快扣 (FAST) 2009 Q3 法說會逐字稿

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

Today's conference is being recorded.

At this time, I would like to turn the conference call over to Mr.

Darin Pellegrino.

Please go ahead, sir.

Good morning and welcome to Fastenal's third quarter earnings conference call.

This call will be hosted by Will Oberton, our Chief Financial 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, and is being recorded by Fastenal.

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

This call is also being audio simulcast on the internet via the Fastenal investor's homepage at www.Investor.Fastenal.com.

A replay of the webcast will be available on this website until December 1st, 2009 at midnight, Central time.

As 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's important to note that the Company's actual results may differ materially from those anticipated.

Information on factors that would cause actual results to differ materially from these forward-looking statements are contained in the Company's 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'll undertake no duties to update that information provided on this call.

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

Go ahead, Will.

Thank you, Darin and thank everybody for joining us this morning.

Spend a few minutes talking about the third quarter, then I'll turn it over to Dan.

I'm going to jump right in and talk about sales.

We started a very nice trend in the third quarter.

It was tough going into the third quarter, but if you look at the June through September daily average trend, or the end of June through the end of September, in a normal times between 1998 and 2008, our average improvement was 2.4%, our June daily average to our September daily average.

During this period, the third quarter of 2009, we improved by 5.2%, so much stronger than we have over the last seven or eight years or ten years I should say.

One thing that impresses me a lot about that, is that we are able to do this without the help of new stores.

Normally new stores would have contributed between 25 and 30% of that growth and we didn't have a lot of new stores opened so the growth is unusually strong considering that.

Talking to people in the field, trying to understand what's going on, our people in the field, I believe the trend is a combination of, one, low inventories at our suppliers, that they've really worked the inventories down and I don't think they're rebuilding from what I hear, but they're using, consuming what they buy, and so we're working off a very low show.

The second is, I believe our sales force is really doing a good job taking market share.

They're out there working hard, and a lot of our customers and even companies that aren't our customers are still trying to save money so they're very open to changing suppliers if the new supplier has something to offer, so very, very positive sales trend.

We hope we can keep that going forward.

The margin was probably the only tough spot for us or there were a lot of tough things, but the margin was the most difficult point for us in the third quarter.

We knew going into the third quarter that it would be tough on margin, but we believe we hit bottom in August, all indications are that we hit bottom in August, and we should see improvement going forward.

I'm going to break down the components of the margin just a little bit.

The biggest difficulty we had in the third quarter was caused by deflation in our product.

And year-over-year, we believe that cost us probably close to 100 basis points, and it's really that last year was so good because things were moving up, and this year it was moving down so rapidly, it was more of a whip saw effect.

But on a positive note there, the CRU steel index that we follow, actually bottomed out in the April-May time frame for both US steel and Asian steel markets.

This is low carbon.

Stainless steel also bottomed out, but slightly earlier than that, and now is up about 10%.

We've seen that in the prices that we're getting from our suppliers, mainly fastener suppliers, where prices are starting to move up, so the deflation as we work the inventory through, is pretty much over as we see it and we may even see some slight increases going forward so that's a very positive in that note.

Another area that we got, we were hit hard with, would be the volume incentives or product rebates that we receive from our suppliers for buying product.

Our purchasing people did a really good job of renegotiating the deals going in.

I was confident that this wouldn't be a problem earlier in the year.

But that was before I realized that our sales would be down as far as they were.

So we've worked hard to minimize the reduction in rebates, but it's still going to affect us, and a lot of that has to do with our decision to lower inventories.

Another part of that is about probably in the August-September or -- late August, early September, as a management team, we made a decision to not chase the volume incentives and really push hard going into the end of the year.

We looked at our inventory position.

We looked at where we were with our purchases, and we said, you know what, let's just buy what makes sense to us, let's not be aggressive because this is a really good decision for 2010.

So because of that you'll see -- continue to see reductions in our inventory going forward into the year.

I was involved in that decision, believe it's a very good decision for Fastenal, but it will probably cost us, or did cost us 20 to 30 basis points more in margin than it would have if we would have been aggressive, but yet a good decision.

The third thing in the margin that is -- has been very difficult for us are what I would call market pressures.

Earlier in the year, we were seeing just crazy pricing and it was mainly on the fastener areas.

Not so much on the non-fasteners, but prices that we just were not willing to go down to.

