FAST

Business Context and Reporting Period

Company: Fastenal Company
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2007
Business Overview: Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies, operating over 2,000 company-owned stores. The company serves construction and manufacturing markets, including original equipment manufacturers (OEM) and maintenance, repair, and operations (MRO).

Key Financial Metrics

Note: All amounts in thousands except per share data. The company had no outstanding debt on its $40 million lines of credit as of March 31, 2007.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 13.3% year-over-year, driven primarily by higher unit sales from new store openings and growth at older store sites, with a lesser contribution from price increases.
• Margin Expansion: Gross profit margin improved to 51.0% from 50.4%, attributed to a new freight model and improvements in direct sourcing operations.
• Expense Growth: Operating and administrative expenses grew faster than sales (32.9% of sales vs. 32.5% prior year), primarily due to increased occupancy costs from new store openings and CSP2 store conversions.
• Working Capital: Accounts receivable increased 12.3% year-over-year, while inventories increased 20.2%. Management noted a conscious decision to limit inventory growth in the short term, resulting in a decrease in inventory levels from December 2006 to March 2007.
• Share Repurchases: The company purchased 100,000 shares of common stock in Q1 2007 at an average price of $34.35 per share.

Guidance, Outlook, and Risks

• Store Expansion Strategy: Management outlined a "Pathway to Profit and Shareholder Wealth" plan, targeting 7% to 10% annual store growth. With 2,000 stores at year-end 2006, the company expects to open approximately 140 to 200 stores in 2007. 73 stores were opened in Q1 2007.
• Operational Initiatives: Continued conversion of stores to the CSP2 format (expanded inventory and sales personnel) and the implementation of a "master stocking hub" in Indianapolis to improve distribution efficiency.
• Fuel Costs: While fuel prices softened in Q1 2007 (average $2.59/gallon), rising fuel costs remain a risk factor. The company's freight initiative has helped mitigate these costs.
• Tax Rate: The effective tax rate was 39.1% in Q1 2007. A discrete event added $827 in tax expense. A new jurisdictional tax law passed in April 2007 is expected to increase the core tax rate by 0.1% in Q2 2007.
• Risks: Forward-looking statements are subject to risks including economic downturns, disruption in store format conversions, and the ability to attract qualified personnel. The company faces exposure to commodity steel pricing and foreign currency exchange rates (primarily Canadian dollar).

Investor Verification Checklist

• Inventory Management: Verify the execution of inventory reduction strategies, as inventory growth (20.2%) currently outpaces sales growth (13.3%), impacting the target Annual Sales: AR&I ratio of 3.0:1.
• Store Profitability Timeline: Monitor the 10-12 month ramp-up period for new stores to achieve profitability, as new openings impact short-term earnings leverage.
• Freight Initiative Impact: Assess the continued effectiveness of the internal trucking network in offsetting volatile diesel fuel costs.
• Stock Repurchase Program: Track the utilization of the remaining 986,000 shares authorized for repurchase under the January 2007 authorization.
• Tax Rate Volatility: Watch for the impact of the new jurisdictional tax legislation on the effective tax rate in the second quarter of 2007.