Below is the transcript of the Fastenal Company (NASDAQ:FAST)‘s Q4 and FY2014 Earnings Results conference call, held on Thursday, January 15, 2015 at 10:00 am EST.
Over the past 47 years, Fastenal Company (NASDAQ:FAST) has grown from a small-town Fastenal shop, to a thriving regional business, to North America’s largest Fastenal distributor, to the world’s most efficient supplier of OEM, MRO, and construction products. Along the way, they’ve never wavered in their belief that great service starts with being close to their customers, which is why today they operate nearly 2,700 stores spanning all 50 states and 20-plus nations.
Company Representatives:
Leland J. Hein – President & Chief Executive Officer
Daniel L. Florness – Chief Financial Officer
Willard D. Oberton – Chairman of the Board
Analysts:
Adam Omen – Cleve and research
John Milani – John Capital Market
Wanda Clark – UBS
Garden Peter – Lambo Security
William Blair
Raymond Jane
David Mandy
Operator
Good day, ladies and gentlemen and welcome to the Fastenal company Q4 and fiscal year 2014 earning result conference call. At this time, our participants are in a listen only mode. Later, we’ll continue a question and answer session & instructions will follow at that time. If anyone should require assistance during the conference, then please press star then 0 on your touchstone telephones to reach an operator. As, a reminder this conference call is being recorded. I’m going to introduce you to your host or today’s conference and trustee of investor relations. Please go ahead
Host
Welcome to the Fastenal company 2014 annual fourth quarter earnings conference call. This call will be hosted by Leland J. Hein – President & CEO Hein, our president and CEO and Daniel L. Florness our chief financial officer. Also present for our call today Will Overton, our chairman. The call will last for upto 45 minutes. The call will start with a general overview of our quarterly results and operations with Leland J. Hein – President & CEO and Dan, with remainder of the time being open for questions and answers. Today’s conference call is a preparatory Fastenal presentation and is being recorded by Fastenal. No recording reproduction transmission or distribution of today’s call is permitted without Fastenals consent. This call is being audio simulcast on the internet via the Fastenal investor relations homepage and vested at Fastenal.com.
Our replay of the webcast will be available on the website until March 1st 2015, at midnight central time. As, a reminder today’s conference call includes statement regarding the company’s anticipated financial and operating results as well as other forward looking statements based on current expectations, as defined by the private security litigation reform act of 1995. Forward looking statements may also be identified with words such as we expect, we anticipate, upcoming or similar indications of future expectations.
It’s important to now that the company’s 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 as the security in 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’s no assurance that the matter contains and such statements will occur. Forward looking statements are made as if for today’s day only and we undertake no duty to update the information provided on this call. I would now like to turn the call over to Mr.Leland J. Hein – President & CEO Hein.
Leland J. Hein – President & CEO
Thanks Ellen, Good morning. Before, I start I’d like to just say thank you to the Fastenal members on the call. I know there’s a lot of you that tuned into this. And we’re so appreciative of the work that you did in the fourth quarter. So just a great job and I’d like to report that it was a good quarter for our company. 13.8% sales growth that’s 15-7 on the daily average and there will be some questions I’m sure on Christmas. And December was in line with the rest of the quarter. We just felt that it was the right thing to do to take the 26th off. 20.1% on earnings growth and that equated to 28% incremental margin growth which again these are strong numbers for our company and, how we got there really was we continued to work hard on our gross margin, but in this quarter we really focused our attention on our expenses and the Fastenal company and the members, I gotta tell you really did a nice job looking at all different types of expenses and we really clamped down.
And one thing that really came on is our ability to manage our labor. Historically, our daily average is going to decline somewhere around 10% from the end of October to the end of the year. We know that, and what we simply did is we turned down the hours and pulled back the hours and we looked at the timing of thanks giving, Christmas etc, and just with the natural decline in our daily average. But, we continue to add people at the company except in the part time ranks. And I’d say in 2015 with a good economy we are committed to putting selling energy in our stores. And I just again when we talk internally, we are committed to a store based model, we are committed to the fact, that we really believe being close to our customers offering a high level of service is… really the best way to really approach the industrial market.
