Greetings. Welcome to the Fastenal 2023 First Quarter Earnings Results Conference Call. Please note that this conference is being recorded. At this time, I’ll turn the conference over to Taylor Ranta of Fastenal Company. Taylor, you may now begin.

Welcome to the Fastenal Company 2023 first quarter earnings conference call. This call will be hosted by Dan Florness, our President and Chief Executive Officer, and Holden Lewis, our Chief Financial Officer. The call will last for up to 1 hour and will start with a general overview of early results and operations, with the remainder of the time being open for questions and answers. Today’s conference call is a proprietary Fastenal presentation and is being recorded by Fastenal. No recording, reproduction, transmission, or distribution of today’s call is permitted without Fastenal’s consent. This call is being audio simulcast on the Internet via the Fastenal Investor Relations homepage, investor.fastenal.com. A replay of the webcast will be available on the website until June 1, 2023, at midnight Central Time. As a reminder, today’s conference call may include statements regarding the company’s future plans and prospects. These statements are based on our current expectations and we undertake no duty to update them. It is important to note that the company’s actual results may differ materially from those anticipated. Factors that could cause actual results to differ from anticipated results are contained in the company’s latest earnings release and periodic filings with the Securities and Exchange Commission, and we encourage you to review those factors carefully. I would now like to turn the call over to Mr. Dan Florness.

Thank you, Taylor, and good morning everybody, and welcome to the first quarter Fastenal earnings conference call. This call is a little different for Holden and me today because we are at the site of our customer expo that just finished up yesterday, and I am really pleased with the event—lots of great customer engagement. One thing nice about the event this year is some of the natural things that were occurring. Obviously, 2 and 3 years ago, we didn’t have an event because of COVID. Last year, we had an event, but we had to limit the attendance and also, due to international travel, we had to limit the attendance. This year, we didn’t have those restrictions, so we had a great event. There were four areas of focus for the theme of the event this year. One was continuing to accelerate our customers’ digital transformation to give them better visibility into what is happening inside their four walls, inside their facilities. The second was really securing their supply chain. The world has seen a lot of change and impacts to supply chains over the last several years, and we are allowing our customers the opportunity to think about their supply chains continually in a more strategic way as we move forward. The third was powering productivity. A lot of this is about digital transformation and understanding the elements of your supply chain; it’s also about bringing productivity to your production floor or some element of your operation—we provide the tools to do that. The fourth piece was understanding our customers’ goals and sharing with them ways we can serve their goals on their journey in ESG. I think those four points resonated well throughout the event. Now moving on to the quarter. So in the first quarter, we had earnings per share of $0.52, an increase of 10.5% over last year. The team had really strong expense management during the quarter, and I am pleased with the incremental margin we were able to produce, despite the fact that, as you saw in our monthly numbers, the March daily sales came in a bit softer. We are now in our fifth month of ISM below 50, and it ticked down in March. We see that in our business, particularly in the fastener side and the OEM piece of the business. But, despite that, I am really impressed with our team’s ability to manage through it. As we have talked about in prior years, we have done a really nice job of managing pieces of our business if we compare to pre-COVID and post-COVID. I apologize for the beeping in the background; my laptop is here. If you look at operating cost as a percentage of sales, in the first quarter of 2019, operating costs were 27.8% of sales. In the first quarter of 2023, they were 24.6%. It’s really about all the changes we have made to the organization. Our average branch is larger today than those back in 2019. More of our business is coming from onsite. We have done a nice job of digitizing our business to bring efficiencies to it, and you can see that shining through. The other piece is as we understand better our engagement with our customers and their needs—as supply chains have improved globally—we have been able to not only lower our days on hand of inventory from what we were seeing a year ago as we deepened our inventory, but to also compare it with where our business was pre-pandemic. We have taken about 3 weeks’ worth of inventory out of the network over that entire timeframe, and I am really impressed with our team’s ability to do that. Finally, if you manage your business well, manage your expenses well, and manage your working capital well, in a distribution business, you see that show up in your cash flow. Our operating cash flow was $389 million, which was 132% of earnings and was 70% higher than a year ago—about $160 million of additional operating cash that we generated in the quarter. Our CapEx, net CapEx, is very similar in both periods, so a very strong free cash flow, which puts us in a position to invest in the business or return to our shareholders. We continued that pattern and we will be able to pay out a nice dividend in the first quarter. Last night, we just announced the second quarter dividend of about $200 million a quarter we are paying out right now in dividends. Moving to Page 4 of the flipbook, Onsite, we signed 89 in the quarter. Active sites finished at 1,674—about a 16% increase from the first quarter last year. If you ignore the transferred sales that come from the branch when you open an Onsite, our Onsite business grew about 20% Q1 to Q1, so strong performance. We remain steadfast in our intention to sign 375 to 400 Onsites this year. The number was a bit weaker in the first quarter, and most of that we saw in March. But when I think of the engagement at the event here over the last several days, I feel good about where we are going to be in the next 6 months. If I look at FMI technology, there was incredibly strong performance by the team this quarter. We have talked in the past about building infrastructure to support 100 signings per day. During COVID, our numbers dropped from the upper 70s and low 80s region as we built up towards the ability to sign 100 per day. We dropped down to the 60s, and we are slowly starting our way back. Last year, in the first quarter, we signed 83 per day. This year, in the first quarter, we signed 92 per day. In March, we signed 99 per day. So, really strong performance by the team, and you can see that continuing to expand on our platform. Our FMI for the quarter was 39.4%. In March, we broke 40 for the first time ever. And I am really pleased and we feel good about our goal of signing between 23,000 and 25,000 for the year. As we have seen in prior quarters, we continue to experience strong growth in e-commerce—recall that last fall broke 20% of revenue for the first time. I believe this quarter we are at about 22%. Finally, if you combine all those pieces together, our digital footprint came in at 54% of sales, versus 47% a year ago. In March, excuse me, we hit 55%. Our goal is to drive that to 65% later in the year. Time will tell if we are able to accomplish that, with a long-term goal believing that number will be about 85% of our business is going through some type of digital footprint. With that, I will turn it over to Holden.

