快扣 (FAST) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fastenal Company second quarter 2014 earnings conference call.

At this time all participants are in a listen-only-mode.

Later we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder this call is being recorded.

I would now like to introduce your host for today's conference, Ellen Trester, of Investor Relations, please go ahead ma'am.

Welcome to the Fastenal Company 2014 second quarter earnings conference call.

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

Also present for today's call is Lee Hein, our President.

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 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, 2014 at midnight Central Time.

As a reminder today's conference call includes statements regarding the companies 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 the companies actual results may differ materially from those anticipated.

Information on factors that could cause 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 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 thank you for everybody who's joining us on the call today.

Looking at the second quarter 2014, I would rate it as a good quarter, not a great quarter, but a good quarter, the most positive numbers being in the sales area.

We had 12.1% sales growth for the quarter.

Some of the highlights as I see it, our older stores grew right at 10% and even stronger in last two months of the quarter, so when our store -- historically when our older stores are growing in the double digit, Fastenal does very well.

Our sequential pattern from January to June, which we follow the sequential pattern very closely, was up 14.8% from January to June.

Our fastener sequential growth was up 15.1% from January to June and our construction business was up more than 20%.

To see those numbers -- to see numbers similar to that you'd have to go all the way back to 2010 where we had similar results and you can see how it came out after that, so from a sales standpoint we're feeling very good about what we've done.

We believe a lot has to do with us adding the people back at the end or during 2013 and continuing to be committed to drive more sales calls.

On the EPS side we were somewhat disappointed we thought we would do a better job or produce higher earnings per share and it's really a margin story.

I think Dan did a nice job in the earnings release stating our margin and some of the pressures we're having with larger accounts and things like that, and that we're not going to push the margins so hard internally that we put our people in a position to make bad business decisions.

A couple things on the margin though that were disappointing other than the net result, freight slipped just a little bit which we have to work on that.

That's really about pounding the drum and making sure that we make that work and some of our measurements on pricing have but slipped slightly so we're looking at that very hard.

We're working very hard on the margin and believe we'll continue to do well there.

On the expense side, the team did a nice job.

We grew our SG&A by 10% and that was with 15% more FTE.

So we added the people, we got the sales results, we produced the sales results and we still maintained our expense level at a very well, so we're happy about that.

Also on the sales side our vending performance remains strong.

We had good signings.

Our sales growth was good, still above 20% and we saw improvement in the margin and we have a tremendous upside on the margin for the vending.

It will take time to do it but with things we're doing with T HUB and buying better, better packaging, there are a lot of initiatives going on with vending.

And so we're very excited about the vending opportunity and believe it's a big part of our future along with fasteners and many other things.

So to summarize, I'm going to keep my comments short today.

To summarize as I see it we have very good sales momentum.

Our fastener sales are recovering.

Our vending remains strong.

We have done a very nice job on our expense control and we need to continue to work hard on our margin.

So as looking at our business that's what you can expect from the future is continue to work hard in the sales, work on the margin, manage our expense and hopefully be a very good company for you to own.

With that I'm going to turn it over to Dan who will give you more color on all of the numbers, thank you.

Thanks, Will, and good morning, everybody.

And also thank you for joining us on our call today.

I'll just add a few noteworthy points on the patterns and primarily looking at the sequential patterns.

As Will touched on since January our business is up about 15% daily average and he touched on some of the components and he touched on the fasteners growing with the company.

He touched on construction growing faster than the company.

Now my guess is for the analytical folks listening to this you're looking at them saying yes, but you're comparing to a January that wasn't that impressive because the weather really dampened it.

If you take 4 points -- 3 or 4 points out of each of the numbers that Will cited, it's still a number that nobody is coming close to and we haven't come close to since 2010, 2011 time frame.

So we have great momentum going into the second half of the year, and I think that the real impressive part of that is we talked a year ago about we're investing in people at the store.

We're investing in selling energy at the store.

That's going to provide us the energy to ramp up our growth and that's what you're seeing in the year-over-year numbers, but more importantly that's what you're seeing in the sequential patterns and that's a really strong statement going in.

There are some sacrifices that come along the way and right now one of those sacrifices is a weaker gross margin than we would prefer.

