快扣 (FAST) 2007 Q1 法說會逐字稿

Welcome to the Fastenal Company 2007 first-quarter earnings conference call.

Today's call is being recorded.

This call will be hosted by Mr.

Oberton, Chief Executive Officer, and Mr.

Dan Florness, Chief Financial Officer.

The call will last for up to 40 minutes.

The call will start with a general overview by our Fastenal host, Mr.

Overton and Mr.

Florness.

The remainder of the time will be open for questions and answers.

As a reminder, certain statements contained in this discussion are not historical facts, but are forward-looking statements and are thus prospective.

These forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements.

More information regarding such risks can be found in Fastenal's quarterly and annual SEC filings.

I would now like to turn the conference over to Mr.

Overton.

Please go ahead, sir.

Good morning, and thank you for joining us for this call.

I'm going to spend a few minutes talking about the sales environment.

Talk a little bit about the sales environment that we've seen in the last three months, a little bit about the earnings and some of my thoughts on how we've done, and then I'm going to turn it over to Dan and he'll talk a little bit more about the financials and the balance sheet (technical difficulty).

The sales environment we're currently in continues to be slow.

We (technical difficulty) starting in the second half of 2006 when our manufacturing customers were slowing down slightly.

Right now, we seem to be at a steady state.

A little pickup in March from where we were in January/February.

Some of that was due to better weather, a little bit execution.

But overall, we're still seeing generally a slow economy in the industry that we sell into.

And the biggest area that we slowness is really in the manufacturing OEM business.

I've been instructed to speak up.

Sorry about that.

So we're going to work very hard to -- continue to work hard on growing our business in a slow environment, and right now, we don't see anything that makes us believe it's going to pick up in the near term.

We're hoping in the second half of the year, we might see a stronger manufacturing environment.

Geographically, we're seeing greater slowdown in the automotive area, basically from Illinois, a little of Ohio, up into southern Canada.

That is the area that we're seeing our slowest top-line revenue growth.

The rest of the country is pretty much the same, with a little stronger area between really the southern half of the United States, from Dallas, Texas all the way to the Atlantic Ocean.

That area has been a little stronger for us, but marginally.

From an earnings standpoint, I'm really very happy with what we've been able to do.

The sales growth [left] from 15%; as an organization, we've never been able to manage our expenses at anywhere near the level that we could show earnings leverage or even close to the same growth as earnings as we've had in sales.

We've done this by working very hard on our margins, very hard on our expense control.

The margin was up about 60 basis points year-over-year.

Forty basis points of that came from our freight initiatives and product movement activities.

And 20 basis points came from the product margin.

We're actually selling the product for a little higher price or buying it better.

Other areas on the expense control -- I apologize, it's a little jumpy.

We're getting feedback over the phone.

I'll try this.

Other areas that we're doing a nice job on would be the labor.

Our labor growth was up just under 12%, which is very low considering we opened -- excuse me, folks -- 73 new stores in the first quarter and continue to do CSP2 conversions, almost 40 in the first quarter.

The one area for expense control that we did not do a very good job of -- it was planned, but it still surprised us that the amount of growth was our occupancy costs.

With the store openings that we opened last year, the CSP conversions, our occupancy costs, which is our second-largest area in SG&A behind labor, more than doubled our sales growth, the growth.

And that is everything including occupancy, the utilities, the rents, and all the maintenance on our buildings.

That is an area that we need to work very hard on going forward.

We're trying to look at ways to take smaller buildings at the [osts] that are opening of new stores, reduce the moves going into the year because we really need to slow that growth as a percentage of sales and get it back more to the level of our sales growth going forward.

One very positive area for us has been our inventory growth, or, in this quarter, lack of inventory growth.

As we stated in January, we knew that we had spent too much on inventory.

We understood the reasons; we thought we understood how to control it, and we did do a nice job.

Where I am very -- what makes me very happy is we're able to reduce our inventory by almost $10 million without putting a lot of risk into our business.

First thing we did is we sold through the product that we did on year-end buys last year, and a little bit of that came through in the product margin, an improvement we saw.

