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| FAST > SEC Filings for FAST > Form 10-Q on 25-Apr-2008 | All Recent SEC Filings |
25-Apr-2008
Quarterly Report
The following is management's discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements. (Dollar amounts are in thousands except for per share amounts and where otherwise noted.)
The following discussion refers to the term daily sales. Daily sales are defined as net sales for a period of time divided by the number of business days in that period of time.
Business Overview - Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies. We distribute these supplies through a network of over 2,200 company owned stores. Most of our customers are in the construction and manufacturing markets. The construction market includes general, electrical, plumbing, sheet metal, and road contractors. The manufacturing market includes both original equipment manufacturers (OEM) and maintenance and repair operations (MRO). Other users of our product include farmers, truckers, railroads, mining companies, federal, state, and local governmental entities, schools, and certain retail trades. Geographically, our stores and customers are primarily located in North America.
Financial Overview - During 2007 and the first three months of 2008, the weakness of the global industrial environment negatively impacted our business. During most of 2006, the strength of the global industrial environment positively impacted our performance. The impact of the economy is best reflected in the growth performance of our stores opened greater than ten years ago (store sites opened as follows: 2008 group - opened 1998 and earlier, and 2007 group - opened 1997 and earlier) and opened greater than five years ago (store sites opened as follows: 2008 group - opened 2003 and earlier, and 2007 group - opened 2002 and earlier). These two groups of stores are more cyclical due to the increased market share they enjoy in their local markets. The stores opened greater than two years ago represent a consistent "same store" view of our business (store sites opened as follows: 2008 group - opened 2006 and earlier, and 2007 group - opened 2005 and earlier). The daily sales growth rate for each of these groups was as follows:
Three months ended
March 31,
Store Age 2008 2007
Opened greater than 10 years ago 6.7 % 4.6 %
Opened greater than 5 years ago 9.1 % 5.5 %
Opened greater than 2 years ago 11.8 % 7.6 %
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Note: The age groups above are measured as of the last day of each respective year.
ITEM 2. (Continued)
Sales Growth - Net sales and growth rates in net sales were as follows:
Three months ended
March 31,
2008 2007
Net sales $ 566,210 489,157
Percentage change 15.8 % 13.3 %
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The increase in net sales in the three month period in 2008 came primarily from higher unit sales, and to a lesser degree, increases in prices. The higher unit sales resulted from increases in sales at older store locations (discussed earlier) and the opening of new store locations in 2007 and 2008.
The mix of sales from the original fastener product line and from the newer product lines was as follows:
Three months ended
March 31,
Product line 2008 2007
Fastener product line 50.2 % 50.8 %
Newer product lines 49.8 % 49.2 %
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Daily sales growth rates for the twelve months of 2006 and 2007, and the first three months of 2008, were as follows (compared to the comparable month in the preceding year):
Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
2006 23.9 % 21.3 % 21.1 % 19.1 % 19.2 % 20.6 % 19.7 % 20.7 % 16.1 % 15.9 % 16.3 % 17.7 %
2007 12.6 % 11.8 % 15.5 % 12.0 % 13.2 % 14.8 % 13.9 % 13.4 % 13.7 % 14.7 % 15.2 % 16.8 %
2008 15.6 % 15.0 % 16.9 %
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The strong growth in the January 2006 to March 2006 time frame generally represents a continuation of the strong environments experienced in 2004 and 2005. The first two months of the second quarter of 2006 experienced weaker sales growth than we expected. The April 2006 growth was negatively impacted by Easter (which occurred in March during 2005), but was still weaker than we expected. The June to August 2006 time frame represents stronger sales activity than the preceding two to three month period. The daily sales growth amount in September 2006 appears weaker due to the difficult comparison with Hurricane Katrina's added sales in September 2005 (approximately $4,000 impact); however, the increase in our daily sales number from August 2006 to September 2006, of 4.1%, is consistent with historical norms. The final three months of 2006 continued in the same variable fashion as the previous six months. The October growth number was negatively impacted by the difficult comparison with Hurricane Katrina's added sales in October 2005 (approximately $1,500 impact). The months of November and December 2006, like the months of April and May 2006, were weaker than expected. The first five months of 2007 continued the trend of a weak economic environment as experienced during 2006 (as described above). The month of March 2007 improved relative to January and February 2007. The month of June 2007 improved relative to April and May 2007. The June improvement was meaningful as it came in a month with fairly challenging comparisons from 2006. Unfortunately, the strength in June moderated in the third quarter. This pulled our daily sales growth rate from the 14.8% in June to 13.5% in the third quarter of 2007. This moderation reflected a continuation of the weaker economic environment experienced in four of the first five months of the year. The final three months of 2007 continued in the same variable fashion as the previous nine months but showed consistent improvement from the third quarter daily sales growth rate of 13.5%. This improvement remained in the first three months of 2008. We believe the improvement in the final months of 2007 and the first three months of 2008 were driven, in part, by our 'pathway to profit' initiative described below.