With that -- an industry leading gross margin -- and when you start peeling back, it's really about what's happening in the business more so than what's happening in our habits although our habits like anything else in life we could tweak them and make them a little bit better.

And we should have been in the range.

There's no question about that.

We're less concerned today about the noise in the range and more concerned about what are our patterns with sales growth, but the sacrifice that comes with the hangover that we have in gross margin, a hangover that I think that everybody is aware of.

That hangover changes dramatically as we transition now from Q2 to Q3 because what will the dynamics of a gross margin a year ago.

And so because of the short-term sacrifice we didn't hit, we get frustrated internally when our incremental margin does not have at least a 2 in front of it.

We are in the mid teens.

I believe looking into the second half of the year, we have an incremental margin that we'll be proud of and it pushes us well as we approach 2015 and beyond.

Will touched on T HUB.

Our T HUB facility is ramping up.

You know, like any new business that's taken us some time to work through the pains of quite a few of the regions have now turned on.

I was looking at our picking activity as it relates to T HUB facility and our vending replenishments and our picking activity from May to June went up 2.5 times.

So 2.5 times is the ramp up and we still have a ton of opportunity and what comes as that improves is it creates great efficiency at the store level.

It helps us on working capital, but it creates great efficiency at the store level because we're picking that product of replenishment for those machines, that's high frequency product; we're picking that in a more efficient manner.

It also allows us to drive towards product consolidation of what's in T HUB.

The efficiency is the win at the store, the gravy on top of that is as we drive consolidation, we improve the gross margin of our vending business, because we're consolidating the brand of SKUs going through the machines.

Finally, touching on our cash flow.

Oh, I missed one point, sorry.

We did announce also in our release that we're closing some stores in the second half of the year.

You know, we've closed a number of stores over the last several years and as we've said in the past we're always challenging ourselves of looking at our business today, based on how we go to market today and say what is the best thing for this local market, because the key to our success long term is being the best distribution company where we're located.

If that's Au Claire, Wisconsin we're the best distribution business in Au Claire, Wisconsin for serving the customers needs there and serving the growing opportunity of the marketplace.

So we announced in the latter half of the year we're going to close about 45 stores.

The way we approached that internally is we reached out to our regional leaders -- we have 20 plus regional leaders scattered around North America -- and we said to them hey folks, if you could do a do over, if you could look at your business right now and identify where you want to open stores, because there's still a lot of stores for us to open, where you want to open stores, where you would prefer to consolidate some businesses into fewer locations in this market because it makes more sense for our business today.

It makes more sense because of our vending, because of our distribution capabilities, because of all of the tools we have in place, what would you do?

And they identified 45 stores.

So during the second quarter, we accrued up some costs for the future leases related to those facilities and we're moving on to our future, but I think that's a good healthy thing for our organization to do.

Touching on the cash flow which I was getting to a second ago, I'm still proud of all of the things we're doing.

As a growth company we produce operating cash as a percentage of earnings that's in the 90s.

It was 92% in the first 6 months of this year, 93% in the first six months of last year.

That's an impressive number when you look at what our growth is doing today versus a year ago at this time because that takes cash to fund that growth.

We continue to invest heavily in both the vending side as well as our distribution infrastructure and if you look at the numbers we have published in our annual report, looking at CapEx for the year, and you apply that to our patterns of business, historically our investing activities are just shy of 30% of earnings.

Last year we were in the mid 40s so we invested a lot of cash into the infrastructure of the business.

This year we anticipate being in the mid 30s.

That number is working back down to a more normal number and we think that infrastructure investments that we've made positions us well for the years to come.

With that, I will turn it over to Q&A.

Thank you.

(Operator Instructions)

The first question comes from the line of Holden Lewis of BB&T.

Great, thank you very much.

Good morning, guys.

I just sort of wanted to get a sense of on the one hand you're kind of talking about working hard on sort of the margin, but I think in the sort of in the transcript you talked about how you definitely have a sort of a focus now on perhaps more growth than margin.

So I'm trying to reconcile in terms of trying to get a sense of when we could start to see margins getting better.

