Fastenal Company

Good day, ladies and gentlemen, and welcome to the Fast and All Company First Quarter 2019 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press start and then zero on your touchtone telephone. And as a reminder, this conference is being recorded. I would now like to hand the call over to Ms. Ellen Stoltz. You may begin.

Welcome to the Fast and All Company 2019 First Quarter Earnings Conference Call. This call will be hosted by Dan Florinus, our President and Chief Executive Officer, and Holden Lewis, our Chief Financial Officer. The call will last for up to one hour, and we'll start with general overview of our quarterly results and operations, with the remainder of the time being open for questions and answers. Today's conference call is a proprietary Fast and All presentation and is being recorded by Fast and All. No recording, reproduction, transmission, or distribution of today's call is permitted without Fast and All's consent. This call is being audio simulcast on the Internet via the Fast and All Investor Relations home page, .fastandall.com. A replay of the webcast will be available on the Web site until June 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 Flornes.

Thank you, Ellen, and good morning, everybody, and thank you for joining us for our first quarter earnings call. I'm going to, before I step into Holand's flipbook, just going to touch on a few comments that I had with our leadership in our normal call at 7 o'clock this morning to talk about the quarter, to give them a little insight about some things we'll be focusing on in the call as well as just some -the-cuff comments I made to them. My first comment to them this morning was a sincere thank you for a job well done. I think it's a really nice start to the year and pleased with the performance we're seeing across our business units throughout the planet and a very positive start to the year. I also mentioned to them about the challenges that come when you get into the multi-year improvement in business. When I think back to stepping into this role back in late 2015, we've had a tough year, the economy and the economy, and we've had a tough year. We've not been our friend that year. And when you're exposed to the industrial marketplace and it flips on you, it can cause some pain in the short term. But we kept focusing on what we focused on. That's our customer. We kept focusing on things to make our business better, and we really started to transition to a much more focused approach on some of our growth drivers, particularly breathing some new life into vending and challenging ourselves to look at onsites as not a solution to the problem, but as a way to make sure that we're able to do that. And we're able to do that as a solution when there's not an alternative, but as a means to grow faster and a new growth driver within our business. Because it's a wonderful way to extend what is the traditional fast-norm relationship, but lower your cost structure at the same time. And I hope these numbers are all correct. I haven't proofed them through our screening process. This is just me jotting down some numbers. But what I shared with them was if I stack together multiple years, five of the last seven months, if I look at it taking three years added together, and again, I hope I calculated it correctly, I believe five of the last seven months we've been 30% plus when you look at the cumulative impact of the last three years. And November and January is the only two months that didn't break that 30, and they were at 29. So a good number. And I believe for the last 14 months, if you looked at it on a two-year basis and combined year one and year two growth, you're at a number that starts with a two, so north of 20%. But since August, I believe that number is north of 25. So not only do we have great local plans to engage with our customer and grower business, but we're able to stack that on top of some comps that are frankly challenging. So I'm really pleased with what the group is doing, and I'm really proud of the group and proud to be associated with them. I also shared with them one of the blessings and curses of the Internet age is it's easy for people to make comments. Sometimes you read through a newspaper and some of the comments you see, you're kind of like, boy, that person just seems angry about something. It's not this article, but they're just angry. Or you can tell that person's maybe political views is driving their commentary they're putting into an article. But at 10 o'clock last night, I was reading a comment that came in from a customer. And every comment that comes in to Fassinal, I'm on an email distribution list and I read through them. Sometimes I do it late at night before I go to bed. Sometimes I do it early in the morning. And I'm reading one last night. It was a fellow. He said, I'm an older gentleman. He said, I'm 61 years old. That pained me a little bit because I'm 55. And I hear somebody at 61 refer to themselves that old was a little troubling, but that's a different issue. But this individual was talking about where our branch, it was the San Antonio, Texas branch, but where our branch went above and beyond the call and really helped them solve a problem. And I floated out to our regional leadership last night and I said, you know what, folks, this is what we're about. We're about solving people's problems. Because in today's world, sometimes it's hard to find people to help you solve a problem. And it was fun one to share because sometimes you get in a few here and there that aren't as positive and you assess them to understand what we can do to be better. But now I'll flip to Holden's book here. We had 68 cents of earnings. Nice start, Dan. Almost 12% earnings per share growth. Bottom line is we grew our earnings faster than our sales. And that's not an easy act in a quarter where weather was very impactful. And with one less selling day, we were in the situation of with $20 million a day in revenue, there's a chunk of revenue, a chunk of gross profit dollars that aren't there. But the expenses typically are. So to pull off what we did when we're down a day is a pretty positive thing. Despite the challenging weather, our demand continued to be healthy. Our daily sales growth was 12.2 in the quarter. And I think Holden said it well, 2019 has started where 2018 left off. Operating margin expanded 20 basis points and our incremental margin was 21.7. As we've talked about in prior calls, our growth drivers are changing the mix of our business. If we're successful with it, it's going to pull gross margins down. If we're successful with it, we should be able to leverage our operating expenses and it should result in a great win for our customer, for our employee, for our supplier, and for you, our