The other question, we get is you know, if you’re gonna add 10-15% more hours in the store can you really afford it? That really equates to about 7% net effect on the labor dollar impact and so, It’s a good model for us. It really holds well for our stores and for most importantly our customers. So, strong quarter, we continue to stay disciplined on the gross margin and there’s pressure there but we really like the momentum and the direction we’re moving with that. I’ll turn it over to Dan.
Daniel L. Florness – Chief Financial Officer
Thank you Leland J. Hein – President & CEO, and Good morning everybody and thanks again for participating in our call today. I think our press release is self-explanatory on the quarter. We’ve probably smuffed, the numbers I think as we touched on our sales transit remains strong throughout the quarter, endeavored well as we go into 2015. I tried to highlight on the bottom page 1 titled page 2 a handful of bullets of things that I think were important to the business, and you know what I wanted some of this commentary is based on questions that I might get, and so you know I did wanna touch on the head count patterns as we were going through the fourth quarter, specially at the store level as we talked in the past about the investment and selling energy and adding hours, the one position we were in this year that we really weren’t in last year is we are in a position that much more acutely managed the expense because we weren’t in a ramp up mode, we were in a manage the business mode and so, we did a much better job in managing our expenses, as we went into the fourth quarter, we were able to dial up and down the variable components of our expense, a big piece of that being store based labor, to really match the needs of the business and really the needs of the customer to serve the customer.
One item that I typically touch on or get questions on is the table we have on passage way of profit. I think it’s a good way to assess some of the underlying things going on our business. One of the things that is helpful is to appreciate how we look at our business. One thing that we do is we’re an organization that rewards our personnel internally whether that be people at the store, at the district level, distribution center or some other support roles. We reward folks on our ability to grow the business. We reward more fore for growth sales then we do for maintenance sales, that’s an example.
We reward for managing and containing the costs of our business and growing the profits of the business. So, these are the three things really critical when we look at how we compensate and so, one thing to keep in mind when we look at that pathway to profit table over the three years, I would look at different buckets and in my childhood always look at 150,000 plus store or I look at the last two groups combined, it helps me understand what’s really going on in the business, and I’m pleased to say when I look at 2014, I look at that group the level of profitability, the components of the profitability make a lot of sense to me and position us well to go forward. One thing, you will notice is the profit in that group slipped slightly from a year ago. Now ,we’re largely beyond the noise we’ve had in the past months so, what’s going on with growth margins in over a year so, it’s really about how are we managing the expenses of the business, investing to grow the business.
When I look at that slight leakage, what really drove it is the decision we made to a year ago to dramatically expand our district and regional leadership. We went from roughly 230 district managers to shy of 300. We expanded the key accounts teams, we expanded our ability to manage the business and grow the business, and everything that happened, if you look at the business this year as Leland J. Hein- President & CEO just mentioned we grew a 20.1 percent. Our top line a 15.7 on daily while 14 percent on absolute basis. A year ago those numbers were 9 percent pre tax growth and about 7 and a half percent sales growth. So what the other component of our P and L that changed dramatically is folks at the district level, folks at the regional level, our teams throughout the organization were paid a premium to grow our earnings.
Bonuses and store compensation were up meaning this from a year ago. So, when I looked at that we picked up about 70 bases points of expense because of the fact we’re not growing earnings in 20 percent versus 9, I don’t want to get too deep in the weeds here, but despite that 70 basis points our profitability in that group only went down 20. The other 50 pathway to profit leverage, which only did we improve the profitability of the organization because the mix changed, but the underlying health of the business improved and where we did get deterioration it’s because of the investments we made, A and the way our incentive compensation was B, and I think that’s a winning combination. What is with that again, our press release I think gives most people more details about the world within Fastenal. With that I’ll stop and well if you have anything you wanna add let’s all turn over to Q & A.
Operator
Ladies and Gentlemen at this time please press star and then the number one key on your touchstone telephone. If your question has been answered or you wish to remove yourself from the que please press the power key. In the interest of time, we’ll ask that you please lend yourself to one question and one follow up question. Our first question comes from Raymond Jane. Your line is open.
