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Fastenal Company  (NASDAQ:FAST)
Q3 2018 Earnings Conference Call
Oct. 10, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Fastenal Company Third Quarter 2018 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. Later there will be a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the call over to Ellen Stolts with IR. Ma'am, you may begin.

Ellen Stolts -- Investor Relations

Welcome to the Fastenal Company 2018 Third Quarter Earnings Conference Call. This call will be hosted by Dan Florness, our President and CEO; and Holden Lewis, our CFO. 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 IR homepage investor.fastenal.com. A replay of the webcast will be available on the website until December 1, 2018 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.

Daniel Florness -- President and Chief Executive Officer

Thank you, Ellen. Good morning everybody, and thank you for joining the third quarter earnings conference call for Fastenal Company.

I'll start the discussion with (inaudible), just recap a few things going on in our business and to add some transparency to some things that are going on in the business. Had a call early this morning with our regional leadership and our -- around the planet. Holden ran through a bunch of the financial aspects and discussed the release in general, talked about some of the points that we will be focusing on in the earnings call today, to have that group be really well-informed of what's happening in the business. And that's something we do every quarter.

I started my comments with a simple message to the group. September was a big month. Coming into the month, we had an aggressive goal. And January caused us to just miss our internal sales goal, earlier in the year. Since then we've been in excess of goal every month, very similar to what we experienced in 2017 from the standpoint of good solid top line growth, hitting our internal goals, which gives us the confidence to invest in the business. Year-to-date, we're at 100.7% of goal. When I looked at the numbers on last Saturday, a week ago Saturday, we were at 99.9%, not all the numbers are in yet. So I thought, OK, we have a good shot of hitting goal. We came in at 100% of goal in September. Proud of what we accomplished as an organization from the standpoint of establishing a goal and going out and getting it.

In the last two days, we had our typical Board meetings, and the evening before our Board meeting is typically a session where we introduce a topic that we delve deeper into. In past quarters, we've talked about some of the acquisitions we've done, we've talked about some business development opportunities, we'll talk specifically about our Onsite business, our vending business, our e-commerce business, our construction business, just to share additional insight for our Board of Directors, for their own knowledge and engagement as a Director of Organization, but also to solicit input from a very talented group.

Our meeting on Monday evening, I typically don't cover that session, I covered that session and talked a bit about the Company, and I just want to share some of the things we talked about. As we did at last year's annual meeting, we talk about Fastenal, what we looked like when we were a $2 billion Company, which was roughly 11 years ago, in 2007.

We talked a bit at that time about what we'll look like as a $4 billion Company. And this year, as we prepare for our internal discussions in December and our annual meeting next year, we will get to talk about Fastenal as a $5 billion Company, and we'll talk about how we've morphed, how we've evolved over the last 10, 11 years.

We also had a pretty lengthy discussion about what we'll look like when we are a $10 billion Company. And we focused on four aspects of the business. One was the products we sell. If you look at it, fasteners, and now, safety products, combined make up roughly half of our business. Fasteners made up half our business a decade ago, but as the other businesses have grown, especially safety has grown, it's morphed a little bit.

We talked about our selling channels, our branch, our Onsite integrated supply, a relatively small business that's kind of tucked away into the Onsite business. And our channel extender in everything that we do, a little thing called vending and bin stocks. We talked about the definition of our customer, who it was 10 years ago, who it is today, who do we believe it's going to be 10 years -- when we're a $10 billion Company. And there we talked about the manufacturing customer, little bit of some of the subsets; the construction customer, a government customer and all the others.

We talked at length about the request mode, and what I mean by that is how that's changed over time, in how our customers are ordering. A big swathe -- our request mode is vending, where the customer doesn't request it. Our supply chain delivers it to them at point of use, at time of use and it's a -- we measure our fulfillment in the context of minutes, not hours, not days, but minutes. In our branch network, we measure in the context of minutes and hours. In our distribution network, we measure it in the context of eight hours away, but impressive supply chain in how -- customers ordering patterns and how that's morphing can play really into the strengths of Fastenal.

Four things I highlighted just for additional discussion. Some that were tangential to this discussion was our branch economics. We started talking about what we call pathway to profit, 10, 12 years ago. Pathway to profit is still alive and well within Fastenal when I think of our branch network, and understanding how that branch network funds our ability to migrate the business into a more Onsite world.

The continuing traction we're seeing in the e-commerce -- Web, I mentioned to the Board that night. I said, last quarter was kind of fun to casually mention on the call that we now have a $100 million Web business within Fastenal. That's ignoring EDI, that's ignoring the electronic orders that are coming in from vending. That's just looking at where people hop on the Web and we've rebranded that mostly to what we call Fastenal Express, but it's a $100 million business within Fastenal, growing handsomely. To that extent, three months later, I can look at that and say that $100 million business is now $110 million business, you can do the math on what that means as far as growth, but it's seeing substantial growth.

And interestingly enough, we're seeing the growth, not just in our branch network, we're actually seeing faster growth in our Onsite network, it's a more efficient way of ordering. So not only does it help us grow faster, it helps us be more efficient. And a critical part of our success as we morph from a $5 billion to a $10 billion Company, is managing the operating expense within the organization. And you've seen some of that shine through as we go quarter-to-quarter.

We did a bit of a recap on how we communicate and learn internally. How we define the message and our focus and how our emphasis is always on what is special about Fastenal, and how does that something special benefit our customer. And let's make investments to grow there and differentiate ourselves in the market, be something special for the customer. We also touched on people development and some leader development aspects we have in place for 2018 and how that's changing us going into 2019.