Some cases, we did lower our -- many cases we lowered our prices but not as far as we were getting pushed to do.

We believe it was caused by several things.

One is our competitors had a lot of inventory and they needed to create cash, turn the cash into inventory.

We know that was happening with some of our suppliers because they actually talked to us about it and explained their motives.

We also believe it was going on with some of or competitors.

Another part of it was, people just trying to survive, the market was very difficult out there earlier in the year.

Since about the June, July time frame, the talk of that has been going down slightly, and I was out in Indianapolis last week and had the opportunity to talk to dozens of customers that were there for a show, and it really seems like the crazy pricing has slowed down, things have stabilized and we believe going forward it will actually be more of a normal environment, maybe not an improving environment, but a normal environment from what we had seen earlier in the year, so as a Company we're very confident that we will see improvement in our margin going forward for all three of those reasons.

Switching gears to expense control, not a lot to talk about on the SG&A.

We did a nice job in almost all areas and believe we can continue that trend going forward.

Inventory, another good area.

I think we've done a very nice job in inventory.

The guys, people were able to reduce inventory more than we had expected going into the quarter.

Part of that is due to our decision to not chase the rebates and the volume incentives, but a lot of it is due just to hard work, looking at areas that we can reduce things out of, areas that we need to add inventory.

Going forward, I see in the fourth quarter, that we'll see another reduction in our inventory, but it will be far slower than it was in the third quarter.

It's more of flat to down versus down.

But still a very positive trend.

Accounts receivable, the accounts receivable area is the area that I was most concerned with going into the year.

When you read about -- every time you read the newspaper, it was about bankruptcies and companies going out of business, and I was very worried that our accounts receivable would stretch.

As it turns out, that didn't happen, and at this point year-over-year, we're actually slightly better than we were last year, which is a very positive surprise or very positive trend, and I guess a surprise in my mind because you would think accounts receivable would stretch in a very, very difficult time.

And I think a lot of that has to do with the hard work our collections people have done, they've just really been stepping it up and trying to chase down customers or bad debt before it becomes a real problem.

Transportation area, you saw if you read the release, we lowered our costs in transportation again, a little bit due to fuel costs.

Well, quarter-to-quarter, it was fuel costs were about the same or the cost of fuel.

Really, rationalizing what we're doing, making sure that we're looking at all of our routes, hard work by the transportation group to keep things in line.

And so with the exception of gross margin, most parts of our business are really doing well and I'm very confident we'll see improvement in the margin going forward.

Another positive, and this is kind of a side note, is that we've done a really good job or the Company has done a good job of retention, especially with our middle and senior management.

I went through it this morning and I could not identify one person that has left us for another opportunity in the middle and senior management so we have at least a 99% retention.

From what I can tell it's at 100%, but I don't want to quote that without making sure my reports are right.

At the store manager level, we've done very well there also.

One thing that this will do for us is, going forward, these people that are running these districts, running the stores, running our distribution centers, almost all of them have ran a bigger business, and they ran it back in 2008 when our business was bigger, and the most difficult thing we've ever done as a Company is to develop people that can run larger businesses.

We have thousands of people in place today that have already done that, so as the business comes back and things pick up, it will be easier for us because the people that are running the businesses, individuals, have already done it before, so the learning curve should be far lower and we should be able to accelerate the growth going forward.

Based on the recent sales improvements and our confidence going forward, we've made a decision to open up the store openings or increase the store openings slightly.

We're going to open approximately 25 stores in the fourth quarter, most of them being in the November-December time frame.

With that being said, we will continue to hold very tight on all other expenses, including labor.

We'll probably have to add a few people to put into those stores.

I'm not sure of those numbers yet.

I haven't looked at the individual numbers.

We're going to hold tight on all of our expenses.

We believe getting the new store machine running again and getting a head start going into 2010 is a very good decision considering a lot of the costs of opening a new store are in a very good spot right now.

Rents are down.

A lot of good reasons to open businesses.

With that, I thank you and I'm going to turn it over to Dan to touch on a few more areas.

Thank you, Will.

Four things, just going to highlight from the release, Will has touched on most of them but I'll just run through quickly and touch on a few of them myself.

The gross margin challenges that Will talked about, I think he covered it in pretty good detail.

The sales trends strengthening, I'll touch on that a little bit more in a second.

Our SG&A, I believe that we managed it well going through the quarter.

And as we've seen in the previous two quarters, continued strong cash flow, as we've done I think good job managing the working capital side of our organization.

