Ellen Stolts - Investor Relations Dan Florness - President and Chief Executive Officer Holden Lewis - Chief Financial Officer

Ryan Cieslak - Northcoast Research Hamzah Mazari - Macquarie Adam Uhlman - Cleveland Research Evelyn Chow - Goldman Sachs

Good day, ladies and gentlemen and welcome to the Fastenal Company Third Quarter 2018 Earnings Results Conference Call. At this time, all lines are in a listen-only mode. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to Ellen Stolts with Investor Relations. Ma’am, you may begin.

Welcome to the Fastenal Company 2018 third quarter earnings conference call. This call will be hosted by Dan Florness, our President and Chief Executive Officer; and Holden Lewis, our Chief Financial Officer. The call will last for up to 1 hour and we will 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 Fastenal presentation and is being recorded by Fastenal. No recording, reproduction, transmission or distribution of today’s call is permitted without Fastenal’s consent. This call is being audio simulcast on the internet via the Fastenal Investor Relations homepage investor.fastenal.com. A replay of the webcast will be available on the website until December 1, 2018 at midnight Central Time. As a reminder, today’s conference call may include statements regarding the company’s future plans and prospects. These statements are based on our current expectations 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 Florness.

Good morning, everybody and thank you for joining the third quarter earnings conference call for Fastenal Company. I will start the discussion with – before I get to the flipbook, just recap a few things going on in our business and to add some transparency to some things that are going on in the business, had a call early this morning with our regional leadership and around the planet. Holden ran through a bunch of the financial aspects and discussed the release in general, talked about some of the points that we will be focusing on in the earnings call today to have that group be really well-informed of what’s happening in the business and that’s something we do every quarter. I started my comments with a simple message to the group. September was a big month. Coming into the month, we had an aggressive goal. And January caused us to just miss our internal sales goal earlier in the year. Since then we have been in excess of goal every month, very similar to what we experienced in 2017 from the standpoint of good solid top line growth hitting our internal goals, which gives us the confidence to invest in the business. Year-to-date, we are at 100.7% of goal. When I looked at the numbers on last Saturday, a week ago Saturday, we were at 99.9%, not all the numbers were in yet. So I thought okay, we have a good shot of hitting goal. We came in at 100.0% of goal in September. Proud of what we accomplished as an organization from the standpoint of establishing the goal and going out and getting it. In the last 2 days, we had our typical board meetings and the evening before our board meeting is typically a session where we introduce a topic that we delve deeper into. In past quarters, we have talked about some of the acquisitions we have done, we have talked about some business development opportunities, we will talk specifically about our Onsite business, our vending business, our e-commerce business, our construction business, just to shed additional insight for our Board of Directors for their own knowledge and engagement as a Director of our organization, but also to solicit input from a very talented group. Our meeting on Monday evening, I typically don’t cover that session, I covered that session and talked a bit about the company and I just want to share some of the things we talked about. As we did at last year’s annual meeting, we talk about Fastenal, what we looked like when we were a $2 billion company, which was roughly 11 years ago in 2007. We talked a bit at that time about what we will look like as a $4 billion company. And this year as we prepare for our internal discussions in December and our annual meeting next year, we will get to talk about Fastenal as a $5 billion company and we’ll talk about how we have morphed, how we have evolved over the last 10, 11 years. We also had a pretty lengthy discussion about what we look like when we are a $10 billion company. And we focused on four aspects of the business. One was the products we sell. If you look at it fasteners and now safety products combined make up roughly half of our business. Fasteners made up half our business a decade ago, but as the other businesses have grown, especially safety has grown, it’s morphed a little bit. We talked about our selling channels, our branch, our Onsite integrated supply, a relatively small business that’s kind of tucked away into the Onsite business. And our channel extender in everything that we do, a little thing called vending and in-stock. We talked about the definition of our customer, who it was 10 years ago, who it is today, who do we believe it’s going to be 10 years – excuse me when we are a $10 billion company, and there we talked about the manufacturing customer, little bit of some of the subsets, the construction customer, a government customer and all the others. We talked at length about the request mode. And what I mean by that is how that’s changed over time in how our customers are ordering. A big swathe, our request mode is vending, where the customer doesn’t request it. Our supply chain delivers it to them at point of use, at time of use, and we measure our fulfillment in the context of minutes, not hours, not days, but minutes. In our branch network, we measure it in the context of minutes and hours. In our distribution network, we measure it in the context of 8 hours away, but impressive supply chain in how -- customers ordering patterns and how that’s morphing can play really into the strengths of Fastenal. Four things I highlighted just for additional discussion, some that were tangential to this discussion was our branch economics. We started talking about what we call pathway to profit, 10, 12 years ago. Pathway to profit is still alive and well within Fastenal when I think of our branch network and understanding how that branch network funds our ability to migrate the business into a more Onsite world. The continuing traction we are seeing in the e-commerce, web, I mentioned to the board that night. I said last quarter was kind of fun to casually mention on the call that we now have a $100 million web business within Fastenal. That’s