Fastenal Company

Greetings. Welcome to the Fast and All Third Quarter 2019 earnings results conference call. At this time all participants are in listen-only mode. The question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note that this conference is being recorded. I'll now turn the conference over to Ellen Seltz with Investor Relations. Ellen, you may now begin.

Welcome to the Fast and All Company 2019 Third 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 will start with a general overview of our quarterly results and operations, with the remainder of the time being open for questions and answers. Today's conference call is a proprietary 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 homepage, .fastandall.com. A replay of the webcast will be available on the website until December 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 Florinus.

Thanks, Ellen, and good morning, everybody, and thank you for joining the Q3 Fast and All earnings call. Just a few observations on the business as I start out. This is no secret that the industrial marketplace has weakened in the last 12 months. The blue team has reacted. I am impressed with the group I call friends and associates. They're a talented group and it shines through this quarter. My next comment isn't really a trade secret. The third quarter of 2019 had one additional business day. We generated about 21 million per day in revenue. This helped our quarter. The sarcastic side of me was thinking that perhaps everybody on this call could petition our respective governments about modifying the global calendar to add one business day in every quarter going through. It would probably do more for our economy than all the silliness that we typically see coming out of our respective capitals, and I'll leave it at that, and no political party has a monopoly on ridiculousness. All kidding aside, the supply chain for our customers has become more expensive in the last year and a half and more volatile. Our job is really straightforward. We provide supply chain solutions. We challenge the status quo with both our customer and with our supplier, and trust me, they reciprocate. That's a good, constructive balance, a good friction balance. Challenge sometimes means considering a different product. Our business model has an advantage here over many of our local competitors. Sometimes it means a different solution. As you know from what you've learned about Fast and All over the years in prior quarters, we have many to offer. Fortunately for us, many of our competitors are one-trick ponies, and this helps us win in this type of environment. Never lose sight of the strength of an organization where our team, 75% of our employees have intimate knowledge of our customer's operation. They have knowledge of their local and global business culture and the scale to stitch it together. This is more powerful than an abstract server study of customer's keystrokes that can only do fulfillment. I believe we can win, but we have to figure out where we win with that strategy, and I think the things that we do with our growth drivers play very well into understanding that advantage. All that technology, though, does bring tremendous productivity wins. We are slowly introducing technology in our business, and I believe you see it shine through in our ability to manage the labor side of our business. Getting to Holden's Flipbook, we reported earnings of 37 cents. There were just some discrete tax items in the quarter, actually in both years, but adjusting for these, the EPS remained at 37 cents. I'm pleased to see our pre-tax profit growth accelerate from, frankly, a disappointing second quarter. Two things stood out. First, the team executed nicely on pricing, which produced a better gross margin. Does it mean that we're not behind on the price cost? The goal isn't about who wins on the price cost, because this is a supply chain relationship between our supplier, our business, and our customer, and we need a supply chain that works for all. It's not about who wins. It's about who provides the best value to our customer. Secondly, our team adjusted really well to the slowing business. We couldn't adjust as fast in the second quarter. We just moved it faster in the third to provide nice incremental margins, while at the same time we continue to invest in the growth service of our business. That's one of the most important aspects of this, is we still have the resources to invest in growth. Business conditions remain sluggish, and our customer tone remains cautious. Very pleased with the cash generated during the year to date, the improvement during the period. My compliments to our team in the field, my compliments to Holden and Shero and their respective teams performed really well on managing our working capital. The nice thing about this page, in one page we talked about two things that we haven't been able to talk about with confidence and maybe even some pride in recent years, is that we perform well on gross margin and on working capital. But we still have work to do. Onsites, we signed 84 in the quarter, a little bit less than the second quarter. I think there's two things driving that. One, a lot of discussions during the quarter with customers centered on supply chain, challenging supply chain. Some of those discussions were about pricing. Also, in an environment like this, and we see it in our bending as well, when there's uncertainty in an environment, a natural human reaction is, sometimes it's easier to not make a decision at all than to worry about what decision is the right one. So a little bit of a slowdown. But we're still at up 30% over where we were a year ago at 1,076 onsites. The business continues to grow in the low teens. And we believe we'll still sign between 375 to 400. It's a little bit more difficult of a goal than it would have been three months ago or six months ago. Own time will tell if that belief will be turned into a reality. But we believe we can accomplish it. The one thing I might jump out at you is we closed 22 traditional branches during the quarter. That's not a surprising number. We've been doing similar numbers of that over the last four, five, six years. But we did close 35 onsites. I'm a firm believer. Some organizations sometimes not hide from the truth, but hold back the truth and won't acknowledge things challenging the status quo. And as a result, they don't do anything, don't do anything, and all of a sudden do something big all at once. And then spend all their efforts adjusting for the numbers to explain it to what was going on in the world. We don't do that. We challenge the business every day. And if our team feels, along with their customer, there are some onsites that don't make sense in today's environment. Perhaps the business has slowed down. Perhaps a plant's been consolidated. We want to understand the why from the standpoint and trends of our business, but I consider this a healthy thing. Vending. You know, we continue to have a very good clip with vending. To me, the most noteworthy thing that stood out on our vending numbers, so our install base is up 12.2 percent, Q3 to Q3. Our product sales are up in the mid-teens. Now, I'm not real good numbers, but I do know that means our revenue per machine increased in the 12-month period. I consider that a tremendous accomplishment in an economy where things have weakened and you would expect your revenue per machine to decrease a little bit. I think there's two things that are shining through there. One, a lot of the stuff that goes through our vending machines is about PPE, so stuff people need. We're in a high employment environment, so there's still plenty of employees, and employees need stuff. I think that's part of it. I think the other part is our team has become really dialed in at managing their vending asset base and utilizing that asset base to the benefit of their customer. And it means sometimes you pull parts out, you put new parts in. And those two things drive the fact that that base of business actually expanded in a declining economy. E-commerce was up about 28 percent, Q3 to Q3. I consider that a weaker number. One thing that shines through in that for me is a chunk of that e-commerce is to larger customers, and a chunk of that was economically weakened. With that, I'll turn it over to Holden. Great.

