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## 2004  $_{ }$ Management’s Discussion & Analysis of Financial Condition & Results of Operations 

(Dollar Amounts in Millions except Per Share Information and as Otherwise Noted) 

The decrease in the gross margin percent in 2003 resulted from several factors. The DIY Business operated at a lower gross margin, approximately 30%, so the sale of this business caused an improvement in the overall gross margin. This improvement was more than offset by (1) the influence of increases in sales to certain large accounts and to certain large one time sales, which were made at lower margins, (2) the influences of changes in product mix, and (3) the slowdown in the growth of inventories since May 2003, which also lowered the savings to Fastenal related to vendor incentive programs, including vendor freight allowances and rebates. 

## Operating and Administrative Expenses— 

Operating and administrative expenses as a percent of net sales was as follows: 

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The changes each year are primarily due to changes in payroll and related costs, changes in occupancy costs, and fluctuations in growth of net sales in store sites greater than five years old. The latter drives the Company’s ability to leverage its operating expenses. 

Payroll and related costs represent approximately 69%, 69%, and 71% of operating and administrative expenses in 2004, 2003, and 2002, respectively. In 2004 and 2003, payroll and related costs increased at a rate which was less than the rate of increase in net sales. 

The changes in payroll and related costs were due to the following increases (decreases) in the average number of employees: 

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The 2004 increase in the average number of support people was due to an increase in the overall store count and the increasing sales growth. The 2003 drop in the average number of support employees was amplified by two events: 

(1) the sale of the DIY Business, which resulted in a drop of approximately 194 employees (or 8.0%) and (2) tight management of employee head count. The 2002 increase in the average number of support employees was amplified by the DIY Business acquisition. 

In 2004, 2003, and 2002, the rate of increase in occupancy costs was greater than the rate of increase in net sales. Occupancy costs increased due to (1) a 16.7%, 12.4% and 14.0% increase in the number of store locations in 2004, 2003, and 2002, respectively, and (2) the upgrade of store locations in connection with the CSP initiative. 

The loss on sale of property and equipment in all years came primarily from the sale of used vehicles. The gain on sale of the DIY Business in 2002 of $5.9, before taxes, was from the sale of the business acquired in 2001. The extraordinary gain of $0.7, net of tax, in 2002 resulted from the negative goodwill recognized on the DIY Business acquisition. 

Net earnings— Net earnings, growth rates in net earnings, and net earnings per share (EPS), were as follows: 

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As indicated earlier, the net earnings in 2002 included a gain on disposal of the DIY business, before tax, of $5.9 and an extraordinary gain on acquisition, net of tax, of $0.7. The net earnings growth rate before the gain on disposal of the DIY Business and before the extraordinary gain on acquisition was 18.2% and 1.5% in 2003 and 2002, respectively. 