shareholders. And I think you saw that in the first quarter here. But sequentially, we did hold gross margin flat, which was really a sign of some of the price increases we put in late last year in the wake of tariffs and inflations. Allowed us to low breathing room in the short term. But Holden will touch on that a little bit more in his comments. We've talked about this in the past. Our business, as it continues to grow with larger customers and with international customers, sometimes we get caught in a situation where you have a customer that's doing some window dressing at the end of a year, end of a quarter. And they frankly stop paying with two, three, four weeks left in the quarter. And it makes for a challenging situation. Our solution here is to constantly be engaged in discussion with our customer about, you know, our value proposition to you is a better supply chain. We take inventory off your balance sheet. Don't do this to us at the end of the quarter, because what it ultimately does, it puts us in a position where we can't fund inventory. Because there's a tradeoff. If we know that we're going to have an extra $5 million receivable, we have to squeeze that somewhere else. And that doesn't serve our customer. And we need to be engaged in that dialogue and challenge. If you want to do window dressing, do it with somebody else's payable, not with ours. But we did produce a stronger cash flow in the quarter and allowed us to pay a higher dividend. And we reduced that a little bit. Onsites. You know, I remember years ago when we did CSP. And we really went through a change in our branch network. But at some point in time, we stopped talking about CSP because CSP became part of us. Now, we're going to keep talking about onsites from the standpoint, sharing with you our location count and our penetrations in the market and where we're finding success. But, you know, we're going to break a thousand onsites sometime here in the second quarter. I guess that's a forward-looking statement, but it's one I'm pretty safe in saying. But it's truly part of Fast and On now. We have onsites throughout our regions, throughout our districts. And so it's not something we're experimenting with or pushing people to change or even pushing customers to consider and change. We're doing all that, but we're doing that from a base of knowledge, similar to not too many years ago when we were talking to the industry about vending machines. But on onsites, our goals are pretty simple this year. Let's sign 375 to 400. You know, there's 52 weeks in the year. You've got to take out a couple of those weeks because it's the holidays and not a lot happens those weeks. But if we can do eight signings per week and do it 50 weeks of the year, that's 400. And so in the first quarter, we got off to a really nice start. We hit that number and we signed 105. So very pleased. Our sales growth, removing the transferred sales. So if I have an existing customer and we go onsite, we probably pull some revenue out of a branch and move it over there. But ignoring that, that business is growing north 20 percent. Really pleased with what the team's doing. On vending, our goal is to do 23 to 25,000. So there's 254 business days in the year. We need to sign roughly 100 every day to get it to high end of that number. If we sign 90 every day, we're at the low end of that number. We were just shy of 90 in the first quarter, but in the month of March we rounded up to 100. We were at 99.6 per day. So we're off to, I think, a nice start. And again, it's just part of our extension into our customers' facilities. Speaking of vending, I had a new experience yesterday. So one of the things that we've struggled with is we've had, I remember a few years ago, at Investor Day talked about the idea of having outdoor lockers or having lockers where we can do deliveries into. Frankly, we struggled to make the technology easy to use. And so we didn't get really much traction with it. And we have very few branches that have outdoor lockers. We have now built the interface between our point of sale system and our vending platform, which is a third party software. And yesterday morning I ordered something. We had turned on our Winona branch on Monday. So yesterday morning I ordered something. Immediately had a confirmation of that order. And a couple hours later I got an email, your order is ready to pick up. And I went over and I punched in my six digit code and I pulled an item out of the locker. It was a really easy and seamless transaction. Now that doesn't mean we're going to be getting into the retail business anytime soon. But if I think of our onsites, if I think of our customers that need something and they want to get in and out quickly, or they're coming in after hours, it provides a great extension of the hours of our day and our ability to serve our customers. And I'm really excited about what that means, but really also proud of our technology team for developing that. And it worked really easily. And I've gotten in the habit in recent months of buying a lot of stuff online. One of the companies I'm really impressed with, and I buy from them once a week to understand what they're changing, and I keep bringing comments to our folks as a result. I don't know if any of you have ever bought on Walmart online. They do a really nice job. Now again, we're not a retailer, but making it easy and making it efficient for your customer is an important part of the equation and we finally have that working. National accounts grew 17% in the first quarter. The team continues to do a great job of making promises to customers. And our branch and onsite network, along with everybody else that supports them, does a great job of honoring those promises. So good quarter. Outside the U.S., exchange rate is a full right now. International is about 14% of our revenue. We grew in the mid-teens. I believe the number was about 17%. And so continue to be really impressed with our teams there and our ability to extend the U.S. and Canadian relationships broadly around the planet. So excellent job to the team. With that, I'm going to turn it over to Holan, but before I do that, when I read through his notes, one thing jumped out at me, and that was the PMI at 55.4. And I almost, when I read stuff or even read his notes, it almost felt like that was kind of an E number. And I've been here for 23 years and I've never thought of 55.4 as an E number and I've seen that in some of the external reporting. So we're seeing a good tone in the marketplace. Holan's going to touch on some oil and gas concerns. And being a farm kid, I know the agricultural side has had some tough time in the last year with commodity prices, and I'm sure there'll be some weakness there. But we're pretty bullish on what we're seeing.

