Attached files

file filename
EX-31 - SECTION 302 CEO AND CFO CERTIFICATION - FASTENAL COfast63016ex_31.htm
EX-32 - SECTION 906 CEO AND CFO CERTIFCATION - FASTENAL COfast63016ex_32.htm

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
 
FORM 10-Q
 
 
(Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2016, or
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from __________ to __________                   
Commission file number 0-16125
 
 
FASTENAL COMPANY
(Exact name of registrant as specified in its charter)
 
Minnesota
 
41-0948415
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
2001 Theurer Boulevard
Winona, Minnesota
 
55987-1500
(Address of principal executive offices)
 
(Zip Code)
(507) 454-5374
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
 
ý
  
Accelerated Filer
 
¨
 
 
 
 
Non-accelerated Filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller Reporting Company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.
 
Class
 
Outstanding at July 11, 2016
Common Stock, par value $.01 per share
 
288,965,949
 
 
 
 
 



FASTENAL COMPANY
INDEX
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




PART I — FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS
 
FASTENAL COMPANY AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Amounts in thousands except share and per share information)
 
(Unaudited)
 
 
Assets
June 30,
2016
 
December 31,
2015
Current assets:
 
 
 
Cash and cash equivalents
$
155,458

 
129,019

Trade accounts receivable, net of allowance for doubtful accounts of $11,123 and $11,729, respectively
537,341

 
468,375

Inventories
985,085

 
913,263

Prepaid income taxes

 
22,558

Other current assets
113,022

 
131,561

Total current assets
1,790,906

 
1,664,776

 
 
 
 
Property and equipment, net
859,490

 
818,889

Other assets, net
48,740

 
48,797

 
 
 
 
Total assets
$
2,699,136

 
2,532,462

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Current portion of debt
$
67,610

 
62,050

Accounts payable
158,698

 
125,973

Accrued expenses
176,556

 
185,143

Income taxes payable
8,318

 

Total current liabilities
411,182

 
373,166

 
 
 
 
Long-term debt
362,390

 
302,950

Deferred income tax liabilities
57,402

 
55,057

 
 
 
 
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; 288,945,899 and 289,581,682 shares issued and outstanding, respectively
2,890

 
2,896

Additional paid-in capital
27,701

 
2,024

Retained earnings
1,871,813

 
1,842,772

Accumulated other comprehensive loss
(34,242
)
 
(46,403
)
Total stockholders' equity
1,868,162

 
1,801,289

Total liabilities and stockholders' equity
$
2,699,136

 
2,532,462

See accompanying Notes to Condensed Consolidated Financial Statements.


1


FASTENAL COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Earnings
(Amounts in thousands except earnings per share)
 
(Unaudited)
 
(Unaudited)
 
Six Months Ended
June 30,
 
Three Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Net sales
$
2,000,967

 
1,951,144

 
$
1,014,287

 
997,827

 
 
 
 
 
 
 
 
Cost of sales
1,007,915

 
965,007

 
512,695

 
495,740

Gross profit
993,052

 
986,137

 
501,592

 
502,087

 
 
 
 
 
 
 
 
Operating and administrative expenses
582,800

 
557,031

 
292,619

 
276,644

Gain on sale of property and equipment
(130
)
 
(498
)
 
(236
)
 
(390
)
Operating income
410,382

 
429,604

 
209,209

 
225,833

 
 
 
 
 
 
 
 
Interest income
153

 
162

 
92

 
63

Interest expense
(2,867
)
 
(1,155
)
 
(1,484
)
 
(797
)
 
 
 
 
 
 
 
 
Earnings before income taxes
407,668

 
428,611

 
207,817

 
225,099

 
 
 
 
 
 
 
 
Income tax expense
149,920

 
160,648

 
76,296

 
84,742

 
 
 
 
 
 
 
 
Net earnings
$
257,748

 
267,963

 
$
131,521

 
140,357

 
 
 
 
 
 
 
 
Basic net earnings per share
$
0.89

 
0.91

 
$
0.46

 
0.48

 
 
 
 
 
 
 
 
Diluted net earnings per share
$
0.89

 
0.91

 
$
0.45

 
0.48

 
 
 
 
 
 
 
 
Basic weighted average shares outstanding
288,863

 
293,192

 
288,919

 
291,177

 
 
 
 
 
 
 
 
Diluted weighted average shares outstanding
289,132

 
293,870

 
289,119

 
291,830

See accompanying Notes to Condensed Consolidated Financial Statements.


2


FASTENAL COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(Amounts in thousands)
 
(Unaudited)
 
(Unaudited)
 
Six Months Ended
June 30,
 
Three Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Net earnings
$
257,748

 
$
267,963

 
$
131,521

 
140,357

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments (net of tax of $0 in 2016 and 2015)
12,161

 
(15,661
)
 
(1,555
)
 
3,789

Comprehensive income
$
269,909

 
$
252,302

 
$
129,966

 
144,146

See accompanying Notes to Condensed Consolidated Financial Statements.


3


FASTENAL COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands)
 
(Unaudited)
 
Six Months Ended
June 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net earnings
$
257,748

 
267,963

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation of property and equipment
47,937

 
39,295

Gain on sale of property and equipment
(130
)
 
(498
)
Bad debt expense
3,894

 
4,806

Deferred income taxes
2,345

 
2,527

Stock-based compensation
1,700

 
3,441

Excess tax benefits from stock-based compensation
(5,469
)
 
(1,274
)
Amortization of non-compete agreements
263

 
263

Changes in operating assets and liabilities:
 
 
 
Trade accounts receivable
(70,560
)
 
(83,552
)
Inventories
(68,144
)
 
(12,615
)
Other current assets
18,539

 
8,496

Accounts payable
32,725

 
29,563

Accrued expenses
(8,587
)
 
8,395

Income taxes
36,345

 
(5,036
)
Other
(553
)
 
(620
)
Net cash provided by operating activities
248,053

 
261,154

 
 
 
 
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(88,723
)
 
(88,020
)
Proceeds from sale of property and equipment
2,988

 
4,112

Other
(206
)
 
(20
)
Net cash used in investing activities
(85,941
)
 
(83,928
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Borrowings under credit facility
435,000

 
790,000

Payments against credit facility
(370,000
)
 
(550,000
)
Proceeds from exercise of stock options
22,423

 
6,911

Excess tax benefits from stock-based compensation
5,469

 
1,274

Purchases of common stock
(59,440
)
 
(250,425
)
Payments of dividends
(173,188
)
 
(164,736
)
Net cash used in financing activities
(139,736
)
 
(166,976
)
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
4,063

 
(3,580
)
 
 
 
 
Net increase in cash and cash equivalents
26,439

 
6,670

 
 
 
 
Cash and cash equivalents at beginning of period
129,019

 
114,496

 
 
 
 
Cash and cash equivalents at end of period
$
155,458

 
121,166

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
2,873

 
1,155

Net cash paid for income taxes
$
110,934

 
162,891

See accompanying Notes to Condensed Consolidated Financial Statements.

4

FASTENAL COMPANY AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Amounts in thousands except share and per share information and where otherwise noted)
June 30, 2016 and 2015
(Unaudited)

 
(1) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Fastenal Company and subsidiaries (collectively referred to as the Company, Fastenal, or by terms such as we, our, or us) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information. They do not include all information and footnotes required by U.S. GAAP for complete financial statements. However, except as described herein, there has been no material change in the information disclosed in the Notes to Consolidated Financial Statements included in our consolidated financial statements as of and for the year ended December 31, 2015. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

(2) Stockholders’ Equity
Dividends
On July 11, 2016, our board of directors declared a dividend of $0.30 per share of common stock. This dividend is to be paid in cash on August 23, 2016 to shareholders of record at the close of business on July 26, 2016. Since 2011, we have paid quarterly dividends. Our board of directors expects to continue paying quarterly dividends, provided the future determination as to payment of dividends will depend on the financial needs of the Company and such other factors as deemed relevant by the board of directors.
The following table presents the dividends either paid previously or declared by our board of directors for future payment on a per share basis:

 
2016
 
2015
First quarter
$
0.30

 
0.28

Second quarter
0.30

 
0.28

Third quarter
0.30

 
0.28

Fourth quarter


 
0.28

Total
$
0.90

 
1.12

Stock Options

The following tables summarize the details of grants made under our stock option plan that are still outstanding, and the assumptions used to value these grants. All options granted were effective at the close of business on the date of grant.
 
