Good morning ladies and gentlemen and welcome to the Fastenal Company fourth quarter and full year 2018 earnings results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Ellen Stolts of Investor Relations. You may begin.

Welcome to the Fastenal Company 2018 annual and fourth 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 one hour and will 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 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 March 1, 2019 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.

Thanks Ellen and good morning everybody, and welcome to the fourth quarter conference call for Fastenal. Before we delve into Holden’s flip book, I just want to touch on a few things. If I go back in time to late 2015 or just 2015 in general, we’d seen a dramatic slowdown in the economic we sell into. We’d had a tough year. I was stepping into this role and I remember the first comment I made to the team was, hey folks, we have a ton of great things we can do for our customer, that we can do for our employees, our suppliers and our shareholders that’s focused on the future, and let’s just get going. In 2016, it was a year of investment. We invested in inventory in our branch network to support our customer. We invested in growth drivers of the business and the infrastructure to support those growth drivers, and as all you recall, we had a tough year from the standpoint of nominal growth but we really grew our expenses and our working capital because we were setting ourselves up to be a better supply chain partner for our customer. In 2017, armed with an economy that was not kicking us in the face but was actually giving us a little bit of tailwind, we looked at the team and said, you know what? Let’s grow our sales and earnings this year, and when I talk about earnings, I’m not talking just about Fastenal, I’m talking about our people too. We did a nice job that year of doing all three. In 2019, we’ve improved that from the standpoint I think we found a better balance in growing the aspects of our business, and one thing that was really important to us was an incremental margin that started with a two. The second half of the year, we’ve been able to deliver that. It was good enough in the second half of the year that we produced it for the year, and that’s an important component because it’s not just about growth but it’s about profitable growth and creating opportunities for your customer and your employee in the process. In 2019, I think that mantra is let’s find a little bit more balance and let’s extend what we’re doing it already, but let’s extend it to the cash flow statement and really hit all pieces and rewards all constituencies. Speaking of constituencies, we keep it really simple here - there’s four. There’s customers, there’s employees, there’s suppliers, and there’s shareholders. It has to work for all four for our business to be successful short term and long term, and we look at everything with a long-term perspective but we try to have a short term edge to it, to have a sense of urgency. From a customer perspective, the biggest thing that we do every day is we thank them for their business. Thank you for trusting, embracing our supply chain partnership. The supply chain is critical to each and every one of our customers, and I thought I’d share a few tidbits out of a recent customer letter that came in. It was an unsolicited letter that I received last week. It was a customer where we had taken on--we signed an onsite earlier in the year. It’s been a customer for years from an MRO perspective, but we took on their OEM fasteners, and as we’ve talked in the past, OEM fasteners is a very intimate relationship because we’re selling them not just the stuff they need in their facility, we’re selling them the components of what they’re representing and selling to their customer. We’re part of their DNA in the OEM fastener world, and the letter touched on a handful of bullets about the business. It first talked about the bidding process. The last sentence in a brief paragraph, Fastenal by far presented the best with the most advantages for present and future growth. Fastenal is the best option. From a transition and implementation, again that’s a scary place for a customer to be because your production line is dependent on hiccups that can occur in a transition, and the second sentence in this paragraph, Fastenal immediately brought onsite a team of professionals with a lead implementation person that managed through each item of inventory with each group function within our company, and not seen a single stock-out situation within our company. Communication was and is top notch on all matters. Urgency - Fastenal’s communication and sense of urgency has been exceptional. Engineering support - knowledge support and testing that we get now on all parts is exceptional. Sourcing - we have been able to keep current manufacturers as well as looking at other options for cost savings. The value we bring is the high level of service, but it’s also an opportunity to challenge status quo and take costs out of supply chain. That’s what we do for our customer. It’s not just about fulfillment - that’s an important component, but it’s also about bringing the supply chain knowledge to lower your cost and improve yours and your customer’s value proposition in the marketplace. Service support - Fastenal onsite management has been exceptional, and our letter closes to say, we look at Fastenal as an extension of our company and with the onsite service we have, our folks don’t have any doubt on where to go. So I thought I’d share that letter. It was really fun to receive it. I called the individual that sent it and personally thanked her, but it’s really indicative of what our business and our onsite strategy is about as it relates to engaging with our customer. Secondly, employees. We grew our business 13% in the last 12 months. Our FTE growth is up about 6%. Now, it’s no secret in the marketplace there is some inflation going on because it’s a tight labor market. There is also--when you have advancements in the organization, folks that are stepping