Raymond Jane
Good morning Leland J. Hein – President & CEO, Dan, Will. How are ? Very nice quartet with respect to expense control. First question, the spread between vending customers and non-vending customers in terms of the growth rates, continues to moderate. How should we look at that? I’m concerned obvious to the reflection of the maturation of the initiative but there’s gotta be some other factors and components driving the contraction of the spread.
Daniel L. Florness – Chief Financial Officer
Well, I think it’s really a function. If you look at the growth of the customers for the vending. You know they’ve been in a neighborhood of representing about 40% of our sales for that group of customers. Inches up a little every quarter but it’s been in upper 30s now, it’s approaching 40. The growth has been basically a 20% all year. I would say that the moderation of spread is really about the fact that the other 60% of our business, investments we made at the people at the store and at the district level. The rest of the business has lifted itself up. It isn’t so much. The gap has narrowed. It’s the performance of the other 60 that’s improved and it’s raised our company number. Because we’ve been basically at 20% growth in that group through the entire year.
Leland J. Hein – President & CEO
And part of that is that a little bit research in the Fastenal business. But like a year ago, The Fastenal business was almost seeing no growth at all. Bringing that growth back was basically does not come back through vending. It’s not vending business. It changes the mix a little bit but we’re business
Daniel L. Florness – Chief Financial Officer
And that business is about half of the sixty that isn’t vending.
Leland J. Hein – President & CEO
Yeah and that really influences the gap
Raymond Jane
Helpful.. Yeah and my follow up question. How do you look against a million dollar question. How do you look at gross margins here in 2015, both early on and for the year. I know you voyaged to 51% expectation. What are your thoughts around pricing in Fastenals and non-Fastenals and how realistic the 51 expectation should be in for the near term?
Daniel L. Florness – Chief Financial Officer
You know for the 51, I frankly don’t know. What I can tell you is I think that we’ve demonstrated with this quarter is, we can invest heavily in the business. We can manage the expenses, we want exactly the profit that can shine through on our profit growth. And we can do that without expansion of growth margin. And to me that’s the most critical. It’s a competitive market out there right now. Our mix as we talked on prior calls is not inherent to raising margin. If you’ve looked at growth drivers of our business. But the profitability on those growth drivers is great when it comes to the pretext fund.
Willard D. Oberton – Chairman
Let me say we got a couple of positives on the market and we do have a couple TL wins. One is we still have a tremendous opportunity on upside for our exclusive brands, our private brands and the other is our transportation costs with fuel where it is, our oil situation is going to drop and you saw on the fourth quarter and other quarters, our latte quarters that the flexibility of our fuel and the cost going up on our fuel and utilization. Our utilization will be high in the first quarter of our transportation and it looks right now fuel costs will be down so how are we going to get gross margins, looks great. So exclusive brands till when are on the fuel and also our Fastenals business is doing a little bit better, so there are gives and takes all over the place in margin and it’s always gonna be a fight. But, I tell you that the team has done a great job of managing our margin through changing business environment.
Raymond Jane
So no reason to think why the 28-33% incremental margins should not hold true in 15.
Daniel L. Florness – Chief Financial Officer
We feel very good about our ability in getting strong incremental margins. You know we had in July and well in April, we talked about getting the 20% in the third quarter. Excuse me. In the third quarter call we talked about this quarter really being in the upper 20s. And, we feel very good about what where we positioned, going into 2015.
Leland J. Hein – President & CEO
And, I think going into other reasons I feel good about that is that we made very heavy investments at the end of 13. And our district managers, a lot of outside sales people of the stores. So we were in a heavy investment mode. We don’t have to do much of that this year in fact in the leadership role district, regional, outside sales people were very set for at least the first 6 months of the year. And if that’ll come through in the PNL and incremental margins.
Raymond Jane
That was very helpful. Thank you guys. Thank you all.
Operator
Our next question comes from John Millani with Janie capital market. Tour line is open.
John Milani – John Capital Market
Good morning, thanks for taking question. Dan is part of the assumption for 15, i know it’s really in the year but w.r.t to gross margins the fact that you pointed out the the mix business being a larger customer is it fitting the time being expecting that the mix just kinda stays where it is ?
