Good morning and welcome to Fastenal 2023 Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. At this time, I would now like to hand the call over to Taylor Ranta of Fastenal Company. Thank you. You may begin.

Welcome to the Fastenal Company 2023 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 1 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 the proprietary Fastenal presentation and is being recorded by Fastenal. No recording, reproduction, transmission or distribution of today's call is permitted without Fastenal 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, 2023 at midnight Central Time. As a reminder, today's conference call will include statements regarding the company's future plans and prospects. These statements are based on our current expectations and we undertake no duty to update them. It is important to note that the company's actual results may differ materially from those anticipated. Factors that could cause actual results to differ from anticipated results are contained in the company's latest earnings release and periodic filings with the Securities and Exchange Commission and we encourage you to review those factors carefully. I would now like to turn the call over to Mr. Dan Florness.

Good morning, everybody and thank you for our second quarter earnings call. Before I start on Fastenal matters, I'd like to share a message. When I joined Fastenal back in 1996, one of the things that was unique in my joining is that I stepped into the role of Chief Financial Officer, Bob Kierlin offered me the opportunity. And so, I joined in an unconventional way in that I didn't start in a branch or in a distribution center and work my way up through the organization. And sometimes when you join an organization that promotes from within, you're not sure -- kind of reception you'll get when you join. One of the first people I met was Colleen Quad [ph], it was Bob Kierlin sister. She had retired in a retirement. She worked for Fastenal a few years in sales support. One of the nicest ladies I ever met and we lost Colleen [ph] earlier this year. And to her children and grandchildren, you have my condolences and as well as to Bob on the loss of your sister. What a wonderful lady and we were all blessed to know her. We started back in 67. So our 5 founders aren't in their 20s anymore. And Van McConnon -- Henry McConnon [ph], he goes by Van, he was our first employee. In fact, I think that's how he earned his stake in Fastenal, did well with that stake and I'm proud of them. He lost his wife Wilma earlier in the year and the same message. Van was -- could not have been more of a welcoming person to me when I joined the organization and here is my condolences in the loss of his wife to spring. With that, I'll move on onto the Fastenal quarter. Second quarter '23 is a challenging quarter. Last fall, when we -- or last December, when we had our leadership meetings and our planning discussions for 2023, the ISM had weakened. We knew that 2023 was going to have some slugging aspects to it. We warned -- we cautioned our team. Second quarter and third quarter will be tough quarters to get through and prepare yourself, prepare your teams from the standpoint that we're going to have to manage our expenses really well. We'll have to keep all of our heads skewed on the right way because there's been -- it's been an interesting number of years between tariffs and COVID and congested supply chains and inflation and all this stuff, there's noise, noise, noise. We're going to experience something we have experienced for a number of years and that's a slowing economy and prepare for what that means and get the muscle memory back. But it was a challenging quarter. Our earnings came in at $0.52, rising about 4.5%. Softer manufacturing activity led our data sales growth to decelerate. We grew 5.9% in the second quarter. We did not leverage. That's an important element of our business. Our sales grew 5.9% but as we're cycling through some mix changes and Holden, touch on a little more detail. Our gross profit dollars grew about 3.6% and our operating expenses grew 4.1% and I'm not real good with math but I know that's not a good combination if you want to leverage your earnings. And one of the elements is, we didn't anticipate it softening quite as much as it did and that 4.1% needed to be a little bit lower. We didn't adjust our variable costs quite quickly enough. As we've seen in prior time frames when the economy is weakening and it affects our ability to grow, the high amount of working capital on our balance sheet really can influence our ability to generate cash and given my old role as CFO, second quarter is a painful quarter for us typically because we have 2 tax payments. And when you're a profitable organization, you operate a lot of business in the United States, you pay a lot of good tax. And so second quarter hits us really hard. And normally, we -- for every dollar in earnings, we generate $0.60 to $0.70 in operating cash flow. I don't recall us ever having a second quarter where we generated more cash -- operating cash flow than earnings perhaps Holden will cite an example where we did. But -- and maybe it was 2009. But that's a strong cash flow as we've ever seen for this time of year. And it also -- and a chunk of it is from not just what's happening in the economy and the working capital needed to fund receivables and to fund inventory for growth. In the last several years as supply chains were really getting congested, the message that I made very clear to our supply chain folks and our teams, we have a covenant with our customer and that is worded supply