Good day, ladies and gentlemen and welcome to the Fastenal Company Q1 2017 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. I would like to introduce your host for today’s conference call, Ms. Ellen Trester. You may begin.

Welcome to the Fastenal Company 2017 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 45 minutes and we 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, investor.fastenal.com. A replay of the webcast will be available on the website until June 1, 2017 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.

Good morning, everybody and thank you for taking time today to listen to our first quarter earnings call. You will note two meaningful changes to our method of reporting from prior quarters, and I attribute that to our CFO and our Chief Accounting Officer, really challenging the format which we convey the information. You will find a much more abbreviated earnings release document and then something new as we have a short slide deck to supplement the earnings call to help some of the talking points, I hope you find it useful. My comments are going to primarily center on the first two pages of commentary which I believe are pages 3 & 4 in the book, if you’re looking at those pages. Earlier this morning, and this is typical with every quarter end. At 7 this morning, central time, I had a call with our regional leaders and our national leaders, talk a bit about the quarter, give them some insight, a little bit about what we’re going to cover on the call, but really just give some insight on the quarter. I want to touch on a couple of points that were mentioned in that call and will dig into the slide deck. The first one and for those of you that have covered Fastenal for any period of time, you know that we are a sales-centered organization and growth-centered organization. That’s been our D&A for 50 years and 2017 does mark our 50th year in business. The first one centers on establishing goals and hitting goals. In the first quarter of 2017, we came in at roughly 101% of goal, 100.7% is the exact number, but roughly a 101% of goal. And we hit or exceeded goal every month of the first quarter. I mentioned that because…

Great, thank you and good morning. Before jumping into the quarterly results, I do want to remind the listeners that as Dan said, we closed the acquisition of Mansco on March 31st, so what this means is our first quarter income statement is not going to reflect any of Mansco's revenues or cost, but our balance sheet will include the assumed working capital and asset. So bare that in mind and we’ll call out when necessary when we’re removing that information. But flipping over now to Slide 5, as Dan has covered our Slide 3, our total and daily sales in the first quarter of 2017 were up 6.2%, that’s a nice acceleration from up 2.7% in the fourth quarter. We do estimate that the benefit of the shift of Good Friday from March into April this year was about 50 basis point benefit to the quarter, but regardless even adjusting for this, the first quarter was the strongest that we’ve seen in the last two years. And frankly that’s strengthening was evidenced through the quarter with March finishing up 8.4%, now that does probably include about 100 to 150 basis points benefit from holiday timing in the month end particular, but again we just continue to see acceleration during the period. On Page 5 of the presentation, first the point is that the backdrop against which we’re operating, it really did continue to improve in the quarter. The Purchasing Managers' Index in the U.S. which still represents 88% of our revenue that averaged and improved to a pretty healthy reading of 57 in the period. Industrial production returned to growth with an even stronger showing from key subcomponents like primary metal, fabricated metal and machinery areas that are more pertinent to our business. And this broadening of industrial demand…

[Operator Instructions] Our first question comes from David Manthey with Baird.

First of all, Holden, I think you said that gross margin within the fasteners and the non-fasteners were each higher, but the mix was the thing that drove that 30 basis points of the gross margin degradation. Did I catch that right?

That’s correct. If you look at just fasteners and non-fasteners without considering sort of the mix of those, you had margins that were slightly higher in both cases.

Great. Okay. So, as it relates to gross margins, two questions here. First, I’m wondering if you can help us understand the range of gross margin from sort of highest product to lowest and not to get specific on what those percentages are. But just that we understand the delta between the high and the low, and I’m thinking sort of the 80/20 rule here, products you sell everyday, not manufactured or modified products, but y just sort of general products available for sale. Could you just help us understand what the difference is between the high and the low? And then the second part of the question is, you mentioned that if you can keep the gross margin flat, you can get to 25% plus contribution margin. Assuming that this mix shift is going on is pretty much of secular trend given your growth initiative. If you’re able to keep gross margin flat, what would be the mechanism that would get you there that you haven't been able to achieve over the past several years?

