Fastenal's (FAST) CEO Daniel Florness on Q2 2016 Results - Earnings Call Transcript

| About: Fastenal Company (FAST)

Fastenal Company (NASDAQ:FAST)

Q2 2016 Results Earnings Conference Call

July 12, 2016, 10:00 AM ET

Executives

Ellen Trester - Investor Relations

Daniel Florness - President and CEO

Sheryl Lisowski - Interim CFO, Controller, and CAO

Analysts

Robert Barry - Susquehanna

Chris Dankert - Longbow Research

David Manthey - Robert W. Baird

Scott Graham - BMO Capital Markets

Ryan Merkel - William Blair

Adam Uhlman - Cleveland Research

Operator

Good day ladies and gentlemen and welcome to the Fastenal Company Second Quarter 2016 Earnings Results Conference Call. As a reminder, this conference is being recorded.

I would now like to hand the meeting over to Ellen Trester, Investor Relations. Please go ahead.

Ellen Trester

Welcome to the Fastenal Company 2016 second quarter earnings conference call. This call will be hosted by Dan Florness, our President and Chief Executive Officer and Sheryl Lisowski, our Interim Chief Financial Officer, Controller, and Chief Accounting Officer. The call will last for up to 45 minutes and we’ll start with a general overview of our quarterly results and operations 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 1st, 2016 at midnight Central time.

As a reminder, today’s conference call may include statements regarding the Company’s future plans and prospects. These statements are based on our current expectations and we undertake no duty to update them. It is important to note that the Company’s actual results may differ materially from those anticipated. Factors that could cause actual results to differ from anticipated results are contained in the Company’s latest earnings release and periodic filings with the Securities and Exchange Commission and we encourage you to review those factors carefully.

I would now like to turn the call over to Mr. Dan Florness.

Daniel Florness

Good morning, everybody and thank you for joining our earnings call for the second quarter of 2016. I've been in my role here at Fastenal as CEO and President or -- I'm in my seventh month, started in January, unofficially stepped into the role last October.

I'm a firm believer, and I have some CEOs that came before me at Fastenal that did an excellent job of doing two things; providing vision to our shareholders and to the employees at Fastenal and providing perspective periodically on what we are doing for course correction as we go through a period of time.

In the case of vision, I like to believe the vision that we laid out last November on our investor day and the vision that we believe, I believe is a correct one for Fastenal is being presented in a meaningful fashion. I think we are seeing traction on it. From the vantage point of the second item perspective, perspective is looking at the business in my mind as you go through the quarter again pointing things out as you go through the quarter you go through the year, you go through the month pointing things out and seeing a cause and effect from the standpoint of a reaction and the improvement on certain things, or you accelerate on certain things that aren't moving fast enough.

In that regard, I would have to say I let the Fastenal organisation and our shareholders down in the second quarter, there were some miss steps we made, but let's look at vision first. We talked last November about the vision of Fastenal and one thing that I think is critical to our success as we go forward in this year and into the years to follow is the momentum we are building as an organization.

One of the hallmarks of the organization that I have known for over just over 20 years, in June I hit 20 years with Fastenal, a milestone I'm particularly proud of, is the fact that we are an organization that builds momentum, whether that momentum is coming from the opening of stores, the adding of people, the signing of and installing of vending machines, we are an organization that creates momentum for ourselves and that allows us to separate in the market place our ability to grow long term. Now we operate in a large market, we have a large opportunity and it's upon us to build the momentum to go out and take that opportunity.

We didn't have great momentum coming into the year and you see that shining through on some of our numbers this quarters and I'll get into a few more specifics in a second. But on the building of momentum front, in the first six months of this year we signed 92 onsite, 48 in the first quarter, 44 in the second quarter. Our stated goal is to sign 200 for the year, firstly I want to have no quarter that doesn't start with at least a four, and it will be great to have a quarter or two that starts with a five. So far, I believe in the first two quarters of the year we've made a tremendous transition in our ability to sign on-sites.

And on-sites for those of who not familiar with it is really about us setting up a store inside the customer's facility and having an even more intimate relationship than we've had in the past. We have currently 333 I believe that's the number, on-sites that are operating of the 92 we've turned on I believe close to 50 on-sites, but we are making very good progress on changing the organization to build, start building that momentum that we'll need as we go into '17, '18 and beyond.