 
Options
Granted
 
Option
Exercise
(Strike)
Price
 
Closing
Stock Price
on Date
of Grant
 
June 30, 2016
Date of Grant
 
 
 
Options
Outstanding
 
Options
Exercisable
April 19, 2016
845,440

 
$
46.00

 
$
45.74

 
819,466

 

April 21, 2015
893,220

 
$
42.00

 
$
41.26

 
775,020

 

April 22, 2014
955,000

 
$
56.00

 
$
50.53

 
642,500

 
10,000

April 16, 2013
205,000

 
$
54.00

 
$
49.25

 
115,000

 
2,500

April 17, 2012
1,235,000

 
$
54.00

 
$
49.01

 
1,015,250

 
617,500

April 19, 2011
410,000

 
$
35.00

 
$
31.78

 
200,800

 
163,300

April 20, 2010
530,000

 
$
30.00

 
$
27.13

 
181,725

 
121,725

April 21, 2009
790,000

 
$
27.00

 
$
17.61

 
252,650

 
208,900

April 15, 2008
550,000

 
$
27.00

 
$
24.35

 
114,100

 
114,100

Total
6,413,660

 
 
 
 
 
4,116,511

 
1,238,025


5

FASTENAL COMPANY AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Amounts in thousands except share and per share information and where otherwise noted)
June 30, 2016 and 2015
(Unaudited)

Date of Grant
Risk-free
Interest Rate
 
Expected Life of
Option in Years
 
Expected
Dividend
Yield
 
Expected
Stock
Volatility
 
Estimated Fair
Value of Stock
Option
April 19, 2016
1.3
%
 
5.00
 
2.6
%
 
26.34
%
 
$
8.18

April 21, 2015
1.3
%
 
5.00
 
2.7
%
 
26.84
%
 
$
7.35

April 22, 2014
1.8
%
 
5.00
 
2.0
%
 
28.55
%
 
$
9.57

April 16, 2013
0.7
%
 
5.00
 
1.6
%
 
37.42
%
 
$
12.66

April 17, 2012
0.9
%
 
5.00
 
1.4
%
 
39.25
%
 
$
13.69

April 19, 2011
2.1
%
 
5.00
 
1.6
%
 
39.33
%
 
$
11.20

April 20, 2010
2.6
%
 
5.00
 
1.5
%
 
39.10
%
 
$
8.14

April 21, 2009
1.9
%
 
5.00
 
1.0
%
 
38.80
%
 
$
3.64

April 15, 2008
2.7
%
 
5.00
 
1.0
%
 
30.93
%
 
$
7.75

All of the options in the tables above vest and become exercisable over a period of up to eight years. Generally, each option will terminate approximately nine years after the grant date.
 
The fair value of each share-based option is estimated on the date of grant using a Black-Scholes valuation method that uses the assumptions listed above. The risk-free interest rate is based on the U.S. Treasury rate over the expected life of the option at the time of grant. The expected life is the average length of time over which we expect the employee groups will exercise their options, which is based on historical experience with similar grants. The dividend yield is estimated over the expected life of the option based on our current dividend payout, historical dividends paid, and expected future cash dividends. Expected stock volatilities are based on the movement of our stock price over the most recent historical period equivalent to the expected life of the option.
Compensation expense equal to the grant date fair value is recognized for all of these awards over the vesting period. The stock-based compensation expense for the six-month periods ended June 30, 2016 and 2015 was $1,700 and $3,441, respectively. Unrecognized stock-based compensation expense related to outstanding unvested stock options as of June 30, 2016 was $16,993 and is expected to be recognized over a weighted average period of 4.90 years. Any future changes in estimated forfeitures will impact this amount.
Earnings Per Share
The following tables present a reconciliation of the denominators used in the computation of basic and diluted earnings per share and a summary of the options to purchase shares of common stock which were excluded from the diluted earnings calculation because they were anti-dilutive:
 
 
Six-month Period
 
Three-month Period
Reconciliation
2016
 
2015
 
2016
 
2015
Basic weighted average shares outstanding
288,863,482

 
293,191,566

 
288,918,945

 
291,176,985

Weighted shares assumed upon exercise of stock options
268,820

 
678,586

 
200,525

 
653,152

Diluted weighted average shares outstanding
289,132,302

 
293,870,152

 
289,119,470

 
291,830,137

 
 
Six-month Period
 
Three-month Period
Summary of Anti-dilutive Options Excluded
2016
 
2015
 
2016
 
2015
Options to purchase shares of common stock
2,941,864

 
2,395,247

 
3,253,343

 
2,724,639

Weighted average exercise price of options
$
50.39

 
$
52.97

 
$
49.91

 
$
51.56

Any dilutive impact summarized above relates to periods when the average market price of our stock exceeded the exercise price of the potentially dilutive option securities then outstanding.
 


6

FASTENAL COMPANY AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Amounts in thousands except share and per share information and where otherwise noted)
June 30, 2016 and 2015
(Unaudited)

(3) Income Taxes
Fastenal files income tax returns in the United States federal jurisdiction, all states, and various local and foreign jurisdictions. With limited exceptions, we are no longer subject to income tax examinations by taxing authorities for taxable years before 2013 in the case of United States federal and foreign examinations and 2012 in the case of state and local examinations.
As of June 30, 2016 and 2015, liabilities recorded related to gross unrecognized tax benefits were $5,085 and $4,299, respectively. Included in these liabilities for gross unrecognized tax benefits is an immaterial amount for interest and penalties, both of which we classify as a component of income tax expense. We do not anticipate significant changes in total unrecognized tax benefits during the next twelve months.

(4) Operating Leases
Certain operating leases for pick-up trucks contain residual value guarantee provisions which would generally become due at the expiration of the operating lease agreement if the fair value of the leased vehicles is less than the guaranteed residual value. The aggregate residual value guarantee related to these leases is approximately $76,442. We believe the likelihood of funding the guarantee obligation under any provision of the operating lease agreements is remote other than where we have established an accrual for estimated losses, which is immaterial at June 30, 2016. To the extent our fleet contains vehicles we estimate will settle at a gain, such gains on these vehicles will be recognized when we sell the vehicle.

(5) Debt Commitments and Contingencies
Credit Facility, Note Payable, and Commitments
Debt obligations and undrawn letters of credit outstanding at the end of each period were as follows:
 
June 30,
2016
 
December 31,
2015
Outstanding loans under unsecured revolving credit facility
$
415,000

 
350,000

Note payable
15,000

 
15,000

Total debt
430,000

 
365,000

   Less: Current portion of debt
(67,610
)
 
(62,050
)
Long-term debt
$
362,390

 
302,950

 
 
 
 
Undrawn letters of credit under unsecured revolving credit facility - face amount
$
36,267

 
36,266

Unsecured Revolving Credit Facility
We have a $700,000 unsecured revolving credit facility ('Credit Facility'). The Credit Facility includes a committed letter of credit subfacility of $55,000. The commitments under the Credit Facility will expire (and any borrowings outstanding under the Credit Facility will become due and payable) on March 1, 2018. In the next twelve months, we have the ability and intent to repay a portion of the outstanding line of credit obligations using cash; therefore, we have classified this portion of the line of credit as a current liability. The Credit Facility contains certain financial and other covenants, and our right to borrow under the Credit Facility is conditioned upon, among other things, our compliance with these covenants. We are currently in compliance with these covenants.
Borrowings under the Credit Facility generally bear interest at a rate per annum equal to the London Interbank Offered Rate ('LIBOR') for interest periods of various lengths selected by us, plus 0.95%. A change in LIBOR impacts the interest rate on our borrowings, which in turn impacts interest expense incurred and cash flows. Based on the interest periods we have chosen, our weighted per annum interest rate at June 30, 2016 was approximately 1.4%. We pay a commitment fee for the unused portion of the Credit Facility. This fee is either 0.10% or 0.125% per annum based on our usage of the Credit Facility.

7

FASTENAL COMPANY AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Amounts in thousands except share and per share information and where otherwise noted)
June 30, 2016 and 2015
(Unaudited)

Note Payable
On December 7, 2015, we signed an agreement to acquire, effective January 2, 2017, certain assets related to the collection and management of certain portions of our business and financial data from Apex Industrial Technologies, LLC ('Apex'), a provider of automated point-of-use dispensing and supply chain technologies. The agreement includes a transition arrangement which requires us to assume responsibility for certain software that is licensed by Apex assuming that hosting services are transitioned from Apex to us. The total consideration for the assets and transition arrangement is $27,000, of which $12,000 was paid in cash in December 2015 to cover costs associated with decoupling systems and programs, transition planning expenses, completing system enhancements, and engaging in training to effectively and efficiently transfer hosting activities to us. The remaining $15,000 covers equipment costs and post transfer expenses related to the transition, and is payable in installments pursuant to an unsecured note, with the final payment due in December 2017. Payment of the $15,000 is dependent upon the transfer of hosting activities to us. We reserve the right to terminate the transition of hosting services from Apex to us and, if we decide to exercise that option, then we will not be required to make the $15,000 in payments and Apex will continue to provide us with fee-based hosting services. The note bears interest at an annual rate of 0.56%. Interest on the unpaid principal balance of the note is due and payable on the last day of each calendar quarter.
Legal Contingencies
The nature of our potential exposure to legal contingencies is described in our 2015 annual report on Form 10-K in Note 9 of the Notes to Consolidated Financial Statements. As of June 30, 2016, there were no litigation matters that we consider to be probable or reasonably possible to have a material adverse outcome.