That transitioned from Monday night into Tuesday, and we had a pretty lengthy discussion on tariffs and inflation in general. We started that discussion to make sure everybody's on the same page, is awareness to what we're talking about, because there's lot of terms that get thrown around in the media, there's is lot of terms that get thrown around in the press in general, lot of terms that get thrown around in our organization. Since they emanate from a government source terminology, you know darn well, they're never going to be intuitive.

So we walked through and tried to make some intuitiveness to it. We talked at length about the 232 steel tariffs. It took place early in the year, a 25% tariff that frankly had limited impact -- direct impact on Fastenal, but does create a step-up in the introduction of inflation in the marketplace. We talked about the 232 auto tariffs, a minimal impact, first off, they've been implemented; but secondly, even when they are, the focus for us is really understanding what that means to demand aspects of the North American marketplace.

We also operate a pretty sizable fleet, we have about 6,500 Dodge Ram pickups parked in front of our branches, delivering product and making sales calls every day. We have a distribution infrastructure, about 500 vehicles between semis and straight trucks, supporting our customers every day, and anything that impacts that category of our cost pool, we would be mindful of.

We talked at length about Section 301, because here's where it starts to change. Back in July, for lack of a better definition, our folks described it as List 1, I'm not sure if that's an official name, it's just our name, but List 1 came out in July and it involved about $34 billion in North American spend going into China; 25% tariff on that. As we've talked about in previous discussions, that's pretty limited for us. There were some impacts. Again, it's about the element of inflation it's introducing into the economy.

On August 23, a second list, list number two, came out that impacted about $16 billion worth of imports, again there was a 25% tariff. While there were some impacts to Fastenal, it was relatively limited in how it played out in our business. List 3 was announced on September 17, became effective September 24, so starting a number of weeks ago. It's directly impacting the North American supply chain for our customers.

We are an important component of that North American supply chain for our customers in the marketplace in general. Therefore, it has an impact on our business. If I -- an added piece to that is that meaningful impact that kicked in place a number of weeks ago, is scheduled to go from 10% to 25% on January 1. Only time will tell what actually happens. It wasn't too long ago, it looked like NAFTA could easily fall apart into sort of a trilateral relationship, couple of bilateral relationships, till eleventh hour calmer heads prevailed.

And while everything isn't a done deal yet, it appears that the differences that existed between the respective governments, respective countries have been largely resolved, and time will tell if the two sides of the Pacific Ocean will have a similar coming of the minds and anybody's guess on this call is good as, if not better, than mine on how that will play out.

Our commitment is to our customer and our employee. Every day we balance this commitment with four overriding aspects of our covenant with our customer. One is a reliable supply to support their business, whether that is OEM fasteners, MRO fasteners, MRO non-fasteners, product going through our branch, our Onsite, our vending, it doesn't matter. A reliable supply that consists of quantity and quality. One of the challenges with redirecting your supply chain or making changes to your supply chain, you can interrupt both of those and it impedes the ability to move quickly.

The second is value. We're all about total cost of ownership for our customer. That means time that means price. We are managing through this. The third is ideas, solutions and alternatives. One aspect of our approach with our customer is suggesting alternatives to their supply chain, to minimize the impact. Again, that's our covenant with our customer.

Finally, the health of our supply chain; that dictates everyday where we push and how hard we push on our supplier base, because ultimately supplier that is not able to invest in their business is not a great long-term supplier in our supply chain.

Our steps started three to four months ago, an active resourcing effort. The reality of it is, and this isn't unique to Fastenal's business, this is true of the North American supply chain. A lot of categories are directly impacted by the Section 301 and they're meaningful spend, if I look at the business in North America. Some categories of ours that really jump out, that have big impacts; power transmission, electronics and battery, plumbing, machinery, welding, paint -- paint supplies, material handling. These are items that actually have a really big impact. For us they are a relatively small part of our business. So that's more of an issue for a supply chain that's going through other sources, generally speaking, than Fastenal, because they're all as a percentage of our business single digits.

Number 11 on my list here of categories that are impacted, that thing that's near and dear to our hearts, called fasteners. It's a meaningful impact for that group and that group is a big percentage of our spend. And as we've talked in the past, a large part of the North American supply chain and Fastenal supply chain comes through sources outside the United States, and -- or our sources outside North America, excuse me. And a big -- a high percentage of that source, and this data is publicly available, where we import from, a good piece of that is coming from China and that's true in our business as well.

If I go a little deeper down the list, I see safety products, another one that's a meaningful component of our business, because of our vending platform. One of the things that we have to help manage through it better than in the past is we have a great national account team and a great Onsite team, a great implementation team, a great engineering team and a great supply chain support infrastructure for that piece of our business. Those discussions have been going on in earnest. They continue to go on in earnest and we are shedding light to the supply chain of those customers and having discussions about prices and options.

Another piece is, and we talked about this, not in great detail, in the July call, but we talked about it with meaningful detail in the April call, about on our local pricing. Our tools for managing that weren't as sophisticated, and frankly, a lot of the tools we had for managing that disappeared in -- over the last three, four, five years as we were plugging up back doors to our point-of-sale system with changing prices, in an effort to improve our security.

In July, we rolled out a new means to manage local contract pricing or local pricing. Holden mentioned in our release that we got some improvement in our price cost inflation during the third quarter and we kept pace with the third quarter. That is a true and accurate statement for the third quarter. One point I'd make is, we started this in July and really got traction in August. While in the third quarter we kept pace with the current inflation and we didn't get back any of the inflation we lost in the first two quarters of the year, in the month of September, if I look at our local pricing, we did achieve a very good claw-back into that first and second quarter. And so we exit the quarter at a much better position than we entered the quarter or in what the quarter experienced and that's a positive from our business, from our standpoint, to be an efficient supply chain to manage that inflation dynamics in the marketplace and to manage the relative gross margin of each component of our business. But it was really shining through in September, not in July, or August and September.