In regards to vending, in the first two quarters of this year we signed 9,516 devices and we signed more in the second quarter than the first quarter. Earlier in the year we added 200, roughly 230 people into our business to support vending and to drive our signing with vendings, and I'll touch on a few stats in a second of why that's important. But I'm proud to say that we are gaining some momentum there.

Part of the process with this new group of people was to go out and optimize our existing devices. In many cases that optimization involved adding products into the machines to improve the throughput of the machine. In some cases it was changing the configuration of the machines to improve the efficiency of replenishing the machine and so an optimization is an all revenue base and might be service based aspect.

But we've optimized approximately 75% of our machines in the first six months of the year, that's good news. The second set of good news that we continue to see good statistics out of the group of stores. The bad news is it also required the removal of a certain number of machines. We've removed 7,200 machines in the first six months of this year as we went through our optimization process.

Many of those machines are great decision - that we removed are great decisions because we went from 10 machines to 9. We went from 4 machines to 3, because we really rationalized the equipment we needed to support that customer and that's a great decision because it allows us to get a better return on that asset that's deployed.

Unfortunately some of the machines we removed were examples where we had the machine in an environment where either the business had changed or the business never truly justified the vending machine and we went from one to zero or two to zero. But I believe we have a much better business vending business today than we had six months ago and we continue to see great traction in our signings and every day we are doing a better job, vetting new signings than we did the day before. We are becoming a much better vending company.

If I look at the second quarter, we grew our business just under 2%. Our vending customers grew just under 3. Those customers like many of our customers especially in particular industries heavily hit by either weaker energy prices or weaker activity in the industrial market place.

Our fastener business with vending customers was down 5% in the second quarter. So a group of customers that grew 3% their fastener business with us was down 5, I think that's an indicator of what's going on in their economic circumstance.

For non-fastener business with that same group of customers grew about 6%. If I take it one step further the dollar that’s going through the vending machine grew about 11. So what we are seeing is a group of customers about 45% of our revenue is with customers that have vending.

Our revenue with that group of customers is growing at about twice the rate of our overall business as a company. That group of customers is as hurt by the economy as any other group and you are seeing that shine through in the fastener business and yet our non-fastener business continues to grow very well and our business through the vending machine is growing double digit.

We believe vending is an example of engagement with our customer just like on-site and is an example of engagement with our customer we believe we are building momentum that will serve us well in the years to follow.

The third piece of momentum I believe we are building is our CSP 16, I believe we are about 1,900 stores converted. Our CSP 16 is largely in place with the revenue drivers of our business and what I mean by that is there are some stores that have yet to convert, there might be smaller stores or stores that are in the process of moving, but they but our revenue base is largely complete as it relates to CSP 2016 and that positions us to a better same day supplier to our customers, be a more efficient supplier to our customers and broaden our appeal on the range of customers that can buy from us, and I believe that will serve us well in the months and years to follow.

Finally we have very good momentum on our national account signings we highlighted that in the points raised I believe it was on the second page of the press release. That’s being helped by on-site signings, on-site signings are being helped by that, they serve each other well because 75% of our on-sites are with national account customers. That's the vision and I believe the momentum we are building as we go through 2016.

Now the perspective part, and the part where as I mentioned earlier I think frankly I could have done better it's from the standpoint provided perspective to the team at Fastenal.

Our top 10 customers in the first quarter and our top ten customers represent 8% to 10% of revenue -- the month or the quarter you are looking at. That group was growing at about 14% in the first quarter, largely buoyed by a few customers that were new to that group. The key to that group every year is what is the new blood you are bringing into it, and what are you doing with your existing group of customers that were in there -- in the past.

In the district level we refer to that as our top 25, at the regional level we refer to that as our top 300 customers, it's really what's happening with you know big customers and what new customers are you bringing into that group. The growth for that group which was double digit in the first quarter and was double digit in April went to zero in the month of May and went to negative six in the month of June. So in the second quarter that group of customers grew at about 8%.

If I look at the top 100 customers in our business and again they represent about 25% of the revenue, the top 10 I just talked about would be a subset.

In the first quarter that group of customers grew about 4.5%. In the month of April that group of customers grew 6.5%. In the month of May that group of customers contracted about 2%, in the month of June that group of customers contracted about 2.5%. For the quarter that group of customers which grew almost 5%, 4.5% in the first quarter grew 7/10s of a percent in the second quarter.

