April 12, 2006

2006 Q1 Earnings Report

The Fastenal Company of Winona, MN (NASDAQ Symbol FAST) reported the results of the quarter ended March 31, 2006. Dollar amounts are in thousands.

Net sales for the three-month period ended March 31, 2006 totaled $431,703, an increase of 22.0% over net sales of $353,809 in the first quarter of 2005. First quarter operating income increased from $59,428 in 2005 to $76,940 in 2006, an increase of 29.5%. Net earnings increased in the first quarter from $37,031 in 2005 to $47,854 in 2006, an increase of 29.2%. Basic and diluted earnings per share increased from $.24 to $.32 for the comparable periods, an increase of 33.3%.

During the first three months of 2006, Fastenal opened 73 new store sites (Fastenal opened 74 news sites in the first quarter of 2005). These 73 new sites represent 4.2% additional stores since December 31, 2005. There were 6,783 sales employees as of March 31, 2006, an increase of 6.1% from December 31, 2005.

SALES GROWTH:
Note - Daily sales are defined as the sales for the month divided by the number of business days in the month.

Stores more than five years old - The strength of the economy, over time, is best reflected in our subset of stores more than five years old (Store sites opened as follows: 2006 group - opened 2001 and earlier, 2005 group - opened 2000 and earlier, and 2004 group - opened 1999 and earlier). These stores are more cyclical due to the increased market share they enjoy in their local markets. During the twelve months of 2004 and 2005 and the first three months of 2006, the stores more than five years old had daily sales growth rates of (compared to the comparable month in the preceding year):

Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
2004 8.4% 13.4% 11.6% 15.0% 18.2% 19.3%  18.4%  15.6%  16.4% 16.5% 13.8% 16.1%
2005 15.8% 13.7% 12.1%  15.7%  12.3%  9.5%  11.7%  11.9%  14.7%  12.0%  11.1%  7.7%
2006 13.9% 11.9% 10.8%

Stores more than two years old - Our stores more than five years old above, when combined with stores two to five years of age, represent a consistent same-store view of our business (Store sites opened as follows: 2006 group - opened 2003 and earlier, 2005 group - opened 2002 and earlier, and 2004 group - opened 2001 and earlier). During the twelve months of 2004 and 2005 and the first three months of 2006, the stores more than two years old had daily sales growth rates of (compared to the comparable month in the preceding year):

Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
2004 11.5% 15.2% 13.9% 16.4% 20.1% 19.8%  19.8%  17.5%  17.8% 18.5% 16.0% 18.0%
2005 19.2% 17.1% 14.1%  18.0%  14.0%  12.1%  13.3%  13.3%  16.7%  13.3%  13.0%  9.0%
2006 17.8% 15.0% 14.6%

All company sales - During the twelve months of 2004 and 2005 and the first three months of 2006, all the selling locations combined had daily sales growth rates of (compared to the comparable month in the preceding year):

Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
2004 16.1% 20.1% 19.1% 22.1% 25.6% 25.7%  27.0%  24.9%  26.2% 27.6% 25.0% 27.4%
2005 26.2% 25.1% 22.5%  26.6%  22.9%  21.2%  21.8%  21.7%  26.8%  22.7%  21.7%  17.0%
2006 23.9% 21.3% 21.1%

The January 2004 to November 2005 time frame generally represents improvement followed by stabilization in our daily sales trends. The January 2004 to November 2005 general improvement and stabilization reflects continued strengthening in the economy as it relates to the customers we sell to in North America and the impact of the Fastenal standard inventory stocking model (see reference below regarding the Customer Service Project, or CSP). The 2004 period was positively impacted by inflation in the steel based products we sell. The December 2005 daily sales growth rate was weaker than we expected; however, we believe this was an abnormality due to the following reasons (1) historically we have seen fluctuations in December's daily sales growth rates due to the presence of the various holidays and their impact on our customers' buying patterns and (2) December 2004 experienced strong growth, which creates a more difficult comparison in the next year. In 2005, item (2) is also noticeable in months such as May, June, July, and, to a lesser degree, October. The noticeable exception to item (2) is the month of September, which experienced stronger growth due to the demand generated by Hurricane Katrina. The continued strong growth in the January 2006 to March 2006 time frame generally represents a continuation of the strong environments experienced in 2004 and 2005. The March 2006 growth was impacted by the correction of an error during the quarter. This correction, which is immaterial to our financial statements, was recorded as a reduction in the March 2006 sales of $1,623. This error accumulated over the last five years. We disclosed it in the interest of transparency to our sales amounts; we apologize for the previous error.