With that I'm going to switch over to the flip book and then I'll transition over to Holden. If I look at the quarter, a very good quarter. 13% sales growth in the third quarter of 2018. It's our sixth straight quarter of sales growth greater than 10%. Excellent leverage in the business. As we've talked about in the past, our big challenge as we were -- as our growth was expanding was the incentive compensation component of our cost pool, at the branch, at the district, at the region, at the distribution center, and the support functions throughout the organization, as our growth came back in 2017 and 2018 and our earnings growth improved. We reloaded up on the incentive comp and we saw meaningful inflation, because the incentive comp was expanding, a very typical thing I would expect to see in the Fastenal business. We've anniversaried that now and you see it shining through in our ability to get operating leverage at the operating expense line.

The earnings per share grew 38.3%, obviously aided by tax reform. Absent this, on 13% sales growth, we grew our earnings 15%. That's the fastest rate so far in the cycle. We're very pleased with that and we're proud of what our teams did. As -- Holden's point here, incremental pricing was realized in the third quarter, largely offset incremental cost increases in the period. We exited the quarter in a much different place.

Flipping over to page two, we signed 88 Onsites in the third quarter. We've talked in the past about participation and the importance of participation in our business. Last year, through nine months of the year, 64% of our district managers had signed an Onsite. We hang out for our district managers, if we can get to 80% participation on anything we do, we will be successful. Our goal is to hit 80% for the year. Through nine months of 2018 that 64% has grown to 72%. Onsite is part of Fastenal. It's not a subset within Fastenal, it's part of our business now. And you're seeing it shine through in the numbers. We've signed 269 Onsites year-to-date, last year we signed 270 for the year.

Switching to vending, also part of our business now, like Onsite. We signed 5,877 vending devices in the quarter. There's 63 days in the quarter, we're signing 93 devices per day, not too far from hitting 100 devices signed each and every business day of the year. Our revenue in that is growing well, our installed base is growing well. And we feel very good about -- in both of those, Onsite is probably going to be at the lower end of that range based on our run rate, and well into the range in case of vending signings. We are taking market share here and there is something special about Fastenal that our competitors cannot bring to the marketplace in the same way we can.

Total in-market locations, 3,089. If you look at it, we're up 116 year-over-year, it's about 4% increase. Branches are down 157, which is about a 6.5% decrease. But Onsites are up 273, almost a 50% increase. Lot of numbers flying around here. What it means is, as our business is morphing, our need for people is always important, because we are a service organization, and that's what we represent for our customer, but it allows us to manage the business a little bit more efficiently from a headcount perspective and you're seeing that shine through in our numbers.

National accounts grew 18% in the quarter, impressive team, both the sales team, the implementation team, as well as our service teams in our branches in Onsite. Non-US daily sales, which are about 15% of our business, grew 20% in the quarter, despite some pretty extensive foreign exchange headwinds and that shined through in our gross margin a bit as well.

With that I'm going to turn it over to Holden.

Holden Lewis -- Executive Vice President and Chief Financial Officer

Great. Thanks, Dan. Flipping over to slide 5. As covered, total and daily sales were up 13% in the third quarter, which is consistent with the growth of the first half. This runs our monthly streak of 10%-plus growth to 16 months, but perhaps is as notable to say that adjusting for acquisitions and foreign exchange, our August and September daily sales rate actually hit 14%. What that means is that nearly one and (ph) three quarters into the current year's -- into the current expansionary cycle, we're still posting new highs for organic growth. We also estimate that pricing contributed between 120 basis points and 170 basis points in the period, an increase from the first half when we did 50 basis points to 100 basis points.

In addition to contribution from our growth drivers, as Dan discussed, this growth is supported by healthy macro conditions. The PMI averaged 59.7 in the third quarter and industrial production continues to expand at a low to mid-single digit rate. From a market standpoint, non-residential construction grew 16.2% and manufacturing grew 13%, in both cases, consistent with the prior quarter's growth. From a product standpoint, fasteners were up 10.8% and non-fasteners were up 14.9%. Again, in both cases, in line with the second quarter levels.

Lastly, from a customer standpoint, national accounts were up 18% in the quarter with 79 of our top 100 accounts growing and non-national accounts grew mid-to-high single digits with nearly 67% of our branches growing. In terms of market tone, sentiment in the field remains constructive and we would characterize conditions being stable at high levels.

Now sliding over to slide 6. Our gross margin was 48.1% in the third quarter, down 100 basis points from the third quarter last year. This was a larger decline than we expected, especially as the improved price realization largely neutralized incremental product cost increases we continued to experience in the quarter. Roughly 80 basis points of this decline was from product and customer mix, higher branch freight expenses and higher growth allowances that are attributable to the sustained strong growth we are experiencing with our largest customers. The remainder is a function of foreign exchange and other organizational factors. Sequentially, we believe the lion's share of our 60 basis points decline is due to seasonality, foreign exchange and branch freight costs.

As it relates to the outlook for price costs, we think that being able to neutralize the impact of inflation in the third quarter speaks to our rebuilding of pricing muscle memory in the organization and the effectiveness of the tools we've introduced. These would be helpful as the situation with tariffs play out. Still, the latter likely means we've not seen the end of product cost increases and until greater clarity comes to the market, it's difficult to know how price cost will play out in the upcoming quarters.