When I look at that group of customers, I see that sudden fall of as an example not of the momentum we are building but of slowdowns with the momentum we have built in the past with customers we have had in the past where we have a large market presence and that business fell off later in the quarter.

The perspective part that we failed on is we didn't react fast enough locally and companywide to that falling revenue in the month of May and June. As it relates to gross margin, you'll notice a couple of thing omitted from our press release this quarter. One is a stated range and that stated range was not removed because I felt was accurate, it was removed because it was becoming too much noise to our conversation. I believe you owned Fastenal, because Fastenal is an organization that builds momentum and carries that momentum forward and is good enough at executing the business that we are able to capture that momentum in very attractive profit growth overtime and very attractive returns.

Therefore our focus internally is 90% on building the momentum. But in the case of gross margin, our gross margin dropped about 30 basis points during the quarter from the first quarter. About 25 basis points of that drop remain was tied to some of the activities around a very rapid CSP 2016 roll out and really more than that a number of efficiencies we introduced into our store network, inventory by location. They come under a bunch of names but we are introducing and we want to do it very rapidly maybe too rapidly, but we want to do it very rapidly to move forward.

During that process, there were some components of our inventory we decided to sell off at a lower price, there were some components of our inventory that we decided to remove from our business. There is about 10 basis points of that drop that I believe are behind us, there is about 15 to 20 basis points of that drop that I believe will remain for several quarters. I was willing to move quickly on that as we entered the second quarter because I felt there were enough other things we were doing that we could fund that if you will by other gross profit initiatives. Those didn't materialize, unfortunately and the gross margin that you see as a result.

And related to operating expenses, there's really probably two things that are noteworthy in our operating expenses and Sheryl is going to touch on a hand -- give us a little depth on these and a few more. But the two things that jump up from me, are few costs were up about $2.5 million from Q1 to Q2, that's a fact of the price of gasoline at the pump and diesel fuel at the pump where we didn't execute real well as we didn't react quickly to adjusting some of our store routes, our local routes but more importantly we didn’t wrap very quickly to our propensity charge freight and therefore we largely bore that expense without sharing any of that expense.

The second one and this is a mechanical thing and it's something that I talked about with many of you over the last year on earnings call. And that is historically we have a very good flex in our operating expenses as it relates to incentive comp and what it means in the short term for our ability to absorb some worsening environments and in a little bit of the incremental margin we give back in strong periods.

And that is, as we had gone through 2015 our incentive comp was compressing dramatically. And if you take a look at our proxy, you could see that from the standpoint of the impact on the executive compensation. But it contracted dramatically and so our -- the district and regional and store leadership component of that is at a compressed level and so the ability to flex there is limited in the current environment and you sell that shine through unfortunately in the current quarter.

Finally two things I'll touch on and it really relates to the momentum items I was discussing earlier and that is and we highlighted it. We installed during the quarter approximately 3000 locker lease devices under our locker lease program that we initiated earlier in the year with Wal-Mart. Now the total roll out of that will be approximately 1,500 devices and will roll out as we go through the balance of this year and I believe a little bit into early next year. We think it's an excellent program for us long term and we entered into it.

The second one is at our investor day last year we unveiled our outdoor locker. As of today we have approximately 30 outdoor store lockers in place. We expect to have about 50 by September. And while it's not very meaningful from a revenue perspective and it won't be very meaningful from a revenue perspective when I look at 2016 or 2017. It’s a step we're taking in one more means to be a much better supplier to our customers. With that, I'll it over to Sheryl.

Sheryl Lisowski

I will start by providing an overview of our operating and administrative expenses. Regarding employee related expenses we added approximately 800 people to the Fastenal organization in the last 12 months. Approximately 37% of these people were added to a store or some other type of selling location.

During the first half of 2016 our payroll related expenses increased due to the addition of personnel related to the acquisition of Fastener's Inc which occurred in November 2015, and the addition of vending specialists, information, technology, development resources and distribution personnel, and we also experienced an increased in our healthcare cost.

These increases were partially offset by contraction in our performance bonuses and commission and in our profit sharing contribution, primarily due to lower sales growth and due to lower operating income both on a dollar basis and a relative basis. The increase in the second quarter of 2013 when compared to the second quarter of 2015 was driven by the same factors as the six-month period.

Regarding occupancy expenses, the increase in the first half of 2016 when compared to the first half of 2015 was driven by an increase in industrial vending equipment and also an increase in investment in our distribution infrastructure over the last several years primarily related to automation, the largest impact related to the industrial vending equipment.

