Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Fastenal Company Third Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time. As a reminder, this call is being recorded.
I would now like to turn the conference over to Ellen Traster of Investor Relations. Ma'am, please go ahead.
Welcome to the Fastenal Company 2013 Third Quarter Earnings Conference Call. This call will be hosted by Will Overton, our Chief Executive Officer and Dan Floronis, our Chief Financial Officer. Also present for today's call is Lee Hine, our President. The call will last for up to 45 minutes. The call will start with a general overview of our quarterly results and operations by Will and Dan with the remainder of the time being open for questions and answers.
Today's conference call is a proprietary Fastenal presentation 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 December 1, 2013 at midnight Central Time.
As a reminder, today's conference call includes statements regarding the company's anticipated financial and operating results as well as other forward looking statements based on current expectations as defined by the Private Securities Litigation Reform Act of 1995. Forward looking statements may often be identified with words such as we expect, we anticipate, upcoming or similar indications of future expectations. It is important to note that the company's actual results may differ materially from those anticipated. Factors that could cause actual results to differ materially from these forward looking statements are contained in the company's periodic filings with the Securities and Exchange Commission, and we encourage you to review those carefully. Investors are cautioned not to place undue reliance on such forward looking statements as there is no assurance that the matter contained in such statements will occur.
Forward looking statements are made as of today's date only and we undertake no duty to update the information provided on this call. I would now like to turn the call over to Will Overton. Go ahead, Mr. Overton.
Thank you, Ellen, and thank you everyone for joining us today for our Q3 2013 conference call. Thinking about the quarter, overall, I would consider that or I believe that we had a good quarter considering the environmental excuse me, the challenging environment that we're into. I need to get warmed up here. Starting out with sales growth, sales growth came in about where we thought it would be for the quarter. On a sequential basis, we showed improvement over our historical numbers in 2 out of 3 months.
July was a tough month, but we came back nicely in August, had a good growth month in September. And 3 out of the last 4 months, we actually had we're over the sequential pattern that we look at the historical pattern. So we're moving ahead nicely, although there's still low growth numbers in the high single digit mid to high single digits. On the margin, we had 51.7%. We were very disappointed with the margin.
But saying that, I do believe the team is doing a very good job and they're working very hard on the margin. There are several factors that weighed into this quarter's margin and are weighing into the year that I'd like to talk about. The first, in no particular order here, our slow growth in fasteners, fasteners in a difficult market this year. We've seen basically no inflation in the product and we've had very slow growth in the product line. And it's historically or it is the highest margin product that we sell.
We had growth of 1% in the quarter. So that's hurting. So it's a mix issue. On the other side of that, our non fastener products grew about 12% roughly and they're traditionally lower margin products, so there's a mix issue going on there. Another mix issue that we're facing right now is the customer growth.
We're getting better than average growth or better growth out of our large customers and slower growth out of our small customers. And the large customers, again, are the lower margin customers, smaller customers producing the higher margin. So we have that going on. Another thing that we're seeing in the market right now, and I've actually spent a lot of my time traveling over the last 2 months, I spent quite a bit of time traveling to customers, visiting with customers on many issues. And our customers are becoming more creative every day at pushing for lower prices and better deals.
And if you look at the 1st and second quarter reports of the industrial companies, many of them are hitting their numbers, but they're not doing it on the top line. They're doing it by squeezing on the bottom line. My guess is that's going to come through again this quarter. And when that happens, a company like Fastenal and our competitors are the ones that are helping support those lower operating costs. So the customers are pushing us very hard and many of our competitors are responding to that just as Fastenal is.
So if you look at the margin on a macro view, our Fastenal growth is not doing well. Our non Fasteners lower margin products are growing faster. The large customers up, small customers not growing as well. And then the pressure, just the competitive pressures out there. Putting that all into perspective, I think 51.7% is probably yet disappointing from where we thought we would be, a very good effort by our Fastenal team.
On the expense control side, I think Lee, Dan and the team or their teams are doing a very good job. They seem to have a great handle on what we can afford to spend, where to put the money and they're making the right investments and managing our expenses very well, not just this quarter, but over a longer period of time. I'm very happy with what they're doing there. Another area I want to talk about is vending. But before I go into the vending performance for the quarter, I just want to clarify a point that I made last quarter.