Thanks, Dan. Good morning. Let's just jump on to slide five. Total sales were up 7.8 percent in the third quarter. Adjusting for the one more selling day in the period, our daily sales were up 6.1 percent, which is a deceleration from the second quarter. September daily sales growth was up 5.8 percent, which is fairly consistent with the July and August rates. But business activity has continued to soften. The leading purchasing managers index averaged 49.4 in the third quarter, and it was 47.8 in September. Those are levels that are consistent with modest contraction in industrial production. For its part, industrial production was up just 0.3 percent in the July-August period. The cautious tone is reflected in the feedback of our regional leaders and in the trends of our end markets. Manufacturing was up 7.7 percent, and heavy equipment was up 4.4 percent. Oil and gas and industrial end markets are also softening, while transportation and consumer-linked customers are stable. Construction was up 2.9 percent in the third quarter, with larger customers outperforming smaller ones. We estimate that price in the third quarter contributed 90 to 120 basis points, which is slightly improved on the second quarter. However, we think the degree of price realization in the period is partially masked by the current period having to grow over last year's rising contribution from price, because the third quarter of 2018 marked the rollout of our pricing tool. We're pleased with the efforts of the blue team to mitigate the effects of tariffs and inflation during this period. For our product standpoint, non-fasteners continued to lead, but did decelerate with 8 percent growth in the third quarter, while our more cyclical fastener line was up 3 percent. From a customer standpoint, national accounts were up 10.2 percent in the quarter, with 62 of our top 100 accounts growing. Non-national account growth was less than 1 percent, with roughly 57 percent of our branches growing in the third quarter. Our growth today is coming largely from the growth drivers, which only reinforces our commitment to them. Regardless of the market conditions, Fastenal provides a value to our customers and has a financial model that allows us to invest as others pull back, and we intend to do so. Now moving over to slide 6. Our gross margin was 47.2 percent in the third quarter, down 90 basis points versus last year. The components of this decline are familiar, product and customer mix, price cost, and transportation expense, plus the absence of the difficult comparison we had last quarter. However, the third quarter was also up 30 basis points versus the second quarter, which bucks the more traditional -to-down sequential pattern. This largely reflects moderation in the variables that impacted the second quarter. Mixed drag was 70 to 80 basis points, narrowing a bit as onsite growth rates slowed. Price cost improved through the quarter, as pricing efforts to offset tariffs and inflation gained traction. It's common for the fourth quarter gross margins to slip versus the third quarter, as has happened in four of the last five years, typically by 20 to 40 basis points. With the momentum we built in the third quarter, however, we anticipate being able to sustain our gross margin above 47 percent in the fourth quarter. Our operating margin was 20.4 percent in the third quarter, down 10 basis points year over year. SG&A's percentage of sales was 26.8 percent, better by 80 basis points, and a record low for the third quarter. We leveraged operating costs despite the slowdown in sales growth, aided a bit by an extra selling day in the period. Looking at the pieces, we achieved 65 basis points of leverage over employee-related costs, which were up 4.2 percent. This growth was largely due to a 4.1 percent increase in FTE growth at the end of the period. We realized 20 basis points of leverage over occupancy-related costs, which were up 2.8 percent, comprised of higher vending expenses as we expand the installed base and flattish occupancy. Conditions remain challenging, so we remain focused on adding resources as necessary to finance our growth drivers and support our ability to take market share, while tightly managing other costs and investments. If you put it all together, we reported third quarter 2019 EPS of 37 cents, which is up 8 percent from 34 cents in the third quarter of 2018. As Dan mentioned, we did have discrete tax benefits in both the current and prior year periods. And if you include a 3.6 million benefit in the third quarter of 2019, if you adjust for these, third quarter 2019 EPS remained 37 cents, up 7.3 percent. Turning to slide seven, looking at cash flow, we generated $257 million in operating cash in the third quarter, or 121 percent of net income. Higher earnings combined with lower working capital needs to produce the cash flow. -to-date cash conversion is 96.4 percent. Net capital spending in the third quarter was $60 million, up from $35 million in the third quarter of 2018. This continues to reflect investments in hub property and vehicles that are necessary to support high service levels, as well as investments in vending equipment to support growth in our installed base. Our 2018 range for total capital spending is unchanged between $195 million and $225 million, with the same factors driving the third quarter increase, impacting the full year. We also paid out $126 million in dividends in the period and reduced debt by $55 million. We finished the quarter with debt at 14.7 percent of total capital, in line with last year's 14.4 percent, but down sequentially and from year end. Inventories were up 13.4 percent in the third quarter of 2019. Nearly half of this growth related to inventory to support new onsites. The remainder relates to higher hub inventories. We planned for growth in inventory to slow meaningfully in the fourth quarter, as actions taken earlier in 2019 to reduce overseas purchasing in response to slower demand begins to be felt. Accounts receivable grew 5.8 percent in the third quarter of 2019. Receivables benefited from slower growth and the timing of quarter end. If I try to adjust for the latter, we estimate that receivables growth would have been roughly 7.5 percent, with a roughly half day increase in DSO, the slowest rates of increase since the first half of 2017. Our customers continue to aggressively pursue longer payment terms and withhold payment at quarter's end. We expect growth in our working capital assets to be more modest in the fourth quarter than it was in the third, producing another strong cash flow quarter. That's all we have for our formal presentation. So with that, operator,