The increase in the second quarter of 2016 when compared to the second quarter of 2015 was driven by the same factors as the six months period. Selling transportation costs included in operating and administrative expenses increase in the first half of 2016, when compared to the first half of 2015.

This was driven by an increase in the number of vehicles for sales personnel and the timing of leased vehicles sales which was partially offset by a decrease in fuel cost. The increase in the second quarter of 2016 when compared to the second quarter of 2015 was driven by the same factors as the six-month period.

During the second quarter of 2016, we did not repurchase any stock, however in the first quarter of 2016 we purchased 1.6 million shares of our common stock at an average price of $37.15 per share.

We spend approximately $396 million buying back stocks since June 30 of 2014 and we purchased approximately 3.3% of our shares outstanding from the start of this timeframe.

Regarding net capital expenditures, in the first half of 2016 our net capital expenditures expressed in dollars and as a percentage of net earnings were $86 million or 33.3% of net earnings.

We expect our net capital expenditures to be approximately $200 million in 2016 and we plan to fund the portion of our planned capital expenditures with proceeds of our private placement of debt. We expect to close on this funding in late July 2016.

Regarding operational working capital, on a year-over-year basis our inventory grew by $108 million and this growth was driven by the following factors; CSP 16 was approximately 50% of the increase.

Our international inventory growth was approximately 9% of the increase, the acquisition of Fasteners Inc related to 8% of the increase, on-site and large customer impacts which were approximately 14% of the increase.

From a cash flow perspective, our operating cash flow as the percentage of net earnings contracted slight in the first half of 2016 when compared to the first half of 2015 due to our current initiative to add additional products into store inventory under our CSP 16 format. This was partially offset by a reduction in net cash used to fund accounts receivables.

Our first quarter typically has stronger cash flow characteristics due to the timing of tax payments, and this benefit reverses itself in the second, third, and fourth quarters as income tax payments go out in April, June, September, and December. Our free cash flow year to-date for 2016 is 63% of earnings which compares to year to-date 2015 at 66% of earnings.

Last night we announce the Q3 dividend of $0.30 per share. As a takeaway I'd like to share with the group that we have a strong cash flow and we're optimistic about our cash flow potential throughout the year.

And with that, I'll turn it over for questions from the group.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Robert Barry with Susquehanna. Your line is open.

Robert Barry

Hey, guys. Good morning.

Daniel Florness

Good morning, Rob.

Sheryl Lisowski

Good morning.

Robert Barry

Dan, I wondered if you could just provide a little bit more color on June sales, what verticals slowed especially in light the ISM which seems to be showing improving conditions? And I wondered if you would attribute any of the pressure to things that might consider temporary or like these extended shutdowns you mentioned?

Daniel Florness

In the construction front we saw slowdown in our energy customers in both May and June. And a piece of that is we're seeing projects that were still going on from a year ago that just are not being replaced. I would not look at that as a temporary one. On the temporary front we saw quite a few customers that were shut down, I think our largest impact was actually on-site we have where the customer was shut down for three weeks of the month in doing maintenance, but the week of Memorial Day in early June we saw shutdowns, we saw some shutdowns here in the over the week of July 4th and I believe those are – while they are temporary will impact third quarter as well because of the July 4th and I would suspect there'll be some over Labor Day as well.

Robert Barry

Yes. I mean, I know it's probably hard to quantify, but any rough estimate of the extent which these temporary items weighed on June or the quarter?

Daniel Florness

Well, in the case in June I could comfortably say a point – a percentage point of revenue; going beyond that I wouldn't be as comfortable.

Robert Barry

You also mentioned pricing has an impact from deflation, can you dimension that and given steel prices have started to rise how should we think about that potentially becoming a benefit?

Daniel Florness

We were seeing probably more propensity for fastener prices to rise two and three months ago, while there still is – there still are examples of that, some of the propensity had lessened, but I won't – I'm less certain. I think that's probably more of a – we need some traction in the economy to make some of that become a little stickier.

Robert Barry

Yes. So the steel prices rises aren't yet potential tailwind, just not enough or long enough or…?

Daniel Florness

There are not as pronounced. I guess, we were seeing more of that two and three months ago, and while there's still a lot of discussions both on the fasteners and the non-fasteners, I would say its probably less noise from it now than there was two or three months ago.

Robert Barry

Got you. Thank you.