On the sales trends, a lot of you, when I've talked on previous calls and as Will touched on, we look at different periods in time and try to understand the sequential dynamics of our business, what happened in August and how that will influence September and how that will influence October, et cetera.

Historically, you've heard us talk about January being very, very driven by the October of the previous year from a daily average standpoint.

A couple things appear to me when I take the historical numbers, and just apply those to the reality we have right now, and as Will touched on, the last two months, we've exceeded the trend line of those normal sequential patterns.

If we were to just meet those trend lines as we go through the balance of the year and into next year, what you would see is a continuing drop in our contraction level.

I believe if -- well, if the trends held true, and I just apply that to where we are today, we would have contraction in the December time frame in the single digits, and that would flip to growth in January in the low single digits, and continue to grow from there, if the historical patterns play out, and last two months we have exceeded them, the previous months we were behind them.

Some information I touched on last quarter, I'll touch on again, as relates to some specifics within different industries we sell into.

As we've talked in the past, manufacturing, customer base is our largest single customer base.

It represents approximately 50% of our sales.

Our next largest customer base would be non-residential construction.

That represents somewhere between 20 and 25% of sales.

In the the current quarter, it was about 23.

Selling to other wholesalers represents about 10% of our business.

Government represents about 3.

Transportation, warehouse customers represent about 2 and then a whole group of other ones combined add up to about 8%.

All those are less than 2% individually.

When I start looking at those pieces of our business and I'll focus on the manufacturing, construction, because those two represent over 70% of our sales, if you go back to January, and you look at where we were versus the previous October, the business dropped off dramatically as the economy melted down throughout -- globally, but extremely in the US.

Since January, our manufacturing book of business contracted from January down to about April.

Since April, we have seen stabilization in that business and improvement of that business to where we are today.

On a year-over-year basis in the month of September, our manufacturing business was down about 20%.

So it was performing slightly better than our overall Company numbers for the month of September.

The construction business really has been sliding since February, and as of September, that business is down 27% versus September of a year ago.

Fortunately for us, the strengthening manufacturing is more than two times larger than the construction piece, so it's been driving our improvements.

The other piece of the business that's been fairly strong is our government sales.

Partly because of execution, partly because of the expanded spend by our Federal Government.

Our government business on a year-over-year basis, September to September, is up about 10%.

And so you lump all those together, our September number was down 20.8.

It's a combination of all those pieces.

The second item I want to touch on is SG&A, and Will touched on a bit about the things we've been doing and we touched on previous calls about things that we're doing to manage that.

A lot of discussions I've been having with our regional and national leadership has centered on not just what we've done, but our ability to hold those improvements as we go into the new year.

If you look at the payroll piece of the equation, between 60 and 65% of our operating expenses, we've done a nice job on that throughout the year.

Some of that's occurred naturally because of our compensation models.

Our commission dollars have dropped year-over-year.

Our bonus dollars have dropped year-over-year, just because of the level of sales and the level of profitability.

If I look at that going into the first quarter, that will be our biggest challenge to manage through but I look at that as a good problem.

I look at that as I'm talking to our leadership of those dollars we want to be there so we need to manage everything else around it to make sure that happens for our store personnel and for our district personnel and I believe it's in the cards as you heard what Will talked about with our headcount plans as we go into the balance of this year and into the new year.

The second biggest component of operating expenses is occupancy.

A couple numbers I'll share with you, from Q2 to Q3, our occupancy expense increased 0.3%.

On a year-over-year basis our occupancy is up 0.7%.

Early in the year we talked about things that we were doing as it related to renegotiating existing leases, as it related to when we do move or when we do open a store, what level of rent we're willing to pay.

We've been very strict on that internally.

We haven't accomplished everything that we set out to do but I'm very pleased with what we're seeing in the numbers right now because it really sets us up in a good position for 2010 to be able to manage our occupancy expense very well because of the changes we've made, the changes that are being made and the discipline we have when it comes to new store openings late this year and into the new year.

Finally, on the third biggest piece within operating expenses is the product movement.

Will touched on it a little bit ago.

Fuel is a piece of it on a year-over-year basis, not so much on a sequential basis, but one thing when I look out to Q1 and Q2, last year we were very, very aggressively selling off vehicles in our store fleet.