into leading a new onsite, maybe you were the second or third person at a branch before, getting added to our implementation team, our national accounts sales team, our industrial services teams, all the teams within Fastenal, our base pay we saw increase about 9%, so on a 6% increase in headcount, base pay is up about 9%. Some of that is inflation, some of that is advancements in positions within the organization because of the opportunity our team and our customers are creating. Incentive compensation, that’s commissions at the branch, that’s incentive to our leaders, that’s incentive to the folks in support areas of our organization, despite the fact that it had grown handsomely in 2017, it grew again in 2018 - it’s up 20%. Profit sharing, we share the rewards of the business with everybody in the business. From 2017 to 2018, I’m proud to say our profit sharing contribution this year is up about 24%. Despite all that, we were able to leverage our employee cost, which meant we were able to leverage our SG&A. Total employee costs are up about 11%. Another way to think about it--there’s a lot of ways to think about productivity, and productivity is key to our current and future success because it’s bringing greater value to the customer but doing it in a more cost efficient manner. Every dollar we spent in payroll in 2017 translated into a $1.02 of profit, so we had $881 million of profit last year, we spent $862 million in total payroll. Holden’s probably cringing right now that I’m sharing that number because people will want it again and again and again - sorry, Holden. But I think that’s an important component of our business, but despite all the investments we made in people and resources in the last year, the last three years, in 2018 we spent $962 million in total payroll costs. That’s everything in there - base pay, incentive, profit sharing, Social Security taxes, workers’ comp, health insurance. Everything added up, we spent $962 million but it didn’t generate $1.02 of profit, it generated $1.04. We generated $999 million, essentially $1 billion in profit in the last 12 months. That’s productivity, and I’m really excited what that means for our team. I think there’s a lot of opportunities to expand that in the future. Our suppliers, that third constituent, they’ve had a really successful few years with us. Suppliers that have been willing to evolve and change to support our vending business in the last 10 years, our onsite business in the last three, four years, our construction business, our national account business, our local business, a Fastenal model, have had really successful years. I’ve met with a lot of them over the last two months, and really excited about what 2019 can mean and what they’re seeing downstream in their business. Finally, shareholders. Our shareholders haven’t been rewarded as well. Our stock has been a little bit in purgatory, it feels like, for a period of years. We’ve started to move out of it, though, and we were seeing that, some in ’17, some in ’18. Our sector, no secret to the folks on this call, has been a bit of a multiple compression, and we’ve tried to offset some of that by strong dividends and buyback aspects. I’m pleased to say when I look at that press release we just put out last night on our dividend and our stock buybacks, if I take the dividend we just declared for the first quarter of 2019 and extend it to the year, assuming we pay about the same each quarter, and look at the last nine year and add the $600 million of buybacks we’ve done, we have returned almost $4 billion - $3.85 billion, to be exact, to our shareholders in a business that’s thrived and grown in that timeframe, and we’ve essentially doubled in size in that 10-year timeframe from a little over $2 billion to about $5 billion in revenue. In the last five years, we’ve returned about 65% of that number, about $2.5 billion, and on a $15.5 billion market cap we’ve returned about 16% of that number over the last five years. We’re proud of that number and we believe we have the ability to grow that in the future. We just need to work on our cash flow statement a little bit better to be able to juice that even further. Turning to the flip book, and before we start in on that, I do want to cite--you know, I mentioned the aspect of employees within Fastenal, a part of our blue team. There’s a few blue team members I want to cite right now. First is we have two employees that are going to hit a really big milestone, and we believe in service and milestones, and every year at our Florida event we recognize our 25-year employees. We actually have two employees here in 2019 that are going to recognize 40 years of service within Fastenal. The first one is Nick Lundquist. He joined us in 1979. In March, he will hit 40 years with the company. He must have started when he was about 10, 10 or 11 years old, because he’s got the--the spunk he has in him and the dedication he brings to the organization every day is impressive, and he continues to develop people around him, which is the sign of a great leader. The second person is Dana Johnson. In August, Dana will celebrate 40 years with the organization. Dana might not be as well known to this group. Dana leads our property area and over the years, Dana has had a multitude of roles within the organization, and the professionalism and the talent he brings to every role he serves is impressive. I congratulate both of them on the 40-year milestone this year. Speaking of blue team, two people that are particularly close to me within Fastenal recently lost a parent. In December, Renee Weisska [ph] lost her father, and here several weeks ago Nick Lundquist lost his mother. Both of those individuals enjoyed long lives, they had great families, but for Nick and Maria and for Renee and John, you’re an important part of our blue team family and our condolence and prayers are with you. Now let’s flip to the book. Fourth quarter 2018 came in at $0.59. There’s a discrete tax item in there. A little bit of noise in tax items in the last four or five quarters, something about a new tax law signed in the U.S. creates a