Operator

Our next question comes from Chris Dankert with Longbow Research. Your line is open.

Chris Dankert

Hi. Morning, guys.

Daniel Florness

Good morning.

Chris Dankert

Last call you've been talking about being able to hold the gross margin flat or roughly flat kind of through the rest of the year. Just kind of given what we've seen pricing wise and demand wise, I guess, can you kind of give us some sort of size of what you do expect for the full year now as far as is 49.5 a new - better benchmark now?

Daniel Florness

I don't know that my credibility is real good on that right now, given some of the statements made in the past. What I touched on is we saw about 25 basis point, 25 to 30 basis points drop largely because of a few what I'd consider internal shorter term things that we've decided that we're moving quickly on and decided to do to be honest with you. I felt we had enough momentum of other things in place to match that in short term.

And my comments here are short term centered and short-term being 2016, because longer term our on-site business which runs in the mid 30s will become a -- as we gain traction in there will become a more meaningful piece. And so if you look at now a longer term three to five years I would expect some progression in our gross margin solely because of mix of business.

Chris Dankert

Okay. That's helpful. Thank you. And then I guess, I don't believe I've missed it, but is there any way to quantify these ex-sales impact, you know, sales impact from CSP or some of the on-siting stuff, I know you've given us some decent progress numbers as far as how those have rolled out, but is there any kind of revenue impact you can give us?

Daniel Florness

I plan to do a little more that in the Q3 call only because the last of our CSP convergence were occurring in that early June timeframe, so we really don't have enough time under our belt because there was a lot of activity going on in the first and second quarter and a lot of in the second quarter.

In the case of the on-site, we want to get a little deeper into the year and then do some discussions on the 80 we saw in last year what we've seeing and what we're learning from it. The 92 we've signed in the first six months of this year, what we're seeing, so for the time being I'll hold off on that.

Chris Dankert

All right. Thanks, Dan.

Operator

Our next question comes from David Manthey with Robert W. Baird. Your line is open.

David Manthey

Thank you. Hey, Dan. Good morning.

Daniel Florness

Good morning.

David Manthey

When you think about the growth of the company today and the build up of sort of a secular growth rate, market growth, share gain, vending on-sites, price et cetera, how do you think about the growth of Fastenal as it stands today?

Daniel Florness

You know, give me a timeframe Dave, so I can…

David Manthey

Yes, I'm talking…

Daniel Florness

You're looking at multi – you're looking at kind of a multiyear thing?

David Manthey

Definitely, definitely, I'm talking three to five years, kind of either from here over the next several years?

Daniel Florness

I believe we have – we talked in the November Investor Day about the number of on-site potential, the number of vending potential, and our existing store potential outside of those two, because there's a lot of national – only a third of our national account business today goes through on on-site, two-thirds of it’s outside the on-site. So there's a whole bunch of pieces to growth and I'm not even including in that the impact of international which is now getting to be a meaningful piece of our business, and a piece of our business that grew nicely both from a revenue and a profit perspective in the current quarter.

But if I look at it, let's say over multiyear period we can sign 200, 300 on-sites a year. And if they truly turned into a 1 million to 1.5 million revenue growers as we move forward. A piece of our business would migrate there, but more importantly, that would provide us, I believe five points of growth when we were looking at this three and four and five years out right there. On top of what vending would do and part of the vending I'm double counting, because some of the vending would to that group of customers and then what our store base would do.

I really believe from a – just doing the math and assuming we can, we have the horsepower, because I know the markets there. The horsepower to pull it off, which I believe we have or can add, it’s a business that over a multiyear perspective could grow in low double-digits. Now we need our store piece to execute well on that environment. We need our vending piece to execute well in that environment. But I believe that's achievable. If I'm wrong on the store piece and how much we can add there it would translate that from lower double-digits to an upper single-digit, but I think in either scenario its very attractive and profitable growth.

David Manthey

Right. And then earlier when you were talking about the growth in on-sites and the traction you're getting there and the factors that's coming through at a slightly lower margin, I guess in terms of the contribution margin I think you use to talk about 25% to 30% was a targeted range and when I look over the past five years and periods where you've grown 5% or greater its been about 25%, should we assume that maybe 20% to 25% is a better range given the importance of on-sites in that growth algorithm?

