ITEM 7.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 consolidated financial statements and should be read in conjunction with those consolidated financial statements. This section of this 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-date comparisons between 2019 and 2018 that are not included in this Form 10-K, can be found in 'Management's Discussion and Analysis of Financial Condition and Results of Operations' in Part II, Item 7 of our annual report on Form 10-K for the fiscal year ended December 31, 2019.
Business and Operational Overview
Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies. We distribute these supplies through a network of over 3,200 in-market locations. Most of our customers are in the manufacturing and non-residential construction markets. The manufacturing market includes sales of products for both original equipment manufacturing (OEM), where our products are consumed in the final products of our customers, and manufacturing, repair and operations (MRO), where are products are consumed to support the facilities and ongoing operations of our customers. 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 companies, oil production and refinement companies, mining companies, federal, state, and local governmental entities, schools, and certain retail trades. Geographically, our branches, Onsite locations, and customers are primarily located in North America.
It is helpful to appreciate several aspects of our marketplace: (1) It's big. We estimate the North American marketplace for industrial supplies is in excess of $140 billion per year (and we have expanded beyond North America) and no company has a significant portion of this market. (2) Many of the products we sell are individually inexpensive, but the cost and time to manage, procure, and transport these products can be quite meaningful. (3) Purchasing professionals often expend disproportionate effort managing the high stock keeping unit (SKU) count of low-volume, low value MRO supplies which is better allocated to their higher volume, higher value OEM supplies. (4) Many customers prefer to reduce their number of suppliers to simplify their business, while also utilizing various technologies and models (including our local branches when they need something quickly or unexpectedly) to improve availability and reduce waste. (5) We believe the markets are efficient. To us, this means we can grow our market share if we provide the greatest value to our customer.
Our approach to addressing these aspects of our marketplace is captured in our motto Growth through Customer Service. The concept of growth is simple: find more customers every day and increase our activity with them. However, execution is hard work. First, we recruit service-minded individuals to support our customers and their business. Second, we operate in a decentralized fashion to help identify the greatest value for our customers. Third, we have a great team behind our customer-facing resources to operate efficiently and to help identify new business solutions. Fourth, we strive to generate strong profits, which produce the cash flow necessary to fund our growth and to support the needs of our customers. Lastly, we identify drivers that allow us to get closer to our customers and gain market share.
We believe our ability to grow is amplified if we can serve our customers at the closest economic point of contact. At one point, the closest economic point of contact was the local branch. Today, in many cases, we have moved the branch inside the customers' facility. We also are frequently positioned right at the point of consumption within customers' facilities through our suite of FMI devices and capabilities. Therefore, our focus centers on understanding our customers' day, their opportunities, and their obstacles. By doing these things every day, Fastenal remains a growth-centric organization.
Impact of COVID-19 on Our Business
In the second quarter of 2020, the impacts of the COVID-19 pandemic on our business were dramatic in two respects. First, local and national actions taken, such as stay-at-home mandates, reduced business activity sharply as many customers either closed their locations or operated at significantly diminished capacity. This effect was illustrated in a significant decline in sales for our fastener products. Second, social actions taken to mitigate the effects of the pandemic produced significant demand for personal protection equipment (PPE) and sanitation products, generating significant sales of such products not only to certain traditional customers but also to state and local government entities as well as front line responders. This effect was illustrated by a significant increase in sales for our safety products. During that period, improved sales of PPE and sanitation products more than offset the general economic weakness. These dynamics affected our business throughout the second quarter of 2020, but the effects were greatest in April, with sequential improvements in May and June as business restrictions gradually eased.
The pandemic continued to have a significant impact on our business in the third and fourth quarters of 2020. The marketplace broadly, and Fastenal specifically, continued to operate with certain modifications to balance re-opening with employee and customer safety. However, most of the markets in which we operate began to normalize in the second half of 2020. This improved the outlook of the manufacturing and construction customers that support our traditional branch and Onsite business and moderated the level of demand for PPE and sanitation products that we experienced at the onset of the pandemic. We
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believe that the sequential gains in economic activity that we experienced in the latter part of the second quarter of 2020 continued through the third and fourth quarters of 2020, although the rate of improvement remains gradual.
Consistent with broader social trends, we have taken steps to safeguard the health of our employees. This includes closing branch and corporate facilities to outside personnel, adjusting work schedules to maximize social distance, creating space between work areas, providing ample PPE and cleaning supplies, having formal policies for mitigation in the event of cases of illness, utilizing technologies where work duties allow to enable work from home capabilities, and utilizing technologies such as vending and mobility to create social distancing. Due to these precautions, our operations have continued to function effectively, including our internal controls over financial reporting.
While there are exceptions, our customers have largely continued to operate their businesses despite a continued high rate of viral infections that exist as of this date, in contrast to the second quarter of 2020 when many temporarily suspended operations. Still, there remains significant uncertainty concerning the magnitude of the impact and duration of the COVID-19 pandemic. Factors deriving from the COVID-19 response that have or may negatively impact sales and gross margin in the future include, but are not limited to: limitations on the ability of our suppliers to manufacture, or procure from manufacturers, the products we sell, or to meet delivery requirements and commitments; limitations on the ability of our employees to perform their work due to illness caused by the pandemic or local, state, or federal orders requiring employees to remain at home; limitations on the ability of carriers to deliver our products to customers; limitations on the ability of our customers to conduct their business and purchase our products and services; and limitations on the ability of our customers to pay us on a timely basis. With respect to liquidity, as of the end of 2020, we have substantially all of our $700.0 bank revolver available for use in the event that the need arises.
We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state, or local authorities or that we determine are in the best interests of our employees, customers, suppliers, and shareholders. While we are unable to determine or predict the nature, duration, or scope of the overall impact the COVID-19 pandemic will have on our business, results of operations, liquidity, or capital resources, we believe that it is important to share where our company stands today, how our response to COVID-19 is progressing, and how our operations and financial condition may change as the fight against COVID-19 progresses.
Executive Overview
Net sales increased $313.7, or 5.9%, in 2020 relative to 2019. Our gross profit increased $52.3, or 2.1%, in 2020 relative to 2019, and as a percentage of net sales declined to 45.5% in 2020 from 47.2% in 2019. Our operating income increased $84.5, or 8.0%, in 2020 relative to 2019, and as a percentage of net sales increased to 20.2% in 2020 from 19.8% in 2019.
Our net earnings in 2020 were $859.1, an increase of 8.6% when compared to 2019. Our diluted net earnings per share were $1.49 in 2020 compared to $1.38 in 2019, an increase of 8.4%.
Although we continued to market our growth drivers in 2020, COVID-19 created an environment that was not conducive to the level of signings we would have expected under normal business conditions. At the same time, significant resources shifted to focus on rapidly and efficiently securing, transporting, and providing PPE to new and existing customers that found themselves managing short-term crisis conditions brought on by the pandemic. These dynamics produced signings of just 223 new Onsite customer locations and 16,417 new industrial vending devices in 2020. Those same dynamics also produced very strong daily sales growth of 51.0% in our safety product line and 129.7% from government and healthcare customers in the period, which more than offset the low growth driver signings and weak activity in our traditional manufacturing and construction customer base.
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The table below summarizes our absolute and full-time equivalent (FTE; based on 40 hours per week) employee headcount, our investments in in-market locations (defined as the sum of the total number of public branch locations and the total number of active Onsite locations), and industrial vending devices at the end of the periods presented and the percentage change compared to the end of the prior period.
In-market locations - absolute employee headcount 12,680 13,977 -9.3 %
In-market locations - FTE employee headcount 11,260 12,236 -8.0 %
Number of public branch locations 2,003 2,114 -5.3 %
Ratio of in-market location FTE headcount to in-market locations 3:1 4:1
Industrial vending devices (installed count) (1) 95,733 89,937 6.4 %
Ratio of industrial vending devices to in-market locations 29:1 28:1
(1) This number primarily represents devices which principally dispense product and produce product revenues, and excludes approximately 15,000 devices that are part of a locker lease program where the devices are principally used for the check-in/check-out of equipment.
During the last twelve months, we reduced our total FTE employee headcount by 1,132. This reflects a decline in our in-market FTE employee headcount of 976, as well as declines in headcount at our distribution centers and manufacturing operations. These reductions are primarily related to efforts to manage expenses in response to weaker demand from traditional manufacturing and construction customers resulting from the COVID-19 pandemic. This was only partly offset by additions in non-branch selling and support roles. The latter most significantly reflects an increase in personnel in Information Technology, which includes the addition of employees from our acquisition of certain assets of Apex, as well as roles to support customer acquisition and implementation, particularly as it relates to our growth drivers and to support general corporate functions.
We opened twelve branches and closed 123 branches, net of conversions, in 2020. We activated 257 Onsite locations and closed 106, net of conversions, in 2020. The number of closings reflects both normal churn in our business, whether due to redefining or exiting customer relationships, the shutting or relocation of a customer facility, or a customer decision, as well as our ongoing review of underperforming locations. Our in-market network forms the foundation of our business strategy, and we will continue to open or close locations as is deemed necessary to sustain and improve our network, support our growth drivers, and manage our operating expenses.