I know it was misunderstood by some because I've had several questions on it. I do not feel that we have overinvested in vending. I believe that we underinvested in supporting vending because several people when I talked last quarter and said that we were pulling back the pressure a little bit, they took that to believe that we are over investing and that's not true. If we had the people in place in the stores, we would be pushing harder than ever on vending and we still believe it is a fantastic way to deliver product to our customers. It's a more efficient vehicle system to deliver product and provide a high level of service.
So our goal is when we have better staffing in the stores and I'll talk more about that in a minute, we plan to introduce new incentives that basically in the early part of 2014 to the vending program with a goal of ramping up the signings in 2014. So it's really about get the people in place and then put the hammer out back or put a little more selling power back into the vending program. And if you look at the numbers, you'll see that we still have good growth in the vending customers, just over 15%. Not as good as we're doing, but compared to almost any other measure that you see for industrial customer growth with us or any of our customers, it's about the best number out there. So we're very happy with the program.
Although the signings were down from where we want them to be, we believe we're moving in the right direction. And one comment on the signings, just a side note, it was it has dropped as you saw, but that is a very natural number. It's a number that's coming without putting a lot of pressure on our field. That's the number that's just happening because it's a great system, not pushing it very hard. On a positive note, we have made very good progress on adding additional support into our stores.
On a quarter over quarter or quarter to quarter basis sequential, we've added 4.6% more FTE, which puts us on track. Our long term goal is to be at 15% plus or around the 15% number. So, on an annualized basis, we're slightly ahead of that, but we do have some ground to make up. So, we are making good progress. Reports from the field is that it's hard to find the right people, but if you work hard at it, they are out there and there are a lot of good people looking for wonderful great opportunities.
So as a company, we are very focused on growth. That's what we're talking a lot about. And I believe that we are taking the right steps to make this happen over the next several quarters. With that, I'm going to turn it over to Dan to give you some more color on other areas of the company. Thank you.
Thanks, Will, and good morning, everybody. And also want to thank you for joining in on Fastenal's earnings call today. Just want to touch on a few items. The store headcount, we go through quite a bit of discussion of stats, probably sometimes you might argue too many, but on Page 11 of our release, go through stats of headcount in various pieces of the business. And some things that I think are worth noting, as Will touched on, we added just over 400 people to the store SCE to the store in the 4th quarter, 4.6%.
One thing that probably isn't as well known is in addition to supporting our store because really what we're doing is our goal here, we want to support every store, every vending machine, every key account and grow our business. And in addition to the headcount we're putting into the store, we're adding resources behind the store to support the sales and leadership the sales leadership of the store. And that is, we went from having just over 220 district managers throughout our organization and we added 50 during the quarter. And so those are folks that are stepping into expanded roles, reducing the number of stores per district manager to put more selling energy, more attention on each and every store, every day, every week of every month. In addition, we expanded our regional VP pool by 3, went from 18 to 21 during the quarter.
So we've put in a lot of selling energy to support our store. Again, it's all about supporting every store, every vending machine, every key account, every pay week and month. There's reading through the analyst reports that have come out during the course of the month, I think this is generally well understood, but I thought I'd just touch on a few aspects of the quarter from the standpoint of calendar. July, as Will touched on, weaker daily sales growth number. One thing to always point out, extra business day in the month and with July 4 being on a Thursday versus with that one orphan day, that really negatively impacts that month.
Rest of the month played out pretty much as expected. So seeing some good trends. Also we had in our sequential pattern 2 consecutive beats. August September, we beat the historical pattern. We haven't had 2 consecutive beats since the spring of 2011.
So if you're looking for some positives, that's the biggest positive in our release is that there's some positive trends going on. The ISM index, I'll be outside, yes, it makes me scratch my head. It's been positive. It's been plus 50 for 4 months starting in June. It's been in mid-50s for the last 3 months.
The ISM historically was a pretty good indicator of our business as far as trends. It tended to lead the industrial distributors in general by about 3 or 4 months. Since spring of 2012, that relationship, in my opinion, has been broken. Given what we're seeing with the strong ISM right now, I hope that old friend returns and it is positive for what we see going into the tail end of this year and into the early part of next year. But hope isn't the strategy.
Our strategy is putting energy into the store to grow our business and it's about growing our top line. Fast Solutions, I would echo Will's comments. Without the pressure on every day, we saw a natural number emerge and the energy and reinforcing that as we go into 2014 will be strong. One other thing that occurred during the quarter and there's I know there's some knowledge of this out there just from the standpoint of discussions on previous calls. Our T Hub facility turned on, on July 22, started picking product for our 1st store.