Daniel L. Florness – Chief Financial Officer
Well, the mix has been changing over many years. That our large account business, if you see it when you look at our vending numbers. Because a good chunk of that is largely become business, our national business, and you see that the rest of the group like we talked on that, on that first question. The rest of the group has stepped up and gotten closer to it. So, we actually have a little bit of more balanced growth in impact of gross margins and dated in the next 12 months and we probably did in the last 24. Because by adding the selling energy in the store the local business is stepping up to the plate a bit more so that it’s not being pulled by the vending, large account business. But there’s still little bit of mix right there but we’ll touch down both the fuel and our private brands are really powerful.
John Milani – John Capital Market
I mean the other distributors have said the same thing, it’s not unusual as administrator that the larger customers are are contributing more but, to the point earlier I think Leland J. Hein – President & CEO brought up the adding up the heads and putting in your release adding more in 15. As you said you did a nice job of controlling your SGNA cost. Do you see that as percentage sales more level with 14 this year given that you are gonna add more heads, but maybe all set with some further focus on cost or how do see that shaping up.
Daniel L. Florness – Chief Financial Officer
I don’t follow your question.
John Milani – John Capital Market
SGNA is a percentage of sales which was down about 54 base points this year are just under 30 percent. And you pointed out that you had pretty tight controls on expenses, especially in the fourth quarter. You also said that you’re gonna add smart heads in 15 to kind of resume what you were doing in 14, i was just curious how you see those two in aggregate, focus on cost control but also adding head, how do you see that aggregating into your SGNA’s or percentage sales.
Daniel L. Florness – Chief Financial Officer
When you think about the pathway to profit, everything about that including adding heads is about leveraging your SGNA. In order to get 28 or 30, low 30s from our perspective that’s all coming from SGNA, the position we’re is that when you look at the labor growth for next year SGNA growth for next year, a lot of the incentive pieces like I touched on what we gave up in the fourth quarter of the year because there is actually bonuses paid out again. That’s in our numbers now, that’s been growing into our numbers as we’ve gone through the year into the stepping up a little bit every quarter. It really puts us in a position to make investments but the rest of the expense pool isn’t growing that fast. So, we think we’re in agreat position to manage the SGNA going into 2015.
John Milani – John Capital Market
Thanks and Lee congratulations on your new position.
Leland J. Hein – President & CEO- CEO
Well, Thank you!
Operator
Our next question comes from Wanda Clark with UBS. Your line is open.
Wanda Clark – UBS
Good morning! So in terms of the store count you have close 52 stores in the second half ahead of that initial 45 target, are closing largely complete at this point and how should we think about next store count additions in 2015.
Leland J. Hein – President & CEO
Store count additions I would expect to be positive in fifteen, marginally positive. We’re always looking at our business even before, we announced the 45 in the second quarter , I think we closed around 20 stores in the first half of the year and you know we think that’s a healthy thing because in our business our locations are about, it’s about inventory and customers have the ability to stop in so we can do a great same day service in a high level of service for our customers but if one of our district or regional leaders looks at a market and says you know what I think this market is better served having us operate out 4 points than 5, our 3 points than 4, well we know we are going to retain an incredibly high percentage of that business. Looking at what’s the smartest way to grow but to answer your question I would expect it to be you know normally positive in 2015.
Wanda Clark – UBS
Okay great, and then just finally I was hoping you could give us a percent about your disclosure to oil and gas regents and how sales growth has been trending int those areas relative to the company average and then maybe how you think about the various puts and takes of your business of oil prices.
Leland J. Hein– President & CEO
Well, I think that when you look at our sales, about 12-13% of our sales are effected in some way they performed. From oil dropping, especially under 50 bucks barrel. And when you look at that there’s a percentage and I’m kinda framing that from Pennsylvania, to Texas to North Dakota, Western Canada and Alaska. We really looked at that and that’s 10-12%. We’re gonna fill it and now what happens is when you look back in time when oil dropped. By the time it drops to the net effect where it hits us, it can be six months out there. or something. There’s that lag, so we’re keeping an eye on it. And we’re definitely gonna fill it in those regions. The flip side is we don’t quite understand what it’s gonna do to our other customers because it actually puts a little wind in their sails so to speak. From the bottom line. So that’s kinda how we look at it. And how it affects company today.