ignoring EDI, that’s ignoring the electronic orders that are coming in from vending. That’s just looking at where people hop on the web and we have re-branded that mostly to what we call Fastenal Express, but it’s a $100 million business within Fastenal, growing handsomely. To that extent, 3 months later, I can look at that and say that $100 million business is now $110 million business, you can do the math on what that means as far as growth, but it’s seeing substantial growth. And interestingly enough, we are seeing the growth not just in our branch network, we are actually seeing faster growth in our Onsite network, it’s a more efficient way of ordering. So not only does it help us grow faster, it helps us be more efficient. And a critical part of our success as we morph from a $5 billion to a $10 billion company is managing the operating expense within the organization, and you are seeing some of that shine through as we go quarter-to-quarter. We did a bit of a recap on how we communicate and learn internally, how we define the message and our focus and how our emphasis is always on what is special about Fastenal and how does that something special benefit our customer. And let’s make investments to grow there and differentiate ourselves in the market, be something special for the customer. We also touched on people development and some leader development aspects we have in place for 2018 and how that’s changing us going into 2019. That transitioned from Monday night into Tuesday and we had a pretty lengthy discussion on tariffs and inflation in general. We started that discussion to make sure everybody is on the same page, is awareness to what we are talking about, because there is lot of terms that get thrown around in the media, there is lot of terms that get thrown around in the press in general, lot of terms that get thrown around in our organization. Since they emanate from a government source terminology, you know darn well, they are never going to be intuitive. So, we walked through and tried to make some intuitiveness to it. We talked at length about the 232 steel tariffs. It took place early in the year, a 25% tariff that frankly had limited impact, direct impact on Fastenal, but does create a step up in the introduction of inflation in the marketplace. We talked about the 232 auto tariffs, a minimal impact. First off, they have been implemented, but secondly, even when they are, the focus for us is really understanding what that means to demand aspects of the North American marketplace, we also operate a pretty sizable fleet, we have about 6,500 Dodge Ram pickups parked in front of our branches, delivering product and making sales calls every day. We have a distribution infrastructure about 500 vehicles between semis and straight trucks, supporting our customers every day, and anything that impacts that category of our cost pool, we’d be mindful of. We talked at length about Section 301, because here is what it starts to change. Back in July, for lack of a better definition, our folks described it as List 1, I’m not sure if that’s an official name or just our name, but List 1 came out in July, and it involved about $34 billion in North American spend going into China, 25% tariff on that. As we’ve talked about in previous discussions, that’s pretty limited for us. There were some impacts. Again, it's about the element of inflation it’s introducing into the economy. On August 23, a second list, list number two came out, that impacted about $16 billion worth of imports, again, there was a 25% tariff. While there were some impacts for Fastenal, it was relatively limited in and how it played out in our business. List 3 was announced on September 17, became effective September 24, so starting a number of weeks ago, it's directly impacting the North American supply chain for our customers. We are an important component of that North American supply chain for our customers in the marketplace in general, therefore, it has an impact on our business. If I – an added piece to that is that meaningful impact that kicked in place a number of weeks ago is scheduled to go from 10% to 25% on January 1. Only time will tell what actually happens? It wasn't too long ago, it looked like NAFTA could easily fall apart into sort of a trilateral relationship, couple of bilateral relationships to 11th-hour, calmer heads prevailed. And while everything isn’t a done deal yet, it appears that the differences that existed between the respective governments, respective countries have been largely resolved, and time will tell if the two sides of the Pacific Ocean will have a similar coming of the minds and anybody's guess on this call is as good as if not better than mine on how that will play out. Our commitment is to our customer and our employee. Every day we balance this commitment with four overriding aspects of our covenant with our customer. One is a reliable supply to support their business, whether that is OEM fasteners, MRO fasteners, MRO non-fasteners, product going through our branch, our Onsite or vending, it doesn't matter. A reliable supply that consists of quantity and quality. One of the challenges with redirecting your supply chain or making changes to your supply chain, you can interrupt both of those and it impedes the ability to move quickly. The second is value. We’re all about total cost of ownership for our customer, that means time, that means price. We are managing through this. The third is ideas, solutions and alternatives. One aspect of our approach with our customer is suggesting alternatives to their supply chain to minimize the impact, again, that’s our covenant with our customer. Finally, the health of our supply chain. That dictates everyday where we push and how hard we push on our supplier base because ultimately supplier that is not able to invest in their business is not a great long-term supplier in our supply chain. Our steps started three to four months ago, an active re-sourcing effort. The reality of it is – and this is that unique to Fastenal’s business, this is true of the North American supply chain. A lot of categories are directly impacted by the Section 301, and they’re meaningful spend if I look at the business in North America. Some categories of ours that really jump out that have big impacts, power transmission, electronics and batteries, plumbing, machinery, welding, paint supplies, material handling. These are items that actually have a really big impact. For us they are relatively small part of our business. So that's more of a issue for a supply chain