we'll take questions. Before we switch over to questions, last night when I was flipping through Holden's book, one thing that hopefully stands out in these calls is Dan's ability on scripted, which probably makes for a frustrating listen from an audience perspective. Holden is nicely scripted, so you get maybe the how from Dan, but you get the what and the meet from Holden. I think that's a good one to punch. There was an item that I added into the notes of my flip book last night that I did want to throw out there because I thought I might get a question on it, and I didn't want to give you an unsatisfactory answer, so I thought I'd preempt you. That is the one item in the quarter that kind of makes me scratch my head is our construction business. And we had enjoyed nice growth in construction over the last several years. That growth has slowed dramatically as we've come into 2019. And in all honesty, we don't completely understand it. It's two worlds there. Our large-acome business continues to grow well. Our local business isn't growing as well, and some of that you can attribute to the fact that we close about 5% of our locations a year. So that's going to take a toll on the local construction business, but that's not a new phenomenon. We've been doing that for four or five years. There is some slowing in our local construction business. I thought I'd point it out to you. I'll give you the unsatisfactory answer that we don't completely understand it. I do know from talking to peers in other organizations, and I know a number of folks in organizations that sell into this arena, in the large-acome business, they're not really seeing it, but they are seeing it in the smaller-acome business as well. And so it's more of an observation than a conclusion. I apologize for that, but I thought I'd point it out. Anyway, with that, we'll turn it over to questions. I'm not sure if Ellen preempts the group, but we'd ask for one question and a brief follow-up if you still need.

As a reminder, please ask one question and one follow-up question. Thank you. Our first question today comes from the line of David Manthee with Robert W. Baird. Please, just see with your questions.

Thank you. Good morning, everyone. Good morning. First off, can you talk about additional price increases that you may be thinking about in the fourth quarter to offset additional tariff-related COGS inflation?

Sure. So as you know, there's going to be another round of tariffs that go into place in mid-October, and then there'll be another round in mid-December. Our intention is, as we get into the latter part of this quarter, that we will adjust our pricing and our pricing tools to reflect the changes that are coming because of those tariffs. So I think you can expect us to take action on those should they ultimately materialize in the latter part of this quarter.

Okay. Thank you. And second, it's a small percentage, I know, but I'm hoping you can provide more details on the 35 onsite closures. Were these purely chance or cyclical customer issues rather than a bad fit or some sort of competitive loss? Is there anything you can share with us regarding that, or is there anything you learned from those closures that will help you better vet potential customers for onsite implementations in the future?

