Dan Florness - President and Chief Executive Officer
Thank you, Ellen and good morning everybody and thank you for participating in today’s call. I realize at this stage of the economic cycle, our industry is a bit out of favor, but however, I believe we have a great story to tell. And I believe our moat is expanding in the marketplace.
Let’s start out by going to Holden’s flipbook. If I look at some of the highlights he called out, I will start with, it will be probably good if I got on the right page, I’d start with our non-residential construction business is accelerating. In June, we hit 17%. In all honesty, I don’t understand the strength behind it. I know the things we have done to build momentum there, but I was very pleased with the progress we saw in the second quarter. Our manufacturing demand is stable at very healthy levels. We rolled that together. We grew our sales 13.1% in the second quarter. That’s our fifth straight quarter of double-digit growth. So, when I think about it I think there is two things that are noteworthy there. One is we are growing on some good growth numbers and I think that’s a pretty strong statement. The second thing is a year ago in late March 2017 we acquired a great organization in Michigan called Mansco, we anniversaried that acquisition on March 31. So, our growth in the second quarter was 100% organic. And we put up I think a great number.
If I look at on the operating income side, our operating income grew 13.3%, which is a beautiful thing. Our reported EPS was $0.74. However, there was a discrete tax item in there, so really pleased with the earnings growth we saw in the quarter and our ability to manage our expenses. Holden will touch on some of this a little bit deeper later. Onsite and vending signings are on pace to achieve our 2018 targets. As mentioned, we had significant operating leverage in the second quarter, including employee-related expenses and our gross margin was stable on a sequential basis, which I think was an important thing to note. And the real key to the stability from Q1 to Q2 from my perspective is we did a little bit better job using our own trucks. We have always talked about the fact that we have a great trucking network we built over the last 35 years. We have a structural advantage in the marketplace. And frankly, the marketplace is becoming increasingly more expensive and so our ability to divert some of our shipments off of third-party carriers on to our own network serve us well in any economy. It served us really well in the second quarter. In the context of normal seasonality, our operating cash flow improved in the second quarter. We repurchased some stock. And as we announced last night, we increased our third quarter dividend from the $0.37 we had been doing in the first two quarters to $0.40.
Flipping to the Page 4 of Holden’s book, we signed 81 Onsites in the second quarter, that’s a 19% increase over the second quarter of 2017 and we finished the quarter with 761 active sites, that’s a 57% increase over last year. Our 2018 goal for Onsite signings remains somewhere between 360 and 385. Total in-market locations were 3,051 at the end of the quarter, up over the 2,937 a year ago. What you are seeing before your eyes is a morphing of the Fastenal distribution model. We are consolidating some locations throughout the marketplace probably a little bit more in the major metros where we have a wide smattering and some of those locations are morphing into Onsites. And so we continue to expand our in-market presence. We signed 5,537 vending devices in the second quarter, a 13.5% increase over the second quarter of ‘17. Our installed base grew 14.3% and the sales through our vending devices grew in excess of 20%. Our 2018 goal is to sign 21,000 to 23,000 and we feel good about that goal at this point. National accounts, our daily sales grew 19% in the second quarter. In June, we broke 20%. I have to say that tasted pretty good and I was proud of the team and everything they are doing to grow their business. Outside the U.S., our sales continued to well outpace the company and we are seeing great results within the U.S. and throughout the rest of the world.
Before I turn it over to Holden, just wanted to share some commentary and call this in the category of trying to be ever more transparent of what we do and what we are seeing in the marketplace. And at 7 o’clock this morning, Holden had his typical call with our leadership group, our regional Vice Presidents, our VPs that lead up support areas as well as our officers. He discussed through the earnings release to give them more insight into what we saw in the business and he gives me a few minutes at the end to throw in a few thoughts and I just thought I’d share with you some of the thoughts that were covered on that call. The first one we talked about with the group is we have really decided that hitting goal matters. We have hit goal – at January, we missed goal. Weather messes us up a little bit. So, we came in just shy of goal. Since February, we have hit goal every month and we had a big goal number in June and I was pleased to say we hit it. And in total for the first and second quarters, we hit goal. Hitting goal consistently gives you confidence to invest in where you are going.
