快扣 (FAST) 2009 Q2 法說會逐字稿

Good day and welcome to the Fastenal Company second-quarter fiscal year 2009 earnings conference call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Darin Pellegrino.

Please go ahead, sir.

Good morning and welcome to the Fastenal Company 2009 quarter two earnings conference call.

This call will be hosted by Will Oberton, our Chief Executive Officer, and Dan Florness, our Chief Financial Officer.

The call will last up to 45 minutes.

The call will start with a general overview of our quarterly results and operations by Will and Dan with the remainder of the time being open for questions and answers.

Today's conference call is a proprietary Fastenal presentation being recorded by Fastenal.

No recording, reproduction, transmission, or distribution of today's call is permitted without Fastenal's consent.

This call is being audio simulcast on the Internet via the Fastenal Investor Relations homepage at www.invester.fastenal.com.

A replay of this webcast will be available on our website until September 1, 2009 at midnight Central time.

As a reminder, today's conference call includes statements regarding the Company's anticipated financial and operating results as well as other forward-looking statements based on current expectations as defined by the Private Securities Litigation Reform Act of 1995.

Forward-looking statements may often be identified with words such as we expect, we anticipate, upcoming, or similar indications of future expectations.

It is important to note that the Company's actual results could differ materially from those anticipated.

Information on factors that could cause actual results to differ materially from these forward-looking statements are contained in our periodic filings with the Securities and Exchange Commission and we encourage you to review those carefully.

Investors are cautioned not to place undue reliance on such forward-looking statements as there is no assurance that the matter contained in such statements will occur.

Forward-looking statements are made as of today's date only and we undertake no duty to update the information provided on this call.

I would now like to turn the call over to Will Oberton.

Go ahead, Will.

Thanks, Darin.

I was wondering if we were going to have any time left after that introduction.

No, start out here.

First, I want to thank everyone for joining us on the call today.

As you can probably guess that overall second quarter was a very disappointing quarter for Fastenal.

Just didn't have the results we thought we would.

Going into the quarter, we thought we would see some improvement in the general economic activity but as the quarter played out, the economy just continued to deteriorate.

Our sales for the quarter were down 21.4% when compared to the quarter -- same quarter in 2008.

Although our sequential growth was not as strong as we would like, we did see sequential daily average growth in the last two months and at this time any growth at all is really perceived as positive to us.

The real problem for the earnings was the 180 basis point drop in our gross margin and that was really caused by three things, three areas really came together to cause the drop in the gross margin.

First was the competitive pressures we are seeing the market.

This competitive pressure lowered our reported margin by an estimated 100 basis points.

And although this is an issue, understand that we are advising our sales people to not make short-term decisions.

We are advising them to be aggressive when they need to, maintain as much margin as they can; if there is a competitive situation that may cause them to lose a long-term customer over a short-term issue, keep the customer if at all possible.

And so that is a tight rope, that is a fine line to walk, but we believe that is the best decision long-term for Fastenal to not make short-term decisions that will have long-term implications.

We believe as the economy improves, this pricing pressure will ease to a more normalized level and things will settle out.

It won't go on forever.

The second margin issue was caused by the deflation in steel and the fact that with the lower sales, we cannot sell through the older, higher price inventory as fast as the market is dropping.

In other times when we have had deflation, the inventory has moved out as the prices have dropped and it has been a natural flow.

Because of higher inventory levels and the unprecedented drop in our sales, we could just not move the inventory through as fast.

This has caused a 50 basis point reduction in our margin and is also more of a temporary situation.

As prices stabilize, that should just work itself through.

The third area of margin that has caused us problems is the volume incentive and rebates.

Our product people, the purchasing people, the product development people, did a very good job of negotiating lower hurdle rates for our 2009 programs but with our inventory reductions and the lower sales which reduced our purchases, we still may not hit these lower hurdle rates, which will cause -- will decrease our rebates, decrease our purchasing incentives, and this cost us about 30 basis points on the quarter.

That's where the 180 came together -- basis point reduction.

All of these serious issues, but all of them are more timing issues.

We believe that most of that will come back over time.

On a more positive note, I believe our team did a very good job in expense control.

We reduced our operating expenses by 11.2% year over year, exceeding our goal and our labor was down almost 19%, so everybody is on board.

We are working hard trying to make the changes we need to make.

We expect this trend to continue into the third quarter, estimating a sequential reduction in operating expenses between 2% and 5%.

So we are going to continue to work hard to lower our expenses and right size them with the size the company is today.

