快扣 (FAST) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to the Fastenal Company 2008 quarter two earnings conference call.

This call will be hosted by Mr.

Will Oberton, Chief Executive Officer, and Mr.

Dan Florness, Chief Financial Officer.

The call will last up to 45 minutes.

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

Oberton and Mr.

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

As a reminder, certain statements contained in this presentation are not historical facts or, excuse me, are forward-looking statements and thus perspective.

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 results.

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

Please go ahead, gentlemen.

Good morning, everyone, and thank you for joining us on our conference call.

This is Will Oberton.

I would like to start off by saying that I believe we had a very good quarter.

I think that the people on the Fastenal team did a great job producing profits and growing our business.

I want to thank all of our Fastenal people that maybe listing today.

Starting out with sales growth, I would categorize our sales growth as okay for the quarter.

We came in just over 16%.

June came in just about as -- almost exactly where May was.

Kind of the trend in that mid- to upper-teens number and, as I said, that's okay.

The reason I'm not real excited about it is that we are investing at a slightly higher level and we would expect a little more.

I am very happy, though, with the older store growth.

Our older stores grew 10%-plus, or is it 5%-plus?

Excuse me -- 11.2% in June.

Sorry about the mistake.

So they are actually doing very well.

I think the reason large stores are doing well is because of our investment in outside salespeople.

We have noticed a trend though in our large account business has slowed down.

If you look in the supplemental information, the Strategic Account group only grew at 12%, down from 14% in the first quarter.

So we think that is mainly economic, the headwind just a little stronger with the big accounts.

But we made that up with the small accounts with our outside sales program.

We are very happy with the results that we have had with the outside sales program.

Looking at information, actually this is not the June information, it's from earlier in the quarter.

I didn't have all of the June information in.

But the outside salespeople, we looked at the group that had been with us since the beginning of the year, so they were employed '07 and before, about 1762 people.

That group of salespeople is growing at about 28% year-over-year, so they are growing much faster than the company.

They are producing about 28% to 30% of our revenue in any given month.

So when you look at that, they are actually producing about more than half of our sales growth with only 1,800 people.

So you back up and you say, what is going on there?

We are calling on the small accounts that we don't have.

We are adding customers at a faster rate.

Another very positive thing about the outside sales program is that the margin that this group is producing is about 300 to 350 basis points higher than the company average.

Again, because they are calling on the small accounts.

The big accounts are slower, typically lower margin.

Small accounts are growing faster, typically higher margin.

That is probably the biggest difference in our gross -- one of the biggest differences in the improvement in our gross margin.

So very happy with the outside sales program.

We are starting to correct some of our problems with the underperformers.

I think our people in the field are doing a great job of that, trying to sort through and see what works and what doesn't, and also developing our tools that the outside salespeople have used.

We just upgraded our software on the handheld computers again, making it faster, making it more efficient, and getting a higher adoption rate of that technology.

So overall sales growth okay, but a lot of bright spots in there.

The margin, we are very happy with the margin.

As I said, the outside sales program is probably the biggest reason our margin has grown.

Second reason is discipline.

Third I would cite is we are keeping up with the price increases.

I'll talk about inflation a little later in the call, but I think our group is doing a good job of keeping up.

I don't think we are really getting ahead.

I don't think the market will allow us to get ahead, because it's some competitive times and when you go to raise prices you get questioned on it.

I have been on a lot of those calls myself and they are not very much fun, but that is business.

I think one other reason our margin is improving is our FASTCO trading continues to find new products, better sources throughout the world.

Our freight initiative, even in the times of fuel where it is, we continue to make improvement.

Dan is going to cover that a little more in his part.

Then our [iHUB] and expansion, so a lot small things that are making a big difference in the profitability of Fastenal.

Expense control, I think we did a good job in expense control.

We did not leverage our expenses and it's really two reasons.

The formula that I put down, high margin plus growth -- profit growth equals high commissions, bonus, and profit-sharing and that's really -- the first one is that we talk about our programs heavily levered to gross margin -- sales growth, gross margin, and profit growth.

Sales growth wasn't really a factor here, at 16% it doesn't lever up hard.

But the gross margin and profit growth really drives bonuses.

It's a very high grade problem.

It's good for our employees and usually what's good for our employees is good for our shareholders.

Then the other expense area would be fuel.

Fuel added about -- incrementally, about $2 million more than it would have had the price per gallon been about the same and that doesn't include energy costs.

I did not pull out the utility energy costs.

We know they have grown tremendously just because of the cost of gas and electricity due to, again, to a higher energy costs.

So overall I think we did a very nice job in expense control, even without being able to leverage, we did a lot of things well.

Earnings growth driven by the sales and profitability -- or sales and margin, excuse me, 20.5% pretax.

I went back, and you have to go all the way back to 1995 to find a quarter when Fastenal was able to report pretax earnings at 20.5%.

I think there is only one or two quarters in our history when we were over 20.5% and they were both in 1995.