How do you reconcile those two comments that caring about margin, but on the other hand really caring about growth perhaps more so than margin at this time?

Well we care about both of them equally but what we've discovered is if we push margin too hard that we make bad business decisions and we're walking away from what might be a very profitable business.

So we have to do is from a margin standpoint, work more on the mechanical side of it, of what the pricing should be versus just standing up and saying we need to be at 52% or we need to be at 53%.

Talk about good decisions, talk about what the opportunities are, talk about how we buy product.

And so it's more of a mechanical discussion piece by piece than it is about getting every penny on every sale.

So it's about creating better habits at the store level and building it into the culture.

As we get there, whether that gets us to 51.5 or 52.5, whatever that is, we still want to be able to grow our business at 15% to 20% plus as we do that.

We've done a lot of soul searching on the margin and we found is if we push it too hard, it throws the brakes on sales.

I don't know if that helps you, it's a fine line.

Yes, okay and then just on the follow-up.

Fewest number of heads I think that you added this quarter since Q1 of 2013.

Are we sort of seeing one of these plateaus or floors in the headcount adds, because you feel like you've sort of over added and you want to grow into it, or is it sort of a temporary random noise?

How should we think about your strategy about heads going forward?

Our headcount growth goal is to stay at 15% right now on the branch side of it, but last year we were very flat in the second quarter so we didn't have to add a lot.

If you look at it we ended up right at the number of 15% growth --

We're north of 16 at the store.

Overall, so at the store we're above our number.

But we'll continue to add.

Through the third quarter the adds won't be real great because we didn't add again a lot last year.

As fourth quarter comes that number will start to ramp up.

So if you just pull out last years number and add 15%, 16% to that, that's pretty close to where we're going to be.

But that again, we've been working very hard with our regionals.

We had them all in this week talking about folks hit your numbers, we aren't going to give you exact headcounts.

Run your businesses like CEOs and when you have 20 of them doing that there's a little fluctuation in the numbers.

Some will be ahead and some will be behind but overall our goal is to add about 15% to our stores.

Only thing I'll add to that is back in both our January and April call we did talk about that, that we wanted to end the year in that 15% neighborhood and we were slowing down.

We weren't pushing as hard on the adds because we're also very conscious of the fact that we want to manage our operating expenses through all of this.

We want to invest for growth, manage our operating expenses and I think that's what you saw in the quarter.

Okay, thank you guys.

Thank you.

Our next question comes from Sam Darkatsh from Raymond James.

Good morning.

This is Josh filling in for Sam.

Thanks for taking my questions.

Hi, Josh.

In light of the store closings coming in the second half, could you give us an update on the potential number of stores you think you could have in the US or North America, like what the potential store count could be years down the road?

Our published number has always been around 3.500 as far as what we've talked about internally and externally.

And we don't frankly know if that number is right or wrong.

What we do know is the market opportunity, depending on whose set of numbers you want to look at, is maybe it's $160 billion, maybe it's $140, maybe it's $110.

At $3.5 billion, we have a tremendous opportunity to go out and take market share for years into the future.

I'm 50 years old.

I'm confident when I'm long gone from being around here, this organization will be growing.

Maybe at that point in time a good chunk of that growth is coming from outside North America who knows.

Depends on how successful we are in the next 10 to 15 years.

But it's really about what's the opportunity.

I don't know how many stores we'll have.

I don't know how many vending machines we'll have.

I don't know how many bin stock programs we'll have.

I know that we'll be doing business with more customers in more locations, doing more dollars, and I look forward to seeing how that evolves.

But our stated number is 3,500 and it's a little bit of a napkin calculation but we think it's a reasonable way to look at the future.

We're also spending time trying to understand the changing customer habits with internet, with more traffic, with where people want to travel and that's going to determine where that number falls, what the customers expect out of us as a distributor or supplier.

Thanks for the color and then specifically on the pick up in fastener growth, could you discuss in a little bit more detail what was driving that and especially what the -- whether pricing was positive or negative?

Pricing is pretty neutral, if anything it's challenging because one thing you have to keep in perspective, if you look at the economic improvements we've had, which have been meager over the last five years, but if you look at them they are heavily skewed to larger companies than they are to smaller companies.

