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ITEM 7.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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The following is management's discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements.
Business and Operational Overview
Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies. We distribute these supplies through a network of approximately
3,000
in-market locations. Most of our customers are in the manufacturing and non-residential construction markets. The manufacturing market includes both original equipment manufacturers (OEM) and maintenance, repair, and operations (MRO). The non-residential construction market includes general, electrical, plumbing, sheet metal, and road contractors. Other users of our product include farmers, truckers, railroads, oil exploration, production and refinement companies, mining companies, federal, state, and local governmental entities, schools, and certain retail trades. Geographically, our branches and customers are primarily located in North America.
It is helpful to appreciate several aspects of our marketplace: (1) It's big, the North American marketplace for industrial supplies is estimated to be in excess of $140 billion per year (and we have expanded beyond North America) and no company has a significant portion of this market. (2) Many of the products we sell are individually inexpensive, but the cost and time to manage, procure, and transport these products can be quite meaningful. (3) Purchasing professionals often expend disproportionate effort managing the high SKU count of low-volume, low value MRO supplies which is better allocated to their higher volume, higher value OEM supplies. (4) Many customers prefer to reduce their number of suppliers to simplify their business, while also utilizing various technologies and models (including our local branches when they need something quickly or unexpectedly) to improve availability and reduce waste. (5) We believe the markets are efficient. To us, this means we can grow our market share if we provide the greatest value to our customer.
Our approach to addressing these aspects of our marketplace is captured in our motto
Growth through Customer Service
. The concept of growth is simple: find more customers every day and increase our activity with them. However, execution is hard work. First, we recruit service-minded individuals to support our customers and their business. Second, we operate in a decentralized fashion to help identify the greatest value for our customers. Third, we have a great team behind our customer-facing resources to operate efficiently and to help identify new business solutions. Fourth, we strive to generate strong profits, which produce the cash flow necessary to fund our growth and to support the needs of our customers. Lastly, we identify drivers that allow us to get closer to our customers and gain market share.
We believe our ability to grow is amplified if we can serve our customers at the closest economic point of contact. At one point, the closest economic point of contact was the local branch. Today, in some cases, we have moved the branch inside the customer's facility. We also are frequently positioned right at the point of consumption within customers' facilities through our industrial vending or FMI capabilities. Therefore, our focus centers on understanding our customers' day, their opportunities, and their obstacles. By doing these things every day, Fastenal remains a growth-centric organization.
Executive Overview
Net sales increas
ed $428.5, or 10.8%, in
2017 relative to 2016. Our gross profit as a percentage of net sal
es declined to 49.3% in 2017 from 49.6% in
2016. Our operating income as a percentage of net sal
es in 2017 was comparable to 2016 at 20.1% in b
oth years.
We recorded a provisional income tax expense of $294.5 in 2017, or 33.7% of earnings before income taxes. This amount reflects an estimated reduction in our deferred income tax liabilities of $30.8 as a result of the income tax rate decrease included in the Tax Act, offset by an estimated increase in income tax payable in the amount of $6.5 as a result of the transition tax on cash and cash equivalent balances related to accumulated earnings associated with our international operations, also included in the Tax Act. Absent the impact of the Tax Act, our income tax expense for 2017 would have been approximately $318.8, or 36.5% of earnings before income taxes. Income tax expense was $290.3 in 2016, or 36.8% of earnings before income taxes.
Our net earnings in 2017 were $578.6, an increase of 15.8% when compared to 2016. Our diluted net earnings per share were $2.01 in 201
7 compared to $1.73
in
2
016. If we excluded the discrete items that benefited our income tax rate in the fourth quarter of 2017 (primarily related to the impact of the Tax Act), our net earnings in the period would have been approximately $554.2, an increase of 11.0% when compared to 2016, and our diluted net earnings per share would have been $1.92.
We continued to focus on our growth drivers in 2017. We si
gned 168 new national account contracts (defined as new customer accounts with a multi-site contract). Additionally, we signed 270 new
Onsite customer locations
(defined as dedicated sales and service provided from within, or in close proximity to, the customer's facility) and 19,355 new industria
l vending devices.
The table below summarizes our in-market location employee count and our total employee count at the end of the periods presented, and changes in that count from the end of the prior periods to the end of the most recent period. The final four items below summarize our cumulative investments in branch locations, Onsite locations, total in-market locations, and industrial vending devices.
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Q4
2017
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Q4
2016
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Twelve-month
% Change
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End of period total in-market locations
(1)
- employee count
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13,424
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|
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12,966
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3.5
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%
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End of period total employee count
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20,565
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19,624
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4.8
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%
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Number of public branch locations
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2,383
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2,503
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-4.8
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%
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Number of active Onsite locations
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605
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401
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50.9
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%
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Number of in-market locations
(1)
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2,988
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2,904
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2.9
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%
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Industrial vending devices (installed count)
(2)
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71,421
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62,822
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13.7
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%
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Ratio of industrial vending devices to in-market locations
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24:1
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22:1
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(1)
'In-market locations' is defined as the sum of the total number of public branch locations and the total number of active Onsite locations.
(2)
This number represents devices which principally dispense product and produce product revenues, and excludes approximately 15,000 devices which are principally used for the check-in/check-out of equipment.
During the last twelve months, we increased our headcount by 458 people in our in-market locations and 941 people in total. Our total headcount at the end of 2017 includes 127 people related to our Mansco acquisition. The remaining increase is mostly a function of additions we have made to support customer growth in the field as well as investments in our growth drivers.
We opened 18 branches and closed 130 branches in 2017. Additionally, eight branches were converted from public branches to non-public locations. Our branch network forms the foundation of our business strategy, and we will continue to open or close branches as is deemed necessary to sustain and improve our network and support our growth drivers.
Results of Operations
The following sets forth consolidated statements of earnings information (as a percentage of net sales) for the periods ended December 31:
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2017
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2016
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2015
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Net sales
|
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100.0
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%
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100.0
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%
|
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100.0
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%
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Gross profit
|
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49.3
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%
|
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49.6
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%
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50.4
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%
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Operating and administrative expenses
|
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29.2
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%
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29.5
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%
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29.0
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%
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Gain on sale of property and equipment
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0.0
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%
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0.0
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%
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0.0
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%
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Operating income
|
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20.1
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%
|
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20.1
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%
|
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21.4
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%
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Net interest expense
|
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-0.2
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%
|
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-0.2
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%
|
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-0.1
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%
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Earnings before income taxes
|
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19.9
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%
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19.9
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%
|
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21.3
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%
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Note – Amounts may not foot due to rounding difference.
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Net Sales
Note – Daily sales are defined as the total net sales for the period divided by the number of business days (in the United States) in the period.
The table below sets forth net sales and daily sales for the periods ended December 31, and changes in such sales from the prior period to the more recent period:
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2017
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2016
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2015
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Net sales
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4,390.5
|
|
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3,962.0
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|
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3,869.2
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Percentage change
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10.8
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%
|
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2.4
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%
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3.6
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%
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Business days
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254
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|
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255
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254
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Daily sales
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17.3
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|
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15.5
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15.2
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Percentage change
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11.3
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%
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2.0
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%
|
|
3.2
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%
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Daily sales impact of acquisitions
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1.0
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%
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0.6
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%
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0.2
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%
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Impact of currency fluctuations
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0.1
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%
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-0.4
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%
|
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-1.2
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%
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The increases in net sales in the periods noted above for 2017, 2016, and 2015 were driven primarily by higher unit sales. Price was not a material factor in the periods presented.
The higher unit sales in 2017 resulted primarily from two sources. The first is improvement in underlying market demand. We believe the improvement in general business activity is reflected in a number of metrics. For instance, the Purchasing Managers Index, published by the Institute for Supply Chain Management, averaged 57.0, 55.8, 58.6, and 58.9 in the first, second, third, and fourth quarters of 2017, respectively, well above 49.8, 51.8, 51.2, and 53.3 in the first, second, third, and fourth quarters of 2016, respectively. Readings above 50 are indicative of growing demand, and we believe this favorably influenced our unit sales. Daily sales of fasteners, our most cyclical product line, grew 8.4% in 2017. We also experienced growth in sales to 79 of our top 100 customers in 2017, which compares to growth in sales to 50 of our top 100 customers in 2016. As business conditions strengthen, they tend to lift our net sales growth rates as well.
The second source is success within our growth initiatives. We signed 19,355 industrial vending devices during 2017, an increase of 7.2% over 2016. In addition to an increase in our installed base, we were also more efficient with the existing base, resulting in a modest increase in average sales per device, and we decreased our device removals by 3.8%. Combined sales through our vending devices accelerated throughout 2017, finishing with growth in the high teens. We signed 270 new Onsite locations in 2017 and had 605 active sites on December 31, 2017, an increase of 50.9% over December 31, 2016. We signed 168 new national account contracts in 2017. The contribution of these new contracts and strong penetration of existing national account customers resulted in daily sales from our national account customers growing 14.5% in 2017 compared to 2016.
In 2016, we saw relative weakness from non-residential construction and heavy manufacturing customers and in demand for our fastener products, speaking to the sustained softness in heavy and general industrial markets. Business with our largest customers was also relatively weak, with sales to our top 100 customers rising modestly in the first half of 2016 and falling modestly in the second half of 2016. While these trends were representative of conditions in the United States and Canada, total sales outside of these geographic areas were relatively strong and improved over the course of 2016.
During 2015, our business weakened compared to 2014. This initially involved customers tied to the oil and gas sector, but expanded during the course of the year to include customers across additional industries and in geographic areas not typically associated with the oil and gas sector. November and especially December experienced a greater frequency and duration of customer plant shutdowns than is typical of these holiday-affected periods.
