Fastenal (FAST) Reports In-Line Q3 EPS

Fastenal (NASDAQ: FAST) reported Q3 EPS of $0.45, in-line with the analyst estimate of $0.45. Revenue for the quarter came in at $980.8 million versus the consensus estimate of $977.9 million.

BUSINESS UPDATE

In July 2013, we disclosed our intention to increase our investment in people at the store level and in additional leadership personnel at the district and regional levels. We felt this expanded investment was necessary to add 'selling energy' to the organization. With expanded investment comes expanded expectations - in July 2013 we grew average daily sales over the same month in the preceding year in the low single digits, in September 2014 we grew average daily sales over the same month in the preceding year by 12.9%.

We believe these investments in 'selling energy', when combined with the related investments in 'support energy' (people, distribution, and internal manufacturing capabilities), in new store locations, and in FAST Solutions® (industrial vending) devices gives us a great platform for growth. Set forth below is information related to average employee headcount during the quarters indicated and actual employee headcount, store count, and FAST Solutions® (industrial vending) device count as of the end of the periods indicated:

In our second quarter 2014 earnings release we discussed the shorter term impacts we were seeing related to gross profit and working capital. The first of these, gross profit, received numerous questions on our follow-up earnings call. Therefore, we felt a revisit of the 'pathway to profit' leverage within our business model was appropriate.

Later in this document there is a discussion about the 'Profit Drivers of Our Business', it is very similar to the discussion in prior quarters. This discussion summarizes the relative profitability of our business based on store size (size defined by monthly sales). Here is an important item to note, our relative gross profit declines as our stores get larger. This occurs because a larger store has larger customers, and these larger customers have more focused buying patterns. These focused buying patterns allow us to offer better pricing (hence the lower gross profit); however, these focused buying patterns also allow us to operate with lower relative operating expenses. This is also part of the 'pathway to profit'. To quantify this, the average gross profit in our two largest groups of stores (stores with net sales of $100 thousand to $150 thousand per month and greater than $150 thousand per month) was approximately 90 basis points (or 0.9 percentage points) below the total store average in the most recent quarter. Conversely, the average gross profit at our smallest two groups of stores (stores with net sales of less than $30 thousand per month and $30 thousand to $60 thousand per month) was approximately 220 basis points above the total store average.

In the second and third quarters of this year, our gross profit was slightly below the range we have cited over the last several years (a range of 51% to 53%). Since 2010, we have had about 60% of our quarters in the range of 51% to 52%. We are optimists; therefore, we previously disclosed that we believe a range of 51% to 53% would be normal. However, given our performance, we now believe a range of 51% to 52% or simply 'around 51%' would probably be more appropriate.

As we indicated last quarter, sales growth and the resulting increase in average sales per store is the greatest driver of our long-term operating profit gains. We state this because we understand our gross profit percentage typically declines as our average store grows, but history shows our operating expenses as a percentage of net sales will typically fall much faster and will produce the profit expansion inherent in our 'pathway to profit'. For example, the group of large stores identified above with approximately 90 basis points of lower gross profit have pre-tax profit margins approximately 350 basis points higher than the total store average.

The second item noted last quarter, working capital, also improves as our average store size increases. Similar to our income statement, there is a two-step offset. Our days invested in accounts receivable typically increase; however, history shows our days invested in inventory at the store will more than offset this increase and result in an improvement in total operational working capital relative to sales and operating profit.

Beginning in 2015, we intend to shorten our earnings releases. This will probably be welcomed by many of you. We will continue to provide a concise business update, some sales growth, store, vending, and headcount statistics, and a brief narrative of the income statement and operational working capital. The remaining information will be included in our quarterly and annual filings.

For earnings history and earnings-related data on Fastenal (FAST) click here.

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