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Fastenal Co. (NASDAQ:FAST)

Q4 2007 Earnings Call

January 22, 2008 10:00 am

Executives

Dan Florness – CFO

Will Oberton – CEO, President, Exec. Director

Analysts

Michael Hamilton – RBC Capital Markets

Michael Cox – Piper Jaffray

Holden Lewis – BB&T Capital Markets

Stan Wayne – Lehman Brothers

Brent Rakers - Morgan Keegan

David Manthey – Robert W. Baird

John Ballioti - FTN Midwest Securities

Louie Itoma (ph) - Delta Partners

Operator

Good day everyone and welcome to the Fastenal Company 2007 Annual and Quarter Fourth Earnings Conference Call. Just a reminder, today’s call is being recorded and will be hosted by Mr. Will Oberton, Chief Executive Officer and Mr. Dan Florness, Chief Financial Officer.

(Operator Instructions)

Just as a reminder, certain statements contained in this presentation that are not historical facts are forward-looking statements and are thus, prospectus. These forward-looking statements are subject to risk, uncertainties and other factors which could cause actual results to differ materially from future results, expressed or implied by such forward-looking statements. More information regarding such risks can be found in Fastenal’s Quarterly and Annual SEC filings.

At this time, I would like to turn the conference over to Mr. Will Oberton. Please go ahead sir.

Will Oberton

This quarter was positive for Fastenal in almost every respect. Our sales improvement over the third quarter by over 2 percentage points from 13.5% to 15.7%, but what was most encouraging for me was the sequential growth 14, 15, 16 as the quarter marched on, and we did that in a pretty tough economic environment. Looking out into this quarter, for the first 14 days of January, our growth was on track with the fourth quarter numbers, so we are feeling pretty confident that we are executing at a high level taking it a day at a time with the economy, but we are actually very optimistic with how things are going right now.

Our earnings growth was really driven by two different areas, one is the gross margin. On a year-over-year basis, our gross margin was up just over 1% from 49.9% to 51%. We also did a nice job in our expense control. One of the biggest areas of expense control that we worked very hard on was controlling the growth in our support labor and on a headcount basis that was up less than 5% year-over-year.

On the margin, that was really driven by really just hard work, not a lot of price increases, not a lot of inflation, it was really just looking at everything we do and finding a little bit here and a little bit there, but we are comfortable. It is very close, we are comfortable that going forward, we will be able to maintain more in that 51% range where we are now with the initiatives that we have going.

On the expense side, we have that tremendous pressure on energy, not only the vehicle field, but utilities are up sharply also over last year, but as I said, we got some help on the support labor and a high grade problem on the expense side is that our bonuses and our 401K match were up because of the improved performance in our fourth quarter earnings growth up at 26%.

We are making very good progress on our initiatives to develop Fastenal as the best distributor of industrial products in North America and when I say that, what I mean is the entire system from purchasing, distribution, moving the products to the store and placing more products closer to more customers than anyone else in our industry that is our goal.

The two big initiatives that we have been talking about other than the pathway to profit are really the Indianapolis inventory expansion project which has gone very well in the second half, actually it has gone well throughout 2007, but we have made nice progress in the second half of 2007.

Our fulfillment levels have improved. We have broadened the inventory. It matches our current catalogs that we are putting out in February or in March, so we have really made tremendous improvements and talking to people in the field, we are getting very, very positive feedback from the people in the field about our ability to fulfill their orders on time and accurately.

The project that we have worked hard on is the transportation initiative and we really made progress there in two different areas, one is we are speeding up the delivery times to our stores. Looking at the calendar, looking at the days of the week and trying to look at how we can get places quicker by using the weekends, but using nights, by pulling product more quickly so we can move product to our stores on our system instead of using outside carriers like UPS and FedEx, which we continue to use, but continue to lower that cost.

The other area that we continue to see improvement is the expense side. We have lowered our transportation costs as a percentage of sales again in the fourth quarter and that is in a time when fuel costs are at record highs, so I have to commend the people that worked on this as far as our transportation group because they are really working hard to lower our transportation cost and we are not backing off and letting them lower the service. We are improving service and lowering cost at the same time.