Great. Thank you, Dan. Before diving into the details of the quarter on Slide 5, I wanted to build a little bit on Dan’s earlier comments in his prepared remarks to offer a little perspective on the overall state of our business. If you recall, simultaneous with the onset of the pandemic in 2020, Fastenal accelerated its technology deployment and shifted the structure and priorities of our sales effort. Those actions are adversely affecting short-term sales, though we continue to grow our Onsite and FMI bases as well as our digital footprint penetration; we continue to achieve historical levels of market outgrowth. This also adds an incremental annual mix-related gross margin pressure. However, those changes need to be weighed against the benefits across the rest of our business. Relative to the pre-pandemic business, we have begun to generate meaningful labor productivity and reduced the cost footprint of our facilities. As a result, the incremental margin from the first quarter of 2019 to the first quarter of 2023 of 24% is appreciably greater than what we saw from the first quarter of ‘15 to the first quarter of ‘19 of 16.2%, and we have improved our capacity for leverage over time. At the same time, from the first quarter of ‘19 to the first quarter of ‘23, our inventory days have declined from 175 to 154 days despite inflation and supply chain disruption and our receivables days have fallen from 56 to 55 days despite growth in our national accounts mix. The Blue Team has sharpened our differentiation in the marketplace while sustainably improving the leverageability of our cost structure and lowering our asset intensity. We are a stronger, more productive business today than we were prior to the pandemic, and that is very clear in these first quarter 2023 results. So let’s jump into those. Daily sales increased 9.1% in the first quarter of 2023. February storms had a modest 20 to 40 basis point negative impact, while currency was a 70 basis point drag. There are several other items affecting sales. First, pricing continues to moderate. It contributed 290 to 320 basis points to growth in the period, down approximately 290 basis points from the first quarter of 2022 and down approximately 60 basis points from the fourth quarter of 2022. This trend is not a surprise and will likely continue through 2023. Second, we continue to see weakness in several major retailer customers, our international business, and our construction and reseller businesses. These dynamics have remained unchanged since the third quarter of 2022. Our retailer customers have tightened their belts concerning facilities and labor, which has also affected our non-North American business, along with a strong dollar and geopolitical events. Softer construction reflects the conscious decision we made to position our branches to focus on larger key accounts, which is contributing to better labor leverage. Third, manufacturing and large accounts continue to perform strongly, reflecting investments in Onsite and changes to our branch structure and sales roles. Even so, we did see a downshift in broader market activity in March as represented by slower DSR growth of 6.8%, including just 2.3% daily growth in fasteners. Now, one month does not make a trend. It’s too early to have a good read on April, and we don’t have a lot of forward visibility. We do continue to anticipate that we will outgrow our marketplace, which frankly isn’t growing right now. However, the quarter did finish on a softer note. Now to Slide 6. Operating margin in the first quarter of 2023 was 20.2%, up from 20% in the prior year. The incremental margin—incremental operating margin was 22.7%. Gross margin was 45.7%, down 80 basis points from the prior year. This decline is entirely due to product and customer mix as we experienced widening sales growth outperformance of non-fasteners over fasteners and Onsites over non-Onsites. Price over cost was still negative year-over-year, but narrowed meaningfully versus the fourth quarter. The remaining gap is largely in our other products category, where pricing actions in the first quarter of 2023 only went into place in February, while in fasteners lower costing eliminated the negative price/cost we experienced in the second half of 2022. GAAP expenses were higher with inbound shipments declining as we adjusted our stocking to reflect a smoother supply chain. On the other side of the ledger, contributions to margin from freight were better than anticipated. We saw annual and sequential declines in both container costs and containers purchased on the import side, and record freight revenues allowed for good leverage of our captive fleet expenses. These dynamics are likely to persist for the next couple of quarters. On the operating expense side, we generated 20 basis points of leverage from occupancy costs as branch closings over the past 12 months produced slightly lower facility expense. We generated 80 basis points of leverage from payroll expenses. Total incentive pay for the company in the first quarter of 2023 was the second highest on record for our first quarter. However, with pre-tax growth in the first quarter of 2023 being roughly one-third of the pre-tax growth in the first quarter of 2022, total incentive pay for the company was down high single digits. Other operating expenses benefited from lower bad debt costs, lower selling-related transportation costs, and higher profits from asset sales, which was largely offset by higher costs for IT, general insurance, and sales-related travel. Putting it all together, we reported first quarter 2023 EPS of $0.52, up over 10% from $0.47 in the first quarter of 2022. Now turning to Slide 7. We generated $389 million in operating cash in the first quarter of 2023, or approximately 132% of net income in the period. I will provide a bit more detail in a moment, but this improvement in our conversion rate reflects working capital swinging from a significant use of cash in the first quarter of 2022 to a source of cash in the first quarter of 2023. This strong cash flow allowed us to reduce debt in the period, putting net debt at 10.9% in the first quarter of 2023, up slightly from 10.4% in the first quarter of 2022, but down from 14.9% in the fourth quarter of 2022. Year-over-year, accounts receivable was up 7.3% on higher customer demand and an increase in the mix of larger key account customers, which tend to have longer terms. This was partly offset by an improvement in receivables quality. Inventories rose 3.2%. Inflation was not a material contributor to inventory growth in the period. Further, as indicated earlier, normalization of global supply chains is allowing us to unwind the layer of inventory that we intentionally built up in late 2021 and early 2022 to manage what had been significant product bottlenecks. We believe the process of rightsizing inventory will continue through 2023 with additional releases of cash as the year progresses. Net capital spending in the first quarter of 2023 was approximately $31 million. Our range for net capital spending in 2023 remains $210 million to $230 million, and our first quarter spending being behind that pace reflects timing of expenditures. Over the course of 2023, we expect higher spending on hub investments, fleet equipment, and IT equipment. With that, operator, we will turn it over to you for questions and answers.