I’m going to chime in and help Holden with that question just given my years. First off, David, if you've know from the prior conversations, range of margins in our business are quite dramatic, depending on -- are you selling something that’s a relatively low value, a convenience pack time or something in our store that it is, I need it right now and price really doesn't matter, I just need that item to -- I’m basically brokering a transaction and I am getting paid a fee for brokering and I am buying a palette of this product or something. So, I mean the ranges can be from the teens to 80%. I mean, if you really want to get crazy with it, but if you look at the bulk of our business, you really have a range that goes from probably the mid 30s to the low 60s. And our fastener product line runs in the 50s, our non-fastener products as a group run in the 40s. And that kind of gives you some semblance of it, and you can see that play out when you’re looking at a lot of our competitors and where their gross margins are in relative to the products they sell. And the only wildcard I throw into that would be the fact that, in our industry we're a little bit unique in that we have one of the lowest cost structures for freight. And we all sell our product line that by and large a lot of items have relatively low value per pound. So freight becomes a big deal and as structural advantages, we have for years to come. If you look at some of the things that we have done or can do to manage to offset a piece of that…

It’s helpful Dan. Thank you and best of luck over the next 50 years.

Our next question comes from the line Ryan Merkel with William Blair.

So I’m going to follow up on Dave’s question. I guess, well I was sort of wondering, you mentioned that mix was a 30 basis point year-over-year headwind. So, should we assume that that continues for the rest of the year or is there something that you’re thinking about that could lessen that impact?

I think given where our mix is going, I think you can look to us several years to probably have a headwind like that. I mean our growth drivers when you think about onsite and safety and vending and things like that, I mean, they lend themselves to that. So, do I think that given where we’re seeing our growth, that that is a reality each quarter of this year, it is. Now, as Dan alluded to, we still hope that there are some things that are going to contribute to somewhat better -- to somewhat better gross margins. Exclusive brands are something we talk about a lot. I called out the freight a little bit, because again while freight was a bit of a drag in the first quarter, there were some signs that perhaps the freight picture is getting a little bit better and hopefully as we go into Q2 and Q3, we’ll make further strides on that to help us sort of dig into that that more structural decline if you will. So, I think the answer is, yes. The structural mix is you were certainly there, but we think that we have means by wish to dig into that, if you will and improve. Also bear in mind that, we’re coming into the Q1 gross margin, when we think about the decline versus the fourth quarter. Some of that reflected the fact of the fourth quarter was an extremely strong period and we went and listed a couple of things. I mean, one thing we looked at was, fourth quarter of ’16 was up 40 basis points over the third quarter. If you look back historically, what fourth quarters typically do against third? So, I spotted that -- I’m sorry, 50 basis points against it. If…

Okay. That’s helpful. So, few things go your way, your framework for 25% to 30% incremental margins at mid single-digit, high single-digit growth that still profitable for this year, but you do need to freight and you probably need mix helping you a little bit. Is that fair?

Well, I mean next two quarters, our comps change quite dramatically because we still were a relative -- if you think what's going on in 2015 and near the part of the 2016. We were getting traction on the onsite model. We were correcting some, getting some traction and fixing some things and some customers were improving from the standpoint of our vending model. So, if you think the growth has been occurring in the last 12 months and how that compares to the components of our business that were there in the 12 months prior to that, Q1 of 2016 is kind of that one of those half -- last high water marks and again, every year I ignore Q4, whether it’s a good or bad number that settle things in fix and much of anything. So, yes, the commentary around the incremental margins is really to try to make a point that we believe from an operating expense standpoint that we deleverage of those lines, and that’s despite the fact that we are -- as we grow, obviously we have that shock absorber effect coming from incentive comp and that sort of thing. But the points about the sort of the leverage, those incremental margins is, we feel that we can continue to leverage those lines and we did a nice job leveraging those lines in Q1, and we think that we’ll continue to do a good job leveraging those lines. And yes, if the gross margins cooperate then we do have some easier gross margins to compare against in Q2 to Q3. But, if the gross margins are stable then we think that we can get the kind of incremental margins that we spoken about.

