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Gross Margin Weakness Dampens Otherwise Solid 3Q for Fastenal

Quarter's highlights include 16.4% increase in FAST Solutions vending machines.

Will Oberton, CEO of Fastenal, was admittedly distracted during his company's quarterly earnings call last Friday. Despite a positive 3Q in which Winona, MN-based Fastenal (NASDAQ: FAST) beat analysts' expectations and reported sales of $980.8 million, Oberton had his eye elsewhere as he briefed investors on the latest numbers.

"I apologize for stumbling," he said at the end of his remarks. "I was looking at the stock going down at the same time, and I couldn’t speak clearly."

Concern over gross margin weakness took a toll on the company Friday, lowering shares as Oberton and other executives discussed the company's otherwise solid performance in the recently ended quarter. Fastenal’s gross margins in the first nine months of 2014 dropped just below 51 percent, a topic Oberton and his colleagues touched on during the 2013 year-end earnings call.

Fastenal executives were proactive this period, mentioning the buzz surrounding its gross profit margins in the 3Q earnings release that preceded the call.

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

"In the second and third quarters of this year, our gross profit was slightly below the range we have cited over the last several years (a range of 51 percent to 53 percent). However, given our performance, we now believe a range of 51 percent to 52 percent or simply 'around 51 percent' would probably be more appropriate."

Though Fastenal expects weak gross profit again in the fourth quarter due to the holiday season and continued softness in the construction industry, the company looks to increase revenue growth through added sales personnel. Fastenal grew its average employee count 11.5 percent in the third quarter to 18,425 employees, while also decreasing its store count 1.5 percent to 2,647 stores.

"Our margin is stable. We have good sequential growth. If the economy stays steady we are in a very good position to see the benefits of pathway to profit in 2015," Oberton said.

Despite ongoing concerns about gross profit, Fastenal's latest quarterly earnings also confirmed the industrial distributor's continued emphasis on vending as a key part of its sales model. Though the number of stores open in the third quarter was down 1.5 percent year-over-year to 2,647, the company's FAST Solutions machines were up 16.4 percent to 45,596 vending machines. And the industrial vending initiative continued to stimulate faster growth among a number of customers.

"We are happy with what’s going on in vending," Oberton said. "Our signings … basically have been steady all year. The best numbers are … the sales going through the customers that have vending. The customers with vending grew at 21.9 percent and that represents 37.8 percent of our business. So very good progress, growing as a percentage of our business and vending in general, the overall business concept has a long pathway."

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