little bit of noise. Absent this, our EPS would have been $0.60 for the quarter. Adjusting for discrete items in both years, EPS grew about 14%. Demand is strong - 13.2% sales growth in the fourth quarter. That’s our sixth quarter of at least 13% growth. We continued to execute really well on our growth drivers, and I’ll touch on that in a few minutes. Operating leverage remains strong. We have gross margin pressure. Some of that is self-imposed because our growth drivers naturally lower our gross margin, but inflation and more recently tariffs are creating some ripples in our business. Despite that, we had incremental margin of 21% in the quarter. Prices are trending favorably, and when I talk about price and cost in these discussions, price is our sale price to our customer. Cost is the inbound, whether that is the cost of goods cost, a freight cost, or an opex cost; but I’ll try to use those terminologies to be more concise in how we describe things. Price trended favorably, but it’s still lagging cost inflation a bit and that is pressuring our gross margin more than just pure mix. Holden will touch on that in greater detail. As you all know, List 3 of the tariffs did impact Fastenal, but most of the impact is on the working capital. They added to inventory late in the year, and again Holden will touch on that. One things that’s positive, we have a supply chain relationship with our customers. Tariffs and inflation are not a foreign concept, no pun intended, to our customers, and those discussions are going well and I’m encouraged about what we saw in the month of December, what we’re seeing in January, February and March--what we expect to see in February and March as it relates to our ability to pass through those tariffs or, better yet, find better cost options for our customer. In many cases, that involves substitution. Q4 cash generation continues to be impacted by the working capital trends; however, we were still able to return $177 million to our shareholders via repurchase and dividends while retaining what I would consider a pretty flexible capital structure. Now let’s go to the growth drivers, Page 4. Onsites - the team really is making progress there. When I think about back in 2014, we had a couple of hundred onsites, we were adding 10 a year which mean 3 to 5% of our district managers were really engaged in this game. The rest of the folks were really engaged in the more traditional side of our business plus the vending that we’ve introduced in the last 10 years. We started to change that in 2015 and we went into high gear in ’16, ’17 and ’18. In 2015, about 25% of our district managers signed an onsite. Next year, that went to 50; last year, it was in the low 70s, and we always talked about let’s drive that to 80%. If we drive that to 80%, we are an onsite company because we’re engaged in it throughout the business, not in a subset of our business. In 2018, 79% of our district managers signed an onsite. We will pierce that number of 80% in 2019, and I’m really excited about what that means for our ability to keep growing and manage the business. However, when you go from 200 onsites to 900 onsites in a few short years, you do deleverage that business quite dramatically, and so our average onsite back in 2014 did $150,000 a month. Today, our average onsite does $120,000 a month, and it isn’t because we’re lowering the bar on opportunity, it’s because we have a whole bunch of really young onsites and that’s deleveraging the business. But on the flipside of that coin, our branch network has been leveraging like crazy, and that’s what allowed us to maintain an incremental margin in the last two years of a low 20%. But onsites, we signed 336 for the year - not quite our goal, our goal was pretty aggressive, but well above the 270 of last year. We have 48% more active sites today than we did just a year ago, and our goal for next year is 375 to 400. Vending - we have really breathed new life into vending. The team has done a wonderful job in the last few years. We met our goal for the year - we signed 22,073. We signed over 90 a day in the third quarter - incredible milestone in my mind, and our install base ended the year at just over 81,000, about a 14% increase from last year. Product sales through those devices is up more than 20%. For next year, our goal is 23,000 to 25,000. I told the team there’s 254 days next year - if we hit 100 a day, that’s 25,400. It’s really nice number, but our stated goal is 23,000 to 25,000. One thing that isn’t mentioned in this list of bullets is construction. When we were making these investments back in ’16, ’17 and ’18, a big one was inventory in our branch network. We had languished in the construction market for the better part of a decade with growth between 3 and 4% - very un-Fastenal-like. We were focused on other things and we lost our sight on construction. Between putting inventory in our branch, opening the door to our customer and we had a great local plan, and in the process beginning the development of a good national and international plan, our construction business is now not growing 3 or 4%, it’s growing 15% as we exit the year. The construction market itself has grown about 5% -the end market. We’re tripling that. That’s market share gains and it’s about a great team going after that market, being prepared. We ended the year with just over 3,100 locations versus 2,988 a year ago, despite the fact we closed 157 branches. That leveraging we’re getting in our system is coming from people leverage and occupancy leverage, and we’re converting those closed locations into ever more customer serving locations by moving onsite, by moving in and lowering our cost structure and improving our value proposition to our customer. National accounts, they had an outstanding year - 18% growth in the fourth quarter. Large customer growth was also 18% for the entire year. Our non-U.S. daily sales [indiscernible] grew at mid to high teens rate and slightly below in the latter part of the year, Europe and Asia have slowed a little bit and currency has given us some headwind. With that, I’ll turn it over to Holden.

