Earnings Call Transcript
FASTENAL CO (FAST)
Earnings Call Transcript - FAST Q3 2023
Operator, Operator
Hello, and welcome to the Fastenal 2023 Q3 Earnings Results Conference Call and Webcast. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Taylor Ranta of the Fastenal Company. Please go ahead, Taylor.
Taylor Ranta, Host
Welcome to the Fastenal Company 2023 third quarter earnings conference call. This call will be hosted by Dan Florness, our President and Chief Executive Officer, and Holden Lewis, our Chief Financial Officer. The call will last for up to one hour and will start with a general overview of our quarterly results and operations, with the remainder of the time being 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. A replay of the webcast will be available on the website until December 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.
Dan Florness, CEO
Thank you, Taylor. Good morning, everybody, and thank you for joining our third quarter call. I'll start on the flip book on Page 3. Conditions remained challenging in the third quarter of '23, reflected in a daily sales growth rate of 4%. Still, regardless of the year, we celebrate milestones when they occur. I remember just over 10 years ago when we hit $10 billion in daily sales for the first time, we recognized that on this call as well as internally to celebrate that milestone. Some years later, we hit $20 million. Here in the month of September, we broke $30 million in sales per day for the first time in our history, and my congratulations to the Fastenal organization for hitting that milestone. Our sales growth in the quarter translated into EPS growth of $0.52, a 4.1% growth over the same period last year. Our results reflect the unique profile of our business. Fasteners still constitute about a third of our sales, and within that subcategory, about 63% is in OEM-oriented fastener, and that business can be very cyclical because of the production needs of each of the customers we're serving. If you look at the rest of the business, it tends to be much more MRO-oriented. Our fastener daily sales, as you've seen in our monthly sales release, have decelerated at a faster rate than our non-fastener business as we've gone through the calendar year. The third-quarter operating margin hit 21%, which matched last year despite one less selling day. Earlier I spoke about the $30 million we do in a day. The quarter had one less day. Many of our expenses are tethered to the day; most are not. I'm pleased that the team was able to match the operating margin of 21% from last year. I believe that understates the reality of the performance. If you looked at it on a same-day basis, we believe we would have increased the operating margin because we'd have had roughly $10 million more, about a third of that $30 million in operating income, because a good chunk of that flows through because of the change in the nature of the expense. The Blue Team, if I think about the last several years, we had a unique opportunity to serve the marketplace because of our pristine balance sheet. When COVID hit the globe back in 2020, we were able to step forward and secure and purchase and fund with cash a meaningful increase in inventory, primarily centered on safety supplies, because our customers and society, in general, needed something to get through that period, and we were proud to be part of the solution. We were able to do that because of our balance sheet. As the global economy reemerged from the pandemic, we saw first-hand, and you saw it in daily news clippings, about congestion that was going on in supply chains around the planet. Again, as supply chains became more rocky and you couldn't rely on how many days it would take to get product, there's a solution to that: stock more product. We beefed up our balance sheet, and our cash flow suffered as a result, but I believe our standing with our customers and in the marketplace never performed better because the market could rely on the covenant that Fastenal provided to them in being a great supply chain partner. As we moved deeper into 2022 and now into 2023, we've been able to unwind a piece of that. On a year-to-date basis, we have converted 121% of our net earnings into operating cash flow. That's our highest performance in a decade that averaged just shy of 100%, about 95%. If I look from the standpoint year-over-year, in the quarter, our operating cash grew about 51%. Year-to-date, our operating cash has grown 69%. Our Onsite and FMI installed bases and our digital footprint continue to expand. Earlier this year, we did some restructuring and announced the elevation of Jeff Watts to Chief Sales Officer in the organization. The restructuring of the sales side of our organization was essential because we wanted to double down on the challenges we had laid out in front of everybody from 2015. That was really stepping into what we saw as an untapped opportunity to grow our business faster and to expand our Onsite presence. It was earlier this year that for the first time, the number of Onsites in the organization outnumbered the number of branches in the organization, and that delta continues to expand. We believe that each district manager has the potential in their market to land two Onsites per year, and it's our job and part of the purpose of the restructuring of the sales team was to really decide, hey, we believe it, but we haven't done it. Let's do this. We expanded; not too many years ago, we