But going forward into 2008, I think we still have a lot of opportunity to not only improve our cost for transportation into the New Year.

A little bit of an update on our pathway to profit to progress, halfway to profit is what I was trying to say, the things that we have stated, we are going to look at and just to cover that a little bit, this is the plan. It is to lower our store openings from 15% to 8% and then take the savings that we have from the lower store openings and reinvest that in outside sales people for those of you that are not as familiar with our project.

The things that we are looking at are our average store size. Our plan is to grow the average store size to increase the profitability. Our average store size fourth quarter-over-fourth quarter ’07-‘07 grew by just over 7%, so now the average store size in the fourth quarter was just over $80,000.00.

Our profit per store, one of our biggest measures grew by 17% profit contribution per store unit and at $42,800.00 per store, so that is a very nice improvement, year over year.

Pre-tax profit percent is the one thing that we talk a lot about. In our stated goal back in April when we rolled this out to the investment community was to see a 1 percentage point improvement year-over-year. This quarter, we actually were able to improve by 1.4% year-over-year so we actually exceeded our goal nicely in our pathway to profit, and we did that with lower revenue growth and we had anticipated way back when we planned this back early in the year. So with higher revenue growth, we could have actually even seen more improvement.

The big part of our plan or the most challenging part of rolling out this plan is developing our outside sales process and really taking a strong approach of developing a process to grow sales, the tools, the people, the systems, the measurements, all of the things that we are doing and I think we are making very, very good progress in these projects. The hand-held computers are working well. The zoning software that we showed at our industrial conference back in April is really starting to work well. The opportunity last week, I was in California and visited 11 stores and talked to managers in every store about this and it was all very positive. The systems are starting to fall in place for our sales people to be more productive, and on the average, they are telling me that their sales people are staying out between one and one and a half hours a day longer because they do not have to come back and download orders because it is being done electronically.

But that being said, I believe we still have a lot of opportunity going forward to improve the process because we are really just getting started on the pathway to profit.

And although these results are very early, we have only been doing this for about six months, I think the most positive improvement that we see is the improvement in our five-year and older store growth. That has gone up from 6% in October to just about 10% in December, I think it was 9.6% and so that is a very nice improvement and the only thing I can attribute that to is the improvement in our sales process because it does not appear that the economy has improved over that time, and those are the oldest stores that are always subjected to the most pressure from a slow economic time.

I think with that, I will turn it over to Dan and then we will come back for Q&A.

Dan Florness

Will covered in good detail items related to sales growth and margin, I am going to touch on a few things related to SG&A and in one item that I will touch on that was talked about in previous quarters, and that is related to the pathway to profit, really looking at it and saying for much of calendar 2007, the pathway to profit from an operating expense standpoint from an operating margin standpoint was the net negative because the store openings that we were not doing in 2007 were very late in the year and will really benefit more into ’08 and the people we are adding, we started adding in the May and June timeframe at a high pace, so we are adding the SG&A to our expenses.

I am pleased to say that the acceleration in top line has really allowed us to, as Will mentioned, realize operating margin benefit from the pathway to profit in the latter quarter of 2007 and I think positions as well going in 2008. Specifically within SG&A, some things I would like to touch on; our payroll grew in the fourth quarter on an absolute dollar basis greater than I would have expected and what really drove that is some things that are a good problem that is our commissions came in higher, because of the added sales growth and our bonus payout came in higher. Usually most of the leadership within Fastenal takes the pay cut in the fourth quarter because of the compression of our operating margin.

We were able to pay out very attractive bonuses this quarter because of the strong performance. Third, our profit sharing contribution, for the year, that number is up about $1.7 million over last year, between $500,000.00 and $600,000.00 of that increase occurred in the fourth quarter, so a nice position to be in where we can report a very strong quarter and also reward our folks internally at the same time.

We have talked a bit about occupancy and with changing the pathway to profit, changing the store openings from the mid-teens to the upper single digit neighborhood, in the fourth quarter as we cited in our press release, occupancy expenses grew about 16.4% contrasting that with first quarter of about 28.5%. And what we have seen over the last several years, occupancy has been growing somewhere in the low 30% neighborhood. Our goal going to next year is for that number to be somewhere in approximately 10% growth for the year and really predicated on the fact, we are opening about 8% new stores and being very, very conscious of managing the occupancy expense in the remaining existing group of stores.