But we also focused on any area that we felt we had enough to satisfy the customers, and we moved the product within our system.

To minimize the risk of service, we basically do not believe we put a lot of risk into the service side of our business, and we're able to reduce our inventory throughout the quarter.

Going forward, both Dan and I believe that we still have an opportunity to improve our turns as the year goes on, hopefully getting back to a level similar to the first quarter of 2006 by within the next three to four quarters.

And that's really what our internal goal will be, is to continue to improve our inventory turns, not at the rate we did in the first quarter; that was very aggressive; but quarter by quarter.

With that, I'm going to turn it over to Dan.

I just wanted to cover the real highlights for the quarter, and he's going to touch more on the balance sheet issues, and then we will go back to some Q&A.

Thank you very much.

Thanks, Will.

We'll talk primarily about items above the operating margin line.

I'm going to talk about a few of the items below the operating margin line.

In the area of interest income, as we saw, it was down from last year.

It was really a reflection of the reduction of overall cash balances that we had outstanding for most of the quarter.

And then our income tax expense, whereas our rate in last year first quarter was 38.1% and for the year was 38%, we did adopt FIN 48 this year, first quarter, as all companies are required to do.

While the adoption did not have an impact on our financial statements, in the definitions of FIN 48 we had a discrete event during the quarter, added approximately 827,000 of expense, and brought our overall rate in just over 39%.

As we mentioned in the press release, we anticipate our rate absent that event would have been about 38.2%, and would expect that rate to continue into the future.

As I flip through the earnings release, some commentary I would point out on the bottom of Page 2, last several quarters, we have highlighted the first three of the four items listed there.

We continue to be pleased with the progress made on the first three items.

The fourth one, which we started talking about last year, really hadn't explicitly called it out in our earnings release, is really about the master stocking hub.

And I would point out to everybody that we will be giving an investor presentation on the 24th of April, where we will talk about the Indianapolis facility and other things about our business, physically from the Indianapolis facility, and we will be broadcasting that over the Internet.

The impact of fuel prices on the quarter, on the top of Page 3, we did talk a bit about what our average cost was per month.

And again, that includes costs that are both in cost of goods sold as well as SG&A.

But basically, the fuel was neutral for us for the quarter, add a little bit of price moderation that was occurring late last year that continued into the first quarter, and we benefited from that, both at the operating expense line and at the gross margin line.

However, I would point out when I look at the gross margin expansion in the first quarter, about -- we had about a 60 basis point expansion.

Forty basis points of that was related explicitly to our freight initiative, and a relatively small piece of that 40 basis points was related to fuel.

The 20 basis points of that was solely related to enhancements in our product overall margin.

Page 4, we talk about accounts receivable and inventory.

Cash flow is a tremendous focus within our organization as is our return on total assets invested in the business.

As we've mentioned on previous calls, we were disappointed with -- while we were very pleased with the progress we're making on our accounts receivable initiative, last year, growing our accounts receivable just under 16% on sales growth of 21%, that continued into this year, growing our accounts receivable at 12.3% versus sales growth the month of March of 15.5%.

The A/R continues to inch down nicely for us as we make now small improvements versus the dramatic improvements we made over the last two years.

Inventory is really the story for this quarter.

And as I mentioned we had been disappointed with our progress on that.

We did drop our inventory this quarter.

That was a better improvement in inventory than we had anticipated coming into the quarter.

And we really continued to build momentum as we went into the quarter.

And the thing I am pleased about is we were able to do it not in a shotgun approach, but in a very strategic approach in that we don't -- we believe we were able to contain inventory growth while not allowing our business to suffer at all from the standpoint of available product.

At the store level, our inventories increased from December 31st.

The increase was solely related to store openings and CSP2 conversions, because our inventory growth at the store level was less than the dollars we needed for those two items.

At the distribution center level, we were able to reduce our inventory nicely, approximately $14 million.

And it really related to our ability to maximize the benefits that we're achieving through our master hub concept, pull down some of inventories in the outlying distribution centers, and really look at our inventory from a standpoint of what is stocked at the store, what's stocked at Indianapolis, and maximize it throughout the organization.

We still have a lot of work ahead of us.