Great. Thank you very much. Good morning. So let's just jump on to slide five. Total sales, as Dan indicated, were up 10.4%. There was one fewer sales day in the first quarter versus last year. So on the same day's basis, sales were up 12.2%. We estimate the severe weather in the northern U.S. and central Canada reduced sales by between 60 and 90 basis points. Though remember, last year there was a weather issue as well. So net of last year's weather impact, the total effect was probably 20 to 30 basis points. In March, our daily sales growth was 12.7%. Pricing in response to tariffs and general inflation contributed 90 to 120 basis points in the period. This is below the level of the fourth quarter of 2018, but incremental progress is being masked in the current period by having to grow over the price increases that began to benefit last year's 1Q. We do look at it and believe that sequentially our price realization was slightly higher. From a macro standpoint, as Dan said, the PMI averaged 55.4 in the first quarter of 2019. This is the lowest level in nine quarters, which is what is getting a lot of the print, but it does still constitute a healthy level as reflected in continued low to mid single digit growth in industrial production. Relatedly, our manufacturing end markets were up 13.4%, with recent trends remaining in force. Most subverticals that we track are healthy, the main exception being oil and gas, which remains soft. Construction was up .1% in the first quarter of 2019. The January comparison was easy, but February and March also continued to grow double digits as a result of healthy markets and strong internal selling energy. For a product standpoint, on a daily sales basis, fasteners were up .8% and non-fasteners were up 12.7%. In March, fasteners outgrew non-fasteners. Fastener growth has been sustained at high levels, while safety growth moderated to a mid-teens rate following what were two years of 20% plus growth in that product vertical. This has served to narrow the growth gap between fasteners and other products, but overall we remain pleased with the growth of our main product categories. From a customer standpoint, national accounts were up .9% in the quarter, with 81 of our top 100 accounts growing. Growth to non-national accounts was mid single digits. Nearly 65% of our branches grew in the first quarter. In terms of market tone, regional leadership remains constructive on demand, with the caution that was evident last November largely gone. The exception, as I mentioned, was oil and gas. We haven't seen the weakness in that market deepen, but we have seen it broaden across more of our regions. Still, on the whole, 2019 seems to be starting much as 2018 finished. Now to slide six. Our gross margin was .7% the first quarter of 2019, down 100 basis points from first quarter of 2018, but flat on a sequential basis, something we haven't seen since the first quarter of 2015. On a -over-year basis, the familiar variables played out. Customer and product mix pulled the margin down, which is expected given that the national accounts and on-site continue to drive our growth. Freight remained a drag, though not to the same degree we experienced through 2018. Net rebates were a slight negative as well as a result of efforts to limit inventory growth. Our price-cost deficit in the first quarter of 2019 was 20 basis points, which is half of the deficit that we experienced in the fourth quarter of 2018. As a result of incremental progress with pricing in the period to address inflation and tariffs, we expect to make further progress towards eliminating this deficit in the second quarter of 2019 and over the course of the full year. Our operating margin was 20% in the first quarter of 2019, up 20 basis points -over-year. Continued healthy growth drove 110 basis points of cost leverage and generated an incremental margin of 21.7%. Looking at the pieces, we achieved 60 basis points of leverage over employee-related costs, which were up 7.1%. This leverage was generated because FTE headcount growth lagged sales at up .2% and due to our incentive competition growing at a healthy but moderated level versus last year. Occupancy-related costs were up 2.3%, generating 35 basis points of leverage. A decline in branch expense as we continue to rationalize sites and only modest increases in non-branch occupancy costs mitigated what was double-digit growth and vending costs as we continued to expand the installed base. We generated 20 basis points of leverage over other operating administrative expenses. The benefits of higher sales on this line was partly offset by a relatively active quarter for legal settlements and a large net debt write-off. These generated probably 2 to 2.5 million more in costs in this period than we would have otherwise expected. As described in the past, successful growth drivers is likely to reduce gross margin over time but also provides the platform and volume that generates good operating expense leverage. That played out in the first quarter of 2019 and we expect it to continue to play out over time. So putting it all together, we reported first quarter of 2019 EPS of 68 cents versus 61 cents in the first quarter of 2018, an increase of 11.9%. Turning to slide seven. Before jumping into the numbers, I just wanted to call your attention a change in our balance sheet. This quarter we adopted FASB's new standard for accounting for leases, which requires us to move operating leases onto the balance sheet. You will see these values on separate lines identified as right of use assets and current long-term liabilities. The impact of adopting this standard on our income statement and cash flow was immaterial. Now looking at the cash flow statement, we generated 205 million in operating cash in the first quarter of 2019 or 106% of net income. This remains below the historical rates of conversion that we have experienced in first quarters but is meaningfully above last year's 92% figure. The challenge remains working capital, which I will cover in a moment. Net capital spending in the first quarter was 53 million, up from 29 million in the first quarter of 2018, but consistent with expectations. This reflects investments in hub property and equipment that are necessary to support our high service levels as well as investments in vending equipment to support growth in our installed base. Our 2018 range for total net capital spending is unchanged between 195 million and 225 million to invest in hub property and equipment and vehicles to support our growth and vending devices to support our rising success in this initiative. We increased funds paid out in dividends by 16% to 123 million and reduced debt. We finished the quarter with debt at .9% of total capital, above last year's 15.7%, but down sequentially 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 but improved. Inventories were up 14% in the first quarter of 2019, with days on hand flat year over year. We continue to experience inflationary pressure on our inventories. However, during the period we worked off the foreign sourced inventory that was accelerated into the US in the fourth quarter of 2018 and advanced several initiatives aimed at making us more efficient with inventory. AR grew .2% in the first quarter of 2019, with customers continuing to aggressively push payments out past quarter end. As has been the case in past quarters, we are not seeing any meaningful change in hard to collect balances. Reducing these annual growth rates will be an area on which to improve over the balance of the year. That is all for our formal presentation. So with that, operator, we'll take questions.