The other item within SG&A, some things that I had touched on, as Will mentioned on energy prices, impacted us and so I am pleased to say that 16.4% occupancy growth came in a quarter with meaningful increases in utilities.

On the fuel going into our vehicles, a couple of numbers I would cite, in the month of December, our gasoline going into our fleet of vehicles at our stores, averaged $3.00 a gallon, a 32% increase over last year. In Q4 for the entire quarter, it was about $2.93 a gallon, an increase of 30%. Diesel, $3.37 a gallon in the month of December, $3.25 a gallon in the fourth quarter of upper 20% neighborhood in the fuel cost, so we are able to leverage that into our organization very attractively because of continued improvements in our distribution management.

One item on the P&L I would touch on just to save myself two questions later on, going through all the static that occurs because of the discrete events that can occur in a $10.48 environment, we believer our core booking rate was about 38.2% for the year and would expect that on a go forward basis as well.

Finally, on working capital, I will touch on it very briefly so we can turn over to Q&A.

I am very pleased with our cash flow statement for the year, as most of you are aware, I personally, as well as the organization, we are frustrated with the operating cash flow performance in 2006. Our operating cash flow as a percentage of net earnings for the year came in at just shy of $0.50 on the dollar, so for every dollar of earnings generated, is just over $0.49 cents of operating cash flow and generated about $0.12 of free cash flow.

Those numbers have changed quite dramatically in 2007. Our operating cash flow as percentage of earnings came in at $0.98 on a dollar. Even stronger than I would have expected coming into the year, and the goals we laid out last April of targeting a consistent $0.85 on the dollar number on a go forward basis, we believe it is still very much in the cards and expect to perform at that level.

The free cash flow during the year came in at about $0.77 on a dollar of earnings, and looking at that figure for the last decade, ignoring this year, we have only had two years in the last decade where our free cash flow was greater than $0.50 on a dollar of earnings, and one of those years was a year we sold off a business unit and it was the year we were very, very conscious with our inventory, but consistently, we were not able to do that, very pleased with the free cash management in the current year and feel there is still improvements in the cards for our accounts receivable and inventory on a go-forward basis to drive our operating cash flow.

The improvements we have made with distribution and with our master hub in Indianapolis really provide us opportunities for inventory management that frankly did not exist, one, two and three years ago.

With that, I would turn it back to the moderator to open it up for Q&A.

Question and Answer Session

Operator

(Operator Instructions)

Our first question comes from Mike Hamilton with RBC.

Michael Hamilton – RBC Capital Markets

I was wondering if you could just kind of hit at a high level where you see the pathway to profit’s initiatives evolving here as we roll into 2008 if you are coming up with any areas that you think either needs more focus that you are pulling back on?

Will Oberton

On the initiative, we need to continue to focus very strongly on the outside sales development as I had mentioned because there is really nothing glaring in it at all and there is nothing we plan to pull back on. Right now, we plan to continue with our 8% store openings. Our hiring will really be dependent on how our sales growth rolls out over the next, one month at a time and we can control that very well, so our store openings will be on track. If sales were to pick up, we would probably increase our hiring, but again, we will stay with that because we want to maintain the 1% improvement in our operating profit, one percentage point improvement in the operating profit line.

Michael Hamilton – RBC Capital Markets

How is your Asian sourcing playing into that at this stage?

Will Oberton

Our Asian sourcing is really a separate initiative. Our Asian sourcing is actually going very well. We continue to improve the things we do over there. In the last year, we opened two laboratories, one in Taiwan and one in Shanghai so we can speed up the sourcing before a lot of that product had to be shipped over here for quality checking and it was a little slower, so we invested heavily in putting the two labs and having them certified A to LA-accredited and we have tremendous upside with our sourcing operation.

Right now, we are sourcing just over 20% of the product. Based on the product mix, we there is potential to source 40% direct, but that will take us years to achieve that level.

Operator

Our next question will come from Piper Jaffray, Michael Cox.