The 180-plus days of inventory we had on hand at the end of last year is much too high, we believe, for our business.

And our real question as we move forward, as we move through the balance of this decade, is where we can move that number to.

At the start of this decade, we operated in the low 140s as far as days of inventory on hand.

As we evolved through the decade, we initiated our CSP1; we set up our direct sourcing operation in Shanghai; we did a number of things that naturally caused our inventory to grow.

In the last year, with our Indianapolis facility, we made a commitment to put inventory into that facility, which we continued, and we grew the inventory this quarter in that facility as well.

And -- but our real question is on the 180 number, or the 180-plus number at the end of last quarter, how much do we believe we can reduce that over the balance of the decade?

We have some goals we've identified internally, and we will see how those progress.

And we will talk about some of those goals on April 24th at our investor day.

The other item of note on the balance sheet, we did buy back some stock during the quarter.

In hindsight, I believe I made a mistake during the quarter in that I wasn't more aggressive at buying stock.

When I had talked to my board back in January when they gave us the authorization to move forward, I made a commitment to them that I wouldn't take on debt to buy back stock.

And so we bought back a nominal amount, 100,000 shares in the early part of March.

As you can appreciate with our dividend payment going out in March and the inventory growth that we'd seen in late in last year, that continued into the first half of this quarter, we weren't flush with cash.

The cash we have on the balance sheet really built up in the last 20 days or so of the quarter.

And I probably missed an opportunity to have bought a little bit more opportunity -- a little bit more of our stock back at very attractive prices, but we will see how that plays out over time.

And in the list of problems that we have, that's probably a high-class problem.

The final item I wanted to touch on, and this really relates to the cash flow statement in general, and I thought I would throw out a few statistics.

Historically, I'm looking at the last four reported years for Q1, our worst performance on cash flow in the first quarter was our cash flow -- operating cash flow -- equaled our earnings for the quarter, and that was in 2004.

In 2005, that number was 127%.

Last year it was 133% as our inventory growth really occurred later in the year.

This year, our operating cash flow versus earnings was approximately 156%, and we, the Fastenal organization, are quite proud of that number and will continue to challenge our operating cash capabilities as we go through this year and into the future.

If I look at that on an annual basis, that number is hovered somewhere between 50% and 75% over most of the last three, four years.

And as I look into this year, really challenge ourselves of saying we believe that our goal and, again, this is an internal goal, but really look at it and say we should be able to put out $0.60 on the dollar from an operating cash flow, and that's a goal that we have internally.

It's not necessarily a forward-looking statement, but really just a stated goal.

With that, I will turn it over to Gwen to start the Q&A session.

Thank you.

(OPERATOR INSTRUCTIONS).

Jeff Germanotta, William Blair.

Good morning.

I wanted to inquire a little bit about your rate of reinvestment, to cumulatively include the sum of new stores plus CSP2 and CSP3.

How do you see that rate going forward?

Are you inclined to temper that in a more moderate economic growth environment or sustain it, or --?

I'll let you provide the color on that.

Right now our plan is to continue to look at the environment, and try to determine what is the best blend between new stores, outside salespeople, and CSP2 or CSP3 stores.

And it's -- we will make changes going forward as we see a need, but at this point we really don't want to comment on what our exact plan is going forward.

Is that fair?

Let me ask you just a bit of a follow-up question to that.

You previously said that the rate of new store development would be in a range of 13% to 18%; has that range changed much at all?

We're at the lower end of that range based on 73 openings.

I think if we -- that would put us in a range of about 13% if we did that four quarters in a row.

We're looking very hard, Jeff, at trying to determine, over the longer period, not the current economic cycle, but over the longer period, what is the best way to grow our business and get a high return for our shareholders.

And at this point there's not a high [region] the highest return.

At this point we're really not -- we have not determined exactly where that is.

Right now we're sticking with our existing plan.

And then Last question, are you seeing much selling price inflation, or how has that changed in the past twelve months?

The only area we've seen selling price inflation would be in our stainless-steel fasteners -- or much inflation.

The stainless-steel fasteners, which make up less than 5% of our total product sales, have grown more than 30% inflation.