Late in 2008, we built a little bit of a backlog of vehicles in that we buy our vehicles and we turn our vehicles with a certain level of frequency to maintain a very new fleet at our store locations and in doing that in the first and second quarters of this year, we incurred about $1 million a quarter in losses because we were turning our fleet so dramatically.

Those dollars discontinued as we got into Q3 and they will be behind us as we get into the new year so that was a good decision early in the year to cycle our fleet but we incurred some expenses because of it.

Finally on the cash flow side, I'm also very pleased with what we've been able to do on the working capital.

If you look at our third quarter, our sales are down 21.7.

Our accounts receivable are down 22.6.

If I look at the year, personally the year's been frustrating from the standpoint we incurred bad debt as a much higher rate than we've historically seen.

We were at close to 50 basis points in the third quarter here.

Our expense for the year will be up roughly -- year-to-date is up roughly 25% versus what it was in 2008, even though our sales are off quite dramatically.

However, when I really split that apart, if you look at our 2009 expense, about 15% of that is because we've increased the reserves as we've gone through the year because of some of the aging and some of the bankruptcies we've been dealt.

So I feel very good about that going into the new year as the trends improve, and I believe they will, that we will be in a good position to not only maintain the improvement in collections that we've enjoyed but also see a reduction in our bad debt rates and one item I would touch on when I look at our accounts receivable, the improvement has really been driven by improvements in the aging of 30 to 60 day year old receivables.

We modified some things we do with billing.

We have more electronic billing today than we ever had in the past.

It speeds up the process both for us and for our customers.

When I look at the improvements in accounts receivable, it's actually not shining through as strongly as it could, because of some of the bankrupt accounts that are still sitting in our aging.

But very pleased with not only the improvements but the sustainability of the improvements.

Inventory, if you look at the year-to-date reductions, about a third of that is at the store level, about two-thirds is at the DC.

I feel good about that because historically we have struggled when it comes to managing inventory at the store level.

You can manage inventory at the DC level by turning off the inbound spigot, by pulling back on your buying, but because of the decentralized nature of our organization, managing at the store level is really more challenging and I believe we've built the mechanism to do that, and we'll have the benefit of that as we go into the new year.

Finally on cash flow, the second piece of cash flow after working capital really looks at your CapEx.

Coming into the year, we said we expected about $65 million worth of CapEx.

That number I believe now would be closer to 55 or maybe just slightly below that number.

If you look at the delta, about half of that is coming from pullback in some of the store openings that we've had this year, and pullback in some of the vehicles we're buying this year.

The other half is coming from IT spend just being less than we anticipated coming into the year, which is a great thing, and so I believe for the year it will be 55 or just slightly below.

As I look out to 2010, and 2011, I don't want to get too far ahead of myself and we haven't done our detailed capital budgeting for next year, I really believe we can get to a number that's in the 40s.

That's the realist side of me talking.

The accountant side of me says that will probably in the 50s, that's because I'm hedging my bet, but I think we can get that number down into the 40s.

It really reflects our ability to leverage the dramatic capital infusion we've had over the last several years in our distribution side, most notably our Indianapolis facility and our Denton, Texas facility, and our ability to leverage that into the future and reduce the need for some capital spending and improve on the operational side at the same time.

With that I will turn it back over to the Q&A section and again would appreciate just so everybody can have an opportunity to ask questions, limit yourself to one question and then get back in queue if you want to do a second.

Thank you.

(Operator Instructions).

And in the interest of time, we are asking that you limit yourself to one question and one follow-up only.

We'll take our first question from David Manthey of Robert W.

Baird.

Hi, guys.

Good morning.

Good morning, Dave.

Just a quick question on outside sales reps.

Do you have a target for OSRs in 2010?

We really aren't putting out a number, Dave, right now.

It's going to depend on sales growth.

As sales pick up, we'll move that number up and right now we're still historically high if you compare it to our daily sales rate.

Just as a follow-up there, Will, can you then compare it maybe to the seven to ten range and give us an idea if there's a multiplier or a different range that you might fall into relative to the store openings?

I didn't quite understand that.

Go ahead, Dan.

If you look at the -- if we open 7 to 10% stores, each of those stores will have an OSP.

An outside salesperson, excuse me.

And assuming the sales numbers trend out the way we're talking, I'm shooting a little from the hip here, maybe 130% of our store openings will be our number for OSPs as far as -- if we're at 7%, maybe that number is more like 9% outside sales growth, but I don't want to get too far ahead of myself because we're really waiting to see how that plays out because it's going to be driven -- what's really going to drive that number is when you look at our five plus and ten plus year old stores, seeing the contraction drop and the growth pick up in that group, because that's really what's going to drive it.