Thank you. And our first question comes from the line of Chris Dankert with Loop Capital Markets. Please proceed with your questions.

Hey, good morning, guys. Thanks for taking the question.

Good morning.

I guess, first off, thinking about your conversations with RVPs right now, how do they feel about adding FTEs or kind of management there? Just how are we thinking about labor management today and growth kind of going forward?

We have talked about labor management with the RVPs really coming into this year. The premise was when you look at where the PMI is and the trend in industrial production, we needed to be looking forward and really have a plan to be cautious about hiring. Now in January and February, I will tell you that demand grew pretty healthily, and I think we added people sort of related to that. In March, obviously, we called out that demand softened a little bit. I would also point out that our hiring adds softened a little bit in March as well. We have always talked about how we can react fairly quickly to changes that we are seeing. The message to the field has been that you have to be prepared to adjust for a downshift in demand. Again, that’s not a message we just conveyed; we entered the year having that same conversation. I think they have been really responding by adding resources where they need to and adding the right resources. We continue to see the mix of part-timers growing in the overall piece of our business, right? Where we have added full-timers, a significant portion of those would be made in India. I think that the organization is focused on the right metrics to understand what they need to do from a labor standpoint. I think they are executing on that. I was encouraged that as demand slowed down in March, so did the hiring adds. So I think we are doing the right things.

That’s great color. Thank you so much on that. And then again, just thinking about the CSP growth seems to be lagging a bit more relative to the rest of the business here. Does that change any of the calculus around the pace of closures there, or how you are positioning the business from a channel perspective?

By CSP growth, what are you referring to?

Just the non-national accounts piece of the business, obviously under growing national accounts and Onsite. I guess my assumption is most of that is the more traditional branches, correct?

So remember that our traditional branches support not only the local businesses you refer to but they also support the national accounts business. But yes, I think you’re referring to the non-national accounts sector on our release. Thank you for that clarification. When you think about what’s happening in the construction— the reseller segment, traditionally, there have been a lot of smaller customers there, right? I mean, what confuses me is when you talked about CSP; CSP was our old stocking model that we began to unwind a few years ago. That CSP was intended to draw in that smaller local construction customer, provide them a high degree of service in the local market, and things of that nature. Our priorities in the branch have shifted a little bit, trying to move that customer online and create a focus on some of those larger customers in the market. I can’t say that I’m surprised by what we’re seeing. I think the relative weakness you see in construction compared to manufacturing is tied to the difference you’re seeing in the national accounts versus the non-national accounts growth as well. So I think those things are all related. Does that get to your question?