Pathway To Profit - During April 2007 we disclosed our intention to alter the growth drivers of our business. For most of the last decade, we have used store openings as the primary growth driver of our business (opening approximately 14% new stores each year). As announced in April 2007, we intend to add outside sales personnel into existing stores at a faster rate than historical patterns. We intend to fund this sales force expansion with the occupancy savings generated by opening stores at the rate of 7% to 10% per year (we opened approximately 8.1% new stores in 2007 or 161 stores) versus the historical rate of approximately 14%. Our goal is four-fold: (1) to continue growing our business at a similar rate with the new outside sales investment model, (2) to grow the sales of our average store to $125 thousand per month during the five year period from 2007 to 2012, (3) to enhance the profitability of the overall business by capturing the natural expense leverage that has historically occurred in our existing stores as their sales grow, and (4) to improve the performance of our business due to the more efficient use of working capital (primarily inventory) as our average store size increases.
Store Count and Full-Time Equivalent (FTE) Headcount Growth - In response to the 'pathway to profit', we have increased our year-over-year store count and FTE head count as follows:
March December September June March
2008 2007 2007 2007 2007
Store count 6.8 % 8.1 % 9.7 % 12.5 % 13.4 %
Store personnel - FTE 18.5 % 18.8 % 18.4 % 13.7 % 13.0 %
Distribution and manufacturing
personnel - FTE 10.9 % 7.7 % 12.8 % 9.2 % 8.9 %
Administrative and sales support
personnel - FTE (5.9 )% 1.5 % 2.1 % 4.4 % 15.2 %
Total - FTE 13.5 % 14.1 % 15.0 % 11.5 % 12.5 %
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Store Size and Profitability1 - Approximately 90% and 91% of our sales in the first quarter of 2008 and 2007, respectively, were generated by our stores included in the table set forth below. Our remaining sales related to (1) our in-plant locations, (2) our direct Fastenal Cold Heading business, or (3) our direct import business. Our average store, excluding the business not sold through a store, had sales of $71,600 per month in the first quarter of 2007. This average grew to $76,800 per month in the first quarter of 2008. The average age, number of stores and pre-tax margin data by store size for the first quarter of 2008 and 2007, respectively, was as follows:
Three months ended March 31, 2008
Pre-Tax
Average Number of Percentage of Margin
Sales per Month Age (Years) Stores Stores Percentage
$0 to 30,000 2.6 384 17.3 % (20.2 )%
$30,001 to 60,000 5.2 718 32.4 % 10.3 %
$60,001 to 100,000 7.8 555 25.1 % 20.9 %
$100,001 to $150,000 10.1 342 15.5 % 25.4 %
Over $150,000 13.3 214 9.7 % 27.4 %
Total 2,213 100.0 %
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Three months ended March 31, 2007
Pre-Tax
Average Number of Percentage of Margin
Sales per Month Age (Years) Stores Stores Percentage
$0 to 30,000 1.9 428 20.7 % (22.0 )%
$30,001 to 60,000 5.0 664 32.0 % 10.9 %
$60,001 to 100,000 7.5 493 23.8 % 20.7 %
$100,001 to $150,000 9.6 307 14.8 % 23.8 %
Over $150,000 13.6 181 8.7 % 25.7 %
Total 2,073 100.0 %
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Note - Amounts may not foot due to rounding difference.
As we indicated in April 2007, our goal during the five year period from 2007 to 2012 is to increase the sales of our average store to approximately $125,000 per month by 2012. This will shift the store mix emphasis from the first three categories ($0 to $30,000, $30,001 to $60,000, and $60,001 to $100,000) to the last three categories ($60,001 to 100,000, $100,001 to $150,000, and over $150,000), and we believe this will allow us to leverage our fixed cost and increase our overall productivity.
1Note - Dollar amounts in this section are presented in whole dollars, not thousands.
Impact of Fuel Prices During the Quarter - Rising fuel prices negatively impacted the year ended December 31, 2007 and the first quarter of 2008. During the first quarter of 2007, our total vehicle fuel costs averaged approximately $2.1 million per month. During the first quarter of 2008, our total vehicle fuel costs averaged approximately $2.9 million per month. The increase resulted from variations in fuel costs, the freight initiative discussed below, increases in product sales, and the increase in the number of vehicles necessary to support additional sales personnel and to support additional store locations. These fuel costs include the fuel utilized in our distribution vehicles (semi-tractors, straight trucks, and sprinter trucks) which is recorded in cost of goods and the fuel utilized in our store delivery vehicles which is included in operating and administrative expenses (the split is approximately 50:50 between distribution and store use).
