Greetings, welcome to the Fastenal Company Second Quarter 2019 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I would now like to turn the conference over to Ellen Stolts, Investor Relations. Ms. Stolts, you may now begin.

Welcome to the Fastenal Company 2019 second 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 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 September 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.

Thank you, Ellen, and good morning, everybody. Before I start, I just want to share a thought with the group. And I had the distinct pleasure over my 23 years at Fastenal to have worked with some really fine people. And two of them I mentioned are original CEO, Bob Kierlin, and his successor Will Oberton, two individuals that I think were stellar in the role, and I learned a tremendous amount from and not only were they great at their role, they’re really good people. I remember back in -- I believe it was 1998 October and our business growth dropped in one month, about a third we went from 20% some growth, we dropped 10 point. I think we went from 27% to 17%, don’t quote me on that, but I think that’s what it was. And we did six simple things. And if you want to -- if you are a CEO out there and you want to know six things to do in a time like this, these are really useful. The first thing you do is you take a step back, you revisit that your long-term priorities. These priorities should center on your goals or something is wrong to start with, but you take a look at your priorities. And that’s step one. Step two is you remind everybody about these priorities and you remind everybody, hey, we keep doing these things. 20 years ago that was opening branches, because we were spreading across North America. Today, it’s executing on our growth drivers. Step three, you take a step back and you identify those things that are really, really important to your long-term success, but you pull back on that a bit. And you explain to everybody why and a good example is something that we were pulling back, back in late May, I sat down with Reyne Wisecup, our Head of HR; and Peter Guidinger, our Head of our Fastenal School Business and I said, you know, what we need to pull back expenses and we need to do it in a bunch of places. We need to pull back our instructor-led programs for the second-half of the year because we need to pull back the travel expenses, so if you are in an airline right now or a hotel in Winona, Minnesota or one of our distribution centers, you will lose some business in the next six months because we pulled back on -- we pull back about 40% of our online -- excuse me, our instructor-led trainings and the team didn't react with anger, didn't react with fear. They reacted with resiliency. Now maybe they had some fear in their stomach, maybe they had some anger in their stomach, but they didn’t let that show and they immediately identified what some of the resources they would be freeing up, what could they do that help Fastenal in the short-term and long-term. They identified some courses they are going to develop because most of our courses are delivered online. There we identified an abrasives course, a metalworking course, a blueprint reading course, an ISO quality course. Several new courses relating to Lean and Six Sigma. Now my guess is there aren't anybody in this call that’s signing up to take those courses, but they’re really important to our employees and to our customers, and that's something that you do when you do trade-offs and you pull back expenses in the short-term. Really important thing as an organization or individual, in the case of me that believes in education more. But in the short-term you pull back because we don’t have the dollars to pay for it. Step four, you have to also identify those activities that don't support your long-term priorities or that quite frankly aren't really that necessary in the first place. Fortunately for us we’re pretty frugal. So, we don't have any of those, but we are human beings, so we -- you always develop some and those you just stop and you stop today. The third thing to do is you communicate this throughout the organization. You create normalcy in your organization. You remove fear and replace it with resiliency. And then step six, you repeat that communication to everybody, and you repeat it again and again and you build resiliency in the organization. Six really simple steps, but they’re really effective in a time when all of a sudden your business has slowed down and you’re not sure how long. I took comfort we are market share, but the business has slowed down. Had a call with our Regional VPs at seven this morning, actually Holden did. I chimed in at the tail end of it. I talked to them about a number of things we're doing right. I also talked about on aspects of the quarter that don’t fall in the normalcy where our execution faltered and gross margin is one that stands out. To be honest with you, last fall, we thought we had really good plan to address some of the inflation we were seeing, and there has been tariffs now in place on steel-based products for a year on fasteners since late last fall. So, we had a really good plan coming in the year how to approach it. I often encourage our team to think big about the business. Unfortunately, on that front I feel shy on where we were last fall. In that, we had a good plan coming into the year. We didn’t have a great plan. And part of that where we faltered was the resiliency part. We didn’t prepare our team for a bunch of things coming their way. We prepared them for that, that big wave coming in was tariffs that were direct. That’s an easy one to identify. That’s an easy one to go after. It's not easy to take it downstream no pun intended. But it is easier to go after. We also prepared them for some of the things that would be coming from our suppliers in the U.S that import product and resell it to us. Though it is not as easier to identify, but relatively easy; and I think on those two fronts we did a relatively good