Our next question comes from Scott Graham from BMO Capital Markets.

Obviously, a little bit more on this operating leverage. So, if you were to sort of sketch out, how you generate operating leverage, gross income versus your O&A expenses? Is there a way to look at this with sales, whether your sales where for it is and where the trends are going, mid to high single. Does that give you -- is that more of a gross margin thing leverage or SG&A and then sort of a higher level or let’s say low to mid single? Does that switch between those two lines? Could you kind of maybe sketch out how you look at that?

So, again, the guidance that we’ve sort of given on that is, if we hold gross margin stable then we think that we can get those types of incremental margins, just by leveraging the SG&A as we grow. So, when we envision discussing those incremental margin levels, I mean that really talked about leveraging our SG&A more so than the gross profit. And again, we saw some good signs of that, we talked a little bit about how employment grew and occupancy grew from a cost standpoint. But if you really look at it, when we think about like sales per head for instance, that was up 10% during the quarter, right, because we grew revenues nicely on slightly lower activity. Those are sort of the keys to how we get the type of incremental margins that we hope to get, but the discussion that we’ve had was really wanted to address our ability to leverage our operating expenses and intending to hold gross margin flat. So, if we can achieve significant improvements in our gross margin, I think that that’s additive but again that’s working against the structural mix that we’re talking about.

Yes, I guess I get that holding, but where I guess where I am confirmed on this is that, if you’re putting more stuff in a box, we’re putting more boxes in the truck. There should be gross margin leverage on that too, right?

Well, that would be the leverage on the freight side in that year, you're having better utilization. First off, we have really excellent utilization of our trucking network to-date and so, it's not so much about you putting more boxes into a truck, it's -- those boxes you’re putting into the truck. What customer are they going to? What’s the nature of the business? You know, if it’s a box or an item that’s going to vending machine and it’s a safety product, it's going to have a different margin profile than if it's a box of fastener that’s going to an MRO user. And so, it's really depending on what that box is destined for. The other thing to remember is as a distributor, the very large majority of the cost that runs through COGS for us is simply the cost of the product. So there maybe pieces within COGS that we can get leverage on, but at the end of the day, the very large majority of what goes through cost on COGS is going to be the cost of the product.

Okay, got you. And then follow-up question essentially is on share repurchases. Is there a point in time? Is there, I’m sure if you worked this carefully through an ROIC analysis and all that. Is there some type of trigger for share repurchase in ’17 that you envision?

I will spend on that one. We have no trigger price as this will buyback or we won’t buyback. That's a conversation we have with our Board on regular basis, we have not been in the market for some time. Historically, we have preferred to use our excess cash from the perspective of investing in the business, investing in our growth and if in case were we’re not drilling enough to use up all the cash generate because the cash we generate is quite attractive. History has said, the bulk of that cash, we return to our shareholders in the form of dividend and that’s just the way we structurally had it overtime. Our dividend release went out last evening has a good 10-year history to give you a perspective on that. No secret anyway in this call, our stock periods and then attractive multiple. And the periods where you’ve seen it, we’ve had some periods with a multiple fell off and we took some excess cash where we took some -- we incurred some borrowings to buy back some stock. But we focus our energy -- we really focus on time and energy on growing the business long term because we think that’s in the best interest of our shareholder. And in the short term, we return a fair part among the cash through a dividend. If you then recall that, I mean last year we had the leased locker program show up which is not something that so expected to begin the year and our first priority is to use our resources to be able to grow. And so we had a very nice quarter in Q1 by any measure. Q2 won’t be as high and we use some of those resources to acquire great company and…

I'd say Q2 won’t be slightly come up with cash.