Our operating margin was 20.5% in the third quarter, up 30 basis points year-over-year. Strong volumes drove 130 basis points of cost leverage and generated an incremental margin of 23.1%. Looking at the pieces, we'd see 50 basis points of leverage over employee-related costs, growth in incentive compensation outpaced sales and profits, but it did moderate versus where we were last year. Occupancy-related costs were up 2.3%, generating 50 basis points of leverage. Lower branch costs were offset by higher cost related to non-branch facilities, with the increase deriving from higher vending expenses to support the growth in our installed base. We realized an additional 40 basis points of leverage from general corporate expenses.

Putting it all together, the third quarter of 2018 EPS were $0.69. Now, excluding a discrete tax item, this would have been $0.68, or up 37% from the third quarter of 2017. In the absence of tax reform and the lower rate that it provides to us, EPS would have been $0.57 and growth would have been 15%. We continue to anticipate a tax rate of 24.5% to 25%, absent refinements in the application of, or discrete events arising from the recent tax reform.

Flipping to page 7. We generated $185 million in operating cash in the third quarter, which is 93% of net income. This is a lower conversion rate than we might typically see in third quarters, which relates to working capital and I'll cover that in a moment. Net capital spending in the third quarter was $35 million, bringing our year-to-date outlays to $89 million, an increase of 16% over the first nine months of 2017. The timing of outlays is such that we do expect higher spending in the fourth quarter for expansions and upgrades at our properties, as well as IT assets than we have seen in any of the first three quarters of 2018. However, given the rate of spending to this point in the year, we are reducing 2018 capital spending projection to $152 million from our previous $158 million. We increased funds paid out in dividends to shareholders by 25% to $115 million and we finished the quarter with debt at 14.4% of total capital, below last year and last quarter and at levels that provide ample liquidity to take advantage of opportunities to invest in our business.

The picture of our working capital grew more challenging in the third quarter. Inventories were up 14.1% in the period, representing the first quarter where growth in inventory has outpaced growth in sales since the fourth quarter of 2016. And that's largely due to inflation beginning to ripple through our balance sheet.

Receivables grew 22.2% in the third quarter. This continued to be affected by growth in our national accounts and international businesses, both of which tend to have longer terms than our business as a whole, but the biggest factor continues to be customers pushing payments past quarter-end, a trend that we have seen since the fourth quarter of 2017. After that moderated last quarter, it intensified again in the third quarter, but (inaudible) we have not seen any meaningful change in hard to collect balances, the quality of our receivables remains solid.

That's all for our formal presentation. And with that operator, we'll move to questions.

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from Ryan Cieslak with Northcoast Research. Your Line is open.

Ryan Cieslak -- Northcoast Research -- Analyst

Hey, good morning guys.

Daniel Florness -- President and Chief Executive Officer

Good morning.

Ryan Cieslak -- Northcoast Research -- Analyst

Yes, I guess the first question, just wanted to go back to the gross margin comments, weaker than expected versus our model. It seemed like maybe below what you guys were expecting as well. Holden, maybe sequentially it sounds like the freight component once again it creeped up and was a big factor there. Can you just discuss, what changed this quarter versus last quarter and do you view this more as transitory, or how do we think about freight costs, certainly for the balance of the year, but even as we get into next year?

Holden Lewis -- Executive Vice President and Chief Financial Officer

Yes. I think that cost continues to go up from a freight standpoint and I think we've talked about how we did a nice job offsetting some of those issues in the second quarter. We talked a little bit about moving more product onto our own trucks, doing a better job sort of finding means of generating additional revenue and we still worked through that in Q3. But pricing is still a challenge, and I would say that that is a part of the equation still. Now, the impacts from freight was more meaningful on a year-over-year basis than it was on a sequential basis, make no mistake, right. But the -- I think if you look from a sequential standpoint, I think that you're looking at -- seasonality played a role. I think foreign exchange certainly played a role. And then you do get into some drag from branch freight and some of the customer allowances, but they are relatively smaller. So I think that the impact on -- from freight was more annual than it was sequential.

Daniel Florness -- President and Chief Executive Officer

Sequential, one thing we're seeing, and this has been our mantra all year is, fuel prices are what they are, whether that is diesel going into our semi fleet or gasoline going into our pickup fleet. The real mantra is charge freight where it's appropriate, and we've seen a pretty consistent level of that. And use our trucks. The challenge to our branch employees, our Onsite employees, use our trucks -- a challenge to our supply chain, use our trucks, because it's a lower cost, and we've seen some success in that as we've gone through the year.

Ryan Cieslak -- Northcoast Research -- Analyst

Okay. So it doesn't sound like there is anything unusual or one-time in nature as it relates to freight here in the quarter. So I know you guys aren't -- big on giving your quarterly guidance on gross margins, but directionally, is the 48.1% that you put up a good starting point and should we be thinking about just normal sequential progression into the fourth quarter, or is there something that we should be thinking about where you see it maybe playing out better than that going into the fourth quarter?

Holden Lewis -- Executive Vice President and Chief Financial Officer

Yes, as it relates to the freight side of it, no, I don't think there's anything unusual there. And honestly, I have to say it's been fairly impressive, the degree to which the field has been able to move some product off of third-parties onto our own fleet and other things of that nature. As Dan said, fuel was a big issue. So as it relates to branch -- to branch freight, or freight generally, I don't think there's anything unusual there.