Sure. Yeah, the quick answer is probably a little bit of all of the above, but you're right, Dave. I mean, we closed more this quarter than we've typically done, and I think there's a couple of things to think about here. One is simply the installed base has gone up, and as the installed base goes up, there's going to be a natural degree of churn that happens. And so the fact that it's a high number, but frankly, the three or four quarters that proceeded this quarter were higher than the ones before that. And so there's an element simply of it's become a big part of our business. We have a lot of them out there. There's going to be a natural element of churn that goes up over time. But the second piece is you're right. As we've achieved a degree of critical mass in that initiative, the reviews, we always review our business, not only in onsites, but elsewhere. But we get more active in terms of reviewing the business that we have as we get critical mass, as we have more aged facilities. And if I look at the 35 that we closed in this quarter, I was able to get a good explanation on about 27 of them just to let you know. And if I look at that, there's a handful where the plant closed. There's a handful where the model changed, right, where we opened the onsite because a purchasing manager liked the model, and that purchasing manager has now moved on and new ones in place doesn't like the model as much. And so they've changed it. And so there's a few of those. There are a few where we lost some business to competitors. Usually that's because they decided to go for maybe a better pricing scheme or what have you. But those do exist. Or somebody new in their procurement function. Or somebody new in their procurement function, right. So those elements do exist. They've existed every quarter before this. Now I will also say there were 11 onsites that frankly we closed them because maybe the financials didn't play out as we would have expected. In fact, if I look at those 11 onsites, they were running at about 20K a month. That's well below what we need to have in order to make that model make sense. And so we wound up closing that onsite. But in nine of those 11 cases, that business moved back to the branch that's nearby, right. So it's not lost business even though it is a closed onsite. But the financial decision is better at the branch than it was an onsite in those cases. So, you know, I think the perspective that you have to have here is we always review our business. And as the base goes up, I think closures will go up as well. But that said, I think that this quarter was pretty high. I don't expect to see that level of closings in the fourth quarter. And even at that high level, we're talking about roughly 3% of our installed base. I mean, not a big number. So, which I think you kind of commented. That's probably how I'd respond to

that. I'll add just an item in there, Dave. And that is if you think about growth drivers, if you think about our business in general, we consider this a healthy part of the business. Take our national accounts business as an example. I know based on history that when we come into a new year, I can assume that 5% of our national account revenue from last year will be gone. Not because we lost a customer, but because across those thousands of locations, there were special projects going on in 2019 that won't happen in 2020. And so, if we want to grow our national account business, and I'll just pick an arbitrary number. If we want to grow our national account business 15%, we have to go into the year with a plan to hit 20, because we know we're starting down five. When I think of our vending business, this year we will pull out about 13% of our vending machines based on our install base. And that's been true for years. Actually, if I go back five years ago, we were pulling out about 25% of our install base every year from the prior year. Because we put in 10, we realized we needed 8. We put in 2, realized that wasn't a great place to put vending. And we improved the business. Over the last decade, we've pulled out north of 40,000 vending machines from locations where we've installed them. And what do we have to show for it? We have a business that went from zero to, we'll do about 1.1 billion through vending this year. It helps our overall organization grow faster. It's a nice, discreet business in and of itself. But I know that every time we place 10 machines, there's a likelihood we're going to pull a few of them back. And I love the business, and I love the fact that we're always rationalizing. I don't know, ultimately, like on the onsite, what is the turn rate. But I don't know. Maybe 5% a year is a number. And I hope I don't see that in every darn report that comes out now that Florida thinks they will do this. But I'm just saying it's a business, and you approach it from a pragmatic business perspective. What's a win for your customer? What's a win for your team? And what's a win for the future of the business as well? And we love the onsite business, and we think a healthy look at it is a good thing.

All right. Very helpful caller, as always. Thanks very much. Thanks, Dave.

The next question is from the line of Nigel Koh with Wolf Research. Please review your question.

Thanks. Good morning, guys. Good detail on the first couple of questions there. Yeah, hi, guys. So I just want to maybe just address kind of what you're seeing out there in a bit more detail. It feels like September was a weaker month more broadly, yet you saw a nice uptick in September sequentially. So you didn't seem to see that, although you are talking about a greater proportion of national accounts customers are declining. So I'm just wondering if you maybe just dig into sort of the feedback you're hearing from branch managers. And then more specifically, you called out, I think, last quarter weakness in heavy industry and oil and gas. You didn't call that out this quarter. So I'm just wondering what you're seeing in those two areas. Thank you. Sure. So, yeah,

the September number was a little bit below where July and August was. I would agree that they were substantively in the same range, but we did do a little bit better with pricing in the quarter, obviously. And I think that that kind of moved through as the quarter went on as well. I don't think I'm going to get into disclosing month by month kind of what we think the pricing was. But I think it's fair to conclude that it got better as the quarter progressed. And that probably, you know, you probably saw a little bit of a decline in volume, a backing up in volume growth filled in a little bit by an improvement in the pricing side. And I think that was probably an element of it, because if I think about the markets, yeah, they're getting softer. And that probably doesn't surprise anybody. And you're right. I didn't call out oil and gas and heavy machinery specifically. It feels like it almost goes out saying at this point. But those areas are weak. The industrial manufacturing sector broadly is weak. And I kind of feel like volume for us outside of our market share gains is probably in the area flattish. And that's where we've gotten to at this point. In terms of feedback from the RVP groups, you know, it's probably what you would expect. Most are talking about Tone being cautious, much as they have been. They did call out, obviously, oil and gas, heavy equipment. We've talked a bit before about, you know, some of the automotive. We don't have a lot of direct exposure to automotive, very little, if any. But indirectly, some of the regions that are there have certainly called that out. You know, I'm not sure that I'm adding any markets to the list that are soft, but, you know, I'm not seeing anything getting better either. And so it's still a bit of a challenge. What I will say is I think some of the commentary from the RVP is what got added in in the last month or two. A little bit more discussion about seeing some layoffs in their markets, a little bit more discussion about, you know, seeing people deciding or choosing to defer spending decisions. I would say those really began to creep into the dialogue in the last quarter or two. And again, I just think it feeds this narrative that conditions, they're not spiraling out of control by any means, but they continue to soften up in our marketplace.