In terms of the cash, correct, relative to earnings, just because of the double tax payments. But in Q1 we use the resources to buy great company and as a result our leverage is based in the same area that it has been for some time, and at this point we prefer to kind of look for other opportunities internally to spend -- to spend our resources on and like we did last year you never know when they’re going to come up. So that remains a priority and what we are looking for.

Our next question comes from Robert McCarthy with Stifel.

Holden, just one housekeeping item, which I am holding, I think we discussed, but just on Page 10 of your well-applauded new slide deck, you have the new benchmark out and just to remind, I think myself and investors, this is a new benchmark, the one you've published, right, that's going to be taking into account the five year average from ‘12 to ‘16 as opposed from a ‘11 to ‘15. Is that correct?

That’s correct and last year’s documents, we had two benchmarks that we were referring to. One was sort of our historic way of looking at it, which looked at most years from 1998 and then other one was sort of the five year average that last year would have included 2011 to 2015. As the calendar rolls forward so did our five year average into 2012 to 2016, and that’s where we are focusing on now for a benchmark.

Perfect. Okay. Just want to make sure people saw that. Now just in terms of on the fastener side of the house, what’s your expectation for could you review and I do apologize, if you already kind of walk through this. Your expectations for what you saw for price in the quarter in terms of growth and then what are your expectations for the balance of year in terms of what we can see in place on the fastener side of the house?

Right. So, pricing was not a meaningful factor in the quarter. Price is something that we just continue to review at this point. Now, we obviously have seen some of our competitors take price increases. Many of them have talked about it publicly. We've seen charts where prices for metals are clearly up. So, it’s hard to conclude anything other than the environment today is certainly more inflationary, that has been quite some time. But that said, Fastenal has the advantage of being a FIFO company with a pretty long supply chain for fasteners and that means it takes a while for cost to hit our COGS. And that gives us the ability to evaluate how durable the marketplace is for pricing, and if you remember last year there was a time or two where we thought pricing could occur and then it wound up not materializing for probably demand reasons. And so, it’s nice to be able to get that sort of look, if you will. I think the real question at this point is, if the marketplace in fact does look like it’s going to be willing to accept pricing, is that something that we believe, we can get to protect our margins and protect our place in the market. And the answer is that, we think that we can, but we do have some time to evaluate at this point.

I mean just looking at the math whether be any way to those price actions say the inflation did well attractive in this context for the balance of the year. Do you think, you could overcome the mix headwind in the gross margins? Will that math work or not?

Oh, in the short-term? Yes, surely.

Yes. So, there is not used that for that to occur?

Yes. But keep in mind our inventory turns twice the year roughly. So, I mean, it would be -- it'd be short-lived event.

And then the last question because I know you want to move onto others on the call. Could you just talk about perhaps March in terms of your expectations kind of exiting February, taking into account the Easter shift, how you feel about the months? And how you feel about kind of the prospects exiting the months?

We felt better and better I think as the quarter we're on.

And the months.

Yes and the months were on. When I think about the feedback that we’re getting from our regional Vice President about their marketplace, we talk about how -- in December we started to getting some pretty story that on the oil and gas business that we’re translating on the ground, but by the time you’ve got to February, you’re starting to see the oil and gas business really sort of pick-up again and showing itself in results. And frankly through March are continued to be case, I think they remain enthusiasm from that area. But what we began to see began to gain some real excitement as we based in February and then into March was the manufacturing site. And frankly the construction side, they’re seems have been a consensus that is come together through March from our regional that construction is doing much better and I think you can see some of that in the growth of the CSP products, I mean the fact they grew 10% plus in the quarter, I think some construction as well. So even as recently in December, the marketplace didn’t feel that great, but as we proceeded through the quarter and through the month of March. There was clear progress and improvement in the tender of the marketplace.

Was there re-budgeted into the Easter shift during the April? I mean, how should we think about, it more than, Rob, 200 basis points in March or is that actually more favorable March rather? Would we expect further deceleration in April?

In quarter, the shift costs us about 50 basis points. In March, they cost us about a 150. It’s probably around 5 -- it's probably around third of the day, if you think about it Rob, historically. So, it gave us probably not $5 million lift in March and you probably get it back in April.