As it relates to gross margin more broadly, yes, I think thinking about typical seasonality is not unreasonable here. There are certainly some comp give and takes as we move into Q4, freight being one of those. It was in Q4 last year that we began to see a lot of these costs really beginning to move up. So I mean that's one where there might be some easier comps, but there are some other items in there that might be less favorable comps. So I think if you think about the gives or takes, I feel like you should probably think about the seasonality. And the one perhaps caution I'll give there is, seasonality is usually maybe 20 basis points to 40 basis points lower in fourth quarter than third quarter. It also tends to be a much more volatile quarter than is typical, in terms of where that comes through. I think that we can find some gives and takes that move us to the high end of that and that's what we're going to strive to do, but I don't think it's unreasonable to think in terms of normal seasonality at this point.

Daniel Florness -- President and Chief Executive Officer

I'll chime in with a couple positives when I think about going into the fourth quarter. We exited the quarter in a better position than we entered the quarter from the standpoint of our pricing in general, because of things we've put in place in July and August. Point number one. Point number two, one of our hard presses on our folks as it relates to all the noise, (inaudible) right now is be engaged with your customer from the standpoint of product substitution. That tends, historically, to help us from a gross margin perspective. And so, when I look at that, there's some built in enlist to it, but we'll continue to have the impact that we've seen in the mix of our business, that's not a new thing.

The last piece is, one component of our gross margin centers on the volume allowances that either go to customers or come from suppliers. When I look at that, some years you will have a bias toward what direction one or the other might go, depending on the relative strength of that, of our overall growth for the year, because a lot of those programs are calendar based. As we've been seeing as we've gone through the year, the customer side, strong growth in national accounts, so there's a piece there, but nothing new as far as any kind of change sequentially. If I look at it on the supplier side, so now you can get an uptick or a downtick in the fourth quarter depending on where the programs come out. With our strong growth this year, the bias is toward up, not down. So I would look at that and say on the ledger there's more things that are ignoring seasonality, more things that are biased up versus down.

Ryan Cieslak -- Northcoast Research -- Analyst

Okay, that's helpful. And then just for my follow-up. Last quarter you guys gave sort of an initial estimate on what you think the direct exposure was to China from a sourcing standpoint as a percentage of your COGS. Any update there, certainly as you've gotten through, there's some additional list has come out, I'm sure you guys have done some additional work around that. And then just how do we think about, maybe just directionally going into next year, I know you guys have always talked about mix always being a net negative to your gross margins. Should we think about the tariff situation also being a net negative to your gross margins next year, or is it too early to tell at this point? Thanks.

Daniel Florness -- President and Chief Executive Officer

I think on that, there is a number of things punched into that question. So as you unwind it from a tariff perspective, it's way too early to gauge, because we don't know what the next leg is going to be, is there going to be a next leg. We don't know if we are going to be sitting here in March and 10 is at 25 or 10 is at 10 or 10 is at zero, we don't know if it's on -- the SKU is (ph) on today, if it's on expanded list or a contracted list. So I don't think anybody can intelligently predict that today. I do know we have a really good plan for how we're approaching it. If I look at historically, we have talked about -- and I'm a big believer in transparency, I might be a little opaque here, because I don't want to put our field team in a bad position from the standpoint. If I sat down with 10 different customers, the percentage of what they're buying that's sourced in one country or another or in different parts of the world, in general, can vary dramatically depending on if it's a fastener. Fastener products have a very high content of imported products and a lot of that is coming out of China.

So if you think about that third of our business, a big piece of that is sourced globally and most of that had moved outside of North America, heck, before we even started in business back in the late-1960s. And that 35%, it's a pretty big piece. On the non-fastener, it's also a quite large piece and this isn't just a comment about Fastenal, this is a comment about supply chains in general. So I would suspect most companies you'll find is that you're going to have over half of their revenue -- half of their business is sourced outside of North America, and a meaningful piece of that half comes out of China and you'd see the same. I don't want to get into specifics beyond that, because one customer it might impact there, what they're spending 10%, another customer it might be 30%.

Holden Lewis -- Executive Vice President and Chief Financial Officer

Well, Ryan, I think, yes, just to touch on last call. You're right, I mean I had indicated at that call that we were looking at basically -- roughly 10% of our product sourced from China, in that there was a chunk of that, it was just a guess, right, just a guess, because one-quarter of our total buys across the Company are bought by the field rather than corporately. And this local capability to buy is a big reason for our industry outgrowth, but it also reduces the visibility. And as you said, we've sharpened our pencils on this and we are trying not to be overly specific about it, but I think it is fair to say that our number is north of that 10% range that I had indicated earlier. So that is definitely a larger number that comes directly from China.

Daniel Florness -- President and Chief Executive Officer

In fairness to Holden, I felt he was answering a different question on that call, or I would have corrected him on the spot. I know he was talking about the -- the first rounds being a single-digit, a low percentage impact and I didn't realize the intent of this answer.

Holden Lewis -- Executive Vice President and Chief Financial Officer

Yes. And not all that 30% -- not all that that amount is going to be captured in the first -- in this first round. So we'll see what happens going forward.

Operator

Thank you. Our next question comes from Hamzah Mazari with Macquarie. Your line is open.

Hamzah Mazari -- Macquarie Research -- Analyst

Good morning. Thank you. My first question is --

Daniel Florness -- President and Chief Executive Officer

Good morning.

Hamzah Mazari -- Macquarie Research -- Analyst

Morning. Just the first question is around working capital. It seems like it's a much bigger source of cash, the first three quarters this year than the last number of years. Clearly, some of that is inventory, but a lot of that is AR. So, maybe just walk us through, are customers just paying later or just walk us through sort of how you think about that piece, does that normalize or just any color that would be great.