At least that's my perception when I read in the paper and what I see in the media, what I see in connections I have with friends in my hometown that own businesses, that employ anywhere from 5 to 25 employees or 50 employees of where the recovery, albeit meager, has been achieved.

The other thing as it relates to our fastener business, we talked a bit about 20% of our business today is heavy equipment manufacturing and that pummeled us in 2013.

In 2012, we were seeing very attractive growth in that business and as we went through 2013 that growth weakened.

We bottomed out in the third quarter with low single digits growth.

We had a month there where we actually went slightly negative and the only growth that we were seeing in the months around it were the fact we were adding market share but our core business was down.

That business has been improving as we've entered into 2014.

We saw mid, kind of mid- single-digit growth in that business in the first quarter.

That improved a few percentage points in the second quarter.

We were at about 8% to growth in that business and from a sequential pattern that's given legs to our fastener business as well.

Thank you, I'll get back in queue.

Our next question comes from Adam Uhlman from Cleveland Research.

Hi guys, good morning.

Good morning, Adam.

Just to clarify, Dan, you mentioned earlier that the second half of the year you're looking for an improvement in the incremental margins.

Do you think you could still hit that mid- to high- 20% range that we were talking about a couple of months ago?

Well if I look off the fourth quarter, I'm very comfortable with that because the hangover is gone in gross margin.

You know, the wild card for third quarter is top line and gross margin.

Coming into the quarter, I personally will be disappointed and this is a dangerous place for me to go, but since you asked question, I'd personally be disappointed if there's not a 2 in front of our incremental margin.

And I don't think I'm going out on a limb with that comment when you look at where our expectations are and where our expectations should be.

We just had all of our regional leaders in on Wednesday and Thursday of this week and those are discussions we had with them.

I believe the selling momentum we have in the business lends itself to having that type of belief in the future and I don't think I'm smoking something in saying it.

Okay, got you, and then unrelated to that, percent of sales to vending customers fell for the first time I think ever.

What exactly is unfolding there?

You know, similar to the what you saw in assessing our stores and our stores that we have today, we have a business that's gone from zero to $350 million, $400 million in sales, annual run rate.

Plus in a handful of years and in 2012 and 2013, we signed a tremendous amount of vending machines.

As we become smarter about the business, we see vending machines that are performing unbelievably.

We see vending machines that are performing damn well, excuse my choice of words; we see vending machines that are disappointing.

And we take a good hard look at them and we've pulled some machines out.

And when we pull it the way we report the number is we count if we have a customer that has 30 locations that we sell to and we have vending in 20 of those, we only count the business in those 20 when we're reporting our numbers.

So if we pull vending machines out of one location and scratch our head and say this location just doesn't have enough employees, want to pull it out of this one, that might be a location that spends a fair amount of dollars on something but a vending machine didn't make sense and it pulled out a little bit.

To me the number that really matters is the 21% or 22% growth with the customers that have vending because that's what's going to drive our business long term.

The other thing you have to keep in perspective, some of the things that are raising our numbers right now, improving our growth, the 15% fastener improvement, the 20% construction.

Some of those customers don't have vending yet.

So one thing that's happening we've pulled machines up but what's really happening is the tide is rising.

Better business mix.

Yes, but essentially, you look at 37 or 38, it's a little bit of noise.

Got you, thank you.

Our next question comes from Robert Barry from Susquehanna.

Hey guys, good morning.

Good morning, Rob.

I had a follow-up question on the gross margin outlook.

So in the release you alluded to it being near or just below the low end of the range for the short-term.

I'm curious what gives you confidence this pressure on the gross margin will only be a short-term phenomenon?

Well the real reason I put it in there, to be honest with you, you guys wore me out in the last three months.

The number of questions I got about are we going to be here, be here, it almost wore me out and it's really more of a statement to everybody, hey let us manage growing the business.

We're going to work really hard on the gross margin.

There's a whole bunch of things mechanically that I can look at that we're doing today, tomorrow, next week.

I touched on a few with T-HUB that we're doing to structurally improve the gross margin.