Michael Cox – Piper Jaffray

I was hoping you could touch a little bit on the sales productivity of the new sales associates. I guess, I am a little surprised by the pace of acceleration in sales that you experienced in the fourth quarter. I was hoping you could maybe just talk a little bit about how the productivity of these new sales associates compare to existing sales reps and the ability to move them up the curve?

Will Oberton

What we are actually finding is the new sales rep, well, there is a wide range, some of the new reps come in and they come in at a very high level. What we need to do, our real opportunity is improving the bottom probably a third of the group and we still have not figured out if it is training, if it is just we hired the wrong people. It is leadership, and that is what our sales development group, we have a team that we put together. It is new for Fastenal since June that they are working on trying to go through all the information and really determine why some are growing so well and some are just not performing at the same level, the question I guess that all sales managers face.

On the whole, our productivity is right about where we thought it should be, but the range is much wider than we thought it would be. The good ones are really well above and the ones in the bottom, we have a lot of improvement to make. Does that help?

Michael Cox – Piper Jaffray

Yes, it does and if I can ask one follow up, as you look at working capital and the 3:1 ratio that you have talked about for some time now, I am curious as to what sort of timeframe we should expecting reaching or attaining that goal. Obviously, you are shooting for a sooner rather than later but, what would be a realistic expectation? Is it 2008 or perhaps ’09?

Will Oberton

I believe in 2008, it is achievable. I think it is probably going to be 2009, but because I do not want to pain ourselves into a corner. The wild card when I go into 2008 that will challenge that is, there is going to be a decrease in the inventory number and so that is going to create a challenge, but when I look at the operating cash flow, then that relative to our earnings number, I feel very comfortable on our ability to perform strongly on that in 2008 and going forward and feel we are in a great position to ramping up that in the next two years.

Operator

And our next question will come from Holden Lewis with BB&T.

Holden Lewis – BB&T Capital Markets

Just comment a little bit about the sort of the revenue trends that you are seeing out there and I guess in a broader sense, you said before that you thought the biggest mistake you made in the last down turn was to slow your store openings. If in fact there is a tough environment out there somewhere, you had made comment about sort of watching your sales personnel pretty closely, but I mean just sort of point through with the same sort of strategy by the weekends or strengthen, how we should sort of view, you are looking at your cost structure in an environment that is some what not certain.

Dan Florness

First of, going back in time, I think what we have talked about in the past is back in the ’98 timeframe when the Asian flu came through and things really slowed down. We have slowed our store openings, but more explicitly, we slowed our investment in selling energy and in the 2001 timeframe, we chose not to do that. We maintained a very high level of investment in our sales initiatives, which at that point in time, we have the ’98 and was centered very much on new store openings and the only change in 2002 that you saw; it was supplemented by our CSP project.

When I look at today’s world, we have really taken our sales investment dollars or sales investment energy and split it, investments in new store openings and investment in additional outside sales people at the store level. I really would anticipate that our new store openings will come into play very much as we are talking about them today in that 7% to 10% range, kind of zeroing in probably on an 8%, and our investment and outside sales people, as we have mentioned in last quarter’s call will be continuing at a very high pace and be influenced within a range of the higher low-end of our range in that upper teens neighborhood really based on with our top line we are seeing and as Will mentioned, we can influence that in a relatively short timeframe to the upper lower end of that scale.

Will Oberton

One of the other positives that we are seeing out of the outside sales program is that the sales generated by the outside sales people calling at smaller accounts, the margins are running at three to four points over the company average, so if that is the growth that fuels or that drives our growth, we have some upside on the margin to help pay for these program too. There are the huge customers with that group, the small more traditional Fastenal customer.

Holden Lewis – BB&T Capital Markets

Obviously, if you can continue to grow at this level, you start spinning off a fair amount of profitability and leverage and that type of thing, are there other areas that given that increasing profit and cash flow that you would want to invest in, I guess, specifically, are the management ranks kind of where you want them or do you want to add managers, reduce maybe the size of the geographies that they cover, anything of that sort that would go hand in hand with this now that it is beginning to kick in?

Will Oberton

I do not know if it goes hand in hand with that, but we have made a decision in the fourth quarter to try and reduce the average number of stores per District Manager. The District Manager, the field leaders and the store managers report to, and that number had been growing and the average number of stores have been growing and we made a very conscious effort with Nick Lundquist and Leland Hein going district by district and bringing that back, but we have already put those people in place and we have basically paid for them by taking savings in other areas, mainly support labor, so it was not a greater investment overall, it was just a greater investment in leading our troops in the field.