So I'm very proud of what everyone did.

Hard work, but we knew we would get there if we worked hard.

Earnings growth of 26%; also a very good number.

We picked up a 170 basis points improvement year-over-year that goes to our pathway to profit discussions we have been having over the last year.

Our internal goal is 100 basis points.

We got a little bit of a run on its year, so we are very excited about that.

The pathway to profit, a little bit of a recap.

Average store size grew 7.8%.

We are happy with that, but we really need about 9% or 10% to hit our long-term goal.

So we are going to have to push and, hopefully, push our top-line revenue up as the economy picks up a little better as maybe we can execute at a slightly higher level.

We are not real disappointed, but slightly disappointed with that.

Our pretax profit growth, as I just said, 170 basis points.

Far exceeded our goal.

Our return on assets, one of the other things that we stated would be improved.

Looking at a mid-year snapshot -- it's a little difficult because it's not year-end.

But second quarter rose 7 over second quarter '08 and went from 20.4 to 22.1.

Very nice improvement on the return on our assets.

The other one that -- probably not quite as good as we are a little bit behind on our store openings.

Very confident that we will get caught up.

All of our people have their plans in place to get the stores open in the third and very early in the fourth quarter.

So we are going to hit our numbers for the year, we are not worried about that.

But as we have stated in the past, it works better -- the early we can open the stores in the year, the better off we are.

So a little work to do there, but generally a very positive report on pathway to profit.

As I said earlier in my comments, that the outside sales program is starting to gain more traction internally.

The last thing I want to talk about before I turn it over to Dan are some of the inflationary pressures that we are seeing.

It's almost all hinges around our steel product.

When you break out our products, as you see, 50% of our revenue is driven by fasteners, but it's really about half of that, or 25% of our overall product, that is greatly affected by steel.

It's the commodity fasteners, the nuts, the bolts, the washers that are the heavy steel parts that have a very high component of their cost driven by steel.

I'll give you a little bit of history of how it has came through.

Back in July of 2007 the Chinese government repealed the VAT tax.

That was 13% tax; they brought it down to 5%, so there was an 8% increase in our product.

That hit about 10% of our costs of goods and added about 80 basis points to our costs.

Now when you think about this, it's about a 9-month cycle from the time we place an order till we sell the product.

It takes 90 to 120 days to receive the product and then we turn the product just over two times a year, so there is another six months.

So the product that went up that we purchased, say the middle of July of last year, would have sold through at the end of the first quarter, something like that.

So that 80 basis points is fully baked-in.

Later in the fall, September/October, they started re-evaluating the renminbi, or the yuan, in China and another about 10% increase added another [one point 10%] -- on 10% of our spend added 1%.

That is pretty much fully loaded in into the second-quarter.

The real inflation started in January of this year when steel just went on fire.

It's right after the Asian steel companies agreed to the 67%/68% increase ore and everything went crazy.

That is just coming through right now as incrementally it's a long path, as I said, nine months.

Some comes through quickly because you buy it and sell it.

Some goes over a long period of time.

The other piece -- and that part is a 20% to 40% increase on a select group of our products.

It will probably translate into 4% to 5.5% of gross -- or inflation by the end of this year.

Now some of that will be offset with the things we are doing with FASTCO with all the other initiatives we have going.

But we will see more inflation later in the year as a product that we are buying in the second quarter sells out in the fourth quarter and the first quarter.

So we are just trying to give you a better understanding of that.

One other part that is added to our inflation, and this is probably 20 to 30 basis points, is the fuel increase.

Transportation, both on the ground, on water, on the rail, transportation is up every where we look.

So it's difficult to get an exact number because it's thousands of transactions -- thousands of purchasing transactions and millions of sales transactions put together.

But both Dan and I have worked hard on this and our best estimate today is that we have between 3 and 3.5 percentage points of our growth is coming from inflation, based on all the things we are seeing, all the price increases we have pushed.

That is our best estimate today with it going up a little bit, a couple more points, later in the year.

With that I am going to turn it over to Dan.

Dan is going to give you some more color on the balance sheet, which I want to thank Dan for doing a great job of managing our assets and especially on inventory side.

He did a really -- I believe these guys have done a really good job on that.

Thank you.

Thanks, Will.

Good morning, everybody.

Again, thanks for your time to listen in on our call today.

I'm going to run through the press release and touch on some points in somewhat of a Paul Harvey fashion.

I will start with page one.

Just a couple comments I noted on the sales trends that we schedule out -- the five-plus, the two-plus, and the all category -- solid, consistent daily trends throughout the quarter, throughout the month.

The one item that isn't in our press release, but is in our supplemental data, our 10-plus-year-old stores grew at 10.7% in the month of June on a daily basis.

That is a number that is off the chart.

The same month a year ago that group grew at 4.4% and that was the third highest month of the year in 2007.

So it wasn't a case of it was an easy comparison by any means.

When I look at the -- April.