Great, thank you, Dan. Good morning. I’m going to begin with a quick recap of our 2018 results before moving onto the quarter. In 2018, Fastenal generated a record $4.97 billion in sales, which is up 13.1% from 2017. We generated at least 13% growth in each quarter of the year, reflecting what have been stable and sustained macro tailwinds as well as effective execution of our growth drivers. To touch on those growth drivers, for onsites we signed 336 new agreements in 2018. That was shy of our 360 to 385 goal, but it’s well above last year’s 270 signings. If I exclude the branch transfer revenues, sales through onsites grew more than 20% for the full year. We’re targeting 375 to 400 signings in 2019. For vending, we finished 2018 with more than 81,000 installed product dispensing machines, which is up 13.6% over 2017. Our 2018 signings of 22,073 machines were up 14% and around the midpoint of our 21,000 to 23,000 signing goal for the year. Sales through our machines rose more than 20% in 2018, and we’re targeting 23,000 to 25,000 signings in 2019. Lastly, national accounts paced the overall business with sales growth to our largest customers in 2018 accelerating to up 18.1%. We were active with new signings, but this acceleration also reflects success in expanding our sales to existing customers. Though today they represent a relatively small part of our business, we also continue to see healthy growth in our non-North American revenues as well as sales through our ecommerce channel. Our operating margin was flat year to year at 20.1% in 2018. This stability does mask improved leverage as the year progressed, with our operating margin expanding by about 30 basis points in the second half of 2018. Our gross margin finished 2018 at 48.3%, down 100 basis points largely from product and customer mix, freight costs, negative price costs, and growth allowances. Our ability to narrow our gross margin declines going forward will rest heavily on our ability to close the gap between rising prices and rising costs. We generated an offsetting 100 basis points of SG&A leverage. Thirty to 40 basis points of this was from employee-related expenses as we cleared our incentive reset in the second quarter of ’18 and grew headcount more slowly than sales. Thirty to 40 basis points was some leveraging occupancy as the closure of 157 branches in 2018 mitigated growth in our base of vending machines. Finally, we leveraged our remaining operating costs by 30 to 40 basis points. Given continued growth in our business, there remains further room to leverage our operating expenses. Given continued healthy growth, our overall goal for operating margins entering 2019 is unchanged: achieve an incremental margin between 20 and 25% and deliver some margin expansion. Below the operating line, interest expense was up 39% on higher average debt balances largely from share repurchase activity. Our tax rate fell to 23.8% in 2018 from 33.7% in 2017. Excluding discrete items from both periods, our tax rate fell to 24.5% in 2018 from 36.5% in 2017, reflecting the Tax Act which had the effect of lowering our tax rate beginning in the first quarter. It all blended to a full-year 2018 EPS figure of $2.62 versus $2.01 in 2017. If I exclude the discrete tax items, however, our EPS would have been $2.59, a 35% increase from $1.92 in 2017. If I further adjust for the differing tax rates that applied between 2017 and ’18 as a result of U.S. tax reform, our EPS grew 13.4%. Moving to Slide 5 and our review of the fourth quarter, as Dan covered, sales were up 13.2% in the fourth quarter of 2018, which included daily sales growth of 14.5% in December. We have now grown our organic daily sales at a 10%-plus rate for 19 consecutive months. We continue to see good contribution from our growth drivers. We also saw continued favorable macro trends as illustrated by fourth quarter ’18 purchasing managers index and industrial production readings. Still, sentiment was a bit choppier in the period with rising cautiousness in November seeming to dissipate in December. Our business does not provide much visibility to future trends, so we cannot speculate as to whether this choppier tone will persist; however, it did not affect performance in the fourth quarter, as you can see by the growth of our end markets, our products, and our channels provided in Slide 5. As it relates to pricing, during the quarter we put in place focused resources to evaluate and execute our pricing strategies. This is appropriate in light of the prevalence of inflation and tariffs, as well as the growth of our national accounts business, all of which makes the pricing environment more complex than we have seen it in many years. In addition to this group’s strategic objectives, it is also taking a fresh look at how we measure pricing costs, with two observations resulting. First, as we reported before, we have achieved improved price realization throughout 2018 with a notable step-up in the third quarter, as is necessary because our costs have also risen throughout 2018. Second, the impact of price on our results is slightly below what we had previously modeled. As a result, we realized between 110 and 140 basis points of price in the fourth quarter of 2018, which is improved on the 85 to 150 basis points of price that we realized in the third quarter of ’18. As it relates to tariffs, there was minimal impact on the P&L in the fourth quarter of ’18, but that will grow in the first quarter and full year of 2019. The impact on the balance sheet is also modest at this point with one exception. While we did not buy any excess inventory in anticipation of higher tariffs, we did accelerate the shipping of planned spend to arrive before the potential 25% tariffs kicked in, which was originally expected on January 1. This pulled roughly $12 million in inventory that would have otherwise gone into the first quarter of 2019 into the fourth quarter of 2018 Now to Slide 6, our gross margin was 47.7% in the fourth quarter of 2018, down 110 basis points versus the fourth quarter of 2017. This decline was slightly more than we expected. Relative to prior periods, we did see the negative effects of freight and net rebates moderate in the fourth quarter primarily as a result of easier comparisons; however, product margin was below where we thought it would be. The negative impact of price cost widened as product cost increases outpaced our price increases. The negative impact of customer product mix similarly widened as an increasing proportion of our growth derived from our growth drivers. Our operating margin was 19% in the fourth quarter of 2018, up 30 basis points year over year. Continued healthy growth drove 130 basis points of cost leverage and generated an incremental margin of 21%. Looking at the pieces, we achieved 60 basis points of leverage over employee-related costs, which were up 10%. Growth in headcount was below growth in sales, and growth in incentive compensation, though healthy, moderated versus last year. Occupancy-related costs were up 7.2%, generating 25 basis points of leverage. Total occupancy costs grew very slightly with higher expenses at non-branch facilities more than offsetting a decline in branch facilities. As a result, most of the growth in costs related to higher vending expenses to support the growth in our install base. We realized an additional 55 basis points of leverage of other and operating administrative expenses. Putting it all together, reported fourth quarter EPS was $0.59 versus $0.53 in fourth quarter 2017; however, the current year does include a $3.2 million discrete tax charge while the prior year period includes a $24.4 million discrete tax benefit, both related to the effects of the Tax Act. Excluding these discrete items, fourth quarter ’18 EPS would have been $0.60, or up 34.2% from the fourth quarter of 2017, boosted by a lower tax rate as a result of the Tax Act. Absent tax reform, EPS growth would have been 13.9%. Turning to Slide 7, we generated $178 million in operating cash in the fourth quarter of 2018, or 106% of net income. This is slightly below the conversion we typically see in fourth quarters, again relating to working capital - I’ll cover that in a moment. Net capital spending in the fourth quarter of 2018 was $78 million, bringing our year-to-date outlays to $167 million, an increase of 48.3% over 2017. We expected an uptick in spending in the fourth quarter just based on project timing related to hub investments, but we also had an opportunity to purchase property in North Carolina for future hub expansion that was unanticipated and added nearly $20 million to this total. Our current growth and growth drivers require additional investments in 2019, and we expect net capital spending to be in a range of $195 million to $225 million largely for investments in hub property and equipment, vending devices to support our rising success in this initiative, and vehicles. We paid $114 million in dividends in the quarter and $442 million for the year. We also repurchased 63 million stock in the quarter and 103 million for the year, the second most active year in our history. We finished the quarter with debt at 17.8% of total capital, a little bit above last year’s 16.5% but still at levels that provide ample liquidity to take advantage of opportunities to invest in our business. The working capital picture remained challenging. Inventories were up 17% in the fourth quarter and days on hand ticked up slightly for the first time in 2018. Some of the growth related to supporting demand in our growth drivers and some was related to the accelerated shipments mentioned above; however, a third major element was simply the growing impact of inflation. Receivables grew 17.5% in the fourth quarter and is up more than three days. Sustained strong growth in national accounts and international businesses matter, but the biggest factor remains customer pushing payments past quarter end, which intensified further in the fourth quarter of 2018. Receivables quality remains good with no deterioration in past due balances. That’s all for our formal presentation, so with that Operator, we’ll take questions.