We also did a very nice job on reducing our inventory.

Credit there goes to everyone in the stores, our purchasing department and Dan's financial group.

We lowered our inventory by $36 million, exceeding our goal of $30 million and our goal for the third quarter is to reduce our inventory between another $12 million and $15 million.

At that point, we will be very close to where we were -- actually lower than we were last year at the same time, but our terms will be getting back to the more normalized levels.

So we are working hard to achieve that goal.

The collections group did a very nice job on accounts receivable.

They held up very well and we saw no deterioration in the second quarter from a days out standpoint, so another very positive from cash flow and managing the asset base.

Looking forward, our plan is to maintain our current headcount level at the stores and continue to work very hard at reducing the support headcount wherever it makes sense, where it is a fine line between service and support.

And we are trying to identify the areas where we may be able to reduce.

In some cases, we have actually reassigned support people back in the store positions they had previous, and that's actually gone very well.

People are very happy to have the jobs and be gainfully employed.

Also looking forward, we are planning for the rest of the year, we plan to maintain our store openings in the 3% to 5% range -- or excuse me -- 2% to 5%.

Dan just gave me the peace sign.

My mistake.

And with any pickup at all, in 2010, we would plan to go back to our more historical opening pattern of 7% to 10%.

So we are looking out trying to understand what is going on.

In an effort to try and understand the whole industry, a couple weeks ago I went to our purchasing, our vice president of purchasing and our senior product development leader in fasteners and I asked them to contact some of the companies that we know well, old suppliers basically Fastenal friends and see if we could gather some information to see what they are seeing out the market as far as how their businesses are holding up.

They contacted actually five of our largest distributors.

These would be importers, people bringing product in from Asia and reselling it.

And four of them were able or willing to give us good information.

We averaged out the results from those four and they came out to be 38% down, their sales to us and our competitors are down 38% year-over-year and that is year-to-date.

So they are way down.

We also contacted five of our Asian manufacturers and all five of them got back to us with good information and their shipments to the United States are down -- and this is in dollars, not in pounds -- the pounds or the tonnage is not quite as bad because of deflation.

But in US dollars, their shipments are down 59% year-over-year.

And the reason I give you this is it just brings more color to how beat up the fastener business is and many other industrial businesses this year.

I was actually quite surprised that their business was down that far and I got a lot of different information back with it.

From the US suppliers, some of them were talking about the numbers of companies they have on credit hold and that some of our smaller distributors or competitors are actually buying product on credit card at this point.

So there's a lot of pain going on out there and hopefully it will ease soon.

Switching gears, I lost track there.

Looking back at my notes, on a very positive note we continue to sell to more customers.

Our actives for the second quarter grew 3.5% over the same quarter in 2008, which is lower than we would want but Dan has done some work on frequency and when you look at the reduced frequency that we are seeing, you add that in and it translates into about 8% to 9% increase in our actives on a real basis.

So considering everything that's going on, we believe that is pretty good, pretty aggressive.

When I look at that, I am trying to think of how that affects us.

A real example of how this plays out to our business, in June of 2008, we sold 214 million -- excuse me -- we sold to 214,000 customers and we sold them $206 million in product or $959 per customer.

So 214,000 customers bought $206 million.

Roll the clock forward 12 months to June of 2009, we sold to 226,000 customers.

We sold to 12,000 more customers, but we only sold $167 million.

So our sales were down by -- sorry, I'm drawing a blank here, by $39 million, but we sold to 10,000 more customers, 12,000 more customers.

$739 per customer.

And I look at that, it tells me a few things.

One is really the state of what our average customer is doing.

But on a positive note, we seem to be maintaining and retaining our customers, just at a lower level.

So when things do come back, we should be in pretty good shape.

Sorry about fumbling around with that, but I'm going to turn it -- at this point, I am going to turn over to Dan and Dan is going to give you more color on what our actual customer groups are doing and then just a little bit of information on cash flow.

Thank you very much.

Thanks, Will.

And I will be -- as Will mentioned, I'm going to cover a little bit on some -- a little color in the customer components as well as cash flow.

My comments today will be relatively brief.

I think the earnings release speaks for itself.

On the -- in the first-quarter call, I spoke of what I called a core customer comparison and what I was really trying to do is look at October of the prior year and the reason October historically for those of you that have followed us for many years, historically we look at October as our springboard to the next year.

It serves as the guidepost to where January daily averages will come in and where we will start the new year in building our business.

When I talked about these numbers and again last October, we had about 225,000 active customers.