From a gross margin perspective, we maintained our gross margin and the mantra of, hey, just use our trucks, played out really well. We have, as I mentioned earlier, a great trucking network and we are tapping into it a little bit more. We have been having a lot of discussions about expenses. And this is one where if I am looking at myself in the mirror, I have to say either we are not communicating really well or you are not listening. And I think it’s probably more we need to step it up on how we communicate. So I am taking that piece on from the standpoint – after the first quarter, when we grew our labor expense about 14%, I got a lot of phone calls from shareholders in the sell side community really wondering, what the heck is going on that you are growing your expenses so fast and you are not able to leverage. What we have been talking about the last 2 years is the investments we are making in growth drivers. We made dramatic investments in our ability to sign vending devices. We made tremendous investments in our ability to implement and improve our Onsite network. We made sizable investments a little over a year ago in our ability to grow our e-commerce locally, and the other piece is understanding the fundamentals of how we compensate. Historically, a sizable piece of conversation within Fastenal has been incentive-based. If you read our proxy, you can see that if we don’t grow our earnings, our leadership better enjoy living on base pay because that’s the key driver of incentive comp.
In the first quarter of 2018, we added $21 million in pre-tax to our business that was double the $11 million we had added the year before when we compare ‘17 to ‘16. That causes our incentive comp to grow quite dramatically. And if I look at the 14% labor growth in the first quarter, 6 points of it comes just from expanding incentive comp, 1 point of it comes from Mansco acquisition, and the other 7 comes from adding people in the organization.
If I look at the transition from Q1 to Q2, you saw our labor expense growth drop 400 basis points from 14 to 10. What really changed there? We put a little bit of a pause on hiring. We had gotten ahead of ourselves, but that wasn’t the real change. The real change was we anniversaried Mansco and our incentive comp, while at a high level, is not disproportionately higher than second quarter of 2017, because in the second quarter of 2017 we added about $27 million in pre-tax. In the second quarter of ‘18, we added $31. The delta there isn’t as great. So, our team throughout the organization are enjoying enhanced incentive, but they were second quarter last year. So, the comp is different. I apologize that I haven’t communicated that better, but we saw a nice change in our ability to leverage. Frankly, I didn’t think it was going to happen until the third quarter and the team did a nice job of deciding to move it up 3 months.
If I look at the MSAs and I have started to talk about that more, talked about that in the President’s letter, talked about that at our annual meeting and in previous discussions, we are really learning a lot by really taking a good look at those 100 large MSAs, communities little over 0.5 million, what is our plan in those markets? And there was something that’s jumped out for me and this isn’t an exclusive thing to the MSAs, but it stands out when I look at it from things we are doing. And so, yesterday at our board meeting, the individual that leads the e-commerce drive is within Fastenal, it’s a relatively small business, because there is so many things we do that don’t lend themselves to e-commerce. We do Onsites. We do our local branch network. In many cases, we are fulfilling things for our customers that they don’t even have to order and so e-commerce really isn’t part of the Fastenal model.
But one thing that’s really was interesting to see is that as we have been quietly building momentum in our ability to go to market in a bunch of different ways. And if I look at true, local e-commerce transactions where we are taking advantage of our last mile advantages, that’s about a $100 million business and it’s growing 30% a year. I think that speaks well and forget the fact that it’s e-commerce. It speaks well to the capabilities of the Fastenal organization to fulfill and to serve customers’ needs. And the interesting thing is we are seeing really nice growth within our Onsites as well. It’s about ease of doing business. If I – I am also – and bear with me a second, I like milestones. Sometimes they are fun to point out. And this is probably a ridiculous one, but bear with me.
