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FAST > SEC Filings for FAST > Form 10-Q on 16-Jul-2014All Recent SEC Filings

Show all filings for FASTENAL CO

Form 10-Q for FASTENAL CO


16-Jul-2014

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements. (Dollar amounts are stated in thousands except for per share amounts and where otherwise noted.)
BUSINESS DISCUSSION
Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies. We distribute these supplies through a network of approximately 2,700 company owned stores. Most of our customers are in the manufacturing and non-residential construction markets. The manufacturing market includes both original equipment manufacturers (OEM) and maintenance and repair operations (MRO). The non-residential construction market includes general, electrical, plumbing, sheet metal, and road contractors. Other users of our product include farmers, ranchers, 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.
Similar to previous quarters, we have included comments regarding several aspects of our business:
1. Monthly sales changes, sequential trends, and end market performance - a recap of our recent sales trends and some insight into the activities with different end markets.

2. Growth drivers of our business - a recap of how we grow our business.

3. Profit drivers of our business - a recap of how we increase our profits.

4. Statement of earnings information - a recap of the components of our income statement.

5. Operational working capital, balance sheet, and cash flow - a recap of the operational working capital utilized in our business, and the related cash flow.

While reading these items, it is helpful to appreciate several aspects of our marketplace: (1) it's big, the North American marketplace for industrial supplies is estimated to be in excess of $160 billion per year (and we have expanded beyond North America), (2) no company has a significant portion of this market, (3) many of the products we sell are individually inexpensive, (4) when our customer needs something quickly or unexpectedly our local store is a quick source, (5) the cost and time to manage and procure these products is meaningful, (6) the cost to move these products, many of which are bulky, can be significant, (7) many customers would prefer to reduce their number of suppliers to simplify their business, and (8) many customers would prefer to utilize various technologies to improve availability and reduce waste. Our motto is Growth through Customer Service®. This is important given the points noted above. We believe in efficient markets - to us, this means we can grow our market share if we provide the greatest value to our customers. We believe our ability to grow is amplified if we can service our customers at the closest economic point of contact. For us, this 'closest economic point of contact' is the local store; therefore, our focus centers on understanding our customers' day, their opportunities, and their obstacles.
The concept of growth is simple, find more customers every day and increase your activity with them. However, execution is hard work. First, we recruit service minded individuals to support our customers and their business. Second, we operate in a decentralized fashion to help identify the greatest value for our customers. Third, we build a great machine behind the store to operate efficiently and to help identify new business solutions. Fourth, we do these things every day. Finally, we strive to generate strong profits; these profits produce the cash flow necessary to fund the growth and to support the needs of our customers.


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SALES GROWTH
Net sales and growth rates in net sales were as follows:
Note - Daily sales are defined as the total net sales for the period divided by
the number of business days (in the United States) in the period.
                       Six-month period           Three-month period
                      2014           2013          2014         2013
Net sales         $ 1,826,439     1,653,922     $ 949,938     847,596
Percentage change        10.4 %         5.1 %        12.1 %       5.3 %


                                               Six-month period             Three-month period
                                              2014           2013           2014           2013
Daily sales growth rate                       10.4  %          5.9  %       12.1  %          5.3  %
Impact of currency fluctuations
(primarily Canada)                            -0.5  %         -0.1  %       -0.4  %         -0.1  %

The increase in net sales in the periods noted for 2014 and 2013 came primarily from higher unit sales. Our growth in net sales was impacted by slight inflationary price changes in our non-fastener products and some price deflation in our fastener products, but the net impact was a drag on growth. Our growth in net sales was not meaningfully impacted by the introduction of new products or services, with one exception. Over the last several years, our FAST Solutions® (industrial vending) initiative has stimulated faster growth with a subset of our customers (discussed later in this document). The higher unit sales resulted primarily from increases in sales at older store locations (discussed below and again later in this document) and to a lesser degree the opening of new store locations in the last several years. The growth in net sales at the older store locations was due to the growth drivers of our business (discussed later in this document). The impact of change in currencies in foreign countries (primarily Canada) relative to the United States dollar is noted in the table above. The stores opened greater than two years represent a consistent 'same store' view of our business (store sites opened as follows: 2014 group - opened 2012 and earlier, and 2013 group - opened 2011 and earlier). However, the impact of the economy is best reflected in the growth performance of our stores opened greater than five years (store sites opened as follows: 2014 group - opened 2009 and earlier, and 2013 group - opened 2008 and earlier) and opened greater than ten years (store sites opened as follows: 2014 group - opened 2004 and earlier, and 2013 group - opened 2003 and earlier). These two groups of stores are more cyclical due to the increased market share they enjoy in their local markets. The daily sales change for each of these groups was as follows:

