Fastenal Company — Q3 2020 Form 10-Q Summary
Business context and reporting period
Fastenal is a North American wholesale distributor of industrial and construction supplies serving manufacturing, non-residential construction, government, healthcare, and other customers through branches, Onsite locations, and industrial vending devices. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods.
Results were materially influenced by COVID-19. Traditional manufacturing and construction demand remained below pre-pandemic levels, while demand for personal protective equipment, sanitizer, and other safety products remained elevated but moderated from the second quarter.
Financial performance and key metrics
| Metric | Q3 2020 | Q3 2019 | Change |
|---|---|---|---|
| Net sales | $1,413.3 million | $1,379.1 million | Up 2.5% |
| Gross profit | $640.6 million | $651.1 million | Down 1.6% |
| Gross margin | 45.3% | 47.2% | Down 190 bps |
| Operating income | $290.1 million | $281.9 million | Up 2.9% |
| Operating margin | 20.5% | 20.4% | Up 10 bps |
| Net earnings | $221.5 million | $213.5 million | Up 3.7% |
| Diluted EPS | $0.38 | $0.37 | Up 3.4% |
| Metric | Nine months 2020 | Nine months 2019 | Change |
|---|---|---|---|
| Net sales | $4,289.3 million | $4,056.8 million | Up 5.7% |
| Operating income | $877.4 million | $818.3 million | Up 7.2% |
| Net earnings | $663.0 million | $612.2 million | Up 8.3% |
| Diluted EPS | $1.15 | $1.07 | Up 8.0% |
| Gross margin | 45.4% | 47.3% | Down 190 bps |
Q3 daily sales increased 2.5%. Safety product sales remained elevated, while fastener daily sales declined 6.9%. For the first nine months, safety product daily sales increased 56.5%, while fastener daily sales declined 8.7%.
Sales mix shifted toward lower-margin products: safety supplies represented 23.8% of Q3 sales versus 18.2% in the prior-year quarter, while fasteners represented 30.5% versus 33.7%. Government customer sales represented 8.5% of nine-month sales versus 3.7% in 2019.
Operating and administrative expenses declined to 24.8% of Q3 sales from 26.8% in the prior-year quarter, reflecting headcount reductions, lower incentive compensation, reduced travel, lower transportation costs, and other expense controls. Total absolute employee headcount was 20,336 at September 30, down 7.3% from a year earlier.
Cash flow, liquidity, debt, and capital allocation
- Cash provided by operating activities was $780.8 million for the first nine months, compared with $590.3 million in 2019.
- Cash and cash equivalents were $331.8 million at September 30, 2020, compared with $174.9 million at December 31, 2019.
- Cash used in investing activities was $238.8 million, including $125.0 million for the Apex Industrial Technologies asset acquisition and $123.5 million of capital expenditures.
- Net capital expenditures were $114.9 million. Management maintained its 2020 net capital spending expectation of $155.0 million to $180.0 million.
- Total debt was $405.0 million, including $40.0 million classified as current. The company had substantially all of its $700.0 million unsecured revolving credit facility available and was in compliance with its covenants.
- The company paid $430.2 million in dividends and repurchased 1.6 million shares for $52.0 million during the first nine months. It had authorization to repurchase an additional 3.2 million shares at September 30.
- On October 12, 2020, the board declared a quarterly dividend of $0.25 per share, payable November 24, 2020.
Material changes versus the prior comparable period
- Revenue growth slowed to 2.5% in Q3 from 7.8% in Q3 2019, reflecting weak underlying industrial demand and moderating pandemic-related sales.
- Gross margin declined 190 basis points because of unfavorable product mix, lower margins on safety and pandemic-related products, reduced fixed-cost leverage, rebates, and import costs.
- Operating margin improved modestly because expense reductions more than offset the gross-margin pressure.
- Cash generation improved substantially, aided by higher earnings and lower working-capital requirements.
- The company acquired Apex assets for $125.0 million, including $123.8 million of identifiable intangible assets with an approximately 19.4-year weighted-average amortization period.
- In-market locations increased 1.5% from a year earlier to 3,269, driven by a 14.9% increase in active Onsite locations to 1,236, while public branches declined 5.3% to 2,033.
- Industrial vending devices increased 6.9% year over year to 94,395, but device signings declined 17.5% in Q3 and remained below pre-pandemic expectations.
Guidance, outlook, commentary, and risks
Management stated that economic activity improved gradually during Q3 but remained below pre-pandemic levels. The company withdrew its 2020 vending and Onsite signing goals in April and had not reinstated guidance as of the filing date. Management continued to view the long-term outlook for these growth initiatives favorably, but the timing of normalization remained uncertain.
Management expected an ongoing tax rate, absent discrete items, of approximately 24.5% to 25.0%. The 2020 net capital spending outlook remained $155.0 million to $180.0 million.
COVID-19 creates significant uncertainty regarding customer demand, supplier production, employee availability, logistics, receivable collections, branch operations, product mix, and margins. Favorable pandemic-related safety-product demand may not recur, while any renewed restrictions or economic weakness could adversely affect results and liquidity. Safety and sanitation products generally carry lower gross margins than fasteners, and a sustained mix shift could continue to pressure profitability.
Other disclosed risks include manufacturing and construction weakness, competitive pricing pressure, commodity and energy costs, foreign currency exposure, interest-rate changes, supply-chain disruption, inventory and receivable management, technology and cybersecurity risks, and execution risk in the vending and Onsite businesses. No litigation matters were considered probable or reasonably possible to have a material adverse outcome as of September 30, 2020. The company reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether manufacturing and construction demand continues to recover and whether pandemic-related safety-product demand remains elevated.
- Whether the product mix normalizes toward higher-margin fasteners and whether gross margin recovers from the 45.3% Q3 level.
- The sustainability of cost reductions and the effect of lower employee headcount on service levels and growth initiatives.
- Progress in industrial vending and Onsite signings, revenue per device or location, and the timing of reinstated operating targets.
- The contribution, amortization expense, and strategic benefits of the Apex asset acquisition.
- Actual 2020 capital spending relative to the $155.0 million to $180.0 million expectation.
- Liquidity and debt maturities, including the $40.0 million current debt portion and the July 2021 maturity of Series A notes.
- Potential effects of renewed COVID-19 restrictions, supply-chain disruptions, customer credit deterioration, and changes in government or healthcare demand.