We believe that ten is a good average number for the number of stores per DM, now that is going to range from 6 to 15 more than likely.

Holden Lewis – BB&T Capital Markets

And you are sort of at 10 now. That process of putting more people in place is complete?

Will Oberton

We should be right at ten. 11.5, so we will see a few more.

Holden Lewis – BB&T Capital Markets

Now, did most of those get out in the fourth quarter or was that cost largely borne in the fourth quarter, therefore it is kind of in there?

Will Oberton

It was added in the third and fourth quarter, so almost all of it is in there.

Operator

Our next question will come from Lehman Brothers, Stan Wayne.

Stan Wayne – Lehman Brothers

Just a question that was regarding your comment about the first 14 days of January, you saw trends that are similar to Q4. I think January probably has slightly more favorable comps, but could you talk about kind of the core trends out there and perhaps some of the end market trends that you are seeing?

Will Oberton

The end market trends we are seeing right now are very similar to the fourth quarter. Now, we will have to qualify that within the last few weeks, I have not been with many customers, I have been out in several of our stores and I am getting positive reports, but I have not spoken to a lot of customers. The larger accounts I think, you put out the key account numbers.

Our large accounts grew at just over 13% in the fourth quarter that is tracking in line. Some of the major changes were there, but we are really seeing nice growth from these small to medium sized accounts and that is being driven by our ability to distribute product on time and accurately and solve problems and that we are just making more sales calls. We are really out there hitting and pounding on the doors harder and for the first fourteen days, January is a little easier than December, but we are really looking at the October to January.

As a company, we have always looked at our October to January growth because historically, I believe we are at 1.5%. The daily average in January would be 1.5% over the daily average in October, and that is the trend line that we are seeing right now through the 14 days in the month. So it is more of a different view than year-over-year, does that make sense?

Stan Wayne – Lehman Brothers

Yes, it does. And just going back to the December sale, I think that was the result of December was better than what most of us had anticipated, you talked about that you think part of that acceleration in daily sales growth rate in the fourth quarter versus third quarter came from the pathway to profit starting to contribute, is there any way to quantify like what would have daily sales been without the benefits in pathway to profit in December.

Will Oberton

We really do not know that because it is fast and we would have opened another 140 stores and they would have contributed to it, so you would really have to dissect it. I will go back to what I said in my earlier comments. If you look at the growth in our five-plus stores, the way it grew sequentially month to month and I have put my sheet back out here, 6.3, 7.9, 9.6, I think we are beating the economy there. We are outperforming what the market is giving us and these are the stores that what really dropped to bottom line is that the big stores are growing and they are the most profitable stores or what the bottom line is what I meant to say.

Dan Florness

But we are very reluctant to try to pull the pieces out because that is who we are today. We are a company opening 8% more stores and adding sales people.

Stan Wayne – Lehman Brothers

Pathway to profit is a monthly thing, so you think you will start calling it PTP in line with the whole CST?

Will Oberton

Who knows.

Dan Florness

There are too many acronyms.

Will Oberton

It is just a world of acronyms.

Operator

And our next question will come from Morgan Keegan, Brent Rakers.

Brent Rakers - Morgan Keegan

Dan, earlier, I think in your comments, you talked a little bit about the payroll numbers coming in I think higher than you expected and commissioned and again, I guess driven by the better revenues, I was wondering if you could maybe put some firmer numbers on those?

Dan Florness

I do not have real firm numbers that is right on my fingertips, but I can tell you this, the commission numbers and the percentage of sales were consistent. It was more of common on the absolute dollar, it came in higher because our sales came in better than I expected. We were very pleased with December’s results.

Will Oberton

The increase in dollars between the third quarter and the fourth quarter can all be attributed to the 401K match increase and the profit bonus because the way our 401K match works is that we have to exceed 16% operating profit, our pre-tax profit before it kicks in and last year, I believe we were at 16.4% pre-tax and so we are just barely there, but once it goes up, and so it is a very positive increase because it is a very positive problem because it is coming back to benefit our employees.