[Operator instructions] Our first question comes from Chris Dankert of Longbow Research. Your line is now open.

Morning guys, thanks for taking my question. I guess first off, and I know visibility is limited, but we’re going into the new year here, obviously price cost was a headwind; last year, we’re kind of comping on that. Given that you’re going to be pushing some more pricing in a more focused way, given that volumes are going to be up, is it fair to assume that gross margin in the first quarter should be up a little bit sequentially, or are we still kind of fighting sideways here?

Well, I think if you look sort of sequentially at how things usually play out with gross margin, historically we’ve seen an uptick in Q1 over Q4, but over the last three years really the Q4 to Q1 cadence has been more flattish, and I think a lot of that has to do with sort of the inherent volatility in gross margin in Q4. It can be difficult to predict. We’re moving into a quarter where we’re going to see how the tariff price cost dynamic plays out. We still have an inflation price cost dynamic playing out. I think if what you’re asking about is what you should think about in terms of sequential gross margin, I would think about Q1 looking somewhat similar to where Q4 comes in.

Got it, thanks. That’s helpful. Just as a quick follow-up, thinking about the full year price cost, with the team in place, is it fair to expect that by Q2 we’re starting to claw back some of that price cost, or is this more of a back half type of dynamic?

Well, what I’ll emphasize is we have improved our price realization each quarter this year, and setting aside the question of tariffs, just looking at generalized inflation, I would expect that that’s going to continue as we enter 2019. Given that, the question really comes down to what do we expect out of costs as we go into 2019. I’ll tell you that as much as we’ve realized the incremental pricing, we’ve also realized incremental costs each quarter this year as well, so we still see pressure there, quite frankly. But that said, we are making a lot of progress in terms of our ability to realize price. We talked a little bit about the pricing tools that went in, in midyear 2018, we talked a little bit here about how we’ve sort of re-jigged the group a little bit to give us a bit more focused information, etc., and I think that’s going to continue to provide us some additional incremental benefits. Our expectation in 2019 is that we’re going to continue to narrow and, frankly, get rid of the gap that exists today between price and cost.

Got it. Thanks Holden, that’s so helpful. Congrats on ’18, and good luck in the new year.

Thanks Chris. Just one item I’ll add to Holden’s commentary. When I think of the dynamic that’s going on right now, whether it’s inflation or tariffs in general, I think this is a huge opportunity for the Fastenal supply chain capabilities where we can flex our skill set. I mean that from the standpoint we’re not a fulfillment company, we don’t just supply you what you ordered, we also challenge in the process of saying, you know, the item you’re ordering, based on what we know about your business, we question if that’s optimal for your business. Sometimes it’s substituting the product from the standpoint of the durability of that product, does it fit, either is it adequate or too adequate to the demand of the use, but also we have great partner brands, we have great exclusive brands, and sometimes it’s coming to a customer and saying, you’ve used this same brand for years, we have this brand that we actively support and we have a better price point on, a better cost point which translates into a better price point, and we can offset inflation and/or tariffs by actively substituting, and that comes from an active engagement with knowing how the customer is using it and where their pain points are, where they’re willing to be flexible and where they can’t be flexible. I think that’s an important component of Fastenal’s supply chain.

Awesome, thank you, Dan.

Thank you. Our next question comes from David Manthey of Baird. Your line is now open.

Hi, good morning guys. Happy new year. First of all, I’m hoping I can get a little bit of color on these large customer pricing conversations. Are you through all of them? When do the changes start taking effect, and I assume you’ve outlined agreements for the 10 and 25% tariff environments, but have you also reached contractual agreements as it relates to when the tariffs are eventually rolled back?

