快扣 (FAST) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Fastenal Company second-quarter 2012 earnings conference call.

(Operator Instructions).

As a reminder, this conference call is being recorded.

Now I will turn the conference over to Ellen Trester of Investor Relations.

Please begin.

Welcome to the Fastenal Company 2012 second-quarter 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 for 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 being audio simulcast on the Internet via the Fastenal Investor Relations homepage, investor.fastenal.com.

A replay of the webcast will be available on the website until September 1, 2012 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 may differ materially from those anticipated.

Information on factors that could 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 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, Mr. Oberton.

Thank you, Ellen, and thanks, everybody, for joining us today.

I'm very happy with the quarter that we reported this morning.

I'm going to make my comments pretty brief.

Dan does a very good job in his press release, and so I'm going to go through it pretty quickly and basically just give you the color as I see it.

Manufacturing has slowed, that is clear.

But on a very positive note, I have been off talking to a lot of our regional people and district people, and we have not seen a lot of abrupt change.

It is more of a step down, and we have not seen a lot of panic from our customers.

So we think although it is much slower, somewhat slower than it was, it does not appear to be a lot of panic going on.

So that gives us some optimism for the next several months.

Construction has also slowed, but we are actually having a difficult time with the comparisons or understanding the comparisons.

Because of the very warm winter, now the hot summer, it is hard to see where the business would have normalized.

But overall it appears to be somewhat weaker than it was, but there is still a lot of business and a lot of opportunity out there.

On the margin, my comments there is I think we have made nice progress.

I am happy with what the team has done.

We believe there are still several opportunities or many opportunities to show additional improvement in margin, and we are going to continue to work very, very hard on the margin as we go forward.

One of the areas that I guess I am the happiest with is our expense management.

The second quarter, this quarter, was the first time that we have ever reported SG&A below 30%, which we are proud of, and it's really -- I believe it is really just a result of focus and hard work by the team.

A lot of people working on it and a lot of people understand the expenses and just really doing a nice job, and I want to give the chief people on our team kudos for that because they are working very hard.

Initiatives, our sales initiatives, we continue to see very nice progress on those.

Metalworking continues to show progress.

We continue to outpace or run at a nice pace, but we have a long ways to go.

We are learning a lot about it.

Our learning curve is very steep right now.

I have been meeting with several groups of managers and talking about this initiative and finding out what we need to improve upon in areas that we can move faster with.

Government is also very similar.

We are making nice progress with our government initiative, and there is a tremendous opportunity going forward.

Both of those areas were pretty much fully staffed as we see it today with our sales teams, and those sales teams continue to improve their knowledge level.

So we think that -- we should continue to see incremental improvement quarter to quarter as we go forward, so that is some built-in upside for us.

Vending, all I can say is I feel we made great progress.

Our team, Russ Rubie, and his team that runs the vending program, they are working hard.

And I've had the opportunity to talk to several of our larger customers that have deployed our vending solutions, and the positive feedback has all been very positive.

So the customers are seeing the savings.

The customers like the control on their inventory.

The software is working well for them to show them what they are using and how they are using these products.

So there is very positive customer feedback.

And our processes, internal processes, for how we receive the orders from the customers, how we set the machines up, all the different things that we have developed continue to improve, and we still have a lot of opportunities there to improve these processes.

And every time we do that, we lower our costs, and we improve the customer service at the same time.

So we have a tremendous amount of focus on the entire process of the vending business from the start to finish and think that that will just continue to get better as we go forward.

Sitting back or stepping back and thinking of the overview of our business and the puts and the takes, thinking about the economy, the economy, as we see it, is I guess we would say it is not great but it is okay.

So we should continue -- we should be able to perform at a reasonable level in the current economic situation.

I think we are doing a nice job, as I mentioned, with expense control, which creates cash flow, so we are in a very positive position there.

I feel good about that.

Our sales drivers, initiatives that we continue to talk about are getting stronger, which is very good.

You saw that with the vending numbers that we reported last year.

We are actually accelerating in those areas.