Daniel Florness -- President and Chief Executive Officer

So I'll throw in a few pieces, because I've got a few years under my belt that Holden doesn't have yet. If you think about our business, our local -- if you go back years ago, our days of collect (ph) would have been better, because our business was primarily a local business. And if I look at our local business, which is roughly half our revenue, you would see that our stats for that business is largely unchanged from what it would have been 10, 15, 20 years ago. In the last 20 years, we've gone from 2%, 3% of our revenue being national account to 52% of our revenue being national account. And we've gone from international being two locations in Southern Ontario to 15% of our revenue. Two things I can tell you about national account customers and international customers in general. They'd pay slower than our local customers. And so they've been attributing to 70% of our growth between Onsites. A lot of things we do Onsites, vending etc., really go toward a larger key account in that local market, whether it's a national account or not, but a larger customer and oftentimes their ability to negotiate terms that are linked to growing the business occur. And so, there are some structural aspects to it. The offset to that is that they also drive volume through our branch network and over time allow us to continually drive down the days of inventory on hand, because we're leveraging it across a bigger revenue base. So it's finding that balance, but it creates some challenges in near-term.

Hamzah Mazari -- Macquarie Research -- Analyst

Great. And then just a follow-up question is sort of, how do you think about sort of headcount growth going forward? I realize your sales are growing a lot faster, but at the same time your business mix has shifted more to Onsite. So, is historically the relationship between sales growth and headcount growth different now that the model is changed or just any thoughts on how you think about that piece would be great. Thank you.

Holden Lewis -- Executive Vice President and Chief Financial Officer

Yes, Hamzah. So the -- it is -- I think it's fair to say, I believe that the source of our headcount growth has diversified over the past few years, right. There was a time when we were heavily branch oriented, where most of our headcount was going into the branches and we're adding branches and filling those out. As we have become as reliant on the Onsites and vending, national account growth, then a lot of the headcount that we add is coming outside of the branches, perhaps to a degree that was not true 10 years ago, let's say. And we should be able to build a fairly significant revenue base off of that headcount relative to what we've been able to achieve before. I think it's fair to say that in the past, we would have had to throw a lot of bodies and heads into growing the revenues. And today, I think that there is more leverage in the model for headcount growth than it has been the case in the past.

That said, growing 13% does require investment in the business and that investment is in the form of headcount, both in the branches, as well as outside of the branches, and we began to see in August and September those numbers begin to tick up, and we would expect to continue to add branches to support our growth going forward.

Daniel Florness -- President and Chief Executive Officer

What I might add, if you look at the table in the press release, we talk about absolute employee headcount, and I'm talking about the in-market locations, and then the FTE employee headcount in-market locations. And you see that FTE growing a bit faster than the absolute. I have challenged our team to add a little bit more absolute, but to build to our recruiting pool. And the way we build staff in our branches, we aggressively go into four-year state colleges, two-year technical colleges and recruit and ask you to come work for us part-time while they're still in school. And those numbers need to be built a little bit. And -- but if you add 1% to that number, for example, it doesn't translate into 1% FTE, because it translates into about a half, and it's a less expensive FTE, and you don't do it for the cost, you do it for the recruiting pool of the future. And so, you will see that pick up a little bit, but will be very, I believe, efficient at managing the expense of that component.

Hamzah Mazari -- Macquarie Research -- Analyst

Okay. And then just lastly, I'll turn it over, just to make sure we're consistent with how you're thinking about tariffs. At this moment, you're sort of not quantifying how much of your business is directly sourced in China or you're sort of not quantifying how much of the business is sourced in China that is impacted by tariffs, because I realize those are two different numbers.

Daniel Florness -- President and Chief Executive Officer

There is a subset of SKUs that we do import from China that are impacted. That subset is much larger in some of those categories I touched about earlier. In fasteners, it's about -- it's 10 or 11 down the list as far as subcategories. And so it hasn't been fully impacted. If you look at it, and a lot of things that I've been looking at, the fact that it's about half of the imports coming in, that $500 billion (ph) are now tariffed, that's not too far off the mark of what we're seeing in our business too.

Hamzah Mazari -- Macquarie Research -- Analyst

Got it. Thank you.

Operator

Thank you. Our next question comes from Adam Uhlman with Cleveland Research. Your line is open.

Adam Uhlman -- Cleveland Research Company -- Analyst

Hi guys, good morning.

Daniel Florness -- President and Chief Executive Officer

Morning.

Adam Uhlman -- Cleveland Research Company -- Analyst

Sticking with that theme, I guess, when you think about the strategy here in the medium term of -- your purchasing strategy, I guess, should we expect the Company to be pre-buying ahead of what potentially could be bigger price increases for those tariff-related products from China, or are you looking to resource items from other countries more aggressively and not pre-buy? I guess I'm just trying to think through the inventory cadence here through the next quarter or two?

Daniel Florness -- President and Chief Executive Officer

I'd say, yes to each and every one of those to a certain degree and no to another. And that is we started some months ago in earnest looking at where we're sourcing. But you also have to look at it from the standpoint of what's the alternative source. Is there capacity available. Is the quality the same, and what's the price point. We could move some stuff out of China to another source if you add 5%, 6%, 7% and that 10% is there for the next three years, it's a good decision. If you add -- if you do that and you add 15% or 20% or 30% of the cost, it's a really bad idea. It becomes a less bad idea if 10% goes to 25% and it sticks. So in an environment where there's political variability as opposed to economic variability, it makes it very challenging to plan, and the biggest thing is having a good open dialog with your customer, but also understanding for a lot of our customers what we spend is a relatively small part of their spend, or what we sell is a relatively small part of their spend. So it's creating the least amount of disruption to their supply chain, but we have redirected some already.