In 2005, we introduced our new freight model as a means to continue to improve our operating performance. The freight model represents a focused effort to haul a higher percentage of our products utilizing the Fastenal trucking network (which operates at a substantial savings to external service providers because of our ability to leverage our existing routes) and to charge freight more consistently in our various operating units. This initiative positively impacted the latter two-thirds of 2005, all of 2006, all of 2007, and the first three months of 2008 despite the changes in average per gallon fuel costs shown in the following table:
2007 - Quarter 2008 - Quarter
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Diesel fuel $ 2.59 2.85 2.94 3.25 $ 3.47
Unleaded gasoline $ 2.31 2.96 2.86 2.92 $ 3.07
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The price of a gallon of diesel fuel and unleaded gasoline increased by 34.0% and 32.9%, respectively, from the first quarter of 2007 to first quarter of 2008. Given the nature of our distribution business, these fluctuations in fuel prices can have a meaningful impact on our short-term results. This impact is also covered later in our discussion about gross margin and operating and administrative expenses.
Statement of Earnings Information (percentage of net sales) -
Three Months Ended
March 31,
2008 2007
Net sales 100.0 % 100.0 %
Gross profit margin 52.4 % 51.0 %
Operating and administrative expenses 32.9 % 32.9 %
Loss on sale of property and equipment 0.0 % 0.0 %
Operating income 19.4 % 18.1 %
Interest income 0.0 % 0.0 %
Earnings before income taxes 19.4 % 18.1 %
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Note - Amounts may not foot due to rounding difference.
Gross profit margins for the first quarter of 2008 increased over the same period in 2007. The improvement was driven by several factors: (1) a focused effort to challenge our sales force to increase the gross margin on business with a lower than acceptable margin, (2) a focused effort to stay ahead of inflationary increases in product cost, (3) improvements in our direct sourcing operations and (4) continued focus on our freight initiative (discussed earlier). The rising fuel costs discussed earlier had only a nominal negative impact on our gross margin in the first quarter of 2008 because of item (4). This impact could prove more challenging if fuel costs continue to increase.
Operating and administrative expenses grew at a rate consistent with net sales in the first three months of 2008. As noted in the 'pathway to profit' discussion earlier in this report, we expected to see operating and administrative expenses grow at a rate slower than sales growth due to the added leverage that occurs as the size of our average store increases. On a positive note, we were able to leverage our occupancy costs for the first time since earlier in the decade. Occupancy expenses grew approximately 10.9% in the first quarter of 2008. This leverage was due to the decrease in store openings pursuant to our 'pathway to profit' initiative.
As we have noted in the past, almost 70% of our operating and administrative expenses consist of payroll and payroll related costs. Our employee head count (measured on a full-time equivalent basis) increased 13.5% from March 2007 to March 2008. However, our payroll costs increased approximately 16.9% and did not leverage. This de-leverage occurred because the commission and bonus component of payroll grew approximately 20.5% from the first quarter of 2007 to the first quarter of 2008 (this was driven at the store and district level). Our employees are rewarded for growth in gross profit dollars and pre-tax earnings. The gross profit margin expansion discussed earlier drove this reward faster than sales growth. The other component of
operating and administrative expenses that experienced meaningful de-leverage was transportation cost. These costs grew approximately 27.3%, primarily driven by the increase in fuel costs discussed earlier and by the increase in the number of vehicles needed to support an expanded sales force.
The operating and administrative expenses for the three months of 2008 include $673 of additional compensation expense related to the adoption of new stock option accounting rules. This expense relates to options granted in April 2007. We anticipate these options, which vest in five to eight years, will result in compensation expense of approximately $224 per month for the next five years; and dropping slightly in the remaining period. No other stock based compensation was outstanding during these periods; however, we did grant additional options during April 2008.
Income taxes, as a percentage of earnings before income taxes, were approximately 38.2% and 39.1% for the first quarter of 2008 and 2007, respectively. During the first quarter of 2007, we implemented FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN No. 48). As defined in FIN No. 48, we had a discrete event during the first quarter of 2007 which resulted in recognition of approximately $827 of additional tax. Absent this event, our tax rate would have been 38.2% for the first quarter of 2007. This rate fluctuates over time based on the income tax rates in the various jurisdictions in which we operate, and based on the level of profits in those jurisdictions.