job. We realized in the process we were going to share some of it with our customers. We were going to share some of it with ourselves. We are a supply chain partner. Our customer is not a means to an end for us. Our customer -- we are not a business that just sells products and the customer goes away and we don’t really care what they do with it. We are a supply chain partner and that's what we represent to our customer. Where we failed though is, there wasn’t just a couple of waves coming in, there was once rip tides too. And those rip tides came from a bunch of different directions and we weren't ready for that. And as a result and Holden will touch on a little more detail about that, we lost some gross margin. To me that’s a thing that stands out in this quarter that is troubling from the standpoint if the economy slows down, the economy slows down, the economy expands, the economy expands, you react to both. We did not execute on gross margin. And as a result, the statement I made to this group, I believe look back on the January call where I said, when I look at Fastenal and I’m describing it to our folks internally when we were a $10 billion company, I believe a 46 gross margin is a reality that we can achieve. I believe a 24% operating expense is a reality we can achieve and we should aspire to an operating margin around 20%. I believed it then I believe it now. I didn’t think I would be sitting here six months later talking to you about a quarter where we just put up gross margin that’s 46 and change, 46.7 I believe is the number. And in that regard we’ve some work to do as we go into Q3. I will go to now the flipbook. The sales growth slowed about 8%. It's our first sub 10% reading in nine quarters. We continue to realize double-digit growth through vending and Onsites and to our National Account customers, our growth drivers, if you will. Our fourth growth driver construction, did weaken as we got deep into the quarter. Not exactly sure what's driving all of that at this time. But overall our activity in the end markets we serve slowed as we stepped into the quarter. I don't know if it continue to slow during the quarter, but it did slow as we stepped into the quarter and I will let Holden touch more on that in a few minutes. There were a few milestones in the quarter. And one that occurred right after the quarter that I will touch on as well. The first milestone was we installed our 100,000 -- that’s a hard thing to say, vending device during the quarter. We have little over 85,000 vending machines now. We have another 15,000 that we lease to some customers where they use them for second check out, so 100,000 of them out there. I like to personally thank Oshkosh Corp and specifically their Pierce Manufacturing facility in Appleton, Wisconsin. They were an early adopter, I should say an early guinea pig, with our vending program back 11, 12 years ago continued to have a great relationship with that organization and they added machine number 100,000 in early June. And had the opportunity to go over there and thank them in person. It worked out really well because they’re based in Appleton, Wisconsin, my father-in-law Gus [ph], lives about 10 miles away in Neenah, so I had a -- I didn’t need to get a hotel that night. But I had a chance to learn a lot about business and what they do is pretty special, they make fire trucks, a beautiful product. Late in the quarter we signed Onsite number 1,000. I think that’s a big accomplishment. It took us quite a few years to get the branch number 1,000. It took us a lot less time to get Onsite 1,000. I’m not at liberty to share with you the name of that customer right now. I believe we’re announcing in a day or two. We need to get all the formalities worked out, but I would like to thank them incognito for Onsite 1,000. I think we’re in a 1,026 right now. The third milestone occurred is not in the flipbook. But yesterday and it wasn’t even in the quarter, yesterday our facility in Connecticut, Wallingford, Connecticut, Holo-Krome back in 2009, we acquired Holo-Krome. They were in a business -- a process of being shutdown. Within two years of the acquisition, we moved them from a 80-year old facility that was rather tired into a newly renovated facility. And -- but Holo-Krome manufacturing started back in 1929, kind of an odd year to start given what happened in the next decade. But they celebrated nine years of operation yesterday. My congratulations to the team at Holo-Krome. They have been a great addition to the Fastenal family. Price realization as I’ve alluded to has been insufficient to fully offset the tariffs and general inflation we’re seeing. We are seeing in a bunch of fronts. Obviously, the direct impact of tariffs, but the indirect through companies we buy from some pass it on in different ways, some spread it across all products, some apply it strictly to tariff related products. Nonetheless, it's created a lot of supply chain inflation. In the short-term, we’ve not been able to realize the price to fully pass that along. We’ve taken further price adjustments going into the third quarter. We will, as a supply chain partner, share some with our customer. We will absorb some of it, but we plan to call back the gross margin degradation that came beyond just customer mix in the current quarter. As a result, we struggle to obtain leverage. We did get operating expense leverage. The flipbook talks about that. The only disagreement I would have with the flipbook is that’s looking at operating expense to sales growth. I think the operating expense to gross profit as the growth. And in that regard we did not lever, but I think the team did a good job of managing operating expenses in the second quarter. We’re dialing down as we go into the third. On the next page, I don’t need to read these all individually. What I can say as it relates to our growth drivers, the team did a great job, continuing to take market share. We just need to continue to do a great job on executing the business. With that, I will turn it over to Holden.