were signing 80 Onsites a year, and we laid out the plan to get to 400 a year. We expect, as you see on the next page, we'll do about 350 this year. However we haven't hit that number, and we've been somewhat stuck. COVID threw some challenges our way. It's never an easy time to move in with somebody when they're trying to isolate from the rest of the world, and that challenged our ability to grow coming out of COVID. But looking at the opportunity that's out there, I believe we can do that. We need to turn that belief into a reality. Speaking of Onsites, we signed 93 in the quarter. As a result, our active sites are 1,778, 13.5% greater than they were at the end of the third quarter of 2022. Our daily sales in those Onsites, excluding transferred business when you open an Onsite, is in the low-double digit rates. Therefore, we're seeing good growth there; we're just not signing enough. As I said, we still anticipate signing roughly 350 this year. FMI technology, we set lofty goals as well. We asked ourselves, can we do 100 a day? Not 100 a quarter, but 100 a day of our weighted device count. In the quarter, we did 5,969, which averages 95 per day versus 81 a year ago. When you look at our sales by product line in our monthly and quarterly releases, one thing you do see is our safety business grew almost 10% in September. A lot of that could be attributed to the success we're seeing in FMI. We anticipate we'll sign between 23,000 and 25,000 MEUs this year, which is a combination of FASTBin and FASTVend. eCommerce remains a relatively small piece of our business, just under 25%, but it's up from single digits a few years ago. It currently grew about 41% during the quarter, showcasing how the marketplace is expressing preference to purchase from us this way. Our challenge is to continue to make it easier for our team to facilitate these purchases in the field. In addition to our earnings release, several 8-K filings went out around the earnings period. I wanted to share some insights on three of them: First, we announced a dividend of $0.35, consistent with the dividends paid in each of the first three quarters of the year. Secondly, we announced a leadership change. Tony Broersma has been promoted to Executive Vice President of Operations. He has been with the organization for roughly 20 years and has demonstrated excellence throughout his career. And finally, we said goodbye to Terry Owen, our Chief Operations Officer, who has been with the organization for about 24.5 years. I wish him all the best in his next chapter. We always see another layer of talent ready to step in to discover their future and opportunity.
Holden Lewis, CFO
Thank you, Dan. Good morning, everyone. I'm going to start on Slide 5. Total sales in the third quarter of 2023 were up 2.4%. Adjusting for the fact that we had one fewer selling day in the quarter, our daily sales were up 4%. Frankly, the dynamics of the quarter varied very little from the second quarter of 2023. Macro data points and feedback from the regional leadership continue to indicate sluggish demand and a cautious outlook for spending and production. We are encouraged by the improvement in our September daily sales rate to up 5%. However, it seems to have more to do with easing comparisons in certain parts of our business than a clear signal of firming customer demand or brighter outlooks. Dynamics around our products, customers, and end markets have also trended similarly over the past three and six months. Manufacturing grew 6.4% despite soft demand, benefiting from further growth in the Onsite installation base and initiatives in national accounts in the field to target key account plan spend, which is disproportionately manufacturing-oriented. Non-manufacturing was down 1.3%, although the rate of decline moderated as we began to hit easier comparisons in non-residential construction, reseller, and warehousing customers. From a product standpoint, fasteners are relatively weak, down 2% due to their more cyclical profile and rapid pricing moderation. In contrast, non-fastener products remain healthy because of further growth in our vending installed base and improved comparisons. As it relates to pricing, it remains positive but has come back to a range of 0% to 2%, which we consider typical under normal economic conditions. We did experience modest deflation within our fastener product line. Now to Slide 6. Operating margin in the third quarter of 2023 was 21%, equaling our margin from the third quarter of 2022. Typically, given mid-single digit daily sales growth, we should be able to defend our margin. The fact we were able to do so despite the headwinds related to the fewer selling days Dan described points to what we believe was more effective cost management by the team relative to the second quarter of 2023. Gross margin was 45.9%, flat in the period from the prior year. Freight remained favorable, reflecting modest leverage of our captive fleet expenses, reduced use of external freight providers, and lower fuel and shipping costs. We also benefited from the absence of last year's $3.4 million glove write-down and slightly positive price-cost. These favorable variables matched the margin drag related to product and customer mix. The impact of mix was slightly less negative, and the impact of price-cost was slightly more positive than anticipated in the second quarter call. We did not take any incremental pricing actions in the period, and the favorable