April was lifted a little bit by the Easter shift.

May and June followed with nice strong growth.

Again, as Will touched on, with the investments we are making, we believe it should be better than that number, but solid growth nonetheless.

Some items on page two and three as it relates to pathway to profit, we are executing as expected from the store growth and headcount growth standpoint.

Could be a little bit higher on the store growth piece.

To reiterate our stated goals -- store growth 7% to 10%, last year we targeted that 8% number.

It will be similar to that this year.

Store FTE growth looking at upper teens.

D.C.

and manufacturing FTE growth upper single digits.

Admin and sales support lower single-digits.

That is really where our thinking is that is where those numbers should be growing and we are executing within those -- within that framework.

Some items on the store statistics that we break out on top of page three, you are starting to see what we talked about a year ago when we first talked about pathway to profit.

Really what we are doing over a five-year period is we are morphing the mix of stores such that the percentage of stores that are in the categories one and two will over time flip with categories four and five, which will drive our average store from the 75,000 to 80,000 a month neighborhood is today to about 125,000 at the end of five years would be our goal.

You can see, especially in group one and group five, that shift is pointedly starting to occur as 17% of our stores are now in that first group versus over 20 year ago and 11% in that fifth group versus 9% a year ago.

As Will mentioned, our average store size went from $74,300 to $80,100 a month, an increase of 7.8%.

Looking at pages three and four on fuel trends, fuel is taking its toll.

We've quantified some figures in there again.

About half of those dollars at you see are included in cost of goods, it's the diesel going into our transportation fleet -- or our semi fleet.

About half of those dollars going into the pickup trucks that we have for our store delivery vehicles.

A few things to point out last year, and that we saw this year, is the trend during the quarter was rising each month of the quarter similar to the trend we saw last year.

What we saw last year was June and July really peaked and you saw some moderation of the gasoline prices in the August/September timeframe.

The gross margin on the bottom of Page four, I'm going to touch on a number of points there.

The points we touch on -- increase the gross margin on business with a lower than acceptable margin.

That is really about discipline and where we want that lowest margin points to be on what is good business.

We are challenging that very hard and bring up that bottom.

That is a meaningful piece of the improvement in our gross margin.

The second one that Will touched on, staying ahead of the inflationary increases.

In the first quarter we cited an estimate, and this is an estimate.

It's very difficult to perfectly pinpoint the impact of the gross margin expansion looking at our FIFO costing of inventory because there are so many pieces that come into play.

The product, the shift that is occurring because of FASTCO, the product that sourced at the store level, the varying quantities at which we are sourcing at can dramatically influence the price per pound of the product we are buying.

But we estimated in the first quarter about 50 basis points of our margin improvement was related to that.

In the second quarter we feel that has dropped at about half to about 25 basis points of our gross margin is attributed to pure inflation.

Again, that is a rough estimate.

As Will touched on, improvements in our direct sourcing.

The FASTCO organization that we created some years ago continues to find new opportunities for sourcing our products and improving our gross margin over all.

Fourth item, our freight initiative.

On a year-over-year basis -- earlier I touched on the fuel costs and what they are doing.

On a year-over-year basis our overall freight number that is in cost of goods, we picked up 30 basis points of gross margin.

Again I repeat, our gross margin improved 30 basis points on a year-over-year basis looking at all freight components.

Some years ago Bob Kierlin wrote the book "The Power of Fastenal People." When I look at this quarter there are two powers -- there is the power of Fastenal people and there is the power of Fastenal trucking and logistics in general.

They were a big part of our improvement year-over-year and a lot of it is about what alternative we used to move product around North America.

Are we sending out one of Fastenal's trucks?

Are we using a third-party LTL shipper or are we using a third-party small parcel shipper?

We have done a very nice job of continuing to challenge ourselves in our day-to-day thinking on sending more and more product on the Fastenal truck.

Even though costs are going up on our fleet, as well as external fleets, we still have a 10-to-1 cost advantage when we send it on one of our trucks.

So even with added costs there, if we can migrate some stuff from the $10 category to be the $1 category, you don't have to do a lot of math to figure out that is a dramatic win.

I'll throw in an example.

If you look at end of the second quarter, we had 2,272 stores.

Now, our average small parcel shipment that we do today is somewhere between $10 and $15.

If I use the low-end of that range, the $10, that means if we were able to reduce one shipment a day, one small parcel shipment a day in each of our stores, that would save us roughly $23,000 a day.

With 64 business days in the month that would save us just under $1.5 million in the quarter, if we were able to accomplish that.

That $1.5 million number is approximately 25 basis points.

That is the type of math you need to go through to understand how are we improving our gross margin when it comes to freight.

I applaud Chris [Duttenbach] who has been leading that charge in our logistics group and his team that are really making that happened day-in and day-out.

It's just through sheer persistence.

I think I get more e-mails in my inbox from Chris than I do anybody else in the organization throughout the month.

The fifth item, product availability in network, that really touches on the master stocking hub concept we talked about several years ago.