Great. Thank you and good morning. Before jumping in, I just want to remind everyone that on May 22 we split our stock two-for-one. Therefore any references and the materials to per share information such as EPS will reflect this action. Moving to Slide 5. Total sales were up 7.9%, which includes up 7% daily sales in June. Pricing in response to tariffs and general inflation contributed 72 to 100 basis point during the period. The lower range than what we saw in the first quarter that largely reflects the current period having to grow over last year's rising contribution from price. Sequentially, we believe price realization was stable. From a macro standpoint, it's clear that activity slowed. The Purchasing Managers' Index averaged 52.2 in the first quarter, which is still suggestive of a growing market, but well off the 56.9 level recorded as recently as -- as recently as the fourth quarter. Similarly, U.S industrial production in April and May was up 1.3%, which is well below the 3.7% growth that we experienced just in the fourth quarter of 2018. There's no panic in the market and the month-to-month cadence to the quarter was mostly steady, but sentiment has become more cautious. In terms of end markets, manufacturing was up 9.1%. Oil and gas remain soft and our heavy equipment categories also slowed. Construction was up 7.2% in the second quarter with larger customers outperforming smaller ones. From a product standpoint, fasteners were up 5.5%, with non-fasteners up 9.5%. Fasteners are the most cyclical of our product lines and we believe the relatively faster deceleration from 1Q to 2Q like to reflects the slower macro environment. From a customer standpoint, National Accounts were up 12.5% in the quarter with 72 of our top 100 accounts growing. Our non-National Account growth was less than 1% with roughly 59% of our branches growing in the second quarter. Our two quarters of quarterly growth averaged 12.9%, our current rate is clearly disappointing. Still ebbs and flows of the cycle aside the goal every day is to capture more market share of a fragmented industrial distribution market, judging by our out growth relative to industrial production we believe the Blue Team continue to execute its growth drivers effectively. Now to Slide 6. Our gross margin was 46.9% in the second quarter, down 180 basis points versus the second quarter of 2018, a larger decline than was expected. There were a handful of smaller drags, including the year to year comparison in transportation. But there were two primary factors behind the decline. First, customer and product mix. This remains an expected outcome of our success in driving market share gains through our current growth drivers. However, the greater deceleration in our higher-margin non-National Account customers, which grew less than 1% in the quarter serve to wide net mix drag, which was 80 to 90 basis points in the quarter. Second was a widening in our price cost deficit to an estimated 40 to 60 basis points. As Dan alluded to, initial steps to raise price to offset tariffs were effective as far as they went, but were not expansive enough in terms of the range of products covered or their ability to offset generalized inflation above and beyond and, frankly, catalyzed by the tariffs. We continue to pursue a range of actions to mitigate these effects including a broader price increase that we've already instituted in the third quarter. Broadening our sales streams and realizing the incremental benefits of the pricing that recently introduced should improve our gross margin performance in the second-half. Our operating margin was 20.1% in the second quarter of '19, down 110 basis points year-over-year. We leveraged operating expenses despite the slowdown in sales growth, but not sufficiently to overcome the lower gross margin. Looking at the pieces, we achieved 20 basis points of leverage over employee related costs, which were up 6.8%. This growth was largely due to a 6.6% increase in absolute and FTE growth in the period. We realized 25 basis points of leverage over occupancy related costs, which were up 2.5%, comprised of higher vending expenses as we expand the installed base and flattish occupancy expenses. We generated 20 basis points of leverage over other operating and administrative expenses, which were actually down slightly in the period. In light of the slower top line growth, we will seek to reduce our own spending. We will continue to add resources as necessary to finance our growth drivers and support our ability to take market share, but cost and investments that do not support those growth drivers will be more tightly managed. Putting it all together, we reported second quarter '19 EPS of $0.36, which was down 3.2% from the $0.37 in the second quarter of '18. Recall, however, that last year's quarter did benefit by two pennies from a one-time tax gain if we adjust this out, our EPS were up 1.5% in the second quarter. Turning to Slide 7. Looking at the cash flow statement. We generated $128 million in operating cash in the second quarter, which was 63% of net income. Remember the cash generation in the second quarters are typically seasonally lower. The conversion rate in the current quarters below last year's 72%, the last year we would have been close to 66% absent one-time benefits deriving from the Tax Act. Overall, we view the current quarter's conversion rate to be consistent with the typical 2Q conversion rate. Net capital spending in the second quarter was $67 million, up from $25 million in the second quarter of 2018, but consistent with our expectations. This reflects investments in hub property and equipment and vehicles that are necessary to support our high levels of service as well as investments in vending equipment to support growth in our installed base. Our 2019 range for total net capital spending is unchanged between $195 million and $225 million with the same factors driving the second quarter increase impacting the full-year. We increased funds paid out in dividends by 16% to $123 million. We finished the quarter with debt at 16.6% of total capital above last year's 16%, but down sequentially and from year-end and at a level that we believe provides ample liquidity to invest in our business and pay our dividend. The working capital picture remains challenging. Inventories were up 15.7% in the second quarter, almost 40% of this increase relates to inventory added to support Onsites. We believe we can reduce overall inventory even while making these investments. And as a result began to reduce our overseas purchasing in the fourth quarter of 2018. This can be difficult to discern both because of the lag between such an action and its impacting our balance sheet and because of the slower sales growth this quarter, which lowered our inventory burn rate. However, we would expect these actions to become more visible to the second half of 2019. Our accounts receivable grew 11.7% in the second quarter. Customers continue to aggressively push payments out past quarter end and as a result of 2.9 day increase in our receivable days is unsatisfactory. Still, the rate of increase has moderated versus last year and there are signs that we are reacting more effectively to our customer's actions as its been the case in recent quarters we are not seeing any meaningful change in hard to collect balances. That is all for our formal presentation. So with that, operator, we will take questions.