IMPACT OF CURRENT INITIATIVES:
During 2005 and the first three months of 2006, Fastenal has been actively pursuing several initiatives to improve its operational performance. These include: (1) a new freight model, (2) tactical changes to our working capital model, and (3) an expanded store model called CSP2.

The freight model represents a focused effort to haul a higher percentage of our products utilizing the Fastenal trucking network (which operates at a substantial savings to external service providers because of our ability to leverage our existing routes) and to charge freight more consistently in our various operating units. This initiative positively impacted the latter two-thirds of 2005 and the first quarter of 2006 despite the fact we experienced year-over-year increases of approximately 31.7% and 30.7%, respectively, in per gallon diesel fuel costs.

The tactical changes to our working capital model include the establishment of a central call center for accounts receivable collection and the establishment of financial business rules for the purchasing of products outside the standard stocking model (formerly referred to as CSP) at the store. The balance sheet impacts of these changes are described below in the working capital discussion.

The CSP2 store model represents an expansion of the core stocking items and sales personnel in an existing store with the goal of driving additional product sales to existing customers, target customers, and specific geographic areas within established markets. During the first quarter of 2006, 44 stores were converted to the CSP2 format. This resulted in 74 stores converted to the CSP2 format since the third quarter of 2005. The balance sheet impacts of these conversions are described below in the working capital discussion.

IMPACT OF FUEL PRICES DURING THE QUARTER:
Rising fuel prices continue to take a toll on the quarter ended March 31, 2006. Our vehicle fuel costs averaged approximately $1,248 per month in the first quarter of 2005. Our fleet consists of a variety of distribution vehicles as well as store delivery vehicles. During the first quarter of 2006, vehicle fuel costs have averaged approximately $1,864 per month. These increases relate to the rising fuel costs, the freight initiative discussed earlier, and to the increase in sales and store locations.

STATEMENT OF EARNINGS INFORMATION (percentage of net sales):

 

Three Months Ended

March 31,

 

2006

2005

Net sales

100.0%

100.0%

Gross profit margin

50.4%

49.4%

 

 

 

Operating and administrative expenses

32.6%

32.5%

Loss on sale of property and equipment

0.0%

(0.1)%

Operating income

17.8%

16.8%

 

 

 

Interest income

0.1%

0.1%

Earnings before income taxes

17.9%

16.9%

Note - Amounts may not foot due to rounding difference.

Reclassification note: Historically, we have included certain of our internal trucking costs in operating and administrative expenses. These costs include items such as driver pay, truck depreciation, and the cost of our transfer stations and transfer trucks. Historically, we felt this classification was appropriate for a distribution business; however, we now believe our distribution operation has many characteristics of an outside trucking firm. Our costs associated with outside trucking, such as small parcel and less-than-truckload (or LTL) shipping have historically been included in cost of goods sold. We have reclassified the distribution expenses discussed above from operating and administrative expenses to costs of goods sold as we believe it provides a more accurate presentation for the readers of our financial statements; and have also reclassified the 2005 presentation to consistently reflect the new classification. This reclassification lowered the gross profit margin and the operating and administrative expense percentages above by 0.7% points in first three months of 2005. (Note - this reclassification was first discussed in our 2005 annual report.)

Gross profit margins for the first three months of 2006 increased over the same period in 2005. The improvement was driven by our freight initiative (discussed earlier) and by improvements in our direct sourcing operations.

Operating and administrative expenses grew approximately the same as the net sales growth rate during the first three months of 2006. This was primarily due to the tight management of employee numbers throughout the organization in all of 2005 and the first three months of 2006. As discussed in our 2005 annual report, payroll and related expenses have historically represented approximately 70% of operating and administrative expenses. Effective management of this expense allows us to leverage the sales growth more effectively. This tight management was significant, given the store expansion (discussed earlier and later). We will continue to manage headcount in a similar fashion and expect to maintain most of the labor efficiency. The 2006 operating and administrative expenses include $168 of expenses related to the adoption of new stock option accounting rules. This expense will also occur in the second quarter of 2006, but will then cease as all outstanding options will be vested.

Income taxes, as a percentage of earnings before income taxes, were approximately 38.1% and 38.0% in 2006 and 2005, respectively. This rate fluctuates over time based on the income tax rates in the various jurisdictions in which we operate, and based on the level of profits in those jurisdictions.