Net sales in 2016 and 2015 were also impacted by slight inflationary price changes in our non-fastener products and some price deflation in our fastener products, with the net impact being a slight drag on growth.
Sales by Product Line
The approximate mix of sales from the fastener product line and from the other product lines was as follows:
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2017
|
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2016
|
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2015
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Fastener product line
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35.6%
|
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36.6%
|
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38.3%
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Other product lines
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64.4%
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63.4%
|
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61.7%
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The decrease in our fastener sales as a percentage of total sales arises from two factors. First, we believe non-fastener products represent a larger market opportunity than fasteners, and that we are relatively under-represented in this market. Over time, this
has led to faster growth in the non-fastener product lines, a trend amplified by the growth of our industrial vending program through which we sell primarily non-fastener products. We believe this factor impacted each year shown and will continue to promote a lower mix of fasteners in our total sales over time. Second, a weak industrial production environment, has a disproportionately negative effect on fastener sales relative to non-fastener sales (which relates more to plant operations than production). This weakness is more of a cyclical factor than a structural one, and as such was relevant in 2015 and 2016, but not in 2017 when a better economic environment at least partially mitigated the first factor discussed.
Annual Sales Changes, Sequential Trends, and End Market Performance
This section focuses on three distinct views of our business – annual sales changes by month, sequential trends, and end market performance. The first discussion regarding sales changes by month provides a good mechanical view of our business. The second discussion provides a framework for understanding the sequential trends (that is, comparing a month to the immediately preceding month, and also looking at the cumulative change from an earlier benchmark month) in our business. Finally, we believe the third discussion regarding end market performance provides insight into activities with our various types of customers.
Annual Sales Changes, by Month
During the months noted below, all of our selling locations, when combined, had daily sales growth rates of (compared to the same month in the preceding year):
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Jan.
|
|
Feb.
|
|
Mar.
|
|
Apr.
|
|
May
|
|
June
|
|
July
|
|
Aug.
|
|
Sept.
|
|
Oct.
|
|
Nov.
|
|
Dec.
|
2017
|
3.8
|
%
|
|
6.1
|
%
|
|
8.4
|
%
|
|
8.9
|
%
|
|
9.7
|
%
|
|
13.0
|
%
|
|
12.9
|
%
|
|
12.8
|
%
|
|
15.3
|
%
|
|
13.8
|
%
|
|
15.4
|
%
|
|
14.7
|
%
|
2016
|
3.3
|
%
|
|
2.6
|
%
|
|
0.0
|
%
|
|
3.8
|
%
|
|
1.1
|
%
|
|
0.0
|
%
|
|
2.1
|
%
|
|
0.3
|
%
|
|
2.8
|
%
|
|
3.9
|
%
|
|
1.2
|
%
|
|
3.2
|
%
|
2015
|
12.0
|
%
|
|
8.6
|
%
|
|
5.6
|
%
|
|
6.1
|
%
|
|
5.3
|
%
|
|
3.7
|
%
|
|
3.2
|
%
|
|
1.6
|
%
|
|
-0.3
|
%
|
|
-0.8
|
%
|
|
-1.1
|
%
|
|
-3.8
|
%
|
Sequential Trends
We find it helpful to think about the monthly sequential changes in our business using the analogy of climbing a stairway –
This stairway has several predictable landings where there is a pause in the sequential gain (i.e. April, July, and October to December), but generally speaking, climbs from January to October. The October landing then establishes the benchmark for the start of the next year.
History has identified these landings in our business cycle. They generally relate to months where certain holidays impair business days and/or seasons impact certain end markets, particularly non-residential construction. The first landing centers on Easter and the Good Friday holiday that precedes it, which alternates between March and April (Good Friday occurred in April 2017, in March 2016, in April 2015, and in 2018, will fall in March), the second landing centers on July 4th, and the third landing centers on the approach of winter with its seasonal impact on primarily our non-residential construction business and with the Christmas/New Year holidays. The holidays we noted impact the trends because they either move from month-to-month or because they move around during the week (the July 4th and Christmas/New Year holiday impacts are examples of the latter).
The table below shows the pattern to the sequential change in our daily sales. The line labeled 'Benchmark' is an historical average of our sequential daily sales change for the trailing five year average (2012-2016). We believe this time frame serves to show the historical pattern and could serve as a benchmark for current performance. The '2017', '2016', and '2015' lines represent our actual sequential daily sales changes. The '17Delta', '16Delta', and '15Delta' lines indicate the difference between the 'Benchmark' and the actual results in the respective year.
It is important to note that these benchmarks are historical averages. In a year where demand is strong, our daily sales growth rates will tend to have more months that exceed the benchmark than fall below it. In a year where demand is weak, we will tend to have more months that fall short of the benchmark than exceed it. In both cases, there is a random element that makes it difficult to know how any single month will perform.
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Jan.
(1)
|
|
Feb.
|
|
Mar.
|
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Apr.
|
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May
|
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June
|
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July
|
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Aug.
|
|
Sept.
|
|
Oct.
|
|
Cumulative Change from Jan. to Oct.
|
Benchmark
|
-1.1
|
%
|
|
0.9
|
%
|
|
4.5
|
%
|
|
-1.0
|
%
|
|
1.9
|
%
|
|
1.8
|
%
|
|
-3.7
|
%
|
|
3.8
|
%
|
|
1.8
|
%
|
|
-2.4
|
%
|
|
7.6
|
%
|
2017
|
0.2
|
%
|
|
1.5
|
%
|
|
3.6
|
%
|
|
2.2
|
%
|
|
1.4
|
%
|
|
2.8
|
%
|
|
-2.4
|
%
|
|
2.2
|
%
|
|
3.8
|
%
|
|
-2.1
|
%
|
|
13.5
|
%
|
17Delta
|
1.3
|
%
|
|
0.6
|
%
|
|
-0.9
|
%
|
|
3.1
|
%
|
|
-0.5
|
%
|
|
1.0
|
%
|
|
1.3
|
%
|
|
-1.6
|
%
|
|
2.0
|
%
|
|
0.3
|
%
|
|
5.9
|
%
|
2016
|
0.4
|
%
|
|
-0.8
|
%
|
|
1.5
|
%
|
|
1.7
|
%
|
|
0.6
|
%
|
|
-0.2
|
%
|
|
-2.3
|
%
|
|
2.4
|
%
|
|
1.5
|
%
|
|
-0.9
|
%
|
|
3.6
|
%
|
16Delta
|
1.5
|
%
|
|
-1.7
|
%
|
|
-3.0
|
%
|
|
2.7
|
%
|
|
-1.3
|
%
|
|
-1.9
|
%
|
|
1.4
|
%
|
|
-1.4
|
%
|
|
-0.2
|
%
|
|
1.5
|
%
|
|
-4.0
|
%
|
2015
|
-3.6
|
%
|
|
-0.1
|
%
|
|
4.2
|
%
|
|
-2.1
|
%
|
|
3.4
|
%
|
|
0.9
|
%
|
|
-4.3
|
%
|
|
4.1
|
%
|
|
-0.9
|
%
|
|
-2.0
|
%
|
|
2.9
|
%
|
15Delta
|
-2.5
|
%
|
|
-1.0
|
%
|
|
-0.4
|
%
|
|
-1.1
|
%
|
|
1.4
|
%
|
|
-0.9
|
%
|
|
-0.6
|
%
|
|
0.3
|
%
|
|
-2.7
|
%
|
|
0.4
|
%
|
|
-4.7
|
%
|
(1)
The January figures represent the percentage change from the previous October, whereas the remaining figures represent the percentage change from the previous month.
Note – Amounts may not foot due to rounding difference.
A graph of the sequential daily sales change patterns discussed above, starting with a base of '100' in the previous October and ending with the next October, would be as follows:
End Market Performance
The sequential trends noted above were directly linked to fluctuations in our end markets. To place this in perspective – we estimate approximately 65% of our business has historically been with customers engaged in some type of manufacturing, a significant subset of which finds its way into the heavy equipment market. The daily sales growth rates to these manufacturing customers, when compared to the same period in the prior year, were as follows
(1)
:
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Q1
|
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Q2
|
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Q3
|
|
Q4
|
|
Annual
|
2017
|
6.2
|
%
|
|
11.5
|
%
|
|
15.3
|
%
|
|
16.6
|
%
|
|
12.3
|
%
|
2016
|
1.3
|
%
|
|
1.4
|
%
|
|
1.1
|
%
|
|
2.8
|
%
|
|
1.6
|
%
|
2015
|
8.2
|
%
|
|
4.6
|
%
|
|
1.6
|
%
|
|
-2.5
|
%
|
|
2.9
|
%
|
(1)
In July 2017, we reclassified certain end market designations. The daily sales growth rates in the above table for all periods through the second quarter of 2017 differ from prior disclosures.
Our manufacturing business consists of two subsets: the industrial production business (this is business where we supply products that become part of the finished goods produced by our customers and is sometimes referred to as OEM - original equipment manufacturing) and the maintenance portion (this is business where we supply products that maintain the facility or the equipment of our customers engaged in manufacturing and is sometimes referred to as MRO - maintenance, repair, and operations). The industrial business is more fastener centered, while the maintenance portion is represented by all product categories.
The best way to understand the change in our industrial production business is to examine the results in our fastener product line (35% to 40% of our business) which is heavily influenced by changes in our business with heavy equipment manufacturers. From a company perspective, daily sales growth rates of fasteners, when compared to the same period in the prior year, were as follows (note: this information includes
all
end markets):
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Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
|
Annual
|
2017
|
0.8
|
%
|
|
7.9
|
%
|
|
12.1
|
%
|
|
13.4
|
%
|
|
8.4
|
%
|
2016
|
-1.7
|
%
|
|
-2.4
|
%
|
|
-2.9
|
%
|
|
-2.4
|
%
|
|
-2.3
|
%
|
2015
|
5.5
|
%
|
|
0.0
|
%
|
|
-4.4
|
%
|
|
-6.2
|
%
|
|
-1.4
|
%
|
The daily sales growth rates of fasteners noted in the table above for the second, third, and fourth quarters of 2017, include 3.6, 3.8, and 3.9 percentage points, respectively, attributable to Mansco (acquired on March 31, 2017).