that’s going through other sources generally speaking than Fastenal because they are all as a percentage of our business, single-digits. Number 11 on my list here of categories that are impacted is that the thing that’s near and dear to our heart called fasteners. It’s a meaningful impact for that group and that group is a big percentage of our spend. And as we have talked in the past, a large part of the North American supply chain and Fastenal supply chain comes through sources outside the United States or sources outside North America. And a high percentage of that source and this data is publicly available as far as where we import from, a good piece of that is coming from China and that’s true in our business as well. If I go a little deeper down the list, I see safety products, another one that’s a meaningful component of our business because of our vending platform. One of the things that we have to help manage through it better than in the past is we have a great national account team and a great Onsite team, a great implementation team, a great engineering team and a great supply chain support infrastructure for that piece of our business. Those discussions have been going on in earnest. They continue to go on in earnest and we are shedding light to the supply chain of those customers and having discussions about prices and options. Another piece is and we talked about this, not in great detail, in the July call, but we talked about it in meaningful detail in the April call about on our local pricing. Our tools for managing that weren’t as sophisticated and frankly a lot of the tools we had for managing that disappeared over the last 3, 4, 5 years as we were plugging up backdoors to our point-of-sale system for changing prices in an effort to improve our security. In July, we rolled out a new means to manage local contract pricing or local pricing. Holden mentioned in our release that we got some improvement in our price cost inflation during the third quarter and we kept pace with the third quarter. That is a true and accurate statement for the third quarter. One point I would make is we started this in July and really got traction in August. While at the third quarter we kept pace with the current inflation and we didn’t get back any of the inflation we lost in the first two quarters of the year, in the month of September, if I look at our local pricing, we did achieve a very good claw back into that first and second quarter. And so we exit the quarter at a much better position than we entered the quarter or in what the quarter experienced and that’s a positive from our business, from our standpoint, to be an efficient supply chain to manage that inflation dynamics in the marketplace and to manage the relative gross margin of each component of our business, but it was really shining through in September, not in July, August and September. With that I am going to switch over to the flipbook and then I will transition over to Holden. If I look at the quarter, very good quarter, 13% sales growth in the third quarter of ‘18, that’s our sixth straight quarter of sales growth greater than 10%, excellent leverage in the business. As we have talked about in the past, our big challenge as our growth was expanding was the incentive compensation component of our cost pool, at the branch, at the district, at the region, at the distribution center and the support functions throughout the organization as our growth came back in 2017 and 2018 and our earnings growth improved. We reloaded up on the incentive comp and we saw meaningful inflation, because the incentive comp was expanding, a very typical thing I would expect to see in the Fastenal business. We have anniversaried that now and you see it shining through in our ability to get operating leverage at the operating expense line. The earnings per share grew 38.3% obviously aided by tax reform. Absent this, on 13% sales growth, we grew our earnings 15%. That’s the fastest rate so far in the cycle. We are very pleased with that and we are proud of what our teams did. As Holden’s point here, incremental pricing was realized in the third quarter, largely offset incremental cost increases in the period. We exited the quarter in a much different place. Flipping over to Page 2, we signed 88 Onsites in the third quarter. We have talked in the past about participation and the importance of participation in our business. Last year through 9 months of the year, 64% of our district managers had signed in Onsite. We hang out for our district managers, if we can get to 80% participation on anything we do, we will be successful. Our goal is to hit 80% for the year. Through 9 months of 2018 that 64% has grown to 72%. Onsite is part of Fastenal. It’s not a subset within Fastenal it’s part of our business now and you are seeing it shine through in the numbers. We have signed 269 Onsites year-to-date. Last year, we signed 270 for the year. Switching to vending, also part of our business now, like Onsite, we signed 5,877 vending devices in the quarter. There is 63 days in the quarter. We are signing 93 devices per day, not too far from hitting 100 devices signed each and every business day of the year. Our revenue in that is growing well. Our installed base is growing well. And we feel very good about in both of those, Onsite is probably going to be at the lower end of that range based on our run-rate and well into the range in case of vending signings. We are taking market share here and there is something special about Fastenal that our competitors cannot bring to the marketplace in the same way we can. Total in-market locations, 3,089, if you look at it, we are up 116 year-over-year, which is about 4% increase. Branches are down 157, which is about a 6.5% decrease, but Onsites are up 273, almost a 50% increase, lot of numbers flying around here. What it means is as our business is morphing, our need for people is always important, because we are a service organization and that’s what we represent for our customer, but it allows us to manage the business a little bit more efficiently from a headcount perspective and you are seeing that shine through in our numbers. National accounts grew 18% in the quarter, impressive team, both the sales team, the implementation team, as well as our service teams in our branches in Onsite. Non-U.S. daily sales, which are about 15% of our business, grew 20% in the quarter despite some pretty extensive foreign exchange headwinds and that shined through in our gross margin a bit as well. With that, I am going to turn over to Holden.