Thank you. Ladies and gentlemen, at this time, if you do have a question, please press the star and the number one key on your touchtone telephone. And if your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from the line of Robert Berry of Buckingham. Your line is open.

Hey, guys. Good morning. Morning. Good morning. Congrats. Solid start to the year. So you mentioned in the slide deck that, you know, reminded us that Good Friday is in April this year versus in March last year. How much did that impact the March number? And adjusting for that, is it your read that things may be decelerated a little bit in March?

Yeah. So I think it's difficult to really burrow into what that number meant. I mean, last year, Good Friday fell on the last day of the month and it fell on a Friday. And so we have a lot of sort of month-end payments coming through. So was there a modest impact as a result of the timing of the holidays in the month? There probably was. But look, I guess the perspective that I would give to you, Rob, is this. If we're going to try to parse out the impact of a holiday, the impact of days in the month, et cetera, we also should probably be talking about variables such as foreign exchange and weather and all these other things that impact our month. And if I look at – if I try to adjust for all of these things, the fact is the growth that we experienced in the first quarter, if I adjust for acquisitions over the past 22 months, if I adjust for foreign exchange, if I adjust for weather events that we call out, we grew north of 13% adjusting for all of those things. If I look at the six-month growth rate, it was a little over 13%. If I look at the 12-month growth rate, it was a little over 13%. So the question that you're trying to get at, at the end of the day, is if you take out one piece, does that suggest that we're growing more slowly? And the answer I would give you is that's not what we're experiencing in the market through March. I would say that if you try to adjust for all the pieces, our growth rate has been remarkably stable at a fairly high level. And I think that with the exception of oil and gas, it's reflective of a business environment that remains fairly healthy through March. So that's probably how it characterizes. So no, I think you're right. But let's not lose sight of the fact that foreign exchange was as big of a drag on this quarter as we've seen since we began to grow. There's a lot of moving pieces that go into it. But generally speaking, you know, the environment feels healthy to us.

Rob, I'll just throw in a little adder. Holden's dead on right. And he comes at it. I can always tell he worked in your world for many years. He thinks about stuff. I enjoy our conversations. He thinks about things fundamentally different. My answer probably would have been a little briefer. I'd probably have said, you know what, I honestly don't know. If I asked 10 people, I'd get 14 answers. Historically, internally, I've always said to our team, you know what, you know, when we pick up a day or lose a day or Good Friday comes into play, I usually throw in the joke that Easter's on a Sunday this year and Good Friday's on a Friday. But I've always had in my head it's probably half a point. And when Holden asked me earlier about this question, I said, yeah, I said, it helped us. Weather hurt us. This morning my kids are at home driving my, you know, my dog's crazy because we have a snowstorm in Winona and it was thunder and lightning all night long. Weather impacted us. Good Friday impacted us. Good Friday, you know, hurt us here in April. And if I were to put a number on it, probably half a percent. But your underlying question is did the tone change? And I honestly don't think it did.

All right. Great, great. I guess my other question was just on, you know, seeing the FTEs grow just over six and kind of looking at, you know, data from the BLS looks like wage inflation and manufacturing is running 2, 3 percent. So to see your employee-related expense of only seven seems like, you know, pretty noteworthy performance. And I was just wondering if you can comment on kind of what's driving that and kind of how sustainable you think the ability to kind of leverage that line at this level is as we kind of look out, you know, over the next several quarters.

You know, I'll chime in on that and Holden can add some nuance of some things that I might not be sharing or appreciating. And, you know, if you think of what was going on the last couple years, we were seeing massive inflation in our numbers, not because of the marketplace, but because of our performance. We pay a lot of incentive comp. And so, you know, this morning, as an example, I was talking when we were talking to the RBPs, our regional vice presidents, one of the things I said to them is I said, hey, folks, congratulations on a nice first quarter. But I gave them a little bit of a cautious tone going into the second quarter. I said, second quarter of this year is our most challenging year from a comp standpoint, from a comparison standpoint and earnings, the incremental margin standpoint, because last year in the first quarter, we grew our earnings. I believe it was $21 million. And then from Q1 to Q2, that number, that earnings growth number went to $30 million. And so our incentive comp expanded dramatically. I mean, if you looked at our proxy, you could see, you know, from a leadership standpoint, and that proportion works out throughout the organization. We pay off earnings growth. And so, you know, I gave them a caution for Q2. But in answer to your question, are we seeing underlying inflation in labor rates? If I think of people, you know, that are working in our distribution centers that are throughout the organization, yeah, we're seeing inflation rates of the economy. One of the things that's masking a bit right now is the fact that our incentive comp isn't expanding at the pace it was the last couple years. And that's why our incremental margin is shining through things we talked about in the past. But it gives a buffer. And one of your peers described it really well years ago when he talked about the shock absorbers in our system. When we're getting great earnings growth, we share a chunk up with our employees, and we take a little leverage out. In a weaker environment, everybody steps up to the plate and loses a little bit of pay because the incentive comp contracts. And so that's part of the dynamic going on there is, yeah, is there underlying inflation in wage rates? Yeah, we're employing the same base of people everybody else is from the standpoint where we draw from. But our incentive comp is at a high watermark a year ago, and it's at that high watermark now. But incrementally, it's not growing the same way. That's right. But yeah,