By contrast, the best way to understand the change in the maintenance portion of the manufacturing business is to examine the results in our non-fastener product lines. From a company perspective, daily sales growth rates of non-fasteners, when compared to the same period in the prior year, were as follows (note: this information includes
all
end markets):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
|
Annual
|
2017
|
9.4
|
%
|
|
12.2
|
%
|
|
14.6
|
%
|
|
16.1
|
%
|
|
13.1
|
%
|
2016
|
4.7
|
%
|
|
4.7
|
%
|
|
4.9
|
%
|
|
5.9
|
%
|
|
5.0
|
%
|
2015
|
11.7
|
%
|
|
9.0
|
%
|
|
5.9
|
%
|
|
1.2
|
%
|
|
6.8
|
%
|
The non-fastener business demonstrated greater relative resilience over the last several years, when compared to our fastener business and to the distribution industry in general, due to our industrial vending program. However, this business was not immune to the impact of a weak industrial environment.
Our non-residential construction and reseller customers have historically represented 20% to 25% of our business. The daily sales growth rates to these customers, when compared to the same period in the prior year, were as follows
(1)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
|
Annual
|
2017
|
6.9
|
%
|
|
8.8
|
%
|
|
9.4
|
%
|
|
11.6
|
%
|
|
9.1
|
%
|
2016
|
1.6
|
%
|
|
0.5
|
%
|
|
2.8
|
%
|
|
2.6
|
%
|
|
1.8
|
%
|
2015
|
10.1
|
%
|
|
5.6
|
%
|
|
0.1
|
%
|
|
-2.6
|
%
|
|
3.1
|
%
|
(1)
In July 2017, we reclassified certain end market designations. The daily sales growth rates in the above table for all periods through the second quarter of 2017 differ from prior disclosures.
Our non-residential construction and reseller business is heavily influenced by the industrial economy, particularly the energy sector. The volatility and weakness of energy prices weakened this business, particularly beginning in the second quarter of
2015 and throughout 2016. In 2017, improvements in energy sector metrics, including oil prices, as well as an improving outlook for industrial capital spending contributed to an improvement in growth for these end markets.
Gross Profit
The gross profit percentage during each period was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Q1
|
|
Q2
|
|
Q3
|
|
Q4
|
|
Annual
|
2017
|
49.4
|
%
|
|
49.8
|
%
|
|
49.1
|
%
|
|
48.8
|
%
|
|
49.3
|
%
|
2016
|
49.8
|
%
|
|
49.5
|
%
|
|
49.3
|
%
|
|
49.8
|
%
|
|
49.6
|
%
|
2015
|
50.8
|
%
|
|
50.3
|
%
|
|
50.5
|
%
|
|
49.9
|
%
|
|
50.4
|
%
|
Our gross profit, as a percentage of net sales, was 49.3% in 2017 and 49.6% in 2016. The gross profit percentage for 2017 declined by 30 basis points due to two elements of mix. The first was a change in product and customer mix. Fasteners are our largest product line and our highest gross profit margin product line due to the high transaction cost surrounding the sourcing and supply of the product for customers. As a result, the decline in our fastener product line to 35.6% of sales in 2017 from 36.6% of sales in 2016 contributed to the decline in our gross profit margin. This effect was exacerbated by relative growth in the period from sales of our OEM fasteners, which tend to have a lower gross profit margin than our MRO fasteners. Larger customers (for which national accounts are a good proxy), whose more focused buying patterns allow us to offer them better pricing, also influence the gross profit margin. Sales to our national account customers increased to 48.7% in 2017 from 47.4% of sales in 2016, which contributed to the decline in our gross profit margin. The combination of relatively slower growth in our fastener product line and relatively faster growth in sales to our largest customers explains the decline in our overall gross profit margin in 2017. The second element of mix was driven by the acquisition of Mansco. Mansco's customer mix is more heavily oriented toward larger customers and its product mix tends to carry a lower gross profit product mix than the company's other products.
During 2016 and 2015, our gross profit, as a percentage of net sales, decreased when compared to the prior year. In each year, the decrease was primarily caused by changes in product and customer mix.
Operating and Administrative Expenses
Our operating and administrative expenses (including a gain on the sale of property and equipment), as a percentage of net sales, improved to 29.2% in 2017 from 29.5% in 2016. The primary contributor to this improvement was relatively modest growth in occupancy-related expenses. Though our employee-related and selling transportation expenses grew more quickly than our occupancy expenses, they also contributed to this leverage in 2017.
The growth in employee-related, occupancy-related, and selling transportation expenses (the three largest components of our operating and administrative expenses) compared to the same periods in the preceding year, is outlined in the table below.
|
|
|
|
|
|
|
|
|
|
|
|
Approximate Percentage of Total Operating and Administrative Expenses
|
Twelve-month Period
|
|
2017
|
|
2016
|
|
2015
|
Employee-related expenses
|
65% to 70%
|
10.2
|
%
|
|
2.7
|
%
|
|
0.7
|
%
|
Occupancy-related expenses
|
15% to 20%
|
1.3
|
%
|
|
10.1
|
%
|
|
7.4
|
%
|
Selling transportation expenses
|
5%
|
8.1
|
%
|
|
2.9
|
%
|
|
-13.1
|
%
|
Employee-related expenses include: (1) payroll (which includes cash compensation, stock option expense, and profit sharing), (2) health care, (3) personnel development, and (4) social taxes. Our employee-related expenses increased in 2017. This was related to: (1) an increase in full-time equivalent ('FTE') headcount related to efforts to support growth in our business, (2) higher performance bonuses and commissions due to growth in net sales and net earnings, as well as regulatory driven incremental compensation, (3) an increase in our profit sharing contribution and option awards, (4) increased health care costs, and (5) the inclusion of Mansco personnel. The increase in 2016, when compared to 2015, was caused by increases in average annual FTE headcount and an increase in health care costs, which were partially offset by a contraction in our performance bonuses and commissions and in our profit sharing contribution, primarily due to lower sales growth, gross profit, and operating income (both on a dollar basis and on a relative basis). The slight increase in 2015, when compared to 2014, was caused by increases in full-time equivalent headcount and growth in our profit sharing contribution, primarily due to our expanding growth in operating income. Offsetting factors included lower performance bonuses and commissions due to the decrease in our gross profit percentage, and a focused reduction in overtime hours paid.
The table below summarizes the percentage change in our FTE headcount at the end of the periods presented compared to the end of the prior period:
|
|
|
|
|
|
|
|
|
|
|
Twelve-month Period
|
|
2017
|
|
2016
|
|
2015
|
In-market locations
|
7.0
|
%
|
|
-5.6
|
%
|
|
15.7
|
%
|
Total selling (includes in-market locations)
|
7.3
|
%
|
|
-4.9
|
%
|
|
15.8
|
%
|
Distribution
|
8.4
|
%
|
|
-0.7
|
%
|
|
5.5
|
%
|
Manufacturing
|
8.4
|
%
|
|
-9.1
|
%
|
|
3.3
|
%
|
Administrative
|
10.7
|
%
|
|
0.3
|
%
|
|
8.3
|
%
|
Total
|
7.7
|
%
|
|
-4.1
|
%
|
|
13.3
|
%
|
Occupancy-related expenses include: (1) building rent and depreciation, (2) building utility costs, (3) equipment related to our branches and distribution locations, and (4) industrial vending equipment (we consider the vending equipment, excluding leased locker equipment, to be a logical extension of our branch operation and classify the depreciation and repair costs as occupancy expense). The slight increase in occupancy-related expenses in 2017, when compared to 2016, was mainly driven by increases in costs related to industrial vending equipment, FMI bins, and automation equipment at our distribution centers. The most significant components of our occupancy-related expenses, facility costs and utility expenses, were mostly flat in 2017, when compared to 2016 due to a reduction in our number of public branches. The increase in 2016, when compared to 2015, was mainly driven by an increase in the amount of industrial vending equipment and an increase in occupancy expense related to rent. The largest impact came from the industrial vending equipment. The increase in 2015, when compared to 2014, was driven by an increase in the amount of industrial vending equipment and an increased investment in our distribution infrastructure over the previous several years, primarily related to automation.
Our selling transportation expenses consist primarily of expenses for our branch fleet of vehicles, including branch fuel expense, as most of the distribution fleet costs are included in cost of sales. Selling transportation expenses increased in 2017 when compared to 2016. We increased the size of our field-based vehicle fleet for sales personnel which resulted in higher expenses. However, the larger impact was an increase in fuel expense due to higher fuel prices and consumption during the period. This was partially offset by gains on sales of leased vehicles. Selling transportation expenses increased in 2016, when compared to 2015. This was driven by an increase in the number of vehicles for sales personnel, and was partially offset by a decrease in fuel expense. The contraction in selling transportation expenses in 2015, when compared to 2014, was driven by the decline in fuel costs.