Great. Thanks, Dan. Flipping over to Slide 5, as covered, total and daily sales were up 13% in the third quarter, which is consistent with the growth of the first half. This runs our monthly streak of 10% plus growth to 16 months, but perhaps as notable to say that adjusting for our acquisitions and foreign exchange, our August and September daily sales rate actually hit 14%. What that means is that nearly one and three quarters into the current year’s – into the current expansionary cycle, we are still posting new highs for organic growth. We also estimate that pricing contributed between 120 and 170 basis points in the period, an increase from the first half when we did 50 to 100 basis points. In addition to contribution from our growth drivers, as Dan discussed, this growth is supported by healthy macro conditions. The PMI averaged 59.7 in the third quarter and industrial production continues to expand at a low to mid single-digit rate. From a market standpoint, non-residential construction grew 16.2% and manufacturing grew 13%, in both cases, consistent with the prior quarter’s growth. From a product standpoint, fasteners were up 10.8% and non-fasteners were up 14.9%, again in both cases in line with the second quarter levels. Lastly, from a customer standpoint, national accounts were up 18% in the quarter, with 79 of our top 100 accounts growing and non-national accounts grew mid to high single-digits, with nearly 67% of our branches growing. In terms of market tone, sentiment in the field remains constructive and we would characterize conditions being stable at high levels. Now, sliding over to Slide 6, our gross margin was 48.1% in the third quarter, down 100 basis points from the third quarter last year. This was a larger decline than we expected, especially as the improved price realization largely neutralized incremental product cost increases we continued to experience in the quarter, roughly 80 basis points of this decline was from product and customer mix, higher branch freight expenses and higher growth allowances that are attributable to the sustained strong growth we are experiencing with our largest customers. The remainder is a function of foreign exchange and other organizational factors. Sequentially, we believe the lion’s share of our 60 basis points decline is due to seasonality, foreign exchange and branch freight costs. As it relates to the outlook for price costs, we think that being able to neutralize the impact of inflation in the third quarter speaks to our rebuilding of pricing muscle memory in the organization and the effectiveness of the tools we have introduced. These will be helpful as the situation with tariffs play out. Still, the latter likely means we have not seen the end of product cost increases and until greater clarity comes to the market, it’s difficult to know how price costs will play out in the upcoming quarters. Our operating margin was 20.5% in the third quarter, up 30 basis points year-over-year. Strong volumes drove 130 basis points of cost leverage and generated an incremental margin of 23.1%. Looking at the pieces, we achieved 50 basis points of leverage over employee-related costs, growth in incentive compensation outpaced sales and profits, but it did moderate versus where we were last year. Occupancy-related costs were up 2.3% generating 50 basis points of leverage. Lower branch costs were offset by higher costs related to non-branch facilities with the increase deriving from higher vending expenses to support the growth in our installed base. We realized an additional 40 basis points of leverage from general corporate expenses. Putting it all together, the third quarter of 2018 EPS were $0.69, excluding a discrete tax item, this would have been $0.68 or up 37% from the third quarter of 2017. In the absence of tax reform and the lower rate that it provides to us, EPS would have been $0.57 and growth would have been 15%. We continue to anticipate a tax rate of 24.5% to 25% absent refinements in the application of or discrete events arising from the recent tax reform. Flipping to Page 7, we generated $185 million in operating cash in the third quarter, which is 93% of net income. This is a lower conversion rate than we might typically see in third quarters, which relates to working capital that I will cover that in a moment. Net capital spending in the third quarter was $35 million bringing our year-to-date outlays to $89 million, an increase of 16% over the first 9 months to 2017. The timing of outlays is such that we do expect higher spending in the fourth quarter for expansions and upgrades at our properties as well as IT assets than we have seen in any of the first three quarters of 2018. However, given the rate of spending to this point in the year, we are reducing our 2018 capital spending projection to $152 million for our previous $158 million. We increased funds paid out in dividends to shareholders by 25% to $115 million and we finished the quarter with debt at 14.4% of total capital below last year and last quarter and at levels that provide ample liquidity to take advantage of opportunities to invest in our business. The picture of our working capital grew more challenging in the third quarter. Inventories were up 14.1% in the period. Representing the first quarter were growth in inventory has outpaced growth in sales to the fourth quarter of 2016 and that’s largely due to inflation beginning to ripple through our balance sheet. Receivables grew 22.2% in the third quarter. This continued to be affected by growth in our national accounts and international businesses both of which tend to have longer terms than our business as a whole, but the biggest factor continues to be customers pushing payments past quarter end, a trend that we have seen since the fourth quarter of 2017. After that moderated last quarter, it intensified again in the third quarter, but we have not seen any meaningful change in hard-to-collect balances, the quality of our receivables remains solid. That’s all for our formal presentation. And with that operator, we will move to questions.