Some of the areas that we don't talk as much about are internal things.

One that I'm very optimistic about is our IT group has developed some new software programs to use in our stores.

In all of them, there is actually two or three large ones that we are either rolling out or testing at this time.

Our systems that are set up to make store life far easier and automate different processes like receiving product, how we process orders and several other areas.

Three weeks ago I had the opportunity to go out and visit 11 stores in Eastern Wisconsin, larger stores, some of our more mature area, and talk to managers about how these were working.

And in every case, they were talking about this one saves me an hour a day or this one saves me two a week.

And we only have these initiatives rolled out to a handful of stores or a smaller percentage of our stores.

As we do that, it has a tremendous upside to save labor in the store, and usually the way that works is that labor will now be used for sales activity.

So I am very optimistic about the potential this has for our Company over the next two to six, seven quarters.

Very optimistic.

Our warehouse and transportation group continues to work on automating their systems.

We are within about four weeks of setting up our new automated warehouse here at the Winona facility, and that should not only shorten up our cycle times to produce the orders but also lower our expense.

And we have several other projects that we are working on for warehouse automation.

The transportation group, the people that run all our entire fleet or direct our entire fleet, are a ways into a project trying to understand the use of Compressed Natural Gas, CNG, to run our trucks off, and we have actually had some very good feedback.

It is a small experiment with our Blanch vehicles, and now they have some semis coming in, some large vehicles coming in.

And it has some real potential if it works out for the future.

As an example, the semis that we are working on, we would save on the average between $1500 and $2000 per month in operating expense on those trucks after paying a higher price for the vehicle and the tanks.

So it has some potential going forward to lower our expense, and as you know, transportation has always been a very big part of our business.

So overall I am very positive about the future, things that we have going on, and we will just have to work through this slower economic time and go from there.

With that, I will turn it over to Dan, and I thank you, again, for joining us today.

Thank you, Will, and good morning, everybody, and thank you for joining us as well on our call.

I'm going to touch on a handful of things in the press release, just to highlight a few things that we believe are noteworthy.

I will start with the sequential trends on page three.

If you look at the three years we have displayed there, it really is a story of three different years.

If I look at 2010, from January to October, we were soundly beating the historical pattern about 60% to 70% of the time.

February was what I would call a setback month, and at June our cumulative number was in line with history.

We were beating it most of the time.

We had a big setback month, but we were trending with history.

2011 was a little different story.

From January to October, we actually were soundly beating the pattern a little bit less, about 50% or 60% of the time, but we did not have any big setback months.

And at the midpoint of the year, we were about 370 basis points ahead of what history says we should be building.

And so coming into the year, we estimate we would grow around [19%] based on history.

We ended up growing closer to [22%] based on just having better momentum and better trends throughout the year and no big setback months.

When I look at 2012, March was a deal in the January to June timeframe that we have history on.

March was a huge beat, and April and June were essentially in line with our historical patterns.

February and May where our setback months, and because of those two months, we were sitting there about 330 basis points behind our history.

Those are just some of the things I guess to note when we look at the sequential patterns of our business.

When I look at the second half of the year, there are some positives and negatives.

The positives, I think, we have some nice built-up momentum with our vending machines that have been fined when we installed, the ones that have been installed in the last six months, which are significant.

And the headwind is the uncertainty about the economy and some of the things going on with our currency rates.

One of the things we did see change quite abruptly in the spring and I mentioned it on page four of the release is on our production fastener side or on our fasteners in general.

In the first quarter, that business is growing about 15.5%.

In the second quarter, it dropped just over double digits in April, dropped down to about 6% in May, and rebounded a bit to about 9% in June, but it definitely has taken a step back.

If you look at non-fastener areas, areas where most of our growth drivers are centered on, we are seeing still very strong results still in the close to [20%] neighbor.

The ISM Index, I touched on that in the release as well.

It dropped just below [50%] here in June.

I believe that is the first reading below [50%] since August of 2009, which was a quite long stretch.

Growth drivers, as Will mentioned, we continue to make nice progress on those.