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Ryan Merkel of William Blair. Please proceed with your questions.

Hey, thanks. So, a couple questions on gross margins to start here. So, first, what exactly is the issue with recapturing product inflation? I recall you thought you’d recapture the 20-basis-point price cost deficit last quarter, this quarter, but it in fact got worse. So what exactly is going on?

The -- I mean, the goal coming into the year was to eliminate the price cost deficit that we had. The -- that was the goal the prior year as well, but we still wound up with one, and so it comes down to execution. And the issue was, we put in place a plan to address tariffs in particular and that resulted in our getting incremental price to offset those tariffs. What I think we underestimated Ryan was the degree to which there was general inflation in the marketplace, including general inflation that was being sort of caused and following on the tariffs that were going into place. And on top of that, the pricing improvements that we put in affected a significant amount of product within our overall portfolio, but didn’t necessarily affect all of it. And we had assumed that we would get enough price to sort of make up for what we didn't address in terms of the product categories, but we didn't quite get there. Again, a lot of the reason for that is simply the incremental inflation above and beyond tariffs that we saw in the marketplace. So we looked at the situation, we’ve sort of evaluated the issues that were in place and we’ve taken additional pricing actions at the beginning of Q3, the end of Q2 really to address both the gap that we had for the inflation that we didn't build into the original expectations so to catch up, if you will, as well as the new tariffs that are beginning to come through the system that we will experience in our COGS and the -- in the latter half of the year.

So just a follow-up, if I understood what you said correctly, it sounds like your systems aren't capturing inflation appropriately for you to be able to pass it on because you're not saying that you’re -- you’ve been unable to pass on the price inflation to your customers or that they’re pushing back too hard? Am I hearing that right?

No, that’s correct. The pricing that we put through, we captured. The -- what we didn't capture is the pricing that we didn't put through that we should have. And so the new pricing is intended to address the gap between what we did capture and the price increases that we've seen, and what -- and sort of what we didn't wind up putting through the first time around.

Okay. And then presumably you’ve improved the systems and you have a better handle on what more inflation is coming. So how much price do you estimate you’re going to need in the second half of '19, and maybe into 2020 to offset rising product inflation?

You know, I think we've looked at it and we're expecting -- we are putting into place a couple of percentage points of price.

Okay. And you’re confident that will cover or at least offset most of the price cost deficit?

Yes, we are.

Okay.I’ll pass it on. Thanks.

Thanks.

The next question is coming from the line of David Manthey with Robert W. Baird. Please proceed with your questions.

Thank you. Good morning, guys.

Hi, David. Good morning.

First question on gross margin. Holden, I think you gave some data on this, but could you just disaggregate the gross margin decline of 180 basis points into mix factors versus pricing factors? And then, along with that, Dan, I’m wondering if you can address this, the 46%. I’m wondering why is 46% a line in the sand when you’re at 47% and change today and your gross margin has been declining, I don't know, 70, 80 basis points annually for the last 5 plus years. Can you talk about that issue as well?

I will handle the mechanical side of it first and then we will pass it over. But the mix piece was about an 80 to 90 basis point drag, which was probably about 20 basis points more than I would've expected, frankly. The price cost piece was a 40 to 60 basis point drag, which again was a widening versus what we saw in the first quarter. There was about a 20-basis-point drag from freight than there's a couple other sort of organizational elements that make up the difference.

Got it. Okay. Thank you.

David, I’d think about it this way. Think about it as it's a desired outcome. If we desire over the next $5 billion of growth to expand our operating margin, there’s two ways to do it. Either you do it by how much you allow your gross margin to move or how much you allow your operating expense to move or force the operating expense to move. Could you make the math work by it going to 44% and operating expenses going to 22%, that’s conceivable, but that's really difficult to do because you really have to -- you’ve to understand how much of your business is going to be going through our Onsite model versus our branch model, what our average branch is going to do. The old pathway to profit that we talked about years ago was really about as that branch population matures, it becomes much more profitable because you run away from a lag of fixed costs. And so, it's really a case of putting a line in the sand, tells your team because this is about a message for internal as much as it’s a message for external. It tells your team that if we want to be able to afford these things in the future, we have to clawback on this piece, this piece, this piece, and this piece. Sometimes that’s clawing back on gross margin and some of price. Sometimes it's about cost, sometimes it's about mix. Sometimes, it's about how much freight you put on your own truck versus somebody else's, how much you charge for freight? It's looking at all those pieces and saying if we can be a $10 billion company at 46%, we can afford to be at 24 and hit 22. If we can't and that goes to 45% or 44%, which is conceivably possible. I mean, in January I talked about that. If -- then we either need to decide is 24 the number and we're willing to be at 20 or 21 or do we squeeze that down to 23 and 22. So, the line in the sand is more about the desired outcome and what you’re going to challenge your business internally to do to achieve that outcome.