The last several years have seen some variation in the cost of diesel fuel and gasoline. During the first, second, third, and fourth quarters of 2017, our total vehicle fuel costs were approximately $8.9, $9.0, $8.5, and $9.7, respectively. During the first, second, third, and fourth quarters of 2016, our total vehicle fuel costs were approximately $6.4, $8.2, $8.3, and $8.0, respectively. The fluctuations were a result of: (1) variations in fuel costs, (2) the service levels provided to our in-market locations from our distribution centers, (3) the number of vehicles at our branch locations, (4) the number of other sales centered vehicles as a result of the expansion of our sales force, and (5) changes in driving conditions. These fuel costs include the fuel utilized in our distribution vehicles (semi-tractors, straight trucks, and sprinter trucks) which is recorded in cost of sales and the fuel utilized in our branch delivery and other sales centered vehicles which is included in operating and administrative expenses (the split in the last several years has been approximately 50/50 between distribution and branch and other sales centered use).
In 2017, aside from these larger impacts, our operating and administrative expenses were also affected by increases in spending on information technology, incremental operating expenses, including amortization, related to our acquisition of Mansco, and the absence of supplier marketing incentives that existed in the first nine months of 2016 as part of our CSP 16 initiative.
Net Interest Expense
Our net interest expense was $8.7 in 2017 compared to $6.1 in 2016, and $2.7 in 2015. The increase in 2017, when compared to 2016, was mainly caused by higher average interest rates and a slightly higher average debt balance during the period. The increase in 2016, when compared to 2015, was driven by higher average interest rates and increased borrowings.
Income Taxes
We recorded a provisional income tax expense of $294.5 in 2017, or 33.7% of earnings before income taxes. This amount reflects an estimated reduction in our deferred income tax liabilities of $30.8 as a result of the income tax rate decrease included in the Tax Act, partially offset by an estimated increase in income tax payable in the amount of $6.5 as a result of the transition tax on cash and cash equivalent balances related to accumulated earnings associated with our international
operations, also included in the Tax Act. Absent the impact of the Tax Act, our income tax expense for 2017 would have been approximately $318.8, or 36.5% of earnings before income taxes. The decrease in our income tax rate from 2016 to 2017 was also related to changes in our reserve for uncertain tax positions and the adoption of the Financial Accounting Standards Board ('FASB') Accounting Standard Update ('ASU') 2016-09,
Improvements to Employee Share-Based Payment Accounting
, in the first quarter of 2017. This standard addresses accounting for excess tax benefits from stock-based compensation that were previously recorded in additional paid-in capital on the balance sheet and are now recognized in income tax expense on the consolidated statement of earnings for the year ended December 31, 2017. A more detailed description of the adoption of ASU 2016-09 is included in Note 1 of the Notes to Consolidated Financial Statements.
Income taxes, as a percentage of earnings before income taxes, were approximately 36.8% and 37.5% for
2016
and
2015
, respectively. The decrease in our income tax rate from 2015 to 2016 was caused by a slight change in jurisdictional income and changes in the reserve for uncertain tax positions. As our international business and profits grew the past several years, the lower income tax rates in those jurisdictions, relative to the United States, lowered our effective tax rate.
We are evaluating the impacts of the Tax Act on our 2018 provisional income tax expense booking rate. We currently estimate this rate will be in the range of 24% to 26% of earnings before income taxes.
Net Earnings
Net earnings, net earnings per share (EPS), percentage change in net earnings, and the percentage change in EPS, were as follows:
|
|
|
|
|
|
|
|
|
|
|
Dollar Amounts
|
2017
(1)
|
|
2016
|
|
2015
|
Net earnings
|
$
|
578.6
|
|
|
499.4
|
|
|
516.4
|
|
Basic EPS
|
2.01
|
|
|
1.73
|
|
|
1.77
|
|
Diluted EPS
|
2.01
|
|
|
1.73
|
|
|
1.77
|
|
|
|
|
|
|
|
Percentage Change
|
2017
(1)
|
|
2016
|
|
2015
|
Net earnings
|
15.8
|
%
|
|
-3.3
|
%
|
|
4.5
|
%
|
Basic EPS
|
16.1
|
%
|
|
-2.3
|
%
|
|
6.0
|
%
|
Diluted EPS
|
16.2
|
%
|
|
-2.3
|
%
|
|
6.6
|
%
|
(1)
Absent the impact of the Tax Act, our net earnings for 2017 would have been $554.2, an increase of 11.0% when compared to 2016, and our basic and diluted earnings per share would have each been $1.92, an increase of 11.2% and 11.3%, respectively.
During 2017, net earnings increased, primarily due to stronger sales and operating profits combined with a reduction in income tax expense. The slightly higher increase in basic and diluted earnings per share was primarily due to the purchase of our shares of common stock in 2017. During 2016, net earnings decreased, despite our nominal sales growth, primarily due to the reduction in the gross profit percent realized and an increase in operating and administrative expenses. The contraction of basic and diluted earnings per share was smaller due primarily to the purchase of our shares of common stock in 2015 and early 2016. During 2015, the net earnings increase was greater than that of sales primarily due to the effective management of operating expenses.
Liquidity and Capital Resources
Net Cash Provided by Operating Activities
Net cash provided by operating activities in dollars and as a percentage of net earnings were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Net cash provided
|
$
|
585.2
|
|
|
519.9
|
|
|
550.3
|
|
% of net earnings
|
101.1
|
%
|
|
104.1
|
%
|
|
106.6
|
%
|
In 2017, the increase in net cash provided by operating activities was primarily due to our net earnings growth. The decline in our operating cash flow as a percentage of net earnings largely reflects working capital trends, and specifically accounts receivable as further described below. In 2016, the slight contraction in the net cash provided by operating activities was driven by our current initiative to add additional products into branch inventory under our CSP 16 format, and an increase in net accounts receivable growth. This decrease was partially offset by a reduction in net cash paid for income taxes. In 2015, the increase in net cash provided by operating activities was driven by growth in net earnings, and a decrease in the cash required
to fund our net working capital, which includes accounts receivable and inventory changes. This was partially offset by an increase in cash paid for income taxes.
Operational Working Capital
Operational working capital, which we define as accounts receivable, net and inventories, is highlighted below. The annual dollar change and the annual percentage change were as follows:
|
|
|
|
|
|
|
|
Dollar change
|
2017
|
|
2016
|
Accounts receivable, net
|
$
|
108.1
|
|
|
31.3
|
|
Inventories
|
99.9
|
|
|
79.7
|
|
Operational working capital
|
$
|
208.1
|
|
|
111.1
|
|
Annual percentage change
|
2017
|
|
2016
|
Accounts receivable, net
|
21.6
|
%
|
|
6.7
|
%
|
Inventories
|
10.1
|
%
|
|
8.7
|
%
|
Operational working capital
|
13.9
|
%
|
|
8.0
|
%
|
Note – Amounts may not foot due to rounding difference.
In 2017, the annual growth in net accounts receivable reflects accelerating growth in sales throughout the course of the year combined with relatively stronger growth of our national accounts and international business. Growth in accounts receivable continued in the fourth quarter of 2017, with the timing of the Christmas and New Year holidays affecting the timing of these customers' payments. Currency fluctuations also impacted accounts receivable in 2017. In 2016, the annual growth in net accounts receivables outpaced the growth in sales. This was not the case through the third quarter, and was mostly a function of conditions in the fourth quarter of 2016. In the fourth quarter of 2015, we collected receivables from our seasonally stronger third quarter, but because demand fell off surprisingly sharply in November and December, our fourth quarter receivables were unseasonably low. In the fourth quarter of 2016, by contrast, we collected receivables from our seasonally stronger third quarter, but because demand was more closely in line with seasonal norms, our receivables in the period were similarly more normal. Over a longer period of time, if we continue to see relatively strong growth in our international business and of our large customer accounts it could continue to create difficulty in managing the growth of accounts receivables relative to the growth in net sales.
Our growth in inventory balances over time does not have as direct a relationship to our monthly sales patterns as does our growth in accounts receivable. This is impacted by other aspects of our business. For example, the dramatic economic slowdown in late 2008 and early 2009 caused our inventory to spike. This occurred because the lead time for inventory procurement is typically longer than the visibility we have into future monthly sales patterns. Over the last decade, we increased our relative inventory levels due to the following: (1) new branch openings, (2) expanded stocking breadth at distribution centers (for example, our master stocking hub in Indianapolis expanded its product breadth over six fold from 2005 to 2011), (3) expanded direct sourcing, (4) expanded Fastenal brands, (5) expanded industrial vending solutions, (6) national accounts and Onsite growth, (7) international growth, and (8) expanded stocking breadth at individual branches related to our CSP initiatives. All of these items impacted both 2017 and 2016, though new branch openings have taken on a significantly diminished role. However, in 2017, the most significant contributor to the increase in inventories was improving business activity and the growth of our Onsite business. In 2016, the most significant contributors to the increase in inventories were the impact of infusing incremental inventory into our network beginning at the end of 2015 as part of our CSP 16 initiative, the relative growth of international sales, the growth of our Onsite business, and opportunist product purchases at year-end. Absent the opportunistic product purchases at year-end, growth in inventories would have moderated substantially from earlier in the year, reflecting the stabilizing of CSP 16 inventories.
The approximate percentage mix of inventory stocked at our selling locations versus our distribution center and manufacturing locations was as follows at year end:
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Selling locations
|
65
|
%
|
|
64
|
%
|
|
61
|
%
|
Distribution center and manufacturing locations
|
35
|
%
|
|
36
|
%
|
|
39
|
%
|
Total
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
Net Cash Used in Investing Activities
Net cash used in investing activities in dollars and as a percentage of net earnings were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Net cash used
|
$
|
179.3
|
|
|
188.1
|
|
|
180.6
|
|
% of net earnings
|
31.0
|
%
|
|
37.7
|
%
|
|
35.0
|
%
|
The changes in net cash used in investing activities were primarily related to changes in our net capital expenditures as discussed below and cash paid for acquisitions in 2017 and 2015.