But Will mentioned it earlier, what we don't want to do is blare the music so darn loud that we have a store somewhere in Fastenal tomorrow that turns down a 28% margin sale or a 22% margin sale because of the noise they heard from us.

And we want to say to them, grow your business and grow profitably.

One thing Bob Kierlin taught us years ago that we can never forget, at the end of the day it's about returns.

At the end of the day it's about your operating margin, are you generating cash to support your growth in terms of the business?

And if you do that every day, and you service your customer well, you will grow your business and you will build a better business tomorrow than you have today.

I think also staying on what we learned from Bob is that the biggest factor we believe in margin isn't markets and isn't products, it's pay programs and I've been saying that for a long time.

When we were all fasteners, our margin was at 52.

We're now 40% fasteners, our margin's at 51.8 so not a lot of variance over 20 years, or excuse me 50.8, so it has not moved a lot and we have the pay programs in place that motivate these people to make the good decisions and those decisions just aren't all about margin.

They are about growth versus margin and that's what we want to let that work, but we haven't lowered our programs to allow lower margins and pay it.

So I think the systems are in place at the store level, at the district, at the regional and at the top level and that's why I have confidence that the margin is not going to move a lot and going down that we'll keep our hand out.

And to be honest, I'd rather report second quarter with 12% growth and 50.8 gross margin than 8% growth and we're at 51.8.

Yes.

I mean I guess it all normalizes out on the earnings line and I think that there's a big picture concern that its becoming more expensive to grow in industrial distribution.

And so I guess the follow-up question is if you wanted to shift the conversation to operating margin that's fine or even earnings growth, help us see how you get back to your kind of target growth range of 15% to 20% without it costing so much that you're not really seeing as much or greater leverage on the earnings line.

We grew our expense at 10%, so we had leverage on the growth.

Our problem wasn't a sales growth versus expense.

Our problem is we had a tough margin comparison from last year so if we roll it forward, if we maintain our margin in the 51% range and hopefully we'll move it up.

I'm not giving guidance, I'm saying we will have earnings leverage.

So we're controlling our expenses well.

We have great sales momentum, again we're up 14% from January, and so we think we're in a good spot.

We just have to continue to do well.

Okay, thank you.

Our next question comes from Ryan Merkel from William Blair.

Thanks.

First question on pathway to profit.

I noticed you changed the 23% EBIT margin target.

You're now needing $110,000 per month for the average store from $100,000.

Just wondering if you can expand on that a bit.

Yes.

The language we had in there was a range of 100 to 110.

We're at, we're basically at $100,000 average store this quarter and our gross margin slipped, at 50.8 we need to be closer to 110 to hit 23.

At 51.5, that would be a different discussion.

Right okay.

And then on vending, what is the average gross margin today on those products and where do you think it could go?

Is 50% achievable at some point or is that too optimistic?

If I look at our vending where it's running right now, you know a few years ago when we were talking about vending and a lot of questions about the weaker gross margins and we had to take a step back and say, whoa, whoa, whoa the customers that have vending are larger customers and their gross margin is around X. And our gross margin in vending is very much in line and when we look at our customers before vending and after vending, the gross margins didn't really change and they were in that neighborhood of 40%.

If you look at our vending today, we've improved it meaningfully from where it was two years ago and if we hadn't, we would have more drag from it because it's roughly 12% of our sales right now, vending, 12% to 13%, I don't have the exact number in front of me.

It's north of 13.

Is it north of 13, and so we've moved that margin up more in that 43.5 to 44 range.

And right now, if I look at the concentrations of products going through vending -- that's where I touched on the T-HUB comment earlier -- our concentrating effect isn't that strong yet.

And so I really see no reason why and that the gross margin in our vending can't normalize to the gross margin of the company allowing for the products.

What I mean by that is our fastener gross margins aren't 51%.

Our non-fastener margins aren't 51%.

Fasteners are above that number, non-fasteners are a little bit below that number, but there's plenty of room for us to improve gross margin over time and it's really about being smarter about the products that go into a machine, a machine that we know a lot more about today than we did two years ago and that's why our margin has improved by 3.5 points.

Right, and I would assume private label more than the machine is only going to help as well?

It's private label, it's brands.