chain partner, we will not let our customers down in their supply chain. If that means we need an extra 15 and extra 30, an extra 45 days of inventory, don't get ahead of yourself but we need to have inventory to support the business, period. And when the ports on the West Coast of North America were getting congested, the economy is turning back on, everything was getting congested, we beefed up our inventory. We started -- we were harvesting that. We were doing it in the first quarter. We're doing it this quarter. I think the team has done a wonderful job. It means we have capacity now to look at our balance sheet and say, where does it make sense to make strategic investments in inventory. I'm not saying there's stuff on the table right now but that discussion can be had, whereas a year ago and 2 years ago, we couldn't really even think about it because we were focusing all of our energy on something else. In the second quarter, we made some leadership changes. First off, Jeff Watts, who's led our international -- who joined Fastenal back in 1996, so he's been here for 27 years and started in our Canadian organization when we were -- when we had just a handful of locations in Ontario. He's led our international sales efforts since 2015 and he will oversee all of our sales efforts across the planet. And obviously, we know each other really well. The team in the U.S. -- international knows them really well because he's led that team for quite a few years. But the U.S. team is no stranger to a 27-year employees. So we know each other well but I believe we'll have greater coordination on our efforts. And Jeff has a very entrepreneurial approach to how he leads a business and I welcome him and look forward to the success he's going to see. Terry Owen, who's been in EVP Operations role, we formalized this role and that he's our Chief Operating Officer. And this bullet was added kind of late in the process. I found out yesterday as a team that I should mention this since we had announced it this quarter. And there's an error in our release. I thought I'd let you know and it's probably not material in the true aspects of life. But it is Terry has been here 28 years and I know he joined in June of 1999. And if I do the math, I think it's 24. So sorry, we didn't catch that error in our process. But in conclusion, cyclical factors aside, the last several years, we've taken a lot of steps to improve both our labor and our inventory productivity. And I believe this forms an excellent foundation for our ability to generate long-term share gains in the marketplace. Switching to the next page. Onsites, I'll state the obvious. 86 Onsite is a disappointing number. Our aspiration internally has been to drive that to 100 per quarter, 400 per year. That's been our stated aspect mentioned internally. Prior to COVID, we hit 362 and that was a ramp-up from 80 in 2015 to 176 to 270 to 336 to 362 per year. When COVID came along, it really impaired our ability to sign Onsites because the last thing you want when you're worried about people being around you is inviting a bunch of folks of Blueshirt to come in and operate inside your four walls. And so we saw that drop dramatically. We recovered to about -- we did 356 signings last year. We broke 102 out of four quarters. Perhaps some of the leadership changes we made in the last 60 days created some distraction, perhaps we're not as focused as we should be. But that number needs to be 400 a year or more. And right now, we've adjusted our number. We think we'll probably come in similar to last year, somewhere in the 350s. And with that said, the fact that our Onsites are up, we have 15% more Onsites than a year ago. That's a great number. We're just not building the pipeline the way we need to. FMI Technology, that's a different story. So, our goal in Onsite is 100 a quarter. Let's get there and then figure out how we take it to 110, 120 but let's get to 100 first. Same with FMI technology, it's not 100 a quarter, it's 100 a day. And I'm pleased to say in the fourth quarter -- excuse me, the second quarter, we did 106 per day. And that's market share gains. That's us going out and planting new flags in new locations to improve the supply chain for our customer, illuminate the supply chain for our customer and us being a great supply chain partner. That's a huge positive. I believe it tells me the marketplace is conceding the space to us. Maybe I'm wrong on that but I believe it is because we are so far out ahead of the marketplace. Year-to-date, I told the Board yesterday we're with the 106 this quarter -- we had our Board meeting yesterday, with 106 this quarter, we're at 100 year-to-date. I misspoke, we're actually at 99, but I'm really pleased with what the group is doing there. And the 39.8% of our sales went through our FMI platform in the second quarter. News flash, it was 40% in June. So we hit the number -- we hit 40%. Now we need to get to 45% and 50% but continue to see really nice progress there. E-commerce continues to grow handsomely for us and grew about 45% in the quarter. For us, this has been a different journey than other things because a lot of e-commerce is unplanned spend. If you think about our FMI Technology, that's all about planned spend. That's stuff you're using daily, weekly, every month in your business and it makes sense to stage it accordingly. E-commerce, a lot of that is stuff that you're hopping on to order. So it's unplanned. Historically, not a strong suit for us. And I'm pleased to say it's growing to be a bigger piece of our business. It's, as I mentioned, 45%. The EDI portion of it is up 37% and that's typically larger