Net capital expenditures (purchases of property and equipment, less proceeds from the sale of property and equipment) in dollars and as a percentage of net earnings were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Net capital expenditures
|
$
|
112.5
|
|
|
183.0
|
|
|
145.3
|
|
% of net earnings
|
19.4
|
%
|
|
36.6
|
%
|
|
28.1
|
%
|
Note – A reconciliation of net capital expenditures is outlined in the table below.
Our net capital expenditures decreased in 2017, when compared to 2016, primarily due to lower spending in 2017 related to: (1) the absence of spending on vending equipment that occurred in 2016 related to the leased locker rollout, (2) the absence of spending on shelving and signage that occurred in 2016 for the CSP 16 initiative, and (3) timing associated with the addition of pickup trucks. Our net capital expenditures increased in 2016, when compared to 2015, which was primarily due to the purchase of industrial vending devices related to the leased locker program we signed in February 2016 and spending on automation in certain distribution centers. Our net capital expenditures decreased in 2015, when compared to 2014, which was largely related to the completion of distribution center automation projects in process during 2014.
Property and equipment expenditures in
2017
,
2016
, and
2015
consisted of: (1) the purchase of software and hardware for our information processing systems, (2) the addition of fleet vehicles, (3) the purchase of signage, shelving, and other fixed assets related to branch openings and our CSP 16 initiative, (4) the addition of manufacturing and warehouse equipment, (5) the expansion or improvement of certain owned or leased branch properties, (6) purchases related to industrial vending, and (7) costs related to enhancements to distribution centers including automation systems equipment. Disposals of property and equipment consisted of the planned disposition of certain pick-up trucks, distribution vehicles and trailers in the normal course of business, and the disposition of real estate relating to several branch locations and a distribution center (2015).
Set forth below is an estimate of our
2018
net capital expenditures and a recap of our
2017
,
2016
, and
2015
net capital expenditures.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
2015
|
|
(Estimate)
|
|
(Actual)
|
|
(Actual)
|
|
(Actual)
|
Manufacturing, warehouse and packaging equipment, industrial vending equipment, and facilities
|
$
|
87.0
|
|
|
66.2
|
|
|
131.8
|
|
|
112.5
|
|
Shelving and related supplies for branch openings and for product expansion at existing branches
|
16.0
|
|
|
8.3
|
|
|
14.1
|
|
|
8.9
|
|
Data processing software and equipment
|
28.0
|
|
|
23.2
|
|
|
18.0
|
|
|
19.7
|
|
Real estate and improvements to branch locations
|
14.0
|
|
|
6.2
|
|
|
5.5
|
|
|
4.2
|
|
Vehicles
|
12.0
|
|
|
16.0
|
|
|
20.1
|
|
|
9.9
|
|
Purchases of property and equipment
|
157.0
|
|
|
119.9
|
|
|
189.5
|
|
|
155.2
|
|
Proceeds from sale of property and equipment
|
(8.0
|
)
|
|
(7.4
|
)
|
|
(6.5
|
)
|
|
(9.9
|
)
|
Net Capital Expenditures
|
$
|
149.0
|
|
|
112.5
|
|
|
183.0
|
|
|
145.3
|
|
We anticipate funding our capital expenditure needs with cash generated from operations, from available cash and cash equivalents, and from our borrowing capacity.
Net Cash Used in Financing Activities
Net cash used in financing activities in dollars and as a percentage of net earnings were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Net cash used
|
$
|
407.2
|
|
|
346.8
|
|
|
340.9
|
|
% of net earnings
|
70.4
|
%
|
|
69.4
|
%
|
|
66.0
|
%
|
The fluctuations in net cash used in financing activities are due to changes in the level of our dividend payments and in the level of common stock purchases. These amounts were partially offset by the exercise of stock options and net proceeds from debt obligations. These items in dollars and as a percentage of earnings were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Dividends paid
|
$
|
369.1
|
|
|
346.6
|
|
|
327.1
|
|
% of net earnings
|
63.8
|
%
|
|
69.4
|
%
|
|
63.3
|
%
|
|
|
|
|
|
|
Common stock purchases
|
82.6
|
|
|
59.5
|
|
|
292.9
|
|
% of net earnings
|
14.3
|
%
|
|
11.9
|
%
|
|
56.7
|
%
|
|
|
|
|
|
|
Total returned to shareholders
|
$
|
451.7
|
|
|
406.1
|
|
|
620.0
|
|
% of net earnings
|
78.1
|
%
|
|
81.3
|
%
|
|
120.1
|
%
|
|
|
|
|
|
|
Proceeds from the exercise of stock options
|
$
|
(9.5
|
)
|
|
(29.3
|
)
|
|
(19.1
|
)
|
% of net earnings
|
-1.6
|
%
|
|
-5.9
|
%
|
|
-3.7
|
%
|
|
|
|
|
|
|
Cash borrowings, net
|
$
|
(35.0
|
)
|
|
(30.0
|
)
|
|
(260.0
|
)
|
% of net earnings
|
-6.0
|
%
|
|
-6.0
|
%
|
|
-50.4
|
%
|
|
|
|
|
|
|
Net cash used
|
$
|
407.2
|
|
|
346.8
|
|
|
340.9
|
|
% of net earnings
|
70.4
|
%
|
|
69.4
|
%
|
|
66.0
|
%
|
Stock Purchases
In 2017, we purchased 1,900,000 shares of our common stock at an average price of approximately $43.43 per share, in 2016, we purchased 1,600,000 shares at an average price of approximately $37.15 per share, and in 2015, we purchased 7,100,000 shares at an average price of approximately $41.26 per share.
Dividends
We declared a quarterly dividend of
$0.37
per share on
January 16, 2018
. We paid aggregate annual dividends per share of
$1.28
, $
1.20
, and $
1.12
in
2017
,
2016
, and
2015
, respectively.
Debt
In order to fund the considerable cash needed to purchase industrial vending devices under our leased locker program, to expand our industrial vending business, to increase the use of automation in our distribution centers, to purchase our common stock and pay dividends, and to fund the acquisition of Mansco on March 31, 2017, we have borrowed under our Credit Facility and our Master Note Agreement in recent periods.
Our borrowings under the Credit Facility peaked during each quarter of 2017 and 2016 as follows:
|
|
|
|
|
|
|
|
Peak borrowings
|
2017
|
|
2016
|
First quarter
|
$
|
325.0
|
|
|
440.0
|
|
Second quarter
|
365.0
|
|
|
485.0
|
|
Third quarter
|
365.0
|
|
|
460.0
|
|
Fourth quarter
|
325.0
|
|
|
405.0
|
|
As of December 31, 2017, we had loans outstanding under the Credit Facility of
$280.0
and contingent obligations from letters of credit outstanding under the Credit Facility in an aggregate face amount of
$36.3
. As of
December 31, 2017
, we also had
loans outstanding under the Master Note Agreement of
$135.0
. Descriptions of our Credit Facility and Master Note Agreement are contained in Note 10 of the Notes to Consolidated Financial Statements.
Unremitted Foreign Earnings
Approximately $92.0 of cash and cash equivalents are held by non-U.S. subsidiaries. These funds may create foreign currency translation gains or losses depending on the functional currency of the entity holding the cash. We have considered the financial requirements of each foreign subsidiary and our parent company and will continue to reinvest these funds to support our expansion activities outside the U.S. even after taking into consideration the deemed repatriation and transition tax under the Tax Act. The income tax impact of repatriating cash associated with investments in foreign subsidiaries is discussed in Note 7 of the Notes to Consolidated Financial Statements.
Effects of Inflation
Throughout 2017, we experienced increasing product cost inflation, particularly in our fastener products. We were able to take actions during the period, including pricing adjustments, to mostly offset this inflation. In the aggregate, the overall impact of inflation and pricing on sales and profits was not material in 2017. During the first half of 2016, we experienced some deflation in our fastener products, which was largely offset by some inflation in the latter half of the year, and minimal price movements in our non-fastener products. In 2015, we experienced some deflation in our fastener products and minimal price movements in our non-fastener products, with the net impact being a slight drag on growth.
Critical Accounting Policies and Estimates
In preparing our consolidated financial statements in conformity with U.S. GAAP, we must make decisions that impact the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, we apply judgments based on our understanding and analysis of relevant circumstances, historical experience, and actuarial valuations. Actual amounts could differ from those estimated at the time the consolidated financial statements are prepared.
Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements. Some of those significant accounting policies require us to make difficult, subjective, or complex judgments, or estimates. An accounting estimate is considered to be critical if it meets both of the following criteria: (i) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and (ii) different estimates reasonably could have been used, or changes in the estimate that are reasonably likely to occur from period to period may have a material impact on the presentation of our financial condition, changes in financial condition, or results of operations. Our critical accounting estimates include the following:
Allowance for doubtful accounts
– This reserve is for accounts receivable balances that are potentially uncollectible. The reserve is based on an analysis of customer accounts and our historical experience with accounts receivable write-offs. Our methodology for estimating this reserve includes ongoing reviews of the aging of accounts receivable, the financial condition of a customer or industry, and general economic conditions. If business or economic conditions change, our estimates and assumptions may be adjusted as deemed appropriate. Historically, actual required reserves have not varied materially from estimated amounts.
Inventory obsolescence reserves
– These reserves are based on an analysis of inventory trends including reviews of inventory levels, sales information, and the on-hand quantities relative to the sales history for the product. Our methodology for estimating these reserves is continually evaluated for factors that could require changes to the reserves including significant changes in product demand, market conditions, condition of the inventory, or liquidation value. If business or economic conditions change, our estimates and assumptions may be adjusted as deemed appropriate. Historically, actual required reserves have not varied materially from estimated amounts.