Thank you. [Operator Instructions] Our first question comes from Ryan Cieslak with Northcoast Research. Your line is open.

Hey, good morning guys.

Good morning.

Good morning.

Yes. I guess the first question I just wanted to go back to the gross margin comments weaker than expected versus our model, it seemed like maybe below what you guys were expecting as well. Holden, maybe sequentially, it sounds like the freight component once again it creeped up and it was a big factor there. Could you just discuss what changed this quarter versus last quarter, and do you view this more as transitory or how do we think about freight costs certainly for the balance of the year, but even as we get into next year?

Yes, I think that costs continue to go up from a freight standpoint, and I think we have talked about how we did a nice job offsetting some of those issues in the second quarter, we talked a little bit about moving more product on to our own trucks, doing a better job sort of finding means of generating additional revenue and we still worked through that in Q3, but pricing is still a challenge. And I would say that, that is a part of the equation still. Now, the impact from freight was more meaningful on a year-over-year basis than it was on a sequential basis, make no mistake right, but I think if you look from a sequential standpoint, I think that you are looking at seasonality played a role, I think foreign exchange certainly played a role. And then you do get into some drag from branch freight and some of the customer allowances, but they are relatively smaller. So, I think that the impact from freight was more annual than it was sequential.

Sequential, one thing we are seeing and this has been our mantra all year is fuel prices are what they are whether whether that is diesel going into our semi fleet or gasoline going into our pick-up fleet. The real mantra is charge freight where it’s appropriate, and we’ve been a – we’ve seen a pretty consistent level of that. And use our trucks, the challenge to our branch employees, our Onsite employees -- use our trucks, a challenge to our supply chain, use our trucks because it’s a lower cost and we’ve seen some success in that as we’ve gone through the year.

Okay. So, it doesn’t sound like there is anything unusual or one-time in nature as it relates to freight here in the quarter. So, I know you guys aren’t big on giving your quarterly guidance on gross margins, but directionally is the 48.1% that you put up, good starting point and should we be thinking about just normal sequential progression into the fourth quarter or is there something that we should be thinking about where you see it maybe playing out better than that going into the fourth quarter?

Yes. As it relates to the freight side of it, no, I don’t think there’s anything unusual there. Honestly, I have to say it’s been fairly impressive the degree to which the field has been able to move some product off of third-parties on to our own fleet and other things of that nature, as Dan said fuel is a big issue. So, as it relates to branch – to branch freight or freight generally, I don’t think there’s anything unusual there. As it relates to gross margin more broadly, yes, I think thinking about typical seasonality is not unreasonable here. There are certainly some comp give and takes as we move into Q4, freight being one of those. It is in Q4 last year that we began to see a lot of these costs really beginning to move up, right. So, I mean, that’s one where there might be some easier comps, but there are some other items in there that might be less favorable comps. So, I think if you think about the gives or takes, I feel like you should probably think about the seasonality. And the one perhaps caution I’ll give there is, seasonality is usually maybe 20 basis points to 40 basis points lower in fourth quarter than third quarter. It also tends to be a much more volatile quarter than is typical in terms of where that comes through. I think that we can find some gives and takes that move us to the high end of that and that’s what we’re going to strive to do, but I don’t think it’s unreasonable to think in terms of normal seasonality at this point.

I’ll just – I’ll chime in with a couple positives when I think about going into the fourth quarter. We exited the quarter in a better position than we entered the quarter from the standpoint of our pricing in general because of things we’ve put in place in July and August, point number one. Point number two, one of our hard presses on our folks as it relates to all the noise, the turmoils going on right now is be engaged with your customer from the standpoint of product substitution. That tends over historically to help us from a gross margin perspective. And so, when I look at that, there’s some built-in enlist to it and – but we’ll continue to have the impact that we’ve seen in the mix of our business, and that’s not a new thing. The last piece is, one component of our gross margin centers on the volume allowances that either go to customers or come from suppliers. When I look at that, some years you will have a bias towards what direction one or the other might go depending on the relative strength of that of our overall growth for the year because a lot of those programs are calendar-based. As we’ve been seeing as we’ve gone through the year, the customer side, strong growth in national accounts, so there’s a piece there but nothing new as far as any kind of change sequentially. If I look at it on the supplier side, sometimes you can get an uptick or a downtick in the fourth quarter depending on where the programs come out. With our strong growth this year, the bias is toward up not down. So, I would look at that and say on the ledger there’s more things that are – ignoring seasonality, more things that are biased up versus down.

Okay, that’s helpful, and then just for my follow-up. Last quarter you guys gave sort of an initial estimate of what you think the direct exposure was to China from a sourcing standpoint as a percentage of your COGS. Any update there certainly as you’ve gone through, there’s some additional lists have come out, I’m sure you guys have done some additional work around that. And then just how do we think about maybe just directionally going into next year, I know you guys have always talked about mix always being a net negative to your gross margins. Should we think about the tariff situation also being a net negative to your gross margins next year or they are – is it too early to tell at this point? Thanks.

I think it’s – on that – there is a number of things punched into that question. So, as you unwind it from a tariff perspective, it’s way too early to gauge because we don’t know what the next leg is going to be, is there going to be a next leg. We don’t know if we’re going to be sitting here in March and 10 is at 25 or 10 is at 10 or 10 is at zero, we don’t know if it’s on the SKUs it’s on today, if it’s on expanded list or a contracted list. So I don’t think anybody can intelligently predict that today. I do know we have a really good plan for how we are approaching it. If I look at historically, we have talked about and I am a big believer in transparency, I might be a little opaque here, because I don’t want to put our field team in a bad position from the standpoint. If I sat down with 10 different customers, the percentage of what they are buying that’s sourced in one country to another or in different parts of the world in general can vary dramatically depending on if it is a fastener. Fastener products have a very high content of imported products and a lot of that is coming out of China. So if you think about that third of our business, a big piece of that is sourced globally and most of that had moved outside of North America before we even started in business back in the late 60s. And so that 35% is a pretty big piece. On the non-fasteners, it’s also a quite large piece. And this isn’t just a comment about Fastenal this is a comment about supply chains in general. So, I would expect most companies you will find is that you are going to have over half of their business is sourced outside of North America and a meaningful piece of that out of China and you would see the same, but I don’t want to get into specifics beyond that, because one customer and might impact what they are spending 10%, another customer might be 30%.