If I go back to 1987, the year we went public, we had about 50 locations back then. We had 300 and some employees. For the year, we did just under $20.3 million. I believe it was $20,294,000 or something like that. In the month of June, on a daily basis, we broke $20.3 million. So, in June of 2018, we did more revenue everyday than we did 31 years ago that the company that went public. I think that’s a pretty neat milestone and I am proud of what our team has done in that 30 some years to accomplish that. Said another way, we are 254 times bigger than we were 31 years ago, that’s kind of fun. I also thanked our regionals and our VPs and RVPs for a great quarter. I think they really demonstrated the power of the Blue Team and what we can accomplish in the marketplace and some of our structural advantages. I am blessed from the standpoint I have a wife that’s not afraid to challenge me in most things in life, personal and business. And the other day, she was asking me some questions about the quarter. And I told her I can’t tell you, because it’s not public yet. But all kidding aside, she was asking about what we are seeing from the tariffs, she said, you are thinking any of your strength you are seeing is coming from the tariffs in the marketplace. And I answered really quickly and with confidence I said, absolutely not. I said what our business is about is we are a supply chain partner. And most of our customers are able to operate in a very lean environment because of what we do.
And I don’t believe there is any impact from the lift other than if there is any impact to any of our customers and their activity that would create but there is no inventory build in the cycle from what I am seeing, which caused me to immediately go to Holden and say, hey, Holden, this is what I told my wife, am I accurate? And he canvassed our RVP group and he got a resounding, no, we are not seeing that at all. So, I thought I’d address that in the context of the time. Second question she had which was actually just as good as the first was how does Fastenal react in an environment like this? And I looked at her, and I said, well I gave her the proverbial, I’m a farm kid. And I learned at a young age, you don’t react to the weather. You plan for it because you can’t change it.
This is just like the weather. It seems to change on a daily basis. What I can tell you is Fastenal’s biggest strength is our field network, our branch and Onsite network we unlike any other regional, national, or global distributor, we source a tremendous amount of product locally and so, we don’t have a small, centralized group that has to be really agile, although they are. We have 15,000 people working in our branch and Onsite network that are agile every day so our ability it is not easy to manage through it, but our ability to manage through it is stronger than anybody else in the marketplace. And I would be going into a period like this, the confidence I have comes from the team we have on the ground. And that makes it pretty exciting. When I was finishing up with the RVPs this morning, I didn’t say this to them because I didn’t want to get weird on the call but I thought back to a movie – Gene Hackman is one of my favorite actors of all time. And I thought back to a movie he made back in the early ‘80s called Hoosiers.
And at the end of the movie, he cites a line as the scene is going dark to his team that, I love you guys. 22 years ago, I joined the Fastenal organization. And I didn’t join because of the growth of the organization. I didn’t join because of the opportunities of the marketplace. And I didn’t even join because of the great people. All three of those were true. I joined because I saw in Fastenal an organization that treats people differently than other organizations I’d seen in my prior experience. And I wanted to be a part of that. In an organization where you’re inclusive, and you treat others well, and you invite others to join, and the only requirement to join us a willingness to learn and change, a willingness to help each other succeed, and a willingness to be challenged by others and to be willing to challenge others to think big, when you have all that, you have a home at Fastenal. Come join us. We can do great things together.
And I think you see it come through in a quarter like this and in what we’re doing in the evolution of the last few years. I’ll close with two thoughts, and then I’ll turn it over to Holden. My mom is having a double mastectomy at 11:00 this morning. I wish her well on that. I’m going to visit her after the call and Godspeed on her recovery. 60 days ago, my wife had the same surgery, and I’m proud to say that today, she looks and feels better than she ever has. So, I’m thankful for organizations like Gundersen Health down on La Crosse. Our medical in this nation can do great things.
With that, I’ll shut up and turn over to Holden. Thank you.
Fastenal Company (FAST) CEO Dan Florness on Q2 2018 Results - Earnings Call Transcript | Seeking Alpha