Wanda Clark – UBS
Okay thanks for taking my question.
Leland J. Hein – President & CEO
You got it
Operator
Our next question comes from David Mandy with Robert W. Bear. The line is open
David Mandy – Analyst
Thanks. Hi guys good morning. First off you know back at the contribution margins side, just given the level of profitability and the earnings growth that you’re seeing right now. I know on the upside and the downside that we’ve had these stabilizers or shock absorbers through bonuses and profit sharing. And i just wanna press a little bit more on that contribution margin side. It sounds like you took a little bit of that in the fourth quarter here but as we look to next year is there a possibility that those things kick in and even at a flat gross margin, it’s a little bit more difficult to get to that 30% level Dan.
Daniel L. Florness – Chief Financial Officer
Well you know, with growth where we’ve talked about it and that it teams neighborhood. We’re in a position to invest in energy at our stores and in the neighborhood of those operating margins, the incremental margins stayed. Because when I look at our incentive comp, it really stepped up when i look at this when i look at it in the fourth quarter of this year. It really stepped up when we got into second quarter. And in the first quarter it was really healthy and in number 2 it really stepped up. And i think that layer of added expense is really in our numbers when i look at the details of the opening 15. And i think it positions us well.
And the offset of that, some of the pieces you normally don’t count on, we just touched on it. And then well based on our earlier is you have some SGNA that’s going the other way in the short term. We have some nice benefit coming into the first quarter through this energy. I know you’re down Florida and you don’t appreciate this anymore. You’re no longer in the mid-west it’s gold up here. And energy prices for heating a lot of our locations and the northern half of the country and throughout Canada is a meaningful piece too. So it gives us entail when coming into the first part of the year.
Willard D. Oberton – Chairman
Dave I’ll jump in this as well. But the biggest component of our SGNA so far is our labor and what the plan that Leland J. Hein – President & CEO and this team have laid out for adding the past majority of our new selling energy. We’re not selling energy but store energy that our sales people can get out on by hiring college students. We can add 15, not saying we are gonna add, but the math says we can add 15% percent more hours in our stores and that would translate to just under 7% labor not including bonuses. So the base labor to fuel that or just work that 15% more hours. And then there’s a scenario that we’re looking at, and that gives us a tremendous amount of leverage when you look at the labor bi carve a big expense. We can add the hours of with only just under half the expenses as a percentage. That’s we’re a lot of it comes from. And it allows us to be very bullish out there. They’re our customers and so are customers are very high in level.
David Mandy – Analyst
Okay alright thanks Will. And then on the gross margins always gets far too much attention lately, but the 51% as i look historically as the company maintains that level of gross profit, profitability. I know that historically there’s been offsets whether that was direct sourcing Fastenals or ramp up the exclusive brand or change it to the logistics network etc. So i know historically even no national councils have moved up in the mix and non fasteners as a percentage of the mix. You’ve been able to maintain that level. what I’m wondering about is as those secular changes continue as they have in the past several decades, are there offsets that will allow you to remain in that range or is it just we’ve reached a point where gross margins could potentially be lower and we have to rely on better cost leverage?
Willard D. Oberton – Chairman
Well if you recall, I probably tried to walk through what happened from the past that the profit as our average store size could stagger. But i think that’s really the underlying cause of a lot of what we’re trying. Our average store size is fair cuz we’re more and more successful with our larger customers and we drive some key accounts in those individual stores. And that’s what pushes a store from 80 to a 100. Or from a 100 to 150 or 150 to 200. Over time we have some 40 and 50000 dollars per month customers. Or maybe even 80000 dollars per month customers. But you have some big businesses coming into stores and like i talked about in the last call if i look at our stores that do more than a hundred thousand a month in sales so at the time it was just over a thousand of our 2700 hundred stores. That group operates at a lower gross margin and it goes up to 70 bases points lower than the company does. And so as we move from a 100 to a 110 to a 130 to a 160000 average store over the next few years cuz we’re only nominally adding units. Which means our average store size is gonna grow. I would expect our gross margin to compress and right know I’d be expecting it to be close to over 50. And that say 51 or 50.5 we just reported because of the impact of that. But as I also talked about given up that 70 bases points you give up You pick up about 450 bases points in operating leverage. And that’s the secret.