                               Six-month Period        Three-month Period
                               2014         2013        2014          2013
Store Age
Opened greater than 2 years     9.1 %        4.2 %       10.7 %        3.6 %
Opened greater than 5 years     8.3 %        3.1 %       10.0 %        2.7 %
Opened greater than 10 years    7.6 %        1.6 %        9.4 %        1.3 %

Note: The age groups above are measured as of the last day of each respective calendar year.

SALES BY PRODUCT LINE:
The mix of sales from the original fastener product line and from the other
product lines was as follows:
                        Six-month Period       Three-month Period
                         2014       2013        2014         2013
Fastener product line    40.4 %     43.1 %      40.6 %        43.1 %
Other product lines      59.6 %     56.9 %      59.4 %        56.9 %
                        100.0 %    100.0 %     100.0 %       100.0 %


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MONTHLY SALES CHANGES, SEQUENTIAL TRENDS, AND END MARKET PERFORMANCE This section focuses on three distinct views of our business - monthly sales changes, sequential trends, and end market performance. The first discussion regarding monthly sales changes provides a good mechanical view of our business based on the age of our stores. The second discussion provides a framework for understanding the sequential trends (that is, comparing a month to the immediately preceding month, and also looking at the cumulative change from an earlier benchmark month) in our business. Finally, we believe the third discussion regarding end market performance provides insight into activities with our various types of customers.
Monthly Sales Changes:
All company sales - During the months noted below, all of our selling locations, when combined, had daily sales growth rates of (compared to the same month in the preceding year):

      Jan.     Feb.     Mar.     Apr.     May      June     July     Aug.    Sept.    Oct.    Nov.    Dec.
2014  6.7 %    7.7 %   11.6 %   10.0 %   13.5 %   12.7 %
2013  6.7 %    8.2 %    5.1 %    4.8 %    5.3 %    6.0 %    2.9 %    7.2 %    5.7 %   7.7 %   8.2 %   6.7 %

2012 21.3 % 20.0 % 19.3 % 17.3 % 13.1 % 14.0 % 12.1 % 12.0 % 12.9 % 6.8 % 8.2 % 9.7 %

Stores opened greater than two years - Our stores opened greater than two years (store sites opened as follows: 2014 group - opened 2012 and earlier, 2013 group
- opened 2011 and earlier, and 2012 group - opened 2010 and earlier) represent a consistent 'same-store' view of our business. During the months noted below, the stores opened greater than two years had daily sales growth rates of (compared to the same month in the preceding year):

      Jan.     Feb.     Mar.     Apr.     May      June    July    Aug.    Sept.    Oct.    Nov.    Dec.
2014  5.5 %    6.5 %   10.2 %    8.4 %   12.1 %   11.4 %
2013  5.0 %    6.5 %    3.4 %    3.1 %    3.5 %    4.3 %   1.4 %   5.5 %    4.2 %   6.1 %   6.2 %   4.9 %

2012 18.8 % 17.1 % 16.8 % 14.5 % 10.1 % 11.1 % 9.1 % 8.6 % 9.8 % 3.8 % 5.1 % 6.6 %

Stores opened greater than five years - The impact of the economy, over time, is best reflected in the growth performance of our stores opened greater than five years (store sites opened as follows: 2014 group - opened 2009 and earlier, 2013 group - opened 2008 and earlier, and 2012 group - opened 2007 and earlier). This group, which represented about 90% of our total sales in the first six months of 2014, is more cyclical due to the increased market share they enjoy in their local markets. During the months noted below, the stores opened greater than five years had daily sales growth rates of (compared to the same month in the preceding year):

      Jan.     Feb.     Mar.     Apr.     May      June    July    Aug.    Sept.    Oct.    Nov.    Dec.
2014  4.6 %    5.4 %    9.5 %    7.7 %   11.5 %   10.8 %
2013  3.2 %    5.6 %    2.3 %    2.0 %    2.7 %    3.4 %   0.6 %   4.7 %    3.2 %   5.3 %   6.1 %   4.8 %