Okay. That makes sense. Thanks, Dan. I appreciate it.

And one thing I would also mention is recall when we sort of had that initial conversation about those aspirations, we also noted that the impact of mix and stuff might pull the margin down to 45% and then improvements we make in the business would actually add another 100 basis points or what have you now. That’s from $5 billion to $10 billion. Obviously, we haven't had the time to get that additional 100 basis points of improvement just from the things we do to improve our supply chain, right. So, when you think about the baseline, don't forget that always inherent in that guidance was the suggestion that over that period we would also make process improvements on our own business that would offset some of that mix drag.

Got it. Okay. Thank you. And then just quickly on the SG&A. I think you’ve only been growing it at a 5% or 6% rate in the first half before you’ve taken any actions relative to the slowing market. But -- and obviously if things slowdown you will get a little natural flex in OpEx lower. Where can you take that set point in the back half of this year? I mean, are you prepping this for sort of mid single-digit top line and you can set that at 3% or can take it a flat, I don’t know. I mean, you’ve done a good job to this point. I'm just wondering how much further you can work down on that?

Yes, I will answer it, Dave, in this context where my -- where our thinking is right now, based on what our business is doing right now. We are closing some branches every quarter. That frees up some expense every quarter. Based on our run rate we’re going to do about a 100 branches that we close. So that gives us some flexibility. There are some branches that we need to expand that existing footprint and expand the cost. But we are able to fund all that through the branches that we’re closing and some of our Onsites the customer might not have sufficient room and we might have a low-cost storage within a mile or two of our customer and while it's a lot cheaper than a branch it's still an expense. And so that's funding that piece and so our branch occupancy, onset occupancy, net net is not growing. That has been contracting slightly. The growth in occupancy is coming from the fact we put more vending machines out there. If you look at expenses, other operating -- other non-labor operating expenses that we've done a really nice job which is raining that in and we will -- we have some pieces -- triggers we are pulling right now, for example, the travel component, because we've reduced our training in the second half of the year. The real dollars is in labor if you think about our operating expenses. So there we’ve some flex points from the standpoint of how our incentive comp works, I can tell you that. The incentive comp for a number of folks within Fastenal is materially different in July of 2019 that was in July of 2018. And that -- what that does and you’ve described it aptly in the past as the shock absorbers, it gives us the luxury of not having to get crazy with expenses right today in the last 90 days, because you’re not sure what’s happening. And -- but we are pulling back headcount growth rapidly and because that expense can't be growing at 6% or 7% in an environment where sales are growing 8% and gross profits growing 4%. So that's really where you’re going to see that the toggle because the other two components which are 30% of SG&A, those are managed really well and we’ve been managing the first one labor really well, but that was for a different environment and we need to change our tact.

Yes, if you think, David, our -- if you look at our headcount adds whether it be full-time or FTE, I mean they’re up 6.5% and just to zip back to May, go back one month and if I look at the absolute headcount it was up 7%, that’s actually the highest rate of growth in our headcount that we’ve seen through this cycle, right? And so, obviously, we need to take that rate down and there's room to do so. Certainly outside of the selling functions we all need to look at sort of where we have opportunities to be more conservative, but even within the selling organization, we're going to continue to invest in people to support the Onsite growth. We need to do that because it drives our market share gains, but if you look at where headcounts are getting added, payrolls are getting added there, you’re seeing growth outside of the Onsite environment as well, even in environment we’re closing some branches. And so whether it's in the selling organization outside of the Onsites to support growth or whether it's in the non-selling organization, we -- we're coming off a quarter where we had pretty good growth in heads that’s simply that rate needs to come down given the reality of the growth in the marketplace and should be able to.

A good example over the last few years as we ramped up our Onsites, our implementation team that we’ve in the field, I believe we took the number over the last two years from about a 140-ish, 130-ish to about 230 to handle all these implementing of National Accounts and Onsite, so it's not just Onsite, but National Accounts in general. That team we’re not having to grow as rapidly now attracted it's relatively stable because we’re not going from signing Evian sites 280 to 300 to 400, we are kind of in that zone of around 400. We think that’s a good cadence for our customers and for our business. So it doesn’t require us to expand that group. So that group has been, I think were up 5% in the last 12 months. So it's things like that that we can do in the short-term.

Great color, guys. Thanks.

You bet.

Thanks.

Our next question is from the line of Nigel Coe from Wolfe Research. Please proceed with your questions.

Thanks. Good morning, guys.

Good morning.

Thanks for the detail. Just going back to the price increases and I think Holden you mentioned 2%. Is that across the whole boats or that be the non-National Accounts? And certainly the spirit of the question is, are you able to get price for National Accounts, so is that so contractually locked in at this point?