customers. The web portion of it can be large or small and that's up almost 70%. And to give you a magnitude of how that's changed and again, we're not great at this piece of the business, but we can be. But with that said, in 2015, when I stepped into this role, the web portion of it was less than 2% of sales and we were at $3.8 billion, $3.9 billion of the company back then. So about $75 million going through web sales back in 2015. In 2023, in the second quarter, it was 6.5% of sales. So right now, we're on a 12-month run rate of about $7.5 billion. So that's a business that's approaching $500 million and we're not that good at it, but we can be. And so it's 6.5x bigger than it was a handful of years ago. And obviously, it's been accelerated by the events of the last few years, COVID is a perfect example. What really accelerated as people do -- some people are working remotely. Some people are ordering a lot more stuff electronically. We're seeing that in our numbers and we're getting better at it every day. And when you push the FMI technology and the e-commerce together and you think about our digital footprint, that was 55.3% of sales in the second quarter of '23, was 47.9% a year ago. We thought we could get to 65% this year. We've tweaked it to 60%. I don't know if I completely agree with our language there about FASTStock conversions. I think it's really -- part of it is the case of we're doing more and more every day. But some of the activity, because a lot of the FASTStock, for example, is going into fastener installs. It's going into OEM production areas, it's going in the MRO production and we're doing more transactions every day. However, the transactions are a little bit smaller because industrial production is slowing down in our business. And so we might be doing more orders. There are just fewer of them. And I'll cite you a few statistics. In January of 2022, our FASTStock, we did 234,000 scans of orders through our tool which is 11,100 every day. So our employees are going out with an Android device and scanning 11,100 planograms every day and generating about a $250 order. Actually, it's closer to 260. And then in January of this year, that 11,100 had grown to 14,700 and between January and June, that 14,700 scans per day is now 16,300. That's a combination of market share gains and conversion of -- instead of going out with a yellow note pad, we're going out with an Android device in scanning bins. And so that's a huge win in our system from efficiency. It's a huge win from a standpoint of ability to take market share. But looking at the numbers, our average order size was $258 in calendar 2022. And in January, that number had dropped to $246. So it was down about 4.7%. And I think there's enough transactions going on there that, that's probably more a tone of the economy than anything else because when you're doing 300,000 a month, it's not a mixed thing. Between January and June, the $246 order dropped about $222, so it's down $24 which is 9.6%. That's primarily activity that's declining in the industrial marketplace. And there might be an element between January and June of a little bit of deflation because there's some fasteners in there, but it's mostly about activity. Just thought I'd share those start to get in the weeds. And I will share one last thing before I turn it over to Holden. And that is, again, this FASTStock tool, this Android device that we have out there. In October of -- excuse me, in the summer and fall of 2019, we did a beta version out in the Southern California of that device and work through some bugs, work through some bugs and started rolling it out to regions late in the year with a planned 2-year rollout. COVID-hit and we accelerated that rollout and we rolled it out across the company by June of 2020. So, we rolled -- we had a 2-year rollout in 6 months. And today, that's about 12% of our revenue. The -- in October of this year, we plan to roll out what we call our order pad which will be on the same device. It will be an internal-facing device and use it in beta for -- in the October time frame. If all goes well, our goal would be to roll it out in Q4. And essentially, it's a tool for our personnel when they're out visiting a customer, not only can I take a recurring order, I could easily take a customer asking for something or I can do a search on it and I can respond to the customer right in front of them. That's a capability we've never had and we plan to have -- we expect to have that by the end of this year for 2024. A second piece, that's an internal facing app. We've also developed an external-facing app called FASTScan, it's with beta customers right now. Our goal is in August to have that out in the Apple store and the Google Play for customers. If they choose to download that and that would be a bin stock app for customers. It's primarily smaller customers or customers that might be a few hours from a facility in Montana or in Western Canada, where they can do some bin stock scans themselves, transmit the orders so when we visit, we aren't surprised by a stock out and it makes for a better supply chain for that customer base. That will be, again, coming out in August. And depending on what we -- the success we find with our order pad, our goal would be next summer to roll that out in the customer-facing app as well. Again, we're not great at the web portion of our business. It's a $0.5 billion business within Fastenal now but we can be and we're building tools to do that because we think that's a better reaction to some of the buying habits that's going on in the marketplace. With that, I'll turn it over to Holden.