Brent Rakers - Morgan Keegan

Dan and Will, if the FTE numbers in the quarter, I think we are up about 14.5% year over year, do you think the total payroll number is about in line with that or a little above that or?

Dan Florness

Well, ignoring the profit piece that Will was touching on and the profit sharing piece that will was touching on, our payroll growth on an FTE growth, it was actually 14.1% for the month of December, it would trail that.

The new folks coming in are early in their career and so they are not adding it at an equal weighted basis.

Brent Rakers - Morgan Keegan

And then last question, I think in the press release you just briefly mentioned a comment about the general insurance cost? Could you maybe elaborate on that?

Dan Florness

In calendar of 2006, the big driver in our general insurance really centers on three things. The Workers Compensation portion, the vehicle fleet and our vehicle fleet that is split into two pieces, our semis as well as our store delivery vehicles, on the semi side of the equation, we had from a trend’s standpoint, a very safe year. We had very good results from the standpoint of occurrences of any kind of accidents et cetera and so that was trending quite nicely.

Workers Compensation, sometimes what you see when the economy weakens is Workers Compensation expenses going up. We did not see that. And then the third and final piece which I consider a real plus, if you can appreciate this, now that I am 44 years old, I am getting on the other end of the spectrum, I am 44 years old with four children. I am on the other end of the spectrum when it comes to driving, but when I was in my 20s, I was not quite as safe a driver as I am today.

We have a lot of folks in our organization, young people driving our vehicles everyday and our frequency of accidents is improving on a year over year basis. Despite the fact, we have added all these outside sales people and each have a vehicle they are driving, and so it improved our trend and it improved from what I would have expected in the fourth quarter and in the third and I believe puts us in a nice position going into the next year.

Will Oberton

Part of the frequency, we have made a real conscious effort to try and do better background checks on our new employees. They actually have to get a Fastenal driver’s license to drive our vehicles where we check little things that make a big difference in the end.

Operator

Our next question will come from David Manthey with Robert W. Baird.

David Manthey – Robert W. Baird

Gross profit margins solidly at 51% throughout ’07 and Will, I think you mentioned smaller customer size as you roll out pathway to profit here, could you discuss in 2008 what you see the impact from the China value-added tax and then overall, I believe Will, you mentioned that you thought you could sustain a 51%, could you just give us an idea what the put and takes are there and what your level of confidence is even if the demand environment slows somewhat?

Will Oberton

If you look at our numbers historically, Dave, our margin has not dropped in recessionary times. If you go back to 2001 or go back to the early ‘90s, we have always been able to maintain our gross margin through slower times. Part of it is, it normally slows down first in a smaller cost pickup because there is more maintenance and repair and less building. So that is good for our business from a margin standpoint.

As far as the Chinese value-added tax, the positive about that is that it is across the board. It is not a selective thing like someone buys better than another company and so that should not pass through the market, and the other positive on that is that it is going into only about half of our importing comes out of China, so it affects the fasteners and so it is a small group, a smaller part of our inventory and we have been able to pass it along so far. It really came in in July so you have seen six months of that increase and still had been able to maintain our margins.

At the same time, we continue to resource products to help that out. Everyday we are looking for new lines, high quality product lines that we can bring in to soften some of the pressure from other areas like the value-added tax.

The outside sales people are calling in smaller customers, that benefits yet our margin, I think that is more of a go forward, and it is what I meant to indicate there that it is an opportunity as we grow the business, and we are very, very focused on the margin, maybe a little more than we were one or two years ago. We have always been focused on it. We are working on it.

Dan Florness

To put some color to it, we will talk about the numbers to put. The only pull that we will be challenged with and we were challenged with this in the fourth quarter is what fuel pricing does, but I think we are executing well against that.

Will Oberton

I think we still have opportunity to improve the margin through transportation even in this economy with the high fuel prices.

Operator

Our next question will come from John Ballioti with FTN Midwest Securities

John Ballioti - FTN Midwest Securities

I was wondering if we could talk about free cash flow. You pointed out that that improved significantly over last year and I was just curious and you also discussed focusing on inventory turns, of the three working capital components on your balance sheet, and maybe Will or Dan, do you have an idea or some sort of a target as to where you think that might be by ’08, back towards 2.2, how do you look at that because obviously that would swing that combined ratio you look at the fastest?