Great. Thanks, Holden. That's a great color. And then just on the gross margin, you kind of pre-interview went out with the 47% number for 4Q. Obviously, you'd have to top our minds. I understand, just given your turns and the timing of tariffs, the 25% list 3, start to filter into your P&L in 4Q. So I'm just curious, if you are seeing that incremental inflation, what could be the offsets to that? Well,

remember, you know, the list 3 tariffs went into place initially, I think, in December of 2000, the number in March of 19. Those, frankly, the costs of those actions were largely in our 3Q. I know, I think I know what you're talking about. We have turns of two times. But remember, tariffs are a little bit different in that it's not about when you purchase the product, it's about when it hits the shores. And so if our, you know, six-month sort of supply chain lag is three months over season on the water and three months domestically, then the impact from tariffs, you're going to feel that once it hits the shore, but from that period to the time that it flows through the network. That's really more like three months. So the list 3 tariffs, those costs were largely in 3Q. I don't anticipate a incremental impact in 4Q from the list 3 tariffs. On list 4, those go into play in October and then again in December, if they ultimately go through. And I expect that those costs would then roll forward into the first quarter of next year. And we'll adjust our business ahead of that to make sure that we're neutral on it. So, you know, our intention is obviously not to fall behind based on sort of what the new tariffs are. But I think I want to emphasize as well, Nigel, when we fell behind, it had a lot more to do with general inflation in the marketplace than it did with the tariffs. Now, I think general inflation was sort of goosed by the tariffs, if you will. But it wasn't so much the tariffs that presented the challenge to us as it was the generalized inflation. And I think the change of approach that we've taken in recent months, you know, in three areas. One, you know, the group has new information and new tools in the field that they didn't have 18 months ago. We have a new structure internally dealing with our pricing and our costing versus what we had 18 months ago. And I think that structure, the people involved in that structure and its oversight, I think are doing a phenomenal job. And then just the muscle memory that's been built up in the field, again, very different from what existed 18 months ago. And so I think our capabilities now versus what existed 18 months ago are far stronger. I think the execution speed of what you saw in 3Q reflects that. And I think we can manage what comes as effectively today as we've been able to at any point in this period. But I don't anticipate tariffs being an incremental drag to 4Q relative to 3Q at

this point. I'll just throw, as Holman was talking, I was just flipping through some stats here on the components of our business just to shed a little additional light on the first question about heavy equipment. If I look at heavy manufacturing, now heavy equipment is a subset of that. If I look at heavy manufacturing as a business, that's about between 35 and 40 percent of our revenue. So it's a big swath of our revenue. That was growing about 13.5 percent in the first quarter. That dropped to a little over 8 percent in the second quarter. And it was about 6 percent in the third quarter. So it mirrors up pretty well with what our reported number is. If I look at heavy equipment subset in there, which is about two-thirds of that component, it's about 27 percent of our revenue. 13.5 percent in the first quarter, so in line with the overall heavy manufacturing. 7.5 percent in the second quarter, so it was starting to pull down the overall heavy manufacturing group. It dropped to 4.5 percent in the third quarter. So two things jump out at that. That's a lot of OEM factors in there, a lot of production in there that weakened as we went through the year. The interesting thing is that there was a divergence between the two-thirds of the heavy manufacturing, that's heavy equipment, and the one-third that isn't. There's a divergence in there's more resiliency in the other group. So the overall number isn't declining as much. And I go into the weeds and get a little wonky on you only from the standpoint of that demonstrates what our team is doing, our national accounts team, our regional teams are doing. That's market share gains. We're picking up great market share there because our customers are struggling right now. And it shines through in our heavy manufacturing. It shines through in some of the stats that Holden puts out as far as our top 100 customers. How many are growing with us? All that kind of information really sheds light.

Great, thanks.

Thank you. Our next question is from the line of Ryan Merkle with William Blair. Please receive your questions.

Hey, thanks. A couple of questions.

Yeah.

Ryan, before you start, congratulations on a new baby. Oh, thank you. A lot of work but a lot of fun.

There you go. Thanks, Dan.

You must be

tired because usually you get into Q earlier than this.

I'll tell you what, three hours of sleep. You're getting a little slow. Yeah, I'm a little slow. So on gross margins, just a follow-up. So if you do a little bit better than 47% in the fourth quarter, that would be a -over-year decline of like 56 bits. So how should we think about the components of mix, price, cost, and freight?