WORKING CAPITAL:

Two components of working capital, accounts receivable and inventories, improved as compared with sales growth in the first quarter of 2006. The March 2005 to March 2006 percentage growth (i.e. year over year) and the year-to-date dollar increase was as follows:

 

 

March 31,

Annual rate of growth

 

2006

2005

Accounts receivable (gross)

 

14.2%

21.5%

Inventories

 

19.6%

28.8%

 

 

 

 

 

 

Three Months Ended

March 31,

Dollar growth for the period

 

2006

2005

Accounts receivable (gross)

$

28,250

21,236

Inventories

$

9,534

3,071

 

 

 

 

These two assets were impacted by our initiatives to improve working capital. These initiatives include (1) the establishment of a centralized call center to facilitate accounts receivable management (this facility became operational early in 2005) and (2) the tight management of all inventory amounts not identified as either expected store inventory (see reference below regarding CSP), new expanded inventory, or inventory necessary for upcoming store openings.

The accounts receivable increase of 14.2% represents a meaningful lag behind the 21.1% and 22.0% sales increase in March 2006 and in the first quarter of 2006, respectively. We continue to be pleased with the improvements in accounts receivable during 2005 and the first three months of 2006, and with the related reduction in bad debt expense when compared to historical amounts.

The inventory increase of 19.6% represents a lag behind the 22.0% sales increase in the first quarter of 2006. The increase of $9,532 since December 31, 2006 primarily relates to approximately $4,400 for new stores and $2,600 for CSP2 conversions.

Overall, our initiatives are having a positive impact on accounts receivable and inventory. As we indicated in earlier communications, our 2006 goals center on our ability to move the ratio of annual sales to accounts receivable and inventory (Annual Sales: AR&I) back to better than a 3.0:1 ratio (on December 31, 2005, we had a ratio of 2.8:1). Historically, we have been able to achieve a 20% after tax return on total assets (our internal goal) when our Annual Sales: AR&I ratio is at or above 3.0:1.

STORE OPENINGS:
As discussed in previous public statements, the Company's goal is to continue opening approximately 13% to 18% new stores each year (calculated on the ending number of stores in the previous year). On December 31, 2005, the Company operated 1,755 stores; therefore, we expect to open approximately 228 to 316 new stores in 2006. The Company opened 222 new stores in 2005 and 219 new stores in 2004, or an increase over the previous December of 14.5% and 16.7%, respectively. While the new stores continue to build the infrastructure for future growth, the first year sales are low, and the added expenses related to payroll, occupancy, and transportation costs do impact the Company's ability to leverage earnings. As disclosed previously, it has been the Company's experience that new stores take approximately ten to twelve months to achieve profitability. The planned openings can be altered in a short time span, usually less than 60 to 90 days.

In June 2002, we began our 'customer service project' (or CSP). This project centered on stocking all of our stores with a consistent base of product and with a consistent merchandising scheme. This project was 97% complete on December 31, 2005 and will be completed during 2006 as the last 55 stores are converted. Since the CSP format represents the stocking model in substantially all of our locations, during the first quarter of 2005 we began to refer to these converted locations simply as stores with our expected inventory stocking model, versus the CSP designation. Consistent with our operating philosophy, we intend to continue identifying products and store display themes to position our stores to the Fastenal goal of being 'the best industrial and construction supplier in each local market in which we operate'. In June 2005 we disclosed our intention to convert locations to the CSP2 format. The CSP2 format represents a further expansion of the Fastenal standard inventory stocking model at the store level. As of March 31, 2006, 74 stores had been converted to the CSP2 format. Of these stores, 30 were converted in the latter half of 2005 and 44 were converted in the first quarter of 2006. We expect to convert additional stores to the CSP2 format throughout the remainder of 2006.

Additional information regarding certain Fastenal Company statistics for the current quarter is available on the Fastenal Company World Wide Web site at www.fastenal.com. The Company discloses sales and store information on a monthly basis. This information is posted at www.fastenal.com on the third business day following the end of the first two months of a quarter and simultaneous with the earnings release following the third month of a quarter. This press release contains statements that are not historical in nature and that are intended to be, and are hereby identified as, "forward looking statements" as defined in the Private Securities Litigation Reform Act of 1995, including statements regarding management of headcount and labor efficiency, working capital goals, rates of return on assets when working capital is appropriately managed, increases in selling locations, the time it typically takes a new store to achieve profitability, the timeline for altering planned store openings, the completion of the CSP initiative, and the conversion of stores to the CSP2 format. A change in the economy, from that currently being experienced, could cause the store openings to change from that expected and could impact the CSP1 and CSP2 rollout. A change in the economy from that currently being experienced, a change in customer buying patterns, a change in forecasts, or a change in vendor production lead times could cause working capital (including inventory) and rates of return on assets to change from expected amounts. A change in the number of markets able to support future store sites could change the management of headcount, which in turn, together with changes in sales growth and store openings, could impact labor efficiency. A discussion of other risks and uncertainties is included in the Company's 2005 annual report under the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations".