We've seen more than 30% inflation in that product.

Otherwise it's been very stable environment.

The carbon steel has actually backed off a little bit.

The branded products, we've done a nice job of holding the cost very flat.

You get a little bit here and there, but overall it's probably the lowest -- in the last five years we're seeing the smallest amount of inflation in our business that we've seen over the last five years.

So just as a follow-up to that, within the 13% sales growth that you reported for the quarter, does that translate to a low single digit, maybe 1% or 2% number?

No more than 2%.

I guess I would say not much over 1% to 2% is probably fair.

Thank you very much.

David Manthey, Robert W.

Baird.

Good morning.

I was wondering if you could talk about the gross margin implications of your current inventory strategy and the impact on rebates, etc.?

Our current inventory strategy shouldn't have any effect on our rebate amounts.

Most of our rebates are set up so that we don't have to hit growth bogeys, meaning 10% or 20% or 30% growth.

It's really on absolute dollars.

If I did $5 million in spend with a supplier last year, that's a fixed amount.

Maybe I'll get 3% at $5 million and 4% at $6 million or something like that.

So as we grow our spend, it has a natural ratchet in there for that number to go up.

So we're really in a good position.

So over time, our rebates should continually increase as a percentage of our cost of goods.

But it's very marginal because at the higher dollars, people aren't willing to throw 1% or 2% kickers in there.

It goes up by a few basis points.

But with our current strategy from an inventory standpoint we don't think it will affect our margin.

We do believe we have opportunities to improve our margin going forward because we continue to do a better job with our purchasing -- with our FastCo trading company.

And I'm in contact with our president of FastCo trading weekly, and every week we're talking about new things that he's finding; high-quality, value-oriented product that our customers are buying.

We recently had a big customer show down in Nashville, where we brought in more than 3500 customers for a couple days.

And there was tremendous interest from the customers in these products because every one of them is looking to save money if we bring -- provide value.

One other item I would add to that is in addition to that, those pieces, we have what we're doing with our master distribution center in Indianapolis.

And really what we're doing there is, one, making a more efficient process for our stores to service their customers' needs on items that we don't sell a lot of in any given region, but we sell a fair amount of throughout the Company over the course of the year.

And giving them the way to easier -- to get that in an easier fashion.

And two things that we find on products that we're putting in Indianapolis, and one of our objectives going into it, was we're able to source better because we're not buying it in relatively small quantities.

We are buying it in a strategic fashion in a larger quantity basis because we're buying for the Company, not for a store's needs today.

Secondly, the freight differential on that product is -- is meaningful from a standpoint of it's a one-off transaction that is expensive to ship.

And if we do it in a more orchestrated fashion, it works much better for our business.

Okay.

Can you still hear me?

Yes.

Okay.

Could you just talk broadly about CSP2, and how you see the project going, especially given the weakness in the market right now.

Are you still encouraged by the results you're seeing?

And I know a lot of people are hung up on this 3500 store thing.

Could you give us the big picture here, about 10 years, and kind of talk about sales force additions beyond the limit of stores?

CSP2, we have a lot of success stories; many of our stores are doing very well, and some of them aren't doing well at all.

But what we've really determined in all of our analysis of CSP2 and a lot of it is anecdotal, just talking to our managers in those stores.

But much of it comes off the actual reports.

Where we put in the salespeople, we've done very well in almost every case.

We've not done a good job of keeping the salespeople in all of the stores, and I can't blame that all on the field people.

Dan and I have been tough on managing our expenses and trying to control labor, at the same time pushing the CSP.

So it's a little bit of a mixed message but one we felt was probably necessary to get many things done at one time.

So we're still very committed to what we're doing with CSP2.

Next, on the 24th when we have our analyst day, we're going to talk more about the reporting of our CSP2 numbers.

I think what you will -- I know what you will hear is that we believe going forward our CSP2, the whole strategy, we have to be more flexible with the inventory, giving the managers better input into what we stock, and a lot more of an a la carte strategy.

Our standard stock works great in the small store, but we boxed it in a little too much in the larger stores.

For the last six months, our product development people have been working on like modules of inventory.