Leland J. Hein– President & CEO
That’s going out over 1-3 years.
Willard D. Oberton – Chairman
Oh, absolutely let’s look it out into the future because that group of stores had over 160000 dollars a month.
Leland J. Hein – President & CEO
Yeah and just quarter of that group of stores is a 20.5 % pretext. That’s the 4th quarter. So that gives the idea of a potential of the profitability of the organization.
David Mandy – Analyst
Yeah got it. Okay thanks a lot, stay warm.
Leland J. Hein – President & CEO, Will & Dan
Thanks Dave
Operator
Our next question comes from Garden with Lambo security. Your line is open
Garden Peter- Lambo Security
Thank you. Good morning everyone. I’m glad to listen that the over emphasis of gross margin has finally been recognized. I have two questions. One that can we look at the current business situations as we look at the 15. First quarter has a very easy composite as we did in december from the weather impact as we did it a year ago. If you look into it, you’re not gonna forget january and february so quickly. Can you give some ideas, some benefits from there and as second part of that thing can you talk about how the heavy manufacturing impact in the 20% of your business . You know if you talk about the impact of Ag, and the Canadian economy which you know is is starting to show signs of stretch. And particularly the Agmark is the winner, we know it’s crashing at the moment. And with Canada becoming a bit of problem or not.
Daniel L. Florness – Chief Financial Officer
A bunch of, quite a few items there that I’ll try to bounce through with you and Leland J. Hein – President & CEO or Will if you wanna chime in, feel free. Um, you know first off on the end market piece the manufacturing that business really improved for us and I think that really shines through in the fact that, you know, we exit the year with our Fastenal business growing double digit. We started the year with the Fastenal business growing low singles, one, one and a half per cent, first quarter, 1.9 fourth quarter of the last year. That says a lot to the health, og our O.E.M manufacturing customer out there. So I think that has you know, uh very good trends going into the new year. You know when I think of our Canadian business, and I know enough of you know, some, about a lot of the details sometimes get myself in trouble in a conversation. To me the biggest issue we have with our Canadian business right now isn’t how well it’s growing, it’s the, it’s the value of currency.
That business grew in the mid-single, in the double digits, excuse me. Here when I’m looking at the last few months but what shines through on our company level when you look at it in USD it cuts that down by almost two thirds because of the inflation in the currency but the underlying business up there is, for us it’s healthy. One thing you have to keep in mind when you look at our business in Canada, it is weighted towards the eastern part of the country. We went in on Ontario first and because we were expanding from the basically the Great Lake states in the U.S when we first entered Canada in the mid-nineties. So we’ve a big chunk of business that’s in the Ontario Province and then out towards the Maritimes. It was later that we more expanded into Western Canada from the standpoint of where our dollars are. And that business, that Eastern part of the country is stronger than the western part. Obviously the western part is much more linked to extractive industries.
Garden Peter- Lambo Security
I think you can just restrict that to weather impact and Ag.
Daniel L. Florness – Chief Financial Officer
Well the weather coming into last year, we had a tough start to the year. The weather really beat us up and weather, while it’s been cold in the upper Mid-West hasn’t been pounded by the weather you saw. And time will tell how that plays into January and into February but I don’t see weather as a threat right now.
Willard D. Oberton – Chairman
We did have a good March last year so that balances it out to weather, why we came back very strong, it wasn’t the entire quarter that was affected. It was mainly January.
Daniel L. Florness– Chief Financial Officer
Yes.
Garden Peter- Lambo Security
Can I ask another question, you had an initiative in metal working that was started several years ago, which really hasn’t done very much, the relationship with keta metal really just seems to be plotting along, is that still a focus of the company or future growth whatever, or is that sorta just been put on the back burner ?