~

2006 Q1 Earnings Report, Page 2

FASTENAL COMPANY AND SUBSIDIARIES

Consolidated Balance Sheets
(Amounts in thousands except share information)

(Unaudited)
March 31, December 31,

Assets

2006

2005

Current assets:

Cash and cash equivalents

$

69,118

56,204

Marketable securities

781

669

Trade accounts receivable, net of allowance for doubtful accounts of $3,164 and $3,875, respectively

212,517

183,556

Inventories

371,095

361,561

Deferred income tax asset

9,925

9,925

Other current assets

36,734

37,093


Total current assets

700,170

649,008

Marketable securities

13,163

13,228

Property and equipment, less accumulated depreciation

236,655

224,448

Other assets, less accumulated amortization

3,384

3,351


Total assets

$

953,372

890,035


Liabilities and Stockholders' Equity


Current liabilities:

Accounts payable

$

54,845

38,572

Accrued expenses

51,088

50,258

Income taxes payable

29,986

2,708


Total current liabilities

135,919

91,538


Deferred income tax liability

16,085

14,948


Stockholders' equity:

Common stock 200,000,000 shares authorized; 151,054,752 and 151,754,752 shares issued and outstanding respectively

1,511

1,511

Additional paid-in capital

168

-

Retained earnings

794,241

776,598

Accumulated other comprehensive income

5,448

5,440


Total stockholders' equity

801,368

783,549


Total liabilities and stockholders' equity

$

953,372

890,035


~

2006 Q1 Earnings Report, Page 3

Consolidated Statements of Earnings
(Amounts in thousands except earnings per share)

(Unaudited)
Three months ended
March 31,

2006 

2005 

Net Sales

431,703

353,809

Cost of Sales

214,216

179,047


Gross profit

217,487

174,762

Operating and administrative expenses

140,512

115,086

Loss on sale of property and equipment

35

248


Operating income

76,940

59,428

Interest income

388

299


Earnings before income taxes

77,328

59,727

Income tax expense

29,474

22,696


Net earnings

$

47,854

37,031


Basic and diluted earnings per share

$

0.32

0.24


Weighted average shares outstanding

151,055

151,754


Diluted weighted average shares outstanding

151,390

151,988


~

2006 Q1 Earnings Report, Page 4

FASTENAL COMPANY AND SUBSIDIARIES
 
Consolidated Statements of Cash Flows
(Amounts in thousands)
 

(Unaudited)
Three months ended
March 31,

                  2006   2005

Cash flows from operating activities:
  Net earnings $ 47,854 37,031
  Adjustments to reconcile net earnings to net cash
    provided by operating activities:
      Depreciation of property and equipment 7,592 6,646
      Loss on sale of property and equipment 35 248
      Bad debt expense 837 1,687
      Deferred income taxes 1,137 -
      Tax benefits from exercise of stock options 168 -
      Amortization of non-compete agreement 17 17
      Changes in operating assets and liabilities:
        Trade accounts receivable (29,798) (22,618)
        Inventories (9,534) (3,071)
        Other current assets 359 2,454
        Accounts payable 16,273 3,835
        Accrued expenses 830 3,349
        Income taxes, net 27,278 18,927
        Other (30) (1,410)

            Net cash provided by operating activities   63,018   47,095

 
Cash flows from investing activities:
  Purchases of property and equipment (20,986) (12,266)
Proceeds from sale of property and equipment 1,152 1,489
  Net (increase)/decrease in marketable securities (47) 19,747
  Increase in other assets (50) (23)

            Net cash (used in) provided by  investing activities   (19,931)   8,947

 
Cash flows from financing activities:
  Payment of dividends (30,211) (23,522)

            Net cash used in financing activities   (30,211)   (23,522)

 

Effect of exchange rate changes on cash   38   (28)

 
            Net increase in cash and cash equivalents 12,914 32,492
 
Cash and cash equivalents at beginning of period   56,204   33,503

Cash and cash equivalents at end of period $ 69,118   65,995

 
Supplemental disclosure of cash flow information:
  Cash paid during each period for:
    Income taxes   $ 2,196   3,769


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