When I looked at that business from October to March, what I saw was if you looked at that over the entire decade, our what we call our core group, the customers that would buy in both of those two months, October and the following March, you saw basically a parallel pattern from the standpoint of dollars.

On average for the decade, it was not up, it was not down.

If you looked at that a little closer within the decade, you would see that in the early part of the decade, we averaged down about 7% in the recessionary environment.

In the middle of the decade when the economy was strong, we averaged up plus about 9%.

And then in the last three years, we had gone from plus 9% to 0% -- in other words, flat -- to down 7% and in March of 2009, and our business was off 27%.

So summarizing that all out, we saw about a 2800 basis point decline versus our norm in the October to March timeframe.

When I extend that forward, now to June, what I -- and I compare it to historical norm, as Will mentioned, we did see additional softening in the marketplace.

But if I compare it to historical norms, we lost about 100 basis points of growth from what we saw in the balance of the decade.

So while it did worsen, it was a marginal worsening as opposed to the previous six months or the previous fourth quarter and first quarter, where it was a dramatic drop-off in business.

So while the business has not stabilized, the rate of worsening has narrowed dramatically.

The other item about frequency, as I mentioned in the March call and these vendors are holding pretty true to this day, our frequency is down about 5 percentage points.

Just over 5 and that is really that comparison Will had to the 3.5% going to about an 8.5% active account growth comparison.

The second type -- and I put a paragraph in the first page of our earnings release.

Historically we have not given a lot of color on components of our customer base but I thought I would share some in the context of the release and elaborate on it a little bit in the context of narrative.

Our manufacturing customer base, which represent historically somewhere between 45% and 50% of our sales, on a Q2 to Q2 basis, that business was off about 28%.

We don't have perfect information for delineating OEM versus MRO because sometimes it is commingled in a common account.

Near as we can ascertain, the OEM business is down somewhere in the neighborhood of 40%, the MRO business is down somewhere in the mid to upper teens and that is really given our overall balance of being down about 28%.

Some positives we did note is that in the period from October through April, we saw sequential drops in our business on a month-to-month basis.

From April to May, the business did improve from the standpoint there was a sequential gain in the daily average.

And from May to June, we saw a positive.

Now the numbers are slight, but they are positive nonetheless.

On the second component of our business, non-residential construction, again historically that has run somewhere in the 20% to 25% of our business.

That business was off 23%, as I cited in the press release.

Sequentially that business did soften some from April to May and May to June and so that's a little bit of a negative coming into the summer.

It offset the improvement we saw in the manufacturing component.

The third category and this category is a little bit of a gray category in that its product were assigned to a reseller.

Some of that product is a contractor, it might be an electrician whose -- that business is going into nonresident construction.

Some of it is going into manufacturing.

It might be a reseller of products.

That business represents about 10% to 15% of our sales.

It was off about 22% for the quarter.

Sequentially, April to May and May to June, that business improved.

The third piece of our business and this business is about 2% to 5% of our sales historically is our government component.

That business Q2 to Q2 was up 10%.

So the government is out spending dollars.

Unfortunately for us it's a small enough piece that it doesn't really move the needle.

And as you can imagine, that business improved from April to May and from May to June as well.

Finally on the cash flow statement, if you recall when we started the pathway to profit back in 2007, we laid out a long-term goal of what we thought our cash flow statement would look like and that goal really centered on looking at our operating cash and our CapEx and our free cash flow, all as percentages of earnings in a given year on where we thought that would come in.

And our range for operating cash was 80% to 90% of earnings.

CapEx, shoot for a 25% to 30% of earnings and be in a position where we had a free cash available of somewhere between 55% and 60% of earnings in any given year to build strong cash flow to use in a variety of measures to improve the return for our shareholder base.

In the -- as you saw in the first six months of this year, much as we saw in the first three months extremely strong cash flow.

The operating was about 182% of earnings and that was really driven up because of, as Will referred to earlier, our strong management of inventory.

If you look at our balance sheet when you really get down to it, we have three primary assets, accounts receivable, inventory, and fixed assets.

From an accounts receivable standpoint, as Will mentioned, we have been able to minimize the cash flow or balance sheet risk in this environment and have been able to maintain or nominally improve our days.

Have felt some income statement impact with some bankruptcies in our customer base, but a number we can manage through.

On the inventory side, we've made nice progress.

We have had a balanced approach to both our store and non-store, primarily DC inventory.

If you look at the components of our inventory, our June 2009 balance is essentially in line with our June 2008 balance and our goal is to get back to, as Will mentioned earlier, where we were in December of 2007 so we can hit 2010 lean and ready to go as we charge into the new year.