We are not looking at our business differently in that sense as it relates to the impact of cost increases and the price we’re putting in place, right? We can't go after the 50% of our business that is non-National Accounts and not address the 50% of the business that is National Account. Now National Account has certain mechanisms that are build into the contracts that that make that process perhaps a little bit more mechanical, but the intention is to work through that process and get price increases there where necessary as well because we are selling the same products into National Accounts as we are non-National Accounts and the costs are behaving the same. So we're not taking half of our business and setting it aside as we are not going to touch this. We can do that and be successful what we’re trying to achieve.

Okay.

One thing I will just add for a little color is Holden cited an average. Average sometimes can be dangerous. We have -- if you think about China as an industrial producer, I believe 52% of the steel that’s produced on the planet Earth is produced inside of China. I might be off of a point or two, but I’m in the ballpark. Our fastener product, which is roughly a third of our business was made of steel. And a high percentage -- most of the -- they’re are the Holo-Kromes of the world, the company I started earlier, but they represent a minority of the fasteners that are consumed in North America. So most of the fasteners regardless of where you’re getting them, I mean, who is the distributor or who is the importer, most of the fasteners on this planet are made in China. And we’ve moved some production out, actually we've moved. If you look at the amount we've moved in the last nine months out of China and compare it to what the U.S economy is moving, we've actually moved more than the U.S economy has, if you look at the statistics. And -- but the reality is even in a 10% or a 25% tariff environment, they oftentimes are still the lowest-cost producer of an item. And so there's -- while Holden like said, an average across a whole bunch of products, there's a lot of different parts in there. There's four lists of items that have been identified by the U.S government. List one and list two didn’t really impact us that much. We don’t import raw steel. List three hit last September, hit us quite hard and that list went from 10% to 25% here in the second quarter. That hits squarely into our fastener product. List four, nothing has happened yet, it's on hold. I don’t know what’s going to happen there. We do have products on list four and most of those will be in the non-fastener area. And so there are parts for we’re raising materially higher than 2% and there are parts we’re not touching. And -- but be mindful of that.

Okay.

And as it relates to National Accounts versus non-National Accounts specifically, so yes, 2% is an average. Difficult to say whether National Accounts will be more or less given -- in any given quarter or what have you, but again the intention we're not setting aside 50% of our business and saying this is not something we think that we can impact. We think we can.

Understood. Understood. And then, Holden, very quickly, I mean, can you maybe just address the gross margin cadence over the balance of the year because we tend to have a seasonally lower gross margin in the second half versus first half 2Q. How does the price increase that you’re implementing, how does that impact that normal seasonal pattern?

Yes, so the price increases are already -- have already been installed. So I would expect it would begin the season benefit in July and that we would see a greater benefit in August or September and then heading into the fourth quarter, right? So that will ramp up. The cost from the new tariffs, of course, we’re already behind on cost and generalize inflation, but costs from new tariffs would begin to impact us probably in the middle part of Q4. So think about that cadence on cost. If I think about the pieces that affected our gross margin this quarter, how that plays out. I -- seasonally, I think Q2 would typically be down, 10 to 20 basis points, maybe flat to down 20 basis points from Q2. So I think that’s probably the typical seasonal pattern. But I think that some of the drag from freight, I think we might be able to get 10 basis points back from freight that we saw this quarter. I think that there may be a path to 40 basis points give or take on price cost in the third quarter. And when you lay that all out, I think that there's a path in the third quarter to have a gross margin, that’s a little bit North of 47%, which would cut the 180 basis point drag we had this quarter and half. And I think that we can expect something like that, maybe a little bit less of a decline in the fourth quarter as well given the things that we're seeing. So that’s kind of the cadence that that we see. Obviously, it relies on our executing effectively, which we expect. But should we do so, I think that there's the seasonality, then I think you add a little bit from price cost gain and you could add a little bit from freight gain.

All right. Okay. Thanks, guys.

Yes.

The next question is from the line of Robert Barry with Buckingham Research. Please proceed with your questions.

Hey, guys. Good morning.

Good morning.

Maybe actually we just to pick up where you’ve left off there, Holden. So it sounds like you think you can kind of call back into the call it low to mid 47s on the gross margin, but then I think you also said that the impact of the new tariffs are going to start to you in the fourth quarter. So does that mean you need to go back then, again and get more price or will be then kind of start moving back down in the other direction there?

Well, first, I think what I said was a little -- I think what I said was a little over 47. I don’t think I’ve said mid 40s, first off. I will just throw off …

[Indiscernible] 47.5.