Results of Operations
The following sets forth consolidated statements of earnings information (as a percentage of net sales) for the periods ended December 31:
Operating and administrative expenses 25.3 % 27.4 % 28.2 %
Gain on sale of property and equipment 0.0 % 0.0 % 0.0 %
Net interest expense -0.2 % -0.3 % -0.3 %
Earnings before income taxes 20.1 % 19.6 % 19.9 %
Note – Amounts may not foot due to rounding difference.
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Net Sales
Note – Daily sales are defined as the total net sales for the period divided by the number of business days (in the United States) in the period. The table below sets forth net sales and daily sales for the periods ended December 31, and changes in such sales from the prior period to the more recent period:
Percentage change 5.9 % 7.4 % 13.1 %
Percentage change 5.5 % 7.4 % 13.1 %
Daily sales impact of currency fluctuations -0.1 % -0.3 % 0.1 %
Daily sales impact of acquisitions 0.0 % 0.1 % 0.4 %
The increase in net sales noted above for 2020 was a function primarily of higher unit sales for safety products, specifically pandemic-related sales of PPE. The effect of higher prices during the period were not material. The increase in net sales noted above for 2019 was a result of higher unit sales and, to a lesser degree, higher prices. Higher product prices in 2019 were a result of actions taken to offset increases in product costs, and we believe these increases contributed 0.9% to 1.0% to sales growth during 2019.
Higher unit sales in 2020 were heavily influenced by actions taken by governments and businesses around the world to address COVID-19, which influenced the period in a couple of ways. First, by virtue of our ability to source and transport PPE, we were able to supply the needs of governments, first responders, and businesses as they worked to mitigate the effects of the pandemic on our communities and normalize business activity under more stringent safety protocols. This generated significant PPE sales through the year. We believe the best proxies for this trend was daily sales growth of our safety products of 51.0% and daily sales growth to our government and healthcare customers of 129.7%. Second, we managed the effects of business closures, disruption in labor forces and supply chains, and a reduction in general business activity that was a by-product of the responses of governments and businesses to the pandemic. The impact of this is best illustrated by several metrics. For instance, United States Industrial Production, which is published by the Federal Reserve, decreased 7.1% in 2020. Based on the large proportion of our sales that are derived from the United States, we believe United States Industrial Production is a good proxy for the state of our marketplace and that the significant decline in this metric is consistent with the weakness we experienced in our traditional manufacturing and construction markets. This was also reflected in the daily sales of fasteners, which is our most cyclical product line. Daily sales of fasteners declined 7.2% in 2020. Although traditional manufacturing and construction business activity has gradually, but steadily, improved from depressed second quarter of 2020 levels, it did remain negative through the year. Taking these two variables together, higher unit sales of PPE more than offset the decline in unit sales in our traditional manufacturing and construction business, resulting in higher net unit sales in 2020.
Our growth drivers did not contribute meaningfully to higher unit sales in 2020, which we believe is largely a function of difficulties gaining access to customers and facilities due to social distancing and safety guidelines in response to COVID-19. We signed 16,417 industrial vending devices during 2020, a decrease of 24.9% from 2019. This did increase our installed base to 95,733 devices at the end of 2020, an increase of 6.4% over 2019, but this increase was not sufficient to offset reduced throughput per device. As a result, sales through our vending devices declined at a low single-digit rate during 2020. We activated 257 new Onsite locations in 2020, a decrease of 17.6% over 2019. This allowed us to increase our active sites to 1,265 at the end of 2020, an increase of 13.6% over 2019, but this increase was not sufficient to offset significant sales declines in our older, more established Onsite locations. As a result, sales through our Onsite locations declined at a low single-digit rate during 2020. We did experience growth in our National Account customers of 6.7% in 2020 compared to 2019, though this was due to the sale of PPE to customers navigating the challenges of operating during a pandemic.
The higher unit sales in 2019 resulted primarily from two sources. First was higher underlying market demand, as illustrated by U.S. Industrial Production, which increased 0.8% in 2019, and daily sales of fasteners, which grew 5.5% in 2019. It is notable, however, that underlying demand in 2019 began strong but weakened throughout the year. Referring again to U.S. Industrial Production, it increased 2.9% in the first quarter of 2019 but decreased 0.9% in the fourth quarter of 2019. The slowing in these metrics from the start to the end of 2019 mirrored the slowing growth we experienced in our unit sales over the same period.
A relatively greater contributor to our growth in 2019 was the success of our growth initiatives. We signed 21,857 industrial vending devices during 2019. While this represented a slight decrease in signings of 1.0% from 2018, it also contributed to growth in our installed base to 89,937 vending devices at the end of 2019, an increase of 10.8% over 2018. Growth in our installed base was primarily responsible for sales growth through our vending devices in the mid-teens during 2019. We signed 362 new Onsite locations in 2019, an increase of 7.7% over 2018, and had 1,114 active sites on December 31, 2019, an increase
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of 24.6% over December 31, 2018. Growth in our number of active sites was primarily responsible for sales growth through our Onsites in the mid-teens during 2019. The contribution of new national account contracts and strong penetration of existing national account customers resulted in daily sales from our national account customers growing 11.9% in 2019 compared to 2018.
Sales by Product Line
The approximate mix of sales from fasteners, safety supplies, and all other product lines was as follows:
Shifts in product mix in 2020 largely reflects the factors that impacted our sales growth in the period. Specifically, strong demand for PPE generated strong sales growth in our safety products, while weak trends in underlying conditions affected our traditional manufacturing and construction customers resulting in a sales decline in our fastener products. The effect on other products was relatively muted, as certain lines benefited from pandemic-related demand (such as janitorial products), while others were negatively impacted by underlying demand (such as metalcutting and material handling). Shifts in product mix in 2019 were based on more traditional factors. The decrease in our fastener sales as a percentage of total sales arises from two factors. First, we believe non-fastener products represent a larger market opportunity than fasteners, and that we are relatively under-represented in this market. Over time, this has led to faster growth in the non-fastener product lines, a trend amplified by the growth of our industrial vending program through which we sell primarily non-fastener products. We believe this factor impacted 2019 and will continue to promote a lower mix of fasteners in our total sales over time. Second, the weakening industrial production environment had a disproportionately negative effect on fastener sales, particularly OEM fasteners sales, relative to non-fastener sales (which relates more to plant operations than production). This weakness is more of a cyclical factor than a structural one, and as such was relevant in 2020 (albeit overwhelmed by pandemic-related effects) and 2019.
Annual Sales Changes, Sequential Trends, and End Market Performance
This section focuses on three distinct views of our business – annual sales changes by month, sequential trends, and end market performance. The first discussion regarding sales changes by month provides a good mechanical view of our business. The second discussion provides a framework for understanding the sequential trends (that is, comparing a month to the immediately preceding month, and also looking at the cumulative change from an earlier benchmark month) in our business. Finally, we believe the third discussion regarding end market performance provides insight into activities with our various types of customers.
Annual Sales Changes, by Month
During the months noted below, all of our selling locations, when combined, had daily sales growth rates of (compared to the same month in the preceding year):
Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
Sequential Trends
We find it helpful to think about the monthly sequential changes in our business using the analogy of climbing a stairway – This stairway has several predictable landings where there is a pause in the sequential gain (i.e. April, July, and October to December), but generally speaking, climbs from January to October. The October landing then establishes the benchmark for the start of the next year.
History has identified these landings in our business cycle. They generally relate to months where certain holidays impair business days and/or seasons impact certain end markets, particularly non-residential construction. The first landing centers on Easter and the Good Friday holiday that precedes it, which alternates between March and April (Good Friday occurred in April in 2020 and 2019, occurred in March during 2018, and will fall in April in 2021), the second landing centers on July 4th, and the third landing centers on the approach of winter with its seasonal impact on primarily our non-residential construction business and with the Christmas/New Year holidays. The holidays we noted impact the trends because they either move from month-to-month or because they move around during the week.
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The table below shows the pattern to the sequential change in our daily sales. The line labeled 'Benchmark' is a historical average of our sequential daily sales change for the trailing five year average (2015-2019). We believe this time frame serves to show the historical pattern and could serve as a benchmark for current performance. The '2020', '2019', and '2018' lines represent our actual sequential daily sales changes. The '20Delta', '19Delta', and '18Delta' lines indicate the difference between the 'Benchmark' and the actual results in the respective year. Under normal circumstances, the sequential trends shown below are directly linked to fluctuations in our end markets. Further, in any given month it is possible to get significant deviation from the benchmark. However, we do not believe that fully explains the exaggerated delta between the sequential rates of change and the benchmark from March 2020 to July 2020. We believe deviation of this duration and order of magnitude is uncharacteristic in our business and is related to the dramatic impacts of the pandemic in that period.
It is important to note that these benchmarks are historical averages. In a year where demand is strong, our daily sales growth rates will tend to have more months that exceed the benchmark than fall below it. In a year where demand is weak, we will tend to have more months that fall short of the benchmark than exceed it. In both cases, there is a random element that makes it difficult to know how any single month will perform.
(1) The January figures represent the percentage change from the previous October, whereas the remaining figures represent the percentage change from the previous month.
Note – Amounts may not foot due to rounding difference.