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

And as we have said and Lori might touch on this, but as we have said in previous calls, there's always a number of questions that come through.

We would appreciate if you could attempt to limit your questions to one and then cycle through.

Thank you very much.

(Operator Instructions) Michael Cox, Piper Jaffray.

Thanks and good morning, guys.

My question is on the margin side, I was just hoping you could comment on your inventory position, the flow through of higher cost inventory.

How long should we expect that to continue from I guess a mismatch to where current selling prices are?

And then I have a follow-up on SG&A.

Well, it's getting better already, Mike, but it's not like it's just a drop dead because you buy a product and it sells off.

Some of the slower moving product will still be in the system three, six, nine months from now because on the importing side where we are really seeing it, the fasteners, many of the slower moving parts will buy -- we only turn them 1.5 to 2 times a year in a normal situation.

So it will just continue to become less of a problem over the next three to six months and by the end of the year, it should be pretty well normalized.

Okay, that's helpful.

On the SG&A side, your comments around the sequential drop in SG&A would imply a pretty significant year-over-year decline in SG&A dollars.

I believe you were at about $22 million in the second quarter and your guidance would imply double that.

I was hoping you could give a little more color of incremental cost cuts that you are looking at.

It might be best to look at it from a sequential standpoint.

As you recall last year in the third quarter, we had a settlement in the number of about $10 million.

But if I look at it -- if I ignore that and look at it from both either a sequential or year-over-year, the improvements you are really seeing -- if you look at the components of our operating expense, the biggest component relates to labor costs.

We have been able to manage labor headcount quite well through this process.

There's a fair amount of incentive compensation both at the store, district, region, and national level component of our business and that as you put can appreciate, has contracted quite dramatically to help us manage through it.

So a piece of the additional savings sequentially and year-over-year will be coming from that component, a meaningful piece.

And if you look at the balance of our P&L, we still have some benefits in the P&L from fuel.

We still have some benefits or reductions in pain because our occupancy expense is improving dramatically.

And probably the only outlier on that of expenses year-to-date whether it be the six-month period or the three-month period, interestingly enough, our healthcare costs are running higher not because of anything other than we have seen about the 8% increase -- our healthcare is up about 11% in the second quarter.

About 8 points of that 11 relates to additional employees opting expanded coverage as their spouses have either lost their jobs or they've seen benefit reductions at other employers.

So what is one of the offsetters, but even with that in there, the real big piece on a sequential and year-over-year basis relates to payroll costs.

One of the areas that is positive from a headcount standpoint is both our distribution centers in Dallas and Indianapolis, the large investments are starting to come on line.

We are certainly starting to operate those.

We are seeing the efficiencies that we thought we would and it has allowed us to lower headcounts in both those facilities, which will add into the -- or reduce our expense in the third quarter.

That's a very positive.

Great, thank you very much.

Brent Rakers, Morgan Keegan.

Good morning.

Just wanted some I guess additional clarity on the SG&A.

I guess I was surprised that in light of the cuts to the FT&E on a sequential basis and the revenue decline sequentially and the a substantial gross margin decline substantially that the payroll numbers were not down more than they were sequentially.

I understand the healthcare component, but maybe could you dissect some of that on maybe a per head basis and maybe talk about both kind of the kind of the wages or the base compensation and contrast that with the incentive compensation?

I guess when you look at the base component, that was dropping quite dramatically when you went from Q4 to Q1 because actually our base component dropped off about 14%, 13.8%.

But excuse me, 16%.

But from Q2 -- Q1 to Q2, that is shallowing quite dramatically and that dropped off about 4%.

I think one other piece that you don't see is that the margin reduction, only about half of that actually goes through the branch pay program.

Where the deflation -- revaluation through deflation doesn't go through POS and so it doesn't affect our bonuses as much.

That's the way it was on the way up and the way down.

Same thing with the rebate component.

-- with a rebate component.

Neither one of those affect the POS store system, so it doesn't have the effect of reducing bonuses as much.

The other piece is that basically the growth was out of the pay program in the first quarter, so we didn't see a lot of benefit in the second quarter lower pay because of the growth.

Once you go below zero, there's no growth component left.

Great, that's very helpful.

One other question.

Will, you did a great job kind of breaking out the components of gross margin earlier.

Could you maybe also address though the impact of product mix sequentially and then also the fuel component?

I think Dan said last quarter -- I want to say it was 30 or 40 basis points.