Willard D. Oberton – Chairman
Oh I’ll jump in on that, metal working continues to do well. Our relationship with keta metal is good, you know. People, I think have too high of an expectation going in thinking that we are gonna be as big as MSE overnight and that doesn’t happen. Our metal working business has grown, not doubled, but almost double-digit above the fast growth in 2014. We even got better than in 2013. We’ve grown a very nice sized business, we’re doing well with it, we think the upside is great. It gets hard to grow a business, at this rate now we’re just at ten percent of our total revenue. So it’s a meaningful sized business. And it’s hard to grow at more than twenty plus per cent, year over year with a business that big.
We’re very committed, we think we’re gonna continue to do well at it for a long time and part of it, of what we learned is that although keta metal is a very good supplier, they don’t have full spectrum of what the customers need and neither does any of the other suppliers so we developed relationships with a wide range of suppliers and mostly we’re enjoying very good growth through Fastenal and we’re also very committed in Blade, it’s a great opportunity for the future. The main thing that makes sense is our Fastenal and M.R.O customers, most of those are using metal working products. We’ve already developed relationships, now we have to develop the product relationship in this specific area.
Garden Peter- Lambo Security
Alright, thank you very much.
Operator
Our next question comes from the line of our marketal with William Blair. Your line is open.
William Blair
Thanks, wanna clarify that ten to twelve per cent you said was tied owing gas. Is that direct to energy customers, or were you saying that ten to twelve per cent of our stores are in energy levered states?
Daniel L. Florness – Chief Financial Officer
Um, ten to twelve percent of our sales are in those geographic areas and I would say only half of that would be closer to the energy piece. But that’s angled at someone talking to our regional leaders in those geographic areas, but it’s really looking at the Gulf Coast, the Texas market, Western Pennsylvania, Western North Dakota, up in Oklahoma and Western Canada and looking at those and engaging it.
Willard D. Oberton – Chairman
And it’s pretty close to 12 per cent. And more information, that grew in the third quarter, grew at about 24 per cent versus the company. We have enjoyed very nice growth so that’s the 12% of our business. It’ll probably slow down. But the other part of our business at 90% or 88% remaining we’re hoping we get a little tail through lower energy costs and maybe it balances. If it doesn’t balance we’ll also have about a 12 million dollar quarter energy bill. That we think is gonna go down by 3 or 4 million dollars. So we could give up a little revenue and balance it with expense. We’re hoping we don’t give up any revenue and we get to capitalize on the expense. So we worked that hard right and we’re gonna try to figure it out but it’s no crystal ball for this right now. It’s all about how the rest of the economy is affected because of lower fuel prices.
William Blair
Okay so, I wanna clarify that. You’re saying that 10-12 is the direct and indirect? Yeah okay I just wanted to be clear you said that would’ve been a little bigger than I thought but 5% makes sense. Which would be direct. Fun question. Given that decline in steel prices, should we be worried about deflation in Fastenals? can you just remind us how your Fastenal contracts work with regard of price?
Leland J. Hein – President & CEO
The large contracts which probably make up 20-25% of our Fastenal business are tied a CRU index which is a steel index. & when the triggers on that are typically they’re not all the same but the most majority of them have a 5% trigger. So if steel goes down or up, more than 5% over 6 month period. It’s always on the calendar, January & July are the trigger points. we will either raise our prices or lower our prices accordingly. Then based on that we’re figuring out what percent. If steel goes up 5% or down it doesn’t mean we lower our price as a factor in the labor. So there’s a formula there. So the other 75% of our business is not on these contract when steel goes down, we have some up side from margin that we could hold onto that pricing. And that’s really where we think our balance is. There’s always margin pressure exposure if there’s a lot of deflation in the business. So far we haven’t seen a lot but you know that time will tell. We’ve been very close with our guys in Asia, They run our business for us and, They’re in the trading business. And trying to understand what the manufacturer are saying and seeing.
William Blair
And what would the lag be? So steel prices go up or down 5% you have to change your pricing. Is it a quarter lag or is it right away?