Net earnings - Net earnings, net earnings per share, and their respective growth rates were as follows:
Three months ended
March 31,
2008 2007
Net earnings $ 68,094 54,033
Percentage change 26.0 % 12.9 %
Basic and diluted net earnings per share $ 0.46 0.36
Percentage change 27.8 % 12.5 %
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We increased our net earnings in the three month period primarily due to the aforementioned growth in sales and in the gross margin percentage.
ITEM 2. (Continued)
Working Capital - The year-over-year dollar and percentage growth related to
accounts receivable and inventories were as follows:
Twelve Month Twelve Month
Balance at Dollar Change Percentage Change
Year-over-year change March 31, March 31, March 31,
2008 2007 2008 2007 2008 2007
Accounts receivable, net $ 273,360 238,657 $ 34,703 26,140 14.5 % 12.3 %
Inventories $ 494,360 446,192 $ 48,168 75,097 10.8 % 20.2 %
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These two assets were impacted by our initiatives to improve working capital. These initiatives include (1) the establishment of a centralized call center to facilitate accounts receivable management (this facility became operational early in 2005) and (2) the tight management of all inventory amounts not identified as either expected store inventory, new expanded inventory, inventory necessary for upcoming store openings, or inventory necessary for our 'master stocking hub'.
The accounts receivable increase of 12.3% from March 31, 2006 to March 31, 2007 represents a lag behind the daily sales increase of 15.5% in March 2007. The accounts receivable increase of 14.5% from March 31, 2007 to March 31, 2008 also represents a lag behind the 16.9% daily sales increase in March 2008. We continue to be pleased with the improvement in accounts receivable during 2007 and 2008, and with the related reduction in bad debt expense when compared to historical amounts.
The inventory increase from March 31, 2006 to March 31, 2007 of 20.2% is greater than the rate of sales growth of 13.3% from the first quarter of 2006 to the first quarter of 2007. The inventory increase from March 31, 2007 to March 31, 2008 of 10.8% is less than the rate of sales growth of 15.8% from the first quarter of 2007 to the first quarter of 2008. This improvement relates to our conscious decision to limit the growth of inventory in the future, to halt growth or decrease inventory in the short-term, to stock additional products in our Indianapolis, Indiana distribution center, and then to resize the existing store and distribution center inventory through a process we call inventory re-distribution.
As we indicated in earlier communications, our short-term goals center on our ability to move the ratio of annual sales to accounts receivable and inventory (Annual Sales: AR&I) back to better than a 3.0:1 ratio (on December 31, 2007, 2006, and 2005, we had a ratio of 2.8:1, 2.7:1 and 2.8:1, respectively). Historically, we have been able to achieve a 20% after tax return on total assets (our historical internal goal) when our Annual Sales: AR&I ratio is at or above 3.0:1. During 2006, the incremental investments did not allow us to improve our ratio (these investments include certain store upgrades and the implementation of our 'master stocking hub' model). In 2007, we made considerable improvement as detailed above. We need to continue executing better on the inventory portion of these working capital initiatives in 2008. Please refer to our discussion on 'pathway to profit' earlier.
Fiscal 2008 Reporting - As indicated in our 2007 Annual Report, we intend to focus our 2008 commentary away from the four initiatives discussed in earlier communications (new freight model, working capital model, expanded store model called CSP2, and 'master stocking hub' distribution model); instead we will focus our commentary on the 'pathway to profit'. Some key aspects we intend to disclose center on the full-time equivalent statistics shown above, as well as information on the productivity of our outside sales personnel; the latter being information we intend to start disclosing after the second quarter when we are one year into the 'pathway to profit' which began in the spring of 2007.
Critical Accounting Policies - A discussion of the critical accounting policies related to accounting estimates is contained in our 2007 Annual Report to Shareholders.
Liquidity and Capital Resources -
Cash flow activity was as follows:
Three months ended
March 31,
2008 2007
Net cash provided by operating activities $ 86,736 84,455
Net cash used in investing activities $ 31,603 9,482
Net cash used in financing activities $ 37,280 35,019
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Cash flow activity as a percentage of net earnings was as follows:
Three months ended
March 31,
2008 2007
Net cash provided by operating activities 127.4 % 156.3 %
Net cash used in investing activities 46.4 % 17.5 %
Net cash used in financing activities 54.7 % 64.8 %
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Net cash provided by operating activities has increased from the prior year as the growth in net earnings was aided by improving trends in working capital management (discussed earlier). This improvement was partially offset by the timing of payments for our profit sharing bonuses and income taxes; both of which increased in meaningful fashion due to our increase in pre-tax earnings.
Net cash used in investing activities changed primarily due to changes in marketable securities and property and equipment.
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