You know, the agreements we have allow for windows for discussions. We’ve talked about this in the past of when pricing can change. Legally, you can do things beyond that from the standpoint of there’s always force majeure elements of contracts. We’re not a fan of that up or down, because we don’t think that’s part of a supply chain partnership. We’re having active discussions with the customers. The discussions are going quite well. Are some more successful than others? Yes, a lot of times it depends on where we find success in the things I just mentioned - the ability to substitute, the alternative sources of supply, the level of service trade-offs, are we growing our business, etc., but we’ve been largely successful. We’re seeing some price increases that are going into place as we speak and will be going in place over the upcoming months. In regard to the specifics of what happens when it goes from 10 to 25, or what happens when it unwinds, you can talk through scenarios but there’s no agreement that contemplates the--I don’t know if I want to use the word craziness or the noise, or all the stuff that’s going on in the marketplace, so it’s going to be a fluid environment on all regards. The one thing, we did put through some price increases that took effect in mid-December, and in those we just--we really had a discussion with our customers, saying you know what? The tariffs started on September 24, here is the latency we’re putting in, these tariffs unwind, here’s how we’ll unwind the tariffs in those discussions, and really having the same kind of latency. The idea was trying to match up as best you can where it’s impacting your P&L, where it’s impacting your business, and having a fair trade-off on the in and out because there are going to be distinct lines in the sand. But it’s not a foregone conclusion that the 10 or 25, what’s going to happen when or if, some or all of it remains there essentially and perpetually.

What I’ll add to that, David, is yes, I do believe that the vast majority of the conversations have been had. In fact, when I asked why our signings of onsites were perhaps a little bit lower in Q4 than we’d seen the rest of the year, one of the answers I got was, because of all the time and attention that we diverted to having those conversations. So those groups, both locally and international accounts, have worked really hard to have those conversations in a compressed period of time, and they came to those conversations with a great plan and, every bit as important, with great data which allowed us to define the issue fairly precisely. It’s a known issue, and I think those are the elements that have given--that make us be very encouraged about how those conversations have gone down. We do believe that those conversations have been generally successful. The costs related to the 10% tariff will begin to roll into the P&L in the first quarter, but frankly I think that most of the agreements that we’ve reached with many of our customers will also begin to roll in, in that January and February window as well. What that means in terms of the incremental price cost in the January-February time frame, time will tell, but that’s just a timing issue. Like I say, we’re encouraged by how those conversations went and we’re sort of expecting that we’re going to largely be able to neutralize the tariff impact.

That’s great color. Thanks guys.

Thank you. Our next question comes from Ryan Merkel of William Blair. Your line is now open.

Hey, a couple questions from me. First, I’m getting a lot of questions about tariffs and FIFO accounting, so how should we think about gross margin first half ’19 to second half ’19 as it relates to FIFO?

Well, that’s why we began to build some cost into inventory in the fourth quarter, based on when the containers began to hit the shores at the end of September. We expect that we will begin to see that inventory that’s currently sitting there roll into cost of goods as we get into the first quarter. That was all expected, Ryan. We knew that there would be some impact on the inventory side of the ledger, but it will take some time for that to roll through. But the nature of the tariffs as opposed to our usual purchasing was going to compress that window. That’s why we spent so much time talking to investors in a very tight window, is because we knew how that was going to roll out in Q1. I think the effects you’re alluding to are certainly playing out, but our original goal was to have pricing conversations ready to roll out as we began to see the costs shift off the balance sheet and into the income statement, and we think that we have largely achieved that goal. Going forward, we’re going to continue to see the containers move through the inventory and into the COGS as sort of comparable rate, and we should begin to see the pricing in Q1 and then Q2 related to that specifically, and that’s how we tend to view it. I’m not sure that I see a huge difference between the first half and the second half as it relates to the tariffs.

The only thing I’ll add to Holden’s commentary, and this is putting my old hat on for a second, is when I think of our business just holistically and I think about over the years, we’ve had roughly 160 days of inventory, plus or minus a handful, and I’m not going to get into exacts but just holistically, about 100 of those days were physically at the branch and about 60 of those days were physically at the distribution center. Now in the case of a lot of our products, and I’m setting vending aside and I’m setting OEM fasteners aside, in the case of a lot of our products, that kind of mirrors where the replenishment cycle is coming in, and really what put us in a position of having these discussions and having a little bit of a window to react to them. But that product that was in the branches is now we’re three months away from--a little bit over three months away from the start of tariffs, that product that’s going into the branches is starting to get replaced with stuff that was coming in, and so you’ll see bits and pieces of it coming in in January and February and March. They’ll be building as they go through the quarter. The full steam will really hit in Q2.

I think maybe another way to think about it is traditionally when we buy a product from overseas, it might take six months or two quarters, or whatever, to move into our system, but the tariffs were not applied at the point that you purchased the product, the tariffs were applied at the point that it hit the shores. So when the tariffs went into place on September 24, I think it was, any container that hit on September 25, where we might have bought the product three months earlier, but that tariff hit right then, so that’s why when you talk about the timing, the timing as it relates to tariffs and how our system is compressed compared to our normal purchasing period. Does that make sense?

Yes, okay. That’s helpful, guys. Secondly Holden, I think you mentioned the goal for incremental margins in 2019 was that 20, 25% range. Just two questions on that: first, what level of sales growth do you need to achieve that, and then secondly, it sounds like you’re assuming that you can neutralize tariffs and product cost inflation with price.

Well, currently we’re assuming that we continue to grow double digits. Now however the cycle plays out will have a lot to say about that, but we believe that the momentum that we have in our growth drivers is going to continue. We think that we’ll continue in the current environment to improve the price profile, so the real question is what does the cycle do. But at least through Q4, demand is still fairly healthy, so we’re assuming we’re going to grow double digits in order to achieve that.