Well, the product mix, it really didn't change.

What you are seeing the fasteners drop, but that's really due to the deflation in the fasteners and the other products we really are not seeing a lot of deflation.

I have not -- I don't have this information yet, but I think when we break it out by units or sold versus dollars, the fasteners held up fairly well.

There's probably a little deterioration there because of the OEM fastener or the OEM customer component, but generally the fastener margin dropped, the other -- the rest of it held up quite well.

If you -- in the first quarter when we talked about the components, you are correct, Matt, it was about 35 basis points that we saw in improvement.

As we go from Q1 to Q2, we lost a little bit of the steam on the fuel side.

We still had some operational improvements.

We picked up about seven basis points.

So it was pretty much a neutral.

I have to say though on the transportation side, the group continues to do a great job and we did have our transportation system was a revenue stream for us in the second quarter versus an expense issue.

That's just hard work.

That's helpful, thank you.

Holden Lewis, BB&T.

Great, thank you.

Good morning.

I also wanted a little bit more color on the gross margin.

Can you give a sense particularly as it relates to the competitive pressures and sort of the steel deflation issues, it seems like you have been seeing some movement toward higher raw material costs, both Chinese steel as well as domestic.

But what is sort of your expectation for how that plays out?

Does that take away the need for the price cuts that you took in March and June or do you expect to see more price cuts coming despite that?

Well, talking to our purchasing people, they said it's been pretty stable over what we are paying for product has been stable through May and June.

But as volatile as the world market is from an oil standpoint and order standpoint and just pure volume, it's hard to say what will happen with steel going forward.

If we did see any uptick in inflation at all, it would greatly reduce the repricing of the inventory in the shelf that is basically cost us 50 basis points.

And one commodity, stainless steel, we have seen it move up.

Stainless is a pretty big product area for us.

Nickel has gone up about 20% over the last couple of weeks, so that's a positive.

But it's like looking through that cloudy crystal ball right now as to what the commodity prices will do.

A little bit of inflation at this point would be very helpful from a margin standpoint just to stabilize the position.

Okay, and can you talk about what you did with pricing in June and what your expectation is for September?

Right now with June, we lowered a small group with kind of the center part of the commodity fasteners, the A items because that's where we are seeing the most pressure.

We didn't lower basically none of the non-fasteners and about 50% of the fasteners we held tough on, all the slower moving items.

What we are finding is that -- where we are really getting the pressures on the very high moving parts and that's probably because people are buying them and selling them like hand to mouth.

So it was the lowest or the smallest change we've seen in the last three quarters.

Right now what we see in September if it would remain the way it has been through May and June, we probably wouldn't have to reprice anything.

But we are a couple months away.

Okay, great.

Thank you.

The environment is looking better from a pricing standpoint than it has.

Okay, so based on what you are seeing, it is 150 basis points.

I guess -- the 150 basis points from a competitive prices of steel deflation, how much of that do you think will sort of fade away as you get into Q3 and Q4, if any, based on that statement?

I don't think it will fade away in Q3 because we are well into Q3 and it takes time to go away.

In Q4 if our costs of goods and our purchasing prices stay stable, a lot of them will fade away in Q4.

But we will still have the rebate and volume issue and competitive pressures really depends on what the overall economy does.

If business starts to pick up, people will try and make money.

If business doesn't, they are going to try and survive and produce cash to keep their business -- their doors open.

All right, thanks, guys.

David Manthey, Robert W.

Baird.

Thank you.

Sticking with the pricing theme, can you tell us what the price impact on the top line was in the second quarter and what your expectations would be for the third quarter?

It's a difficult one.

I would say in that neighborhood of 3% to 4%, 4.5%.

I'm looking on a year-over-year basis.

Yes, we are waiting for more -- we are trying to piece all of the information together and the real challenge we have in it is so much of our product is customer-specific for the large accounts.

I think Dan is probably on the high-end of that 3% of 4% year-over-year.

And because we are running up the ramp last year, we are almost at the peak and then it was coming down.

If I -- I would say it's probably more in the 2% to 4%, 2% to 3%.

And in the third quarter, probably won't give much more back at least as we see it today.

We are really, really cautious in saying anything because it has been moving -- when it does move, it moves quickly.

We've never seen it move like that.

Right, okay.

And then second, as you are deciding whether or not to ramp the store growth back up in 2010, could you talk to us about what some of the key indicators you will be looking for?

Is it just primarily related to your business or are there other factors?

For me the number one indicator will be sequential pattern.