Daniel Florness

It plays into it, yes. And that might not be a bad way to think about it. The one perspective that you know the pathway to profit that's underlying in our business within our store network is still there and so that's store network will continue to see that tick up over time. But if we go from on-sites being 15% -- you know on-sites and customer sites that group we've talked about being mid-teens, 15% of our business and that effectively doubles over six to eight year horizon. It would take a little bit out of our incremental margin, yes.

David Manthey

Okay. All right. Thanks very much Dan.

Operator

Our next question comes from Scott Graham with BMO Capital Markets. Your line is open.

Scott Graham

Hi, good morning, Dan.

Daniel Florness

Good morning.

Scott Graham

Just wondering in the – really the two questions are in the current environment where sales are tough to come by and shareholder value tough as a result. Is there any thought behind accelerating share repurchases in the second half of the year? And my second question relates more to the vending program with respect to Fastener side. Just hoping if you can give us a little bit more color on I think what you said was a minus five in that area for the company?

Daniel Florness

Well, the minus five with the customers that have vending, and that's really a function what their underlying activity is. And the reason I call that out is really want to talk about the market, you know, the market share gains we're seeing in that group, in that there is a world of difference between what our fasteners and our non-fasteners are doing and I look at those as two distinctly different businesses, but its really demonstrating how the growth potential of the latter. And so I'm not sure if I addressed your fasteners side question because fasteners and vending really don't go hand-in-hand, the reason I was talking about it is if the subset of our business with that group of customers that has vending, and I think it’s a pretty good proxy to their underlying activity.

Scott Graham

Right. No, I did understand what you – how you were framing that for us, so I just kind of wondering why at a minus five you would consider that market share gain?

Daniel Florness

No, no, I'm talking about the – the minus five is what is, what I would consider the market with that group of customers that relates to fasteners. The market share gain would be the fact that, that group of customers is growing at close to 3% and their non-fastener business is growing at close to 6%, 5.9% to be exact, that's clearly a market share gain, because that is not a rising tide in that customer.

Scott Graham

I got you.

Daniel Florness

But we're taking market from other people.

Scott Graham

All right. Got you. Okay. And on the share repurchases, is there now stock a little weak today and have been below 45 more than it's been about recently, is that an opportunity?

Daniel Florness

Yes, it is. We have – I believe 1.3 million under our current authorization. I have not had discussions with my board about going deeper than that. However what I found in the past is it’s a board willing to discuss it. And so I don't want to commit the board anything deeper than that, but it’s a case of -- we had a debt free balance sheet two and half, three years ago. The debt we have on the balance sheet has solely been from buying back of shares and our in an environment where we continue to pay dividend at a very similar rate that we paid in the past.

And so we demonstrated willingness to do in the past – in the past, I believe the willingness would exist during the future and I'll couch it with one caveat. We are boringly Midwestern conservative and it took us some discussions to take on the first layer of debt that we did, but we also looked at it from a standpoint from a financial decision. I don't want to say it no-brainer, but it wasn't an easy decision. And I think I would had board that would be open to the conversation, but I've not had that conversation beyond the 1.3 authorization we have right now.

Scott Graham

Okay. And if you don't mind my squeezing one last question here. Is there any update that you can provide us for with on the store openings and closings for the rest of the year?

Daniel Florness

I would say the piece that you've seen in 2015 and 2016 as it relates to store closings. That remains. One of things that I believe its important to our business today is that everyday you rationalize your business with a view towards five to 10 years from now. It’s a health exercise everyday are there markets where I believe we'll have more stores today than we -- five years from now we have to take absolutely, but there are markets where I believe in an environment we are adding on-sites where you are adding vending that our business might morph in certain markets. I'm not ready to you know commit to what that means, but it means that from an absolute number standpoint but from a philosophical perspective we are always looking at what is the best business model, what is the best structure to our channel to grow our business long term.

Scott Graham

Thanks very much.

Operator

Our next question comes from Ryan Merkel with William Blair. Your line is open.

Ryan Merkel

Hey Dan, just want to go back to June, you mentioned construction was a bit slower and that might continue, but the fastener number was pretty weak. And I'm just curious, can you flush that out a little bit, what drove that weakness, is that temporary? And then just comment, you had a pretty weak May and June, is the industrial economy still stabilizing your mind or are things maybe potentially getting a bit worse here?

Daniel Florness

I think they potentially got a little bit worse. And sometimes that's a hard one to gauge Ryan because a lot of our internal information as it relates to some of the plant shutdowns is more anecdotal of talking to our regional VPs around the country and kind of getting from them a feel for what we are seeing or what the impact is, but very much a weakening.