Rob, there definitely was a little bit of inflation as it relates to just sort of our base pay to our full timers and our part timers. But when you marry that up with the increase that we had in FTEs and headcount, we were still able to leverage that piece of our business. And then when you throw on top of that, the incentive pay piece, we actually didn't leverage that because the good news is when we're growing like we're growing, incentive pay is a big piece that shock absorbers you when we're growing. You know, we didn't leverage the incentive pay because, you know, we're the folks are driving our business are being fairly successful. But that dynamic has been in place. I would expect a very similar dynamic going forward. We'll continue to expand our headcount. You know, we're probably going to see some wage inflation in the market that's out there today. But this isn't the first quarter that dynamics been in place. It existed for much or all of last year as well. And I think that the first quarter labor dynamics are very similar to what we experienced all last year too. And I would anticipate experiencing much of the rest of this year as well. If we grow double digits, we should be able to leverage that. Got it. All right. I'll pass it

on. Thanks, guys.

Thanks.

Thank you. Our next question is from the line of Evelyn Chow of Golden Facts. Your line is open. Hi.

Good morning, Dan Holden. Maybe just starting on price realization this quarter, you know, fantastic job in encouraging to see that price-cost gap narrow. I noticed on pricing specifically, I think your comps on a standalone basis continue to get even harder throughout the year. So would it be your expectation that though the price-cost gap turns positive, the actual standalone pricing level maybe is at its highest point in 1Q?

Well, you know, you're right that, you know, in 1Q what began to happen relative to 4Q was that we had to grow over price increases that we put in essentially at the beginning of last year. And we'll have that dynamic in Q2, Q3, Q4 as well where we have to grow over those same price increases. And in Q2, they probably got a little bit better. So, you know, from a sequential standpoint, would I expect the fact that we grew, you know, pricing at 1%, a little better than 1% in the quarter, you know, do I expect that necessarily to meaningfully increase? Perhaps not given the comps. But all that said, you know, we do believe that there is incremental sequential pricing to be had in the business over the next, certainly over the next quarter or two as we continue to adjust to what the marketplace, to the marketplace realities. And, you know, regardless of what sort of the year over year comp number looks like, as I said, I still believe there's opportunity for us to be constructive on pricing sequentially in the next quarter or two. And that should allow us to continue to mitigate and eliminate the deficit. So, you know, I think what you're describing is kind of a comp issue and I get it. But I think if you get the substance of the matter, I don't see our ability to pursue price as being worse today than it was in first quarter. And I don't see our ability to narrow that deficit on price cost as being any more difficult today than it was in first quarter or fourth quarter. So I guess hopefully that answers the question, Emily.

That's very helpful, Holden. And then maybe just on onsites, you know, obviously nice to see the pace of signings and the continued commitment there. I noticed you called out you had 66 activations and 15 closures this quarter. So is that about the level of attrition you would expect going forward?

Attrition regarding the closures you're talking about?

Yes, exactly.

So that was a little bit higher this quarter than what we typically see. We will typically see some attrition, right? Looking into the reason behind those 15 closures, there was nothing unusual there. I would say that about half of them were simply because a plant closed or moved. I think that there was probably an equal number where, frankly, we went onsite. We didn't get the kind of revenue that we anticipated getting, so we decided to leave. Or their business was off. Right. Or their business was off. But one way or the other, what made sense at the time didn't make sense today. And so we closed up that onsite and we'll service them from the branches we always have. And I think there might be one or two in there where maybe we didn't deliver the performance we told them we would. Or another competitor sort of made some inroads and we left. But those things do happen every quarter. You know, it was a little bit higher this quarter than normal, but I don't see that as a trend necessarily. And we didn't see any unusual reasons for the number.

It seemed to be the usual stuff. I'll just throw a little tidbit in there and I'll use vending as my example. When we started vending and it really was ramping up five, six, seven years ago, we didn't know what type of attrition there would be because it was a new industry. And what we found when we got into 2014 and 2015, that a lot of those machines that we had signed in 11 and 12 and 13 were extremely successful. But there was a handful that we signed that were just either, oops, we kind of, maybe we shouldn't have put this one in there. And we were pulling out on, you know, going into a given year, I'd look at what we had for install base. And we were pulling out about, and I don't have the stats in front of me, but my recollection is about 15% a year. But when we really looked at underlying data, we saw that five of those, probably a third of those were ones where, you know what? We need to continue to get better at how we make it easy for our branches to serve these machines. Because we thought we could lower that number to 10. What we've done in the last three years is we've lowered that number to about 11. And we still believe we can get it to 10. So if we have 80,000 machines out there, tell me we're probably going to pull out, you know, in a good year, 8,000. In a less than good year, a nine or 10,000. And the bottom line is we think that's a reasonable proposition because it helps us grow faster. In onsites, if I looked at it historically, we'd pull out about 10 a year. But we had 200 of them. And so we didn't really know what it would be. And we still don't, frankly, know because it's still a newer animal. But sending those onsites, we want to be mindful. We're really cautious about where we do it and where we don't do it. Because it's more expensive to pull out an onsite than it is to pull out a vending machine. But I love the fact that we're engaging with our customers and we're growing faster. But it's going to take some time to figure out what that number is. You know, when we're at 1,000 onsites, how many do we pull out a year? Because either the customer closes its facility or, you know, maybe the customer gets acquired. And the acquiring company doesn't use Fastenal. There are a few of those out there and we're trying to reduce that number every day. And

with regards to the new actives, new actives are a little bit lower than quarter. We would expect to have, you know, a greater rate of active growth as you go through the rest of the year.