One thing that I think is really noteworthy when you look at the vending stats is, while we were seeing softening trends as we went through the second quarter, our vending numbers, the growth of our vending customers, actually improved from Q1 where we grew a 33.9% with that subset of customers to Q2 or where we grew a 34.3%, which from a directional standpoint I think that is a huge accomplishment because these are larger customers where a lot of these vending machines are going, and we are really demonstrating our ability to take market share at a faster pace in that subset of customers.

Profit drivers on page eight, of the two things that I thought were noteworthy, we are often guilty a bit of beating ourselves up internally and externally a bit when something is not working as we think they could.

A good example of that is our margin in the first quarter.

We do this because we believe we fix stuff today, we don't just analyze it and talk about it or said another way rationalize it.

However, if I take a longer-term look at our business and look at first quarter of 2007, so the last quarter before we started the Pathway to Profit in the second quarter of 2012, our average store has gone from $72,000 a month to $89,000 per month.

Our gross margin has increased from 51% to 51.6%, and our operating costs have improved through our Pathway to Profit and through our initiatives to improve our relative performance in each category.

Or said a much simpler way, we have increased the size of Fastenal about 65%, and we have doubled our profits.

These are great long-term improvements, and we are all about long-term improvements.

The other thing that I think is worthwhile to note, we probably are a little anal with some of our statistics we put in our press release.

One of them is a table that shows our headcount numbers and our store numbers, etc., as we tried to demonstrate and to communicate what we are seeing on the Pathway to Profit.

If you look at the FTE headcount growth in that table, on page 10 you would notice that since the first quarter of 2007, we have added about 3700 STEs to the business or an increase of about 38%.

Of this, about 3200 or about 87% of our increase, our individuals that have direct contact with our customers, either in-store or a non-store selling role.

We added another 235 people or about 6% into our distribution centers to support that 65% increase in sales.

We added another 229 or about another 6% into our manufacturing centers, and about 40% of this came from our Holo-Krome acquisition back in 2009.

And because of the efficiencies we have gained in our business in the support areas, we have added 27 FTEs or less than 1% of our headcount growth since the first quarter of 2007 have been enrolled that doesn't directly relate to selling, moving product or manufacturing product that we sell.

And I think that is the strong tribute to the individuals internally, as well as the wisdom and the possibilities of our Pathway to Profit.

Speaking of Holo-Krome, I thought I would mention quickly that I had the opportunity here several months ago to go out, and one of our regional VPs, (inaudible), out of Ohio was having his District managers meet there to get a view of the facility, as well as have their district meeting, and I went out to speak to the group.

One comment I would make is we moved into a new manufacturing facility about several years ago.

It was my first chance to see it and a very impressive facility, very impressive people on that that work in that facility, and my compliments to Tim and his team out there.

Also, as noted in the table, we hit 22.2% operating margins.

I don't know if that is -- I think that is our best quarter we have ever had from an operating margin perspective.

I'm sure if I am wrong, somebody will call me later today and inform me, but very impressive.

And we had about an 80 basis point improvement from 2011, not the 100 basis points that we strive for, but I think very strong given that we moved our operating expenses below 30%, and that is a first as well, I believe, as Will mentioned earlier in the call.

The gross margin on page 10, as I mentioned, we kind of beat ourselves up on that a little bit, and that was our warrant in the first quarter.

We are not done yet, but I'm pleased with the progress we have seen in the second quarter.

I am also pleased in general when I look at the 22% pretax, the improvement in gross margin, the improvement in our business that we have experienced, not only in the last year but in the last five, to personally be associated with an organization of this caliber.

As mentioned in prior quarters, our exclusive brands continued to inch upwards.

Today they are about 9.5% of our sales.

Good (inaudible) that is being driven by our vending solution.

Operating and administrative expenses, we talk about the great thing we did with expense control.

I think the story is often understated because under the surface in those expenses, there are some things that are not going quite dramatically, but I see them as high quality items of growth.

401(k) profit sharing contribution, we share a piece of our profits with our employees that participate either in our retirement programs throughout the Company.