That does two things for us -- it allows us to source the product more efficiently, rather than when we do it one at a time at the store level.

It also allows us to move that product more efficiently.

So some of our freight improvement is occurring because of what we are doing in Indianapolis.

But that is having a very nice improvement.

The second half of that product availability is Fastenal becoming much more effective, much more efficient at moving -- at making all product available to all customers at all stores.

That is through our store-to-store transfer program we call inventory redistribution.

It's really about having great visibility and efficient means to move that inventory around.

Today our average store transfers three items a day to another store in the company, which in the month of June translated into about 140,000 picks that occurred and transfers that occurred that were at the store level on top of what we are doing at the distribution center level.

A few other items to note, Will touched on it, our OSP program.

That in and of itself has a positive bias over time to our gross margin.

The fact that the large comp business is running a little bit slower, that is a positive bias as well.

One item I would point out, if you are looking at year-over-year numbers, the gross margin last year was unusually low by about 60 basis points because of the implementation of our ERP system and a true-up we had in the second quarter of 2007, which lowered the gross margin about 60 basis points to 50.6.

Looking at the operating expense side of the equation, pleased to see another quarter where we are leveraging our occupancy.

That is one of the -- a key point within our pathway to profit.

In the first quarter our occupancy when up about 10.9%; in the second quarter about 9%; year-to-date about 10%.

Our personnel in the field, our district managers, our regional VPs, our regional finance managers are doing a great job managing that expense and being very careful about store relocations and what we are paying for the new stores we are going into.

One program that we are doing on the energy side of the equation is we are doing what we call our top 10 opportunities.

That is looking at stores with the highest 10% occupancy costs per square feet in a given region and going and affecting that and making change in that store.

We are making nice headway on that to lower our energy consumption costs.

Payroll, as Will mentioned, we did have a negative leverage in payroll as we saw in the first quarter.

That is one of those good problem situations.

Payroll really is linked to our ability to grow our gross profit dollars and our ability to grow our pretax dollars.

We are doing a nice job with both and it's causing our payroll to increase quite dramatically in the short-term because of the added profitability that we are enjoying as an organization.

Again, occupancy is about 20% of our SG&A, payroll is about 70%, the other 10% is dominated by the vehicles in our fleet and insurance.

Insurance we leveraged nicely.

The fuel, as we touched on, that had negative leverage within our operating expenses.

All other expenses within operating expenses I feel we did a really nice job of managing when looking at that on a sequential basis and year-over-year.

Working capital on the bottom of page five, AR and inventory leveraged quite nicely.

I'm very pleased to see that happening.

There are two inherent negative bias points that are in play right now.

One, when it comes to accounts receivable, again, we continue to lower our days to collect.

Improve our overall AR in general.

That is in the face of a weaker economy, which would tend to, in many cases, slow payment patterns down a little bit and increase your exposure.

We have not seen either.

Our team is doing a great job with maintaining our progress on the accounts receivable growth.

The inventory, the natural bias we have in there that is negative is inflation we touched on.

Most of our increase on a year-over-year basis is related to inflation.

We have done a nice job of managing that asset through our distribution centers and at our store level.

I believe we have ample opportunity to continue to improve that going forward.

We have great momentum there and I feel that will continue to improve as we go through the year and into next.

Looking at our cash flow statement, very nice performance year-to-date.

Operating cash flow as a percentage of earnings came in at 79.5%.

Our stated goal is to be in that 80% to 90% category on an annual basis.

The first six months is usually difficult because of the working capital growth and the tax payments that occur in the first half of the year.

But close to an 8% number for six months is very good.

Historically, that number was $0.50 to $0.70 on the dollar.

Again, that's looking at operating cash flow as a percent of net earnings.

Will touched on the return on assets for the trailing 12 months.

This year 22.1% versus 20.4%.

Our average total assets measured at the June, December, and June snapshots increased 13% year-over-year, whereas our profits on a trailing 12-month basis are up 22.4%.

One item I would also point out -- at the end of last year in our annual report we cited our CapEx for the year would be about $77 million.

I now anticipate that number to be closer to $85 million to $86 million.

The drivers of that change would include two primary components.

One, the distribution expansion that is going on at Indianapolis and Dallas, some of the steel that is going into the ASRS system is coming in a little bit higher than our original estimate, as well as we bought some adjoining land in Indianapolis.

The second piece relates to our SmartStore program, our vending and the CapEX that is going into that program this year.

That is vending where we are putting it in customer locations.

It's a very attractive return.

A couple of other items of note from the press releases last night, we announced our second half dividend of $0.27 per share versus the $0.25 per share we paid out in the first half of this year.

In the for what it's worth department, since we went public in 1987 we have paid out about $315 million in dividends.

46% of that number has been paid out in the last two years -- just in the for what it's worth.

Finally, we did increase our share buyback authorization.

We had an 800,000 authorization; we bumped that up to 1.8 million that we currently are authorized to buyback in the open market.