Great. Thanks, Dan. One loose thread there perhaps to pull a little bit. Last time we had cash conversion of this level. It was actually in the second quarter of 2020. For those who don't remember the second quarter of 2020, there was an event occurring at the time that we now know as the pandemic. But I really think it reinforces the point. It took a once-a-century event to create a second quarter that despite several tax payments, produced cash conversion in that 100% range. And the fact that our teams are able to do that in a quarter where thankfully, there has not been anything remotely looking like a pandemic. Again, I think really gets to the success of the teams in managing kind of the post-pandemic environment. So yes but it does take a condition of that sort. Jumping into the details on Slide 5 of the deck. Daily sales increased 5.9% in the second quarter of 2023. Since March, we have seen overall business activity moderate which culminated in June daily sales growth of up 4.7%. The most meaningful change in trend has occurred in our manufacturing customer. This segment grew 10.4% in the period despite sustained sub-50 PMIs and flat to negative industrial production. This reflects the impact of our investment in Onsite and greater sales focus on key account plan spend which tends to be significant within manufacturing. Even so, we did experience weaker sequential in May and June that represents a macro-driven change from the long string of strong sequentials that we had from 2021 to February of this year. As it relates to pricing, they contributed 190 to 220 basis points to growth in the period, declining approximately 470 basis points from the second quarter of 2022 and approximately 100 basis points from the first quarter of 2023. This trend is not a surprise and will likely continue in the second half of 2023. Other factors cited in recent quarters, specifically weakness among some large retailer customers, lack of growth in our rest of world geography and contraction in our construction end market remain factors in the current quarter but the dynamics around these areas were largely unchanged from prior periods. While we continue to pursue key account plan spend in construction, this market has historically had a disproportionate amount of smaller transactional spend where we are currently putting less emphasis. We believe this shift contributes to manufacturing outgrowth, better labor leverage and better asset efficiency. We have experienced manufacturing-driven weak sequentials in 3 of the last 4 months. Regional leadership continues to characterize customer sentiment as cautious with greater scrutiny over operating and capital spending and some mention of slower or deferred orders. As usual, we have limited forward visibility but most indicators seem to be pointing to the immediate outlook remaining soft. Now to Slide 6. Operating margin in the second quarter of 2023 was 21%, down from 21.6% in the prior year. The incremental operating margin was 11%. Gross margin was 45.5%, down 100 basis points in the prior year. This decline is almost entirely due to product and customer mix as we experienced widening sales growth outperformance of non-fasteners over fasteners and of Onsite growth over non-Onsite growth. Freight was favorable gross margin, reflecting record freight revenues that allowed for good leverage of our captive fleet, reduced use of external freight providers, lower fuel expenses and reduced shipping costs. The benefits of freight were offset by higher organizational or GAAP expenses. Reductions of purchasing and shipping activities of imported products, stemming from a smoother and more predictable supply chain relative to the year ago period caused higher prior period cost to be relieved from the balance sheet to the P&L. The impact of price cost was immaterial to gross margin in the second quarter of 2023. On the operating expense side, we produced 40 basis points of leverage which was not sufficient to fully offset the decline in gross margin. This was due entirely to payroll expenses, of which we experienced 60 basis points of leverage which was related to lower incentive compensation of last year's record level. This was offset by modest deleveraging of both occupancy costs and other expenses. There were 3 distinct elements playing out in our operating margin in the second quarter of 2023. First, I alluded to the GAAP expenses. The GAAP expenses had the convergence of a difficult comparison, aggressive inventory reductions and shortening product order cycles. This alone is a 50 basis point negative impact and is unlikely to repeat by anywhere near the same magnitude in the second half of 2023. Second, certain expenses such as 16% growth in IT spending and 13% growth in cost for FMI devices represent planned and prudent investments in our business, the impact of which is magnified by the slower sales growth environment. Third, the Blue Team did not adjust spending quickly enough to the slower macro environment with the variable cost for meals, travel, supplies, all increasing double digits. Also, while lower incentive compensation produced leverage in the second quarter, we continue to have growth in headcount and part-time hours that exceeds sales growth. I would expect us to tighten this spending appreciably in the third quarter of 2023. Putting everything together, we reported second quarter 2023 EPS of $0.52, up 4.6% from $0.50 in the second quarter of 2022. Turning to Slide 7. We generated $302 million in operating cash in the second quarter of 2023 or approximately 101% of net income in the period. Traditionally, normal second quarters have a conversion rate in the 60% to 70% range. So this is a strong cash performance relating to a reduction in the use of cash for working capital versus the prior period. This allowed us to reduce debt with debt ending at 9.4% of total capital in the second quarter of 2023, down from 13.7% in the first quarter of 2022 and from 10.9% in the first quarter of 2023 -- I apologize, 13.7% in the second quarter of 2022. Year-over-year accounts receivable was up 6.1%, largely tracking sales growth with the impact of mix due to faster growth from larger customers which tend to have longer terms being offset by improved receivables quality. Inventories fell 6%. This is a function of normalized supply chains, allowing us to unwind inventory layers we had built up in late 2021 and early 2022 to manage that period's product bottlenecks. That process will likely continue, though likely to a lesser degree, throughout 2023. It is also notable that our days on hand fell to 138.5, a level not seen since 2002 which reflects improved velocity of inventory through our internal network, a reduction of retail stock in branches and improvements in stocking processes. We have significant strategic flexibility in inventory at this point. We have retained our range for net capital spending in 2023 of $210 million to $230 million, reflecting higher spending on hub investments, fleet equipment and IT equipment. At the same time, we have deferred certain projects related to slowing demand that suggest our capital spending will be at the low end of the range. The second quarter of 2023 was obviously challenging. We expect to have better cost comparisons and to more tightly control those costs that we can affect in the second half of 2023. Obviously, we have little control over end market demand. Whatever direction that takes over the next 6 months will influence our profitability. However, these shorter-term issues shouldn't cloud the structural improvements to our business. The second quarter saw record labor productivity they create some significant strategic flexibility in our inventory and further improvement in our return on capital, as reflected on Page 9 of the investor presentation. We believe we are positioned to strongly outgrow the market, particularly as the industrial cycle stabilizes and improves. With that, operator, we'll turn it over to begin the Q&A.