As far as buying ahead, the problem with that is the -- predicting exactly what's going to be needed where. And for some items you can do it, but again, depending on what's going to happen, because supply chains, when we order stuff today it's not coming in next week or next month, it's coming in three, four months from now. So you have some limited ability to do that. But to the extent we can redirect some, absolutely we've been doing that. But Adam, just to sort of flesh out the question, the inventory I would not expect it to move meaningfully based on pre-bought volumes. Again, we've looked into it, there was tight capacity for products in a lot of places and we didn't have the ability to meaningfully ramp up the amount that we pre-purchased, based on what is pre-existing tight capacity.

Adam Uhlman -- Cleveland Research Company -- Analyst

Okay, thanks for that. And then just related to that, I guess, historically, what do you think the lag has been for your national account customer price realization, relative to your cost inflation and the efforts that you put into place recently. It's good to see in September price cost is covering what you'd done earlier in the year. I guess, should we expect that there is any difference as we start to think about 2019 in terms of your ability to pass along those higher costs to those big customers that push back so hard?

Holden Lewis -- Executive Vice President and Chief Financial Officer

Well, it's always going to be an intimate discussion with every customer and some of it's a willingness to peer into the supply chain flexibility on sourced supply. OEM fasteners has a different dynamic to it than MRO fasteners, for example. But historically, the pricing we saw in September that's more on our local customer, where time frame is different and because it's so diffused that was challenging us earlier in the year, because we didn't have great tools to manage it. I think of our national account relationships, most of that is historically on a -- kind of a six-month window that we can move pricing, and obviously extreme -- certain commodities don't fall into that, if it's things like stainless which has much more variability, we've tightened that window up. In the case of something like this, where it's a political event, you do have the ability to accelerate that, as does our supply base, accelerate that window, because the stuff we're buying last summer or last fall that came in on September 20 doesn't have a tariff. If it came in four days later, it does. So it's not about when you ordered it, it's about when it crossed the border. And so, it's being very mindful of that. And sometimes -- and that can change the timing window. But historically it would have been about a six-month window.

Hamzah Mazari -- Macquarie Research -- Analyst

Okay, thank you.

Operator

Thank you. Our next question comes from Evelyne Chao (ph) with Goldman Sachs. Your line is open.

Unidentified Participant -- -- Analyst

Hi , good morning, Dan and Holden.

Daniel Florness -- President and Chief Executive Officer

Good morning.

Unidentified Participant -- -- Analyst

So I guess first question I have for you is just kind of thinking about inflationary impact on your inventory. Is there any meaningful difference in your turns on the fastener versus non-fastener pieces of your portfolio? And then how do we start thinking about the impact of some of this inflation on your buy, noting that pre-buy has been challenging for you?

Holden Lewis -- Executive Vice President and Chief Financial Officer

The turns on the fasteners will be somewhat slower than the turns on the non-fasteners, simply because we source a much greater proportion of fasteners from overseas than we do non-fasteners. Not just from China, but from other countries as well. I don't think it would be unexpected to suggest that the vast majority of our fasteners spend is from outside the US and significantly in Asia. And so you're going to have a longer turn on fasteners than you will on non-fasteners. Our non-fasteners also carry more of a branded component to them. That lends itself to -- we're sourcing it domestically. Now it might have been manufactured offshore, but we are sourcing it domestically and therefore you have a tighter window too, as far as turns.

Unidentified Participant -- -- Analyst

Makes sense, yes. And then I guess maybe on a sort of related point to this, appreciate that it's challenging to quantify right now exactly what the impact to your COGS might be from List 3 in particular, but just thinking sort of, lot of your fastener buy is from outside the US, some proportion of your buy that's non-fasteners is also outside the US. Is there any thought as to maybe pulling back on how much the field is sort of permitted to dictate the buy and make that sort of more top-down in this challenging inflationary backdrop?

Daniel Florness -- President and Chief Executive Officer

I don't know if I'd phrase it as permitted to buy. I think ultimately our customer decides what supply channel is best for their business from the standpoint of their end customer, what they expect. You know we have domestic capabilities too, where from a distribution perspective, we have the largest -- when I look at our peers, we have the largest manufacturing of fasteners capability in our industry. And so we manufacture -- 35% of our revenue is fasteners. We manufacture about 5% of what we sell . So 5% of that 35%, we manufacture domestically, for the most part, but we have some operations in Europe and Asia as well. But most of our operations are domestic. And there is a customer base that wants that. The reality of it is, for fasteners and for non-fasteners, there's not capacity to handle it domestically, even if we wanted to move more domestically. The capacity doesn't exist, because the fastener capacity that's retained in this country, we're a meaningful piece of it, because of what we've done. But much of it has moved offshore, again, a lot of that back in the '50s, '60s and '70s.

Yes, Evelyn (ph) you have to also remember that the ability of our folks in the field to make decisions about what their customers need is a real important piece to how we service the customer and how we achieve the kind of outgrowth that we do. Now we've obviously encouraged the field to, wherever possible, maybe to use exclusive brands as sort of a product substitution, look for product within our network as opposed to having to go outside of our network, because obviously where we have scale in purchasing, we can do -- we can address the issues of inflation more greatly, but I think it would be a mistake to take something which has served us so well culturally and in terms of growth over such a long period of time and begin to uproot those kinds of things. I think we're far better off taking the relationships that those local sales folks have, have those conversations, use the tools that have never been better, use the experience they have in sort of having these conversations, which again has never been better and continue to service the customer in that way.

