Ruane, Cunniff & Goldfarb Investor Day St. Regis Hotel, New York City – May 16, 2014
company. Fastenal is an absolute powerhouse in OEM fasteners but OEM fasteners are not growing much right now. So that is a bit of a drag.
There is no question that there are cyclical aspects to the company. But the secular growth of the company is more interesting. That will slow, undoubtedly, versus when we purchased the stock in 2001. Fastenal’s valuation is always very high. The management gets a lot of credit from Wall Street, in part because the company returns any savings or cost benefits to the shareholder. Management is very shareholder friendly. Right now, the valuation is middling relative to the historical range. If the growth is slowing, you might say it is a bit on the high side. But keep an eye on the investment in sales force labor. What we are going to be looking for is a top line sales acceleration commensurate with that.
Bob Goldfarb:
One thing I would comment on in addition is that it still had a pretty strong performing year by any standards, other than those of Fastenal and companies of that ilk. But management took a real hit, if you look at the proxy statement, in its own compensation from levels that were not all that high for starters. I do not think I have seen any companies in that same situation where the top executives all took a really big hit. Chase, what were the numbers on compensation?
Chase Sheridan:
I am not sure what the hit was in the proxy. But I recall that the CEO’s compensation was calculated to be 13% of the average CEO’s for a company of his size. He did not regard that as an insult. Instead, he said, “That is because I deliver the best value.” He was actually proud of that. To Bob’s point, a few years ago there was a frivolous lawsuit against Fastenal, and the company settled for $10 million. Of course that hurt the shareholder, but what was interesting was that the company docked everybody’s bonus. The company included that $10 million exceptional charge when calculating the bonuses of its people. Management really shares the pain.
Question:
I have another question about Valeant. Do you agree with Bill Ackman that GAAP earnings are immaterial in evaluating a company like Valeant?
Rory Priday:
Yes, I think for the most part, most of the things that Bill Ackman cited we agree with. If you are analyzing Valeant, you want to focus on what its
adjusted net income is, what management is adding back to get that adjusted figure, and what it is adding back to adjusted cash flow. The big items for adjusted net income are restructuring charges and amortization expense. We do not mind adding back the restructuring charges because we view it as once the business that the company acquired is consolidated, in the next year the synergies are going to be there so that the business will be a lot more profitable than it was.
Usually the way Valeant talks about it, management adds those restructuring charges back as part of the purchase price. Those are the two main differences from GAAP net income. There are some other non-operating add-backs that the company makes. The one area I would focus on maybe is legal expenses and whether you want to add back one-time legal expenses. Some people would say that those are ongoing. Definitely legal expenses are part of an ongoing pharma business, but Valeant expenses its ongoing legal fees. It is the one-time legal charges that the company tends to add back. On the cash flow side, management also adds back restructuring charges. Those are basically all cash.
I know a lot of people complain about Valeant. They say that management is playing games with the acquisitions. Sometimes when companies take big restructuring charges or reserves, they release some later on so that they can make their income look good. Valeant does not do that. Most of the restructuring charge is paid out in cash. I do not think management is playing games in that area.
The one thing I would look at, and I do not think Ackman mentioned it, is that the cash net income and the adjusted cash flow from operations do not always line up because of increases in working capital. Valeant has not shown a tremendous amount of organic growth; so one thing to watch out for is how much of the difference between the adjusted net income and the adjusted cash flow from operations is going towards working capital. It has been significant in the past two years or so, but the company has been growing overseas in emerging markets where if the government is a customer, Valeant is not going to get paid for a long time. That is one reason why working capital can rise. There are other reasons, but for the most part, we agree with most of the add-backs.