It's really about the scale and efficiency that comes from, if I can say to my supplier we would like to buy this product -- and we're selling so many of this product whether it's a private label or a brand we're selling so much of this through our vending machines that we want to buy it this way.

It's not even pallet pricing, it's container pricing.

We're going to bring it into the T-HUB and we are going to push it out through our machines.

It allows you to source so much better and the margin improves and it isn't just because you're putting your brands in it.

It's because you're aggregating the business and you're improving the economics of the business and you're improving the labor efficiency at the store unbelievably and it gives you more selling energy.

I am still completely convinced looking at the numbers that vending will be our most efficient and most profitable business over a long period.

Not in very shortly but for a long period of time.

For years to come.

For years to come because of all of the things we've built in.

And in the second quarter for the first time we are at a run rate to actually be over $0.5 billion going through the machines.

So its become a big business and that's growing well above the company so if we continue any even similar growth rates, our profit picture for the future looks great.

Thank you.

Our next question comes from Eli Lustgarten from Longbow Securities.

Thank you very much.

Good morning, everyone.

Good morning.

I hate to go back to another margin question which is really the focus --

That's okay.

We've heard it before, Eli.

I know, but you articulate a stronger incremental in the second half, the mix is sort of trending a little bit better.

You're controlling expenses to a slower add so the question becomes why are gross margins hanging around the same level as you look out?

There's got to be something else affecting it, whether it's lack of supplier rebate or changes, something else is affecting the market that you shouldn't show some leverage from 50.8% that's meaningful particularly versus last year based on the current trends.

So can you help me get some idea of why it was at the same levels?

We're not saying we're not.

What we're saying is -- like I said, part of my commentary is the focus, the spotlight of every question that comes in is about gross margin, here, here, or there, and we're not going to jump out the window if we report a quarter with 51 or 50.9 or 51.1 gross margin.

We're seeing a tremendous amount of growth in our business right now from non-fasteners.

We're seeing improvements in fasteners, we see great trends in fasteners.

But the year of the numbers are what they are and it's disproportionate to large account business.

If the small customer was growing as fast with us and we had that mix in our numbers we are being challenged by mix in a massive way.

All these things under the hood that we talked about, the improvements in vending gross margin, the improvements in our sourcing, things we do every day, the improvement over the years in our freight, all these things are structural changes we're making to combat the massive change in customer and product mix that's occurring in our business.

When I joined Fastenal in 1996, 4% of our business was national account.

Today it's 44%.

If I add large regional accounts, more than 50% of our business today is a large multi-location customer.

When I joined Fastenal in 1996 I think at that time fasteners were about 80% to 85% of our business.

Today they've dropped in half to the low 40s, but during that time frame we've managed all of the structural components within the respective product categories and end market categories and we've basically had a gross margin that's been unchanged.

There's been periods of turmoil, but you have a business that goes from $220 million a year to $3.5 billion a year in 17 years, that comes with the territory.

Here is our internal thinking on it.

If we had a point of growth to our business where we are right now, it adds just about $10 million in quarterly revenue and $5 million in gross margin.

If we give up 20 basis points which everybody is freaked out about, we give up $2 million.

So do I want the point of growth or do I want the 20 basis points?

I'd like them both but on balance, a point or two of growth is worth a lot of margin and we have to find that balance within our company and keep the Street in the know at the same time or keep -- Dan is checking his calculator here to see if I got it right -- I do have it right so over $1 billion you've got a point of growth and you pick up $10 million so that's trying to find that balance.

Where do you get the return on?

The extra $5 million in gross margin.

Thank you and one follow-up question on a completely different topic.

One of the things I'm surprised I don't hear much is that the company has undertaken a metal working initiative, more venture into cutting tools and I know you have the deal with Kennametal.

So we're not hearing very much about what's going on in that business, how it's growing, whether or not it's still a main focus?

And cutting tools go right through vending machines, it would add a lot to margins at the same time.

So you can give me some idea?

Should I not expect much in this couple years or is that a real focus area outside of what we --?

We're continuing to work very hard in the metal working.

It's continuing to outgrow the overall company revenue, not by the amount that we had expected but we're growing well above what we see our public peers that are working in that area.