price-cost in the current period largely regains the negative price-cost we discussed in the third quarter of 2022. We expect price-cost to trend neutral in coming quarters. SG&A was 25% of sales, up from 24.8% of sales, mostly due to the one fewer sales day. We experienced modest payroll leverage with lower incentive pay, reflecting slower growth in the third quarter of 2023 versus the third quarter of 2022. This was more than offset by rising information technology spending, increased general insurance costs, increased expenses to maintain our selling-related truck fleet, and higher bad debt. Relative to the second quarter of 2023, the organization tightened its management of discretionary expenses with spending on travel, meals, and supplies being down 0.6% year-to-year and continued moderation of growth in our FTE count. Putting everything together, we reported a third quarter 2023 EPS of $0.52, which is up 4.1% from $0.50 in the third quarter of 2022. Turning to Slide 7, we generated $388 million in operating cash in the third quarter of 2023, or 131% of net income in the period. Cash generation is traditionally strong in the third quarter, though conversion in the current quarter was stronger than its historically typical. This reflects reduced need for working capital as demand slows down and improvements in inventory. The resulting strong cash flow means our balance sheet remains conservatively capitalized at the end of the third quarter of 2023, with debt ending at 7% of total capital versus 9.4% in the second quarter of 2023 and 14.9% in the third quarter of 2022. Year-over-year, accounts receivable were up 5.4%, which is a combination of sales growth and the impact of mix due to faster growth of larger customers, which tend to have longer terms. Inventories fell 9.8%, as slower customer demand reduced working capital needs. We are unwinding inventory layers built in late 2021 and early 2022 to manage supply chain constraints. Our days on hand fell again to 134.6 days, the lowest since 2002, which reflects improved velocity of inventories through our internal network. We reduced our net capital spending range to $180 million to $190 million, down from $210 million to $230 million. This largely reflects timing and deferrals related to hub automation and expansion projects that we do expect to include in next year's capital spending plans. The third quarter of 2023 profiled very similarly to the second quarter of 2023. We continue to experience stagnant demand, a cyclical shift favoring non-fasteners, and a secular shift favoring larger manufacturing-oriented customers. Growth driver performance is not quite where we would like it to be, but continues to support good growth in our installed base, success in providing differentiated value to our customers, and further cost and asset efficiency. Operating margin performance remained stable despite slow growth, and our capacity to generate cash to reinvest in the business remains strong. We began to experience easier comparisons in certain markets, and our management of discretionary expenses improved over the preceding quarter. We believe we are positioned to meaningfully accelerate sales growth when underlying demand improves, while sustaining strong profitability and returns. With that, operator, we'll turn it over to the Q&A.
Operator, Operator
Our first question is coming from Nigel Coe from Wolfe Research.
Nigel Coe, Analyst
Thanks. Good morning, everyone.
Dan Florness, CEO
Good morning.
Nigel Coe, Analyst
So the price cost definitely coming a bit better than we expected. Is this as simple as thinking about the ocean freight rate normalization? So I'm just wondering if when we talk about the freight benefits, is that more ocean-bound freight as opposed to domestic?
Holden Lewis, CFO
I think, Nigel, there's a little bit of that flowing through, but we've definitely seen lower costs related specifically to our fastener line. And I think that's largely what you're seeing. So yeah, when we think about what caused a lot of the inflation in our business, there was an element of it that was raw material, but there was a fairly significant element that was related to transportation. I think you're seeing some of that gradual impact play through. But I want to also give a lot of credit to the organization, particularly sort of the field and the national accounts teams and the folks that manage pricing. I mean, I believe five years ago that we wouldn't have been as effectively able to align our pricing and cost as we have. The variance that we've had against the market has been fairly tame. If you remember, this quarter last year, we were talking about a 20 basis point deficit, and we felt that at the time that we hadn't quite caught up with where costing went with fasteners. I think our guidance at the time was that we expected that costing to catch up. It has caught up and probably came in a little bit better. Over the coming quarters, you're going to see the benefit we saw this quarter, which largely recaptures the deficit from a year ago. I think you're going to see that begin to moderate. So it wasn't what we expected either. We target neutral, we continue to target neutral, and I don't think it's a sustained trend.
Nigel Coe, Analyst
Okay. Thanks, Holden. And then on the CapEx pushouts of the projects, was that an elected push out? Just want to confirm if that was maybe just supply chain challenges or delays from a supply side or was that elective?