Right.

Our next question comes from Robert Barry with Susquehanna.

Thanks for all the nice earnings day materials. I wanted to follow up on this op margin -- sorry op leverage outlook. You keep referring to stable gross margin, but just given where the growth is coming from and it also sounds like we’re going to continue seeing some gross margin pressure here for a little while. So, is the bottom-line it for now op leverage is likely to be more in high-teens level or maybe even a little lower given the headcount is started to grow?

Yes. I mean, again, the motivation was just to emphasize the degree of which we think we can leverage operating expenses, right. That’s why we talk about it with the presumption that we hold gross margins stable. Now, as Dan alluded to, gross margins are much higher in Q1 than they'll be in Q2, Q3, so we’ll see what happens there. But, we remain committed to be able to achieve the leverage of the operating expenses. And we’re going to just keep you at work to try to dig into the structural decline in the gross margin that you start with. And we certainly had that conversation with our regionals and our folks. So, I think that there were some early signs that would in the freight side that maybe there is some progress there. So, we’re just going to have to keep working on improving the gross margin metric. But we do anticipate getting the leverage. With regards to the headcount, we would expect that to move up as demand goes up and also as we continue to accelerate our onsite timings. We onsite signing take some folks in the store and we would like to backfill those and really get a lot of energy in that store to keep growing from the new base. And so as growth in our growth drivers continue to move up than we would expect to add head. But again, we saw some good productivity in Q1, and we’re not just looking to give that productivity up. We got to do something to support our growth, but we’re not looking to begin to dilute that productivity by adding heads too quickly.

Got you. I mean I don’t want to beat the dead horse here, but just to connect to dot. I mean it sounds like if gross margin is stable you can lever in the 20s. If gross margin continue to move down then we’re probably levering in the teens. Is that fair?

A couple of things I'll throw in -- in terms of what your top line growth assessment is. In the previous call, we've said south of 6% to 7% is difficult with the cost components we had coming out of 2015 and then through the first part of 2016. But that picture improves and lowers it some, and that's why you saw our ability to grow our operating expenses roughly 5.5%. And if you think what that, you have to take a look at what drove the operating expense increase when you look at Q1-to-Q1. I often try to pull things into some buckets so I can think about it easier. 25% to 30% of that increase is incentive comp whether it's in the commissioning in a store of bonus paid to some of the outside the store, the profit sharing contribution, so things that are expanding as a profit growth improves. That’s really what drives our labor cost to increase right now, it's not so much what headcount because the headcount you're adding typically and it appear this a lot of it is more on the entry level side so you could manage through that. If you think what's the next biggest group of cost that drove our expense up. We’ve been -- it's no secretly that we’ve been increasing our IT spend over a number of years. We have some pieces that are turning on actually this quarter that will help out of store or our onsite model quite meaningfully. We’re turning out our new website in Canada. So the things that we’re turning on that are spiteful investments, those investments we’ve been making and have been won through our P&L and the other component and I think that second bucket that was a jump from last year was the few of that Holder talked about. It’s a big increase in our cost component, that piece of it normalize than Q2, because last year from Q1 to Q2 fuel prices jumped up dramatically, so we'll left that in Q2, but we haven't left in Q1. The final driver of increases is the continued success that we’re seeing in vending. When we add those vending there is an expense that shows up in our occupancy around the cost of the equipment. So those things are really what driving it and outside of that, managing the expense really-really quite well. And so, it puts us in a position when we go into the later part of the year, I believe that we’ll be able to be more optimistic.

Thanks everybody, its 45, 46 minutes past the hour. Thank you for your interest in Fastenal. I’ll close to where I started. I am pleased quite frankly with the quarter from the standpoint of the business is executing better, our end markets have given us some lift or given ourselves some lift. Thank you.

Thank you.

Ladies and gentlemen this does conclude today’s presentation. You may now disconnect and have a wonderful day.