[Operator Instructions] Our first questions come from the line of David Manthey with Baird.

Dan, Holden, I hope you guys are having a great summer. So I have a clarification and then one question. Clarification, Holden, when you're on Slide 5 and you're talking about price contribution, you said this will continue in the second half of '23. And I'm wondering what you're referring to there, first. And then second, the question, I'm hoping you can update us on KPIs relative to your CFCs [ph] and the Focus 5 initiatives.

Sure. The clarification is we continue to expect moderation in the overall contribution from price in the back half, really just a continuation of what we've been seeing over the past few quarters. Does that help?

Yes.

Okay. Then -- yes, if you -- the CFC continues to experience very strong growth. I believe in the second quarter, if you think about the books of business that our CFC or hunter program has, the growth in those books in the current quarter relative to what those books did the prior year, it's actually up north of 50%. So, we continue to see good success in particular with the CFC program. And I don't have specific numbers on the target 5 for you, Dave. CFCs to some extent, have their own target. So I think you can get a sense of how that growth is occurring. But the -- yes. I don't have specific on target 5. The CFCs continue to grow well in excess of our business. And I think the CFCs are a manifestation of the same key account approach that the target 5s are feed into as well.

Our next questions come from the line of Michael Hoffman with Stifel.

Dan and Holden, the trend data that you share so generously, can you -- again, I get that you have limited forward visibility but do you think you're hitting bottom?

I guess I'll just reinforce, we have very little visibility to what the market is going to hold. Here's what I'll say. I've always respected the PMI as an indicator of future activity levels. I tend to think it has a forward look of 3 to 5 months. I think we all know that the PMI in June hit 46 which is not a meaningful new low but a new low nonetheless. And I think the message that we gave to our people internally was that, that would seem to suggest that the back half of this year is going to remain soft. So I don't have an indicator internally that would give you any real insight into what's going to happen in August, September, October. But the PMI has always been a good indicator and the PMI remains relatively low and suggesting the back half is going to be weak and that's what we sort of take our cues off of.

Okay. And then on the digital transformation, one of the things that I think I understand correctly, as you tend to gain a greater percentage of wallet of the individual customer over the life cycle of that penetration, how do you -- how would you characterize where you are in that journey and how that's influencing some of the share gain.

I think -- so if you think about it at the digital foot -- well, I'll talk about the FMI component of the digital footprint. It's about 40% of our business. And internally, the number we've always talked about is we think we can get that to about 65%. A good chunk of that is converting existing customers to the new platforms and it allows us to share insights with our customers in ways that historically you couldn't. It brings efficiency to the business. And the efficiency isn't just for efficiency's sake which is nice. It's the free up time to engage in the marketplace. And so ultimately, we see that time freed up as a means to grow the business faster because you can engage more. The other piece is, it's a separator in the marketplace. There is -- we have a customer event each spring where we bring in thousands of customers and meet -- they meet with suppliers, engage with different tools of the business. And the -- we are winning business because of the capabilities. When I said in a customer discussion last summer and our national account person was speaking to the purchasing team from a bunch of locations within a conglomerate and they were explaining how the -- how our RFID program worked. And that's essentially a compound system with an embedded RFID chip. So in that bin is empty, instead of somebody having to walk around and check things and find stuff and see what needs to be replenished, that bin is placed on the top shelf. The top shelf has a simple RFID reader. It sees bin 14 is empty, oh, okay, I'm hungry, I need to be fed. And that's how replenishment works. And her response when she learned about it, she looked at a person across the room and said, "You remember the issue" and she talked about 4 different manufacturing plants where they struggled. She said, "This thing is ample [ph]", asked a few clarifying questions. And she look to the person said, this is unbelievable. This would solve all of our problems. And that's a light bulb that pops off a lot when people realize what this is. I was visiting an employee down in Illinois 2 weeks ago, employees celebrating 40 years, I drove down to spend the day with them and thank them for 40 years of service. And he said, "Hey, you want to go visit a customer with me" and I'm like "I'd love to". And he showed me something in his wallet, he pulled out a little as the size of a credit card and I said, "What's that?" and he said, "That's my RFID chip". And he said the customer you're going to, I'm going to show you how we're using it in ways above and beyond just the konbond [ph] system. They're using it for pallet replenishment. So they have a little envelope on the pallet rack and they have little card in there. And it's a little plastic card with RFID chip, they grab that and they throw it in the top bin on the konbond [ph] system and it tells our branch, we need another pallet of this product. Not only is that incredibly efficient for us. The customer loves it. The customer showed it to me. He says, our folks love this because they don't need to write stuff down and then call up Fastenal to bring another one over or wait for you guys when you come more tomorrow to check it and realize you need to bring another one over. We just tell you but it's done in a matter of seconds. That's something a supply chain partner does and we're great at plan spend. And that is winning us business because when other customers come and tour that facility when they're in the RFQ process, they see stuff like that and that's a separator, just like vending is a separator. Sorry, I went a little long there but I think it's helpful to use some examples.

And I might add as well that I think that those 2 actually interconnect in the sense that to the extent that it helps to reduce our overall cost of operations than it does, that actually allows us more flexibility in bidding processes and I think makes us more competitive in the marketplace and contributes to our ability to win and gain market share as well. So it really plays -- it plays really strongly in both our ability to leverage as well as our ability to grow.