2012 17.4 % 15.8 % 15.7 % 13.7 % 9.0 % 10.2 % 8.3 % 7.9 % 8.5 % 2.6 % 4.6 % 5.6 %

Summarizing comments - There are three distinct influences to our growth: (1) execution, (2) currency fluctuations, and (3) economic fluctuations. This discussion centers on (2) and (3).
The change in currencies in foreign countries (primarily Canada) relative to the United States dollar impacted our growth over the last several years. During the years 2012 and 2013, it lowered our growth by 0.1% and 0.2%, respectively. In the first six months of 2014 it lowered our growth by 0.5%.
During 2012, the growth in the first three and a half months generally continued the relative strength we saw in 2011. Then we began to experience several distinct economic slowdowns. The first occurred in the late April/May time frame, and then moderated until September 2012. The second occurred in the October/November time frame. This was exaggerated by the impact of Hurricane Sandy and an unusual business day comparison in October (23 days in 2012 versus 21 days in 2011 - the maintenance portion of our business is often linked to monthly spend patterns of our customers, which are not as business day dependent, this can dilute the daily growth picture given the change in business day divisor). The third occurred in the spring of 2013. This involved our fastener product line and our construction business (primarily non-residential construction). This third slowdown, similar to the first two listed, mirrored or slightly led some softening in the PMI Index. The PMI Index is a composite index of economic activity in the United States manufacturing sector. It is published by the Institute for Supply Management and is available at http://www.ism.ws/. The fastener piece was heavily impacted by our industrial production business. These customers utilize our fasteners in the manufacture/assembly of their finished products. The end markets with the most pronounced weakening included heavy machinery manufacturers with exposure to: mining, military, agriculture, and construction. The fourth and fifth occurred in July 2013 and December 2013. The daily sales growth in July 2013 and


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December 2013 were negatively impacted by the timing of the July 4th holiday (Thursday in 2013, Wednesday in 2012, Monday in 2011) and the Christmas/New Year holiday (Wednesday in 2013, Tuesday in 2012, and Sunday in 2011). This resulted in a 'lone' business day on Friday, July 5, 2013, in which many of our customers were closed, and three distinct one to two day work periods in the last two weeks of December 2013. The December impact was amplified due to poor weather conditions.
Our daily sales growth trends have improved since September 2013. This was largely related to changing comparisons to 2012 and to the improving sequential patterns noted in the next discussion. Our sales to customers engaged in light and medium duty manufacturing (largely related to consumer products) are improving; this makes sense given the trends in the PMI Index. In the first quarter of 2014, our sales growth was hampered in January and February due to a weak economy and foreign exchange rate fluctuations (primarily related to the Canadian dollar); however, the biggest impact was a severe winter in North America and its negative impact on our customers and our trucking network. In March 2014, the weak economy and negative foreign exchange rate fluctuations continued; however, the weather normalized and our daily sales growth expanded to 11.6%. This double digit growth in March was helped by the Easter timing (April in 2014), but the real story is good people, good execution, and minimal negative weather impacts. In the second quarter of 2014, the negative impact of the Easter timing was felt, and then a 'less noisy' picture emerged in May and June. One optimistic observation; our sales to customers engaged in heavy machinery manufacturing (primarily serving the mining, military, agricultural, and construction end markets), which represents approximately one fifth of our business, had a very weak 2013, but stabilized late in 2013 and has improved in the first six months of 2014. Sequential Trends:
We find it helpful to think about the monthly sequential changes in our business using the analogy of climbing a stairway - This stairway has several predictable landings where there is a pause in the sequential gain (i.e. April, July, and October to December), but generally speaking, climbs from January to October. The October landing then establishes the benchmark for the start of the next year.
History has identified these landings in our business cycle. They generally relate to months with impaired business days (certain holidays). The first landing centers on Easter, which alternates between March and April (Easter occurred in April 2014, March 2013, and April 2012), the second landing centers on July 4th, and the third landing centers on the approach of winter with its seasonal impact on primarily our construction business and with the Christmas/New Year holiday. The holidays we noted impact the trends because they either move from month-to-month or because they move around during the week (the July 4th and Christmas/New Year holiday impacts are examples). The table below shows the pattern to the sequential change in our daily sales. The line labeled 'Benchmark' is an historical average of our sequential daily sales change for the period 1998 to 2013, excluding 2008 and 2009. We believe this time frame will serve to show the historical pattern and could serve as a benchmark for current performance. We excluded the 2008 to 2009 time frame because it contains an extreme economic event and we don't believe it is comparable. The '2014', '2013', and '2012' lines represent our actual sequential daily sales changes. The '14Delta', '13Delta', and '12Delta' lines indicate the difference between the 'Benchmark' and the actual results in the respective year.