I think at that point, so the freight comparables will get easier. Obviously, our goal as a company is to not rest on comparables but actually execute the freight side better. But at minimum, the freight comparables get easier. And so I'm not expecting a big drag on freight. I think that will be – I think that impact will be diminished. The real question mark there is ultimately there is a cyclical element. How much does our revenue go up or go down based on sort of the macro? But that's the expectation right now, which means that most of what I would expect you to see is going to be related to the -to-customer mix. I think if you look at the cadence of price-cost, it's one of those things where I think the number for the quarter isn't terribly meaningful because pre-quarter and post-quarter were two very different numbers depending on the timing of when you were able to enact the strategy. But by the time you finished up the quarter, you were approaching kind of balance, if you will, on sort of the price-cost side. And our expectation is to kind of maintain something around neutrality. As a result, whatever we achieve in the fourth quarter, I think it's going to be heavily a function of mix.

Okay. Yeah, that's really helpful, especially the price-cost gain neutral. I think that's really critical. Okay. And then next question, and this is more theoretical, but based on what you're hearing from customers and seeing in the macro, what level of end-market growth are you planning for in 2020?

You know, so, yeah, very theoretical. What I would tell you is, as you know, I've studied the PMI and its impact on our business for a long time. And, you know, I always view the PMI as being a bit of a leading indicator, and I think the PMI is probably signaling to us that the conditions that you're seeing today, which I think suggest fairly flattish volumes, that we're going to roll into 2020 in a very similar position. Now, what the second half looks like, I have no idea, but we're going to roll into 2020 in a very similar position. And, you know, I think if volumes are flattish, I think that next year we will get whatever we get based on market share gains, and call that between 5% to 7%. There's probably a little bit of incremental price that flows in there just because we recognize for a full year what we've put in as this year progresses. And, you know, I think that the, you know, you're looking at something in the 5% to 8% range based on where the PMI is today. Depending on where the PMI is in December, ask the question again because it might all change, but that's probably how I would characterize how I look at the PMI and its impact on our business. Got it. Thanks so much. Yep. Thanks, Ron.

The

next question is from the line of Robert Barry with Buckingham Research. Please review your question.

Hey, guys. Good morning. Morning. Congrats on the solid quarter. Thank you. So just trying to get my head around this tariff-related math a little more. Just wanted to clarify, was the full impact of tariffs on List 3 at 25% flowing through the P&L in this quarter? Was that your earlier statement? Yeah, for

all intents and purposes. Because, again, remember, our two-times turns don't really apply where tariffs are concerned, right? Because the moment tariffs go into effect, the first container that hits our shores are tariffed at that point. And from that point, call it three months to move through our system from the ports, through the hubs, through the branches to a customer, right? So we're not talking about a six-month window in which it takes to sort of realize the tariffs through our cost. We're talking about something shorter than that. And that's strictly based on the dynamics of the tariffs themselves.

I'll add one more just

twist to that. The dynamic – there's really a couple things that come into play. And a piece of it I agree with Holden's comment, a piece of it I disagree with Holden's comment. If you think about a customer where we're bringing in, say, OEM Fasters, or we're bringing in – it's vending customers where we're bringing in – we do a lot of hand protection through our vending devices. So where you're bringing in that kind of product, your visibility to need and supply chain are much more dialed in. So that element of the product turns faster because you're bringing in product that – you might have a three-month supply, four-month supply, five-month supply. So it turns a little faster. And the variability in that is dependent on not how quick it hits the cost impact, but how long – how many months of – how many days of inventory you have can change. If all of a sudden the customer's business, OEM Fasters, are down 20 percent, what you thought was a five-month supply just instantly became a six-month supply. Oops. That means you have the legacy of that problem a little longer. But it still hits relatively quickly. Same thing in a lot of our vending – our hand protection. Now, if you went in and visited a bunch of our branches and you looked at a lot of the MRO Fasteners and a lot of the products that are in our branches, that's product where we have less certainty, less visibility to demand, and we stock it a bit deeper because of that. There you have product that might turn once a year. And so there's some elements of both. A lot of our discussions with our customer is on the former, not the latter, because that's the product in their known spend as opposed to their tail spend. It's the tail spend that becomes a little more difficult from a turn standpoint. I hope I shed light there instead of – Yeah. I mean,

a little bit perhaps. I mean, what I'm trying to get my head around is if you look at your sales, 34% is Fasteners. I assume a healthy chunk of that is subject to the tariffs. And if you assume tariffs at 25% on that COGS, it seems like a much bigger number than the 1% price would cover. So I mean, maybe some of the things you're talking about, Dan, are the reasons why price costs can be almost neutral, even though the kind of headline math I just did suggests a much bigger pressure. Maybe there are other offsets.

Yeah. Keep in mind, I'll let Holt and add in, but there's a bunch of Fasteners products that we have moved out of tariff-based country. The issue you run into when you move it, it might be more expensive, but it's less expensive than a 10%, 15%, and 25% tariff. And so there is some stuff that we've moved out, but I'll let

Holt and chime in. Yeah. I mean, the only other nuance I would add to that is it's certainly true that we import the great majority of our Fasteners. But recall that whereas China is one source, which as Dan indicated, we've actually reduced that source over this period of time, we also get a lot from Taiwan and a handful of other countries out there that aren't subject. So don't overstate the impact of if Fasteners are heavily tariffed. They are if they're coming from China. But we get a lot of our Fasteners from Taiwan and other areas in Asia, as well as there's a major supplier in Canada that aren't quite as affected as much. So those obviously aren't impacted the same way.