If we could get our business back onto a pattern that was above the historical norm for sequential growth, then we would believe we're moving in the right direction.

As we said, we saw sequential growth in the last two months but it was below the average, our historical average.

We need to get above the historical average, which means at some level the customers are coming back.

Their businesses are coming back.

At that point, we think our best investment for the future would be to ramp up our store openings and start to hire salespeople at a level that we can afford while at the same time increasing our earnings on a pretax basis.

To frame that a little bit, from May to June, our daily average increased 1.7%.

We would have felt a lot better about it relative to historical norm if that would have been in a range of 3% to 4%.

But that is really what we're looking -- what do we see out there?

Yes, the steps for going up.

Got it.

Thanks, guys.

John Baliotti, FTN Equity Capital Markets.

Thank you.

In the earnings release, you talk about how the cost structure now with changes through your new pathway to profitability is the -- the greater portion of cost is variable versus fixed.

I was just wondering in the context of leverage we saw, I think it was down over 500 basis points and I don't think you had that in the last recession.

Is there a volume point that you would see that where we would start to see that new cost structure kind of materialize?

Well, if you had looked at it, say, in the first quarter, just using that as a benchmark because I've done a fair amount of work on that earlier, we saw where we could have had 0% sales growth and we would have leveraged our income statement.

In the current quarter, our operating expenses on a year-over-year basis are down just over 4% and so let's just say we -- if we had been at a flat growth perspective, it would have probably eaten up half of that reduction, maybe three-fourths of that reduction.

So the wild card here is what gross margin would have done in that kind of environment.

Would we have been able to maintain gross portion?

And so we are looking at the business from the standpoint of the way we are managing it right now in the context of 2009.

With our comparisons to where our operating expenses were in 2008 could operate through the year and we believe we could leverage at 0% sales growth.

If I went to pre CS -- excuse me -- pre-pathway to profit, that number would've been more in the 16% neighborhood and we would have been really challenged to get it much down into 13% or 14%.

And again, the wildcard in what I just said would be in that kind of environment if we would have been at 0% sales growth versus down 20%, what would our gross margin have done?

We know that the gross margin would be better than it was because we wouldn't have given up the volume incentive part.

That part is very -- you can calculate it out where you got hit.

We know where that occurred.

And we would have burned through inventory faster in the first and second quarters.

Yes, even if the competitive nature had stayed where it was, the other two would've probably not existed and we would've lost about 100 basis points.

Is it possible that as the year goes on and you kind of get a look at the locations and how they are progressing that you may find that 2350 is the right number in terms of total stores?

I mean if you look at the other -- a couple of the other large publicly traded distributors that are out there, their combined locations are about 1125.

And I'm just wondering if you look at your inventory turns, it would kind of indicate at sort of a nominal 2.0 times it seems like you may be able to deliver more and you don't necessarily have to be right next to the customer as much.

I'm wondering if there's a possibility that a review of the locations as we go through this difficult time may reveal that you got the right number where you are today.

You know, I don't -- have given too much thought to that to come out with no, I don't believe that's the case.

And part of it stems from the fact of we've slowed openings this year because we really are trying to manage from a short-term and a long-term standpoint, manage our P&L through this as well as manage our investment through it.

But when I look at our stores, you know there's parts of North America where we have been for years, 40 years in Minnesota and the upper Midwest and have expanded beyond that.

There's other parts as you get closer to the oceans where we haven't been there as long and so we continue to have tremendous opportunity for store openings in the Midwest, the upper Midwest, the central Midwest, and that's amplified even greater when you get closer to the coast where we've just been less time.

One thing you have to keep in perspective, fasteners which represent half our sales, it's a relatively low value product per pound.

We're selling process steel and where we are really successful is where we're able to position ourself to be a solution provider to our customers and most of our customers operate within 10 miles of one of our stores.

And it puts us in a position we believe long-term to garner the greatest market share.

And it also puts us in position we believe long-term to increase our store count quite dramatically yet in the future.

I think I will add little on that.

Where I look at -- or what I look at and I look at markets that none of our competitors have ever been in and probably won't go to last fall I made a trip through Northwest Iowa and I went to three cities.

None of them 10,000 people or more.

All of them doing more than well over the company average, about $1 million.

They're all about between $1 million and $2 million stores and they are all operating close to a 30% operating profit.

And I was -- when I got back I had to pull all the numbers because I was so impressed with the people working there.

I had never been to these three stores before.

Those are the types of markets that other people won't go through.

They can't figure it out and there's still hundreds of those out there highly profitable, high service model and we're just going to go take market share that no one else will get.