With that, I will turn it back over to Anthony for the Q&A session.

(OPERATOR INSTRUCTIONS).

Jeff Germanotta, William Blair.

Good morning, gentlemen, and congratulations on a good performance in a tough market.

One of the comments I was curious about was on page three of your press release where you share the pretax margin by size and age of store.

Generally speaking you have done really, really well there, but there is one small anomaly in some of the younger stores that seemed to have contracted their margin year-over-year.

Any insight into what is going on there?

What is going on there, Jeff, is that is where we have added outside salespeople into those stores, because both Dan and I had the same question about what happened.

We are investing more in the smaller stores to grow the business faster.

So because we have more resources in there it's taking slightly longer to ramp up, or we have got a lot of younger salespeople that are still ramping up, is that the conclusion?

No, the conclusion is we have more people.

Remember, we are putting part-time people in all of our stores.

We used to start with two, now we have three people in every store.

So we are putting more resources in the stores earlier to grow them faster.

Jeff, one item I would add into that.

If you recall last year when we were first talking about the path would profit, I think the 0-50 category, which was kind of the sweet spot we are aiming towards, had an operating margin at that point just north of 24% and we were targeting a company number of 23%.

And the real thought process --

Not 0-50, it's above.

So it's a 100 to 150 -- excuse me.

We were targeting a 23% number.

The thought process was that all groups, because we are adding people at a faster clip, there would be a slight dampening in all five groups or really groups two through five, because of that added labor cost we were introducing.

What has really offset it, if you look at year-over-year, is our gross margin expansion has offset it in all the groups.

But in that group that you talk about, the issue there is if you add a part-time person or full-time person a store it just swings the needle too much as a percentage of sales.

It doesn't take a big expense on a $30,000 store.

Do $100,000 for the quarter, you add $3,000 in labor you lose three points of operating profit.

Does that cause you to think about how you allocate that labor, just newer or more established?

Absolutely not.

We want those stores to grow.

That one point on that group of stores is nothing.

If you look at the top group of stores, I think we added about 55 stores into the over 150.

If you look at those stores, and say they do $2 million -- $150,000 a month, roughly $2 million -- at 28% operating profit, every store going in there is worth about 20 of those ones that lost a point or 30 or 40.

The faster we get them to the top the better we are -- if anything we will invest more.

If we lose a little bit more on the bottom or lose a little ground on the bottom, we will make it up in spades for years to come.

Great trade off.

It's a great trade-off.

That's a great trade-off.

Thank you very much.

Keep up the good work.

Michael Cox, Piper Jaffray.

Good morning and congratulations as well.

Through the first half of the year you were up about 150 basis points on the operating margin.

I know you have stated a 100 basis point target for the full year.

What are some of the factors that would lead to exceeding that 100 basis points?

Or what would be some of the factors that would be a drag in the second half of the year to pull it down to your target for the year?

We are not working to pull it down to our target.

I think the biggest factor is the gross margin expansion that has caused it to accelerate.

Because if you really walk through the math of just slowly morphing the stores and getting some leverage on occupancy, getting some leverage on labor and other costs, it would naturally happened there.

But the gross margin is really what has leveraged it up even faster.

Also, because of the higher gross margin, we have been willing to add more outside -- or continue to add people into the stores.

At 16% top-line revenue, if we had not seen the gross margin expansion we would have added fewer salespeople.

So we have been a little more liberal with our additional salespeople because we can.

Okay, and if I could ask one quick follow-up.

You mentioned the 3% to 3.5% inflation impact to sales in the first -- I believe in the second quarter.

I was wondering if you to give us that figure for the month of June, if you could.

I think it's probably about the same, Mike.

We really looked at the carbon.

It doesn't change rapidly because someone is anniversarying product coming in.

We didn't break it out that way, but I think it's pretty accurate for the month of June also.

Okay, great.

Thank you.

Adam Uhlman, Cleveland Research.

Good morning.

Dan, just to follow-up on the gross margin question.

Earlier in the discussion it was pointed out that costs were going to be accelerating even further in the back half of the year.

I would suspect that FIFO accounting eventually starts to work against gross margin.

How should we think about the gross margin rate in the back half of the year?

Well, when I look at the components that make up the gross margin we have today and the improvements that we have today, the piece at risk is that 25 basis points.

That rough number that is inflation that is going to be waning.

The added costs we are seeing -- that we saw the first of this year, you are going to really be seeing those costs late in the third quarter and they will be baked in by start of the fourth.

Then the real challenge for us that is in the marketplace in general is staying with that wave as it comes through.

But again, that last increase, it works out to about 40 to 50 basis points of inflation when you factor it down to what percent -- the inflation on steel and how that translates into impact on our cost of goods.

Now have you seen any change in the competitive environment at all?

We really haven't seen a lot of change in the competitive environment.

Whenever there are price increases people are shopping, and so it goes both directions.