A graph of the sequential daily sales change patterns discussed above, starting with a base of '100' in the previous October and ending with the next October, would be as follows:
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End Market Performance
We estimate approximately 65% of our business has historically been with customers engaged in some type of manufacturing, a significant subset of which finds its way into the heavy equipment market. The daily sales growth (contraction) rates to these manufacturing customers, when compared to the same period in the prior year, were as follows:
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 (which, under normal business conditions, represents 30% to 35% of our business) which is heavily influenced by changes in our business with heavy equipment manufacturers. From a company perspective, daily sales growth (contraction) rates of fasteners, when compared to the same period in the prior year, were as follows (note: this information includes all end markets):
The daily sales growth (contraction) rates of fasteners noted in the table above for first quarter of 2018, include 3.7 percentage points attributable to Mansco (acquired on March 31, 2017).
By contrast, the best way to understand the change in the maintenance portion of the manufacturing business is to examine the results in our non-fastener product lines. From a company perspective, daily sales growth rates of non-fasteners, when compared to the same period in the prior year, were as follows (note: this information includes all end markets):
Two product lines, safety and janitorial, accounted for approximately half of total non-fastener sales and saw a meaningful increase in sales in 2020 due to demand generated in response to the COVID-19 pandemic. As a result, the change in our non-fastener lines in 2020 did not provide as much insight into the trends of our traditional manufacturing and construction customers as is typically the case. Still, we have sold non-fastener products through multiple cycles that do not include a pandemic and believe we can make several observations. Generally speaking, our non-fastener business is not immune to the impact of industrial cycles. However, we would typically expect it to outperform our fastener business in any cycle. This reflects three things: the non-fastener market is larger than the fastener market, we are underpenetrated in the non-fastener market relative to the fastener market, and industrial vending lends itself to sales of non-fastener products. This is what we experienced in 2019. The outperformance of our non-fastener business was far more dramatic in 2020 than can be explained by our traditional drivers of outperformance, and reflects the impact of COVID-19 on our sales of safety products, specifically PPE, and janitorial products, such as sanitizer and wipes.
Our non-residential construction and reseller customers have historically represented 20% to 25% of our business, though in 2020 it was slightly below the bottom of this range. The daily sales growth (contraction) rates to these customers, when compared to the same period in the prior year, were as follows:
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Our non-residential construction and reseller business is heavily influenced by manufacturing, oil and gas, and infrastructure spending. In 2020 and 2019, the poor and slowing production environment, respectively and as described above, and the accompanying worsening trends for commodities such as metals and energy, caused the growth in our non-residential construction and reseller customers to slow. In 2020, this was exacerbated by project suspensions as many states and regions shut down activity in an effort to control the pandemic.
Gross Profit
The gross profit percentage during each period was as follows:
Our gross profit, as a percentage of net sales, was 45.5% in 2020 and 47.2% in 2019. The gross profit percentage for 2020 decreased by 170 basis points based on three items. (1) A decline in product margin for safety and other products, which itself reflects several trends. First, in the second quarter of 2020 in order to procure supplies we utilized unfamiliar supply chains and prioritized speed of acquisition over efficiency, resulting in lower margins. Second, in the third and fourth quarters of 2020 certain pandemic related products became oversupplied, and profits on our inventory fell (masks) while other products were in such short supply that cost rose (gloves). We mitigated these effects as the year progressed, but did not eliminate them. Third, mix within these categories was negative to margin, as in general COVID-related products had lower margins and increased in the mix. (2) A change in product mix. Fasteners are our largest and highest gross profit margin product line due to the high transaction cost surrounding the sourcing and supply of the product for customers. Our fastener product line declined to 29.9% of sales in 2020 from 34.2% of sales in 2019. (3) Overhead and organizational expenses. This includes the negative impact that reduced sales for certain product lines has on vendor rebates, clearance efforts to remove older and slower moving inventory, and the deleverage of certain fixed and period costs related to cyclical weakness in our traditional manufacturing and construction markets. These three adverse variables were partly offset by a better cost profile for our captive fleet. We operate our own fleet of trucks for moving product between suppliers, our distribution centers, and our in-market locations. We believe this provides us a competitive advantage in terms of our ability to move product efficiently and quickly, but there is a cost to supporting and maintaining these assets. During periods of economic weakness, it can become more difficult to charge freight to offset these costs and/or the relatively stable cost profile of these assets could result in deleverage. We successfully mitigated these challenges in 2020 by reducing movement and labor costs.
During 2019, our gross profit as a percentage of net sales decreased when compared to the prior year. The decrease was primarily caused by three variables. (1) A change in product and customer mix, as we experienced the combination of relatively slow net sales growth in our fastener product line and relatively faster net sales growth to our largest customers, for which National Accounts is a good proxy and which tend to have lower margins. (2) We experienced rising freight expense as a result of costs related to transporting products, particularly shipping fees, driver wages, and fuel. (3) We experienced an increase in the cost of our products due to generalized inflation and tariffs resulting from disputes between the United States and its trade partners. We implemented several actions to mitigate the impact of these cost increases in 2019, including price increases. For the full year, the net impact of these actions was minor. However, the impact through the year differed, with a larger negative impact on the gross profit percentage in the first half of 2019 and a relatively modest impact in the second half of 2019.
Operating and Administrative Expenses
Our operating and administrative expenses (including the gain on sales of property and equipment), as a percentage of net sales, improved to 25.3% in 2020 from 27.3% in 2019. This improvement was a function of the growth in employee-related, occupancy-related, and all other operating and administrative expenses being more modest than the growth in sales. Employee-related expenses improved the ratio of operating and administrative expenses as a percentage of sales by 140 to 145 basis points in 2020 from 2019. Occupancy-related expenses improved the ratio of operating and administrative expenses as a percentage of sales by 25 to 30 basis points in 2020 from 2019. All other operating and administrative expenses improved the ratio of operating and administrative expenses as a percentage of sales by 40 to 45 basis points in 2020 from 2019.
Our operating and administrative expenses (including the gain on sales of property and equipment), as a percentage of net sales, improved to 27.3% in 2019 from 28.2% in 2018. This improvement was a function of the growth in employee-related, occupancy-related, and all other operating and administrative expenses being more modest than the growth in sales. Employee-related expenses improved the ratio of operating and administrative expenses as a percentage of sales by 40 to 45 basis points in 2019 from 2018. Occupancy-related expenses improved the ratio of operating and administrative expenses as a percentage of sales by 20 to 25 basis points in 2019 from 2018. All other operating and administrative expenses improved the ratio of operating and administrative expenses as a percentage of sales by 20 to 25 basis points in 2019 from 2018.
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The growth (contraction) in employee-related, occupancy-related, and all other operating and administrative expenses (including the gain on sales of property and equipment) compared to the same periods in the preceding year, is outlined in the table below.
Occupancy-related expenses 15% to 20% 0.3 % 2.8 % 5.0 %
All other operating and administrative expenses 10% to 15% -7.2 % 1.5 % 5.2 %
(1) Employee-related expenses fell within a range of 68-73% of our total operating and administrative expenses during 2020. During 2019, employee-related expenses fell within a range of 65-70% of our total operating and administrative expenses.
Employee-related expenses include: (1) payroll (which includes cash compensation, stock option expense, and profit sharing), (2) health care, (3) personnel development, and (4) social taxes.
Our employee-related expenses decreased in 2020 from 2019. This was related to: a decrease in full-time equivalent (FTE) headcount and related base wages and employment taxes related to efforts to reduce costs given weak demand in our traditional manufacturing and construction markets; lower bonuses and commissions given weak demand in our traditional manufacturing and construction markets; and reduced costs associated with the Fastenal School of Business as training shifted from in-person to online. This was only partly offset by an increase in our profit sharing contribution and health care costs. Our employee-related expenses increased in 2019 from 2018. This was related to: (1) an increase in FTE headcount related to efforts to support growth in our business, (2) higher performance bonuses and commissions due to growth in net sales and net earnings, (3) an increase in our profit sharing contribution and options awards, (4) increases in hourly base wages, and (5) increased health care costs.
The table below summarizes the percentage change in our FTE headcount at the end of the periods presented compared to the end of the prior period:
Twelve-month Period
In-market locations (branches & Onsites) -8.0 % 0.2 % 5.7 %
Non-in-market selling (1) 5.4 % 5.3 % 3.3 %
Selling subtotal -6.2 % 0.8 % 5.4 %
Distribution/Transportation -10.5 % 2.2 % 12.2 %
Administration (2) 8.7 % 8.5 % 7.3 %
Non-selling subtotal -5.2 % 3.1 % 10.9 %
(1) Our non-in-market selling employee count has grown in recent years due to an increased focus on resources to support our growth drivers, particularly Onsite and national account growth
(2) Administration primarily includes our Sales Support, Information Technology, Finance and Accounting, Human Resources, and senior leadership roles and functions. Our administrative employee count has grown in recent years due to an increased focus on technology capabilities. For example, 66.7% of the increase in administrative employees in 2020 over 2019 related to our additions to our information technology teams.
Occupancy-related expenses include: (1) building rent and depreciation, (2) building utility costs, (3) equipment related to our branches and distribution locations, and (4) industrial vending equipment (we consider the vending equipment, excluding leased locker equipment, to be a logical extension of our in-market operations and classify the depreciation and repair costs as occupancy expenses).