Our profit sharing contribution in the quarter grew 74% from the number a year ago.

In fact, if you look at our profit sharing contribution count for the second quarter, we are about 70% of our annual number of just two years ago in 2010.

Also, in our occupancy, our vending machine costs more than doubled from a year ago because of the success we have seen with vending.

Those are two items that are outgrowing the Company, high quality items I might add.

Finally, on the working capital side, all I can say is we had a nice improvement, and I credit that to our team in the field.

They are doing a nice job of managing their working capital needs, both accounts receivable and inventory, which produced a very strong cash flow again as we go through the first six months of the year.

Our expectation when we started Pathway to Profit was operational working capital -- excuse me, operational cash flow at 89% of earnings.

I believe that range has really moved to 85% to 95%.

Year-to-date we are at about 90%.

Net CapEx we have really set our target number of that is about 25% of earnings.

Year-to-date we are at about 23%, which puts our free cash flow at about 66%, 67% of earnings, not only a strong number given our range of estimating about 60% to 65%, but a very strong number when you consider the first half of the year is where we need the most working capital growth because of the seasonality in our business.

I think that bodes well for our cash flow capabilities in the second half of the year.

With that, I would turn it over to questions.

As we have said -- asked in the past, please limit yourself to one question so we can get through the entire group of folks that get queued up.

Thank you.

(Operator Instructions).

Ryan Merkel, William Blair.

Just I wanted to start off with June, maybe you could just provide a little bit more color.

How did the month end?

Did that tell you anything about activity levels and maybe talk about the strengths and weaknesses either by end market or by geography?

June actually was at -- came in about where we thought it was.

In the middle of the month, we had a little uptick and thought we might get closer to the 15%, 16%, but overall it was a very predictable month, up from May and kind of an average growth as we saw in the sequential number.

As far as the geography, there was not a lot of change.

In May we had more slowing up the Eastern Seaboard.

Most of those areas came back in June.

It seems like it is just a step down across the country.

Even in the areas that we were doing so well earlier in the year, the oil patch from Texas, Louisiana, Oklahoma, their growth stepped down about equal to the rest of the Company.

The Midwest where we have been strong also saw a little bit.

So I cannot give you much help there.

Industrywide Dan puts in his number manufacturing, construction.

So overall it just seemed like, and I think I've commented on this, the entire thing gets stepped down a little bit, a little energy like we let off the throttle for the economy.

Even our international business is much lower than it was a year ago.

Mexico has remained very strong for us.

Their growth was slightly lower than it had been in previous months, still well above the Company, more than double the Company.

So it is hard to really pinpoint any one area that has slowed more than another.

Dan?

I would agree.

Okay.

And then touching my follow-up on SG&A, I was also quite impressed with the control in the quarter.

I'm wondering is 9% OpEx growth sustainable if you continue to grow in the mid-teens?

Maybe just talk about the puts and takes there.

If you look at the nature of the items, the quality of our operating expenses, if you are thinking about it that way, are there seasonal things that help it or hurt it?

In the first quarter, one of the questions I had going into the second quarter was the first quarter was helped in a meaningful fashion from the standpoint we had no winter and natural gas prices had dropped.

So we had some things in there that were not necessarily sustainable on a sequential basis.

When I look at our operating expenses in general today, there is nothing in there that is unusual in nature.

So I think our ability to continue managing that at an extra low level like we did in this quarter is fairly sustainable.

And some of the things I mentioned about the software, some of that will be coming through, and that helps the large stores more than anyone else by quite a margin.

And if you look at our report, that is the group of stores that raised their profit and had the most impressive increase in their profitability because we are making those stores more efficient.

So we do have some upside there.

Holden Lewis, BB&T Capital Markets.

Thank you very much.

I'm just a little curious, now that we have had this step down a bit in growth rates, your goal has been to expand your operating margin about 100 basis points a year going forward.

Can you talk about whether or not the current level of growth is still consistent with 100 basis points of operating margin growth?

And then maybe also sort of recognize that that achievement is a series of things you are doing internally.