Our metal working sales are growing well above anyone else that we can get public data on.

We've just we haven't been talking as much about the different product lines.

What Dan and I have learned over a long period of time is the more we talk about it the more we have to support it and it's easier for us to give more general information, continue to work hard on the macro numbers; growth, margin, headcount, and but when people ask we do talk about it.

We're very excited about the metal working opportunity just as we are about fasteners, safety, vending, and many other areas.

Thank you very much.

Our next question comes from David Manthey from Robert W. Baird.

Thanks, hi guys, good morning.

Morning, David.

First off, Dan, you mentioned there's a lot of things that you've got going on, I think you called them mechanical factors that will structurally improve gross margin.

Not to dwell on this too much but could you just tick off a few examples of those things just so we can have a laundry list?

Sure.

The first one is what we touched on with T-HUB, the consolidate, the aggregation of our spend, whether that's going to one of our brands that we support in our T-HUB facility or private label that we support in our T-HUB facility.

It's identifying all of the opportunities we have and communicating that to the field and communicating that to our district managers and our regional leaders of -- here is the gross margin opportunity for this, this, and this.

Then we're always doing that for the business in total but there's tremendous opportunity.

I always think of the vending machine as an end cap if you want to use a retail analogy, and on the end cap as a retailer you have a lot of choice but what goes on to that end cap.

We have a lot of influence about what goes into the vending machine.

We need to exercise that influence and we need to go to our customer every day with cost savings ideas and this is one of them.

You can do a sharing, a gain sharing component of that and it's a win-win scenario for our customer, for our business, and for our suppliers because it's a more efficient supply chain.

The freight one is another component of that, that we always talk about.

Then a third one is being really good on the sourcing side at the store and at the company level on commodity pieces, the branded pieces, and challenging ourself on the exclusive brand piece, And again, that relates to our business every day and I'd challenge our product managers and our sourcing folks on that every day about what we're stocking in the store, about how we're sourcing, how we're expanding our capability to source, and how we're helping our stores do a better job, too.

David I would throw in a fourth there and that is the education of our stores to charge for the value that they provide their customers.

That is I know that's an intangible but I'd tell you, we're adding 16% to 17% more hours in the store.

They are inexperienced people.

As they gain experience and they gain confidence, things will change but that goes right back to the habits of pricing, customer, or a sale appropriately and that is an ongoing item for us too.

As long as I have a list, I'll throw it in a fifth that is that Lee has promoted a gentleman to work for him, working on pricing, but what he's really working on is trying to identify the current systems that are available, software, trends, and study the science of pricing and understanding the opportunity of the products we sell into the market.

And we've always been pretty good at that, but we think there's upside, and it's really that is really more focused on larger customers understanding what the needs are.

So all these things put together give us some help and at the same time everyone is pushing you for the other direction so it's a tug of war forever.

We just hope to win a little more on the rope.

Right, okay and then just to follow-up.

Dragging that down the P&L to where it matters at the EBIT line, historically, you're changing EBIT divided by change in GP dollars has been let's call it around 50% and I guess the theory is that let's say your customers are getting bigger, the mix is changing so forth, but the cost to serve goes down.

Should that number not be as good or maybe even better than it has been historically?

Meaning you get better leverage on your cost structure because the cost to serve these bigger customers is lower.

That's really inherent in pathway to profit, that's kind of what we identified, bigger customers, bigger stores, lower cost to serve.

It's about volume.

And we see it.

We have lots of data points with the number of stores we have and we can see where it is and as long as we continue to grow our average store size -- this quarter is difficult because we had tremendous drop in the margin, I mean it was 140 basis points, everything looks skewed the wrong direction, but in a more normal quarter you would have seen that come through.

Okay, thanks very much.

Thank, Dave.

That is all the time we have for questions.

I would like to turn the call back to Will and Dan.

Once again, I want to thank you for your continued interest in Fastenal.

Hopefully the combination of our earnings release and the commentary on this call helps you understand our business and how we're working to grow the business into the future.

So thank you and have a good day.

Ladies and Gentlemen thank you for participating in today's conference.

This does conclude today's program.

You may all disconnect, everyone have a great day.