All right. Well, thanks again for the time today, guys.

Thanks, Evelyn.

Thank you. Our next question is from the line of David Mandye of Baird. Your line is open.

Oh, hey, guys. Good morning. First off, could you talk about the cost structure of the business today? I'm wondering if you think that the model is more or less variable than it was 10 years ago in terms of costs and what I'm getting at here is, you know, if growth does moderate slightly, are you still going to be able to sustain 20% contribution margins in that environment?

The, you know, first in your underlying, when I think back to a decade ago when we started what we called the path of the profit, one of the things that we were truly doing is we were slowly making the model more variable in that by not opening branches as fast, you know, that added to the fixed cost infrastructure of the business. We were making it more variable. You know, one of the things that hurt our ability to leverage as the economy was picking up is, A, I personally felt we needed to make some additional investments in some people resources to support onsite to our vending, but also we made significant advancements in our infrastructure to do great things from a technology standpoint. And we talked about those dollars that we were willing to spend and consume some of the leverage, but also the variable nature consumes some of the leverage and incentive comp is a good example. To the extent we're talking about incentive comp and the people energy, the model is more variable today than it was in the past. The question about incremental margin really becomes challenging in the short term because it really falls back to how much do you want to dial back on certain growth drivers because the deleverage comes from, if we have a branch out there doing 200,000 and that market softens and they go to 180, that's a painful downhill because that's a highly profitable branch that's levered like crazy and there it's going to delever and it's more fixed than variable. The incentive comp piece obviously comes into play. So it's probably a long, not very, you know, a long non-answer to your question, Dave, but it depends on the timeframe. In the short term, incentive comp pulls back automatically and you're the one that used the historical reference of the shock absorbers, which I think is a great descriptor. And in the shorter term, it's not as difficult. In the longer term, it really comes down to do you want to start cutting away on some of the flesh when the economy we sell into is huge. The opportunity is huge, but our install base has contracted because we have all this customer spend, but their spend is down 20 percent. And so it makes it really challenging to do that because I'm a firm believer. I'm more interested in the going after the 100 billion plus market than I am about reining everything in in the short term.

Yeah. Okay. Sounds different, but still manageable. So that's fair. Second question, in previous quarters, you've talked about the customer conversations you were having around tariff-related price increases. And Holden, you answered this question to some extent, but I guess to refine it, have those sort of negotiated price changes been reflected already in the first quarter results? And also on the inventory side, are you now seeing the tariff cost increases flow through FIFO, or do those two things continue to evolve with a glide path from first quarter into second quarter? Well, yes, on all of it, first off.

Yeah. So the conversations were aggressive through Q4 and frankly fairly constructive. When we said we were encouraged, I see no reason to sort of step away from the fact that we thought the conversations with our customers went fairly well. And I think there's a lot of reasons why that has been the case. One was simply the plan that was put together to address the issue of tariffs. We feel that it was fairly open and fair, and I think our customers responded as we would have hoped they would have given that. We also put a lot of energy into having those conversations -to-face with our customers. And so, yeah, they went fairly well. Now, our expectation at the time, and I think it's played out this way, is that we would begin to see those costs flow through the business in Q1. And so we had to be timed to start getting some of the pricing flowing through the business in Q1. And I believe that that happened. And when we talk about seeing some sequential increase in pricing, I think that some of that is increases coming as a result of tariffs in that February, March period. And when we talk about being able to see some sequential increases in pricing, I think there's going to be some additional relationships that come online as we go through the early part of second quarter and third quarter. But at this point, I wouldn't say that we've been able to narrow the deficit with those things happening. The timing has worked out like we had planned for it to work out, and the dialogue with the customers has been positive around it. So I guess that's where I'd leave that.

Dave, the only thing I'd throw in as an adder is sudden jolts are disruptive as heck. And what it really requires is all of us, our suppliers, Fastenal, our customers, having a really informed, frank discussion about what's happening. Because it's been incredibly disruptive in the last four months. In fact, it probably took away some growth because a lot of our sales teams are having discussions about pricing, when I'd rather have discussions about growing the business. But it's going to be disruptive. If anybody on the call has a crystal ball and can tell me what's going to happen with the tariffs six and 12 months from now, do they get bigger, do they get smaller, do they unwind, is it messy? It's going to be disruptive. Just as disruptive on the unwind as it was on the wind. And only time will tell how that works. Fortunately, on an unwind, whenever it occurs, while it might be disruptive to pricing, it's probably going to be helpful to the underlying economy. So there'll be a lot of noise to our numbers. But in disruptive times and times of radical change, the best cure is just good, open, honest dialogue with your customer, and you manage through it. Yes. Okay. Thanks very much. Thanks, Dave.