Currently, we have 15 districts that are live on the system and we are rapidly rolling it out. And the concept of T Hub it's a centralized facility, it's located in Indianapolis, adjacent to our Indianapolis facility. And it is picking product for our vending machines. So it's a highly automated, highly efficient picking area where we are picking and containerizing a shipment to the machine level that goes out to the store. This will free up a tremendous amount of time at the store and probably is more important than our FTE growth right now.
As far as the energy it's creating at the store, when you look at the next 12 months, I don't want to discount our FTE growth because that's a huge plus. But this really doubles down on that. And since we're adding available selling energy into every store. And this will be rolling out over the next 6 to 9 months and a lot of that in the first part of that time frame. Profit drivers, 22 percent pretax in the quarter.
I think very good performance, given the fact that earlier in the year, we had the added impact of gross margin expansion. We really didn't have that. So we really had to rely on what's our gross profit dollars, what are they growing. Our gross profit dollars grew about 7% in the quarter. They grew about 6.6% in the 2nd quarter.
And so very proud of the fact that we produced a 22% pretax in the quarter. Gross margin, as Will touched on, I don't want to beat a dead horse. It's a tough market out there, a very competitive landscape. Product mix continues to challenge us. Within the product mix, though, we continue to eke out month by month, day by day, additional progress in our private label products.
We refer to them as exclusive brands and vending is a big piece of driving that. And that's a piece that's a wave that's coming through. Again, vending is a big driver of that. Operational working capital, as you saw in the Q2, we continue to generate good cash flow. Year to date, for every earnings dollar we've generated, after paying for working capital needs, we have $0.90 left over.
After paying for capital expenditures, which are significant this year and next year as we've discussed in the past because of our vending initiative, because of our distribution automation initiative. After paying for all that, we still had 50% of earnings year to date left over in free cash flow. I think very powerful reflection of the pathway to profit and where that positions our business for investing into the future. Most of you probably saw last night, we announced our 4th quarter dividend consistent with our 3rd quarter dividend, dollars 0.25 And takeaway message I have is grow the business, grow properly, step back and look at your return on assets. Will touched on earlier the fact that one of the gross margin challenges is the mix.
One thing we always have to take a step back and Bob Kerlin reminds us this every time he talks to us, it's about your operating margin and your return on assets. Sometimes the optics are the gross margin is struggling a little bit because of product mix. But if we're managing the expenses below that and we're generating good operating margins and a good return, or I should say a great operating margin and a great return, that's going to make you successful long term. With that, I'll turn it over to Q and A.
Our first question comes from the line of Ryan Merkel from William Blair.
Hey guys, good morning.
Hey Ryan.
So on the last call you talked about average daily sales growth potentially improving back to a double digit pace at some point during the next few quarters. This was primarily based on adding sales FTEs, which it sounds like you're on track for that. But then if I also start to look at the if you hit the normal sequential math, which you have the last 2 months, this also implies that average daily sales could start to pick up from here. So I guess I'm wondering, is there anything you see out there today that would change this outlook?
No.
Okay. Care to elaborate anymore?
The market doesn't seem to be changing a lot, Ryan. I mean, it's a soft industrial market. We don't believe it's getting any worse. We don't see signs that it's improving. But our attitude internally is we have to deal with the environment out there and go take share and we're adding the people.
Our comps in October become are softer than September. So we have good opportunity to improve our growth nicely in October and going out through the rest of the year, setting ourselves up for a stronger Q1.
One other thing I'd echo in on that is if you think of trends going forward, we're adding selling energy, we're adding vending quality to the organization. And I don't know if this third one will be will prove indicative or not, but the ISM is improving.
Right. Okay. And then on gross margin, I understand the mix headwind, but I guess I'm wondering if you believe further sales reacceleration might come at the expense of gross margin unless the macro improves. What's kind of the outlook there?
No, we don't think that our gross margin is results are a reflection of our hard push on sales. Really believe it's the normal environment that we're in. We're probably overly optimistic going in. So we are still confident or comfortable with our 51% to 53% range and believe that's what we have to work that's we have to try and stay in that range. We see nothing that would push us out of that.
And if sales really took off, could it affect our margin? Yes, but we'd be happy with that problem. I mean, if we had unusually great sequential growth. But we're not pushing so hard
to reduce it. Thank you. Our next question comes from the line of Hamzah Mazari from Credit Suisse.