We believe that a lot of our growth in 2010 will just be our existing customers increasing their spend which really don't require any more selling time.

Really positive is we retain those customers through this difficult time.

Thanks a lot, guys.

We'll go to Sam Darkatsh of Raymond James.

Good morning, Will, Dan, how are you?

Good.

Doing well.

The 51% gross margin I believe was your original expectation.

You were trying to give the differentials, the variances on a year on year basis.

What was -- outside of the 20 to 30 bips of the lower vendor volume allowances because of your decision to take inventories down, what were the primary variances versus your expectations for gross margin heading into the quarter?

Well, coming -- in the second quarter, we were at just north of 51, we were at 51.1.

In our July call, we really talked about we expected the gross margin to contract in the third quarter.

I actually expected it would contract about -- I thought we'd come in at 50.5 coming into the quarter.

I don't necessarily call it out that way on the call because we're always careful not giving guidance because that's just not our MO, but just my gut was telling me that we would see some additional challenges on what we call our point of sale margin, our transactional invoice margin, and I knew just based on what trends we were seeing with spend, well, excuse me, with sales consumption, versus spend, with our suppliers that we would see some contraction, say 20 basis points in our rebate vendor allowances side of the equation.

Both of those end up being a little higher than I anticipated and that's really what pulled us down to 50.

Your expectations for Q4 would be similar, 50, 51 kind of thing or would there be sequential improvement, you believe?

I would expect to see a sequential improvement although I believe it's going to be nominal until we really start getting into 2010.

Some things that link to the calendar, if you think about different components of our gross margin, the biggest one that we talked about is the vendor allowance rebate program.

Those are typically calendar year programs and they'll reset themselves as you get into the new year.

And so you will see a nominal improvement in Q1 and then you really see improvements start to take hold in Q2 because the inventory that you have at the end of -- the rebates or vendor allowances you earn in the first quarter, they're really sitting on your balance sheet at the end of the first quarter just because those are part of your cost of inventory but then they start turning through your cost in the second quarter and those turn faster when we talk about our import dollars that we've been running through this year because a lot of that is very much driven by domestic vendors, that's where the rebate programs are more prevalent.

And that inventory turns faster because we're sourcing it and we tend to stock more of that at our store locations than at our DCs, whereas our DCs tend to stock more at our import side because they're acting as the master importer.

We'll go to Brent Rakers of Morgan Keegan.

Dan and Will, I was hoping you could maybe walk us through each of the three major categories of gross margin and maybe talk us through if August was I guess the worst you experienced of the quarter, September got better, but I just want to understand within the different three metrics, deflation, rebates and market pressures, if all of those three categories got better or maybe which ones got worse and give me a directional feel on that line.

I'll start and then hand it to Dan but you have to understand on both market pressure and the deflation, they're very, very hard to measure on a short-term month to month basis.

Market pressure, mainly it's anecdotal.

You talk to your customers, we talk to our people.

The only measure we have on that is looking at our POS reported margin and that did improve, internal margin, that did improve.

August was the low point for that.

And on the deflation, that's really about inventory coming through and printed or posted numbers, steel hit the bottom in May, April-May time frame, and has been moving up ever since, so that will be improving with August being the low point.

I'll hand it to Dan.

On the final piece, the rebate side, we do a pretty detailed analysis by vendor where we think the number's going to come in at so that doesn't really lend itself to month to month changes.

That's really the number we booked, recorded for the quarter is based on that analysis so really wouldn't lend itself to those type of changes but it's really looking at the POS or transactional data that we focus the energy on.

As a quick follow-up, I think in your guys' opening comments you talked about on the rebate side, making some decisions in September that cost you 20 to 30 basis points for the quarter.

Does that at all mean that given that that will carry over to Q4, does that mean we should take that impact three months fold in Q4 so a greater impact negative in Q4?

No.

No.

It affected the quarter.

I'm just saying the decision was made in the August-September time frame.

It affected the entire quarter.

In the fourth quarter will have the same effect.

Great.

Thank you.

We'll go to John Baliotti of FTN Equity Capital Markets.

Could we break down SG&A a little bit.