In the case of the construction question you raised, the point I was making there is the fact that we saw it particularly weak with energy customers and I don't know that there is enough, I don't know if the overprice is such that there is a -- that there's going to be a rush back to any kind of new construction there, new activity there I think some will be ideal for a period of time.

In the case of fasteners, again that was very much related, that was amplified by the fact that with some large customers that were shut down and it really hit the radar. And that's what you really see when that shut down occurs it hits the OEM faster, because they are shutting down their production. They are still doing some maintenance, so you might not see it in the non-fastener, but you see it in the fastener number.

Ryan Merkel

It's strange I guess to hear about shutdown in June and then there is going to be yet more shutdowns in July, is this just the…

Daniel Florness

Its different customers. And that June was a spell over the Memorial Day week.

Ryan Merkel

Got you, okay.

Daniel Florness

But it's different customers.

Ryan Merkel

Right, okay. And then I guess on the July commentary you already mentioned that you saw some weakness and shutdowns around the fourth. You know can you just help us I guess qualitatively I know you don't like to talk about the current months, but you know is it going to show up in the July numbers, do we need to consider it for modelling purposes, I guess should we think about normal sequential possibly missing that again in July?

Daniel Florness

The June had some big impacts and so from a sequential perspective I'm not willing to concede that enormous sequential won't be there. I honestly don't know Ryan.

Ryan Merkel

Right.

Daniel Florness

But I'm not -- necessarily willing to concede it because some of the shutdowns which were extended in June they are back in full force now, and so that will give us some lift from June to July and I don't even want to speculate on July fourth week.

Ryan Merkel

Okay, fair enough. I guess just lastly with on-sites do you have enough examples now that you could be pretty confident the store is going to replace the loss sales to on-site?

Daniel Florness

We don't have enough time yet.

Ryan Merkel

Okay.

Daniel Florness

We believe it to be true, history has said it's true but that history is on a relatively small sampling and but its enough that we think its -- if you think of what's really happening is we are taken existing relationship and we are stepping deeper into the business and we have proven history that says we can grow faster with that customer.

Let's say the part about the remaining stores, you have a $100,000 store that we pull a $30,000 customer out of it and it becomes a $70,000 store. I believe based on history a $70,000 store can grow faster than a $100,000 store and I believe with the market presence they already have, they will have the ability to stand back quickly. But that's to say we are completely wrong and that, that 70,000 residual store can't grow any faster.

I think what we are doing with that $30,000 customer is the right decision regardless of the aftermath, but that other 70,000 of business won't be harmed by carving that customer out, it can only be helped.

Ryan Merkel

Right. Okay. Great, thank you.

Operator

Our next question comes from Adam Uhlman with Cleveland Research. Your line is open.

Adam Uhlman

Hi, good morning.

Daniel Florness

Hi, Adam.

Sheryl Lisowski

Good morning.

Adam Uhlman

Hi, I guess the first question is a clarification for Sheryl; you had gone through some of the cost drivers for the quarter between you know employee occupancy and transport. I guess, could you tell us what the year-over-year expense increase was for each of those categories just for the second quarter please?

Sheryl Lisowski

Yes I will. Year-over-year and the employee cost were up about $7 million. Occupancy year-over-year was up about $6 million, transportation expenses year-over-year were up about $1.2 million.

Adam Uhlman

Okay. Thank you. And then back to the gross margin question, you know from earlier historically that the second half has been a bit weaker than what we have seen in the second quarter and you guys have provided some good detail on the inventory write down headwinds that you have in the second quarter. I guess beyond that are there any other items that we should keep in mind as to being perhaps you know tailwind or additional headwinds through gross margin, just for the back half of the year.

Daniel Florness

Well I guess the primary tailwind would be the piece of the activity in the second quarter that I believe is largely left behind us which is about 10 basis points. Short of that it's about what we do is from an execution standpoint and what happens to our fastener business.

Adam Uhlman

Okay, got you. Thanks very much.

Daniel Florness

With that, I see we're at actually 46 minutes past the hour. Again want to thank everybody for taking time this morning to listen to the Fastenal earnings call, and for the vision and perspective portion and I think is important, we will do better. Thank you.

Operator

Thank you ladies and gentlemen. That does conclude today's conference. You may all disconnect and everyone have a great day.

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