It creates opportunities for Fastenal and it creates challenges when you are out pushing price increases.

But our competitors are doing the same thing.

So far we have been able to pass our price increases along.

But because we run each one of our stores as an independent business, we charge them the actual cost of the product.

They are raising prices when the pressure comes to them, so it's a very natural process as if they were independent owners.

It basically eliminates most of our opportunity for inventory timing and expanding margin, but at the same time it flows through very well.

They are not going to go out and raise prices if their margins aren't under pressure, because they want to be competitive within the marketplace.

They are business people.

Great.

Thank you.

David Manthey, Robert W.

Baird.

Good morning.

Could you talk about your sales trends in construction, end markets specifically, and then your outlook for that vertical?

Also, one of your competitors discussed longer and broader summer shutdowns than normal.

Are you hearing anything like that?

It seems like you have seen that trend among your larger customers.

But do you think that is what's behind it?

I'll through this one to Nick, he is with us here.

Good question, Dave.

A lot of our larger customers, as you had indicated earlier from some of your other previous communications with some of our competitors, the larger customers are seeing some impact.

However, we see a lot of opportunity with the small to medium contractors with our outside sales initiative.

As a percentage of the market, we have a very small percentage of the overall construction market, so we are still seeing opportunity there to continue to grow from a construction standpoint.

But there is pressure for the large commercial contractors right now and they are not as busy as they would like to be.

Although we did have a record month with our largest contractors in June.

I just got the e-mail two days ago.

The guys who call on those sent me an e-mail, basically, patting themselves on the back.

Very, very nice month in June.

It's almost all being driven by energy of some sort, either power plants or oil refining.

There's a lot of power plant stuff.

Also there is a lot of mining going on right now.

So there is a tremendous amount of activity around energy and because we are located in a lot of these small towns like Central Wyoming and all these places, we get a big opportunity at that.

So we are really not being hurt by construction at this point.

David Manthey Great.

Did you have a comment on the summer shutdowns -- the turnarounds?

I have not heard anything, but to be honest with, I haven't been in the field a lot in the last month or so.

Nick, have you having heard anything on shutdowns?

I don't see any difference in what is historically been happening when it comes to shutdowns.

I have not seen or heard anything different.

Okay.

Thanks a lot, guys.

Brent Rakers, Morgan Keegan.

Good morning.

Just trying to get a little clarity on the additional price increases that might happen during the second half of the year.

Will, I think you mentioned earlier, you estimated about 4% to 5%.

Is that --

I think by the end of the year what were seeing with steel right now, that we could have between four and five percentage points of our growth attributable to inflation in steel.

That is because it's coming -- it came through really hot and heavy in the March/April timeframe.

We will be selling that product out -- what it really comes too is about 25% of our product saw a 20% to 25% increase and it's the basic commodity nuts and bolts.

Now, the price increases that we saw last year are going to anniversary, so that drops it back down a little bit.

But by the last half of this year, I think that is probably where we will be, so it will be interesting to see what the overall economic picture does.

If we can use that to accelerate our sales growth or if the bottom erodes a little bit and we use that to maintain our sales growth.

So we are working hard to accelerate, but right now we don't know what is going on.

We believe that is probably pretty much the same for all of the industrial distributors, because pretty much all of us sell steel products.

That the inflationary picture is very similar no matter who you look at out there in the industry, whether you are an electrical supplier or other products.

So, Will, just again to clarify for me, if you are getting 3 to 3.5 essentially in the second quarter, you are only looking at the equivalent of a new 1%/1.5% on top of what you have already realized?

Yes.

Part of that is because some of the old stuff falls off from a year-over-year basis.

Okay, great.

Thank you.

Do you know what I mean?

It's a moving target.

The bottom keeps rising.

The bottom keeps rising, correct.

There are two lines, the top line and the bottom line.

Okay, great.

Thanks a lot.

Holden Lewis, BB&T Capital Markets.

Thank you, good morning.

Your comments earlier about seeing the smaller -- or I guess the larger accounts slowing down somewhat and that being related to the economy, but making it up with the smaller accounts.

I would tend to think that the smaller accounts would be more volatile and more economically sensitive than the larger accounts.

So I guess I'm kind of confused by the way that you are putting it out there.

Can you maybe just give a little more color?

Yes, Nick will take it.

One thing that you have to keep in mind -- and you are correct in some regards that there is volatility there -- but it's the sheer number of accounts that we are adding.

We are adding accounts, accounts on an active basis, twice as fast as we are growing our stores.

Better than twice as fast; almost three times as fast right now.

So yes, there is a lot of volatility there, but our account base is growing in the mid-teens right now.

So that wipes out a lot of volatility.

So it's not that our existing small accounts are buying more.

We are just adding more small accounts because we have this army of salespeople out there actively knocking on doors and bringing them in new business.

The other thing I would throw into that is when you look at just the volatility of the existing customer base, with 200,000-plus active customers that volatility really gets smoothed out because it's such a wide dispersion of customers.