But Ryan, I think yes, just to touch on last call, you are right, I mean, I had indicated at that call that we were looking at basically roughly 10% of our products sourced from China and that there was a chunk of that, where it was just a guess right, just a guess because one quarter of our total buys across the company are bought by the field rather than corporately. And this local capability to buy is a big reason for our industry outgrowth, but it also reduces the visibility. And as you said, we have sharpened our pencils on this and we are trying not to be overly specific about it, but I think it is fair to say that our number is north of that 10% range that I had indicated earlier. So that is definitely a larger number that comes directly from China.

In fairness to Holden, I felt he was answering a different question on that call or I would correct him on the spot. I know he was talking about the first rounds being a single digit, a low percentage impact and that realized the intent of his answer. And not all that 30% – not all that amount is going to be captured in this first round, so we will see what happens going forward.

Thank you. Our next question comes from Hamzah Mazari with Macquarie. Your line is open.

Good morning. Thank you. My first question is – just the first question is around working capital, it seems like it’s a much bigger source of cash the first three quarters this year than the last number of years. Clearly, some of that is inventory, but a lot of that is AR, so maybe just walk us through our customers just being later or just walk us through sort of how you think about that be as that normalize or just any color there would be great?

So I will throw in a few pieces because I have been a few years on my belt that Holden didn’t have yet. If you think about our business, our local, if you go back years ago, our days on – our days to collect would have been better, because our business was primarily a local business. And if I look at our local business, which is roughly half our revenue, you would see that our stats for that business is largely unchanged from what it would have been 10, 15, 20 years ago. In the last 20 years, we have gone from 2%, 3% from our revenue be in national account, so 52% of our revenue being national account and we have gone from international being two locations in Southern Ontario to 15% of our revenue. Two things I can tell you what national customers and international customers in general, they pay slower than our local customers. And so they have been attributing to 70% of our growth between Onsites and lot of things we do Onsite spending etcetera really go towards a larger key account in that local market, whether it’s a national account or not, but a larger customer and oftentimes their ability to negotiate terms that are linked to growing the business occur and so there is some structural aspects to it. The offset to that is that they also drive volume through our branch network and over time allow us to continually drive down the days of inventory on hand, because we are leveraging it across the bigger revenue base. So it’s finding that balance, but it creates some challenges in near-term.

Great. And then just a follow-up question is sort of how do you think about sort of headcount growth going forward? I realize your sales are growing a lot faster, but at the same time your business mix has shifted more to Onsite. So, is historically the relationship between sales growth and headcount growth different now that the model is changed or just any thoughts on how you think about that piece would be great? Thank you.

Yes, Hamzah. So, I think it’s fair to say I believe that the source of our headcount growth has diversified over the past few years, right. There was a time when we were heavily branch oriented, where most of our headcount was going into the branches and we are adding branches and filling those out. As we have become as reliant on the Onsites and vending, national account growth, then a lot of the headcount that we add is coming outside of the branches, perhaps to a degree that was not true 10 years ago, let’s say. And we should be able to build a fairly significant revenue base off of that headcount relative to what we have been able to achieve before. I think it’s fair to say that in the past, we would have had to throw a lot of bodies and heads into growing the revenues. And today, I think that there is more leverage in the model for headcount growth than it has been the case in the past. That said, growing 13% does require investment in the business and that investment is in the form of headcount both in the branches as well as outside of the branches and we began to see in August and September those numbers begin to tick up and we would expect to continue to add branches to support our growth going forward.

What I might add, if you look at the table in the press release, we talk about absolute employee headcount and I am talking about the in-market locations and then the FTE employee headcount in-market locations and you see the FTE growing a bit faster than the absolute. I have challenged our team to add a little bit more absolute, but to build to our recruiting pool and the way we build staff in our branch is we aggressively go into 4-year state colleges, 2-year technical colleges and recruit and ask you to come work for us part time while they are still in school. And those numbers need to be built a little bit. But if you add 1% to that number, for example, it doesn’t translate into 1% FTE, because it translates into about a half and it’s a less expensive FTE and you don’t do it for the cost, you do it for the recruiting pool of the future. And so you will see that pickup a little bit, but will be very I believe efficient at managing the expense of that component.

Okay. And then just lastly I will turn it over, just to make sure we are consistent with how you are thinking about tariffs. At this moment, you are sort of not quantifying how much of your business is directly sourced in China or you are sort of not quantifying how much of the business is sourced in China that is impacted by tariffs, because I realized those are two different numbers?

There is a subset of SKUs that we do import from China that are impacted. That subset is much larger in some of those categories I touched about earlier. In fasteners, it’s about, it’s 10, 11 down the list as far as subcategories. And so it hasn’t been fully impacted. If you look at it on a lot of things that I have been looking at, the fact that it’s about half of the imports coming in are of that $500 billion are now tariffed, that’s not too far off the mark of what we are seeing in our business too.

Got it. Thank you.

Thank you. Our next question comes from Adam Uhlman with Cleveland Research. Your line is open.

Hi, guys. Good morning.

Good morning.

Sticking with that theme I guess, when you think about the strategy here in the medium term of your purchasing strategy, I guess should we expect the company to be pre-buying ahead of what potentially could be bigger price increases for those tariff-related products from China or are you looking to resource items from other countries more aggressively and not pre-buy? I guess I am just trying to think through the inventory cadence here through the next quarter or two?