Would you be willing to just tell us what your List 3 and List 4 exposures are?

No. Yeah. I mean, what we said is substantially all of our product that we source from China is covered by List 3 and List 4. We have not disclosed historically what that number is specifically. What it was when this all began 18 months ago, it's a little bit lower than that now, or 12 months ago, it's a little bit lower than that now. Because of the work that we have done to, again, as Dan pointed out, to improve the supply chain cost of our customer supply chains, we have moved a material, not a product, out of China into other areas, usually within the region. But it's still a significant minority of our overall purchasing comes from China. And what does come from China is going to be captured by List 3 and List 4.

All right. All right. I'll leave it there. Thank you. Thanks. Thanks,

Bob. The next question is from the line of Josh Prisman. He was Morgan Stanley. Please just use your question.

Hi. Good morning, guys. Morning. Just maybe follow up on some of the non-REZ commentary. You know, it looked like there was a nice uptick in momentum there in the September. Dan, I know you talked a little bit about some slowness. Otherwise, it was a little bit of a head-scratcher. But I think more broadly, construction markets had some weather issues impacting earlier parts of the year. Did the season just kind of go longer or have a bit more tail at the end as a function of weather pushouts? Or any explanation for maybe why September was an uptick?

Yeah. I hesitate to – being a farm kid from Wisconsin, I'm always attuned to the weather, and I'm appreciative of what that means for this time of the year on people getting corn and soybeans in this part of the country out of – you know, harvested. I am hesitant to talk much about weather short of that because we're in a lot of jurisdictions, and unless there's something major that really hits, it's a regional issue more than a company issue. The one – you point out September. September did have a nice uptick in construction. We grew 6.5 percent construction business versus the first couple months we were growing between one and two. I like what I saw in September. One month is not a trend. I would love to see that strengthening we saw in September shine through in October and November, and time will tell if that happens. Right now, I honestly don't know, but I did like what we saw in September.

The other thing I might suggest is if you look at just the comparables, you know, in August of 2018, our construction business was growing 18, 19 percent. In September of 18, it was growing 13, 14. So a little bit easier comp, I think, also contributed to September looking better than the other two months in there. So I would consider that as well.

Got it. And then just to follow up on pricing, obviously some good momentum there, you know, getting kind of caught up after 2Q. Any kind of institutionalized moves? I know there's a lot of discretion at kind of the branch and salesperson level on price movement and what it takes to win business or retain business. Has any of that discretion been lifted to higher parts of the organization where maybe things like 2Q don't happen as often, or did it just need to be a catch-up?

You know, first off, one of the ways we circle the wagon, so to speak, is we have a frank and honest discussion with our teams. And we talk to them, here are the facts at hand. Here's what we need to do and here's some of the discussions we need to have with our customers. And like I say, you always lead the discussion with, here are solutions that make some of the issue go away. You know, maybe there's a different widget that has a similar form and function that you've suggested in the past, but there hasn't been a willingness to change, that all of a sudden now can effectively offset this impact. But you have a frank and honest discussion with your team, and they have a frank and honest discussion with our customers. And you challenge them and say, this isn't a mandatory thing, this is a -to-do thing, which frankly I think is more important than a mandatory thing. We need to do this. But we also need to have a mindset that this isn't a project. This isn't a three-month thing, this isn't a 12-month thing. This is something you just do, just that right now we need to reallocate a little more time to it because the urgency is high, because the volatility is high, and you need to have that conversation with your customer. Unfortunately, when you reallocate some of that energy, maybe your vending drops off a little bit in your signings, maybe your onsite drops off a little bit on signings, because there's always a finite amount of energy in the air.

Yeah, so I would say we really didn't fiddle with any elements of our culture, with the elements of allowing people in the field to make decisions, because they're the ones that know the customer far better than anyone else does. And so we really didn't fiddle with elements of culture, if that's what you're asking. What we have fiddled with, as I said before, is the information and tools that are available to people in the field, the structure internally by which we attack sort of price and cost questions, and then obviously just again building up that muscle memory in the field, getting used to having these conversations, and that sort of thing. We fiddled with those elements, but we didn't fiddle with fundamental culture, payroll, anything, or pay plan or anything like that to achieve what we've done. And the good news is I think that means that it should be more sustainable. Understood. Good call. Thanks a lot.

Great. So we're at 950, so I think we're running to the end, or do we go full hour now? Full

hour now.

Oh, hold it over a little bit. We'll go full hour.

Makes

my calls afterwards easier.

Thank you. Keep

on going, operator.

Thanks. Our next question comes from the line of Chris Dankert with Longbow Research. Please receive your questions.

Hey, morning, guys. Thanks for all the colors thus far. I guess from my perspective, I saw you guys stepped up the IT and technology investment in the quarter by several million bucks. Anything worth writing home about there, any kind of major projects you'd highlight?