Holden Lewis, CFO
The majority of it was not elective. We had a piece of property in there, the signing of which just got pushed out from the fourth quarter to the first quarter, that's just a calendar timing issue. We did have some automation projects where it's just a matter of when the product is going to come in. We always do it would be later in the year, and it's just going to sort of cross the calendar line. The majority of it relates to projects that we remain committed and excited about, which will fall into 2024. It was more a function of timing. Earlier in the year, we did say, look, take a look at your budgets; it's not a great year in terms of demand, and tighten some stuff up. So I think there's some elements of what you're talking about, enforcing discipline across the organization. But I think the larger portion relates to projects that will be coming back into the business in 2024.
Nigel Coe, Analyst
Got it. Okay. Thanks a lot.
Holden Lewis, CFO
Thank you.
Operator, Operator
Thank you. Our next question is coming from Chris Snyder from UBS. Your line is now live.
Christopher Snyder, Analyst
Thank you. I wanted to follow up on some of the price-cost commentary. I understand that price-cost was positive from a year-on-year perspective. But I think you said the deficit was largely caught up, which would kind of maybe imply that you're still a bit price-cost negative at the moment. So when we think about that trajectory back to neutral, is that incremental price-cost positive to get there or is that incremental price-cost give back to get there? Thank you.
Holden Lewis, CFO
I mean I guess I'm viewing the next couple of quarters as being the inverse of the last few. Again, if you remember, in Q3, we talked about fasteners having a little bit of a deficit in price-cost. And the guidance at the time was that over the next few quarters, you would see that deficit begin to decline. Was there a fastener deficit in Q4? Yes, there was. Is it possible that we get that fastener deficit from Q4 back in Q4 of this upcoming quarter? Yeah, I think that's possible. But the deficit Q4 last year was not as wide as the deficit in Q3, and I'm not expecting the benefit in Q4 this year to be at the same level as the benefit we saw in Q3. Really, this feels very much like the inverse of what occurred last year. At the end of the day, yeah, we'll probably wind up over the course of multi-years being neutral from a price-cost standpoint. But within that overall trend, there's been a little bit of swinginess.
Christopher Snyder, Analyst
Thank you. I appreciate that. And then maybe could you just talk a little bit about pricing on the non-fastener side? I think I understand that the fastener is seeing some price pressure, whether it's the metal or the freight. But can you talk about the non-fastener side of the business? Thank you.
Holden Lewis, CFO
Pricing in the non-fastener areas has moderated just like our overall pricing has, but much like our overall pricing levels at this point, it's kind of back in the range that we would normally expect it to be in. It's still positive. It's lower than it was a year ago. But honestly, that area is performing largely as we expected. Historically, we have not traditionally seen negative pricing in non-fastener products, and I don't expect that's going to happen in this cycle either. So we view the conditions for pricing in those products to be pretty stable here.
Operator, Operator
Thank you. Our next question is coming from David Manthey from Baird. Your line is now live.
David Manthey, Analyst
Dan, Holden, good morning.
Holden Lewis, CFO
Hi, Dave. Good morning.
David Manthey, Analyst
First question, could you talk about the feedback and early returns after you reopened the front doors of your stores last month?
Dan Florness, CEO
I haven't received much feedback. Every day, I make it a point to read customer feedback, and I've been doing this for the last eight years. While I don't read every single comment, I do my best to cover a significant amount considering we have hundreds of thousands of customers. Over time, certain patterns emerge. During the COVID era, there were clear themes of frustration, not aimed at us, but stemming from the surrounding chaos. Often, I would call a customer unexpectedly after they submitted feedback, which could catch them by surprise. Our main focus was to maintain consistency in our operations, which the market recognized and appreciated. Good service from our teams benefits everyone. A lot of purchases have shifted online, making it easier for customers to order and pick up. It's also crucial to remind our local teams that our objective is to expand market opportunities and manage our time effectively to address customer needs.
Holden Lewis, CFO
And just one perspective I might add, Dave, is that for a long time we had a lot of different models occurring within the branch. There were some branches that did close their doors. Some had very specific low call averages. Others stayed open. We had branches that flipped their counters and branches that didn't. After several years of experimentation, it was time to say, let's settle on and align around an agreed approach. What you picked up is essentially us saying here’s the path forward that we're going to take.
David Manthey, Analyst
I appreciate the color, guys. Thank you.
Holden Lewis, CFO
Yeah.
Operator, Operator
Thank you. Our next question is coming from Jacob Levinson from Melius Research. Your line is now live.