If a store wants grinding wheels, and they are real good at that, we will let them add a big [spleck].

But they may not want power tools or they may not want some of the other things.

We're going to build the inventory to our current customer mix, to the current market, and we're going to use far better marketing data (technical difficulty) customer codes to build an inventory that matches the customers' needs, matches the strength of our team on the ground, the people that run the store, and we think we will see far better results.

That being said, the return on CSP2 is pretty good the way we see it today.

But we believe we have a tremendous opportunity to improve it.

As far as the 3500 going forward, we're still comfortable with that number.

It could be larger.

But when you look at our better stores, and we haven't really shown a lot of that information, you look at the stores that have been open a little longer, performing at a higher level.

What we need to do is move the big group of stores, 1500 or so stores that are a little above the average down to the smallest stores up into another category, and Fastenal can be a far bigger Company.

Now to do that, we probably need to focus on things other than just new store openings.

We need to focus on number of salespeople.

As I said in the CSP2, we didn't do as good a job as we should have in some of our locations.

So going forward, Fastenal 2015 or whatever it is, I would foresee we're far more focused on outside salespeople.

We're far more focused on market data that shows us what customers buy and how we get the access of that.

We're far more focused on what we're really good at, which product creates the greatest profitability for us, or provides the highest level of profitability, and pushing our sales force and training our sales force to work into that area versus selling whatever the customer asks for every time.

We need to guide the direction of our business.

And that's really probably the story for Fastenal going forward over the next five, six, seven years, focus more on customers' needs and the strengths of each one of our individual stores.

Sounds great.

Thank you.

Dan Whang, Lehman Brothers.

Good morning.

My first question was regarding your comment that the trends were a little bit stronger in March, and also you saw better execution in certain areas.

I was wondering if you could maybe talk about in a little bit more detail about what particular areas you feel you executed better?

Really the execution comment -- we had a product promotion in March, we call the Bounty Hunter.

It's a marketing promotion, and we really -- for the last five years we've been trying to figure out how to push the sales a little harder using marketing, using contests, using cash prizes.

As an organization we've never been real good at that.

Nick Lundquist, our Chief Operating Officer, has been working hard on that program.

This is the third year we've been running it.

And we had a nice boost in these products.

Some of the (technical difficulty) -- it really wasn't geographic, it was who bought in and who sold it.

We think that program probably gave us about 0.5 to 0.75 of a percent point of growth in the March number.

So that program was a one month program.

Go ahead, Dan.

The only thing I was going to add, just so everybody is clear on it, is this program that we executed quite well to in March is not a new program this year.

We've been doing it -- we do it in March and September of each year, and we have been doing it now for a number of years.

This is our third year.

So it's been built into the comp from last year.

But we did a little better job of it.

We're learning how to motivate our troops; we're learning how to put programs together that drive sales over a short period of time.

It's not something you can do 12 months out of the year.

But some good contests.

We had a lot of fun with it?

People made some money, and it worked out well.

Otherwise, we don't see a big change in the environment, between say, even November and March over a five-month period.

And from the standpoint of your customers' sort of mindsets, I guess no real change there as well?

Or could you make any comments about the inventory levels out there?

I had an opportunity last week.

I mentioned this Nashville product show.

Again, we brought in 3500 customers, so I had the opportunity to speak with -- I don't know how many dozens, probably between 100 and 200, would be my guess -- of customers all across the country.

Their general tone is that things are a little slower, but nobody is jumping off the buildings.

It's kind of a ho-hum, yes, we're busy, but not real busy.

But people don't really like to comment on inventory.

I asked several questions about it.

Their goal is always to keep their inventory lower, because that's what their CFO is directing them, or it's a cash-flow world that we live in today.

And so people are saying we're always working on lowering our inventory, how can you help me with that?

The general trend -- and it was not just our customers, but also our suppliers from all different industries -- are saying that they're seeing not a bad environment, but just an okay selling environment and all the way through the channel; and that's really what we're seeing.

So it confirmed our belief that timing is a little slower.

ISM basically says we're in a neutral, not moving up, not moving down.

And we just have to work harder to execute.