Yes, I will just throw something in the latest round of tariffs came into play in the Q2. So there's product that we’re -- but in stuff that was on the water was not impacted, but if it hadn't shift it is impacted. So we’ve cost that are coming in right now that are from that latest wave. Some of those costs will turn in July and then updated piece will turn in August. A bigger piece returned September based on our faster inventory does turn at a certain cadence. But there's customer specific product that we might bring in that turns in 60 days. So the price moves we’re doing and the costs, while that comes in, in waves, we are putting in place, right now. And some will go in place in August, some will go in place in September, but they’re both moving now. It isnt the case of it. There's multiple waves. There is -- what the message I’ve given to our team is we’re not doing a price increase on every part, you are doing some stuff every month based on what’s happening in that month, working with your customer and their individual supply chain because keep in mind, a big piece of what we sell is stuff that’s unique to a customer. That’s it, makes it more difficult to manage. Systematically and -- but our team can be response to locally.

Right.

And then, when I talk about 40 or 50 basis points of clawback in the back half of the year. I’m assuming you get both a little bit more price and a little bit more cost in Q4 versus where you are in Q3. So we’re -- that’s how we see that playing out. I do think costs will be higher in Q3. There will be a little bit higher than Q4, but I think the price side of it will also escalate a little bit.

Right. So given the mention of the waves, I mean, waves is the full impact of the list three at 25% volume to the P&L.

You start seeing the puller impact of it by the time you get into those middle part of Q4. That’s that.

Got it. And then I guess just to circle back to an earlier question about achievability. I mean, given the slowing demand environment impacted, these are now much bigger numbers than 10%. I mean, what’s the confidence on getting to price costs neutral or is that even the goal? Because I think you mentioned earlier planning to share some of the burden with the customers.

I don't believe getting cost price to be neutral is realistic. With that said, we have to work to get -- you have to work to get close of it and some of that as I said on prior calls, some involves having a challenging conversation with your customer, sometimes its price substitution. Sometimes it's looking and saying the cost of this is up, here's a different alternative that’s a cheaper price to start with. For whatever reason, maybe it's a more standard product, maybe what the customers using is actually a nonstandard item and there is a more standard substitute. And Henry what requires in some cases some engineering support to get it approved for use in that process. Those are the challenging aspects, but that’s in times like this, you cradle-more friction to create those challenges, because then it allows both Fastenal and our customer to win. Neither one of us takes the whole branch because you changed the math, but it takes a lot of work. And then bear in mind as well that while I think the environment today might be a little bit more challenging than it would have been six months ago. We also are better at executing this than we were the first time we did it. We’ve learned more about the systems that we have, we made tweet to the systems that we have, so that fewer things, won't be covered in that sort of thing. So I think you’re right that the environment perhaps is little bit more difficult and we’re through six months ago. I think that our knowledge of how to manage the process is also better. And so now we just need to go and execute it.

All right. Thanks, guys.

Thanks.

Thank you. The next question is from the line of Joshua Pokrzywinski with Morgan Stanley. Please proceed with your questions.

Hi. Good morning, guys.

Morning.

Just want to follow-up on the deceleration you guys saw in non-resi in June. Holden any color or Holden or Dan, can any color on maybe some pockets or verticals there. Anything you’ve heard from the regions that may give little bit more of an indication how persistent that is versus maybe one bad month?

Not as much color as I wish I could give you. Our larger customers did pretty well. The customers that we’ve a lot of volume with, they tend to be National Accounts grew fairly well within the construction side. What did not grow as well was the smaller customer base. Now some of the RVPs commented about weather and things like that, but that was scattered. It wasn’t a consensus by any means. And so, I’m not sure exactly why that piece of the market was slower for us than was true of the larger customers, which I had more color for you. But I don’t think I’ve a lot.

Got it. And then, just on the kind of, directionally some more National Account deceleration. I couldn’t help but notice in the press release as well some comments around monitoring investment. How much of that is directed to National Accounts or Onsite programs versus the general concept of investment or cost containment. Just trying to think about if there's a trend to be had here on National Accounts as some of those dollars get caught.

Well, our intention is to continue to invest in those things that allow us to gain market share. We believe that we continue to gain market share in the marketplace that are pretty good clip. And that’s ultimately the goal. The -- whatever happens in the market -- it happens in the market. But what we can control is how we -- how much we gain market share. And so our intension is with Onsites, we have all the staff on sites and we’re going to continue to add personal to be able to deliver that model to the customers that are entrusting more of their supply chain with us. With vending we’re going to continue to invest in what we need to pursue that 23,000 to 25,000 unit gold this year. So there was nothing in there that was intended to convey that we were going to be tighter on gross drivers, because we’re not. We need to invest in those to continue to gain market share. It's really resources outside of the growth drivers where we have to look at it, and we have to say, where can we save ourselves to some expense. And headcount was one thing that we talked about that. And again, I think I emphasized there that we’re going to continue to staff the Onsite. That’s not where we are going to be going after the headcount, but there's other areas whether it would be the hubs, whether it would be the branches, whether it would be the Winona headquarters, etcetera. There is when growth slows there's an opportunity to slow the rate of headcount in the areas like that. And those are types of things we need to look at, but when we talk about monitoring, investment monitoring spending, that really is more of a message outside of the growth drivers provided we're doing the right things on the growth drivers, by the way. If we find that we're doing something we need to in a growth level, we will address that as well. We are not looking to spend where we don’t have to anywhere. But this is the real scrutiny has to occur outside of the growth drivers because we are not -- our goal is to gain market share and the growth drivers are key to that.