Our occupancy-related expenses increased slightly in 2020 from 2019. This was primarily due to higher depreciation related to facility expansions completed in 2019, partly offset by lower utility costs in our branches. Our occupancy-related expenses increased in 2019 from 2018. This was related primarily to: higher depreciation as a result of facility expansions completed during the year; and increases to industrial vending equipment.
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All other operating and administrative expenses include: (1) selling-related transportation, (2) information technology (IT) expenses, (3) general corporate expenses, which consists of legal expenses, general insurance expenses, travel and marketing expenses, etc., and (4) the gain on sales of property and equipment.
Combined, all other operating and administrative expenses decreased in 2020 from 2019. This was related to: lower selling-related freight expenses due to reduced travel as a result of COVID-related restrictions, the rationalization of our branch fleet, and significantly reduced travel and meal expenses due to reduced travel as a result of COVID-related restrictions. This was partly offset by higher spending on information technology. Combined, all other operating and administrative expenses increased in 2019 from 2018. This was related to: higher spending on information technology; and higher selling-related freight expense.
Net Interest Expense
Our net interest expense was $9.1 in 2020 compared to $13.6 in 2019, and $12.3 in 2018. The decrease in 2020, when compared to 2019, was due to a slightly lower average debt balance paired with substantially lower interest rates. During the year, we increased the debt held under our Master Note Agreement to $405.0 as a means of fixing a portion of our debt and freeing up borrowing capacity under our revolver. This debt has various maturities and interest rates, which collectively are at attractive levels. The increase in 2019, when compared to 2018, was mainly caused by higher average interest rates and a higher average debt balance during the period.
Income Taxes
We recorded income tax expense of $273.6 in 2020, or 24.2% of earnings before income taxes. Our income tax expense was reduced by $5.3 due to discrete items mainly relating to benefits associated with the exercise of stock options and changes in the reserve for uncertain tax positions.
We recorded income tax expense of $252.8 in 2019, or 24.2% of earnings before income taxes. Our income tax expense was reduced by $2.6 as a result of applying guideline clarifications issued by the IRS on certain aspects of tax reform, as well as tax benefits associated with the exercise of stock options. This reduced our tax rate in the period by 30 basis points.
Net Earnings
Net earnings, net earnings per share (EPS), the percentage change in net earnings, and the percentage change in EPS, were as follows:
(1) As a result of the Tax Act, discrete tax items benefited our net earnings by $7.1 during 2018.
During 2020 and 2019, net earnings increased, primarily due to stronger sales and higher operating profits, and were only partly offset by an increase in income tax expense. The increase in basic and diluted earnings per share also reflected the purchase of our shares of common stock in 2020.
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Liquidity and Capital Resources
Net Cash Provided by Operating Activities
Net cash provided by operating activities in dollars and as a percentage of net earnings were as follows:
In 2020, the increase in our operating cash flow as a percentage of net earnings is due to working capital assets and liabilities being a modest source of cash in 2020, as opposed to a significant use of cash in 2019. This includes the deferral of $30.0 in payroll taxes resulting from the CARES Act and a timing-related higher accounts payable balance. In 2019, the increase in our operating cash flow as a percentage of net earnings reflects a reduced drag from working capital investment than what was experienced in 2018 and, to a lesser degree, higher net income.
Trade Working Capital Assets
Trade working capital assets are highlighted below. The annual dollar change and the annual percentage change were as follows:
Accounts receivable, net $ 27.6 27.5
Trade working capital $ (1.2) 115.2
Accounts payable 14.2 (0.7)
Trade working capital, net (15.4) 115.9
Accounts receivable, net 3.7 % 3.9 %
Inventories (2.1) % 6.9 %
Trade working capital (0.1) % 5.8 %
Accounts payable 7.3 % (0.4) %
Trade working capital, net (0.8) % 6.4 %
Note – Amounts may not foot due to rounding difference.
In 2020, the annual growth in net accounts receivable reflects growth in sales, mitigated by the substantial increase in sales to government customers, which tended to have shorter payment terms in 2020, and strong collections at year end. In 2019, the annual growth in net accounts receivable reflects not only our growth in sales, but also the fact that our growth is being driven disproportionately by our national accounts program where our customers tend to have longer payment terms than our customer base as a whole. Growth was also relatively stronger with customers outside the U.S., which similarly tend to have longer payment terms than our customer base as a whole. The rate of growth in receivables did slow throughout 2019, largely reflecting the impact on receivables of softer business activity.
Our inventory balances over time will respond to business activity, though various factors produce a looser relationship to our monthly sales patterns than we tend to experience in accounts receivable. One reason for this is cyclical. We source significant quantities of product from overseas, and the lead time involved in procuring these products is typically longer than the visibility we have into future monthly sales patterns. As a result, trends in our inventory will often lag trends in economic conditions. A second reason is our growth drivers, including our FMI offerings, Onsite channel, and international expansion, all of which tend to require significant investments in inventory. In 2020, our inventories decreased, reflecting a number of factors, including reduced stocking needs on the part of our traditional manufacturing and construction customers due to weak business activity, reduced vending and Onsite signings, and good execution on initiatives aimed at improving our inventory balances. This was partly offset by COVID-related PPE balances that we added in the second quarter of 2020 and have been declining over the second half of 2020, but we had no such PPE inventory in the preceding year. In 2019, our inventories increased to support higher sales, reflecting large increases in the number of installed vending devices and active Onsite locations, and from inflation and tariffs.
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In 2020, the annual growth in accounts payable reflected primarily the timing of certain payments that slipped out of the fourth quarter of 2020 and into the first quarter of 2021. In 2019, the slight decrease in accounts payable came as a result of softer year end business activity.
The approximate percentage mix of inventory stocked at our selling locations versus our distribution center and manufacturing locations was as follows at year end:
Selling locations 59 % 60 % 61 %
Distribution center and manufacturing locations 41 % 40 % 39 %
Net Cash Used in Investing Activities
Net cash used in investing activities in dollars and as a percentage of net earnings were as follows:
The changes in net cash used in investing activities in 2020 were primarily related to an increase of $125.0 for the purchase of certain assets of Apex Industrial Technologies LLC, which was partly offset by changes in our net capital expenditures. The changes in net cash used in investing activities in 2019 was primarily related to changes in our net capital expenditures.
Property and equipment expenditures typically consist primarily of: (1) purchases related to industrial vending, (2) purchases of property and equipment related to expansion of and enhancements to distribution centers, (3) spending on software and hardware for our information processing systems, (4) the addition of fleet vehicles, (5) expansion, improvement or investment in certain owned or leased branch properties, and (6) the addition of manufacturing and warehouse equipment. Disposals of property and equipment consisted of the planned disposition of certain pick-up trucks, distribution vehicles, and trailers in the normal course of business.
Set forth below is a recap of our 2020, 2019, and 2018 net capital expenditures in dollars and as a percentage of net sales and net earnings:
Data processing software and equipment 31.4 31.1 30.9
Real estate and improvements to branch locations 16.1 8.9 12.9
Proceeds from sale of property and equipment (10.6) (6.6) (9.5)
% of net sales 2.8 % 4.5 % 3.4 %
Our net capital expenditures decreased in 2020, when compared to 2019. We reduced capital spending expectations early in 2020 across most tracked categories as financial uncertainty related to the pandemic response emerged. The decline relates to lower spending on facility capacity and equipment following our investments in 2019, lower spending for vending devices as a result of our acquisition of certain assets of Apex and lower signings, lower spending on our captive fleet, and lower spending for manufacturing equipment. Our net capital expenditures increased in 2019, when compared to 2018, primarily due to increased spending on hub property and equipment, both to expand current capacity and for potential future expansion, higher spending on vending devices to support the growth of our industrial vending program, and investment in our trucking assets.
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We expect our net capital expenditures in 2021 to be within a range of $170.0 to $200.0. This increase from 2020 relates to increased spending for a non-hub construction project in Winona to support growth, higher maintenance spending across most tracked categories following tighter spending control in 2020, and lower anticipated proceeds from asset sales. These factors will be slightly offset by lower spending on vending devices due to a full year of lower unit cost following our acquisition of certain assets of Apex. We anticipate funding our capital expenditure needs with cash generated from operations, from available cash and cash equivalents, and, if necessary, from our borrowing capacity.
Net Cash Used in Financing Activities
Net cash used in financing activities in dollars and as a percentage of net earnings were as follows:
The fluctuations in net cash used in financing activities are due to changes in the level of our dividend payments and in the level of common stock purchases. These amounts were partially offset by the exercise of stock options and net payments (proceeds) from debt obligations. These items in dollars and as a percentage of earnings were as follows:
% of net earnings 6.1 % — 13.7 %
Proceeds from the exercise of stock options $ (41.0) (58.5) (13.4)
% of net earnings -4.8 % -7.4 % -1.8 %
Cash payments (proceeds), net $ (60.0) 155.0 (85.0)
Stock Purchases
In 2020, we purchased 1,600,000 shares of our common stock at an average price of approximately $32.54. In 2019, we did not purchase any shares of our common stock. In 2018, we purchased 4,000,000 shares of our common stock at an average price of approximately $25.75 per share.
Dividends
We declared a quarterly dividend of $0.28 per share on January 19, 2021. In 2020, we paid aggregate annual dividends per share of $1.40. This included $1.00 in regular quarterly dividends and a $0.40 special dividend paid in December 2020 as a result of our high cash balances and favorable financial outlook. In 2019, we paid aggregate annual dividends per share of $0.87.