                                                                                                                 Cumulative
                                                                                                                 Change from
                                                                                                                   Jan. to
          Jan. 1     Feb.      Mar.      Apr.       May      June      July      Aug.      Sept.     Oct.      June      Oct.
Benchmark  0.8  %    2.2  %    3.8  %    0.4  %    3.1  %    2.7  %   -2.1  %    2.5  %    3.7  %   -1.2  %   12.6  %   15.9  %
2014      -1.4  %    3.0  %    7.1  %   -2.6  %    4.2  %    2.5  %                                           14.8  %
14Delta   -2.2  %    0.8  %    3.3  %   -3.0  %    1.1  %   -0.2  %                                            2.2  %
2013      -0.4  %    2.0  %    3.4  %   -1.1  %    1.0  %    3.2  %   -5.5  %    5.5  %    2.9  %   -2.9  %    8.7  %    8.2  %
13Delta   -1.2  %   -0.2  %   -0.4  %   -1.5  %   -2.1  %    0.5  %   -3.4  %    3.0  %   -0.8  %   -1.7  %   -3.9  %   -7.7  %
2012      -0.3  %    0.5  %    6.4  %   -0.8  %    0.5  %    2.5  %   -2.7  %    1.3  %    4.3  %   -4.8  %    9.3  %    7.1  %
12Delta   -1.1  %   -1.7  %    2.6  %   -1.2  %   -2.6  %   -0.2  %   -0.6  %   -1.2  %    0.6  %   -3.6  %   -3.3  %   -8.8  %

(1) The January figures represent the percentage change from the previous October, whereas the remaining figures represent the percentage change from the previous month.


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A graph of the sequential daily sales change pattern discussed above, starting with a base of '100' in the previous October and ending with the next October, would be as follows:

[[Image Removed]]
End Market Performance:
The momentum has been building in our business during 2014. To highlight this
strength, we included the June 2014 daily sales growth rate in the tables below.
Fluctuations in end market business - The sequential trends noted above were
directly linked to fluctuations in our end markets. To place this in perspective
- approximately 50% of our business has historically been with customers engaged
in some type of manufacturing. The daily sales to these customers grew, when
compared to the same period in the prior year, as follows:
                      Q1       Q2       Q3      Q4     Annual
2014 (June = 12.0%)  9.0 %   11.2 %
2013                 7.0 %    5.9 %    4.7 %   7.2 %     6.3 %
2012                20.3 %   15.8 %   14.0 %   9.7 %    14.9 %

Our manufacturing business consists of two subsets: the industrial production business (this is business where we supply products that become part of the finished goods produced by our customers and is sometimes referred to as OEM - original equipment manufacturing) and the maintenance portion (this is business where we supply products that maintain the facility or the equipment of our customers engaged in manufacturing). The industrial business is more fastener centered, while the maintenance portion is represented by all product categories.
The best way to understand the change in our industrial production business is to examine the results in our fastener product line (just over 40% of our business) and to factor in the changes in our business with heavy equipment manufacturers (discussed earlier in this document). From a company perspective, sales of fasteners grew, when compared to the same period in the prior year, as follows (note: this information includes all end markets):

                     Q1      Q2      Q3      Q4     Annual
2014 (June = 6.6%)  1.6 %   5.5 %
2013                1.7 %   1.9 %   1.0 %   1.9 %     1.6 %
2012               15.4 %   8.0 %   6.0 %   2.6 %     7.8 %

By contrast, the best way to understand the change in the maintenance portion of the manufacturing business is to examine the results in our non-fastener product lines. From a company perspective, sales of non-fasteners grew, when compared to the same period in the prior year, as follows (note: this information includes all end markets):


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Q1 Q2 Q3 Q4 Annual
2014 (June = 17.5%) 14.2 % 17.1 %
2013 10.8 % 8.5 % 8.9 % 12.0 % 10.1 % 2012 25.1 % 21.1 % 18.0 % 13.6 % 19.2 %