Jacob Levinson, Analyst
Good morning, Dan, Holden.
Holden Lewis, CFO
Good morning.
Jacob Levinson, Analyst
I know you guys see lots of different end markets. Maybe it's not always easy to tell where the product is going at the end of the day, but what are you hearing from the field in terms of some of the positive and negative outliers on a vertical basis?
Holden Lewis, CFO
Unfortunately, we don't have great granular insight market by market. The example I often give is that there are a lot of manufacturers considered in our business, but they might have enormous oil and gas exposure, but we don't see that exposure. The feedback from the field continues to be fairly uniform. Aerospace is doing relatively well; I'm not getting a lot of feedback indicating anything else really inflecting more favorably. Overall, managers across our business remain cautious about current conditions. I wish we could provide more detail end market by end market; we just don't have the means to measure that way.
Dan Florness, CEO
Don't read too much into it as it is a relatively small piece of our business. In reviewing the numbers, I often query the data to understand it better. There's a segment often lumped together called 'others,' which is around 11% of our business. Notably, our government business has been gaining strength throughout the year, although it has not increased sequentially in September. The other segment includes parts of transportation business, which has increased but I am still trying to understand why.
Jacob Levinson, Analyst
Okay. That's helpful color. Thanks. Maybe just switching gears quickly, it seems like in past cycles, FAST would have had trouble holding the margin line and revenue growth at these lower levels. What's changed in the business today compared to prior cycles that gives you confidence in being able to maintain higher incremental margins moving forward even if growth rates aren't as strong in this macro backdrop?
Dan Florness, CEO
There are a few things at play here. When we came through the tariff period, it was brutal managing pricing tools which were decentralized, making it hard to communicate changes effectively week-to-week. We had one quarter where we had to prioritize building a better pricing tool after these fluctuations. Over the years, the organization has improved its pricing capability. The transportation team has also become agile in managing expenses through the cycles. The operating expense side involved significant energy on people and leadership development. One aspect I value is our incredible bench of talent that exists throughout the organization. Effective management of expenses has also been key. Our distribution team’s capabilities to manage expenses through cycles is second to none. Overall, we are simply better at what we do now than we were before.
Jacob Levinson, Analyst
Thank you, both. That’s great color. I’ll pass it on.
Operator, Operator
Thank you. Our next question is coming from Patrick Baumann from JPMorgan. Your line is now live.
Patrick Baumann, Analyst
All right. Good morning. Thanks for taking my questions. Maybe one for Holden first. Just wanted to follow up on the near-term gross margin expectations. It sounds like price-cost will be favorable year-over-year in the fourth quarter. Additionally, you mentioned having an easy comp regarding weaker product margins last year. Given that context and your third-quarter performance, do you think the gross margin in the fourth quarter will be up year-over-year? Could it also increase from the third quarter as well?
Holden Lewis, CFO
No, not up from the third quarter. First off, I think you have a number of things from Q3 to Q4. Seasonality typically plays a role, adding around 30 basis points of seasonality between those two quarters. It relates to the mix of our business in the fourth quarter, as well. Second, in Q3, we experienced some cyclically weaker freight revenue. The leverage that you gain from fast freight revenues works effectively with record levels but can weaken in downturns. Lastly, I anticipate moderating price-cost as our field teams make modest adjustments where required by contract. While we're discussing a relatively small number here, these are the components contributing to anticipated marginal weakness in the fourth quarter.
Patrick Baumann, Analyst
Great. Helpful color. I really appreciate that. One more question in terms of branch size. It looks like we're close to that target you laid out in the fourth quarter around 1,450 for U.S. and Canada. Could you update us on that, please? Also, can you provide context on sales momentum in non-res and reseller accounts, which I think have been hurt by consolidation, and further context on the occupancy expense account where you've benefited from some cost savings? Thanks.
Holden Lewis, CFO
1,450 is our target number. It's not a fixed point; it is a target as part of demographic considerations. I could see it moving down to 1,400 or up to 1,500. The closure of branches will quiet down as we move into 2024. It is helpful to remind that openings are important too. We’ll likely remain in the 1,400-1,500 range moving forward. What we've noticed is that the rate of closures has moderated compared to past years, which means a lesser incremental cost takeout than in previous years. We still believe occupancy is ultimately leverageable, but you had inflation counteracting closures in the last twelve months, and we expect that to moderate into 2024 and beyond to some degree.