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Debt
In order to fund the considerable cash needed to expand our industrial vending business, expand capacity and increase the use of automation in our distribution centers, pay dividends, and, in 2020, to purchase our common stock, pre-pay vendors to secure access to critical products during the pandemic, and acquire certain assets of Apex Industrial Technologies LLC, we have borrowed under our Credit Facility and our Master Note Agreement in recent periods.
Our borrowings under the Credit Facility and Master Note Agreement peaked during each quarter of 2020 and 2019 as follows:
As of December 31, 2020, we had no loans outstanding under the Credit Facility and had contingent obligations from letters of credit outstanding under the Credit Facility in an aggregate face amount of $36.3. As of December 31, 2020, we had loans outstanding under the Master Note Agreement of $405.0. Descriptions of our Credit Facility and Master Note Agreement are contained in Note 10 of the Notes to Consolidated Financial Statements.
Unremitted Foreign Earnings
Approximately $186.8 of cash and cash equivalents are held by non-U.S. subsidiaries. These funds may create foreign currency translation gains or losses depending on the functional currency of the entity holding the cash. We have considered the financial requirements of each foreign subsidiary and our parent company and will continue to reinvest these funds to support our expansion activities outside the U.S., even after taking into consideration the deemed repatriation and transition tax under the Tax Act. The income tax impact of repatriating cash associated with investments in foreign subsidiaries is discussed in Note 8 of the Notes to Consolidated Financial Statements.
Effects of Inflation
In 2020, we experienced changing price levels for COVID-related supplies, with inflation for certain products that were in short supply (e.g., nitrile gloves) and deflation for certain products that became oversupplied (e.g., disposable masks). These were event-specific circumstances related to the pandemic. As it related to the non-COVID environment, we experienced stable product costs through 2020 relative to 2019. We experienced higher product costs through 2019 relative to 2018 as a result of generalized inflation and tariffs, though the impact of these items did moderate later in the year as economic activity slowed and conditions around trade stabilized. We took actions during the year to mitigate the effects of higher product costs, including increasing product prices. These actions were not able to offset the pressure we experienced on our gross profit percentage in the first half of 2019, but were more effective at doing so in the second half of 2019.
Critical Accounting Policies and Estimates
In preparing our consolidated financial statements in conformity with U.S. GAAP, we must make decisions that impact the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, we apply judgments based on our understanding and analysis of relevant circumstances, historical experience, and actuarial valuations. Actual amounts could differ from those estimated at the time the consolidated financial statements are prepared.
Our most significant accounting policies, including Revenue Recognition and Inventories, are described in Note 1 of the Notes to Consolidated Financial Statements. Some of those significant accounting policies require us to make difficult, subjective, or complex judgments, or estimates. An accounting estimate is considered to be critical if it meets both of the following criteria: (i) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and (ii) different estimates reasonably could have been used, or changes in the estimate that are reasonably likely to occur from period to period may have a material impact on the presentation of our financial condition, changes in financial condition, or results of operations. Our most critical accounting estimates include the following:
Allowance for Credit Losses – This reserve is for accounts receivable balances that are potentially uncollectible. The allowance for credit losses is based on an income statement approach which adjusts the ending balance sheet to take into consideration expected losses over the contractual lives of the receivables, considering factors such as historical data as a basis for future expected losses. If business or economic conditions change, our estimates and assumptions may be adjusted as deemed appropriate. Historically, actual required reserves have not varied materially from estimated amounts.
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Inventory valuation – The valuation of inventory is based on an analysis of inventory trends including reviews of inventory levels, sales information, and the on-hand quantities relative to the sales history for the product. Our methodology for estimating whether adjustments are necessary is continually evaluated for factors including significant changes in product demand, market conditions, condition of the inventory, or liquidation value. If business or economic conditions change, our estimates and assumptions may be adjusted as deemed appropriate. Historically, actual required adjustments have not varied materially from estimated amounts.
General insurance reserves – These reserves are for general claims related to workers' compensation, property and casualty losses, and other general liability self-insured losses. The reserves are based on an analysis of reported claims and claims incurred but not yet reported related to our historical claim trends. We perform ongoing reviews of our insured and uninsured risks and use this information to establish appropriate reserve levels. We analyze historical trends, claims experience, and loss development patterns to ensure the appropriate loss development factors are applied to the incurred costs associated with the claims made. Historically, actual required reserves have not varied materially from estimated amounts.
New Accounting Pronouncements
A description of new accounting pronouncements is contained in Note 1 of the Notes to Consolidated Financial Statements.
Geographic Information
Information regarding our revenues and long-lived assets by geographic area is contained in Note 3 and Note 4 of the Notes to Consolidated Financial Statements. Risks related to our foreign operations are described earlier in this Form 10-K under the heading 'Forward-Looking Statements' and 'Item 1A. Risk Factors'.
Certain Contractual Obligations
As of December 31, 2020, we had outstanding long-term debt and facilities, equipment, and vehicles leased under operating leases. Our future obligations to pay principal of and interest on such long-term debt and to make minimum lease payments under such operating leases are as follows:
(1) Interest on the long-term debt outstanding under our Credit Facility was calculated using the interest rates and balances at December 31, 2020.
(2) Amounts include lease liabilities for pick-up truck leases, which typically have a non-cancelable lease term of less than one year and are not included on the consolidated balance sheets as an operating lease right-of-use asset.
Purchase orders and contracts for the purchase of inventory and other goods and services are not included in the table above. Our purchase orders are based on current distribution needs and are fulfilled by our suppliers within short time horizons. We do not have significant agreements for the purchase of inventory or other goods or services specifying minimum order quantities.
Liabilities for uncertain tax positions have been excluded from the table above due to the uncertainty surrounding the ultimate settlement and timing of these liabilities, which we believe will be immaterial. A discussion of income taxes is contained in Note 8 of the Notes to Consolidated Financial Statements.
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ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We are exposed to certain market risks from changes in foreign currency exchange rates, commodity steel pricing, commodity energy prices, and interest rates. Changes in these factors cause fluctuations in our earnings and cash flows. We evaluate and manage exposure to these market risks as follows:
Foreign currency exchange rates – Foreign currency fluctuations can affect our net investments, our operations in countries other than the U.S., and earnings denominated in foreign currencies. Historically, our primary exchange rate exposure has been with the Canadian dollar against the United States dollar. Our estimated net earnings exposure for foreign currency exchange rates was not material at year end. We have not historically hedged our foreign currency risk given that exposure to date has not been material. In 2020, changes in foreign currency exchange rates reduced our reported net sales by $5.7 with the estimated effect on our net earnings being immaterial.
Commodity steel pricing – We buy and sell various types of steel products; these products consist primarily of different types of threaded fasteners and related hardware. We are exposed to the impacts of commodity steel pricing and our related ability to pass through the impacts to our end customers. During 2020, the price of commodity steel as reflected in many market indexes fell sharply early in the year as business activity declined in response to actions to address the COVID-19 pandemic, recovered sharply as business activity rebounded, and finished 2020 above the preceding year end levels. During 2019, the price of commodity steel as reflected in many market indexes declined.
Commodity energy prices – We have market risk for changes in prices of oil, gasoline, diesel fuel, natural gas, and electricity. Prices for gasoline and diesel were mostly lower over the course of 2020 as business activity declined in response to actions to address the COVID-19 pandemic. As a result, we experienced lower fuel costs through most of 2020. In 2019, prices for gasoline and diesel were stable in the early part of the year, but began to decline in the latter part of the year with slowing economic activity. As a result, we experienced stable fuel costs through 2019. Fossil fuels are also often a key feedstock for chemicals and plastics that comprise a key raw material for many products that we sell. Although fuel prices were lower through much of 2020, we experienced stable, not lower, prices for products with high chemical or plastic content. Stable fuel costs in 2019 resulted in stable product costs. We believe that over time these risks are mitigated in part by our ability to pass freight and product costs to our customers, the efficiency of our trucking distribution network, and the ability, over time, to manage our occupancy costs related to the heating and cooling of our facilities through better efficiency. In 2020, our estimated net earnings exposure for commodity energy prices was immaterial.
Interest rates - Loans under our Credit Facility bear interest at floating rates tied to LIBOR (or, if LIBOR is no longer available, at a replacement rate to be determined by the administrative agent for the Credit Facility and consented to by us). As a result, changes in LIBOR can affect our operating results and liquidity to the extent we do not have effective interest rate swap arrangements in place. We have not historically used interest rate swap arrangements to hedge the variable interest rates under our Credit Facility. A one percentage point increase in LIBOR in 2020 would have resulted in approximately $1.3 of additional interest expense. A description of our Credit Facility is contained in Note 10 of the Notes to Consolidated Financial Statements.
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ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
Fastenal Company:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Fastenal Company and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of earnings, comprehensive income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2020 and the related notes and financial statement schedule listed in the table of contents at Item 15 (collectively, the consolidated financial statements). We also have audited the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's consolidated financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Sufficiency of audit evidence over inventory quantities
As disclosed in the consolidated balance sheet, the Company held $1,337.5 million of inventory, the majority of which was held at 3,268 in-market locations, as of December 31, 2020. The Company’s processes to track and determine consolidated inventory relies on a perpetual inventory system which involves the interaction of multiple information technology (IT) systems.