(6) Subsequent Events
We evaluated all subsequent event activity and concluded that no subsequent events have occurred that would require recognition in the condensed consolidated financial statements or disclosure in the Notes to Condensed Consolidated Financial Statements, with the exception of the dividend disclosed in Note (2) 'Stockholders' Equity'.

(7) New Accounting Pronouncements
In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers 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 is 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. ASU 2015-14 defers our effective date until January 2018. We are evaluating the impact this ASU will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.
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 guidance will be effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years with early adoption permitted. The guidance will be applied on a modified retrospective basis with the earliest period presented. We are evaluating the impact of the future adoption of this standard on our consolidated financial statements and related disclosures.
In March 2016, the FASB issued 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 tax withholdings requirements, as well as classification in the statement of cash flows. The guidance will be effective for annual reporting periods beginning after December 15, 2016 and interim periods within those fiscal years with early adoption permitted. We are evaluating the impact of the future adoption of this standard on our consolidated financial statements and related disclosures.

8


ITEM 2 — MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 condensed consolidated financial statements. (Dollar amounts are stated in thousands except for per share amounts and where otherwise noted.)
BUSINESS DISCUSSION
Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies. We distribute these supplies through a network of approximately 2,600 company owned stores. 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 products 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 stores and customers are primarily located in North America.
We are a growth focused organization and we constantly strive to make investments into the growth drivers of our business. These investments typically center on people. By adding more people we add to our ability to interact with and to serve our customers from our local store and to back them up in some type of support role. In recent years this investment has also centered on more industrial vending devices to serve our customers’ needs on a 24 hours a day, 7 days a week basis.
The table below summarizes our store employee count and our total employee count at the end of the periods presented. This is intended to demonstrate the change in energy (or capacity). Later in this document we discuss the average full-time equivalent employee count to help explain the expense trends in more detail. The final two items below summarize our investments in industrial vending machines and in store locations.
 
 
 
 
 
 
 
Change Since:
 
Q2
2015
 
Q4
2015
 
Q2
2016
 
Q2
2015
 
Q4
2015
End of period total store employee count
13,203

 
13,961

 
13,499

 
2.2
 %
 
-3.3
 %
Change in total store employee count
 
 
 
 
 
 
296

 
-462

 
 
 
 
 
 
 
 
 
 
End of period total employee count
19,527

 
20,746

 
20,324

 
4.1
 %
 
-2.0
 %
Change in total employee count
 
 
 
 
 
 
797

 
-422

 
 
 
 
 
 
 
 
 
 
Industrial vending machines (installed device count)
50,620

 
55,510

 
58,346

(1) 
15.3
 %
 
5.1
 %
Number of store locations
2,616

 
2,622

 
2,605

 
-0.4
 %
 
-0.6
 %
(1) In February 2016, we signed an agreement to lease a significant number of industrial vending lockers to one of our customers. As of June 30, 2016, we have deployed approximately 3,000 devices under this agreement. These devices are excluded from the count noted above.
Several items worth noting with respect to our results:
(1)
During the last twelve months, we have added 296 people into our stores and 797 people in total. The headcount additions outside of stores related to additions in vending support, the information technology development center, and distribution. Our store headcount increased in the last half of 2015 and then contracted in the first half of 2016 as we managed our store headcount levels.
(2)
We opened 27 and 8 stores in the first six months of 2016 and 2015, respectively, and currently expect to open 30 to 45 stores in total in 2016, which is an annual rate of approximately 1% to 2%. We closed or consolidated 34 and 26 stores in the first six months of 2016 and 2015, respectively. Most of these closed or consolidated locations were in multiple store markets with expiring leases and the impact to sales was not considered meaningful. We intend to continue evaluating markets for openings and for closures and consolidations in the latter half of 2016 and into 2017.
(3)
We are seeing a very strong pace of national account signings (defined as new customer accounts with a multi-site contract). In the first half of 2016 and 2015, we signed 100 and 87 new contracts, respectively. Beyond signings (or growth activities), we look at the health of our large customer market, and by extension our market place, by watching the trends of our top 100 customers. In the recent past (2011 to 2014), the typical ratio of growth versus contraction in the sales to our top 100 customers was 3:1 (75 grew and 25 contracted). By the fourth quarter of 2015 the ratio was

9


approximately 1:1; 49 grew (32 with growth of 10% or more) and 51 contracted (37 with contraction of 10% or more). In the first quarter of 2016 this ratio improved slightly; 53 grew (38 with growth of 10% or more) and 47 contracted (31 with contraction of 10% or more). In the second quarter of 2016 this ratio weakened; 47 grew (31 with growth of 10% or more) and 53 contracted (34 with contraction of 10% or more).
(4)
We have continued to expand our Onsite business (defined as dedicated sales and service provided from within the customer's facility). Our goal is to sign 200 Onsite customer locations in 2016, and we signed 48 and 44 in the first and second quarters of 2016, respectively. Of the 92 signed in the first half of 2016, 55 are operational as of June 30, 2016. All of the 80 new Onsite customer locations we signed in 2015 are operational.
(5)
We have converted approximately 1,900 stores to the CSP 16 (Customer Service Project 2016) format as of June 30, 2016. This merchandising footprint, disclosed at our November 2015 Investor Day, involves expanded inventory placement at our store locations to enhance same-day capabilities.
(6)
The net sales of our Canadian business, which grew about 4% in 'local currency' based on local business days during the fourth quarter of 2015, improved to about 7% growth in the first quarter of 2016. In the second quarter of 2016, this growth slid back to about 4%. However, the locations affected by the fires in Western Canada in May reduced our sales by approximately $1.1 million (approximately $850 thousand U.S. Dollars), which lowered the growth of our Canadian business by approximately one to two percentage points.

The following sections contain an overview of the following:
1.
Sales and sales trends – a recap of our recent sales trends and some insight into the activities with different end markets.
2.
Growth drivers of our business – a recap of how we grow our business.
3.
Profit drivers of our business – a recap of how we increase our profits.
4.
Statement of earnings information – a recap of the components of our income statement.
5.
Cash flow impact items – a recap of the operational working capital utilized in our business, and the related cash flow.
The most important thing to note before you read this is to remember Fastenal is several businesses within itself; a fastener distributor (about 40% of our business) and a non-fastener distributor (about 60% of our business).
FASTENER SALES
First and foremost, we are a fastener distributor. We have been in this business for almost 50 years. We are good at it. We have strong capabilities at sourcing and procurement, at quality control, at logistics, and at local customer service. Each of these capabilities is focused on the customer at the end of the supply chain. This business is split about 60% production/construction needs and about 40% maintenance needs. The former is a great business, but it can be cyclical because about 75% of our manufacturing customer base is engaged in some type of heavy manufacturing. The sale of production fasteners is also a sticky business in the short-term as it is expensive and time consuming for our customers to change their supplier relationships. While our customers value the capabilities we bring to the table, in the last eight quarters this group of customers has seen a contraction in its production and therefore its need for fasteners. During this time frame, our fastener product line has seen its daily growth decrease from about 10% growth in the last six months of 2014 to about 6% contraction in the fourth quarter of 2015 and about 2% contraction in the first half of 2016. Our market share gains continue to be strong, but the contraction in purchases from our existing customers, plus some price deflation, has eliminated our growth and led to contraction. This contraction lessened from the fourth quarter of 2015 into the first half of 2016; however, it worsened in June.
NON-FASTENER SALES
Second, we have a non-fastener maintenance and supply business. We have actively pursued this business in the last 20 to 25 years. The capabilities we developed as a fastener distributor, described above, provide a backbone to growing this ‘newer’ business. This backbone has been enhanced in the last five years with our added capabilities in industrial vending. Given our local customer service, we believe we have a structural advantage in the industrial vending business. There is more to industrial vending than the device or the financial resources to deploy; we believe the ability to replenish with a local team from an integrated supply chain network (i.e., the 'Team behind the Machine') is critical to the long-term success of this channel. Because of these capabilities, the non-fastener business remains more resilient. However, similar to our fastener business, our non-fastener business has generally weakened in the last eight quarters. During this time frame, daily sales of our non-fastener product line experienced growth of about 18% in the last six months of 2014, contracted to about 2% growth in the fourth quarter of 2015 and improved to about 5% growth in both the first and second quarters of 2016.
Please read through the detailed Sales and Sales Trends section later in this document for additional insight.
Our gross profit decreased from 50.3% in the second quarter of 2015 and 49.8% in the first quarter of 2016 to 49.5% in the second quarter of 2016. The relationship between sales and gross profit depends on our success within our large account