Dan Florness, CEO
I feel good about our ability to continue managing occupancy. Despite our efforts to optimize that area, we did not leverage occupancy in the third quarter. Our occupancy expense consists of our branch and Onsite network, distribution centers, vending, and FASTBin. And while we've closed branches, our rent hasn't decreased in the past 12 months. One positive element is our FMI business is growing well, and that offers some operational leverage, despite the general market inflationary pressures. We need to remain focused on operational efficiencies.
Patrick Baumann, Analyst
Thanks for the color. Best of luck.
Holden Lewis, CFO
Thanks.
Dan Florness, CEO
Thank you.
Operator, Operator
Thank you. Our next question is coming from Tommy Moll from Stephens. Your line is now live.
Tommy Moll, Analyst
Good morning and thanks for taking the questions. I wanted to start on fasteners and ask whether it's possible to parse the down 2% DSR into an MRO versus OEM component. While it's really the OEM side that's significant. Any context you could provide there would be great.
Holden Lewis, CFO
We're seeing non-manufacturing fasteners still down while OEM fasteners are experiencing growth. The important point to recognize is that our OEM fasteners are growing as a proportion of the mix, benefitting from growth in Onsite relationships. Historically, OEM fasteners grew mid-20s, and currently, it is a low-single digit growth rate. OEM fasteners are still growing but at a slower pace due to a more cautious production environment.
Tommy Moll, Analyst
That's helpful. Thanks, Holden. Continuing the OEM conversation, your recent commentary has mirrored several quarters now about destocking dynamics at customer locations. Is there anything you can do to differentiate real underlying demand versus shorter product delivery cycles and perhaps customers ordering later in their production cycles?
Dan Florness, CEO
The optimal scenario for providing OEM fasteners is that we're supplying customers according to their needs in production. This shouldn't change regardless of the cycle because the essence lies in inventory availability. Some customers increased ordering during market turbulence. Fortunately, with Fastenal, they have a reliable supply chain for fasteners. Demand should correlate directly to production activity. Still, we have seen inventory piling up for some customers due to uncertainty, but largely this aligns with commonly observed market patterns.
Holden Lewis, CFO
One final note - typically, at the end of the year, suppliers approach us with offers to clear out excess inventory as a normative practice. This year, we haven't experienced as many requests. It indicates suppliers might be nearing their desired inventory levels, but we remain cautious until we get closer to year-end.
Tommy Moll, Analyst
That's all very helpful. Thank you both.
Operator, Operator
Thank you. Our next question is coming from Ryan Merkel from William Blair. Your line is now live.
Ryan Merkel, Analyst
Hey, guys. Thanks for fitting me in. I had a couple of questions on gross margin. Gross margins typically remain flat sequentially into Q3; however, it surprisingly increased by 40 bps. Can you unpack the drivers behind that surprise?
Holden Lewis, CFO
Mix wasn't quite the headwind I expected, and price-cost ended up being more favorable than anticipated, relative to the guidance shared during the Q2 call. Those are the main drivers.
Ryan Merkel, Analyst
In your definition of price-cost, are we talking about product and freight? It appears freight is a key driver you mentioned.
Holden Lewis, CFO
Yes, in many cases, freight rolls into our product costs. The inflationary pressures we've seen over the past few years come more from the cost of moving products, not solely raw material costs. Understanding our price-cost dynamics means viewing freight as part of landed costs presented at shelf level.
Ryan Merkel, Analyst
Understood. That's helpful. As we move into Q4, you anticipate a decline in gross margin beyond normal seasonality. Are you considering lowering fastener prices in response to reduced product costs or finding charging for freight becoming more challenging?
Holden Lewis, CFO
The prevailing factors regarding Q4 gross margin include typical seasonality, reduced freight revenues due to softness in demand, and the expectation for worsening price-cost dynamics, particularly lumped with pricing adjustments being made by our teams. While the expected drop is minor, it accounts for all elements contributing to forward-looking challenges.
Ryan Merkel, Analyst
All right. Thank you.
Dan Florness, CEO
Thanks, Ryan. I see it's about two minutes before the hour. I realize everybody on this call has a busy week of earnings conversations. Thank you for your time. Good luck in the fall, and my thanks to the Fastenal team. Have a good day, everybody.
Holden Lewis, CFO
Thank you, everyone.
Operator, Operator
Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.