That does. That makes a ton of sense. Thanks so much for the detail there. I’ll leave it there. Best of luck on the quarter, guys.

Thank you.

Our next question comes from the line of Steve Volkmann with Jefferies. Please proceed with your question.

Great. Thanks, guys. Can I just pull on that thread slightly one more time, Holden? How long do you think that transition takes in the construction-type business where you sort of move away from some of these smaller customers? I assume that’s a process that lasts a year or two; I don’t know. How long do you think that goes on?

I don’t love the phrase ‘move away’ from those types of customers. The truth is we’re trying to service them through a different model, but setting aside the semantics, I suspect just looking at how that cadence has played out in the preceding, call it, 15 months, I suspect that we will probably have some softness in that area. That transition period will probably last the bulk of this year. I think as we get into Q4 and into next year, I think you begin to lap those comps. I think we’re probably in a position where it doesn’t represent the drag on our business than it does today. So I think you are right to look at it as a transition, and once we lap that transition, I think the growth you’re seeing today in those manufacturing customers and those large customers is really going to begin to shine as we sort of work through that transition over the next two or three quarters.

Also, if you think of the chart we’ve shared in January of each of the last several years, we talk about branch consolidations; we’re near the end of that process. If you think about our customer segments, the customers we’re highly engaged with from a Digital Footprint perspective are our supply chain partners. Those customers rarely, if ever, come into one of our facilities; they probably don’t know we’re located. If you’re in a market and you consolidate a few locations, you are actually moving further away from this other segment of customers. If you look at where we get to that ultimate branch count, we’re probably a year away from being at that point, and that ties right into Holden’s comment.

Yes. So looping that back to Chris’ comment earlier, pardon the pun. I failed to mention that. I mean that’s another reason why those smaller customers have been relatively weaker as well because a lot of the time when you go through branch consolidations, you'll find that’s the customer that no longer is visiting that location that would have otherwise been there. So that’s an element of that as well.

Right. Got it. Yes. Apologies for the semantics; I was struggling for something better unsuccessfully. But can I switch slightly? When you talk about some deceleration, it’s kind of an interesting dynamic. Do you have visibility? Do you think your customers are destocking because the supply chains are now better, and so that might be part of what we’re seeing? Or do you think it’s actual sort of end market slowdown? The other interesting overlay that’s going on is that you would think that production rates would actually go up at your customers as supply chains normalize rather than down. So I’m just curious if you have visibility into any of that, and then I’ll pass it on.

Yes. The feedback from the regionals really touched on both things that you brought up, Steve. One is they did talk about how as supply chains normalize, you’re seeing suppliers of products begin to shave back their production simply because their customers can now—they may have tried to hold extra product, and now they can back that up a little bit. So there is an element of adjusting to the supply chain. But I also did get a number of comments from regionals that they’re also seeing our customers tightening their wallets a bit in terms of capital spending and operating expenses. I think there is a little bit of both of those dynamics playing out.

The other piece I’ll add from an insight perspective, if you think about our business from a product line and product use perspective, if I go back to January, OEM fasteners represent 20-22% of our revenue, kind of low 20s. That business was growing around 13.5% in January. In March, it grew 7%. So that is production dropping off. If I contrast that with safety, for example, our safety business grew stronger in March than it did in January. Now, I honestly haven’t given that much thought in the last few days; I don’t know if there was a comp issue because some of the safety was being pushed around a little bit due to some COVID activity. But that’s a case of that business fell off a bit in February, which I know was a comp issue with last year. However, I don’t believe January and March had a comp issue. I think that ties into the strength we’re seeing in our pending deployment. If I look at remaining products, that did also fall off a little bit, and there will be some production impact there as well, particularly in metalworking.

Got it. That’s great color. Thank you, guys.

Thanks, Steve.

Our next question comes from the line of David Manthey with Baird. Please proceed with your questions.

Dave, if you’re talking, unmute.

And moving on, our next question is from the line of Ken Newman of KeyBanc Capital Markets. Please proceed with your questions.

Hey, good morning, guys.

Hey, Ken. Good morning.

Holden, I’m curious if you could just talk a little bit more on the fastener sales trends in March. Obviously, a bigger sequential slowdown here, and the comp for April looks pretty similar. I guess, two minor questions here. One, should we assume that the fastener volumes were negative in the month? And two, how do we think about the net margin impact of that part of the portfolio since I think it’s typically accretive to mix, but you also called out lower shipping container costs?

Yes. With regards to the volume side versus the price side, I’m trying to think. So I think that’s an element. Again, it’s our most cyclical line. Dan referenced sort of the commentary about the OEM fasteners in particular. Today, OEM fasteners represent about 62% of our fastener business. When you get a slowdown of some sort in a period, it’s going to affect the volumes in the fastener side of the business. You’re right; it tends to be a higher margin line. To the degree that fasteners grow slower than the rest, that does have an adverse mix impact. I think that’s always been the case, cycle to cycle; it’s something we talk a lot about, about sort of mix impact.