10


business (an area that is still under-represented in our customer mix). The large account end market produces a below-company average gross profit; however, it generally leverages our existing network of capabilities and allows us to enjoy strong incremental operating income growth. This customer mix change (larger versus smaller), as well as our product mix change (from fasteners to non-fasteners), over time are a constant drain on our gross profit. We continued to face these headwinds during the first half of 2016 as our national accounts sales grew approximately two percentage points faster than the total company percentage. We expect the customer mix and product mix change to continue into the future. Our gross profit was also negatively impacted by some short-term activities. These include doing a bit of 'house cleaning' during our CSP 16 set-up process.
Regarding operating expenses, we added 797 people to the Fastenal organization in the last twelve months (about 37% of these people were added to a store or some other type of selling location). During the first half of 2016, our payroll related expenses increased due to the addition of personnel related to the acquisition of Fasteners, Inc. (which occurred in November 2015), and the addition of vending specialists, information technology development resources, and distribution personnel. Below is a quick recap of our full-time equivalent headcount to supplement the information discussed earlier in this document:
 
 
 
 
 
 
 
Change Since:
 
Q2
2015
 
Q4
2015
 
Q2
2016
 
Q2
2015
 
Q4
2015
Average full-time equivalent store employee count
10,887

 
11,436

 
11,545

 
6.0
%
 
1.0
%
Average full-time equivalent total employee count
16,107

 
16,901

 
17,241

 
7.0
%
 
2.0
%
Note – Full-time equivalent is based on 40 hours per week.
 
 
 
 
 
 
 
 
 
We touched on our industrial vending earlier, but here is a quick recap: During the first and second quarters of 2016, we signed 4,647 and 4,869 devices, respectively. During the first and second quarters of 2015, we signed 3,962 and 5,144 devices, respectively. Our installed device count on June 30, 2016 was 58,346 (excluding the 3,033 devices deployed under our locker lease program), which is an increase of 15.3% over June 30, 2015. The percent of total net sales to customers with industrial vending was 44.6% in the second quarter of 2016. Our total daily sales to customers with industrial vending grew 2.7% over the second quarter of 2015. However, daily sales of non-fastener products to customers with industrial vending grew 5.9%, while daily sales of fasteners to customers with industrial vending contracted 5.1%.
Finally, some thoughts on capital allocation: During the latter half of 2014, throughout 2015, and into the first quarter of 2016, we had been modifying our capital allocation by buying back some common stock. One factor influencing our stock buybacks is our external valuation. Our relative stock valuation had weakened over the last several years, which prompted us to reassess our cash deployment. To this end, we spent approximately $396 million buying back stock since June 30, 2014 and repurchased approximately 3.3% of our outstanding shares from the start of this time frame. We are mindful of our shareholders’ expectations relative to our dividend paying history and have primarily funded this buyback with debt. In 2015, 2014, and 2013, our net capital expenditures, expressed in dollars and as a percentage of net earnings, were $145 million (28.1%), $184 million (37.2%), and $202 million (44.9%), respectively. In the first half of 2016, our net capital expenditures, expressed in dollars and as a percentage of net earnings, were $86 million (33.3%). We expect our net capital expenditures to be approximately $200 million in 2016. We plan to fund a portion of our planned capital expenditures with the proceeds of a private placement of debt. We expect to close on this funding in late July 2016. Please read through the detailed Cash Flow Impact Items section, and the Condensed Consolidated Statements of Cash Flows, for additional insight.
SALES AND SALES TRENDS
While reading these items, 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), (2) no company has a significant portion of this market, (3) many of the products we sell are individually inexpensive, (4) when our customer needs something quickly or unexpectedly our local store is a quick source, (5) the cost and time to manage and procure these products is meaningful, (6) the cost to move these products, many of which are bulky, can be significant, (7) many customers would prefer to reduce their number of suppliers to simplify their business, and (8) many customers would prefer to utilize various technologies to improve availability and reduce waste.
Our motto is Growth through Customer Service®. This is important given the points noted above. We believe in efficient markets – to us, this means we can grow our market share if we provide the greatest value to our customers. We believe our ability to grow is amplified if we can service our customers at the closest economic point of contact. For us, this 'closest economic point of contact' is the local store; therefore, our focus centers on understanding our customers' day, their opportunities, and their obstacles. 

11


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 the store to operate efficiently and to help identify new business solutions. Fourth, we do these things every day. Finally, we strive to generate strong profits; these profits produce the cash flow necessary to fund our growth and to support the needs of our customers.
SALES GROWTH
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. 
Net sales and daily sales were as follows for the periods ended June 30:
 
Six-month Period
 
Three-month Period
 
2016
 
2015
 
2016
 
2015
Net sales
$
2,000,967

 
$
1,951,144

 
$
1,014,287

 
997,827

Percentage change
2.6
 %
 
6.8
 %
 
1.6
 %
 
5.0
 %
Business days
128

 
127

 
64

 
64

Daily sales
$
15,633

 
15,363

 
$
15,848

 
15,591

Percentage change
1.8
 %
 
6.8
 %
 
1.6
 %
 
5.0
 %
Impact of currency fluctuations (primarily Canada)
-0.6
 %
 
-1.0
 %
 
-0.4
 %
 
-1.0
 %
Impact of acquisitions
0.7
 %
 
0.2
 %
 
0.6
 %
 
0.1
 %
The increase in net sales in the periods noted for 2016 and 2015 came primarily from higher unit sales. The higher unit sales resulted primarily from increases in sales at existing store locations and to a lesser degree the opening of new store locations in the last several years. Net sales were also impacted by some price deflation in our fastener products, which was a drag on growth. Our growth in net sales was not meaningfully impacted by the introduction of new products or services, with one exception. Over the last several years, our industrial vending initiative has stimulated faster growth with a subset of our customers. The impact on net sales of the change in currencies in foreign countries (primarily Canada) relative to the United States dollar is noted in the table above.
The impact of the economy is best reflected in the growth performance of our stores opened greater than ten years ago (store sites opened as follows: 2016 group – opened 2006 and earlier, and 2015 group – opened 2005 and earlier) and opened greater than five years ago (store sites opened as follows: 2016 group – opened 2011 and earlier, and 2015 group – opened 2010 and earlier). These two groups of stores are more cyclical due to the increased market share they enjoy in their local markets. The stores opened greater than two years ago represent a consistent ‘same store’ view of our business (store sites opened as follows: 2016 group – opened 2014 and earlier, and 2015 group – opened 2013 and earlier). The daily sales change for each of these groups was as follows for the periods ended June 30:
 
Six-month Period
 
Three-month Period
 
2016
 
2015
 
2016
 
2015
Store Age
 
 
 
 
 
 
 
Opened greater than 10 years
0.5
%
 
6.0
%
 
0.0
%
 
4.6
%
Opened greater than 5 years
0.2
%
 
6.0
%
 
0.0
%
 
4.5
%
Opened greater than 2 years
0.5
%
 
6.1
%
 
0.4
%
 
4.4
%
Note: The age groups above are measured as of the last day of each respective calendar year.
SALES BY PRODUCT LINE
The approximate mix of sales from the fastener product line and from the other product lines was as follows for the periods ended June 30:
 
Six-month period
 
Three-month Period
 
2016
 
2015
 
2016
 
2015
Fastener product line
37.3
%
 
38.8
%
 
37.1
%
 
38.7
%
Other product lines
62.7
%
 
61.2
%
 
62.9
%
 
61.3
%
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%

12


MONTHLY SALES CHANGES, SEQUENTIAL TRENDS, AND END MARKET PERFORMANCE
This section focuses on three distinct views of our business – monthly sales changes, sequential trends, and end market performance. The first discussion regarding monthly sales changes provides a good mechanical view of our business based on the age of our stores. 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.
Monthly Sales Changes:
All company sales – 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):
 
Jan.
 
Feb.
 
Mar.
 
Apr.
 
May
 
June
 
July
 
Aug.
 
Sept.
 
Oct.
 
Nov.
 
Dec.
2016
3.3
%
 
2.6
%
 
0.0
%
 
3.8
%
 
1.1
%
 
0.0
%
 
 
 
 
 
 
 
 
 
 
 
 
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
 %
2014
6.7
%
 
7.7
%
 
11.6
%
 
10.0
%
 
13.5
%
 
12.7
%
 
14.7
%
 
15.0
%
 
12.9
 %
 
14.6
 %
 
15.3
 %
 
17.4
 %
Stores opened greater than two years – Our stores opened greater than two years (store sites opened as follows: 2016 group – opened 2014 and earlier, 2015 group – opened 2013 and earlier, and 2014 group – opened 2012 and earlier) represent a consistent 'same-store' view of our business. During the months noted below, the stores opened greater than two years had daily sales growth rates of (compared to the same month in the preceding year):
 
Jan.
 