I’d say – I’d say yes to each and every one of those to a certain degree and no to another, and that is we started some months ago in earnest looking at where we’re sourcing, and – but you also have to look at it from the standpoint of what’s the alternative source, is there capacity available, is the quality the same and what’s the price point. We could boost some stuff out of China to another source, if you add 5%, 6%, 7% and that 10% is there for the next three years, that’s a good decision. If you add – if you do that and you add 15% or 20% or 30% to the cost, it’s a really bad idea. It becomes a less bad idea if 10% goes to 25% and it sticks. So, in an environment where there’s political variability as opposed to economic variability, makes it very challenging to plan. And the biggest thing is having a good open dialog with your customer, but also understanding for a lot of our customers what we spend is a relatively small part of their spend or what we sell is a relatively small part of their spend, so, it’s creating the least amount of disruption to their supply chain, but we have redirected some already. As far as buying ahead, the problem with that is the – predicting exactly what’s going to be needed and where and for some items you can do it. But again, depending on what’s going to happen because supply chains – when we order stuff today it’s not coming in next week or next month, it’s coming in three, four months from now. So, you have some limited ability to do that, but to the extent we can redirect some, absolutely we’ve been doing that. But Adam, just to sort of flesh out the question, the inventory I would not expect it to move meaningfully based on pre-bought volumes. Again, we’ve looked into it, there is tight capacity for products in a lot of places and we didn’t have the ability to meaningfully ramp up the amount that we pre-purchased based on what is pre-existing tight capacity.

Okay, thanks for that. And then just related to that, I guess, historically, what do you think the lag has been for your national account customer price realization relative to your cost inflation and the efforts that you put into place recently, it’s good to see in September price cost is covering what you’d done with earlier in the year. I guess, should we expect that there is any difference as we start to think about 2019 in terms of your ability to pass along those higher cost to those big customers that push back so hard?

Well the – it’s always going to be an intimate discussion with every customer and some it’s a willingness to peer into the supply chain, flexibility on source supply. OEM fasteners has a different dynamic to it than MRO fasteners for example. But historically, the pricing we saw in September that’s more on our local customer where timeframe is different, and because it’s so diffused that was challenging us earlier in the year because we didn’t have great tools to manage it. If I think of our national account relationships, most of that is historically on a – kind of a six-month window that we can move pricing. And obviously extreme – certain commodities don’t fall into that if it’s things like stainless, which has much more variability, we tightened that window up. In the case of something like this, where it’s a political event, you do have the ability to accelerate that as does our supply base to accelerate that window because the stuff we’re buying last summer that or last fall that came in on September 20, doesn’t have a tariff, if it came in four days later, it does. So, it’s not about when you ordered, it’s about when it crossed the border. And so it’s being very mindful of that, and sometimes – and that can change the timing window, but historically it would have been about a six-month window.

Okay. Thank you.

Thank you. Our next question comes from Evelyn Chow with Goldman Sachs. Your line is open.

Hi, good morning, Dan and Holden.

Good morning.

Good morning.

So, I guess first question I have for you is just kind of thinking about inflationary impact on your inventory. Is there any meaningful difference in your turn on the fastener versus non-fastener pieces of your portfolio? And then how do we start thinking about the impact of some of this inflation on your buy noting that pre-buy has been challenging for you?

The terms on the fasteners will be somewhat slower than the turns on the non-fasteners, simply because we source a much greater proportion of fasteners from overseas than we do non-fasteners, not just from China, but from other countries as well. I don’t think it would be unexpected to suggest that the vast majority of our fasteners spend is from outside the U.S. and significantly in Asia. And so you are going to have a longer turn on fasteners than you will on non-fasteners. Our non-fasteners also carry more of a branded component to them. That lends itself too. We are sourcing it domestically. Now, it might have been manufactured offshore, but we are sourcing it domestically and therefore you have a tighter window too as far as turns.

Right. Makes sense, yes. And then I guess maybe on a sort of related point to this, appreciate that it’s challenging to quantify right now exactly what the impact to your COGS might be from List 3 in particular, but just thinking sort of lot of your fastener buy is from outside the U.S., some proportion of your buy that’s non-fasteners is also outside the U.S. Is there any thought as to maybe pulling back on how much the field is sort of permitted to dictate the buy and make that sort of more top down in this challenging inflationary backdrop?

I don’t know if I would phrase it as permitted to buy. I think ultimately our customer decides what supply channel is best for their business from the standpoint of their end customer what they expect. We have domestic capabilities too, where from a distribution perspective, we have the largest – when I look at our peers we have the largest manufacturing of fasteners capability in our industry. And so we manufacture – 35% of our revenue is fasteners. We manufacture about 5% of what we sell. So, 5% of that 35%, we manufacture domestically for the most part. Look, we have some operations in Europe and Asia as well, but most of our operations are domestic. And there is a customer base that wants that. The reality of it is for fasteners and for non-fasteners there is not capacity to handle it domestically, even if we wanted to move more domestically, the capacity doesn’t exist, because the fastener capacity that’s retained in this country, we are a meaningful piece of it, because of what we have done, but much of it has moved offshore, again, lot of that back in the ‘50s, ‘60s and ‘70s.