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

Thanks. Hey, everyone. Nice quarter. Thanks. Good morning, Ryan. Yes. So first question I had was on oil and gas. I recall going back to maybe February that the RVPs were saying this was just a pullback in spending. It was just a pause. Is this still the case? And what are you hearing today?

Yeah. Well, and so the RVPs obviously respond to what their customers are telling them. And, you know, what we're hearing is that it's a challenging marketplace. We're not seeing wholesale sort of layoffs and, you know, cutting of capital spending and things like that. And frankly, the weakness that we're seeing seems to be fairly measured and tempered, which doesn't always sound like what oil and gas has been like historically, right? And so if I think about the RVP tone around oil and gas, you know, some of them are more encouraged about what the second half looks like than what the first half looks like, but all of them say, you know, what's oil prices going to do, right? And so I think if I think about the tone around oil and gas, like I said, it began to weaken. I think we began talking about this probably November, December last year, you know, and the degree of weakness hasn't necessarily gotten more severe over that period of time. It has persisted, but it's also broadened. So what something which began in, you know, Houston and Dallas has spread to other regions, right, in terms of commentary. And, you know, like I said, some of them feel like this is going to clear itself out by the second half. Some of them feel like they don't know. And all of them understand that it's about what happens to the price of oil and how their customers feel. And we just don't have a great answer to it. But that's where we have oil and gas today.

Okay. Now that's helpful. Then second question, on onsite margin inflection, I recall 2020 could be the year where more mature onsites at higher margins start to offset the newer onsites. Is this still the case based on what we know today? And then how much do you think it could lift overall company margin?

Yeah. So we haven't seen any real change in kind of the pacing of how we expect that to play out. And so what I've said before is, you know, today where we've got so many new onsites, you know, you don't have sort of an equal ratio between how they're aging versus how we're adding them. But over time, that's going to change. And, you know, I think the proxy for that will be when does the average size per onsite stop declining? Right. And my feeling is that that is probably late 19, but probably more in 2020, which means by the time you get to 2021, 2022, instead of this continuing to work against our overall level of gross profitability, you know, that, you know, it'll begin to diminish in terms of the impact on the mix. We still feel like that is the case. Now, what we said before is, and I think Dan laid this out last time, right? I mean, when we double our revenues, we want to be a 22 percent operating margin company thereabouts. And in order for that to happen from 20 percent today, you know, we need to see some of those onsites, you know, begin to mature and become more profitable. And we think that that'll happen. And so what is the impact? I would tell you today the overall impact is a drag, more so on the gross margin, the operating margin, but it's in both. But over the next, let's call it, 18 months, I think you're going to begin to see that drag really flatten out. And then it begins to contribute more towards our goal of being a 22 percent operating margin company.

And one thing to keep in mind, it's a two-prong drag in the last few years. The one drag is the mix of onsites and the average revenue per onsite going down. The other drag is we went from not really signing onsites to 80, then 180, then 280, and now close to 400. And every time we sign an onsite, I shouldn't say that. Most of the times, then, when we sign an onsite, we're taking a customer relationship out of a branch, a highly profitable branch, and we're delevering it. So you kind of have a twofer going on. Not only are you pulling down the average of your onsites, you're actually hurting the profitability of your branch network a little bit in the short term. And when you get to a steady state of how many are coming in and going out, that's when life becomes a little easier. No different than, think about how the math changed a decade ago when we slowed down opening branches through the pathway to profit. All of a sudden, your mix of branches changed.

So that's kind of the trajectory. And frankly, what's been great is that really has been playing out largely as we would have modeled it out a year ago, two years ago.

Perfect. That's good to hear. That's kind of what I was getting at. Thanks, guys. I'll pass it on. Thanks, Brian. Thank you.

Thank you. And our next question is from the line of Hamza Mazari of McQuery. Your line is open.

Hi, guys. This is actually Mario Portolacci filling in for Hamza. I know there's been questions about pricing already, but do you think it's harder for distributors in general to get pricing during this cycle versus prior cycles? Or maybe ask a different way. Given where the demand environment is and where commodity inflation is, should pricing be higher than where it is?

Yeah. Since I've been here longer, I'll take a shot at that and hold him. I guess they can chime in and correct me on some things he disagrees with. But pricing is always hard. You know, people talk about transparency in today's world, and it is greater. But frankly, our customers knew what they were spending for product and what product costs were around town 10 and 20 and 30 years ago. So it's always been hard. It's about how you're bringing a great value to your customer and their willingness to pay for that value if you think of it that way. I think probably the toughest one right now on a pricing front is pricing is always hard. But I think the one that's got a little bit harder is the freight one. Now for us, it's twofold. One, the freight dynamic is a little bit different because onsites are a different dynamic for freight than the branch network. And so we almost have to understand the two pieces individually. But in today's world, there's a lot of examples of where freight's included or freight's this or freight's that. And it's fundamentally different models. And it's always just having a good discussion about the freight side of your picture. And that's probably the more challenging element in today's world, setting mix aside. Yeah.