You know, when I stepped into this role, one of the things that I thought was important, you know, looking at the landscape out there, we decided to make a meaningful move. And I started to talk about this with our shareholders back in that timeframe. We decided to increase our relative IT spend about a half a percent of sales. So I think what our business today is a half percent less profitable relative to 50 basis points less profitable because we decided up that spend. Now, my gut believes that that 50 basis points, we will we are. I don't know if we've clawed it all back, but we're clawing it back because it brings productivity and improves our business. If I if I I've always talking to John Soderberg, our leader in the in the IT area, John's done a Johnson in that area now, what, three and a half years leading that team. He's done a wonderful job. We have great talent. He's done a wonderful job better connecting our IT group with our business. And we were and so the talents, the inherent talents of our IT team really shine through. If I think of some some recent wins just yesterday with our board of directors, I was chatting with them about about two days ago. We we rolled out and some of you are going to roll your eyes at this comment because companies have been doing this stuff for a long time. We haven't. We started talking earlier this year about, you know, the you know, the bot implementing a bot within our business to improve. And in our safety team, we've we've developed an incredible safety business over the last decade, obviously helped by vending 55 percent of our vending revenue is safety products. And our safety team was looking for added resources because they get bombarded with thousands of questions from the field. And and it takes away a lot of their energy. And to me, the two things, a couple of things jumped out there. Boy, that's a that's that that's I'm glad to hear they're getting bombarded with questions. But I'd rather not add resources to answer questions because the ultimate is surface the information for our team. So they so they have it 24 hours a day, seven days a week in the field. So we created our first chat bot. It rolled out two days ago. It's a safety bot. We've loaded it with common questions that our safety team gets. We've loaded it with information, OSHA regs, you know, all the you know, and I'm going to start spewing things I know nothing about. But information that our that our field needs to address customer questions, we rolled it out the 50 branches a couple of days ago. I'm pleased to report the first morning it was out, there were 29 questions asked and 22 responses. 76 percent hit rate on responses as far as satisfactory responses to the questions. And that's something we couldn't have done two years ago. We are doing some things with rolling out some mobility. That's a slow walk. We're but what we're rolling some things out to me. I fundamentally believe the wins are a better partner with our customer. A more productive product, productive business, which which means we can inherently be more competitive in the marketplace and still provide better value. And but that's something a couple of quick examples. Again, you might roll your eyes and say, well, those are pretty small steps. I think they're huge steps and I'm really proud of our team for doing it.

And you're right. I mean, we're looking at an IT spending this year just from a P.L. standpoint, probably probably being up 10, 10, 15 percent. It's an area that we continue to invest in our business because we can we can do so even though things are slowing down. That's not that's not necessarily an area that we're looking to restrict, restrict our spend.

We

invest,

but we get a return.

Yeah. Thanks for the call. That really helps kind of level set things and kind of how the growth goes there. And just the last one for me, from a very high level, we talked about on site already. But just again, thinking about total opportunity in the past, you guys have highlighted maybe 4000 vetted addressable opportunities today. That's still kind of what you see as the opportunity out there.

Yes. And I'll say it that way. I believe that that number has upsides from the standpoint. You know, earlier we were talking about the 35 on site closures. And to me, the reason I believe it's OK to have what you could arguably call a failure is it means we're testing the fringes. It means we're we're constantly trying things that maybe we haven't done before to see if it will work. I remember a trip I did with Troy Parkos, who leads our business here in the upper Midwest. We're down in Milwaukee area and we were visiting an on site. And there's nobody in our organization that knows more about on sites than Troy. He's been successful with a lot of more the years. And he's done what he's doing and he's kind of you know, he's kind of shrugging. And he says, damn, I'm not sure if it'll work. But here's why I did it. Boom, boom, boom. And he laid out his reasons. I'm like, that's awesome. And so so I think there's a there's an upside to that number. But yeah, that's that's where our number sits now. But I think we become more creative because Bob Kerlin created an organization that trusts people to try things and be willing to make a mistake.

And Dan, can you correct me if this is wrong? Because that number was put together before I necessarily was here. But I believe that number also didn't include construction, government, education opportunities. Right. Correct. So we're actually finding opportunities to be on site in environments like that as well, which to Dan's point is kind of expanding the envelope for what's possible within an on site environment. Got it. Got it. Thanks, guys.

Sure. With that, it's five minutes of the hour. I'm going to I'm going to call the call short of five minutes. Sorry about that. I'm a big believer in obligation. One thing I constantly talk to my team about is obligations we have to each other, to our customer, to our shareholder and to our supplier. And one obligation I have to this group is the around the answer calls. Today, I won't I won't be here for that obligation. I'm leaving in a few minutes a friend and and brother. He's technically my brother in law, but a friend and brother pathway from pancreatic cancer here in September. David Gustafson down in Madison and going down to support my wife, my -in-law and my nephew. And I won't be around for any questions. If you have any of me, give me a holler next week. Thank you. Thank you.

Thank you. This will conclude today's conference. Thank you for your participation.