Feb.
 
Mar.
 
Apr.
 
May
 
June
 
July
 
Aug.
 
Sept.
 
Oct.
 
Nov.
 
Dec.
2016
2.2
%
 
1.4
%
 
-1.4
 %
 
2.5
%
 
-0.2
 %
 
-1.2
 %
 
 
 
 
 
 
 
 
 
 
 
 
2015
11.2
%
 
7.8
%
 
4.8
 %
 
5.4
%
 
4.6
 %
 
3.2
 %
 
2.6
%
 
1.0
%
 
-0.9
 %
 
-1.1
 %
 
-2.1
 %
 
-5.0
 %
2014
5.5
%
 
6.5
%
 
10.2
 %
 
8.4
%
 
12.1
 %
 
11.4
 %
 
13.4
%
 
14.0
%
 
11.8
 %
 
13.5
 %
 
14.0
 %
 
16.5
 %
Stores opened greater than five years – The impact of the economy, over time, is best reflected in the growth performance of our stores opened greater than five years (store sites opened as follows: 2016 group – opened 2011 and earlier, 2015 group – opened 2010 and earlier, and 2014 group – opened 2009 and earlier). This group, which represented about 90% of our total sales in the first six months of 2016, is more cyclical due to the increased market share they enjoy in their local markets. During the months noted below, the stores opened greater than five years had daily sales growth rates of (compared to the same month in the preceding year):
 
Jan.
 
Feb.
 
Mar.
 
Apr.
 
May
 
June
 
July
 
Aug.
 
Sept.
 
Oct.
 
Nov.
 
Dec.
2016
1.7
%
 
1.3
%
 
-1.7
 %
 
2.1
%
 
-0.4
 %
 
-1.8
 %
 
 
 
 
 
 
 
 
 
 
 
 
2015
10.8
%
 
7.2
%
 
4.8
 %
 
5.6
%
 
4.6
 %
 
3.1
 %
 
3.1
%
 
1.3
%
 
-1.1
 %
 
-1.0
 %
 
-1.8
 %
 
-5.3
 %
2014
4.6
%
 
5.4
%
 
9.5
 %
 
7.7
%
 
11.5
 %
 
10.8
 %
 
12.9
%
 
13.4
%
 
11.7
 %
 
13.3
 %
 
13.6
 %
 
16.2
 %
Summarizing comments – There are three distinct influences to our growth: (1) execution, (2) currency fluctuations, and (3) economic fluctuations. This discussion centers on (2) and (3).
The change in currencies in foreign countries (primarily Canada) relative to the United States dollar impacted our net sales growth over the last several years. In the first six months of 2016, it lowered our net sales growth by 0.6%. During the years 2015 and 2014, it lowered our net sales growth by 1.2% and 0.5%, respectively.
Beginning in 2013, the fastener product line was heavily impacted by our industrial production business. These customers utilize our fasteners in the manufacture/assembly of their finished products. The end markets with the most pronounced weakening included heavy machinery manufacturers with exposure to mining, military, agriculture, and construction. Our sales to customers engaged in light and medium duty manufacturing (largely related to consumer products) began to improve late in 2013 and into 2014. This made sense given the trends in the PMI Index at that time.
In the first quarter of 2014, our sales growth was hampered in January and February due to a weak economy and foreign exchange rate fluctuations (primarily related to the Canadian dollar); however, the biggest impact was a severe winter in North America and its negative impact on our customers and our trucking network. In March 2014, the weak economy and negative foreign exchange rate fluctuations continued; however, the weather normalized and our daily sales growth expanded to 11.6%. This double digit growth in March was helped by the Easter timing (April in 2014). In the second quarter of 2014, the negative impact of the Easter timing was felt, and then a 'less noisy' picture emerged in May and June. Our sales to customers engaged in heavy machinery manufacturing, which represents approximately one fifth of our business, improved in 2014.

13


During 2015, our business weakened. As mentioned in prior disclosures, the weakening initially involved customers tied to the oil and gas sector, but grew 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. In November and December one distinct trend emerged involving customer plant shutdowns. This is not uncommon during the holiday season; however, we experienced a greater frequency and duration of shutdowns than in prior years during both late November and late December, with the trend more pronounced in late December.
As we indicated last fall, our customers are struggling with a weak economy. During the first quarter of 2016, the impact of seasonal plant shutdowns subsided and the economy showed signs of improvement. The first three months of 2016, as well as April and May of 2016, had some unusual 'noise' due to changing business day counts. The extra day in each of February, March, and May tends to 'understate' the daily sales growth percentage and the missing day in January and April tends to 'overstate' the daily sales growth number. The movement of Easter into March 2016 (versus April in 2015) similarly tends to 'understate' daily sales growth in March 2016 and tends to 'overstate' daily sales growth in April 2016. The decline in daily sales growth in May and June of 2016 was driven by continued weakness with our manufacturing and construction customers. This is evidenced by the trends with our top 100 customers and by additional plant shutdowns/slowdowns before and after Memorial Day. We expect the plant shutdowns/slowdowns to continue into the third quarter.
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 with impaired business days (certain holidays). The first landing centers on Easter, which alternates between March and April (Easter occurred in March 2016, in April 2015, and in April 2014), the second landing centers on July 4th, and the third landing centers on the approach of winter with its seasonal impact on primarily our 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).
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 period 1998 to 2013, excluding 2008 and 2009. We believe this time frame will serve to show the historical pattern and could serve as a benchmark for current performance. We excluded the 2008 to 2009 time frame because it contains an extreme economic event and we don't believe it is comparable. The '2016', '2015', and '2014' lines represent our actual sequential daily sales changes. The '16Delta', '15Delta', and '14Delta' lines indicate the difference between the 'Benchmark' and the actual results in the respective year.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cumulative
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Change from
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Jan. to
 
Jan. (1)
 
Feb.
 
Mar.
 
Apr.
 
May
 
June
 
July
 
Aug.
 
Sept.
 
Oct.
 
June
 
Oct.
Benchmark
0.8
 %
 
2.2
 %
 
3.8
 %
 
0.4
 %
 
3.1
 %
 
2.7
 %
 
-2.1
 %
 
2.5
%
 
3.7
 %
 
-1.2
 %
 
12.6
 %
 
15.9
 %
2016
0.4
 %
 
-0.8
 %
 
1.5
 %
 
1.7
 %
 
0.6
 %
 
-0.2
 %
 

 

 

 


 
2.9
 %
 


16Delta
-0.4
 %
 
-3.0
 %
 
-2.3
 %
 
1.3
 %
 
-2.5
 %
 
-2.9
 %
 

 

 

 


 
-9.7
 %
 


2015
-3.6
 %
 
-0.1
 %
 
4.2
 %
 
-2.1
 %
 
3.4
 %
 
0.9
 %
 
-4.3
 %
 
4.1
%
 
-0.9
 %
 
-2.0
 %
 
6.3
 %
 
2.9
 %
15Delta
-4.4
 %
 
-2.3
 %
 
0.4
 %
 
-2.5
 %
 
0.3
 %
 
-1.8
 %
 
-2.2
 %
 
1.6
%
 
-4.6
 %
 
-0.8
 %
 
-6.3
 %
 
-13.0
 %
2014
-1.4
 %
 
3.0
 %
 
7.1
 %
 
-2.6
 %
 
4.2
 %
 
2.5
 %
 
-3.8
 %
 
5.8
%
 
1.0
 %
 
-1.5
 %
 
14.8
 %
 
16.2
 %
14Delta
-2.2
 %
 
0.8
 %
 
3.3
 %
 
-3.0
 %
 
1.1
 %
 
-0.2
 %
 
-1.7
 %
 
3.3
%
 
-2.7
 %
 
-0.3
 %
 
2.2
 %
 
0.3
 %
(1) 
The January figures represent the percentage change from the previous October, whereas the remaining figures represent the percentage change from the previous month.