Second question was regarding your gross margin improvement, and talked about the bulk of that coming from freight initiative versus sourcing.

I mean, do you anticipate those two factors to be sustainable through the remaining quarters of the year?

I believe they're sustainable, and we have the opportunity to even improve.

Over a period of time -- quarter to quarter, you're going to move up and down a little bit depending on how everything falls.

But going forward over a longer period, the next three to six quarters, we believe that we can show continued improvement.

I'm not talking 50 or 100 basis points but a little bit at a time by continuing to work hard on our transportation.

We have done a nice job of transportation but we still have not achieved the goals that I laid out two years ago in June at our investor show.

Right now we're about 70% of the way where I think we should be, and we continue to work very hard on it.

And close to half of our Company is at that level.

We just have to bring in more participation from some of the stores that aren't doing as good a job and some of the districts and regions.

So we're going to continue to work hard on that, both on the product side and on the transportation side.

And my final question was regarding your comment about the occupancy costs, and that is an area that you're placing additional focus on.

Due to this issue, could this impact the rate of new store growth or at least the size of the store print, and could the master hub concept require smaller footprint stores going forward?

This is Dan.

I'll take that one.

A couple things.

I think if I look over the last four years, with CSP1, we did a lot of things with relocating stores.

And in that process, I think a couple things happened.

We got a lot pickier about the stores we go into, and not just the stores we move into, but the stores we open into.

And when I look at the last several years, where we were moving probably 18% or 19% of our stores, physically moving existing stores; we might have been moving it two blocks down the street, we might have been moving it two miles away into a different area within that city.

Part of that was really related to the runoff of the initial CSP1.

And some of those stores that were converted in early -- in the first couple years of CSP1, coming into this year, our expectation was more of maybe 6% of our stores are moving.

And I think we might be able to challenge that number down a little bit.

So some of it is going to naturally occur as we roll through because we just aren't moving as many stores.

I think the second piece is really challenging all of our regional business units on stores you're opening, how big a footprint does it go into?

And that's not just challenging our regional business unit.

That's challenging our folks in the product and marketing areas of how we place the product in the stores.

We've done a lot to really trim down what that initial side of the store needs to be, challenging ourselves continually to not only reduce the physical (technical difficulty) needs, but also what's our plan for the first three, four years of that store's existence, so we still have room to add inventory as the store needs in its normal growth.

Remember last year when we were making these investments, we anticipated at that time that our sales growth would be much better than 13% to 14% in the first quarter.

So this was all planned.

We didn't get surprised by it.

The impact was just much greater because the sales slowed down so much.

You sign a lease for three years there's not much you can do about it six or nine months from now.

You still need to pay the rent and heat the building.

So I sound disappointed, and I am, but it's not like it surprised anyone internally at least.

Thank you very much.

Holden Lewis, BB&T.

Good morning, thank you.

Looking at sort of the margins in a different light, sort of your incremental operating margins.

It looks like you got about 20% -- a little bit better than 20% incremental operating margins year-over-year.

Clearly, the best reading that you've seen over the past four quarters.

And I remember last time you got close back in Q3, you had about a 19.6%.

I mean the message there was yes, it was a pretty good quarter, but frankly far more things were hitting on all cylinders than we would normally expect.

And so it sounds frankly like you're more convinced that this 20% incremental operating margin in Q1 is sustainable than it was when it was even slightly lower than that in Q3.

I'm sort of curious as to why that is.

Obviously it's not about the revenue growth.

It's about our focus.

Internally, we have taken a really hard look at everything we do.

We found -- what I found, back in January, I took two days and hit and took all the information I could from the previous year, and went through everything and tried to look at all the good, bad and the ugly of our business.

What I determined is some of the good things we're doing were being outweighed by bad decisions that we're supporting.

And so in the last three months, we have tore our business apart and said, what shouldn't we be doing, and what should we be doing?

And we've found enough that we believe we can continue to improve our business over a long period of time.

I'm not talking wholesale changes, [score sterth] or anything like that.

I'm talking that there is some business that we have today that we may not have a year or two from now unless we can improve it.