Good morning. Thank you. The first question is just on the production side of your business. You guys highlighted mix as a negative, but also some competitive pressures. I'm just curious if you're seeing any impact of some of your larger publicly traded peers getting more aggressive on the manufacturing end market side, particularly on production consumables?
Any sense of I realize the market is big enough for a lot of players, but just any sense of is that leading to increased competitiveness in the industry? Any thoughts?
I think the competitive aspects we're talking about really relate to more what the our customers are expecting and asking of us more so than what competitors are doing other than the fact that we're all we are all reacting to the competitive marketplace. But it's really being driven I think not so much by everybody else taking shots at us. It's really being driven by what customers need. We're squeezing our expenses tremendously as you can see when you look at our operating expenses. Our customers are doing that too because in the absence as Will mentioned of sales growth, I need to squeeze profits if I want to get profit
growth expenses to get profit growth. And we're seeing that from the large public companies and we're seeing it from the small private companies. Everybody is out to keep the business they have and try and grow the business the best they can. And I agree completely with Dan, it's customer driven and we're all reacting to the pressures.
Got you. And just a follow-up question on the vending. Clearly, you're taking a more measured approach on the vending side. Could you give us a sense of maybe what inning you are in terms of moving towards higher quality vending? Trying to get a sense of out of your installed base in vending, what percent of that do you really need to prune?
How much is low quality in that installed base? Any sense of that? I don't know if
we know the quality answer yet, Hamzah, because one of the things that we're seeing and I touched on earlier the T Hub rollout. The quality is not about T Hub. I don't want to confuse the issue. The T Hub is about efficiency behind the scenes. But some of the steps our stores are taking to implement T Hub support expanding the quality in addition to what we're doing with our vending improvement program.
For example, looking at the activity of the actual machine and are there tweaks you can make to it. I go to our you go to our warehouse or I go to a place with a lot of younger folks and you might see in a soda machine, 5 out of 6 offerings are Mountain Dew. It's because that's what's turning in that machine and that's what that marketplace wants. Even though I don't want Mountain Dew, I'll take the Doctor Pepper, but Mountain Dew is what's being drawn. It's taken a step back and looking at the machine and saying, what coils are really spinning in this machine for the replenishment from T Hub, but that also optimizes the machine.
So I think after we get T Hub turned on and we've had the opportunity to optimize more of our machine, we've had our vending improvement program in place for a longer period of time, I think at that point in time, we'll be able to take a step back and say, you know what, here's the portion of machines that were suboptimal 6 months ago here's the portion that still are and we need to scratch our head a little deeper on those. But it's a small I believe a small subset where the machine is just a better way of delivering products. Where we have issues is, is it in a do we have too many machines relative to the customer? I think that will run into more than we have a machine where it doesn't belong.
Got it. Thanks a lot. Appreciate it.
Thank you. And our next question comes from the line of David Manthey from Robert W. Baird.
Hi, good morning. First off, I was hoping you could discuss the impact to date of your full time equivalent additions. Have you seen measurable improvement in stores where you've added them? And then also if you could talk about the success you've had in going back and asking customers to make good on the commitment to add an incremental $2,000 per month per machine. You talked a little bit about optimizing the machines, but I understand that some of those are they're not operating at the level that customers had committed to.
So could you talk about those 2 growth drivers?
On the first one, Dave, as far as the improvement adding the people, it's too early to tell. But if you look over a long period of time, we know when we have more hours, our businesses grow faster. So it's very straightforward. We've had very good success on going to visit the customers on the $2,000 per machine. And I don't know the exact percentages, but it's a very low percentage where we've decided to take the machine out.
And in most cases, it isn't about the customer giving us other business, which we would like. It's about resetting the machine so that we have the right product in there. Dan mentioned that with his Mountain Dew analogy. It's really about looking at the customers' needs and understanding what we should put in there. In our vending team, the team running the system has developed some very good software to look at what's spinning and what isn't there, what falling out of the machine and what isn't.
So they have good analytics to go to the customer, identify what we need to put into it. And most customers want that conversation because if they don't use the machine, they don't save any money and they don't run their plant as efficiently. So we're going down the list. We continue to see very good progress and the quality of each machine continues to rise basically on a weekly basis. Team is doing a very good job.