When the falloff is in the OEM fastener component of the fasteners, the mix impact is different than if it’s in the MRO piece, because the OEM fasteners do not have a higher gross margin than our overall company gross margin; the MRO fasteners do.

That’s helpful color. Got it. And then I guess for my follow-up here, I’m curious if you—last quarter, you talked about the need to renegotiate pricing with some of your big vendors because of steel prices as well as transportation costs. You’ve obviously talked a little bit about transportation easing a bit, but the prices have also kind of stayed in here in recent months. I’m curious if you have any update on the color for price/cost negotiations on higher steel material.

We are acutely aware of steel pricing and shipping costs. That’s our covenant with our customer. We’re going to find the best quality, best price, best reliability supply chain for their business. There are always robust conversations going on. However, we also operate in a very dynamic marketplace. We’ve been seeing fastener prices stabilize for a number of months now, and we’re seeing that come through in our cost of goods. That also helps our gross margin in the short-term because we were getting squeezed a little bit 6 and 9 months ago. A little bit of that squeezing is lessening right now, and you’re seeing that in our numbers as well.

I think those conversations—we’ve always talked about how our objective was to talk to those customers about the timing of our costing, and we understand, as Dan said, we have a covenant to sort of adjust as appropriate. Our customers have been great working with us to understand when our products will be coming through at a lower cost, etc. We’ve always felt that as we get to that second quarter, there will probably be more activity around that and adjustments to be made. I still think that’s probably the case, those are sort of second quarter, and third quarter type activities. But again, what you should be getting a sense of is we’re trying to time any decline we may have in pricing to our customers with the declines that we see in costing. I certainly understand the concern. But again, I think we’ve done a good job sort of matching price and cost. I think the team has done a great job on this side of the cycle. The objective is to be price/cost neutral.

Understood. Thanks for the time.

Thanks.

Thank you. Our next questions come from the line of David Manthey with Baird. Please proceed with your questions.

Thank you. Good morning, Dan, Holden.

Hey, David.

Yes. In relation to that—to the prior answer, that’s exactly what I wanted to have you discuss, just the general pricing methodology of how you’re trying to match your customer pricing relative to the actual COGS in your supply chain versus front-running any price increase or, I guess, lagging a price decline. You addressed it to a large extent, but I just want to be clear on that. Your container prices are down, steel prices are up a little bit, and you’re saying that fastener prices are mostly stable today. So you’re not anticipating any major changes as we look at 2023 as we sit here today?

As we sit here today, I would say no, we’re not. Again, we might need to adjust pricing; this is not a surprise. We know where that would have to happen to actual pricing. We have pretty good visibility into our costing. We really do try to align those two things. During the period of inflation, we didn’t have a point where our pricing was ahead of our costing, and that was deliberate. As you got towards the flip side of that cycle, we actually got a little bit behind from a pricing/cost standpoint just because we were trying to respond to the marketplace. All we are seeing—well, as we talked about two quarters ago, we started talking about two quarters ago, we wound up having negative price costs on the fastener side. We anticipated at the time that costing would catch up to our pricing, and that’s largely where we got to this quarter.

If you break our business into three components, Dave, to Holden’s point, I think we’ve done a really nice job managing through it. Part of the lumpiness to it was some of the changes were pretty extreme. If I look at safety, we have great visibility to demand. Over half of that business is going through a vending device. You really understand that business and we’ve been able to manage through that quite well. We adjusted some pricing here as Holden touched on during the quarter on our remaining product lines because we probably weren’t—as we were focused on half our business that’s fasteners and safety, we were probably not as focused on the other half of the business as we should have been and we did some corrections there. We raised some prices on the non-fastener, non-safety piece during the quarter.

Thanks, guys. My dog and I appreciate the answer.

Thanks, David.

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

Thanks. Good morning, everyone. I know the freight is quite a small portion of revenues, but you called out the growth of 14% or so, which is obviously very good margin. Just wondering, given where LTL tonnage is trending right now, how—what did you do to get that kind of growth rate? And it sounds like you can just continue going forward. So just wondering what’s driving that kind of growth?

I think sometimes you can be guilty over time of focusing on a handful of things, and sometimes other things fall off that focus. If anything, we were probably a little bit guilty of that in recent years on the freight side of the equation. I’d say we’re probably reverting to some of the freight pricing habits that we had 3 and 4 years ago that were maybe a little bit waning in the last several years. COVID and all the other distractions of life came into play. The other element to all of this is, while we lost some focus on our ability to charge for freight, we've been quite good at using our own trucks for moving freight. So we have those two dynamics going on. We’re probably back to where we should be on what we’re charging out, and we’ve improved on how much goes through our own network, and that’s a nice one-two punch.