Can you talk about maybe some of the projects that are dropping off or have been successful or not successful and then those that are coming on?

You alluded to certain software, the transportation initiative.

I am just curious about how we are progressing through initiatives with stuff coming and going.

Okay.

The first thing -- and I will let Will touch on some of the initiative piece -- but just from a mechanical -- if you think of the math of our P&L -- we still -- and this problem improves as we move forward.

But, I mean if you look at it, our gross margin was down 60 basis points roughly from a year ago.

And in the first quarter, it was down 80 basis points from a year ago.

So, as we work in -- I'm not going to make predictions of what our gross margin is going to do or not.

But if you think of the mechanics of what was happening in 2011, our gross margin was stepping down during the year.

So our comps changed dramatically as we stepped through this year, and all of a sudden all that headwind from gross margin dissipates as we get into the second half of the year.

So that puts us in a position, if we are doing a good job of operating expenses, to do a great job on raising our operating margin.

But, Will, you may want to touch on a few of the initiatives.

Well, I think on the initiatives, you mentioned transportation.

We continue to see improvement in our transportation.

The first half of the year was a little tougher because fuel prices started out high.

But we are making money on our transportation, and we will be at least based on halfway through the year -- or halfway through the year, we have already made more money in our freight program than we did the entire year of 2011, so well ahead there.

The software things that I talked about are branch-based initiatives where it is just operational efficiencies and how we receive the product, pick the product, ship the product.

Some of the larger stores with higher volume, we are saving labor.

I was in our largest facility on that trip to Wisconsin, and the manager there has had the system for about three to four months now.

He said, well, I could not operate the business today without that.

I suppose he had figured out that that is feeling, which was very positive.

So there are a lot of things we are working on the vending software to streamline that process.

It was -- it would not have been a real big deal when we had 500 or 1000 machines, but now that we have 13,000 machines installed, we are going there.

By the end of year, we could be close to 20.

We should be close to 20.

Those types of things really work and give us some efficiencies.

As an organization, we are very focused on making a more efficient business, a leaner business.

So in the higher economy, we can use that to grow our sales faster and be leaner.

In a slow economy, we can use it defensively to lower our cost and be a better competitor and more profitable.

Okay.

Thank you.

Sam Darkatsh, Raymond James.

This is [Josh] filling in for Sam.

Congrats on the quarter.

First, a bit of a modeling question.

Do you think there was or can you give us a sense of any negative impact on July from the timing of the July 4 holiday being in the middle of the week?

I have said it with a handful of our Regional Vice Presidents situated around North America just to see what kind of impact.

If you think of last year, July 4 was on a Monday.

The month started on a Friday; July 4 is on a Monday.

That is about as perfect an alignment as you can get.

This year we have a few things going on.

I believe we have an extra day in July this year, and the July 4 week falls -- or July 4 falls dead in the middle, so you have a couple of orphan days.

What I was hearing from a lot of the folks is you had businesses that shut down the first two days of the week and some businesses shut down the last two days of the week.

I personally believe it takes a day to a day and a half out of the month, but time will tell how that plays out as we go through months.

Maybe Will has a different opinion.

He might think I am full of it.

No, the timing could not have been any worse, and we will just have to play it out.

But, on a positive note, it is early in the quarter, and so we have plenty of time to make up if we lose some ground.

Thanks.

And then just looking at the spread between your vending growth rate and the companywide growth rate, it seems to imply a fair amount of moderation in the non-vending customers.

Is this entirely driven by moderation in the end markets, and do you think the implied rates somewhere around 10% or 11% accurately reflects those markets?

I guess I will answer it this way, and if you need a follow-up, I will give you a follow-up on that.

But I think it says more -- I think it understates the strength of vending in general because, if you notice, one of the things we touched on was the slowdown in our fasteners.

Our fasteners really are not helped by our vending.

Vending is really about the non-fasteners side of the business.

So I think the fastener business is doing what the fastener businesses do right now because of what is happening in the economy.

And the growth we are seeing is because of our ability to keep taking market share, but the economy has fallen back in my opinion on the fasteners side.