14


A graph of the sequential daily sales change pattern 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:
Fluctuations in end market business – The sequential trends noted above were directly linked to fluctuations in our end markets. To place this in perspective – approximately 50% of our business has historically been with customers engaged in some type of manufacturing. The daily sales growth rates to these customers, when compared to the same period in the prior year, were as follows:
 
 
Q1
 
Q2
 
Q3
 
Q4
 
Annual
2016
 
0.9
%
 
0.7
%
 
 
 
 
 
 
2015
 
6.9
%
 
3.8
%
 
1.1
%
 
-2.2
 %
 
2.3
%
2014
 
9.0
%
 
11.2
%
 
13.7
%
 
13.8
 %
 
12.0
%
As indicated earlier, 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 (just under 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):
 
 
Q1
 
Q2
 
Q3
 
Q4
 
Annual
2016
 
-1.7
 %
 
-2.4
 %
 
 
 
 
 
 
2015
 
5.5
 %
 
0.0
 %
 
-4.4
 %
 
-6.2
 %
 
-1.4
 %
2014
 
1.6
 %
 
5.5
 %
 
9.9
 %
 
11.4
 %
 
6.9
 %

15


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
2016
 
4.7
%
 
4.7
%
 
 
 
 
 
 
2015
 
11.7
%
 
9.0
%
 
5.9
%
 
1.2
%
 
6.8
%
2014
 
14.2
%
 
17.1
%
 
17.6
%
 
19.0
%
 
17.2
%
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 strong industrial vending program. However, this business was not immune to the impact of a weak industrial environment.
Our non-residential construction 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:
 
 
Q1
 
Q2
 
Q3
 
Q4
 
Annual
2016
 
-0.4
 %
 
-1.7
 %
 
 
 
 
 
 
2015
 
6.2
 %
 
1.6
 %
 
-1.7
 %
 
-6.1
 %
 
-0.2
 %
2014
 
2.9
 %
 
7.5
 %
 
9.3
 %
 
12.6
 %
 
7.8
 %
Our non-residential construction business is heavily influenced by the industrial economy, particularly the energy sector. The volatility and weakness of energy prices has weakened this business, particularly in the last four quarters.
A graph of the sequential daily sales trends to these two end markets in 2016, 2015, and 2014, starting with a base of '100' in the previous October and ending with the next October, would be as follows: 
Manufacturing


16


Non-Residential Construction
GROWTH DRIVERS OF OUR BUSINESS
Note – Dollar amounts in this section are presented in whole dollars, not thousands.
We grow by continuously adding customers and by increasing the activity with each customer. We believe this growth is enhanced by great people located in close proximity to our customers. This allows us to provide a range of services and product availability that our competitors can't easily match. Historically, we expanded our reach by opening stores at a very fast pace. These openings were initially in the United States and expanded beyond the United States beginning in the mid 1990's. 
For a little perspective, we began our business in 1967 with an idea to sell nuts and bolts (fasteners) through vending machines. We soon learned the technology of the 1960's wasn't ready, and also learned a lot of products didn't fit, so we went to 'Plan B': sell to business users with a direct sales force. It took us a number of years to 'work out the bugs', but ten years later we began to pick up the pace of store openings. After another ten years of expansion we had approximately 50 stores and sales of about $20 million. Our need for cash to fund our growth was growing, as was our desire to allow employee ownership. This led us to a public offering in 1987.
In our first ten years of being public (1987 to 1997), we opened stores at an annual rate approaching 30% per year. In the next ten years (1997 to 2007), we opened stores at an annual rate of approximately 10% to 15% and, since 2007, at an annual rate of approximately 1% to 8%. We opened 24 stores in 2014, at an annual rate of approximately 1%, and 41 stores in 2015, at an annual rate of approximately 2%. We expect to open 30 to 45 stores in 2016, which is an annual rate of approximately 1% to 2%.
During our almost 50 years of business existence, we have constantly evolved to better serve the market (as is described in the paragraphs below) and have always been willing to challenge our approach. In our first 20 to 25 years, we closed several store locations because we felt the market was insufficient to operate a profitable 'fastener only' business. Every one of those locations was subsequently ‘reopened’ when our business model evolved to serve these markets profitably. During the last 20 to 25 years, we have enjoyed continued success with our store-based model, but we continue to challenge our approach. This resulted in our closing approximately 85 stores in the ten years prior to 2014 - not because they weren’t successful, but rather because we felt we had a better approach to growth. During 2014, we continued to challenge our approach and closed 73 stores. We use the term closed; however, we consider them to be consolidated into another location since the vast majority are in close proximity to another store. Several items we think are noteworthy: the group of stores we identified for closure in the second half of 2014 was profitable in the first quarter of 2014 (our 2014 analysis measurement period); those stores operated with average sales of about $36 thousand per month. We chose to close this group because we felt this was simply a better approach

17


to growing our business profitably. During 2015, we closed 50 stores. Similar to 2014, we chose to close this group of stores because we felt this was simply a better approach. During the third quarter of 2014 (our 2015 analysis measurement period), 35 of these 50 stores were profitable. During the first six months of 2016, we closed 34 stores.
There is a short-term cost for closing these stores, and since we believe we will maintain the vast majority of the sales associated with these locations and most of the impacted employees have a nearby store from which to operate, the cost primarily relates to the future commitments related to the leased locations. We have recorded the impaired future costs related to these commitments. The related expense was not material as these locations have relatively short lease commitments and minimal leasehold improvements.
During the years, our expanding footprint has provided us with greater access to more customers, and we have continued to diversify our growth drivers. This was done to provide existing store personnel with more tools to grow their business organically. In the early 1990's, we began to expand our product lines beyond primarily fasteners, and we added new product knowledge to our bench (the non-fastener products now represent about 60% of our sales). This was our first big effort to diversify our growth drivers. The next step began in the mid to late 1990's when we began to add sales personnel with certain specialties or focus. This began with our national accounts group in 1995, and over time, has expanded to include individuals dedicated to: (1) sales related to our internal manufacturing division, (2) government sales, (3) internet sales, (4) construction, (5) specific products (most recently metalworking), and (6) industrial vending. Another step occurred at our sales locations (this includes Fastenal stores as well as strategic account stores and Onsite locations) and at our distribution centers, and began with a targeted merchandising and inventory placement strategy that included our 'Customer Service Project' approximately fourteen years ago and our 'Master Stocking Hub' initiative approximately nine years ago. These strategies allowed us to better target where to stock certain products (local store, regional distribution center, master stocking hub, or supplier) and allowed us to improve our fulfillment, lower our freight costs, and improve our ability to serve a broader range of customers. During 2013 and 2014, we expanded our store-based inventory offering around select industries (with an emphasis on fasteners, construction products, and safety products) and beginning in the latter half of 2013 we expanded two key employee groups: (1) the number of employees working in our stores and (2) the number of district and regional leaders supporting our stores. To improve the efficiency, accuracy, and capacity of our distribution centers, we made significant investments into distribution automation over the last several years (a majority of our facilities are now automated, and greater than 80% of our picking occurs at an automated distribution center). Finally, we also added a high frequency distribution center, internally known as T-hub, to support vending and other high frequency selling activities. During 2015 and the first half of 2016, we continued to enhance the technology in our automated distribution centers, to sharpen our focus on growing our Onsite business, and to expand our store-based inventory offering (CSP 16). This merchandising footprint involves expanded inventory placement at our store locations to enhance same-day delivery capabilities. The theme that shines through in all of these changes is a simple one – invest into and support our sales machine – the local store.
Over the last several years, our industrial vending operation has been an expanding component of our store-based business. We believe industrial vending will be an important chapter in the Fastenal story; we also believe it has the potential to be transformative to industrial distribution, and that we have a 'first mover' advantage. Given this, we have been investing aggressively to maximize the advantage.
Our expanded industrial vending portfolio consists of 20 different vending devices, with the FAST 5000 device, our helix based machine (think candy machine), representing approximately 40% of the installed machines. We have learned much about these devices over the last several years and currently the target monthly revenue ranges from under $1,000 per device to in excess of $3,000 per device. The following two tables provide two views of our data: (1) actual device count regardless of the type of machine and (2) ‘machine equivalent' count based on the weighted target monthly revenue of each device (compared to the FAST 5000 device, which has a $2,000 monthly revenue target). For example, the 12-door locker, with target monthly revenue of $750, would be counted as ‘0.375 machine equivalent’ (0.375 = $750/$2,000).