Okay. Thanks, Will. And then in terms of this, the emphasis on shorter cycle sales efforts, Sort of unclear what the impact there was on growth, but it seems like you cited that it had a negative impact on gross margin clearly. Could you put that in the context of the price guidance system where you've had such good success year to date? It seems like it overwhelmed the benefits that you had there.
And I'm just wondering, do you expect future improvement in sort of that underlying gross margin exclusive of mix?
On the last part of your question about gross margin, I'm going to shy away from answer. We're going to hold to the $51,000,000 $53,000,000 and the faster move a little bit and half of this discussion goes away. And but in regards to the shorter cycle sales, to me the best indicator I can point to of everything we're doing, going after some shorter cycle sales, going aggressively work having our similar national accounts folks work in stores, the FTE we're adding, the district manager energy we're adding. If you look at all those things, I go back to the sequential patterns. In the sequential patterns, we've now strung a couple of months together where we beat the pattern beaten the pattern, excuse me.
And there's positive energy going to that. Since I don't know if I touched on this earlier, if I did, I apologize for repeating myself. It must be because I'm almost 50 years of age.
Like next week. Losing it
a little bit. But if I look at it since May and I'll probably lose the group with this comment. Since May, we've beaten 3 out of 4 months in pattern. And if you look at the delta, if we beat the pattern by 0.5%, miss the pattern by 0.5%, cumulatively our beating has given us a 0.5 point of lift. In the last 2 years from May to September, we were down about 2% or 3 tenths of a percent.
So we've gone from negative. In 2011, it was negative and that was a stronger year. 2012 was negative and that was a negative year. In 2013, if you look at the sequential beats and misses since May, we're up 0.4 percent and we've beaten 3 out of 4. I think all those tie together that the focus on just grow the business
is impacting our business. And Dave, I didn't mean to indicate that our short cycle sales are affecting our reported gross margin. I'm not saying they are or they aren't, but I really think our gross margin is more about the 2 mix related issues expense control. And that's short on the top line. We did a nice job in expense control and that affects all of us, us and all of our direct competitors.
Got it. Thanks, guys.
Thank you. And our next question comes from the line of Sam Darkatsh from Raymond James.
Good morning, Will, Dan. How are you?
Good, Sam. Good, Sam.
Hi, Sam. Couple of quick questions. First off, I noticed that your store count expectations or the store additions were trimmed on the high end, now 55 to 60 instead of 55 to 80 before. Are you rolling those into next year? Or what's the reasoning behind the trimming there?
Yes. I think the reason behind the trimming is we're now 9 months through the year and we've a better idea where we're going to finish at. And so you narrow the range down. There's nothing more than that. And then we also indicated a starting point range for next year.
And I don't think either one of those are horribly surprising.
Okay. Secondly, Will, you mentioned that you're looking incentive wise to create an environment where you're going to be ramping up the vending signages next year. Could you quantify that in terms of what goals or reasonable expectations might be for installs both on the FAST 5,000 machines and otherwise?
Well, on the overall number, our goal would be to 2014, we'd like to get to the roughly 2,000 per month signing. We think that's a good number. And so that's what our incentives are going to be designed to do. It's too early to say whether we're going to get there. But if you look at the fact we're basically we'd signed 18,000 without putting any pressure on or based on last quarter, it doesn't take a lot more energy to crank that up.
We think that we have some built in energy when T Hub is up and running because right now if a store is struggling to serve the machines because it's a lot of work packaging the product and filling the machines, there's a reluctance to go out and sign more machines. And I talked to a group of managers this week about that very subject. So if we can get T Hub up and running the way we believe it will, we reduce the workload at the store, the stores see, hey, this is pretty good business, they're going to go out and work harder to sell them and they're going to have more time to work harder to sell them. So based on that, based on a little incentive, right now looking at the year and internally, we're saying, hey, we'd like to get the number up around 2,000 machines per month. We signed 23,000 to 25,000 or 22,000 to 26,000 for the year.
That gives us great growth. It's very manageable and it doesn't overload any particular area of the company as far as stores and regions.
And Dan, if I can sneak one more in if I could. I noticed your accounts payable, this might be nothing, but it spiked and I was wondering if perhaps you were building inventory late in the quarter as a result of why that was the case?
There's a few things driving that. One is the timing of some of the inventory spend. We were building some inventory and some of that is inventory going into the V Hub. Another one, which is a relatively minor event, but it's still meaningful dollars, is we changed the organization we use for processing our fuel cards in our vehicle fleet and they're cut off at 5 days earlier in the month. So there's an added accrual in there for some fuel.