Got it. And I guess just a corollary to that inventory and that’s coming in the release. Yes, I would imagine that given some of the advance purchases last year, they weren't much, but there were some and the cutting of purchases this year. Should we expect something to show up in terms of the rebate structure looking like a little bit more of a headwind than you would have contemplated before?

Well, the -- with regards to the inventory, I think we are sort of past that sort of accelerated purchase that we made in Q4. I think between Q4 and Q1 that kind of adjusted itself out. I think more meaningful for the inventory as you go into the second half of this year is our purchasing teams, our supply chain teams they really reduce their spend. Starting in Q3, Q4 last year through Q2 of this year and fairly meaningfully so because we have enough products in the hub today for the level demand that we're currently seeing and that allows us to be a little bit more cautious with that spend. And so we have seen a reduction in spend, particularly of imported products currently versus where we were three quarters ago, two quarters ago. And I think that will begin to flow through in lower inventory as we go through the third quarter and fourth quarter. Now interestingly rebates are actually a heavier component on domestic spend and they are in the imported spend. And so I would necessarily assume that a reduction in import is you’re going to have a terribly dyer impact on the rebate piece. The rebate is going to be more affected by the domestic spend and right now we’ve really gone after that imported spend as much than anything else. Makes sense.

Okay, got it. Yes. Appreciate the color. Thanks.

Thank you. The next question is coming from the line of Adam Uhlman with Cleveland Research. Please proceed with your questions.

Hi. Good morning.

Hey, Adam.

Hey, Dan, you made an interest comment a little bit ago that the company has moved more suppliers out of China than the broader economy. I kind of missed what exactly you were getting at there. Could you just share with us in more detail kind of the actions that the company has taken on moving activity out of China? And then maybe to share with us today where do we stand and in terms of your total purchases that are coming out of that country.

Yes, I prefer not to get into specifics from a standpoint of percentages, just from the standpoint. And I’d honestly want to share that information publicly, and that’s for competitive reasons, quite frankly. But we always have multiple sources of supply for product. In the case of fasteners and non-fasteners they include a variety of suppliers and sometimes that can include a variety of countries, but the universe of countries is not that large, but the university supplier is quite large. And you do that because our covenant with our customers will have product available for them when they needed. And the other reason to have it is you -- the one challenging thing from the standpoint of how many you have and how fast you can move it, it's not only due, it have tail, confidence in your supply, you need to have conference and your quality of supply. Because at the end of the day we're selling a product that hold stuff together or is used by people. Half of our revenue is either a fastener or a safety item. And so you have a important quality consideration in all the products, but especially in those. And -- but if you look at the statistics and the statistics are out there for me to look at. The mono product that has been resourced. As far as what’s coming through and as measured by U.S customs. The percentage that’s been resourced is actually fairly small. And a lot of it is, there's sophisticated supply chains out there that are difficult to change that has been set up not in the last five years, but in the last 25 years. In the case of us, where we head a cost ability early on. The other challenging thing is we might have the resource to supply, they might be 20% more expensive, in different places. You don’t move the 5%. The 5% stuff you move, if you can, and you try to get ahead of everybody else, we what to do the same thing when there is tariffs at 10%. But the 12% you might not or you might, depending on what you think is going to happen next. And so we moved on some of that fairly aggressively last -- late last fall. And so we moved a chunk of our product out of China. Most of that, that we moved went to other Asian countries, Taiwan primarily and so there's inflation introduced because of that because you’re probably buying it for more, but you’re paying less or equal to the tariff. And it's really because of the supply chain relationship we have for our customer. But percentage wise, we’ve moved more than what the U.S economy has looking at import data.

Okay, got you. And then a clarification. You had mentioned that the incentive comp was reduced a lot, and I’m just wondering if that came through the P&L in the second quarter or if that’s the third quarter event and if it was material for the quarter? Thanks.

It would have come through on the second quarter. It's a piece of the equation, because if you think about what’s going on with labor expense, there's two dynamics there. I mean, one is the sheer headcount -- or three dynamics. One is the sheer headcount growth. The other is there's inflation, particularly in the part-time areas, but there's inflation in general, in payrolls across the U.S economy because we have very low unemployment. And so those two dynamics are adding or pushing it up this actually pulled it down a little bit, yes.

Okay. Thanks.

Thank you. At this time, there are no additional questions. Would you like to make some closing comments, Mr. Florness?

Just want to thank everybody for the time this morning and hope you found this call and our disclosures useful and understanding what’s happening in our business selling into industrial in North America and the rest of planet. Thank you.

Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.