The one thing I’ll add to that, Ryan, is if you look at it in the last couple years, Terry Owen--we had our board meeting yesterday and Terry Owen came in and talked to the board about--Terry oversees a big chunk of our behind-the-scenes business, so all of our national accounts team, our solutions people, which is onsite, which is vending, our government, our marketing folks, our finance that support national accounts, all those things rolled into one. Those are the bedrock of our growth drivers. We’ve added 30% more people into his team or teams over the last three years, and so when you look at that non-branch, the sales headcount that’s non-branch, that’s the part I’m talking about. We plan to keep adding aggressively into that area because that customer letter I talked about, that’s reflective of what that group does, as well as our local team and the district manager, of bringing that type of execution to our customer. So in a double digit environment, we’re going to keep growing that group aggressively to support what we’re doing. Obviously if we’re weren’t in a double-digit environment, I’d have to go to Terry and I’d have to go to a bunch of folks in the organization and say, hey folks, tighten the belt because we don’t have the luxury to add that. But before I stepped into this role, one thing I learned from this population quite acutely is great incremental margin if you’re not growing doesn’t matter. Now it’s changed a little bit - great growth where you don’t have great incremental margin doesn’t matter either, and I agree with both statements. But we want to be very mindful of growing infrastructure to be great at onsite because this is--just like vending, it’s incredibly disruptive to the space, and we are designed to be the best at this, so let’s go after it with a vengeance.

Just to finish off the last part of that, so yes, with regards to tariffs, we do expect that the success we’ve had will allow us to neutralize that. That’s a different conversation from price costs. Price cost, I think was about a 30 basis point drag to our business for the year. Our intention is to eliminate that drag, and we’ll see how that plays out over the course of the year, but our expectation is to eliminate that drag.

We think we have a good plan to do it, yes, and that would be part of achieving that incremental margin.

Helpful, thank you.

Thank you. Our next question comes from Scott Graham of BMO Capital Markets. Your line is now open.

Hi, good morning Dan, Holden, Ellen. I want to go back to what your just now comment was, Holden, on price cost and looping your earlier comment that the key to gross margin in 2019 will be to get to this, call it price cost neutrality, price cost broadly defined as being your entire P&L as opposed to just materials, I assume. I guess as we look at the trends of your sales, recognizing that on a longer term basis the onsite stuff does start to even out a little bit, but the mix is still running negative, so you have in the past said you have to look to backfill something like 20 to 30 basis points to just keep your gross margin flat due to mix. Is that number still applicable, and maybe connect the dots here for me that why is that not as important as managing price cost to get to your gross margin, to improve the [indiscernible] gross margin?

Yes, sure. I don’t want to give the impression that mix is not important as something that we need to mitigate, right, because we do need to find ways to improve our profitability, and to the extent that whatever the mix number is, we should be able to reduce it just through other activities. But let’s not lose sight of the fact that the mix is going down or the mix is a drag on gross margin because we’re getting tremendous growth in our growth drivers. I don’t think I’ve ever asserted to you that our gross margin was unlikely to decline provided we are successful with our growth drivers, but it is still incumbent upon us as an organization to do everything we can to maximize our gross margin and mitigate the impacts of that, but you shouldn’t have any expectation that our gross margins are going to be flat to going up as long as we are successful with these growth drivers. Look - onsites have a gross margin in the neighborhood of 35%, give or take. It’s just math, right? I mean, if we’re going to grow that business 40%, take out the transferred sales it’s 20%, the math is going to tell you it’s going to be difficult for us to expand our gross margin in that environment. But it’s a real big reason why we’re outgrowing everybody else in the space, so we’re not as hung up with the idea of offsetting mix fully as perhaps your question suggests that we should. But that said, price cost, that should be in our control. We know when our costs are rising, we know what we need to offset, the market should allow it, and we should be able to go to our customers and say, look, we’re not trying to take advantage here, this is what the marketplace is doing, this is what we need to be doing. That’s something that’s about our discipline as an organization. It’s a very different conversation than the one about mix.

Understood, thank you. I was under the impression that if you were able to backfill the 20 to 30, that the gross margin would be flat for the year; but it sounds to me like you’re not saying that.

Yes, I mean, whatever the number is, if we could backfill it, obviously it would be flat, and we always try to backfill. But the fact is, it’s difficult to find those in any given period, so no, I think we’ve been fairly open that if we’re going to be this successful with our vending and our non-fasteners and our onsites, in all likelihood over a period of time, our gross margin will go down. That doesn’t mean, by the way, that our operating margin needs to go down. We get tremendous leverage from the growth that we’re seeing, and we saw that this year as well. I think the dynamic you saw this year is very comparable to the dynamic we expect to continue to see. Now, I’ll tell you, mix expanded beyond that 20/30 in 2018, and it did so because if you think about it, national accounts in 2017 grew 14.5%, it grew 18% in ’18. Onsites grew 35% including transferred revenues in 2017, they grew 42% in ’18. Non-fastener accelerated. With those accelerations, we did see an expansion in the impact from customer mix, but again, we can’t lose sight of the fact that growth in national accounts going from 14.5% to 18% also drives more dollars to the revenue line that we then have leveraged at the operating expense line. That’s how our model works at this point.

Understood. Thank you. Just a quick follow-up would be in the past, you’ve talked about in product line and in channel mix, so products, fasteners versus non-fasteners, markets, manufacturing versus non-residential. Did you see anything in the mix in any of these four groups that went with you or went against you?

You mean within the group itself, as opposed to the changing mix of the individual groups?

That’s correct.

Yes, where products are concerned, our non-fasteners grew faster than our fasteners this year.