We're digging our heels in, we're making tougher decisions and believe that we have left some of our really good decisions like our freight program, our FastCo trading company, kind of mask over some other decisions because we've been doing pretty good.

Sometimes a slowdown in the economy and a slowdown in your business is the absolute best thing to really understand where you are.

I'm going to use this time also to kind of come back to another question that was asked earlier that I didn't give a good answer on.

Jeff Germanotta asked the question about new stores and what our plan going forward is.

In looking at the business by just describing (technical difficulty) everything, we're trying to determine if opening stores at 13% to 18% is our best plan.

And we're going to be talking about (technical difficulty) meeting between right now and next week, we're not going to answer any questions about other than what Dan and I say right here.

But going forward, it looks like slowing our store growth somewhat and focusing on more salespeople, growing our bigger, more existing stores, would probably give a better return to our shareholders.

We're going to talk about it next week; we're going to continue to open stores; we're going to continue to look at 3500 as the upper end.

But whether we get there in three years or five years, we're not completely sure.

But what we want to do is we want to find the best sustainable long-term return for our shareholders.

And so Jeff, you kind of put me in a corner there because I don't want to say we're going at 13% to 18% forever and then come out next week and say hey, I've been looking at this real hard.

So I felt it was important to bring it up right now and let everyone on the line know that we're researching this; we have a lot of data that shows what we think is the best mix (technical difficulty) new stores, outside salespeople, CSP2, and bottom line (technical difficulty) because all of those are important.

And we really think we have some very good things to talk about.

Certainly, but those shifts certainly would have had no bearing on the past few months.

Without being overly self-reflective in this forum, can you talk about some of the things that, six months ago, the bad decisions or the things that really weren't as tight as they should be, and where we stand with those today?

Just a few examples of sort of that behavior in this past six months or so?

The reason first quarter was better, if you think -- go all the way back to July, we really tightened up our growth in support labor and some of the other areas and it reflected in the first quarter.

Had we had better growth in the first quarter, we would look really good.

Right.

But for instance, you added I think 400 and something people in Q1.

March, you were pretty aggressive.

Typically hiring comes down in March from February, so that hiring holiday is kind of past.

Does that suggest that maybe the incremental operating margins we're seeing in Q1, are a bit higher than maybe we would see in upcoming quarters if the primary issue is one of hiring?

Or is that the wrong way to look at it?

I think it would maintain the incremental margins.

We believe we can -- really the whole -- it really depends on what happens with our sales growth in the second, third quarter.

The one thing I would throw in there, if you look at the month of the year, the first two months, we were holding it very tightly on the support side, actually contracting.

And in the third month of the quarter, we continued to add folks into the store side.

If you look at our headcount growth in general, it's really about growth drivers, and much less about the support needs.

What support we did add in March was really centered on our distribution side, and that number was pretty nominal.

Right.

Thank you.

Michael Cox, Piper Jaffray.

Good morning.

Congratulations on the quarter.

My first question is on the national account business; I believe about a year ago you unveiled some restructuring to that segment of your business.

I was wondering if you could give us an update on how that's progressing?

We continue to be -- if I look at last year, we made some pretty dramatic changes to how we approach our strategic account.

And we shuffled around the deck a bit.

On personnel, we asked Steve [Rasinski], who headed up our largest business unit, to step into that role, because he had had a very successful strategic account program in his previous role.

I believe Steve has good momentum in place.

I don't want to go into a bunch of details.

We were planning on covering at our April 24th meeting generally speaking a discussion about how we want to report those numbers in the future to give you better visibility into what we're doing, and to give better visibility into the type of momentum we believe we have in place.

But we believe Steve is making positive impact.

As Will mentioned in his President's letter, what we've seen as far as energy and activity in that group of customers, we see positive trends.

Last week in Nashville, we had our customer products show, and that customer products show is really bringing in our large customers, our strategic customers, into a venue to talk to them about -- about how we can help their business, how we can help them on the sourcing side, how we can help them manage their inventory, etc.

And that show was the largest show we've ever had.

And the amount of energy we have, the amount of interest we have is quite staggering.

Okay.