I don't think we would ever do $1.5 million in a store like Iowa unless we were there.

The only thing -- I will double down on it too, just from a standpoint (multiple speakers)

We're going after you now.

If you look at communities of less than 100,000 people, really less than 90,000 to 100,000 people, there's very -- you really see a dramatic drop off in national industrial distribution in those marketplaces.

And those are extremely lucrative marketplaces for us and we have really -- I think we have done a nice job as an organization of figuring out how an $80,000 a month store can be a profitable business with an attractive return where we can compensate our store employees well.

We can compensate the leadership off that store well and we can have a nice return for our shareholders and address the needs of really an underserved market place in those communities.

Okay, thank you.

Sam Darkatsh, Raymond James.

Good morning, Will, good morning, Dan.

As always, the level of detail is much appreciated and terrific.

Most of my questions have been asked and answered.

Mostly looking at when you're talking, Dan, about the manufacturing and reseller customers sequentially moderating I guess in May and June and then you are also talking about pricing being more difficult in May and June sequentially, I know you talked about keep the customer and trying to balance that with your sales force.

But how much of those two aspects interrelated and if they are interrelated, how should we look at that sequential moderation looking at 30,000 feet perspective?

I guess looking at it, first off, just the overall statement that the fact that we saw positive sequential gains in those two segments of our customer base from April to May and May to June, if for nothing -- if for lack of a better description, it felt good just to see numbers moving north rather than south.

The pricing pressure that we saw in the second quarter in May and June tended to not -- marginalize those or reduce those numbers.

So the fact that we were able to put up positive numbers in both those categories is probably understated a little bit by the fact we had pricing pressure.

Okay.

I just wanted to make sure I understood what you said earlier about Q3 and Q4 pricing and the overall impacts.

Should we then expect gross margins overall then to be pretty similar Q3 versus Q2 and then a little bit of an improvement in Q4?

Or are there other impacts moving the gross margins around on an overall basis that we are not looking at?

Right now looking into just Q3, we think our margins will be similar to the Q2 level.

Q4 is too far out and that really depends on what happens with the steel pricing and commodities pricing over the next two to three months.

Very helpful, thank you.

Hamzah Mazari, Credit Suisse.

Thank you.

Most of my questions have been answered, but could you remind us again when you expect to cycle through your higher-priced inventory and any timing of benefit you are expecting from customer restocking?

As well as is your CapEx number, the $65 million, is that purely maintenance?

Is there some growth in there?

What is maintenance level CapEx for your business?

You take the first half, I'll take the second half?

Go ahead.

I have to recall the question.

What was the beginning of your question?

I'm sorry, I got lost in the CapEx.

Yes, sure.

The beginning part of my question is just could you remind us when you expect to cycle through your higher-priced inventory and any timing of benefit you are expecting from customer restocking?

We are seeing it cycle through as we speak and we believe it will be -- assuming that prices don't continue to drop, we should be at a pretty normalized level by the end of the year.

And it will continue to diminish as a problem as the year goes on as we sell more of it out.

So it's just a long, gradual slope.

As far as restocking at our customer level, we are not sure when that will begin, but my own gut feeling is that at some level, it's never going to come back and we saw that in the early '90s, we saw that in early 2000 is when customers learn to live with less inventory, they go hey, the CFO is going to say hey, you didn't have it six months ago.

Why do we need to put that back in.

But that's actually a very positive thing for Fastenal because if the customers have a warehouse full of product, they don't need a high value, high service model like Fastenal.

So the more inventory that's taken out at the manufacturer level, at the contractor level, the better off we are.

We are not making a lot of calls just trying to understand customer needs.

And I was in a big contractor in Phoenix and the guy takes me out in his shop and shows me this big shelving area that is almost completely empty and explains that a year ago that was all backup inventory.

But now he wasn't speaking very positively about the guy with the checkbook in this conversation.

He said I don't have anything anymore.

That's why I need guys like you and I'm just smiling to myself.

That was a first-hand example where I was involved where a reduction of inventory, taking cash out of the business benefited one particular -- one Fastenal store with one particular customer.

On the second part of your question about CapEx, the $65 million this year, sometimes you are splitting hairs to figure out what is maintenance, what is growth.

You know, if I look at the pieces as we sit in the release, a good -- most of what we are doing in Indianapolis, what we're doing in Dallas is behind us as far as dollars spent, but there are still dollars being spent there in 2009.

In the case of Indianapolis, we have our ASRS or unit load system but we're still in the process of putting in a [mini] load system.