We identified the evaluation of the sufficiency of audit evidence obtained related to the quantities of inventory as a critical audit matter. Evaluating the sufficiency of audit evidence over quantities of inventory required challenging auditor judgment to assess the number of in-market locations visited, and included the involvement of IT professionals with specialized skills and knowledge due to the interaction of multiple IT systems that track physical inventory quantities by location.
The following are the primary procedures we performed to address this critical audit matter: We evaluated the design and tested the operating effectiveness of certain internal controls related to the critical audit matter. This included IT application controls, as well as certain controls related to access to programs and data, program changes, program development, and computer operations. It also included certain controls related to the Company's physical inventory cycle counts. We involved IT professionals with specialized skills and knowledge, who assisted in testing certain IT controls, inclusive of the interface of multiple IT systems, which support the Company’s perpetual inventory system. We applied auditor judgment in the determination of the locations to test the Company’s inventory quantities by evaluating:
•Historical inventory locations we have visited and results of prior physical counts;
•Inventory dollars by location; and
•The Company's inventory cycle count results, including the results of monitoring and compliance with cycle count program by in-market location.
We tested the existence and completeness of inventory by counting inventory quantities on a sample basis through location visits during the year to evaluate the Company’s perpetual inventory records. In addition, we evaluated the overall sufficiency of audit evidence obtained over the quantities of inventory.
/s/ KPMG LLP
We have served as the Company’s auditor since 1987.
Minneapolis, Minnesota
February 8, 2021
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FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Balance Sheets
(Amounts in millions except share information)
December 31
Assets
Current assets:
Prepaid income taxes 6.7 16.7
Operating lease right-of-use assets 243.0 243.2
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of debt $ 40.0 3.0
Current portion of operating lease liabilities 93.6 97.4
Commitments and contingencies (Notes 6, 9, 10, and 11)
Stockholders’ equity:
Additional paid-in capital 61.9 67.2
Accumulated other comprehensive loss (21.2) (38.4)
Total liabilities and stockholders’ equity $ 3,964.7 3,799.9
See accompanying Notes to Consolidated Financial Statements.
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FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Statements of Earnings
(Amounts in millions except earnings per share)
For the year ended December 31
Gain on sale of property and equipment (1.4) (1.2) (0.5)
Diluted net earnings per share $ 1.49 1.38 1.31
Diluted weighted average shares outstanding 575.7 574.4 574.3
See accompanying Notes to Consolidated Financial Statements.
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FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Amounts in millions)
For the year ended December 31
Other comprehensive income (loss), net of tax:
See accompanying Notes to Consolidated Financial Statements.
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FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(Amounts in millions)
Common stock
Balance at beginning of year $ 2.9 2.9 2.9
Balance at end of year 2.9 2.9 2.9
Additional paid-in capital
Balance at beginning of year 67.2 3.0 8.5
Purchases of common stock (52.0) — (24.0)
Stock-based compensation 5.7 5.7 5.1
Retained earnings
Purchases of common stock — — (79.0)
Accumulated other comprehensive income (loss)
Balance at beginning of year (38.4) (44.8) (25.1)
Other comprehensive income (loss) 17.2 6.4 (19.7)
Cash dividends paid per share of common stock $ 1.40 0.87 0.77
See accompanying Notes to Consolidated Financial Statements.
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FASTENAL COMPANY AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Amounts in millions)
For the year ended December 31
Cash flows from operating activities:
Gain on sale of property and equipment (1.4) (1.2) (0.5)
Stock-based compensation 5.7 5.7 5.1
Amortization of intangible assets 9.1 4.1 4.1
Changes in operating assets and liabilities, net of acquisitions:
Cash flows from investing activities:
Proceeds from sale of property and equipment 10.6 6.6 9.5
Cash paid for acquisitions (125.0) — (3.7)
Net cash used in investing activities (281.7) (239.7) (173.9)
Cash flows from financing activities:
Proceeds from exercise of stock options 41.0 58.5 13.4
Purchases of common stock (52.0) — (103.0)
Net cash used in financing activities (754.4) (595.1) (446.5)
Effect of exchange rate changes on cash and cash equivalents 5.1 (0.2) (3.5)
Net increase in cash and cash equivalents 70.8 7.7 50.3
Cash and cash equivalents at beginning of year 174.9 167.2 116.9
Supplemental information:
See accompanying Notes to Consolidated Financial Statements.
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Fastenal Company and Subsidiaries
Notes to Consolidated Financial Statements
Note 1. Business Overview and Summary of Significant Accounting Policies
Business Overview
Fastenal is a leader in the wholesale distribution of industrial and construction supplies operating a branch-based business (with an increasing number of Onsite locations). Collectively we refer to our branches and Onsite locations as in-market locations. We have over 3,200 in-market locations located primarily in North America.
Principles of Consolidation
The consolidated financial statements include the accounts of Fastenal Company and its subsidiaries (collectively referred to as 'Fastenal' or by terms such as 'we', 'our', or 'us'). All material intercompany balances and transactions have been eliminated in consolidation.
Revenue Recognition
Net sales include products and shipping and handling charges, net of estimates for product returns and any related sales incentives. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products. All revenue is recognized when we satisfy our performance obligations under the contract. We recognize revenue by transferring the promised products to the customer, with the majority of revenue recognized at the point in time the customer obtains control of the products. We recognize revenue for shipping and handling charges at the time the products are delivered to or picked up by the customer. We estimate product returns based on historical return rates. Using probability assessments, which are based on known inputs at year-end, we estimate sales incentives expected to be paid over the term of the contract. The majority of our contracts have a single performance obligation and are short term in nature. Sales taxes and value added taxes in foreign jurisdictions that are collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales.
Accounts Receivable
Credit is extended based upon an evaluation of the customers' financial condition. Accounts receivable are stated at their estimated net realizable value. The allowance for credit losses is based on an income statement approach which adjusts the ending balance sheet to take into consideration expected losses over the contractual lives of the receivables, considering factors such as historical data as a basis for future expected losses.
Foreign Currency Translation and Transactions
The functional currency of our foreign operations is typically the applicable local currency. The functional currency is translated into United States dollars for balance sheet accounts, except retained earnings, using current exchange rates as of the balance sheet date, for retained earnings at historical exchange rates, and for revenue and expense accounts using a weighted average exchange rate during the applicable period. The translation adjustments are deferred as a separate component of stockholders' equity captioned accumulated other comprehensive income (loss). Gains or losses resulting from transactions denominated in foreign currencies are included in cost of sales or operating and administrative expenses.
Cash and Cash Equivalents
We consider all investments purchased with original maturities of three months or less to be cash equivalents.
Inventories
Inventories, consisting of finished goods merchandise held for resale, are stated at the lower of cost (first in, first out method) or net realizable value. We record valuation adjustments for excess, slow-moving, and obsolete inventory that are equal to the difference between the cost and estimated net realizable value for that inventory. These estimates are based on a review and comparison of the current inventory levels to projected and historical sales of inventory.
Property and Equipment
Property and equipment are stated at cost. Depreciation on property and equipment is provided for using the straight-line method over the anticipated economic useful lives of the related property. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If
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Fastenal Company and Subsidiaries
Notes to Consolidated Financial Statements—Continued
circumstances require a long-lived asset or asset group be tested for possible impairment, we first compare undiscounted cash flows expected to be generated by the asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values, and third-party independent appraisals, as considered necessary.There were no impairments recorded during any of the three years reported in these consolidated financial statements.
Leases
We determine if an arrangement contains a lease at inception. Operating leases are included in our operating lease right-of-use ('ROU') assets, the current portion of operating lease liabilities, and the operating lease liabilities in our Consolidated Balance Sheets.
The ROU assets represent our right to control the use of an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and lease liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The operating lease ROU assets also include any prepaid lease payments made and exclude lease incentives. Lease expense is recognized on a straight-line basis over the lease term.
Many of our leases include both lease (e.g., fixed payments including rent, taxes, and insurance costs) and nonlease components (e.g., common-area or other maintenance costs) which are accounted for as a single lease component as we have elected the practical expedient to group lease and nonlease components for all leases. Our pick-up truck leases typically have a non-cancelable lease term of less than one year and therefore, we have elected the practical expedient to exclude these short-term leases from our ROU assets and lease liabilities.
Most leases include one or more options to renew. The exercise of lease renewal options is typically at our sole discretion; therefore, the majority of renewals to extend the lease terms are not included in our ROU assets and lease liabilities as they are not reasonably certain of exercise. We regularly evaluate the renewal options and when they are reasonably certain of exercise, we include the renewal period in our lease term.
As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the lease commencement date in determining the present value of the lease payments. We have a centrally managed treasury function; therefore, based on the applicable lease terms and the current economic environment, we apply a portfolio approach for determining the incremental borrowing rate.
Other Long-Lived Assets
Other assets consist of prepaid deposits, goodwill, and other definite-lived intangible assets. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is reviewed for impairment annually. The identifiable intangible assets are amortized on a straight-line basis over their estimated life.
Accounting Estimates
The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles ('GAAP') requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent liabilities. Actual results could differ from those estimates.