I think what happens with the large customers, Holden, is they are just more sophisticated buyers.

They are very, very tight with what they need.

When they can reduce inventories, they have better visibility to their business than the guy who runs in this morning because the job is starting and he needs $500 worth of concrete anchors or whatever it happens to be.

It's a different type of business.

We are not saying the bottom is falling out on our big business, it grew at 12%.

We are disappointed with that, but we have a lot of -- we are working very hard to improve that.

This is Nick.

I will add a little bit to the larger customers as well and that is somewhat the same thing is happening in that group.

That is we are -- because of the volatility of the marketplace, we have a lot of customers that are buying more product from us or weren't buying from us in the past because of the services we can provide, lowering their inventory, lowering their labor.

So the net-net result is, yes, they are not growing very fast.

They are not growing as fast as we would like them; they are about in that 12 range.

So what is happening is some of our existing large customers might be slowing down, but we also have existing customers that are buying more from us because of the services we provide.

And we are adding customers -- larger customers out there that are looking for the type of services we can provide because they are in a situation where they basically have to lower operating expenses, which is primarily labor, which we can come in and take care of some of those services.

So the net-net result is they are not growing as fast is we think they should.

Most of that is a result of some of our existing large customers being slow, but they are not going away.

Okay.

Then if I could just follow up on that.

You have always commented that you thought your breakeven level in terms of growth was in the 11% to 12% range.

You kind of think that you are down there.

Over the last six quarters, so going out even before the recent gross margin spike, over the last six quarters you have achieved revenue growth between 14% and 15% and you have had SG&A leverage, stripping out the DNA component, SG&A leverage up about 30 basis points.

So essentially breaking even in terms of SG&A leverage at a mid-teens growth rate, which seems like it's a little bit higher than you would normally suggest.

Can you give some color is why that may be?

It's all about the fact that 70% of our SG&A is levering up like crazy because of the gross margin expansion.

Gross margin expansion, profit growth, and addition of outside salespeople.

Okay.

I mean, your gross margin expansion is like the last two quarters, but not necessarily the four preceding it, right?

The 2007 year?

2007 was really about adding outside salespeople.

If you look at the additional salespeople that we added in '07, it drove almost all of our expense.

Then we have had this conversation before, Holden, as long as we can afford it, we are going to keep pushing on growth because long-term that is our best bet right now.

We look at it, we say we are doing things we need to with the gross margin.

We have the money, we can hit our hundred basis points growth and profitability.

Let's add the salespeople because in the future if the economy -- when economy picks up we should be really well-positioned.

Just like we were well-positioned earlier in this decade.

And in the mid-90s.

Early- to mid-90s.

So pathway to profit is a relatively new effect.

At what point do you think that you begin to leverage the revenue that is being driven off of that investment?

Is that something in this environment that we can expect or in the environment that exists today it's going to be difficult to envision leveraging those personnel adds?

You mean from expense standpoint?

You mean operating expense?

Yes.

We are really not focused on just leveraging that, we are focused on growing our operating profit and investing as much as we possibly can and hitting our profit goal.

If it's going out in high bonuses and commissions because we have great gross margin, we will take the profit wherever it comes whether it comes from gross margin or lower operating expense.

If our margin drops or our profit drops, we are going to react very quickly and lower our operating expense.

Part of that reaction will naturally occur because of the bonus component.

If you look at the executive bonuses, they are more than triple from last year in the second quarter -- the group that works for me.

Okay, so you are not getting the leverage because you are adding the expense and that is a deliberate.

You are may be accelerating that because of the gross profits?

Because we know we can.

One of the key pieces to this though is the average size of the store continuing to grow.

That is the basis from the strategy and that is what you have to remember.

If we can continue to grow the average size of our store and use our historical data as reference, which we can, we should be able to drive up our earnings.

All of the other stuff is a lot of detail, which is important.

If you take the -- I believe it's 54 stores that we added into the top category, the 150-plus, and do the math, that adds about $8 million in operating profit year-over-year just that group of stores.

If you take them from the bottom and roll them up to the top -- take them out of the bottom and take them to the top, it adds over $8 million in operating profit with the small group of stores.

That is what Nick is pointing out.

Thank you.

John Baliotti, FTN Midwest Securities.

Good morning.

I was wondering if you could maybe give us some color end-market-wise.

If you kind of look at the overall average and maybe give us some color on end-markets that might have been growing above and below how you grew for the quarter.

If you could remind us, percent of your sales that are more non-res construction versus other.

Well, basically, we have very small exposure to non-res construction -- or excuse me, residential construction.

Very small exposure.

Non-res construction is about 20% to 22% of our business.

The products for construction are greater than that of the actual contractors.

We don't state specific growth numbers in each category, but we haven't seen a lot of change.

Probably the biggest one is our largest OEM customers are dropped and that is reflected in that strategic account number.