There are several factors today, some of which are long-term sustainable and some are kind of in the here and now. We alluded to an increase in capital spend—more plant spend becomes a bigger portion of our business, making it easier for us to plan our own logistics, right? We have seen our third-party freight go down, in part because of that trend. I think that’s going to continue. We did, or are in the process of executing some route consolidation and some rescheduling of routes, which I think will bring some efficiencies into the business; it’s not just the ongoing continuous improvement of the business that I think will be sustainable. What you’re referring to is important because, as our revenues have gone up, and as we focus on that, the cost structure of our semis fleet is fairly stable, so as revenues go up, we leverage that fairly well. The other piece in this quarter that occurred was, one, container costs are down a lot—down about 75% year-over-year. So, that was a benefit. I would also point out that our container flow is down a lot this quarter because of the things we are doing to unwind some inventory, and our container flow in the first quarter was down about 50%. These last two issues are not necessarily long-term issues; they are adjusting to sort of things that appeared in the last couple of years, I do think those will last for the next couple of quarters. But things like plant spend and lower third-party freight route consolidation, those sorts of things, I think are going to continue to improve the business. The big variable will be demand because our freight revenues aren’t different than our other revenues. If activity levels begin to drop, then freight revenue dollars may come in and that stable cost base could work against you. And so we have some great execution going on with freight in the organization.

Yes. No, that’s great. Thanks, guys. Just a quick one, we talked about the March sales now at some length. But you called out weather impact in February; you didn’t call out anything in March, but some companies are blaming weather in March. So I’m just wondering, were there any weather impacts that could explain some of the weakness you saw towards the back end of the month?

No. We’ve tried to raise our threshold of pain; I can find you an RVP that thinks there was some weather in January, sure—can I find just someone that thinks there was some in March? Yes. It doesn’t rise to a threshold that’s worth discussing; that wasn’t true in February.

Okay. That’s great. Thanks, guys.

Nigel, for what it’s worth, as Holden was answering that first question, I did take a quick look; our freight as a percentage of sales that we charged out in the first quarter of 2022 was identical to what it was in the first quarter of 2019. In the last two years, it had dropped off about 30 basis points.

Thank you. Our next question comes from the line of Pat Baumann with JPMorgan. Please proceed with your questions.

Hi, good morning. Thanks for taking my questions.

Hi Pat.

Just a quick one on pricing first. I think there was a wide range on expectations, at least as I understood it for your pricing coming into this year. Maybe you were thinking it could be down 1 point or 2 points or up 1 point or 2 points, depending on how things played out. I guess I am just curious, after the first quarter, and your actions in February and what you just said on kind of fasteners with regard to the input cost on that, what your expectations are now for this year on pricing? And then as a corollary to that, just thinking about your February pricing actions in the non-fastener, non-safety portion of sales, do you think that had anything to do with kind of the volume slowdown you saw there for the month of March?

I will touch on the last part of your question, then I will let Holden handle the meat of it. On that last part, if you think about what happened and what we are just running through on those OEM fastener numbers, the drop-off from January to February was linked to production business. Our OEM fasteners dropped in half in terms of growth, from 13.5% to 7%. There was no pricing action there. If you look at the remaining product lines, the drop-off occurred 30 days after. It was really about the production aspect of our business, not so much the other parts.

Yes, I would agree with that. Plus, frankly, those price increases went in sort of late in the quarter, and I’m not sure you would have seen responses like—you’re alluding to in such a tight window. That said, we’re not really expecting this will be adverse to those lines from a gross standpoint. Yes, so we just didn’t see that; I wouldn’t expect to see that. As it relates to the overall pricing, remember, the wide range I’ve given is because ultimately, we don’t have great visibility as it relates to how much pricing we’re going to have to give away to customers because of contracts and things of that nature. My comment was that if demand softens and there’s a lot of pressure to adjust price based on contracts, etc, maybe our pricing is down a percentage point. If that doesn’t occur because it hasn’t to this point, maybe it’s up a percentage point. That’s why there is a wider range, and I think that’s still the case. We talked a little bit in an earlier question about how I suspect in 2Q and 3Q we will be adjusting some pricing. However, I have spoken to some people before about how I think pricing comes into that zero to 2% range—probably in the lower half of it if nothing changes. We’ve made some changes to our pricing in that other products area and what I would tell you is if we never have to adjust fastener pricing, I suspect that our pricing this year will be in the upper half of that zero to 2% range. But now the wild card becomes what do we have to do with fastener pricing if we give a bunch of that back in 2Q and 3Q? Then that upper half of the range comes down. That’s just something we don’t know the order of magnitude of impact yet.

That’s helpful color. Maybe my follow-up would be around gross margin then for this year. I think you were expecting maybe 50 basis points to 100 basis points of contraction when we talked in January. It sounds like maybe pricing could be tracking a bit better, price/cost may be neutral; I don’t know. The freight commentary sounded better as well. So, wondering if you are thinking any differently about that framework now.