Insurance Reserves
We are self-insured for certain losses relating to workers' compensation, automobile, health, and general liability costs. Specific stop-loss coverage is provided for catastrophic claims in order to limit exposure to significant claims. Self-insurance liabilities are based on our estimate of reported claims and claims incurred but not yet reported.
Product Warranties
We offer a basic limited warranty for certain of our products. The specific terms and conditions of those warranties vary depending upon the product sold. We typically recoup these costs through product warranties we hold with the original equipment manufacturers. Our warranty expense has historically been minimal.
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Stock-Based Compensation
We estimate the value of stock option grants using a Black-Scholes valuation model. Stock-based compensation expense is recognized on a straight-line basis over the vesting period. Our stock-based compensation expense is recorded in operating and administrative expenses.
Income Taxes
We account for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
We recognize the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We record interest and penalties related to unrecognized tax benefits in income tax expense.
Earnings Per Share
Basic net earnings per share is calculated using net earnings available to common stockholders divided by the weighted average number of shares of common stock outstanding during the year. Diluted net earnings per share is similar to basic net earnings per share except that the weighted average number of shares of common stock outstanding includes the incremental shares assumed to be issued upon the exercise of stock options considered to be 'in-the-money' (i.e., when the market price of our stock is greater than the exercise price of our outstanding stock options).
Segment Reporting
We have determined that for our North American regions we meet the aggregation criteria outlined in the accounting standards as these regions have similar: (1) economic characteristics, (2) products and services, (3) customers, (4) distribution channels, and (5) regulatory environments. Considering the insignificance of our operations outside of North America, we report as a single business segment.
Impact of COVID-19
The COVID-19 pandemic has impacted and could further impact our operations and the operations of our suppliers and customers as a result of quarantines, facility closures, and travel and logistics restrictions. We recently experienced an increase in sales volume of safety related products. However, we may realize lower product margins as well as inventory write-downs as a result of the improved supply and the potential inability to sell excess safety related products ordered from suppliers. The extent to which the COVID-19 pandemic impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to the duration, spread, severity, and impact of the COVID-19 pandemic, the effects of the COVID-19 pandemic on our customers and suppliers, and the remedial actions and stimulus measures adopted by local and federal governments, and to what extent normal economic and operating conditions can resume. Therefore, we cannot reasonably estimate the impact at this time.
Stock Split
On April 17, 2019, the board of directors approved a two-for-one stock split of the company's outstanding common stock. Holders of the company's common stock, par value $0.01 per share, at the close of business on May 2, 2019, received one additional share of common stock for every share of common stock they owned. The stock split took effect at the close of business on May 22, 2019. All historical common stock share and per share information for all periods presented in the accompanying consolidated financial statements and notes thereto have been retroactively adjusted to reflect the stock split.
Recently Adopted Accounting Pronouncements
Effective January 1, 2020, we adopted Financial Accounting Standard Board ('FASB') Accounting Standards Update ('ASU') 2016-13, Measurement of Credit Losses on Financial Instruments, which changed the way entities recognize impairment of most financial assets. Short-term and long-term financial assets, as defined by the standard, are impacted by immediate
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recognition of estimated credit losses in the financial statements, reflecting the net amount expected to be collected. The adoption of this standard had an immaterial impact on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which provides guidance to assist entities in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 requires that, to be a business, an acquired set of assets and activities must include, at a minimum, an input and a substantive process that together significantly contributes to the ability to create outputs. The company adopted this guidance during the first quarter of 2020 when evaluating the transaction discussed further in Note 2, 'Asset Acquisition'.
Recently Issued Accounting Pronouncements
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides temporary optional expedients and exceptions to U.S. GAAP on contract modifications, hedging relationships, and other transactions affected by reference rate reform to ease entities financial reporting burdens as the market transitions from the London Interbank Offered Rate ('LIBOR') and other interbank offered rates to alternative reference rates. The guidance was effective upon issuance and may be applied prospectively to contract modifications made, hedging relationships entered into, and other transactions affected by reference rate reform, evaluated on or before December 31, 2022, beginning during the reporting period in which the guidance has been elected. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Note 2. Asset Acquisition
On March 30, 2020, we purchased certain assets of Apex Industrial Technologies LLC ('Apex') that have contributed to the development, design, and scalability of the vending delivery platform utilized since 2008 within our industrial vending business to dispense product and lease devices to our customers. In connection with this transaction, we purchased a perpetual and unfettered use of key patents, designs, software and licenses, as well as direct access to the vending equipment supply chain.
The total purchase price of the assets acquired consisted of $125.0. The majority of this was paid in cash at closing, though a small portion of the purchase price is held in escrow with final payment dependent on certain performance obligations of the seller. We funded the purchase price with available cash and proceeds from borrowings on our unsecured revolving credit facility. We accounted for the purchase as an asset acquisition as substantially all of the fair value of the gross assets acquired is concentrated in the identifiable intangible assets used in the vending delivery platform for our industrial vending business. On a relative fair value basis, the allocated identifiable intangible assets total $123.8 and tangible property and equipment total $1.2. The weighted average amortization period of the identifiable intangible assets is approximately 19.4 years.
Note 3. Revenue
Disaggregation of Revenue
The accounting policies of the operations in the various geographic areas are the same as those described in the summary of significant accounting policies. Revenues are attributed to countries based on the selling location from which the sale occurred. During 2020, we had a single customer that represented 5% of our consolidated net sales, whereas all remaining customers fell below that threshold. During both 2019 and 2018, no single customer represented 5% or more of our consolidated net sales.
Our revenues related to the following geographic areas were as follows for the periods ended December 31:
Twelve-month period
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The percentages of our sales by end market were as follows for the periods ended December 31:
Twelve-month period
Non-residential construction 11.3 % 12.9 % 13.1 %
The percentages of our sales by product line were as follows for the periods ended December 31:
Twelve-month Period
(1) The fastener product line represents fasteners and miscellaneous supplies.
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Note 4. Long-Lived Assets
The accounting policies of the operations in the various geographic areas are the same as those described in the summary of significant accounting policies. Long-lived assets consist of net property and equipment, operating lease right-of-use assets, deposits, goodwill, and other net intangibles.
Property and equipment at year end consisted of the following:
Automated distribution and warehouse equipment 5 to 30 254.7 244.5
Shelving, industrial vending, and equipment 3 to 10 1,141.3 1,036.2
Transportation equipment 3 to 5 87.3 88.7
Construction in progress — 99.0 132.0
Less accumulated depreciation (1,053.9) (943.7)
Our long-lived assets related to the following geographic areas at year end:
Note 5. Accrued Expenses
Accrued expenses at year end consisted of the following:
Employee payroll and related taxes $ 60.3 (1) 28.7
Employee bonuses and commissions 22.3 17.9
Profit sharing contribution 16.2 13.8
Customer promotions and marketing 57.9 52.2
(1) Includes the deferral of $30.0 in payroll taxes resulting from the CARES Act in 2020.
Note 6. Stockholders' Equity
Dividends
On January 19, 2021, our board of directors declared a quarterly dividend of $0.28 per share of common stock to be paid in cash on March 3, 2021 to shareholders of record at the close of business on February 3, 2021. We paid aggregate annual cash dividends per share of $1.40, $0.87, and $0.77 in 2020, 2019, and 2018, respectively.
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Stock Options
Effective January 4, 2021, the compensation committee of our board of directors granted to our employees options to purchase a total of714,867 shares of our common stock at an exercise strike price of $48.00 per share. The closing stock price on the effective date of the grant was $47.65 per share. On the same date, certain of our non-employee directors elected to forgo all or a portion of the 2021 annual cash retainer in exchange for options to acquire a total of 26,643 shares of our common stock at an exercise price of $48.00 per share.
The following tables summarize the details of options granted under our stock option plans that were still outstanding as of December 31, 2020, and the assumptions used to value those grants. All such grants were effective at the close of business on the date of grant.
Date of Grant OptionsOutstanding OptionsExercisable
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 ten 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.
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A summary of activities under our stock option plans consisted of the following:
OptionsOutstanding ExercisePrice(1) RemainingLife(2)
OptionsOutstanding ExercisePrice(1) RemainingLife(2)
(1) Weighted average exercise price.
(2) Weighted average remaining contractual life in years.
The total intrinsic value of stock options exercised during the years ended December 31, 2020, 2019, and 2018 was $26.7, $20.2, and $4.2, respectively. The intrinsic value represents the difference between the exercise price and fair value of the underlying shares at the date of exercise.
At December 31, 2020, there was $12.6 of total unrecognized stock-based compensation expense related to outstanding unvested stock options granted under the employee stock option plan. This expense is expected to be recognized over a weighted average period of 3.87 years. Any future change in estimated forfeitures will impact this amount. The total grant date fair value of stock options vested under our employee stock option plan during 2020, 2019, and 2018 was $6.1, $5.9, and $5.3, respectively.
Total stock-based compensation expense related to our employee stock option plan was $5.7, $5.7, and $5.1 for 2020, 2019, and 2018, respectively.
Shares Outstanding
Shares of common stock outstanding were as follows:
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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:
Weighted average exercise prices of options $ 38.00 — 27.51
Any dilutive impact summarized above related to periods when the average market price of our stock exceeded the exercise price of the potentially dilutive stock options then outstanding.