Maintenance continues to be strong, the energy industry is very strong, agriculture is very strong, and anyone who is exporting product because of the weak dollar seems to be doing very well.

Where we are getting beat up is any manufacturer that sells their product into the residential construction -- windows, doors, equipment.

One of our largest customer or very large customer just announced a 40% lay-off because their products they make are used in building homes.

Right.

Will, earlier you said in your prepared remarks, you said that smaller accounts were higher on gross margin, which makes sense because of how they buy.

I was curious, could you characterize that from an overall profitability on operating margin?

If you characterize the small versus the national --

We don't because we look at the store as a business.

The store manager has to maintain a 50% margin to be -- or mix to be fully comped.

So we don't break it out by customer size -- on the very big customers we do, the very large customers, but we don't do it on the small customers.

We look at it that they are a business manager, we trust them to manage their business profitably.

When they do so, we pay them fairly or, hopefully, better than fairly.

I mean, academically would a smaller customer require more service than a large customer because they may be buying more frequently or--?

It's all over the board.

Some are very needy and others walk in and buy product.

There just is no exact customer type.

We sell to more than 225,000 customers a month.

Some of our largest customers are the most needy customers that we have because they can be.

Then others are not and we have to balance profitability on the large ones.

On the small ones you run your business and you understand the customer needs.

Two things I'd add to that.

One is you need to talk about the concept of need -- it's a case of we are a local distributor to that customer.

We have the ability to provide them a high level of service and they compensate us for that service.

So it's a great win-win scenario.

The second thing I would put out, especially on the smaller customer base, the CSP initiative that we started back in 2002 where we really just laid out the product in a more efficient fashion in our store, lends itself to servicing a wide range of customers, especially smaller customers, much more efficiently than we could have say five or 10 years ago.

Because it used to be a lot of our stores had a sign on the front, minimum order $20, minimum order $25.

Those signs are gone because we can make money on transactions because we don't have so much labor in the transaction at the store.

Also because we let our managers -- we give our managers a lot of decision-making or discretion.

If they have a customer that is very needy they might have to slowly raise the price until it balances between opportunity and energy going in, like any business person would do in managing their business to profitability, because they do have a limited number of resources to use to grow their business.

We work very hard on training them to be independent businesspeople whenever and wherever possible.

On the pricing side, you were talking about how steel prices -- you started to see in the beginning of the year a 67% rise in pricing and I'm --

No, no, it was a 67% raise in iron ore pricing.

Okay, did that kind of translation as it works into the product itself, is that something that you can start to convey to your customer in terms of your pricing?

Do you do that right away or do you -- as you start to see that in the headlines or how do you start to -- (multiple speakers) system?

We have to wait for the market to start reacting, because we can't run out there right away.

If they haven't seen it, they are not going to accept it.

We risked the business.

So what we do is we raise our prices as it comes through, our wholesale price and all of our prices, we go out to our managers, we explain it to them.

They raise prices as soon as they can, but they really have to wait -- normally they will wait until their margin starts being affected.

So if their margin is moving down, they go raise their prices.

If we are doing a good job, that is about the same time as our competitor is probably raising their prices and it becomes a market condition.

We have become pretty good that.

For the 20 years before 2004, we never had to do it.

2004 we learned a little bit, in 2007 and 2008 we have learned a lot about raising prices and understanding what the customers will accept.

I have been more involved in that in the last year than I was in the previous 20 years.

Mainly all the big customers -- it's a challenge, but we get paid to do a job and right now the job happens to include price increases.

This is Dan.

I'm going to interject here.

We are running a little bit longer on the call then we normally like to do.

So I'm going to -- I have a couple of closing comments then we will call it a day.

First off, wanted to reiterate one item within our conference call and that is the whole gross margin area.

One way you will often times hear us talking about, at conferences or just internally, we are straightening out the lines.

Our direct sourcing operation is really straightening out the line between the manufacture of the product and the customer that is buying it.

Where we can straighten out the line of where that product flows, everybody knows the shortest distance is a straight line.

We can lower cost and have a competitive advantage and improve our margin, improve the value we provide to our customer.

The second half of that is, over the years -- a lot of times I have been questioned over the years about the wisdom of having this large internal trucking fleet.

It's a large fixed-cost component of gross margin.

This is a quarter -- this is a period of time when I look at the last three months/six months/the last 12 months where I'm very thankful in my role of the wisdom we had 20 years ago when we started creating this trucking network.

Of what a competitive advantage we have built, the proverbial moat we have put around the business to enhance gross margin over time, to provide a great level of service.

Because when you get down to it we are hauling a gob of steel, relatively low value-per-pound product around a very large continent and we can do it more cost-effectively than anybody.

Getting back to that whole concept of alternative A or alternative B -- alternative B, which is Fastenal trucking, has a 10-to-1 cost advantage.

I can't make that point enough.

Again, thanks, everybody, for taking an hour out of your morning today to listen to our call.

Have a good weekend.

This does conclude today's presentation.

We thank everyone for their participation.

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