Yes. So again, price/cost, most of the variables that were impacting gross margin didn’t surprise us. The degree that mix is impacting—when you think about how the quarter progressed, that didn’t surprise. If I think about the price/cost elements of it, that’s playing out largely as we expected when we talked about it last quarter. The only variable that was a surprise was that freight piece; we executed very well. I do believe that most of the variables that benefited freight will be in place in 2Q and 3Q. So, freight may have increased my expectations around gross margin for the full year, but that’s really the one variable that played out differently than I expected it to from last quarter’s conversations.

Okay. That’s helpful. I will squeeze one more in.

Do we have two?

Yes. That’s great. Thanks for the time. Appreciate it.

Thank you.

Our next question comes from the line of Jacob Levinson with Melius Research. Please proceed with your questions.

Hi, good morning, everyone.

Good morning.

I just—I realize it’s still very early days here, but I’m just curious if you have heard anything coming out of the field in terms of the impact of credit stresses on either customers or some of your smaller competitors?

No. We actually reduced our bad debt expense, which was a benefit to our margin this quarter. We are just not seeing a significant impact in our business regarding that.

Okay. That makes sense. And then just quickly, the second one, I can see that you are still planning on spending that $200 million-ish capital spending this year despite the fact that the growth has come down a little bit. Is that partly just a function of the fact that you haven’t been able to get some things done over the last few years due to all the volatility around COVID, or is it really just a function of the fact that, obviously, 10% growth in the quarter is not exactly a recession?

Well, hey, that’s the piece. The other thing is we are always adding infrastructure for what we need long-term. If you think about what’s going on right now, we are expanding our distribution facility in Denton, Texas and on the other side of the Fort Worth area. We are building a distribution facility in the Salt Lake market. We are adding capacity because we have all grown the capacity we have. If you think about our FMI, that’s quite strong right now, and that’s a capital item we are adding. The last piece would be, if I think of where we have probably struggled the most in recent years to add would be on the vehicle side because stuff just wasn’t available. You couldn't get our Dodge RAM pickups in the way we wanted to; we couldn't get our semis the way we wanted to. That is loosening up now, and some of the CapEx is going into the transportation side. Recently, I was visiting one of our onsite locations. I am pleased to say that I received a picture here about 1.5 weeks ago of a bunch of Fastenal trailers being produced that are coming down the production line. Those kinds of things, we are able to get better today than we could have 6 months or 12 months ago.

That makes sense. Thank you.

Thanks.

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

Good morning, and thanks for taking my questions.

Good morning, Tommy.

I wanted to start off on OpEx. If I’m doing my math right, in the first quarter, employee-related expenses grew at less than half the rate of sales, which is great to see. I suspect you may walk us back from assuming that recurs here in the second quarter or the rest of the year. So to the extent you can frame what you would anticipate for the second quarter, that would be helpful, and just any qualitative commentary for the year would be as well. Thank you.

Yes. I don’t know that I am necessarily going to walk you back. I think it’s important to understand the source, right? The reason why we were able to leverage the way we did was because we are just not growing as quickly this year as we grew last year. I wanted to emphasize that we had a healthy payout of incentive pay; it wasn’t as healthy as last year, and that’s not a surprise. If I think about how the rest of the year plays out, we still have some pretty large numbers that we will lap in the second and third quarters as well. I do expect that we will have healthy incentive payouts in the second and third quarters; we’ll see how the market plays out. But I do believe that they will be lower than what we experienced last year. So I think we’re going to have, for most of the year, that element of lower incentive pay year-over-year that helps us in leveraging payroll-related expenses.

A good chunk of our incentive comp—and we cover this in detail in our proxy. A good chunk of our incentive comp is tied directly to pre-tax earnings growth, so if you think what was going on last year, Q1, Q2, and Q3 had a meaningful expansion of that incentive growth. Q2 was the highest of the three, but I believe it was about $0.5 million higher in Q2 versus Q1. So just nominally higher, and then drops off in Q4. Depending on what’s happening with our earnings growth relative to what was happening in the same quarter of the prior year, that gives us a bit of a buffer here in the first quarter and presumably in the second and third quarters, unless the economy surprises us and turns more positive—that would be a great problem to have.

Thank you. I appreciate the insight, and I wanted to shift for my second question to a higher-level strategic question. The framing you provided on the structural improvements in terms of leverage and asset intensity versus the pre-pandemic base was very helpful. There is clearly some progress on both of those initiatives. If you think about 2023, what are some of the key focus areas, the work that’s still ahead of you for this year? Are there any that you would draw our attention to that you’re really focused on driving through the organization at this point? Thank you.