General insurance reserves
– These reserves are for general claims related to workers' compensation, property and casualty losses, and other general liability self-insured losses. The reserves are based on an analysis of reported claims and claims incurred but not yet reported related to our historical claim trends. We perform ongoing reviews of our insured and uninsured risks and use this information to establish appropriate reserve levels. We analyze historical trends, claims experience, and loss development patterns to ensure the appropriate loss development factors are applied to the incurred costs associated with the claims made. Historically, actual required reserves have not varied materially from estimated amounts.
New Accounting Pronouncements
A description of new accounting pronouncements is contained in Note 1 of the Notes to Consolidated Financial Statements.
Geographic Information
Information regarding our revenues and long-lived assets by geographic area is contained in Note 8 of the Notes to Consolidated Financial Statements. Risks related to our foreign operations are described earlier in this Form 10-K under the heading 'Forward-Looking Statements' and 'Item 1A. Risk Factors'.
Certain Contractual Obligations
As of December 31, 2017, we had outstanding long-term debt and facilities, equipment, and vehicles leased under operating leases. Our future obligations to pay principal of and interest on such long-term debt and to make minimum lease payments under such operating leases are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
2018
|
|
2019 and 2020
|
|
2021 and 2022
|
|
After 2022
|
Principal of long-term debt
|
$
|
415.0
|
|
|
3.0
|
|
|
277.0
|
|
|
75.0
|
|
|
60.0
|
|
Interest on long-term debt
(1)
|
35.5
|
|
|
11.3
|
|
|
16.4
|
|
|
5.6
|
|
|
2.2
|
|
Operating leases
|
324.7
|
|
|
133.8
|
|
|
152.5
|
|
|
36.4
|
|
|
2.0
|
|
Total
|
$
|
775.2
|
|
|
148.1
|
|
|
445.9
|
|
|
117.0
|
|
|
64.2
|
|
(1)
Interest on the long-term debt outstanding under our Credit Facility was calculated using the interest rates and balances at December 31, 2017.
Purchase orders and contracts for the purchase of inventory and other goods and services are not included in the table above. Our purchase orders are based on current distribution needs and are fulfilled by our suppliers within short time horizons. We do not have significant agreements for the purchase of inventory or other goods or services specifying minimum order quantities.
Liabilities for uncertain tax positions have been excluded from the table above due to the uncertainty surrounding the ultimate settlement and timing of these liabilities. A discussion of income taxes is contained in Note 7 of the Notes to Consolidated Financial Statements.
Non-GAAP Financial Measures
On December 22, 2017, the Tax Act was signed into law. The financial information included in this Form 10-K reflects the estimated impact of the enactment of the Tax Act. Our income tax expense, net earnings, our basic and diluted net earnings per share, and our income tax as a percentage of earnings before income tax, excluding the impact of the Tax Act, are non-GAAP financial measures. Management believes reporting these measures will help investors understand the effect of tax reform on comparable reported results.
|
|
ITEM 8.
|
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and board of directors of
Fastenal Company:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Fastenal Company and subsidiaries (the 'Company') as of December 31, 2017 and 2016, the related consolidated statements of earnings, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes and financial statement schedule listed in the table of contents at Item 15 (collectively, the 'consolidated financial statements'). We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in
Internal Control - Integrated Framework
(2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in
Internal Control - Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Fastenal Company acquired certain assets and assumed certain liabilities of Manufacturers Supply Company (‘Mansco’) on March 31, 2017, and management excluded from their assessment of the effectiveness of internal control over financial reporting as of December 31, 2017, Mansco's internal control over financial reporting associated with assets of approximately one percent of Fastenal Company's total assets and revenues of approximately one percent of Fastenal Company's total revenues included in the consolidated financial statements of Fastenal Company and subsidiaries as of and for the year ended December 31, 2017. Our audit of internal control over financial reporting of Fastenal Company also excluded an evaluation of the internal control over financial reporting of Mansco.
Basis for Opinion
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's consolidated financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ('PCAOB') and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
We have served as the Company’s auditor since 1987.
Minneapolis, Minnesota
February 5, 2018
FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Balance Sheets
(Amounts in millions except share information)
|
|
|
|
|
|
|
|
|
December 31
|
|
2017
|
|
2016
|
Assets
|
|
|
|
Current assets:
|
|
|
|
Cash and cash equivalents
|
$
|
116.9
|
|
|
112.7
|
|
Trade accounts receivable, net of allowance for doubtful accounts of $11.9 and $11.2, respectively
|
607.8
|
|
|
499.7
|
|
Inventories
|
1,092.9
|
|
|
993.0
|
|
Prepaid income taxes
|
—
|
|
|
12.9
|
|
Other current assets
|
118.1
|
|
|
102.5
|
|
Total current assets
|
1,935.7
|
|
|
1,720.8
|
|
Property and equipment, net
|
893.6
|
|
|
899.7
|
|
Other assets
|
81.2
|
|
|
48.4
|
|
Total assets
|
$
|
2,910.5
|
|
|
2,668.9
|
|
Liabilities and Stockholders' Equity
|
|
|
|
Current liabilities:
|
|
|
|
Current portion of debt
|
$
|
3.0
|
|
|
10.5
|
|
Accounts payable
|
147.5
|
|
|
108.8
|
|
Accrued expenses
|
194.0
|
|
|
156.4
|
|
Income taxes payable
|
6.5
|
|
|
—
|
|
Total current liabilities
|
351.0
|
|
|
275.7
|
|
Long-term debt
|
412.0
|
|
|
379.5
|
|
Deferred income tax liabilities
|
50.6
|
|
|
80.6
|
|
Commitments and contingencies (Notes 5, 9, 10, and 11)
|
|
|
|
Stockholders’ equity:
|
|
|
|
Preferred stock: $0.01 par value, 5,000,000 shares authorized, no shares issued or outstanding
|
—
|
|
|
—
|
|
Common stock: $0.01 par value, 400,000,000 shares authorized, 287,591,536 and 289,161,924 shares issued and outstanding, respectively
|
2.9
|
|
|
2.9
|
|
Additional paid-in capital
|
8.5
|
|
|
37.4
|
|
Retained earnings
|
2,110.6
|
|
|
1,940.1
|
|
Accumulated other comprehensive loss
|
(25.1
|
)
|
|
(47.3
|
)
|
Total stockholders’ equity
|
2,096.9
|
|
|
1,933.1
|
|
Total liabilities and stockholders’ equity
|
$
|
2,910.5
|
|
|
2,668.9
|
|
See accompanying Notes to Consolidated Financial Statements.
FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Statements of Earnings
(Amounts in millions except earnings per share)
For the year ended December 31
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Net sales
|
$
|
4,390.5
|
|
|
3,962.0
|
|
|
3,869.2
|
|
Cost of sales
|
2,226.9
|
|
|
1,997.2
|
|
|
1,920.3
|
|
Gross profit
|
2,163.6
|
|
|
1,964.8
|
|
|
1,948.9
|
|
Operating and administrative expenses
|
1,282.8
|
|
|
1,169.5
|
|
|
1,121.5
|
|
Gain on sale of property and equipment
|
(1.0
|
)
|
|
(0.5
|
)
|
|
(1.4
|
)
|
Operating income
|
881.8
|
|
|
795.8
|
|
|
828.8
|
|
Interest income
|
0.4
|
|
|
0.4
|
|
|
0.4
|
|
Interest expense
|
(9.1
|
)
|
|
(6.5
|
)
|
|
(3.1
|
)
|
Earnings before income taxes
|
873.1
|
|
|
789.7
|
|
|
826.1
|
|
Income tax expense
|
294.5
|
|
|
290.3
|
|
|
309.7
|
|
Net earnings
|
$
|
578.6
|
|
|
499.4
|
|
|
516.4
|
|
Basic net earnings per share
|
$
|
2.01
|
|
|
1.73
|
|
|
1.77
|
|
Diluted net earnings per share
|
$
|
2.01
|
|
|
1.73
|
|
|
1.77
|
|
Basic weighted average shares outstanding
|
288.2
|
|
|
288.9
|
|
|
291.5
|
|
Diluted weighted average shares outstanding
|
288.3
|
|
|
289.2
|
|
|
292.0
|
|
See accompanying Notes to Consolidated Financial Statements.
FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Amounts in millions)
For the year ended December 31
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Net earnings
|
$
|
578.6
|
|
|
499.4
|
|
|
516.4
|
|
Other comprehensive income (loss), net of tax:
|
|
|
|
|
|
Foreign currency translation adjustments (net of tax of $0.0 in 2017, 2016, and 2015)
|
22.2
|
|
|
(0.9
|
)
|
|
(38.6
|
)
|
Comprehensive income
|
$
|
600.8
|
|
|
498.5
|
|
|
477.8
|
|
See accompanying Notes to Consolidated Financial Statements.
FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(Amounts in millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Additional
Paid-in
Capital
|
|
Retained
Earnings
|
|
Accumulated
Other
Comprehensive
Income (Loss)
|
|
Total
Stockholders'
Equity
|
Balance as of December 31, 2014
|
295.9
|
|
|
$
|
3.0
|
|
|
33.7
|
|
|
1,886.4
|
|
|
(7.8
|
)
|
|
1,915.3
|
|
Dividends paid in cash
|
—
|
|
|
—
|
|
|
—
|
|
|
(327.1
|
)
|
|
—
|
|
|
(327.1
|
)
|
Purchases of common stock
|
(7.1
|
)
|
|
(0.1
|
)
|
|
(60.0
|
)
|
|
(232.8
|
)
|
|
—
|
|
|
(292.9
|
)
|
Stock options exercised
|
0.8
|
|
|
—
|
|
|
19.1
|
|
|
—
|
|
|
—
|
|
|
19.1
|
|
Stock-based compensation
|
—
|
|
|
—
|
|
|
5.8
|
|
|
—
|
|
|
—
|
|
|
5.8
|
|
Excess tax benefits from stock-based compensation
|
—
|
|
|
—
|
|
|
3.4
|
|
|
—
|
|
|
—
|
|
|
3.4
|
|
Net earnings
|
—
|
|
|
—
|
|
|
—
|
|
|
516.4
|
|
|
—
|
|
|
516.4
|
|
Other comprehensive income (loss)
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(38.6
|
)
|
|
(38.6
|
)
|
Balance as of December 31, 2015
|
289.6
|
|
|
$
|
2.9
|
|
|
2.0
|
|
|
1,842.9
|
|
|
(46.4
|
)
|
|
1,801.4
|
|
Dividends paid in cash
|
—
|
|
|
—
|
|
|
—
|
|
|
(346.6
|
)
|
|
—
|
|
|
(346.6
|
)
|
Purchases of common stock
|
(1.6
|
)
|
|
—
|
|
|
(3.9
|
)
|
|
(55.6
|
)
|
|
—
|
|
|
(59.5
|
)
|
Stock options exercised
|
1.2
|
|
|
—
|
|
|
29.3
|
|
|
—
|
|
|
—
|
|
|
29.3
|
|
Stock-based compensation
|
—
|
|
|
—
|
|
|
4.1
|
|
|
—
|
|
|
—
|
|
|
4.1
|
|
Excess tax benefits from stock-based compensation
|
—
|
|
|
—
|
|
|
5.9
|
|
|
—
|
|
|
—
|
|
|
5.9
|
|
Net earnings
|
—
|
|
|
—
|
|
|
—
|
|
|
499.4
|
|
|
—
|
|
|
499.4
|
|
Other comprehensive income (loss)
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(0.9
|
)
|
|
(0.9
|
)
|
Balance as of December 31, 2016
|
289.2
|
|
|
$
|
2.9
|
|
|
37.4
|
|
|
1,940.1
|
|
|
(47.3
|
)
|
|
1,933.1
|
|
Dividends paid in cash
|
—
|
|
|
—
|
|
|
—
|
|
|
(369.1
|
)
|
|
—
|
|
|
(369.1
|
)
|
Purchases of common stock
|
(1.9
|
)
|
|
—
|
|
|
(43.6
|
)
|
|
(39.0
|
)
|
|
—
|
|
|
(82.6
|
)
|
Stock options exercised
|
0.3
|
|
|
—
|
|
|
9.5
|
|
|
—
|
|
|
—
|
|
|
9.5
|
|
Stock-based compensation
|
—
|
|
|
—
|
|
|
5.2
|
|
|
—
|
|
|
—
|
|
|
5.2
|
|
Net earnings
|
—
|
|
|
—
|
|
|
—
|
|
|
578.6
|
|
|
—
|
|
|
578.6
|
|
Other comprehensive income (loss)
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
22.2
|
|
|
22.2
|
|
Balance as of December 31, 2017
|
287.6
|
|
|
$
|
2.9
|
|
|
8.5
|
|
|
2,110.6
|
|
|
(25.1
|
)
|
|
2,096.9
|
|
See accompanying Notes to Consolidated Financial Statements.
FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Amounts in millions)
For the year ended December 31
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
Cash flows from operating activities:
|
|
|
|
|
|
Net earnings
|
$
|
578.6
|
|
|
499.4
|
|
|
516.4
|
|
Adjustments to reconcile net earnings to net cash provided by operating activities, net of acquisitions:
|
|
|
|
|
|
Depreciation of property and equipment
|
123.6
|
|
|
103.5
|
|
|
86.1
|
|
Gain on sale of property and equipment
|
(1.0
|
)
|
|
(0.5
|
)
|
|
(1.4
|
)
|
Bad debt expense
|
8.2
|
|
|
8.6
|
|
|
8.8
|
|
Deferred income taxes
|
(30.0
|
)
|
|
25.6
|
|
|
8.3
|
|
Stock-based compensation
|
5.2
|
|
|
4.1
|
|
|
5.8
|
|
Amortization of intangible assets
|
3.8
|
|
|
0.5
|
|
|
0.5
|
|
Changes in operating assets and liabilities, net of acquisitions:
|
|
|
|
|
|
Trade accounts receivable
|
(103.7
|
)
|
|
(40.5
|
)
|
|
(20.6
|
)
|
Inventories
|
(76.3
|
)
|
|
(80.9
|
)
|
|
(47.8
|
)
|
Other current assets
|
(15.6
|
)
|
|
29.1
|
|
|
(15.8
|
)
|
Accounts payable
|
36.3
|
|
|
(17.2
|
)
|
|
20.6
|
|
Accrued expenses
|
37.6
|
|
|
(28.6
|
)
|
|
11.1
|
|
Income taxes
|
19.4
|
|
|
15.5
|
|
|
(26.6
|
)
|
Other
|
(0.9
|
)
|
|
1.3
|
|
|
4.9
|
|
Net cash provided by operating activities
|
585.2
|
|
|
519.9
|
|
|
550.3
|
|
Cash flows from investing activities:
|
|
|
|
|
|
Purchases of property and equipment
|
(119.9
|
)
|
|
(189.5
|
)
|
|
(155.2
|
)
|
Proceeds from sale of property and equipment
|
7.4
|
|
|
6.5
|
|
|
9.9
|
|
Cash paid for acquisitions
|
(58.7
|
)
|
|
—
|
|
|
(23.5
|
)
|
Other
|
(8.1
|
)
|
|
(5.1
|
)
|
|
(11.8
|
)
|
Net cash used in investing activities
|
(179.3
|
)
|
|
(188.1
|
)
|
|
(180.6
|
)
|
Cash flows from financing activities:
|
|
|
|
|
|
Proceeds from debt obligations
|
1,015.0
|
|
|
950.0
|
|
|
1,215.0
|
|
Payments against debt obligations
|
(980.0
|
)
|
|
(920.0
|
)
|
|
(955.0
|
)
|
Proceeds from exercise of stock options
|
9.5
|
|
|
29.3
|
|
|
19.1
|
|
Purchases of common stock
|
(82.6
|
)
|
|
(59.5
|
)
|
|
(292.9
|
)
|
Payments of dividends
|
(369.1
|
)
|
|
(346.6
|
)
|
|
(327.1
|
)
|
Net cash used in financing activities
|
(407.2
|
)
|
|
(346.8
|
)
|
|
(340.9
|
)
|
|
|
|
|
|
|
Effect of exchange rate changes on cash and cash equivalents
|
5.5
|
|
|
(1.3
|
)
|
|
(14.2
|
)
|
Net increase (decrease) in cash and cash equivalents
|
4.2
|
|
|
(16.3
|
)
|
|
14.6
|
|
Cash and cash equivalents at beginning of year
|
112.7
|
|
|
129.0
|
|
|
114.4
|
|
Cash and cash equivalents at end of year
|
$
|
116.9
|
|
|
112.7
|
|
|
129.0
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
Cash paid for interest
|
$
|
8.7
|
|
|
6.2
|
|
|
3.1
|
|
Net cash paid for income taxes
|
$
|
304.1
|
|
|
248.3
|
|
|
327.0
|
|
See accompanying Notes to Consolidated Financial Statements.
Fastenal Company and Subsidiaries
Notes to Consolidated Financial Statements
Note 1. Business Overview and Summary of Significant Accounting Policies
Business Overview
Fastenal is a leader in the wholesale distribution of industrial and construction supplies operating a branch-based business (with an increasing number of Onsite locations). Collectively we refer to our branches and Onsite locations as in-market locations. We have approximately
3,000
in-market locations located primarily in North America.
Principles of Consolidation
The consolidated financial statements include the accounts of Fastenal Company and its subsidiaries (collectively referred to as 'Fastenal' or by terms such as 'we', 'our', or 'us'). All material intercompany balances and transactions have been eliminated in consolidation.
Revenue Recognition and Accounts Receivable
Net sales include products, services, shipping and handling charges, and lease fees billed, net of any related sales incentives, and net of an estimate for product returns. We recognize revenue when persuasive evidence of an arrangement exists, title and risk of ownership have passed, the sales price is fixed or determinable, and collectibility is reasonably assured. These criteria are met at the time the product is shipped to or picked up by the customer. We recognize services at the time the service is completed and the product is provided to the customer. We recognize revenue for shipping and handling charges at the time the products are shipped to or picked up by the customer. We recognize revenue for lease fees on a straight-line basis over the corresponding lease term. We estimate product returns based on historical return rates. Accounts receivable are stated at their estimated net realizable value. The allowance for doubtful accounts is based on an analysis of customer accounts and our historical experience with accounts receivable write-offs. Sales taxes (and value added taxes in foreign jurisdictions) collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales.
Foreign Currency Translation and Transactions
The functional currency of our foreign operations is typically the applicable local currency. The functional currency is translated into United States dollars for balance sheet accounts, except retained earnings, using current exchange rates as of the balance sheet date, for retained earnings at historical exchange rates, and for revenue and expense accounts using a weighted average exchange rate during the period. The translation adjustments are deferred as a separate component of stockholders' equity captioned accumulated other comprehensive income (loss). Gains or losses resulting from transactions denominated in foreign currencies are included in cost of sales or operating and administrative expenses.
Cash and Cash Equivalents
We consider all investments purchased with original maturities of three months or less to be cash equivalents.
Inventories
Inventories, consisting of finished goods merchandise held for resale, are stated at the lower of cost (first in, first out method) or market.
Property and Equipment
Property and equipment are stated at cost. Depreciation on property and equipment is provided for using the straight-line method over the anticipated economic useful lives of the related property. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, we first compare undiscounted cash flows expected to be generated by the asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values, and third-party independent appraisals, as considered necessary. There were
no
impairments recorded during any of the three years reported in these consolidated financial statements.