And I would say, I don't know what it should be compared to history. I would say this. I mean, every quarter, going back to the beginning of 2018, we have made sequential progress in raising price. We've done that because there has also been sequential increase in cost. And so we don't love, obviously, that we have a deficit on the price-cost dynamic. But part of that is perhaps we needed to be more aggressive than we were. But that shouldn't be read to mean that we weren't doing what we had to do to protect the margins. Because as I said, pricing has gone up every quarter. But we also have to acknowledge that we've had some pretty significant increases in cost. And if I look at how much our cost has increased in the first quarter, it's more than twice what that same increase was in the first quarter of last year. And so we're kind of chasing that piece of it as well. But I don't want to give the impression that because we have a price-cost deficit, that that doesn't mean that we haven't been able to pass price through. Because we pass more price through every quarter in response to the marketplace. But if you give us a flattening in the cost environment, we'll catch up. But I don't want to leave the impression that we haven't been able to pass price through because we have.

Great. And just one more and I'll turn it over. And you actually mentioned freight and just wanted to see if the benefit of essentially running your own captive fleet, if that's been fully optimized, or do you think there's more room to go there? And I guess if there is more room for improvement, I guess how much do you think that that could be?

Well, first off, the advantage of having our captive fleet, it's indescribable from the standpoint of set the cost aside for a second. Our ability to provide service is night and day different from all our competitors. You know, earlier I used the example of that outdoor locker. A year from now, I fully expect us to be able to take an order from a customer that comes in late in the day, maybe in the evening. And let's say one time in 100, that customer is in a jam and they need it like two hours ago. Our competitors are going to be providing that, they're probably going to have to freight that in using small parcel and it's not getting there until 10 o'clock tomorrow morning. And that's a really expensive trip. Our driver gets to that branch at four in the morning or two in the morning or six in the morning. You pick the time because it's different for each branch. But let's say this branch is four in the morning. Our driver could throw that item in an outdoor locker and that customer could get a text at four in the morning and say the item you ordered at five o'clock last night is here. And nobody else in that market can do that. So to me, the value of a captive trucking is you can provide a level of service that just separates you in the marketplace. From a cost standpoint, we have a great cost structure compared to our peers. And we're able to use that cost structure. Part of our gross margin differential in our industry is because of that freight advantage. Our cost structure is lower. But it puts you in a position to challenge it every day. It also puts you in a position to have conversations with your customer and maybe move some product for them on the back haul. So one of the reasons that we've always been successful is we do a nice job with back hauls from our suppliers and more recently from some customers. That's where I think we have some more legs to, especially on the onsite piece of saying to customers, get some pallets. You need to move them. We'll move them for you. And maybe you get freight that way. To quantify the potential, I'm not ready to go there right now because I don't know that we know it. Yeah. The only thing I would add is I think

one direction you're going is it is more cost-effective to move product on our trucks than on third parties. And from the fourth quarter of 2017, we really began to see the field utilizing our truck network at a greater rate because of what was going on outside of our truck network. That kind of hit a level in Q3 of 2018 that we sustained, a very high level. So if the question is, well, can you shift more and more onto your trucks? Yeah, there's always good reasons to use a third party, whether it's a custom requirement or what have you. So we're probably at a good level for that. But I can't emphasize enough that in a period like this of inflation, third party inflation is going up at a far greater rate than the cost that we're experiencing on our own captive fleet. And what that means is we have a huge advantage in the marketplace that is only getting wider by having that fleet. So what we can never tell you is how much of an advantage are we getting in winning business because we have our captive fleet? Even in an environment where there's inflation, especially in an environment where there's inflation, I can't answer that question for you, but it goes into our calculations and it's a reason why we win. So I guess the tenor of the question is, you know, when is it going to stop impacting gross margin? I wanted to take the answer a little bit more broadly because, you know, we've done things to sort of minimize the impact. But you can't underestimate the value of that trucking fleet and our ability to manage costs and our ability to win business.

Got it. Thanks for the time,

guys. Thank you. So I show on my watch 957 and very mindful that we're in earnings season and everybody on this call has a busy schedule and so I don't want to go long. I just want to close out with a few thoughts. You know, I mentioned earlier in the question and I thought I'd just touch on it again to make sure I didn't freak anybody out with my kind of off the cuff comment. The message I have to our team is as we go forward, just like it's more challenging to grow when you start stacking years together, it's more challenging for incremental margin. And that means we need to work hard at it every day to achieve it. Doesn't mean that isn't a cautionary tale. That's just a statement of fact. And I feel great about the team we have and their ability to manage this business and to grow this business. The second item, we talk about the weather impact and usually the discussion centers on impact to sales and the impact to our customers. One thing I'm really proud of is the because the biggest impact, quite frankly, is to the folks that drive our semis down the road. We were talking about freight. Picture you're driving through the middle of the night and you're in the middle of a snowstorm. That's a tough thing. I think I mentioned on last call or maybe I mentioned it to our team internally about a semi driver who was stranded outside of Chicago because their fuel line gelled up because it was so cold. And a branch manager on the last day of the month went and rescued that person and got him into a warm environment because it was 30 below zero. And one thing I'm really proud of is the way our branches and our district and our distribution managers treat our drivers from the standpoint of, hey, make sure your back dock is snow was removed. And it's a safe environment for your driver because that driver is the lifeblood of your business. And really pleased to say we came through it with a very safe circumstance for our semi drivers. Last thing, great people pursuing a common goal can do great things. Learned that from Bob 23 years ago and it's as true today as it was then. Thanks everybody. Have a good day. Thank you.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.