Dan Florness

I will touch on that. As we stated last spring and the couple of conference calls, really our goal is over the next several years is to move that closer to a hundred and fifty days of inventory on hand versus the closer to 170 that we have been running at and the only reason I am a little bit cautious on, I am making a real strong statement on next year is the impact of some of the inflation in our products, but this year, we grew it just over 10%. I think that is a very attractive place for us to be. I would like us to be in a single digit number next year, and our question is in making the investments we want to make with new stores with our ala carte inventory with specific inventory and our distribution base and also driving our direct sourcing, doing those four things and still growing our inventory at less than 10% in calendar ’08.

John Ballioti - FTN Midwest Securities

The other component of your free cash is you had a nice, I do not know how you want to characterize it, maybe more efficient use of CapEx, historically, it has been a little bit above 4% over these last couple of years and this year, it looks like it declined to just under 3 as a percent of sales, is that something that is more of a normalized basis now that you would think about for the next couple of years?

Dan Florness

The CapEx number that came in less than I would have expected this year and probably the biggest driver of that is our distribution center that we are building in Dallas was delayed in the middle of the year because of weather considerations. It was pretty wet down in the area where we are building and the construction was delayed, and so that number came in less than I would have expected that CapEx came in about $50 million, the year before that, it was about $73 million.

When I looked at the next two years, we have the projects going on in Dallas as well as project going on at our Indianapolis facility with both expansion of the building and installing an ASRS system at both of those locations. And so our CapEx will be in the $70 million to $80 million range, net CapEx when I look at 2008 and probably in that similar range in 2009 and then I think it tapers off a little bit.

Operator

Our final question will come from Louie Itoma (ph) with Delta Partners.

Louie Itoma - Delta Partners

I guess what I wanted to try to understand, and I know you said that the trends of January are positive, but just looking at the business and the context of the numbers that we have seen recently with the numbers, and if you go back to the last time we had economic downturn, your stores that were over five years old were down I think 10% in 2000 and around the same in ’01, so if you could help me understand how you guys look at that in terms of if you do enter another type of environment similar to that. Is that kind of a downside to your mature stores or are the initiatives that you are doing are enough to offset that?

Dan Florness

I will comment on that, when you look back to the 2001 timeframe, for the year, I do not have the numbers in front of me, I am going by memory here so excuse me if I am off a little bit, I believe we contracted about 2.5%. The worst month, which was I believe November – October of ’01, we were down about 10% to 11% in that group of stores. The weak environment becomes very challenging for our five-plus year old stores because they have a meaningful market share in the local market and it is a customer basis spending less. They are really finding a head win.

As far as our investments now, once they do encounter that, Will touched on it earlier in the call and we probably should say it about five or ten times out loud because I think it is such a huge statement. Our five-plus year old store, December I think is a tough environment and our five-plus year old stores did not just hold ground, they improved and historically the number I have always cited looking at our data for the last 20 years is our five-plus year old stores. When they are growing in the low double digits that is 10% to 13% neighborhood that is usually a sign of good economy.

That is usually a sign that we are executing well. We have a strong economy and things are going well. The executing well part I think is occurring, when I look at the fourth quarter particularly in December and so I think that puts us very good position for a weekend environment to be able to grow and move the needle on our operating margins. We will start that in the pathway to profit, even in a tough environment.

Will Oberton

I think one difference that you go back to 2000 and 2001, is we were going in a very strong environment and it really just almost like we fell off the edge. We believe 2007, the entire year was slow looking at our customer activity and the fourth quarter was probably the slowest part of the year, so it may slow down more, time will tell, but I do not think it is going to drop like it did, the drop will be slower or less severe is what we are predicting. We will see as the numbers come in.

Operator

And at this time, there appears to be no further questions in the queue.

Will Oberton

Thank you.

Dan Florness

Thanks everybody again for listening to our call today.

Operator

That does end the conference today. We would like to thank everyone for your participation and have a wonderful day.

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Source: Fastenal Co. Q4 2007 Earnings Call Transcript
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