So if I were to look at 2009, that $65 billion and just kind of throw a little bit of a guess at it, it's probably -- when you really get down to it in the traditional definition of the word, it's probably two-thirds/one-third growth versus maintenance.

Because our CapEx -- we are always investing into a marketplace that we believe long-term will allow us to keep growing as obviously in 2009 we are working through unit compression, the demand compression on a per customer basis, but the long-term opportunity, we still invest for that long-term opportunity.

Okay, great.

That's helpful.

Thank you very much.

A follow-up from Holden Lewis, BB&T.

Thank you again.

The new compensation structure that you sort of have out there, can you just comment -- did that have any bearing whatsoever on what took place sort of in the gross margin or just sort of address any impact that the new compensation structure may have had?

No.

Dan and I looked at that because we are very concerned about that also.

And when we looked at how the quarter played out, the one thing that made it difficult to completely understand is we have -- three times a year we have a large promotion called the Bounty Hunter, which is really pushing a lot of lower margin products that is paid for by the tool guys.

And so we looked back historically and said what does the margin do when we -- the month of the Bounty Hunter which the last one was March -- it was March, June, and September that we do this.

Actually it appeared that we had less impact or lowering of the margin in June or we did than in March.

So looking at all the information, looking at large sales take and looking at pricing trends, all the information we could gather, it looked like there was no effect.

And Dan and I just went over it again yesterday because we were trying to understand -- we are working on trying to forecast for the third quarter where our commissions and our margins are going to come out.

The one thing that it has done and on a very positive note is it simplified the program and just got people back to work because they are spending a lot of time managing the numbers.

And very few complaints.

I am actually meeting with a group of regional vice presidents this afternoon, so I'll have some more color on that.

But overall, it appears to be a very good decision from a simplicity standpoint and it didn't affect our margin.

Okay, and then just to follow up, I think you said that sequentially for SG&A you are looking to push the SG&A number down another 2% to 5% sequentially I think you said.

What revenue assumption is in that?

If you see the normal seasonal pickup in revenues that you would expect in Q3, is that the environment in which you expect to be able to cut the SG&A further?

Or if you see the normal seasonal pickup in revenues, is that 2% to 5% off the table?

No, normally because of July there isn't a large pickup from second to third.

You get August and September are good, but July pulls you back a little bit because of the holiday.

So we are looking if we get the normal trend or the trend that we are in here which is a little below line that we will be able to manage it.

Even if sales pick up a little more than that, we are still well below the growth line, so none of the bonuses are going to kick in.

We need to see a lot of sequential growth before our pay programs and bonuses have any effect on our expense.

Because they really are year-over-year programs?

Yes, and we are so far under water that the district, the region, even the store level has to show growth before the commissions tick up.

So we are really -- unfortunately, we are a ways out from that being a problem.

We are comfortable with the 2% to 5% unless it just went on fire, which we don't -- sales went through the roof, which right now we are not predicting.

But we'd take the problem.

But we would take the problem --?

But we would handle it if it came.

All right, thanks.

And at this time, I would like to turn the conference back over to Dan Florness for any additional or closing comments.

Thank you, Lori.

You know, my posing will be short as my comments were.

I really wanted to -- speaking to our shareholder base, I want to thank you for the support you have shown us through the cycle.

We have tried to enhance what we can on at least a cash flow basis, the return by increasing our dividends quite meaningfully over the last six to 18 months.

And we will endeavor to manage our cash flow through this cycle and position ourselves to have ample cash supply to invest in the business and have some dollars to return to our shareholders.

Secondly and of equal importance, I would like to thank -- there's quite a few employees of Fastenal that I anticipate are on the call right now listening or will listen to a replay of it.

I want to say thanks to that group.

We sat down with various groups within the organization last fall and in December when we had our national meeting in the spring here with a lot of the individual groups, all of us traveled quite a bit and are meeting with folks every day.

One thing I have to say about our population of people, the Fastenal -- the blue team is that people have been willing to roll up sleeves and to be flexible.

We don't have written job descriptions.

We do what we need to do to get things done within the organization and folks have been really open to the idea of you know what?

If the organization needs this for the next three months, for the next six months, for the next 12 months, I will step up to the plate and take that on maybe in addition to what I'm doing or in place of what I'm doing.

I want to thank the employees for that willingness because it helps a lot when you manage through a time like this.

That will be it for the day.

I want to thank again all of our shareholders and everybody for listening to the call.

And that does conclude today's conference call.

Thank you for your participation.