In February, I think it was February, I was down in Indiana visiting, speaking to a group of branch managers and visiting with Randy Miller, our most senior Regional Vice President. And they asked me if I want to go up and visit a customer and the customer that took me to was a large Onsite. They've contacted us in the fall of, I believe, it was 2020. I might be wrong on the year but I believe it was 2020. And they need some help and we set up an Onsite in there. And the incumbent had been staffing the Onsite 24 hours a day. And our folks really studied the activity and said, if we put out a handful of -- if we put our product in a handful of lockers in a way that we wouldn't typically do it, we could give you better service and staff 10 hours a day instead of 24 and you'd get better service than you were getting before. And we'd have a better -- it would be easier for us to recruit and we could ramp up faster the business because finding folks to work 24 hours a day is sometimes challenging. Finding folks to work 10 hours a day or a 10-hour window, especially when it's during daylight is less challenging. And again, it was a case of -- that separated us in that instance. And I visited that customer, I had a great visit with them. And they were showing me some of the stuff that we were doing that they just loved about our model.

Our next questions come from the line of Chris Dankert with Loop Capital Markets.

Holden, you had a kind of mid-teens growth in IT spend and an FMI investment. As we're thinking about kind of SG&A spending and investment going forward, can you kind of give us a sense for how you would trend in the back half of the year as you kind of keep investing for growth here?

Yes. Well, I mentioned the IT and the FMI spend because those are investments in our business that we're making that are wise investments to make. And I don't necessarily anticipate where we're making investments in those areas that we're going to pull meaningfully back in those areas. The areas we were talking about more had to do with expenses that we had for travel, both sales and non-sales and related type expenses. When we think about how we're using our part timers and the fact that hours among our part timers are up, 12% in June in a marketplace where revenues are up less than 5%, there's just a number of things that we talked about that are variable that we weren't really treating those expense lines as though we're in an environment that's growing at 5%. And the message is we need to get there. Now what was the impact of that? If I think about the -- if I think about the travel, meals, supplies, et cetera, that's about a 10 basis point impact on our business in terms of overall profit impact. If I think about the increase in base pay that comes from higher absolute headcount that comes from higher part-time hours, those sorts of things. That would have been about a 450 basis point impact to margin. Now that was offset by the fact that incentive compensation was down because last year was such a strong year relative to this year. But those are areas that as an organization, we need to tighten up a lot of our behavior and patterns to reflect more of the environment that we're in. And again, I expect that we'll make progress on that in the third quarter.

Let me add on and I'll put on to that as it relates to IT is when I stepped into this role, back in 2015, one of the first things that I said to the Board and I said to our team is, everybody is going to get lower pay next 12 months because we're going to -- because we're paid off of earnings growth. If you read our proxy, you'll see how our compensation programs work. We're all going to take a pay cut because we are going to increase the investment in IT and I tapped the senior leader who had grown up through our branch network, was a district manager, who was a regional vice president, has led our government sales, our vending business and his name is [indiscernible]. I tapped him and I said, John, I know you know nothing about IT other than you show me apps you download on your Android device. But you're a great leader of people. We have great folks in our IT group. I don't think they're connected well enough to the business and I think we're underinvesting and we increased our spend on IT by 50 basis points in 2016 and we've held that number in there ever since. And I told them we will not sacrifice our investments in the short term. If it's longer term, we have to be pragmatic. But last year, we added 50 people into our Bangalore tech center. In January, we added another 100 people. We're not there yet but I suspect at some point in time, we'll have more people in our India technology group than we do in our 4 U.S. -- 3 U.S. technology groups and that's partly about availability of recruiting because we have great folks here. We can't add them fast enough. But we will continue to make those investments. And because we made those investments today, we have a digital footprint. This 55.3% of sales and the productivity gains over the last 3 years would not have happened without it. I think it's a wise investment and we'll continue that.

Our next questions come from the line of Ryan Merkel with William Blair.

I had a couple of questions on margins. So first off, on gross margin. How should we think about the rest of the year. Is normal seasonality, the right framework for 3Q and 4Q?

I think in the first quarter, we sort of talked about normal seasonality would apply but at a bit more of a muted rate and I think that's still appropriate. I mean, second quarter was down about 20 basis points from first quarter. I typically think of it being down 30. 3Q is fairly typically flat with 2Q and I think that's a reasonable ballpark. And 4Q is usually down about 30 basis points from 3Q. And again, maybe to be a little bit more modest than that. I mean I think about the mix question is still an open one, right? Because the reality is, in a weak cycle, your fasteners weaken more and that winds up sort of having a bigger impact on gross margin and mix than you would normally expect. And you saw that this quarter just as you've seen in the past. And so to some extent, Ryan, part of the question is, well, what's going to continue to happen with the cycle and the gap between fasteners, non-fasteners? And such a cyclical question, I can't answer. But if I think about the transportation piece of it. I think that's going to continue to have a sustained beneficial impact for a number of quarters. If I think about sort of the timing elements that the gap stuff that I talked about, I don't think that that impact is as great in Q3 and Q4 is what we saw in Q2. I think we'll still be price mix neutral just as we were this quarter, right? So when I put all that in together, I think the seasonality is reasonable but I would mute it against history for the next couple of quarters. That's my expectation. And like I said, the wildcard really in my mind is what happens in the cyclical element of seasonality related to fasteners.