So I think it is more about that piece of the business.

Clearly our stores, our stores with fasteners, grow faster -- with vending grow faster than the stores without.

In fact, I believe, if you look at our stores, that, Will, you may want to touch on.

If you look at the stores that have deployed 10 machines or more, those stores are growing at almost double the rate of their peer group.

So there really is something.

Now there is more to it than just vending.

It may be the better managers, people embracing different ideas, but there is a direct correlation.

And also to answer, is 10%, 11% the right number?

If the ISM is flat to down, it says that there is no growth, no underlying growth, so everything that we are getting is taking share.

And taking share at that rate at our size is probably still pretty good performance.

What it really tells us is that we need initiatives to cover a broader base of our business, and that is what we are focusing on.

Saying, okay, vending is working well, government is working well, metalworking is working well.

We just need more of those and figure out what are the best ones to continue our above average growth as an organization.

David Manthey, Robert W. Baird.

Good morning.

A similar question.

I'm looking at the same data here and trying to figure out, is there anything to the thought that the customers that do not have vending for whatever reason are not getting the TLC they need and just not growing as fast?

And then, Dan, to your comment on the fasteners, the non-fastener type products that you are selling through vending seemed to be doing better than your OEM industrial production type products.

Is there anything related to that?

Is it customer mix, or is that margin -- I'm just trying to get underneath the growth rate here.

Because, again, when we look at the overall deceleration that you saw here, which seems a little bit more severe than your comps or that what we are hearing out in the field, I'm just trying to understand what you think is kind of behind the step down in growth rate that you saw here relative to the world?

What I'm hearing talking to our people -- and I have been out to see a handful of customers -- is people are slowing down production at some level.

If you look at the backlogs, the backlogs flattened out -- a lot of them in the April, March to May timeframe.

And what manufacturers typically do when their backlog quits building is they pull back on production so they can stretch that out because you don't want to burn through your backlog and then have nothing to do.

And I really believe that is happening in a lot of the industrial areas in fasteners or production product.

So it steps back just a little bit, and it does not take a lot because understanding we are still growing that business.

But if they are not growing or their production is slower than last year, you have to pick up a lot of additional business to make up for that.

It really is centered around that FAST production fastener business.

I think it is slower than others maybe are seeing because we are more involved in that production.

Okay and then the follow-up.

Is there any trend or type of customer that you are seeing that is adopting vending?

Is it primarily the manufacturing production type of customer, or is it the opposite of that?

Is vending more appropriate for other types of service businesses that are not so manufacturing focused?

My guess is it is the former, but is there any trend there that you would --?

It is actually broad-based.

We are seeing tremendous success in government accounts, a lot of big maintenance accounts like food processing, things like that.

Manufacturing is very strong.

Energy being power plants, producers of energy.

It is so broad-based, we just have not seen an area that is not working well when we present it right.

The biggest hurdle that we have to overcome and we are doing well with it is finding the right person to sell to.

Because in most cases going to our everyday buyer that we call on is not the right contact within the facility, and once we get to the right contract, it goes very well.

But it is a very broad customer base.

A lot of warehousing also.

We have had some great success in big distribution operations, so pick/pack and ship operations for their necessary stuff.

Got it.

All right.

Well, thank you.

Robert Barry, UBS.

Good morning.

I think last quarter when you signed almost 5000 vending machines, you thought that might be a little bit hard to sustain, but it looks like you even exceeded it a little bit.

I was just wondering what had changed there and whether the right pace going forward can now actually be more in the 4000 to 5000 range than the 2500 that you were originally targeting?

And then also, if you could comment on the mix of machines?

I know that originally it was really focused on the FAST 5000, but you had the 3000 and the cutting tool machines, too.

What are you seeing in terms of the other types of machines that you had introduced later?

As far as the beginning of your question, what has changed, nothing has really changed.

We had seen such rapid acceleration that we did not want -- we were hoping it would hold, we thought it would hold, but we did not want to commit to that.

As far as going forward, our goal for the year is 10,000 machines.