18


The industrial vending information related to contracts signed during each period was as follows:
 
 
 
Q1
 
Q2
 
Q3
 
Q4
 
Annual
Device count signed during the period
2016
 
4,647

 
4,869

 
 
 
 
 
 
 
2015
 
3,962

 
5,144

 
4,689

 
4,016

 
17,811

 
2014
 
4,025

 
4,137

 
4,072

 
4,108

 
16,342

 
 
 
 
 
 
 
 
 
 
 
 
'Machine equivalent' count signed during the period
2016
 
3,696

 
3,941

 
 
 
 
 
 
 
2015
 
2,916

 
3,931

 
3,769

 
3,319

 
13,935

 
2014
 
2,974

 
3,179

 
3,189

 
3,243

 
12,585

The industrial vending information related to installed machines at the end of each period was as follows:
 
 
 
Q1
 
Q2
 
Q3
 
Q4
 
 
Device count installed at the end of the period
2016
 
56,889

 
58,346

(1) 
 
 
 
 
 
 
2015
 
48,545

 
50,620

 
53,547

 
55,510

 
 
 
2014
 
42,153

 
43,761

 
45,596

 
46,855

 
 
 
 
 
 
 
 
 
 
 
 
 
 
'Machine equivalent' count installed at the end of the
2016
 
43,329

 
44,707

 
 
 
 
 
 
    period
2015
 
35,997

 
37,714

 
40,067

 
41,905

 
 
 
2014
 
30,326

 
31,713

 
33,296

 
34,529

 
 
(1) In February 2016, we signed an agreement to lease a significant number of industrial vending lockers to one of our customers. As of June 30, 2016, we have deployed approximately 3,000 devices under this agreement. These devices are excluded from the count noted above.
The following table includes some additional statistics regarding our net sales and daily sales growth:
 
 
 
Q1
 
Q2
 
Q3
 
Q4
 
 
Percent of total net sales to customers with
2016
 
44.5
%
 
44.6
%
 
 
 
 
 
 
  industrial vending(1)
2015
 
40.5
%
 
40.9
%
 
42.1
%
 
43.9
%
 
 
 
2014
 
37.8
%
 
37.0
%
 
37.8
%
 
39.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Daily sales growth to customers with
2016
 
3.6
%
 
2.7
%
 
 
 
 
 
 
  industrial vending(2)
2015
 
12.3
%
 
8.6
%
 
4.8
%
 
0.7
%
 
 
 
2014
 
19.7
%
 
20.9
%
 
21.9
%
 
20.0
%
 
 
(1) The percentage of total net sales (vended and traditional) to customers currently using a vending solution.
(2) The growth in total net sales (vended and traditional) to customers currently using a vending solution compared to the same period in the preceding year.
Our total daily sales growth to customers with industrial vending declined during 2015, which was primarily the result of the slowdown in our business with customers connected to the oil and gas industry, including direct industry participants as well as other customers serving those participants. In the first and second quarters of 2016, daily sales to customers with industrial vending grew 3.6% and 2.7% over the first and second quarters of 2015, respectively; however, daily sales of non-fastener products to these customers grew 7.4% and 5.9%, respectively, while daily sales of fasteners to these customers contracted 5.5% and 5.1%, respectively.
In addition to the industrial vending operation noted above, which primarily relates to our non-fastener business, we also provide bin stock programs (also known as ‘keep fill’ programs in the industry) to numerous customers. This business, which relates to both our maintenance customers (MRO fasteners and non-fasteners) and original equipment manufacturers (OEM fasteners), has many similar attributes to our industrial vending relationships. These attributes include a strong relationship with these customers, where we are often their preferred supplier, and a frequent level of business transactions. This business is performed without the aid of a vending machine, but does make use of the latest scanning technologies, scale systems, and our fully integrated distribution network to manage the supply chain for all sizes of customers. In recent years, we have begun to refer to this business as FMI (Fastenal Managed Inventory).

19


PROFIT DRIVERS OF OUR BUSINESS
As we state several times in this document, profit is important to us. For a distribution business, profit and cash flow go hand in hand. Cash flow is what funds our growth, provides us with short-term and long-term flexibility, and enables us to create value for our customers, our employees, our suppliers, and our shareholders. Over time, we grow our profits by continuously working to grow sales and to improve our relative profitability. We achieve our improvements in relative profitability by improving our relative gross profit, by structurally lowering our operating and administrative expenses, or both.
We also grow our profits by allowing our inherent profitability to shine through - we refer to this as the 'pathway to profit'. The distinction is important. The 'pathway to profit' to which we refer is merely the natural 'per store' leverage that occurs as the average net sales per month of a store increases. There are two diverging trends that occur as a store grows; first, the gross profit percentage at a store generally declines, and second, our operating and administrative expense as a percentage of net sales generally improves. The operating and administrative expense improvement starts on day one, while the gross profit percentage decline typically occurs when the average sales at a store move above $100 thousand per month. Fortunately, the operating and administrative expense improvements typically far outweigh the gross profit percentage declines.
The best way to appreciate this dynamic is to look at the cost components of our business. The cost components of a store include the following: (1) cost of sales and (2) operating and administrative expenses. The operating and administrative expenses can be further split into (listed by relative size): (1) people costs (base pay, incentive pay, benefits, training, and payroll related taxes), (2) occupancy costs (facility expenses such as rent, property taxes, repairs, and depreciation on owned facilities, as well as utility costs, equipment expenses, and vending machine related expenses), and (3) 'all other' expenses. The largest component of the last category is the vehicles needed in each store to support selling activities.
The first component, costs of sales, is directly related to sales and fluctuations in sales. However, it is also heavily influenced by product and customer mix. Because of this influence, our gross profit (the residual of net sales after deducting the related cost of sales), when stated as a percentage of net sales, generally declines as the average monthly net sales of a store increases. This is due to the impact of larger customers on the mix.
The second component, operating and administrative expenses, does just the opposite, it generally improves as a percentage of net sales. This is due to the fixed nature of our 'open for business' expenses and the attractive incremental profit margin typically realized in our remaining variable expenses. The 'open for business' expenses are the expenses needed to 'just keep the front door open', and they relate to a base staffing level, a base facility cost, and base vehicle costs. These expenses do not generate a profit; however, they create the opportunity for future sales growth that will generate profits. This drives our 'pathway to profit'.
STATEMENT OF EARNINGS INFORMATION (percentage of net sales) for the periods ended June 30:
 
 
 
 
 
 
 
 
 
Six-month Period
 
Three-month Period
 
2016
 
2015
 
2016
 
2015
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Gross profit
49.6
 %
 
50.5
 %
 
49.5
 %
 
50.3
 %
Operating and administrative expenses
29.1
 %
 
28.6
 %
 
28.8
 %
 
27.7
 %
Gain on sale of property and equipment
0.0
 %
 
0.0
 %
 
0.0
 %
 
0.0
 %
Operating income
20.5
 %
 
22.0
 %
 
20.6
 %
 
22.6
 %
Net interest income (expense)
-0.1
 %
 
-0.1
 %
 
-0.1
 %
 
-0.1
 %
Earnings before income taxes
20.4
 %
 
22.0
 %
 
20.5
 %
 
22.6
 %
 
 
 
 
 
 
 
 
Note – Amounts may not foot due to rounding difference.
 
 
 
 
 
 
 
Gross profit – The gross profit percentage during each period was as follows:
 
Q1
 
Q2
 
Q3
 
Q4
2016
49.8
%
 
49.5
%
 
 
 
 
2015
50.8
%
 
50.3
%
 
50.5
%
 
49.9
%
2014
51.2
%
 
50.8
%
 
50.8
%
 
50.5
%
Over the last several years our gross profit percentage has fluctuated due to our mix of store sizes, customer sizes, products, geographies, end markets, and end market uses (such as industrial production business versus maintenance business). We believe our gross profit percentage will be in the range of 49.5% to 50.0% during 2016 due to the impact, in the short-term, of our growth drivers and the economy. Our internal goal is to move our gross profit percentage back to 50.0%. This is a

20


challenging goal. The structural gross profit change centers primarily on customer mix and, to a lesser degree, product mix. We believe this structural change will improve operating and administrative expenses as a percentage of net sales over the long term.
Ignoring the long-term trend just noted, our short-term gross profit percentages historically fluctuate due to impacts related to (1) transactional gross profit (either related to product and customer mix or to freight), (2) organizational gross profit (sourcing strength that can occur as we leverage buying scale and efficiency), and (3) supplier incentive gross profit (impacts from supplier volume allowances). In the short-term, periods of inflation or deflation can influence the first two categories, while sudden changes in business volume can influence the third. The transactional gross profit, our most meaningful component, is heavily influenced by our store-based compensation programs, which are directly linked to sales growth and gross profit, and incentivize our employees to improve both.
Important factors that impact our gross profit are our locations, our product mix, and our customer mix. Given the close proximity of our sales personnel to our customer’s business, we offer a very high service level with our sales, which is valued by our customers and improves our gross profit. Fasteners are our highest gross profit product line given the high transaction cost surrounding the sourcing and supply of the product for our customers. Fasteners currently account for approximately 40% of our sales. We expect any reduction in the mix of our sales attributable to fasteners to negatively impact gross profit, particularly as it relates to maintenance fasteners. Gross profit is also influenced by average store sales as noted earlier in this document. Larger stores have larger customers, whose more focused buying patterns allow us to offer them better pricing. As a result, growth in average store sales is expected to negatively impact gross profit. A final item of note, our fourth quarter has typically been the season with the most challenges surrounding gross profit. This relates to the decline in sales in November and December due to the ‘holiday season’ and due to the drop off in non-residential construction business. This drop off in sales reduces the utilization of our trucking network which can also slightly reduce our gross profit.
Our gross profit, as a percentage of net sales, decreased in the first six months of 2016 when compared to the first six months of 2015. This decrease was primarily caused by changes in product and customer mix. Our gross profit also decreased in the second quarter of 2016 when compared to the second quarter of 2015 for similar reasons.
Operating and administrative expenses - increased as a percentage of net sales in both the six-month period and in the second quarter of 2016 when compared to the same periods of 2015. 
Historically, our two largest components of operating and administrative expenses have consisted of employee related expenses (approximately 65% to 70%) and occupancy related expenses (approximately 15% to 20%). The remaining expenses cover a variety of items with selling transportation typically being the largest.
The three largest components of operating and administrative expenses grew (contracted) as follows for the periods ended June 30 (compared to the same period in the preceding year):
 
