've seen things decelerate and maybe just inflate a little bit as the competitive landscape changed I know you guys don't really see it maybe some of the way other folks do in the space given your business model, but anything you'd comment on competition.
Yes, I don't think the competitive landscape has changed if you look at it from a product perspective.
And I think one element that's there to is <unk>.
While the.
There is.
Theres more than one element of inflation and there's more than one aspects of cost. There is inflation that we saw in and product cost inflation that we saw in transportation container costs things like that product cost.
The dynamics are different than the container and transportation element.
Third element, which is which is really relevant for our customers and for their supply chain is the cost of labor.
There is no deflation in labor I'll guarantee you that.
There continues to be inflation in labor.
We do have more success in recruiting.
But but but.
But.
We are not unique all businesses are seeing inflation in that arena to this day.
And part of the nice thing about the total cost of ownership approach, we take with our customer because we're really able to understand all those cost components and have intelligent conversations with the customers that they are not emotion conversations the fact.
And tactic conversations, which allows both us and our customers together to make better choices.
On puts and takes but but there are inflation elements still in the business. There are some deflation.
Elements in the business container is coming across the ocean is cheaper to data and it was a year and a half with over a year ago.
And I would say there is also availability elements in the marketplace as well.
No.
During during 2000 22021, there weren't a lot of distributors that had availability of product than we.
We benefited from that as the supply chain has normalized the marketplace sort of normalize as well and I think what you see is a little bit more competitive in terms of customers being able to say, we're going to test the market a little bit again, I don't think thats unique to us I think it's fairly typical in the market and I think it's reflective of the degree to which things are frankly normalized.
At this stage of the game.
And it allows us to really talk a lot about exactly what Dan said, which is.
The supply chain solutions, and how that differentiates us.
In the marketplace.
Got it thank you Bob and.
And Josh in interest of full disclosure I, probably would've gotten your last name incorrect.
Yeah.
Thank you our next questions come from the line of Tommy Moll with Stephens. Please proceed with your questions.
Good morning, and thanks for taking my questions.
Good morning, good morning.
Can you give us an update on fastener product margins associated with those.
The potential for some renegotiation just on pricing that is given some of the volatility around steel and shipping any update you could give there would be helpful. As well. Thank you, yes, yes, I mean product margins. When you when you break fasteners into OEM versus MRO fasteners product margins are fairly stable.
When I think about price cost in the fastener arena.
It's fairly neutral at this point right. So I mean from a from a from a costing and margin standpoint, I think things are fairly as expected.
Now I will say I do believe that we have had circumstances, where again there's contracts that require requires some adjustment based on end markets, where I do believe that we've begun that process, but that is in that is really aligned with what we've talked about before as we see our costing improve and we have.
Half.
On imported product that we have certain agreements with certain very large customers that we will adhere to and I think that you are seeing that happen. So.
It's largely I think as we expected.
I don't think they are having any adverse impact on our overall profitability level.
And that's probably how I'd characterize it does that help.
Indeed, thank you.
Also wanted to talk about supply chain.
Prepared materials this morning.
Talked to.
The reduced inventory is aided by a shorter product ordering cycle for fast at all.
Curious, though with a better supply chain do you see some of the same for customers is there any impact in your daily sales trends from that.
You know if you think about what we do for our customer.
What are the buffer if you know, we're supplying product to them and again.
I'm really talking about both sides of our business, whether it would be planned spend or unplanned spend.
If if supply chains are taken 30 days longer.
We build that inventory so we get it to them when they need it. So I don't know that there would be a destocking element downstream from us I'm sure. There's examples of it if there is a destocking element it's because.
Customer had built up finished goods because they had a strong backlog and that backlog.
It has been worked down their finished goods has been worked down and as they are in that process.
That impacts us because they lowered their production and so it isn't it isn't so much because of the supply chain changes because downstream their needs for finished goods changed.
We typically see a supply chain impact the most.
When we take on a new customer relationship.
It's not uncommon for us step into the new customer relationship although have.
Elements of inventory that we're going to be managing now forum.
Where they have a six or 12 15 months supply.
Four months supply the extreme examples are usually niche.
But.
As we aluminate, what they have in their inventory.
Or how their predecessor supply chain partner was supplying and and I'm not thrown in predecessor under the bus because it could have been there is a bunch of different suppliers supplying the sand and theres not a coordinated effort.
And so you have months of inventory on something that is ridiculous to have months of.
Customer a few years ago.
First off it was a part that I thought was fairly unique I discovered that we had a regular supplier for it but it was an item where the customer discovered they have 14 months of inventory and they had no idea they were appreciative of it and.
And we worked out an arrangement with them to manage it down and they paid us something we're helping manage it down but we didn't have product sales for a period of time, but we had a lot of other sales. It was an onsite doing 130000, a month it just wasn't doing 160.
But then when we burn through it and Thats, what our supply chain partner to us.
But that's that's not about supply chain time, that's about just the.
Inefficient supply chain.
Thank you both I will turn it back.
Thank you our next sorry go on.
I apologize to whoever was in Q.
Hold on and be available.
<unk> do you want to give him a direct call I'm going to run to a meeting in a few minutes, but we we hold these calls to one hour and we are we are at 10 o'clock Central time. Once again. Thank you everybody for attending our earnings call today and best of luck in July and the balance of the year have a good day everybody.
Thank you. This does conclude today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation and have a great day.