We are comfortable we are going to exceed that, but we are not going to ratchet up the number externally because it is still a tremendous amount of work, but we are optimistic that we can keep a fast pace.

As far as the types of machines, the FAST 5000 is still the workhorse.

We are assigning more of those than all the other ones combined.

The second machine that we are seeing tremendous success with is the lockers.

We put out a new locker system, which is actually stand alone, which means it does not need to be driven off the blades of a FAST 5000 or the controller on a FAST 5000.

And we cannot keep up with that machine.

In fact, we would have installed several hundred more machines in the quarter if we would have had the machines to do it.

The success was greater than we had estimated, but we are getting called up and believe we will be called up this quarter and moving forward.

The cutting tool machines are moving slower than we had hoped.

We are assigning lots of them, but not the numbers that we had hoped.

And the FAST 3000 is moving up but also slower than I would have estimated.

But that really -- whether that is a 3000 or a 5000, it really does not matter to us.

And part of the reason I think that is moving slower is we are still very focused on the larger customers, and it is a machine designed for smaller customers or smaller usage.

But, as a group, we are not real concerned which machines sign, we just want to get our footprint out there.

We want to plant our flag in that account, and then for the most part what we are seeing is that customers that have it are aware a lot of our growth is coming from, and they are deploying more equipment in other plants.

So that is a very positive result that we are seeing.

The reason I asked about the mix is, in part, because I think that you require a different amount of incremental net revenue comes to Fastenal based on the machine, right?

Maybe how much (multiple speakers) do the lockers require?

Is that also 2000 a month (multiple speakers) --?

The lockers?

Well, there is different configurations, but for the most part, it is about 1500.

There are several different configurations, but it is about 75% of our trying to model, if you are trying to model it.

Got you.

Okay.

Thank you.

Adam Uhlman, Cleveland Research.

Just a point of reference, Dan, you did hit a new record in the EBIT margin this quarter, so congrats on that.

Thank you.

I thought you were going to correct me.

Just a follow-up on the vending question, it looks like it added maybe on a net basis 4 percentage points to growth.

With all of the machines that were contracted here in the first half of the year, how are you thinking about that contribution to sales growth in the back half of the year?

We think we should at least be able to maintain that level, possibly expand it.

One thing that we have to caution on it is whenever you put a tremendous amount of energy into one area, there is going to be some give.

So it is not all incremental.

We put a lot of energy into this, and I think maybe Dave mentioned is something else giving?

We don't think we are not servicing the other customers.

We may not be selling as hard to those other customers because we are selling so hard to the vending customers.

But as far as a contribution, we believe that we will increase our installs in the third quarter over the second quarter.

We will not talk about the signings, but our installs should be up.

And if that happens, then we should continue to drive the new revenue through those machines because it continues to prove that that works.

And we see that a very high percent of the time.

Plus, we have a lot of built-in sales growth.

All right.

And then secondly, just on the gross margin, there were a couple of headwinds relative to the first quarter with the fastener mix was lower as a percent of revenues than we had in the first quarter, and the vending mix was higher, but you have still got a little bit of gross margin expansion.

I was wondering if you could just maybe elaborate a little bit more on why that played out and how you are thinking about at least the near-term direction of the gross margin rate?

It is really focused.

We spent a lot of time focusing on it, looking at areas that maybe we were not making as much money.

In some cases, you walked away.

In some cases, you raised the prices.

But overall we -- and we were pretty clear on that in the first quarter.

We thought we had been a little sloppy and maybe not as focused as we needed to be.

But you were right.

There were some headwinds, but vending overall is not a headwind, unless it's being sold to larger customers.

We don't see a step down in the margin in vending just because it is vending.

We see a step down in the margin because it is being vended to large customers that are typically lower margin customers.

We want to make that clear because there seems to be a notion out there that if it goes through a vending machine, it is a lower gross margin.

The same product to the same customer, it does not really matter how we deliver it.

It is about the customer?

It is about the customer and the product delivered to that customer.

