FAST

Business Context and Reporting Period

Company: Fastenal Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies, operating over 1,900 company-owned stores. The customer base primarily includes construction and manufacturing markets.

Key Financial Metrics

Note: The company has two lines of credit totaling $40 million, with $0 outstanding as of September 30, 2006.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 19.4% for the nine months and 16.9% for the three months ended September 30, 2006, compared to the prior year. Growth was driven by higher unit sales and price increases.
• Profitability: Net earnings rose 20.2% (nine months) and 17.7% (three months). Gross margins improved due to a new freight model and direct sourcing initiatives.
• Operating Expenses: Operating and administrative expenses grew faster than net sales (32.1% of sales vs. 31.5% prior year) due to rising fuel costs, occupancy costs, and employee increases related to the CSP2 store conversion initiative.
• Working Capital: Accounts receivable increased 13.6% and inventories increased 18.9% year-over-year. The inventory increase was attributed to new store openings, CSP2 conversions, and sales growth.
• Cash Position: Cash and cash equivalents decreased significantly from $56.2 million at year-end 2005 to $7.4 million at September 30, 2006, primarily due to capital expenditures ($63.6 million) and financing activities including dividends ($60.5 million) and stock repurchases ($17.3 million).

Guidance, Outlook, and Risks

• Store Expansion: The company plans to open approximately 13% to 18% new stores annually. For 2006, this targets 228 to 316 new stores. New stores typically take 10-12 months to achieve profitability.
• CSP2 Initiative: 135 stores were converted to the expanded CSP2 format in the first nine months of 2006. This initiative aims to drive additional product sales to existing customers.
• Working Capital Goals: Management aims for an Annual Sales to Accounts Receivable and Inventory ratio of better than 3.0:1 to achieve a 20% after-tax return on total assets. Management stated they do not expect to achieve this goal by the end of 2006.
• Stock Repurchases: The company has repurchased 474,000 shares since the June 2006 authorization, with approximately 86,000 shares remaining available under current authorizations.
• Risks: Key risks include economic downturns affecting new store profitability, rising fuel costs, disruption from CSP2 implementation, and changes in commodity steel pricing. The company noted that the third quarter of 2006 was negatively impacted by having one fewer business day than the prior year and the absence of Hurricane Katrina-related sales seen in 2005.

Investor Verification Checklist

• Verify the sustainability of gross margin improvements given rising fuel costs and the impact of the new freight model.
• Monitor the "Annual Sales: AR&I" ratio to assess if the company can return to its 3.0:1 target for optimal asset returns.
• Track the profitability timeline of the 222 new stores opened in 2005 and those opened in 2006.
• Review the impact of the CSP2 store conversions on same-store sales growth versus the cost of implementation.
• Assess the company's liquidity position given the significant drawdown in cash reserves to fund dividends, buybacks, and capital expenditures.