Fastenal Company and Subsidiaries
Notes to Consolidated Financial Statements—Continued
Leases
We lease space under operating leases for certain distribution centers, branches, and manufacturing locations. These leases do not have significant rent escalation holidays, concessions, leasehold improvement incentives, or other build-out clauses. Any such terms are recognized as rent expense over the term of the lease. Further, the leases do not contain contingent rent provisions. Leasehold improvements on operating leases are amortized over their estimated service lives on a straight-line basis, or the remaining lease term, whichever is shorter. We lease certain semi-tractors, pick-ups, and equipment under operating leases.
Other Long-Lived Assets
Other assets consist of prepaid deposits, goodwill, and other definite-lived intangible assets. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is reviewed for impairment annually. The identifiable intangible assets are amortized on a straight-line basis over their estimated life.
Accounting Estimates
The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent liabilities. Actual results could differ from those estimates.
Insurance Reserves
We are self-insured for certain losses relating to workers' compensation, automobile, health, and general liability costs. Specific stop-loss coverage is provided for catastrophic claims in order to limit exposure to significant claims. Self-insurance liabilities are based on our estimate of reported claims and claims incurred but not yet reported.
Product Warranties
We offer a basic limited warranty for certain of our products. The specific terms and conditions of those warranties vary depending upon the product sold. We typically recoup these costs through product warranties we hold with the original equipment manufacturers. Our warranty expense has historically been minimal.
Stock-Based Compensation
We estimate the value of stock option grants using a Black-Scholes valuation model. Stock-based compensation expense is recognized on a straight-line basis over the vesting period. Our stock-based compensation expense is recorded in operating and administrative expenses.
Income Taxes
We account for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
We recognize the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We record interest and penalties related to unrecognized tax benefits in income tax expense.
Earnings Per Share
Basic net earnings per share is calculated using net earnings available to common stockholders divided by the weighted average number of shares of common stock outstanding during the year. Diluted net earnings per share is similar to basic net earnings per share except that the weighted average number of shares of common stock outstanding includes the incremental shares assumed to be issued upon the exercise of stock options considered to be 'in-the-money' (i.e. when the market price of our stock is greater than the exercise price of our outstanding stock options).
Fastenal Company and Subsidiaries
Notes to Consolidated Financial Statements—Continued
Segment Reporting
We have determined that for our North American operations we meet the aggregation criteria outlined in the accounting standards as our various operations have similar (1) economic characteristics, (2) products and services, (3) customers, (4) distribution channels, and (5) regulatory environments. Considering the insignificance of our operations outside of North America, we report as a single business segment.
Recently Adopted Accounting Pronouncements
Effective January 1, 2017, we adopted the
FASB ASU 2016-09,
Improvements to Employee Share-Based Payment Accounting
. The standard simplifies several aspects of the accounting for employee share-based payment transactions, including accounting for income taxes, forfeitures, and statutory withholding requirements, as well as classification in the Consolidated Statements of Cash Flows. As a result of the adoption, on a prospective basis, for the year ended December 31, 2017, we recognized
$1.8
of excess tax benefits from stock-based compensation as a discrete item in our income tax expense. Historically, these amounts were recorded as additional paid-in capital. Upon adoption, we elected to apply the change retrospectively to our Consolidated Statements of Cash Flows for the years ended December 31, 2016 and December 31, 2015, which resulted in a reclassification of excess tax benefits from stock-based compensation of
$5.9
and
$3.4
, respectively, offsetting cash flows used in financing activities to cash flows provided by operating activities. We elected not to change our policy on accounting for forfeitures and will continue to estimate a requisite forfeiture rate. Additional amendments to the accounting for income taxes and minimum statutory withholding requirements had no impact on our results of operations.
On December 22, 2017, the Securities and Exchange Commission ('SEC') staff issued Staff Accounting Bulletin No. 118 ('SAB 118') to address the application of U.S. GAAP related to the enactment of the comprehensive tax legislation, commonly referred to as the Tax Cut and Jobs Act (the 'Tax Act'). This guidance was adopted in the fourth quarter of 2017. Additional information regarding our adoption of this guidance is contained in Note 7.
Recently Issued Accounting Pronouncements
In August 2015, the FASB issued ASU 2015-14,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,
which deferred the effective date of ASU 2014-09 for all entities by one year. This update is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Earlier application was permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. ASU 2014-09 was to become effective for us beginning January 2017; however, ASU 2015-14 deferred our effective date until January 2018, which is when we plan to adopt this standard. The ASU permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective method). The ASU also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required for customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. We have completed the process of evaluating the effect of the adoption and determined there were no changes required to our reported revenues as a result of the adoption. The majority of our revenue arrangements generally consist of a single performance obligation to transfer promised goods or services. Based on our evaluation process and review of our contracts with customers, the timing and amount of revenue recognized based on ASU 2015-14 is consistent with our revenue recognition policy under previous guidance. We adopted the new standard effective January 1, 2018, using the modified retrospective approach, and will expand our consolidated financial statement disclosures in order to comply with the ASU. We have determined the adoption of ASU 2015-14 will not have a material impact on our results of operations, cash flows, or financial position.
In February 2016, the FASB issued ASU 2016-02,
Leases
, which introduces the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The update is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those reporting periods, with early adoption permitted. The guidance will be applied on a modified retrospective basis with the earliest period presented. Based on the effective date, this guidance will apply beginning January 2019, which is when we plan to adopt this ASU.
While we are still in the process of evaluating the effect of adoption on our consolidated financial statements and are currently assessing our leases,
we expect the adoption will lead to a material increase in the assets and liabilities recorded on our Consolidated Balance Sheets. As part of our assessment, we will need to determine the impact of lease extension provisions provided in our facility and vehicle leases which will impact the amount of the right of use asset and lease liability recorded under the ASU.
Fastenal Company and Subsidiaries
Notes to Consolidated Financial Statements—Continued
Note 2. Acquisition
On March 31, 2017, we acquired certain assets and assumed certain liabilities of Manufacturers Supply Company (‘Mansco’). Mansco, based in Hudsonville, Michigan, is a distributor of industrial and fastener supplies with a particularly strong market position with commercial furniture original equipment manufacturers. As such, this acquisition gives us a presence in a market where we have not meaningfully participated in the past, and provides Mansco with additional tools with which to service its customer base and reduce costs through economies of scale.
The total purchase price for this acquisition, based on the acquisition date fair value, consisted of
$57.9
paid in cash at closing,
$0.8
paid in cash after closing pursuant to a post-closing purchase price adjustment, and a contingent consideration arrangement which requires us to pay the former owner up to a maximum of
$2.5
(undiscounted) in cash after closing based on sales growth of the acquired business. We funded the purchase price for the acquisition with the proceeds from the issuance of a new series of senior unsecured promissory notes under our master note agreement in the aggregate principal amount of
$60.0
.
The fair value of the assets acquired and liabilities assumed as of the acquisition date is summarized below.
|
|
|
|
|
Current assets
|
$
|
21.7
|
|
Property and equipment
|
0.9
|
|
Identifiable intangible assets
|
20.1
|
|
Current liabilities
|
(1.8
|
)
|
Total identifiable net assets
|
40.9
|
|
Goodwill
|
18.4
|
|
Total fair value of assets acquired and liabilities assumed
|
$
|
59.3
|
|
The identifiable intangible assets consist mainly of the value of the customer relationships that were acquired and the goodwill consists largely of the synergies and economies of scale expected from combining the Mansco operations with our existing operations. The identifiable intangible assets and goodwill are deductible for income tax purposes.
The amount of net sales and net earnings of the acquired business included in our Consolidated Statement of Earnings for the year ended December 31, 2017, and the pro forma net sales and net earnings of the combined entity had the acquisition occurred on January 1, 2016, are:
|
|
|
|
|
|
|
|
2017
|
2016
|
Net sales
|
$
|
53.5
|
|
49.6
|
|
Net earnings
|
$
|
5.5
|
|
4.9
|
|
Note 3. Long-Lived Assets
Property and equipment
Property and equipment at year end consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
Depreciable Life
in Years
|
|
2017
|
|
2016
|
Land
|
—
|
|
|
$
|
38.2
|
|
|
37.3
|
|
Buildings and improvements
|
15 to 40
|
|
|
308.2
|
|
|
297.1
|
|
Automated distribution and warehouse equipment
|
5 to 30
|
|
|
220.0
|
|
|
216.3
|
|
Shelving, industrial vending, and equipment
|
3 to 10
|
|
|
812.9
|
|
|
723.9
|
|
Transportation equipment
|
3 to 5
|
|
|
76.3
|
|
|
71.7
|
|
Construction in progress
|
—
|
|
|
149.3
|
|
|
152.5
|
|
|
|
|
1,604.9
|
|
|
1,498.8
|
|
Less accumulated depreciation
|
|
|
(711.3
|
)
|
|
(599.1
|
)
|
Property and equipment, net
|
|
|
$
|
893.6
|
|
|
899.7
|
|
Fastenal Company and Subsidiaries
Notes to Consolidated Financial Statements—Continued
Note 4. Accrued Expenses
Accrued expenses at year end consisted of the following:
|
|
|
|
|
|
|
|
|
2017
|
|
2016
|
Payroll and related taxes
|
$
|
26.0
|
|
|
23.2
|
|
Bonuses and commissions
|
19.8
|
|
|
14.2
|
|
Profit sharing contribution
|
10.6
|
|
|
8.7
|
|
Insurance reserves
|
39.0
|
|
|
34.6
|
|
Promotions
|
31.3
|
|
|
24.9
|
|
Indirect taxes
|
51.1
|
|
|
43.4
|
|
Other
|
16.2
|
|
|
7.4
|
|
Accrued expenses
|
$
|
194.0
|
|
|
156.4
|
|