That's more mechanical than anything. The third one is all the distribution stuff we're doing, there's a piece of that sitting in accounts payable within the quarters and it will be paid out here in October, but nothing horribly meaningful other than that. Okay. Thanks so much. Certainly.
Thank you. And our next question comes from the line of Adam Uhlman from Cleveland Research.
Hi, guys. Good morning. Hey, Adam. Hi, Adam.
I was wondering on
the fastener mix, the business really hasn't been growing too much and it sounds like there has been some added pressure to try to increase the company sales there. I'm just wondering how you think you're doing from a market share perspective on fasteners overall. And then, where do you think over the medium term where that settles out in terms of your mix as you've been addressing non fastener products more aggressively? Adam, it's hard to understand because there's not a lot of data out there. If you look at the fastener index that BB and T uses that they Holden Lewis sends out, Holden, you're probably on the call, thanks for that.
It shows that fasteners are in a pretty tough spot. I think it came out at 46 and change with 50 being the center point on that index, very slow growth. And our Director of Purchasing and a person who heads up our just came back from Taiwan, which was China and Taiwan about 3 weeks ago and I met with them. And they said that the factories that we support very heavily are very slow. The U.
S. Imports coming out of Asia are at a very, very low level, which tells me demand is slow. The Faster Index from Holden tells me that the demand is slow. And we know that there's no inflation in the product. You put all those together and it says that we're probably doing a little better than average with our fantastic 1% growth sarcastically.
But we are working very hard at it. We have a lot of small projects and medium projects, things we're working on, better bin stock technology, doing a better job of calling on the large customers. Lee has implemented some new quoting tools or his team has tools to speed up the process to try and turn an inquiry into an order. We had kind of slowed that down with price guidance. They recognized that.
They developed some software that the store managers and I again spent a lot of time with store managers this week are high fiving us for doing this for them. I get no credit. But so we're doing a lot of things to speed that up and we're pretty confident that we're going to start taking share when that opportunity for share growth comes back. Okay. And then just a follow-up, could you just talk about where we stand about the metalworking initiative, trends there getting better or worse?
Yes. Well, the trends are slow. In the quarter, we grew our metalworking by just over 10%, basically a little almost double where the fastenal growth is. Metalworking is a tough area right now. 2 year pattern, we're up 37%.
So we had a great 1st year, it slowed down this year. But we're still very motivated and believe it's a great opportunity for us. Based on what we're hearing from industrial or industry data from other competitor data, Metalworking may be one of the toughest areas out there right now. And we're still growing the business at 10% off a pretty good base. I mean, we're not huge, but it's a nice piece of business for us and we're still very optimistic.
Believe the team is doing a nice job of growing that business.
Year to date in that, we're up about 13%.
Okay. Yeah, I didn't have that.
Great. Thanks.
Thank you. And our next question comes from the line of John Faglioti from Janney Capital Markets.
Good morning. Thanks for taking my question. You guys have pointed out the correlation pattern or sequential pattern with ISM. And you pointed out that fasteners have been growing a little bit slower than you had hoped. And I was wondering, do you think that all the points that, Will, you mentioned about the headwinds and tailwinds to gross margin, do you think that customers
are
still pruning their inventories? Because ISM picked up quite a bit in the Q3 versus the Q2 in every one of those months. And I'm just I'm wondering, given your high correlation to that, do you think that maybe they're just working down some inventory for in the short term?
No, I don't believe that. Since 2007, 2008, 2009, 2009, 2009, 2009, 2009, 2009, 2009, most of our competitors have been or not competitors, customers, they don't have a lot of excess inventory in the system anymore. They're all living and part of it has to do with there's a lot bigger pressure on taking cash out of the business. And the other thing that's going on is the suppliers are better, we're better, our competitors are better, so you don't need as much inventory. I have been scratching my head just as Dan has over the ISM.
And when you look at the like I said, we have been out with a lot of customers over the last few months. It's hard to find one that's just booming And it will be interesting to see the reports coming out over the next 2 weeks from the big industrials, but it doesn't sound like any of them are seeing robust growth. It's hard to understand where that 56% is coming from. Hopefully, it's a leading indicator, as Dan mentioned, and we're seeing it in the next 2, 3, 4 months. But I do not believe it's inventory.