Note 7. Retirement Savings Plan
The Fastenal Company and Subsidiaries 401(k) and Employee Stock Ownership Plan covers all of our employees in the United States. Our employees in Canada may participate in a Registered Retirement Savings Plan. The general purpose of both of these plans is to provide additional financial security during retirement by providing employees with an incentive to make regular savings contributions. In addition to the participation of our employees, we make annual profit sharing contributions based on an established formula. The expense recorded under this profit sharing formula was approximately $16.2, $13.8, and $13.0 for 2020, 2019, and 2018, respectively.
Note 8. Income Taxes
Earnings before income taxes were derived from the following sources:
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Components of income tax expense (benefit) were as follows:
2020: Current Deferred Total
2019: Current Deferred Total
2018: Current Deferred Total
Income tax expense in the accompanying consolidated financial statements differed from the expected expense as follows:
U.S. federal statutory income tax rate 21.0 % 21.0 % 21.0 %
U.S. federal income tax expense at statutory rate $ 237.9 219.2 207.3
Increase (decrease) attributed to:
State income taxes, net of federal benefit 36.3 32.8 30.2
Transition tax — — 1.2
Remeasurement of deferred taxes for Tax Act — — (11.5)
Effective income tax rate 24.2 % 24.2 % 23.8 %
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The tax effects of temporary differences that give rise to deferred income tax assets and liabilities at year end consisted of the following:
Deferred income tax assets (liabilities):
Inventory costing and valuation methods $ 5.3 4.3
Allowance for credit losses 3.1 2.7
Insurance reserves 9.1 9.1
Customer promotions 2.4 1.9
Stock-based compensation 3.3 3.9
Operating lease liabilities 62.1 62.5
Federal and state benefit of uncertain tax positions 0.8 0.8
Foreign net operating loss and credit carryforwards 1.9 3.2
Foreign valuation allowances (2.2) (2.8)
Other, net (0.3) (0.0)
Total deferred income tax assets 85.5 85.6
Operating lease ROU assets (61.4) (61.7)
Total deferred income tax liabilities (179.0) (176.4)
Deferred income tax liabilities $ (93.5) (90.8)
A reconciliation of the beginning and ending amount of total gross unrecognized tax benefits was as follows:
Balance at beginning of year: $ 8.6 5.3
Increase related to prior year tax positions 0.2 0.2
Decrease related to prior year tax positions (0.1) (0.2)
Increase related to current year tax positions 0.8 4.7
Decrease related to statute of limitation lapses (0.7) (1.4)
Settlements — —
Balance at end of year: $ 8.8 8.6
Included in the liability 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. The amount of gross unrecognized tax benefits that would favorably impact the effective tax rate, if recognized, is not material. We do not anticipate significant changes in total unrecognized tax benefits during the next twelve months. The 2020 and 2019 liability is included in deferred income taxes in the Consolidated Balance Sheets.
We file income tax returns in the United States federal jurisdiction, all states, and various local and foreign jurisdictions. We are no longer subject to income tax examinations by taxing authorities for taxable years before 2017 in the case of United States federal examinations, and with limited exception, before 2015 in the case of foreign, state, and local examinations. During 2020, there were no material changes in unrecognized tax benefits.
In general, it is our practice and intention to permanently reinvest the earnings of our foreign subsidiaries and repatriate earnings only when the tax impact is zero or very minimal. Accordingly, no deferred taxes have been provided for withholding taxes or other taxes that would result upon repatriation of our approximately $365.2 of undistributed earnings from foreign subsidiaries to the U.S. as those earnings continue to be permanently reinvested.
On December 22, 2017, the Tax Act was signed into law. The Tax Act made broad and complex changes to the U.S. tax code which include: a lowering of the U.S. federal corporate income tax rate from 35% to 21% effective January 1, 2018, accelerated expensing of qualified capital investments for a specific period, and a transition from a worldwide to a territorial tax system which requires companies to pay a one-time transition tax on certain unrepatriated earnings from foreign subsidiaries.
ASC 740 requires a company to record the effects of a tax law change in the period of enactment which, for us, was fiscal 2017.
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ASU 2018-05 provides guidance on the application of the Tax Act which includes allowing a company to record a provisional amount during the measurement period for the impacts when the necessary information is not available, prepared, or analyzed in reasonable detail to complete its accounting for the change in the tax law. The measurement period ends when the company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year.
The accounting for the income tax effects of the Tax Act was complete in 2018 when the final impact of the transition tax and impacts of accelerating depreciation for certain physical assets were recorded.
Note 9. Operating Leases
We lease space under non-cancelable operating leases for several distribution centers, several manufacturing locations, and certain branch locations. These leases do not have significant rent escalation holidays, concessions, leasehold improvement incentives, or other build-out clauses. Further, the leases do not contain contingent rent provisions. We also lease certain semi-tractors, pick-up trucks, and computer equipment under 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 was approximately $83.1. We believe the likelihood of funding the guarantee obligation under any provision of the operating lease agreements is remote.
The cost components of our operating leases were as follows for the periods ended December 31:
Variable lease costs are excluded from ROU assets and lease liabilities and consist primarily of taxes, insurance, and common area or other maintenance costs for our leased facilities and equipment which are paid based on actual costs incurred by the lessor as well as variable mileage costs related to our leased vehicles.
Maturities of our lease liabilities for all operating leases are as follows as of December 31, 2020:
Leased Facilities and Equipment Leased Vehicles Total
Less: Imputed interest (8.6) (0.5) (9.1)
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The weighted average remaining lease terms and discount rates for all of our operating leases were as follows for the periods ended December 31:
Remaining lease term and discount rate: 2020 2019
Weighted average remaining lease term (years)
Leased facilities and equipment 3.47 3.26
Weighted average discount rate
Lease facilities and equipment 2.37% 3.18%
Supplemental cash flow information related to our operating leases was as follows for the periods ended December 31:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash outflow from operating leases $ 115.8 117.2
Note 10. Debt Commitments
Credit Facility, Notes Payable, and Commitments
Debt obligations and letters of credit outstanding at year end consisted of the following:
Average Interest Rate at December 31, 2020 Debt Outstanding
Unsecured revolving credit facility 1.09 % November 30, 2023 $ — 210.0
Senior unsecured promissory notes payable, Series D 2.66 % May 15, 2025 75.0 —
Senior unsecured promissory notes payable, Series E 2.72 % May 15, 2027 50.0 —
Senior unsecured promissory notes payable, Series F 1.69 % June 24, 2023 70.0 —
Senior unsecured promissory notes payable, Series G 2.13 % June 24, 2026 25.0 —
Senior unsecured promissory notes payable, Series H 2.50 % June 24, 2030 50.0 —
Less: Current portion of debt (40.0) (3.0)
Unsecured Revolving Credit Facility
We have a $700.0 committed unsecured revolving credit facility ('Credit Facility'). The Credit Facility includes a committed letter of credit subfacility of $55.0. Any borrowings outstanding under the Credit Facility for which we have the ability and intent to pay using cash within the next twelve months, will be classified 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%. 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.
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Senior Unsecured Promissory Notes Payable
We have issued senior unsecured promissory notes under our master note agreement (the 'Master Note Agreement') in the aggregate principal amount of $405.0. Our aggregate borrowing capacity under the Master Note Agreement is $600.0; however, none of the institutional investors party to that agreement are committed to purchase notes thereunder. There is no amortization of these notes prior to their maturity date and interest is payable quarterly. The notes currently issued under our Master Note Agreement, including the maturity date and fixed interest rate per annum of each series of note, are contained in the table above. The Master Note Agreement contains certain financial and other covenants and we are in compliance with these covenants.
Principal payments required on our outstanding indebtedness, based on the maturity dates defined within our debt arrangements, for the succeeding five years, are displayed in the table below, as of December 31, 2020:
Principal Payments
Note 11. Legal Contingencies
We are involved in certain legal actions. The outcomes of these legal actions are not within our complete control and may not be known for prolonged periods of time. In some actions, the claimants seek damages, as well as other relief, that could require significant expenditures or result in lost revenues. We record a liability for these legal actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is reasonably possible but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded. As of December 31, 2020, there were no litigation matters that we consider to be probable or reasonably possible to have a material adverse outcome.
Note 12. Subsequent Events
We evaluated all subsequent event activity and concluded that no subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the Notes to Consolidated Financial Statements, with the exception of the dividend declaration and stock option activities disclosed in Note 6.
Note 13. Selected Quarterly Financial Data (Unaudited)
(Amounts in millions except per share information)
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(1) Amounts may not foot due to rounding difference.
***End of Notes to Consolidated Financial Statements***
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ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the 'Securities Exchange Act')). Based on this evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to our management, including the principal executive officer and principal financial officer, to allow for timely decisions regarding required disclosure.
Attestation Report of Independent Registered Public Accounting Firm
The attestation report required under this item is contained earlier in this Form 10-K under the heading 'Item 8, Financial Statements and Supplementary Data'.
Management's Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act. The company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The company's internal control over financial reporting includes those policies and procedures that:
(i)pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(ii)provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(iii)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision of our principal executive officer and our principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment and those criteria, management believes that the company maintained effective internal control over financial reporting as of December 31, 2020. There was no change in the company's internal control over financial reporting during the company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting.
/s/ Daniel L. Florness /s/ Holden Lewis
Daniel L. Florness Holden Lewis
Winona, Minnesota
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