Yes, makes sense. Super helpful. And then on OpEx, Holden, you mentioned you're going to tighten that up a bit and then you're also going to invest in IT for the long term which I agree with. I guess is there any metrics you can provide? Is there a goal for FTE growth in the second half? And I guess, ultimately, what I'm getting at is, can you adjust SG&A fast enough where you can hold operating margins flat year-over-year in the second half? Or is that maybe optimistic?

It will depend how aggressive we are. The part of the operating margin is going to be a reflection of the gross margin. So again, I will perhaps comp out a little bit in your question about SG&A and a part of the answer to your question is going to rest in what happens to the cyclical element of mix, right? Step that aside and just focus on the SG&A, I think that the -- we need to reduce the cost in our SG&A relative to Q2 by $2 million, $3 million. And we need to do that through tighter control of headcount, through tighter control of those expenses. And I feel comfortable that we'll be able to do that. I think the organization is already sort of responding to the messages and responding to the natural signal of their growth slowing down. So I do believe that we will have better leverage opportunities in the back half. Again, with the wildcard being what happens to the underlying demand environment and what impact does that have on fastener-related mix?

Our next question is coming from the line of Josh Pokrzywinski with Morgan Stanley.

Also, kudos to the operator for nailing the authentic pronunciation there. We don't get [indiscernible].

I was going to ask. That was pretty close.

Yes, that was old country right there. I like that. The -- just maybe a higher level question for both of you. Obviously, we've seen a huge wave of inflation supply chain tightness. Now going back the other direction at least with this inflation, I guess what would you identify Dan, as the biggest change you saw as a function of that? And the biggest things that are changing now as those reverse. Could be customer-facing, could be kind of margin profiles with the business, deliberately a broad question but just thinking of how [it is going to be priced]?

Well, I mean the biggest change that we saw directly in our business from supply chain element was the fact that we had to add a heck of a lot of inventory in those expensive inventory in 2021 and 2022; container costs were sky high. We were doing a lot of things; we were not going to let people down. And fortunately, we have the balance sheet to do that. And we have a shareholder base that appreciates, we're judicious with their capital but they were supportive of the move. And they were confident that when the need for that extra layer of inventory subsided, we figure out a way to harvested out the balance sheet and move forward. That's probably the biggest thing to how it manifests itself, obviously, on our balance sheet and in our cash flow statement. We talked about that earlier. If I think about more broadly, we are seeing changes. And it's one of the reasons I touched on a bit the 2 elements of our business, the plan spend which I believe we've created over time an incredible ability to serve that market. And the unplanned where we're good at it. We're not great at it. And partly because we haven't built the system to support it whether it's technology or supply chain. And we've been busy building that the last several years and I talked about some of those pieces. And we've seen success on what we've built but it's still a relatively small piece of business but we are seeing that trend. If a buyer is working remote 2 or 3 days a week, or covering a bunch of locations, because with technology, you can do a lot of things you couldn't do in the past and you can do it easily. They're buying in a different way. And we need to make sure our systems work for that different way. I hope that's helpful.

And specific on pricing, if you recall during the period of tariffs, we didn't do a great job sort of offsetting all the tariffs and inflation that occurred during that period of time. And the organization kind of buckled down and developed since then, what we call the pricing review tool, PRT and I think what you've seen over the last few years in a period first of fairly significant inflation and now a period of perhaps modest deflation is I think you've seen that tool and our organization's ability to utilize it, result in a much better outcome. We -- there's the occasional blitz here and there. We didn't quite get all the inflation on fasteners. So that's come back. In fourth quarter, I think we got a little bit behind on a certain area. But for the most part, we've been able to be price cost neutral for the entirety of this period of inflation and deflation. And I think it really is reflective of the organization's ability to deploy technology solutions to problems that we run into every day. The other thing that I would say is, from an inventory standpoint, we talked about how inventories dropped a lot because of the -- we're unwinding or sort of harvesting some of the investments. But we peaked from a days on hand standpoint between 185 and 190 days. We're currently sitting between 135 and 140. That's not just because of buying inventory and then harvesting it related to pandemic. That relates to a lot of things the organization did in terms of how it views branch inventory strategically in terms of what's in our hub versus where should inventory be, improving the velocity. And I think the fact that we're able to improve the overall performance of our assets, even in an environment where we're getting a tremendous amount of pressure because of the needs of the pandemic when it started and as it was fading really reflects the organization's ability to do more than one thing at once. And I think the organization can be proud of itself how it's managed a lot of the things that have come up over the course of the past 4 or 5 years.