And overall from an operating margin standpoint, as we develop our processes for vending, although the gross margins may be lower to those customers, our operating margin should continue to improve because it is a far more efficient process.

And we are looking at this as long-term a big tail wind, not a big headwind.

It is a more efficient process which is additive, but at the end of the day, that added sales increased the average size of our store, which increases level of profit for the store mix.

This adds to that.

So it is double in that situation.

Brent Rakers, Wunderlich Securities.

Good morning, just two questions.

First, you have talked a lot about that SG&A, and again I congratulate you as well on performance there.

But could you talk about what your thought process is in this lower growth environment as to towards hiring in the second half of the year?

You know, as I mentioned in the release, our tone is cautious.

You know what?

If you think about where we are really adding heads, it is really in the sales part of the organization.

And what we have strived to do, if you think of the mechanics of the Pathway to Profit, as long as our labor growth on the store side of the business is growing at 70% of the gross margin, running at 70% or better of the gross profit dollar growth, we believe our regionals alone will manage the business.

And but we really strive to have that, and that is really a function of -- that is where the numbers should be just based on the fact that our average store size is growing and it is leveraging.

And so for the areas of the business that are seeing good growth, whether it be because they are introducing vending or growing their government business or growing their metalworking or growing the fastener business, they will be adding people commensurate with that growth to service the needs on areas where we are not managing it very tightly.

And on the support side, we will be managing it very tightly.

Yes.

As we believe we can.

Great.

And then just my follow-on question.

Last year you guys seemed to really have some breakthroughs in Europe and China and Latin America with some new locations.

I'm just wondering if you can give us a better flavor on both how the existing stores are doing internationally year-to-date and maybe how much of these 53 locations opened up this year are non-North American locations?

Dan is looking for the number on what percentage are non-North American.

I can cover the first part of your question.

We are seeing a slowing in our international business.

Some of that is FX.

But also we did not do as good a job of signing new large accounts.

Most of our international business is driven by large account signings, and we did not have quite as many successes in the fourth and the first quarter, which affected our second-quarter growth.

We do have a lot of good things going on.

We just signed a couple of nice large customers that will be coming on later this quarter, early fourth quarter, which will give us a boost.

And we are expecting the growth rates to come back.

But it is always going to be more up-and-down than the rest of our business because it is driven by a handful of large customers or those stores are.

As far as new areas, we are just getting going in Brazil.

It is taking us longer than we expected.

It is a bureaucratic nightmare with the taxes and the things we have to do, but we are very optimistic about that area.

And so overall we still believe international is going to do well for us.

On a very positive note with international is the profitability was up nicely in the second quarter.

So although we did not have quite as good a growth, the profit continued to grow at a very nice level even without the growth dollars that they were expecting.

I checked and 14 of our 53 locations were international.

That includes North American international, so Canada, Mexico, Latin America in general, as well as Europe and Asia.

So 26% of our openings year-to-date are international, so it's just over 2 times the percent of our business.

Because it is about 11%, 12% of our business is international.

Great.

That is very helpful.

Thanks a lot, guys.

We are at 9.46 am.

I apologize to the group that we have gone a minute long.

But just to wrap up by saying, again, thank you for participating in the call.

We are pleased with the quarter.

We have some concerns about the sales patterns, but that just means you manage the business in a different fashion.

But very pleased with the improvements we saw in the gross margin on the operating expense side.

Two sidebar notes.

I always try to add something at the end of the call just to make, because I'm an accountant, I like to be fun.

When I read the headline, I have to say I'm a glass half full guy.

When you read the headline on our quarter release, that headline says Fastenal misses sales.

That is a little frustrating, but that is just me venting.

Secondly, for those of you in the (inaudible) department, I noticed yesterday in the Wall Street Journal my own town of Ellsworth, Wisconsin made the Wall Street Journal because of their Annual Cheese Curd Festival.

They are the cheese curd capital of Wisconsin.

If you ever need any, stop by Ellsworth.

Thank you much.

Have a good day.

Thank you, guys.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the program.

You may now disconnect.

Have a wonderful day.