If you think of the growth drivers, that’s what comes to mind first. That’s not what your question is, but for me, growth drivers come to mind first because the structural changes we are making are driving customer acquisition, both in terms of physically what channel is going through branch versus onsite and what tool are we using within the respective channel, FMI, etc. to serve at a high level in an efficient manner. If I think about things that impact our cash flow, we talk about our covenant with our customers, which includes several elements: finding great quality products, great availability, reliability, and price. One of those elements—availability—we had to take a tremendous amount of working capital inventory onto our balance sheet over the last 6 to 18 months, creating chaos in our supply chain. We had to be late and actually revert back for several years. But that piece is being worked through. When I envision a very, very strong cash flow year as we saw in the first quarter, we can take not just days, but weeks out of our inventory on hand. We are managing our accounts receivable relationships at a strong level. We have a better CFO today than we did 10 years ago. These things help. You put those together, and we have talked internally about what we call our Drive to 35, and what that is, if you look at our internal financial statements, we look at accounts receivable business unit by unit. We look at our fully loaded inventory, which is local inventory as well as the allocation of distribution inventory. We also look at our local vehicles. We analyze these three assets, and we say an optimal place for us in a $175,000 a month branch and a $200,000 a month branch is all 35%, that number: 35% of the annual sales. We haven’t been able to drive towards that in the last few years due to COVID, inflation, and supply chain disruption. We are going to continue moving down that path. I don’t know if Holden believes we can get to 35; he might be a 37 guy, but I believe we can get to 35. If international allows us to make Holden more right or me more right, I think this will create—if we are growing well, I am cool with either number, to be honest. But what puts us in a position to really rationalize this inventory is when you are—conceptually, when you are pulling inventory through the supply chain network and you have great visibility into how we are operating. Sixty-five percent of our revenue is in this FMI footprint; we have great visibility to need. You can manage that, setting aside disruptions like you experienced last year. You address the long-term efficiencies pre-pandemic. You see that shine through our cash flow in the quarter, as well as in our operating expenses, particularly the questions you had about our people costs.

I mean if you talk to our sales EVPs, a lot of the things that you’re seeing happen, it’s us taking advantage of stuff we have already installed. We’re taking advantage of the changes in branches—we’re taking advantage of the digital footprint, the lift, the new role specialization—all those things. We put those in place, but we haven’t necessarily maximized the benefit to our business yet. Our sales EVPs believe we will be more efficient 2 years to 3 years from now than we are today, that there is still plenty of room to run on that. I would say as well that we’re doing a lot of things to improve velocity in our system and things like that. We still have a lot of import inventory that we can work off because we had to think further in advance regarding purchasing behavior during the pandemic. We probably doubled our writing orders period, and we need to revert our behavior to pre-pandemic levels; we have seen an improvement in fulfillment rates but still room to improve. Our commentary regarding where we are as a business is intended to say we have arrived; it was to indicate we have progressed nicely, but there is still room to go.

Great. We look forward to watching the progress; I will turn it back.

Thanks. I think we have time for one more question. If there is one left, we see it’s four minutes to the hour, and we want to wind things up properly. Just one more question; we will take it, otherwise, we will wrap up.

Sure. The next question comes from the line of Chris Snyder with UBS.

Thank you. I guess maybe for the one question, specifically, we are looking for more color on the back half of March softness. It sounds like the month ended softer than it started. Any end markets or product lines that saw a negative rate of change throughout the month? Because the ones you called out were retail customers and international construction—stuff that’s been weak for the last three quarters. Did those just get weaker, or did you see anything else kind of weaken as the month went on? Thank you.

We don’t have great visibility into specific end markets for the most part. What I would tell you is, outside of our Texana region, which was still fairly positive on overall demand—Texas and Louisiana are very oil and gas-oriented. So I think that market is doing well. Frankly, the vast majority of our other regions all had some variation of things softened in March. It was pretty broad throughout the manufacturing space, not specific to any one market or what have you. I will add a little piece, and this isn’t standard; this is an observation. I had a lot of discussions with global operations entities, customers of ours or potential customers over the last few days. There were tremendous intersecting events. A lot of people said part of the reason we are here is we want to learn what you are doing from a technology standpoint to help our business. When there is a breather, when there is less noise and less things you are worrying about, all of a sudden, the things you haven’t done for the last 12 months or 24 months or 36 months become more apparent. I think that’s positive for our ability to take market share. Even if the business itself—the customers we look at in our top 100. If you dial that in slightly and start looking at our top 10, that’s really where we felt the most pain; our top 10 customers were contracting from where they were six months ago. That’s economic. But our customers ranked 10 through 50 were growing; customers 50 through 100 were growing nicely. That is due to our ability to pick up market share, which makes me more enthused. Our long-term success comes from our ability to take market share every day. The economy is going to do what the economy has to do short-term; we have a healthy business; we can generate more cash flow in a year like this. We would rather be deploying the cash flow into the business, but in a year like this, maybe we will return more to our shareholders. It’s all about focusing on the long-term opportunity of the business, and I’m as excited as ever. With that, it’s been an hour. Thanks for your interest in Fastenal today. Everyone, have a great April.

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