You guys mentioned in the release that your payroll and related expenses are down to about 60, 65% of sales, and but SG&A in total was up about 180, 190 basis points.

Could you maybe walk through the other 35 or 40%, how the dynamics there are moving around?

Well, the payroll piece was right around 62%.

Historically, we've always talked about that being 65 to 70.

The reason that's lower is our commissions and bonus payout as well as our headcount and part-time hours are down so dramatically from a year ago that we made that a variable cost component of our operating expenses.

If I look at other items within the operating expenses, our occupancy was basically flat.

It was up 0.3%, or 30 basis points from last quarter and is up about 70 basis points year-over-year.

But if you compare that to sales, that would add almost a point of SG&A relative to sales.

Because our sales were down 20%.

Yes, our occupancy is running about 7% of sales and it was about 6 a year ago.

So that's almost the entire increase that you're talking about.

Right.

The other piece of that -- the other two components of the increase would be.

Our health insurance costs have increased meaningfully year-over-year.

When we look at the percentage of our employees that are opting for healthcare and the percentage of those employees that opt for healthcare that are taking family coverage, both of those are up dramatically from where they were in the first three quarters of 2008, and it really comes from our employee has a spouse, the spouse either loses benefits where they work or loses their job so they either go from not having coverage at all to family coverage, go from single coverage because they each had coverage with their own employer to family coverage, and that's quite a bit more expensive for us to offer to our employees.

That's one piece of it.

The other piece is what we talked about on the bad debt side.

Some of the fixed expense like phone expense, trash, computer license, all of that is up slightly because they're really fixed expenses, your phone lines.

They amount to about 2% of sales, sales being down, those being flat, still increase the SG&A as a percentage of sales.

There's very little we can do in some of those expenses when sales contract.

As a follow-up to that, you mentioned in the release that given the shifts you've done through path way to profitability, that more of your cost is variable versus fixed but I don't know if that -- it didn't seem evident in the quarter.

If you look at sales and profit per store, they seem to be down more than the sales decline and I just -- is that just something that we should see later in the year or it seemed like that would indicate there's more fixed cost than variable cost right now.

You have to look at it in the context of magnitude.

When your sales are off 20 to 22%, there is -- components that are variable, but they're not that variable.

If you look at even on the payroll side, we've done a good job managing that relative to our sales.

Even when you look at the other components of operating expenses, the fixed versus variable, if we were down 10% or business was flat, that's what we talk about when we talk about fixed versus variable.

It's just that the magnitude of the drop in sales is so dramatic, we're still -- even though we're not opening as many stores as is historically normal for us, we're still opening stores so we are adding expenses to the pool and then there's some that quite frankly should be variable when I think of like healthcare, that should be a variable expense, if you're headcount's down your expense should be down and we've seen just the opposite of that.

And we've made some decisions that may not help the bottom line as much.

One is that we looked at our health insurance and we have very generous programs.

We're not going to change that because we believe it's the right thing to do.

Another thing that we've done is we've really tried to keep all of our good people, a lot of companies that have been laying off like crazy so we made some decisions on expenses where we could have reinforced the bottom line or improved the bottom line but they're really good decisions because as things pick up as I said earlier, we've retained our people, we're taking care of them from an insurance standpoint and we really believe going forward the benefits are going to be huge.

So if the future, if more fixed costs -- if more of your cost is variable versus fixed, would that impact your leverage going forward as volume picks up or is it just because on a weighted basis it's not really that much more?

Well, you look at it and say it's variable but again we get back to magnitude.

Let's go back to Q1 as an example.

It's something that's fresh in my mind because I've been talking to a lot of our regionals about it as they've been in for their meetings.

In Q1, if you look at our labor costs, labor costs were down about $10 million year-over-year.

90% of that came from bonus and commission.

And so it was a variable component, and that's one where we have to be very conscious of that number growing as we go into the new year.

But it grows because our profits and sales are growing.

But it's not going to -- when you look at the other components of labor and you look at the other components of operating -- of SG&A, even though they're variable, they're not a one to one match variable to sales.

And so you will -- you would see leverage in that environment.

They aren't variable enough to get us down to negative 20 but they're variable enough to hold the expense from growing as we leverage into the new year.

Got you.

And had we not done the pathway to profit and had 300 or 400 more stores on the books, our profit picture would be far worse than it is because of the fixed expense of those stores.

That's what Dan's referring to in the pathway to profit variable versus fixed cost scenario.