Leland J. Hein – President & CEO
It’s usually 6 months
Willard D. Oberton – Chairman
Okay. And then one more of a kind of a big picture question. There’s a view by some that the MRO industry is more competitive today and therefore the growth is growing slower and less potentially less possible. So what is your view of the past ten years?
Leland J. Hein – President & CEO
Well. Things have changed. If you look at the big players and whoever you throw into that group, we have all grown nicely so maybe we’ve gone from 25% market share to 28 or 30. So it has consolidated but pretty slow rate when you look at us, MFC and Granger combined, there’s others I know. But our growth is probably 10% if you add us all. Takes one time to consolidate the industry. It’s always been competitive and I think it’ll remain competitive but I think there’s a tremendous amount of opportunity out there. We think that the opportunity is as good as it’s ever been. That’s why we’re so focused as Leland J. Hein – President & CEO talked about staying close to our customers using our same day store model to grow our business and take market share.
Willard D. Oberton – Chairman
Alright good. Thank you.
Operator
Our next question comes from the lineman Adam Omen with Cleve and research. Your line is open
Adam Omen – Cleve and research
Hi guys. Good morning. Can we go through the cash flow outlook for next year. Pretty good job this year i guess doing doing cash conversion i guess. And I think that you’re thinking about Kafex. What are you thinking from the inventory side??
Daniel L. Florness – Chief Financial Officer
Our Kafex will drop as we go into the new year. The number i expect to be setting out in our annual report a number of around 150 plus surmise 5 million. & I think we’re positioned well. I think we’re in a good position to manage the working capital needs. The biggest component we need there will be more on the AR side than in the inventory Because I expect our business to keep growing nicely. And i think it puts us in a great position to generate very very strong cash flow. And our operating cash flow this year was even high by our norm as we basically had operating cash essentially in line with earnings. Part of that was the fact that our friend in Washington D.C strive to continue the bonus depreciation and a few other things there so we didn’t get that tax bill coming. And that defers that off. But really a strong cash flow year and I think we have a great position for next year. Because a lot of those investments are in the rear-view mirror rather than the wind shield.
Adam Omen – Cleve and research
Okay thanks. And then clarification on the financial times, that’s still not clear to me. We had 2% of your rear growth in December on FTE. And i was wondering how you think about that ? You know the first half of the next year we’re going to bounce back to the 10-15 % that was mentioned earlier. We’re gonna remain in the single digits and wrap back up at the store level. You know the total head count growth on the FTE basis. Your view in December, we stay there ?
Daniel L. Florness – Chief Financial Officer
Yeah you really have to discount a lotta what the year over year numbers are in November and December. Because the November & December of tthe year ago, as we touched upon that earlier, we were in this massive wrap up stage and we kept the hours just dialled up. Because we wanted to get our sales people out of the store, selling. And this year as we managed through it we were able to dial down the part time hours. In November and in December and that prized EFT and one of the reasons I put that bulletin on page one was really to talk about ‘ hey on the headline it looks like we dropped our hours, our numbers at the store. Our FTE did go down as we dialed down the hours but we actually added people. And so coming into January & February that will dial back up because we have the need.
Leland J. Hein – President & CEO
And when we looked at trying to normalize taking note to people going home from the holidays and all that we’re in the high single digits. I think we have 8-9% more selling energy if everybody was at work all week long. And that’s a little lower than we want but it’s in the neighborhood. Makes sense Adam??
Adam Omen – Cleve and research
Yeah so we kinda get back to that normalized 8-9% then maybe grow from there as you have need
Willard D. Oberton – Chairman
Yeah we wanna push it up from there.
Adam Omen – Cleve and research
Okay. Thank you
Daniel L. Florness – Chief Financial Officer
I see we’re at 9:45 again. I wanna thank everybody for joining on the call this morning and Will, Good luck.
Willard D. Oberton – Chairman
I’ll be here.
Daniel L. Florness – Chief Financial Officer
Take care everybody
Operator
Ladies and Gentlemen, thank you for participating in today’s conference. This does conclude the program and you may disconnect. Everyone have a good day.