The non-fastener business demonstrated greater relative resilience over the last several years, when compared to our fastener business and to the distribution industry in general, due to our strong FAST Solutions® (industrial vending) program; this is discussed in greater detail later in this document. However, this business was not immune to the impact of a weak industrial environment. Our non-residential construction customers have historically represented 20% to 25% of our business. The daily sales to these customers grew when compared to the same period in the prior year, as follows:

                     Q1       Q2      Q3      Q4     Annual
2014 (June = 8.8%)  2.9 %    7.5 %
2013                2.9 %    0.7 %   3.9 %   2.8 %     2.5 %
2012               17.1 %   12.7 %   8.2 %   4.2 %    10.3 %

We believe the weakness in the economy in the fourth quarter of 2012, throughout 2013, and during early 2014, particularly in the non-residential construction market, was amplified by the global economic uncertainty combined with the economic policy uncertainty in the United States. This weakness was amplified by severe winter weather conditions in January and February 2014.
A graph of the sequential daily sales trends to these two end markets in 2014, 2013, and 2012, starting with a base of '100' in the previous October and ending with the next October, would be as follows:

Manufacturing
[[Image Removed]]


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Non-Residential Construction
[[Image Removed]]
GROWTH DRIVERS OF OUR BUSINESS
We grow by continuously adding customers and by increasing the activity with each customer. We believe this growth is enhanced by our close proximity to our customers, which allows us to provide a range of services and product availability that our competitors can't easily match. Historically, we expanded our reach by opening stores at a very fast pace. These openings were initially in the United States, but expanded beyond the United States beginning in the mid 1990's.
For a little perspective, we began our business in 1967 with an idea to sell nuts and bolts (fasteners) through vending machines. We soon learned the technology of the 1960's wasn't ready, and also learned a lot of products didn't fit, so we went to 'Plan B'; sell to business users with a direct sales force. It took us a number of years to 'work out the bugs', but ten years later we began to pick up the pace of store openings. After another ten years of expansion we had approximately 50 stores and sales of about $20 million. Our need for cash was growing, as was our desire to allow employee ownership. This led us to a public offering in 1987.
In our first ten years of being public (1987 to 1997), we opened stores at an annual rate approaching 30%. In the next ten years (1997 to 2007), we opened stores at an annual rate of approximately 10% to 15% and, since 2007, at an annual rate of approximately 2% to 8%. We opened 17 stores in the first six months of 2014 and currently expect to open approximately 35 to 40 stores in total for 2014, or an annual rate of approximately 1% to 2%.
During our almost 50 years of business existence, we have constantly evolved to better serve the market (as is described in the paragraphs below) and have always been willing to challenge our approach. In our first 20 to 25 years we closed several store locations because we felt the market was insufficient to operate a profitable business. Every one of those locations was subsequently 'reopened' when our business model evolved to serve these markets profitably. During the last 20 to 25 years, we have enjoyed continued success with our store-based model, and we continue to challenge our approach. Based on this approach, we have closed approximately 85 stores in the last ten years - not because they weren't successful, but rather because we felt we had a better approach to growth. In the first six months of 2014, we have continued to challenge our approach and closed 20 stores (all but four of these locations were in close proximity to another Fastenal store). In the second quarter of 2014 we took a hard look at our business and identified another 45 stores we intend to close in the second half of 2014 (all but eight of these locations are in close proximity to another Fastenal store). Several items we think are noteworthy: the group of stores we identified for closure in the second half of 2014 was profitable in the first quarter of 2014 (our analysis measurement period); they operated with average sales of about $36 thousand per month. We chose to close this group because we felt this was simply a better approach to growing our business profitably.
There is a short-term price for closing these stores; and, since we believe we will maintain the vast majority of the sales associated with these locations and since most of the impacted employees have a nearby store from which to operate, the price primarily relates to the future commitments related to the leased locations. During the second quarter of 2014, we recorded the impaired future costs related to these commitments. The expense was not material as these locations have relatively short lease commitments and minimal leasehold improvements.


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During the years, our expanding footprint has provided us with greater access to more customers, and we have continued to diversify our growth drivers. This was done to provide existing store personnel with more tools to grow their business organically, and the results of this are reflected in our earlier discussion on sales growth at stores opened greater than five years. In the early 1990's, we began to expand our product lines, and we added new product knowledge to our bench (the non-fastener products now represent over 50% of our sales). This was our first big effort to diversify our growth drivers. The next step began in the . . .

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