Got it. I appreciate it. That's comprehensive. Maybe just a quick follow-up. As you've seen things decelerate and maybe disinflate a little bit, is the competitive landscape change? I know you guys don't really see it maybe some of the way other folks do in the space given your business model but anything you'd comment on competition?

Yes, I don't think the competitive landscape has changed, if you look at it from a product perspective. And I think one element that's there, too, is while the -- there's more than one element of inflation and there's more than one aspect of cost. There's inflation that we saw in product costs. There's inflation that we saw in transportation, container costs, things like that. Product cost dynamics are different than the container and transportation element. The third element which is really relevant for our customers and for their supply chain is the cost of labor. There is no deflation in labor. I'll guarantee you that. There continues to be inflation in labor. We do have more success in recruiting. We -- but we are not unique. All businesses are seeing inflation in that arena until this day. And part of -- the nice thing about the total cost of ownership approach we take with our customer is we're really able to understand all those cost components and have intelligent conversations with the customers that they're not a motion conversation, the fact and tactic conversations which allows both us and our customers together to make better choices on puts and takes. But there are inflation elements still in the business. There are some deflation elements in the business. Container is coming across the ocean is cheaper today than it was 1.5 years ago or a year ago.

And I would say there's also availability elements in the marketplace as well. During 2020, 2021, there weren't a lot of distributors that had availability of product and we benefited from that. As the supply chain is normalized, the marketplace sort of normalize as well. And I think what you see is it's a little bit more competitive in terms of customers being willing to say, "Yes, we're going to test the market a little bit". Again, I don't think that's unique to us. I think it's fairly typical in the market. And I think it's reflective of the degree to which things have frankly normalized at this stage of the game. And it allows us to really talk a lot about exactly what Dan said which is the supply chain solutions and how that differentiates us in the marketplace.

And Josh, in the interest of full disclosure, I probably would have gotten your last name incorrect.

Our next questions come from the line of Tommy Moll with Stephens.

Can you give us an update on fastener product margins? And I know that associated with those, there's potential for some renegotiation just on pricing that has given some of the volatility around steel and shipping. Any update you could give there would be helpful as well.

Yes. I mean product margins, when you break fasteners into OEM versus MRO fasteners, product margins are fairly stable. When I think about price cost in the fastener arena, it's fairly neutral at this point, right? So I mean from a costing and margin standpoint, I think things are fairly as expected. Now I will say, I do believe that we have had circumstances where again, there's contracts that require some adjustment based on end markets where I do believe that we've begun that process. But that is in -- that is really aligned with what we've talked about before as we see our costing improve and we have on imported product that we have certain agreements with certain very large customers that we'll adhere to and I think that you're seeing that happen. So it's largely, I think, as we expected. I don't think they were having any adverse impact on our overall profitability level. And that's probably how I'd characterize it. Does that help?

Indeed. I also wanted to talk about supply chain and in the prepared materials this morning, you talked to the reduced inventory is aided by a shorter product ordering cycle for Fastenal. I'm curious, though, with the better supply chain, do you see some of the same for customers? And is there any impact on your daily sales trends from that?

If you think about what we do for our customer, we're the buffer. If we're supplying product to them. And again, I'm really talking about both sides of our business, whether it be plan spend or unplanned spend. If supply chains are taken 30 days longer, we build that inventory so we get it to them when they need it. So I don't know that there would be a destocking element downstream from us. I'm sure there's examples of it. If there is a destocking element, it's because a customer had built up finished goods because they had a strong backlog. And that backlog has been worked down, their finished goods has been worked on. And as they're in that process, that impacts us because they lower their production. And so it isn't so much because the supply chain change is because downstream, their needs finished goods changed. Where we typically see a supply chain impact the most is when we take on a new customer relationship. It's not uncommon for us stepping into the new customer relationship will though have elements of inventory that we're going to be managing now for them where they have a 6-month, 12-month, 15-month supply, 4-month supply. The extreme examples are usually niche [ph]. But they -- as we illuminate what they have in their inventory and/or how their predecessor supply chain partner was supplying and I'm not throwing in a predecessor under the bus because it could have been there's a bunch of different suppliers supplying this in and there's not a coordinated effort. And so you have months of inventory on something that is ridiculous to have months of a customer a few years ago. First off, it was a part that I thought was fairly unique. I discovered that we had a regular supplier for it. But it was an item where the customer discovered, they had 14 months of inventory and they had no idea. They were appreciative of it and we worked out an arrangement with them to manage it down and they paid us something for helping manage it down but we didn't have product sales for a period of time but we had a lot of other sales. It was an Onsite doing 130,000 a month, it just wasn't doing 160. But then when we burn through it. And that's what a supply chain partner does. But that's not about supply chain time. That's about just an inefficient supply chain. I apologize to whoever was in queue. Holden be available for calls, you want to give him a direct call. I'm going to run to a meeting in a few minutes but we hold these calls to 1 hour and we are at 10:00 central time. Once again, thank you, everybody, for attending our earnings call today. And best of luck in July and the balance of the year. Have a good day, everybody.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.