Yes. It seems like it's an encouraging number because it did move up markedly from the Q2. And to your point, the things that you flagged about gross margins, do you think that I guess we should expect those to continue through the balance of the year? So if we're kind of thinking about your range of your long term range of gross margin, you think it's smarter for us to be on the sort of in the vicinity we are now through the year?
We're not going to give guidance on gross margin, but unless the fasteners pick up and unless business just picks up in general, if the less fasteners pick up that pressure is going to stay there. If the economy doesn't turn around, the competitive pressures from both our competition and our customer base are going to remain the same. So we don't see a lot of change. We don't foresee a lot of change over the next 3 to 4 months.
Okay. Just finally, Dan, you had pointed out historically the sequential patterns and how more recently you've outgrown them by about a half a point or so. And do you have any kind of feel of what we should expect that exceedance? What would you guys view as a successful delta from I guess historical sequential trends?
I think that we call guidance.
Well, I'm just thinking like John, to be honest with you, we don't know. We know what we're doing that we believe positively influences our business and I would hope to positively influence our benchmark our performance to our benchmark. What we're doing with adding energy into the store, what we're doing with working to improve the vending, what we're doing to drive our key accounts, those pieces are ultimately good means to grow our business. The expanding our district manager roles will do 2 things: A, we'll be better at recruiting and B, we'll have better we'll have a higher level of sales energy in our business to support our stores every day, every week,
every month. And if the ISM is an indicator of future opportunity, that is going in our direction.
Okay, great.
Thank you. We do
have some tailwinds from that perspective.
Thank you. And our next question comes from the line of Eli Lusgaarden from Longbow Securities.
Good morning, everyone. Good morning. Somebody has to ask the obvious question. All the data we've gotten was before the insanity in Washington, and now we have a combination of a government shutdown. We have Obamacare scaring a lot of businesses from hiring.
And just wondering whether you foresee or anticipate or looking for any impact from the environment that nobody chose, but we're sort of stuck with at least for now?
We're both kind of looking at each other, shrugging our shoulders. I think as a nation, and I'll go out on a little limb here. I think as a nation, we've grown a little bit accustomed to the fact that we have a bunch of folks in our nation's capital that a high percentage of the time do things that are pretty damn dumb. That's unfortunate speaking as a U. S.
Citizen. With that said, I'm a firm believer if there's core demand for the things that we sell, that core demand will be there. And I don't think that distraction is going to be that destructive longer term, but we don't know.
I was just pointing out it's like the small business optimism index is weakening and there's a lot of commentary coming out of the small business side about Obamacare and her unwillingness to change her business conditions. And that's an important part of the profitability the company would save. But at this point, you're not seeing anything that are in the plans for the Q4. Is that fair?
That's fair. And
the incremental profitability, we talked about gross margins, the cost going, which really weighted on the incremental profitability that we saw in the Q3. And from the sound of it, you expect no real material improvement in those metrics as we go towards the end of this year. If volume is better, obviously, it would be better. But at this point, the conditions you're laying out don't show much improvement in incremental profitability or is it distinct move inside to control costs a little tighter to get the improvement in profitability up for the Q4?
When you're operating at a level of profitability that we are, at 22% and you're in an environment where you're not sure what mix is going to do to your margin and we're heavily investing in selling energy, that does create challenges for us to obtain incremental margin. We've talked in the past about the pathway to profit. Our stated goal and this was a point in time goal, this is an end mark in place, but our stated goal was a number of years ago was to drive the pretax to 23%, which would imply we have another 100 basis points of incremental margin to pick up at some point in time and beyond. Again, that 23% is not a target. It's just a number.
But it's really predicated on the average size of the store. And the average size of the store right now, I forget what it was in the release. 94,000. 94,000. That's what needs to happen to drive that up and we need the top line to drive that.
It gets a little easier if the top line, if we have a good mix of products and our gross margin, has given us a little bit of tailwind. It's good if we're getting a little bit of tailwind in operating leverage. But we're investing in a lot of things right now. We're adding folks into the store, great investments, because we focus on long term.
Our main focus is getting our growth back because if we can do that, that takes care of most of the other things, pre tax profit percent, all the other things. And so we have to stay very focused on that and we believe we're doing the right things to make that happen.
Thank you. And that is all the time we have for questions today. I'd like to turn the conference back to Fast Mall Management for any concluding remarks.
Again, speaking for Will and Lee and myself, we want to thank you again for your support and interest in the Fastenal business and for participating in the call. And have a good day.
Ladies and gentlemen, thanks for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone have a good day.