How did Fastenal perform financially in 2006?

Net sales grew 18.8% to $1,809.3 million and net earnings grew 19.3% to $199.0 million, or $1.32 per share. Gross margin improved to 50.2%, while operating and administrative expenses rose slightly to 32.5% of sales, leaving operating income of $319.8 million.

Why did operating cash flow decline in 2006?

Operating cash flow fell to $97.9 million from $121.9 million, primarily because of a $94.4 million increase in inventory. The inventory build reflected store openings, CSP2 store conversions, and the Indianapolis stocking expansion, and management said much of the Q4 growth should not have occurred.

What is management's plan to improve working capital in 2007?

Management said it is working to slow inventory growth and expects to improve inventory turns in 2007, with remediation planned over the first three to six months. The goal is to return the sales-to-(AR + inventory) ratio to better than 3.0:1, from 2.7:1 at year-end 2006.

How is Fastenal expanding, and what are the growth targets?

Fastenal plans to open new stores at 13% to 18% annually, consistent with its history, and believes North America can support about 3,500 stores versus 2,000 today. It also converted 163 stores to the CSP2 format in 2006, expanded its CSP3 prototype to 8 to 10 stores, and began opening stores outside North America (about 7% of sales came from outside the U.S.).

Are there risks investors should consider?

Key risks include a slowing economy that could reduce sales at established stores, unproven long-term results for the CSP2 and CSP3 formats, rising fuel, steel, and labor costs, competition from consolidating industry players, reliance on foreign suppliers (notably China), and the time new stores take (9 to 12 months) to become profitable.

FAST 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 23, 2007. Cited figures are marked; the original filing is the authoritative source.

Fastenal Company (FAST) closed 2006 with net sales of $1.809 billion^a, up 18.8% from $1.523 billion in 2005, and net earnings of $199.0 million, up 19.3%, or $1.32 per diluted share.

Growth was driven by continued expansion to 2,000 store sites (245 opened in 2006, 14%^b more locations) and solid unit growth in stores older than two years, though management described 2006 as a softer year, with sales slowing in the second half as the North American economy weakened. Gross margin improved to 50.2% from 49.8%, helped by the freight initiative and direct sourcing, while operating and administrative expenses rose to 32.5% of sales from 32.2%, partly due to the CSP2 store conversions and rising fuel and occupancy costs. The key concern for investors is working capital.

Inventory rose 26.1% (about $94 million^c) versus 18.8% sales growth, and operating cash flow fell to $97.9 million from $121.9 million. Management acknowledged the inventory build was poorly executed, particularly in Q4, and cited an Indianapolis stocking expansion and the CSP2 conversions as drivers. The ratio of annual sales to accounts receivable plus inventory slipped to 2.7:1 from 2.8:1, below the 3.0:1 target management associates with a roughly 20% after-tax return on assets.

Management expects to slow inventory growth in 2007, and the company remains financially strong, with no debt outstanding, $1.0 billion^d in stockholders' equity, and a semi-annual dividend increased to $0.21 per share. Overall, the filing shows a high-quality, highly profitable distributor still growing rapidly, but with near-term execution risk around inventory and a slowing economic backdrop. Investors should watch 2007 inventory turns, the performance of the new CSP2 and CSP3 formats, and whether sales growth holds up as the economy softens.

02—Key points

Key Highlights

Net sales rose 18.8% to $1.81 billion in 2006, while net earnings grew 19.3% to $199.0 million ($1.32 per diluted share).
Gross margin improved to 50.2% from 49.8%, driven by the freight initiative and improvements in direct sourcing.
Store network reached 2,000 sites after 245 openings in 2006 (up from 222 in 2005), with about 3,500 stores estimated as the North American market potential.
Inventory grew 26.1% (about $94 million), well ahead of sales growth, and operating cash flow fell to $97.9 million from $121.9 million.
Sales-to-(AR + inventory) ratio declined to 2.7:1 from 2.8:1, below the 3.0:1 target linked to a roughly 20% after-tax return on assets.
Balance sheet remains strong, with no borrowings on the $10 million credit line, $922 million in stockholders' equity, and $19 million in cash (plus marketable securities).
Management reported sales slowing in the second half of 2006 and a difficult Indianapolis inventory expansion that caused service problems; the semi-annual dividend was raised to $0.21 per share.

03—Questions

Frequently Asked Questions

How did Fastenal perform financially in 2006?
Net sales grew 18.8% to $1,809.3 million and net earnings grew 19.3% to $199.0 million, or $1.32 per share. Gross margin improved to 50.2%, while operating and administrative expenses rose slightly to 32.5% of sales, leaving operating income of $319.8 million.
Why did operating cash flow decline in 2006?
Operating cash flow fell to $97.9 million from $121.9 million, primarily because of a $94.4 million increase in inventory. The inventory build reflected store openings, CSP2 store conversions, and the Indianapolis stocking expansion, and management said much of the Q4 growth should not have occurred.
What is management's plan to improve working capital in 2007?
Management said it is working to slow inventory growth and expects to improve inventory turns in 2007, with remediation planned over the first three to six months. The goal is to return the sales-to-(AR + inventory) ratio to better than 3.0:1, from 2.7:1 at year-end 2006.
How is Fastenal expanding, and what are the growth targets?
Fastenal plans to open new stores at 13% to 18% annually, consistent with its history, and believes North America can support about 3,500 stores versus 2,000 today. It also converted 163 stores to the CSP2 format in 2006, expanded its CSP3 prototype to 8 to 10 stores, and began opening stores outside North America (about 7% of sales came from outside the U.S.).
Are there risks investors should consider?
Key risks include a slowing economy that could reduce sales at established stores, unproven long-term results for the CSP2 and CSP3 formats, rising fuel, steel, and labor costs, competition from consolidating industry players, reliance on foreign suppliers (notably China), and the time new stores take (9 to 12 months) to become profitable.

04—Continue

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