I think he’s talking about within the individual components, the dynamic of margin.

Yes.

Oh, okay, I got it. Yes, I mean, the element of price cost was a drag in a lot of these areas, right? I think I indicated price cost was about a 30 basis point drag to margin for the full year, and I think that that affected the margin in most of the channels and products that we’re in. Now, it affected fasteners more than non-fasteners without a doubt. It was probably more significant in the local business than it was on the onsites and the national accounts, etc. There was some differential, but price cost was a challenge across the business.

Fine, thank you.

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

Good morning everybody, happy new year. I was wondering if I could go back to the cash flow outlook for this year. How should I be thinking about working capital in your plan right now for 2019? We’ll get rid of some of the one-time pull forward impacts that you outlined on inventory, but just directionally, should we see cash days improve? Then could you just talk about your downturn scenario planning, if you’ve done any? What if the business kind of ground to a halt? It’s a lot different than several years ago, the last downturn. How would you expect working capital to perform with the change in the mix of the business?

Sure. Frankly, my rule of thumb model for our balance sheet would be a slight increase in days on the AR, simply because of the growth in national accounts and growth in international businesses. But you know, a meaningful multi-day decrease in days of inventory, that’s how we would like to build it out. Now, the reality is right now, there are some challenges that by the back half of 2018 it was very difficult for us to achieve those. We have to take steps in 2019 to get back on the track that I just laid out. We’re not there right now, but we have plans to begin to try to address that. Normally what I would tell you is for the full year, we should convert more than 100% of our net income into operating cash flow, and this year the biggest reason why we did not was because of working capital, and the expectation is that as we go into 2019, we should be able to deliver that. The challenges obviously are related to the inflation and tariffs and things like that, what impact that might have on inventory. That’s sort of the rule of thumb that I look at when I think about the balance sheet. We have to show that we can deliver to that again in 2019, because 2018 was a struggle and the variables that caused it to be a struggle in 2018 have not gone away. As it relates to a downturn scenario, traditionally if it’s a short, relatively normal downturn, we need less working capital in that environment, and our cash flow is traditionally pretty stable and steady.

I’ll just throw in a couple thoughts, just after being here for 20-plus years, I’m the old guy so I can give a little perspective. The interesting thing about a distribution business, it’s a working capital business. We have a little bit more fixed capital in our business now because of things like vending and automation in our warehouse and the fact that we have our own trucking network, but it’s really a working capital business. When we put up good growth, the number Holden just cited, that 100%, that becomes more challenging, and historically I would expect our number if we’re putting up good growth to pull down in to the mid-90s as a percentage of earnings, because your AR and your inventory are growing faster because you’re supporting an ever growing business. That’s considered a good problem. The dynamics have changed a little bit on that math because our tax rate is lower now, so we produced a higher--the 100 of earnings isn’t 100 of earnings anymore, it’s a little bit higher, so you can--it raises that relationship. If I look at when growth really stalls, I mean, the best year we’ve had for operating cash to earnings as a percentage, the best year that I’ve ever seen was 2009. I hope that never repeats itself. We threw out more cash than you could imagine because the business slowed down, and if you don’t have more sales, you don’t have more receivables. If you don’t have sales growing in the future, you don’t need to be beefing up your inventory. The only dynamic that can muck that up is if it slows down quickly because we can’t shut off the inbound inventory fast, but the receivables would drop off as the sales drop off.

With that, I see we’re at 9:59. I just want to close the call with a few final thoughts. First off, thank you for participating on our call today. Thanks for your interest in Fastenal and for being a shareholder in Fastenal. One thing for us to think about as we’ve moving from a $5 billion to a $10 billion company and you start thinking about gross profit, operating expenses and operating margin, the message internally is quite clear for our employees. As our business evolves, if I looked out to that $10 billion company and I was just putting a guess of where I think the numbers are, I think gross margin--if the mix ends up where I think it’s going to be, I think the gross margin is around 46 and I think there’s some things we have to do to get better at, to be at 46. Is there upside to that? Sure, but in planning for that 46, I also tell our team we need to plan on operating expenses being in the lower half of the 20s. Twenty-four is the number I always think of, and that allows us to be in a position where we could throw up operating margins at 22. I think that’s very realistic. If I look at regions where we have a lot of onsites and a mature business, the midwestern U.S. as an example, we’re above those numbers. This is a conservative view of the future, but I look at it and say, if I look at Page 9 of Holden’s flip book, the question a shareholder needs to ask himself is Fastenal is investing to grow rapidly - we’ve added 30% to our key account teams in the last three years. Technology, we decided three years ago to spend 50 basis points more every year to become a leader in technology in our industry, not a follower of technology in our industry. We saw with great partnerships over the years - our vending partnership for the last 10, our mobility partnership we put in place next year, we think we’re a different organization now. Fastenal Express, as I touched on in the last call, is not a train, it’s a rocket. It’s growing nicely in our business. It’s not about the revenue growth it can produce, which I think it can; it’s about the efficiency it can bring to our team. But looking at all those things and are you interested in being a shareholder in Fastenal, looking at the return on invested capital that we throw off, that Holden details out on Page 9, I think we’re a great proposition to own and I would challenge our shareholders to step up and buy some more, just like I challenge our employees to be willing to learn and change, and we challenge our customers to be open-minded about their supply chain. That’s how we all get better. Thanks, and have a good week, everybody.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.