Yes, Evelyn, you have to also remember that the ability of our folks in the field to make decisions about what their customers need is a real important piece to how we service the customer and how we achieve the kind of outgrowth that we do. Now, we have obviously encouraged the field to wherever possible, maybe to use exclusive brands as sort of a product substitution, look for product within our network as opposed to having to go outside of our network, because obviously where we have scale in purchasing we can do – we can address the issues of inflation more greatly, but I think it would be a mistake to take something which has served us so well culturally and in terms of growth over such a long period of time and begin to uproot those kinds of things. I think we are far better off taking the relationships that those local sales folks have, have those conversations, use the tools that have never been better, use the experience they have in sort of having these conversations which again has never been better and continue to service the customer in that way.

Understood. And then maybe if I can just sneak in one on Onsites, I think you noted that you are tracking a little closer to the lower end of the range for the year. I guess what are some of the drivers of that expectation and then do we still think about a 360 to 385 type run-rate into next year?

Well, I think the expectation is if we look at the first three quarters, we divide by three, multiply by four and it gets you to the math, right. How fourth quarter plays out, we will see. It’s entirely possible that we will sign enough to be inside that range. And so it’s really just math, Evelyn. I will say this, if we come in at the low end of the range, around the low end of the range that will be as an effective job that we have done in any year of actually hitting that range. And let’s not lose sight of the fact that whether it’s 360 or 355 or 365, that’s up from 270 last year and represents significant sort of buy-in and execution on the part of the organization. So, I would perhaps put that perspective. With respect to what our expectations are for next year, frankly, we haven’t addressed that yet. I think we will have more to say about that as we get into the fourth quarter, but we haven’t set that range at this point.

Alright. Thanks, guys.

Thank you. We will take one last question and then we will wrap up the call.

Our next question comes from Nigel Coe with Wolfe Research. Your line is open.

Hey, good morning. This is Bhupender sitting in for Nigel here.

Good morning.

So I just wanted to go through the third quarter, pretty nice average daily sales growth here in the quarter, especially for September. And Holden, like you mentioned about the tariffs which became effective September 24, just wanted to see if we can get some color did you see any kind of pre-buy in the quarter before that deadline actually for the tariff went into effect?

Are you talking about from a customer perspective or supply perspective?

I mean if you can give color from a customer perspective that will be good too.

Yes. I will chime in on that. If you think of what we do, we provide real time supply chain for our customers and that’s our value. When the customer needs something they walk over and they push a button on a vending machine and they instantly have what they need, their safety glasses, a pair of gloves, etcetera. When they are producing something, they reach over and they grab in a bin and grab the fastener they need to assemble the item they are producing. If they are doing maintenance, they go to a bin and grab it. So the value we bring is the sourcing of products we supply. There is no sourcing cost. It’s available when I need it. So, it doesn’t really lend itself to pre-buying. So I would say there is no pre-buying in our numbers from the context of any of our revenue numbers in the third quarter or earlier in the year for that matter.

And I have asked that question specifically of the RVPs every month in the last couple of quarters and the feedback from them is very much the same. They have not seen any indication that our products are being pre-bought and stockpiled if you will ahead of these sorts of things. Now, I can’t tell you that’s not happening somewhere else in the supply chain, but as it relates to our products and our supply chain, it’s not something that any of our RVPs or corporation is seeing.

I am going to close up the call with just two quick thoughts. In the last two quarters, I have touched on something that we have never touched on as a company and that is the traction we are seeing in the ease of ordering for our customer through what we call Fastenal Express or Web. I personally have been making use of the system. And I have been probably wearing our team a little bit with things to make it easier, to make it more intuitive as a buy. And I was sharing with our board the other day, I said, yes, a couple of weeks ago I bought a case of filters, I sent the order in, a little after two, little after three I got a reply, order is ready to pickup and I stopped over there a little after 4 and picked it up. Last night, as I was leaving, after 5 o’clock, I ordered a couple of rolls of Talon duct tape, that’s our brand, in case anybody is curious, as well as Fastenal Jobber drill bit set, I ordered that late in the day. At 8:02 this morning, I had an e-mail from Fastenal. My order is ready to pickup. That’s measuring fulfillment of any type of order, whether it’s a vending machine, a bin, an e-commerce order in minutes and hours, not in days. And that transaction is a more efficient transaction for us. And that freight is part of our normal shipping network. What we are finding is between 93% and 94% of the time our customers buy online, they are picking it up at the Onsite or at the branch. They want certainty of supply and they want great availability. Second item I will touch on is we recently had Hurricane Florence hit the Southeastern part of the United States. I am thankful to say that Fastenal and our Fastenal employees and our customers came through it largely undamaged. I love hearing the stories from customers and employees alike about fellow Fastenal Blue Team members stepping into support them. We are hours away from Hurricane Michael hitting the panhandle of Florida. I believe Panama City is dead in its sites. Our best wishes and thoughts and prayers are with our team and our customers and the folks in that area. Thanks everybody. Have a good day.

Ladies and gentlemen, this concludes today’s conference. Thanks for your participation. Have a wonderful day.