Unidentified Participant -- -- Analyst

Understood. And then maybe if I can just sneak in one on Onsites. I think you noted that you're tracking a little closer to the lower end of the range for the year. I guess what are some of the drivers of that expectation and then do we still think about a 360 to 385 (ph) type run rate into next year?

Holden Lewis -- Executive Vice President and Chief Financial Officer

Well, I think the expectation is if we look at the first three quarters, we divide by three, multiply by four and it gets you to the math, right. How fourth quarter plays out, we'll see. It's entirely possible that we'll sign enough to be inside that range. And so it's really just math Evelyn (ph). I will say this, if we come in at the low end of the range, around the low end of the range that will be as -- that will be as an effective job that we've done in any year of actually hitting that range. And let's not lose sight of the fact that whether it's 360 or 355 or 365, that's up from 270 last year and represents significant sort of buy-in and execution on the part of the organization. So I would perhaps put that perspective. With respect to what our expectations are for next year, frankly, we haven't addressed that yet. I think we'll have more to say about that as we get into the fourth quarter, but we haven't set that range at this point.

Unidentified Participant -- -- Analyst

All right, thanks guys.

Daniel Florness -- President and Chief Executive Officer

Thank you. We'll take one last question and then we'll wrap up the call.

Operator

Our next question comes from Nigel Coe with Wolfe Research. Your line is open.

Unidentified Participant -- -- Analyst

Hey, good morning. This is Bupinder (ph) sitting in for Nigel here.

Daniel Florness -- President and Chief Executive Officer

Good morning.

Unidentified Participant -- -- Analyst

I just wanted to go through the third quarter, pretty nice average daily sales growth here in the quarter, especially for September. And Holden, like you mentioned about the tariffs which became effective September 24. Just wanted to see if we can get some color, did you see any kind of pre-buy in the quarter before that deadline actually for the tariff went into effect?

Holden Lewis -- Executive Vice President and Chief Financial Officer

Are you talking about from a customer perspective or supply perspective?

Unidentified Participant -- -- Analyst

I mean if you can give color from a customer perspective, that'll be good too.

Daniel Florness -- President and Chief Executive Officer

I'll chime in on that. If you think of what we do, we provide real time supply chain for our customers. And that's our value. When the customer needs something they walk over and they push a button on a vending machine and they instantly have what they need, their safety glasses, a pair of gloves, etc. When they're producing something, they reach over and they grab in a bin and grab the fastener they need to assemble the item they are producing. If they're doing maintenance, they go to a bin and grab it. So the value we bring is the sourcing of product (inaudible) supply. There is no sourcing cost, it's available when I need it. So it doesn't really lend itself to pre-buying. So I would say there is no pre-buying in our numbers from the context of any of our revenue numbers in the third quarter or earlier in the year for that matter.

Holden Lewis -- Executive Vice President and Chief Financial Officer

And I've asked that question specifically of the RVPs every month in the last couple of quarters. And the feedback from them is very much the same. They have not seen any indication that our products are being pre-bought and stockpiled if you will ahead of these sorts of things. Now, I can't tell you that's not happening somewhere else in the supply chain, but as it relates to our products and our supply chain, it's not something that any of our RVPs or corporation is seeing.

Daniel Florness -- President and Chief Executive Officer

I'm going to close up the call with just two quick thoughts. In the last two quarters, I've touched on something that we've never touched on as a company and that is the traction we're seeing in the ease of ordering for our customer through what we call Fastenal Express or Web. I personally have been making a use of the system. And I've been probably wearing our team a little bit with things to make it easier, to make it more intuitive as a buy. And I was sharing with our Board the other day. I said, yes, a couple of weeks ago I bought a case of filters, I sent the order in and after two -- after three (ph) I got a reply, order is ready to pick up and I stepped over the rope to go and pick it up. Last night, as I was leaving, after 5 o'clock, I ordered a couple of rolls of Talon duct tape, that's our brand, (inaudible), as well as a fast on (ph) Jobber drill bit set. I ordered that late in the day. At 8:02 this morning, I had an email from Fastenal, my order is ready to pick up. That's measuring fulfillment of any type of order, whether it's a vending machine, a bin, an e-commerce order in minutes and hours, not in days, and that transaction is a more efficient transaction for us. And that freight is part of our normal shipping network. What we're finding is between 93% and 94% of the time our customers buy online, they're picking it up at the Onsite or at the branch. They want certainty of supply and they want great availability.

Second item I'll touch on is, we recently had Hurricane Florence hit the Southeastern part of the United States. I'm thankful to say that Fastenal and our Fastenal employees and our customers came through it largely undamaged. I love hearing the stories from customers and employees alike about fellow Fastenal blue team members stepping into support them. We are hours away from Hurricane Michael hitting the Panhandle of Florida. I believe Panama City is dead in its sites. Our best wishes and thoughts and prayers are with our team and our customers and the folks in that area. Thanks everybody, have a good day.

Operator

Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.

Duration: 60 minutes

Call participants:

Ellen Stolts -- Investor Relations

Daniel Florness -- President and Chief Executive Officer

Holden Lewis -- Executive Vice President and Chief Financial Officer

Ryan Cieslak -- Northcoast Research -- Analyst

Hamzah Mazari -- Macquarie Research -- Analyst

Adam Uhlman -- Cleveland Research Company -- Analyst

Unidentified Participant -- -- Analyst

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