Got it.

Thank you.

(Operator Instructions).

We'll go to Tom Hayes of Piper Jaffray.

Great.

Good morning.

Just want to follow up a little bit on the SG&A type questions.

You had mentioned that the Company has been transitions to more of a variable based cost.

I was just thinking, looking towards 2010, assuming as you state in the release that there is some increased store opening with the 25 stores in the fourth quarter and generally improving outlook for the economy, as you stated it's getting a little bit better, what are some of your underlying assumptions for SG&A going forward as far as how much of the reductions you've seen this year are likely to come back?

Well on the -- if you look at the components that we break out in our monthly releases as well as in our quarterly releases, some of the reductions at the store level will come back as the volumes dictate.

But when I look at the ability to leverage, that should be no worse than it would have been a year ago, as far as our ability to leverage.

The piece that relates to distribution, and the piece that relates to support, those are dollars we've pulled back that we believe have much greater staying power because we've improved the efficiency of the organization.

The one thing you do in an environment like this is you challenge yourself to get better.

The headcount reductions on the store side were partly predicated on a need to reduce expense, relative to contracting sales.

It was also predicated on the fact if you're moving 20% fewer boxes or 20% less product, it takes -- a portion of our store labor is about moving the package, not about making the sale.

And so those reductions would be there.

Hopefully we've gained some efficiency, we won't need to replace it dollar for dollar as we grow but if our -- if we were sitting in an environment next year and we're growing at 10, 15, 20, 25%, whatever the market gives us, you would see that store labor going up for two reasons.

One, we're moving more boxes and two, we're willing to invest more aggressively in our outside sales program.

On the distribution side, and on the support side, if we're moving more packages, yes, we would need more people but -- in our distribution centers.

But our distribution centers are night and day more efficient, especially our Indianapolis and Denton facilities, than they were a year ago, because of the automation we've added in those facilities.

The administrative support side, there wouldn't be much additions there, because we really are have leaned up the organization and we leaned that up in an environment where transactionally, our transaction count isn't down that very much from a year ago.

In fact, some of the transactions are up.

It's just the dollars per transaction are down.

So we've really already incorporated those savings into our equation.

Flipping that over to the SG&A side, I believe we'll be in a great position to leverage some of our insurance costs, to leverage our occupancy costs going into the new year.

The transportation side is really going to be predicated on what fuel prices do more than anything else, but we are better than turning our fleet than we were a year ago.

Okay.

We'll also leverage like I talked about computer licensing, software -- or the software agreements, telephone cuts, all of that we'll leverage right up because that's pretty much fixed.

Okay.

You mentioned the increased leverage that you're seeing through the Indianapolis and Denton facilities.

Just to get some idea of scale, how much of the total locations would those two locations support?

Well, Denton only supports about 8 or 9% of our revenue.

Indianapolis is a central distribution and from an expense standpoint, it represents close to 30% of our total distribution expense.

And it's going to show significant improvement.

Okay.

Great.

Thank you.

We'll go to Jeffrey Germanotta of William Blair.

Good morning.

Good morning, Jeff.

This question is kind of a derivative of some things that have been asked already but in the past you've said you lowered expenses to the point where flat sales growth could result in flat profit growth going forward.

As you contemplate ramping up investments in stores and salespeople in the months ahead, does that dynamic still hold, or will that increase investment spending perhaps slow that down a little bit.

That dynamic still holds.

Make one point a little after your question, Jeff, but everyone has to understand that our people are paid out bonuses and those bonuses don't kick in until the profits kick in so they work in parallel or they work -- run together.

If the profits don't come back with the sales, that means the bonuses don't come back with the sales, and we have a highly motivated team, stuck with us through the slowdown, they would like to get their bonuses back.

So on a really positive note, we have a team that's going to work really hard to increase their bonuses and the side product or the end product of that is improved profit and that's the way our system has always worked, and that's why we have the variability in it, because when it's coming back it should come back very rapidly.

Thank you.

And I'll turn the conference back to management for any additional remarks.

Thank you, Shelby.

Again, as Will mentioned at the start of the call, want to thank everybody.

I know we have employees on the call.

We have shareholders on the call.

And I want to thank everybody for participating in our call today.

Hopefully you find these calls useful.

And can appreciate the optimism we have as we look forward to the balance of the year and into 2010.

Thank you and have a good day.

That concludes today's conference call.

We thank you for your participation.