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Fastenal Seeks to Reverse ‘Deteriorating’ Gross Margin for 2014

In its fourth quarter 2013 earnings call today with analysts, Winona, MN-based Fastenal (Nasdaq: FAST) reported “deteriorating” gross margin trends that were worse than expected earlier in the quarter. The distributor was outside of its 51 percent to 53 percent gross margin range in the final quarter of the year.

Gross margin in the fourth quarter 2013 was 50.6 percent, compared with 51.7 percent in the third quarter, and 52.3 percent and 52.2 percent in the first and second quarters, respectively.

Fastenal reported sales growth of 6.1 percent in 2013, and 7.5 percent in the fourth quarter from the prior year.

Fastenal’s leadership attributed the decline to four factors:

  • Lower utilization of its trucking network
  • Supplier incentives, or rebates
  • Product mix, with fasteners carrying a higher gross margin
  • A “very competitive marketplace”

Dan Florness, CFO, said that the first two – utilization and supplier incentives – are expected to self-correct in 2014. Fastenal has renewed its focus on the final two for 2014.

While the first two quarters of 2013 saw improvement in overall gross margin from the prior year, thanks in part to a new price guidance system Fastenal implemented, the distributor’s gross margin fell sequentially from the second to the third quarters. Much of that decline – about 85 percent – was in the transaction margin, according to Fastenal’s quarterly release.

Fastenal reported that product mix was about 40 percent of the total drop in gross margin, reflecting continued weakness in the distributor’s fastener growth and strength in the growth of safety products, which have a lower gross margin than fasteners do.

The remaining part of the transactional decline, Fastenal reported, was split. The distributor expanded its headcount at store locations and focused more on top-line growth, hurting gross margin in the short term. In the fourth-quarter 2013, about 70 percent of the drop in gross margin was due to the transactional margin factors above.

In the earnings call, Fastenal leadership said that part of the drop in gross margin may be due to inconsistent use of the distributor’s new price guidance software throughout its network of more than 2,700 stores. “Margin didn’t deteriorate equally in all stores,” Florness said.

One step Fastenal has taken is increasing its district and regional leadership for better oversight and more consistency. In the second half of 2013, the distributor added three regional vice presidents and 50 district managers, an increase of 27 percent, and decreased the size of its average district. The changes may also have contributed to some inconsistency among the stores, Florness said. “Change creates a little chaos.”

Fastenal’s vending sales were a bright spot in the quarterly report, with fewer machines signed in the second half of the year but an increased focus on optimizing the product mix and growing sales per machine. Daily sales growth to customers with vending machines was 18.7 percent in the fourth quarter 2013, lower than the prior-year quarter but still higher than Fastenal’s overall daily sales growth figure.

The distributor is expecting to return to the 51 percent to 53 percent gross margin range in 2014 and hopes to hit double-digit sales growth this year.

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