Six-month Period
 
Three-month Period
 
2016
 
2015
 
2016
 
2015
Employee related expenses
3.1
%
 
3.6
 %
 
3.5
%
 
0.9
 %
Occupancy related expenses
10.4
%
 
5.4
 %
 
13.1
%
 
3.7
 %
Selling transportation costs
1.6
%
 
-20.4
 %
 
10.9
%
 
-20.7
 %
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. For the first six months of 2016, when compared to the first six months of 2015, employee related expenses grew due to an increase in full-time equivalent headcount (see table below), and an increase in health care costs. These increases were partially offset by a contraction in our performance bonuses and commissions, and in our profit sharing contribution, primarily due to lower sales growth and due to lower operating income (both on a dollar basis and on a relative basis). The increase in the second quarter of 2016, when compared to the second quarter of 2015, was driven by the same factors as the six-month period. For the first six months of 2015, when compared to the first six months of 2014, our performance bonuses and commissions grew, as well as our profit sharing contribution, primarily due to our expanding growth in operating income in the first quarter of 2015 versus the first quarter of 2014. These factors, combined with an increase in full-time equivalent headcount (see table below), caused employee related expenses to grow, and were partially offset by a reduction in health care costs and by a focused reduction in overtime hours paid. The increase in the second quarter of 2015, when compared to the second quarter of 2014, was driven by the same factors as the six-month period.

21


On average, the full-time equivalent (FTE) headcount grew (contracted) as follows for the periods ended June 30 (compared to the same period in the preceding year):
 
Six-month Period
 
Three-month period
 
2016
 
2015
 
2016
 
2015
Store based
8.0
 %
 
3.2
 %
 
6.0
 %
 
4.2
 %
Total selling (includes store)
9.1
 %
 
3.4
 %
 
7.4
 %
 
4.2
 %
Distribution
8.2
 %
 
6.8
 %
 
8.0
 %
 
6.3
 %
Manufacturing
-2.5
 %
 
-0.4
 %
 
-5.7
 %
 
-0.7
 %
Administrative
8.4
 %
 
6.4
 %
 
8.6
 %
 
6.2
 %
   Total average FTE headcount
8.5
 %
 
3.9
 %
 
7.0
 %
 
4.4
 %
Occupancy related expenses include: (1) building rent and depreciation, (2) building utility costs, (3) equipment related to our stores and distribution locations, and (4) industrial vending equipment (we consider the vending equipment to be a logical extension of our store operation and classify the depreciation, repair costs, and hosting services as occupancy expense). The increase in the first six months of 2016, when compared to the first six months of 2015 was mainly driven by (1) an increase in the amount of industrial vending equipment discussed earlier in this document and (2) an increased investment in our distribution infrastructure over the last several years, primarily related to automation. The largest impact related to the industrial vending equipment. The increase in the second quarter of 2016, when compared to the second quarter of 2015, was driven by the same factors as the six-month period. The increase in the first six months of 2015, when compared to the first six months of 2014, was driven by (1) an increase in the amount of industrial vending equipment and (2) an increased investment in our distribution infrastructure, primarily related to automation. These increases were partially offset by a reduction in utility costs at store locations and by the impact of an accrual related to closed and closing store locations in 2014. The increase in the second quarter of 2015, when compared to the second quarter of 2014, was driven by the same factors as the six-month period.
Our selling transportation costs consist primarily of our store fleet as most of the distribution fleet costs are included in cost of sales. Selling transportation costs included in operating and administrative expenses increased in the first six months of 2016, when compared to the first six months of 2015. This was driven by an increase in the number of vehicles for sales personnel and the timing of leased vehicle sales, which was partially offset by a decrease in fuel expense. The increase in the second quarter of 2016, when compared to the second quarter of 2015, was driven by the same factors as the six-month period. The decrease in the first six months of 2015, when compared to the first six months of 2014, was driven by the decline in fuel costs and an increase in gains on the sales of our leased vehicles, which was partially offset by the increase in store headcount and the reduction in mileage per gallon associated with severe winter driving conditions. The decrease in the second quarter of 2015, when compared to the second quarter of 2014, was driven by the same factors as the six-month period, except for the winter component.
The last several years have seen some variation in the cost of diesel fuel and gasoline. During the first and second quarters of 2016, our total vehicle fuel costs were approximately $6.4 million and $8.2 million, respectively. During the first, second, third, and fourth quarters of 2015, our total vehicle fuel costs were approximately $8.8 million, $9.1 million, $8.6 million, and $7.8 million, respectively. The changes resulted from variations in fuel costs, variations in the service levels provided to our stores from our distribution centers, changes in the number of vehicles at our store locations, changes in the number of other sales centered vehicles as a result of store openings and the expansion of our non-store sales force, and 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 store 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 store and other sales centered use). 
Income taxes Income taxes, as a percentage of earnings before income taxes, were approximately 36.8% and 37.5%, respectively, for each of the first six months of 2016 and 2015. As our international business and profits grew over the past several years, the lower income tax rates in those jurisdictions, relative to the United States, have lowered our effective tax rate.

22


CASH FLOW IMPACT ITEMS
As indicated earlier, we included this section to provide some added insight into the items that impact our cash flow.
OPERATIONAL WORKING CAPITAL
The year-over-year comparison and the related dollar and percentage changes related to accounts receivable, net and inventories were as follows:
 
 
June 30:
 
Twelve-month Dollar Change
 
Twelve-month Percentage Change
 
 
2016
 
2015
 
2014
 
2016
 
2015
 
2016
 
2015
Accounts receivable, net
 
$
537,341

 
537,650

 
502,330

 
$
-309

 
35,320

 
-0.1
 %
 
7.0
%
Inventories
 
985,085

 
876,697

 
818,771

 
108,388

 
57,926

 
12.4
 %
 
7.1
%
Operational working capital(1)
 
$
1,522,426

 
1,414,347

 
1,321,101

 
$
108,079

 
93,246

 
7.6
 %
 
7.1
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales in last two months
 
$
682,741

 
663,356

 
634,790

 
$
19,385

 
28,566

 
2.9
 %
 
4.5
%
(1) For purposes of this discussion, we are defining operational working capital as accounts receivable, net and inventories.
The consistency in net accounts receivable compared to sales growth from June 30, 2015 to June 30, 2016 noted above was impacted by fluctuations in foreign currency. In prior quarters, the strong growth of our international business and of our large customer accounts has created meaningful difficulty with managing the growth of accounts receivable relative to the growth in 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 store 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 (private label), (5) expanded industrial vending solutions, (6) national accounts and Onsite growth, (7) international growth, and (8) expanded stocking breadth at individual stores. While all of these items impacted both 2016 and 2015, items (3) through (8) had the greatest impact.
BALANCE SHEET AND CASH FLOW
Our balance sheet continues to be very strong and our operations have good cash generating characteristics. Our operating cash flow as a percentage of net earnings contracted slightly in the first half of 2016 when compared to the first half of 2015 due to our current initiative to add additional products into store inventory under our CSP 16 format, which was partially offset by a reduction in net cash used to fund trade accounts receivable. Our first quarter typically has stronger cash flow characteristics due to the timing of tax payments; this benefit reverses itself in the second, third, and fourth quarters as income tax payments go out in April, June, September, and December. The remaining amounts of cash flow from operating activities are largely linked to the pure dynamics of a distribution business and its strong correlation to working capital as discussed above. During 2015, and the first half of 2016, we incurred some debt to fund capital expenditures, purchases of our common stock, and payments of dividends as discussed earlier in this document.
Operating cash flow as a percentage of net earnings were as follows in 2016 and 2015:
 
2016
 
2015
First quarter
127.8
%
 
141.1
%
Second quarter
65.9
%
 
57.7
%
Year-to-date (June)
96.2
%
 
97.5
%
Third quarter

 
103.2
%
Year-to-date (September)


 
99.4
%