In terms of the direct sourcing you called out as a gross margin driver, I was wondering if you could comment as to what that was as a percentage of your mix, in the most recently completed quarter versus last year's first quarter.

And then looking longer-term where you feel that can go.

Really what we called down in the gross margin, we have about 20 basis points really related to product margin improvement, some of which related to direct sourcing, some of which related to others.

So you're looking at out of that 20 basis points, it's probably a 50-50 split.

As far as the actual percentage for the quarter, if I looked at last year, that number was in the 22% to 24% neighborhood.

And that number will continue to inch up over time.

I don't have the exact statistics for the first quarter.

My suspicion is it would be somewhere in that 24% neighborhood.

When we look at products that are sold through industrial distribution, and this isn't unique to Fastenal.

This would be true of many of our competitors.

We estimate close to 40% of the products that are sold -- that are consumed in North America for maintenance, consumption needs -- probably 40% is produced outside of North America.

And our challenge has been to [Stock Camp], who heads up our Shanghai business unit over there, has -- can we grow that to -- we don't believe we can grow that to 40%.

Because there will be some items in there we just don't have the volume to justify it.

Can we move that up to the low 30s eventually?

And maybe Will wants to [tell you] on that a little bit.

The 40% is the number that we have worked out about four years ago when we opened the office.

I believe that the number actually has grown since then because things produced more and more manufacturers are moving production over there.

Things that normally wouldn't have been imported, some of the higher value items, like electric motors and electrical components, power tools.

It used to be generally North America are moving.

That number will continue to move up.

Our goal is to narrow the gap between what the opportunity is and where we are.

We should be able to grow our importing -- our direct sourcing business in a much higher rate than our overall business.

And we have over the last three to four years.

So it will continue to be an opportunity for us to improve our gross margins.

One of the limiting or governing factors is we offer a better/best strategy in most of our product, which means basically domestic and import, so it's really the customer in many cases to decide which they want; we're finding a lot higher acceptance for the import items that propel you, and the quality is good, so that could accelerate the overall program.

We're not going to cut off our domestic products, because some customers really want them, and that's great.

That's very helpful.

My last question -- and I don't mean to steal too much thunder from the upcoming analyst event in Indianapolis, I was just wondering if you could give any sort of qualitative or quantitative update on the uptake that your store managers and sales reps have for the master hub concept, in terms of relying on the master hub versus the previous way of doing business?

The store people are very excited.

As I stated in my President's letter, adding all the product, Indianapolis hasn't came without some bumps and bruises and maybe a couple black eyes, not literally.

We added a tremendous amount of product to the facility and we're working through our systems and developing our people.

But just this week, we have a group of new district managers in -- when someone becomes a district manager, they have to go through a training program and then do a business presentation to myself and Nick Lundquist.

They have been in, and we've talked to several of them, and it's been very positive about having a broader -- having the breadth of inventory.

But we think what's going to be the real big step is our new catalog is coming out -- I think it's actually being printed this week, but coming out next week -- and that catalog matches up with the products in Indianapolis.

So the salespeople can walk in, lay it on the customer's desk, and say, I have the product that's in this catalog a very high percentage of the time.

There are certain items that still come direct from the manufacturer, like material handling items, big bulky items.

But to a high level, a high degree, they can say, we have this product and it will make life more efficient at the store and more profitable.

Anecdotally, it's been very, very positive.

Great, thank you very much.

That concludes our question and answer session.

I'd like to turn the conference back over to Mr.

Florness for any closing remarks.

I'd like to thank you everybody for listening in on our conversation today.

This is our second conference call.

We resumed, as everybody knows, doing conference calls in January for our fourth-quarter results.

And we hope everybody on the call finds this venue useful and informative.

And our intention is to continue this into the future.

Again, I would invite folks to either attend or listen in on our annual meeting discussion next Tuesday at 10.00 Central time.

And our investor day presentation, listen in on that -- both of which will be simulcast over the Web.

The one in Indianapolis is at 9:00 East Coast time?

Central time.

10:00 East Coast time.

Thank you very much, and have a good day.

Thank you, everyone.

That does conclude today's conference.

You may now disconnect.