Fastenal Company — Q1 2018 Form 10-Q Summary
Business context and reporting period
Fastenal is a North American wholesale distributor of industrial and construction supplies, serving primarily manufacturing and non-residential construction customers through approximately 3,000 in-market locations. This unaudited Form 10-Q covers the three months ended March 31, 2018, with comparison to the three months ended March 31, 2017.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $1,185.8 million | $1,047.7 million | 13.2% increase |
| Gross profit | $577.6 million | $518.0 million | 11.5% increase |
| Gross margin | 48.7% | 49.4% | 70 basis-point decline |
| Operating income | $234.5 million | $212.5 million | 10.4% increase |
| Operating margin | 19.8% | 20.3% | 50 basis-point decline |
| Net earnings | $174.3 million | $134.2 million | 29.9% increase |
| Diluted EPS | $0.61 | $0.46 | 21.7% increase |
| Cash flow from operations | $159.7 million | $210.4 million | 24.1% decrease |
| Capital expenditures, net | $28.8 million | Approximately $19.1 million | 50.8% increase |
Net earnings benefited from the Tax Cuts and Jobs Act. Management estimates that the lower tax rate increased Q1 2018 EPS by approximately $0.10. The effective tax rate was 24.8%, compared with 36.4% in Q1 2017; excluding the Tax Act, management estimates the Q1 2018 rate would have been approximately 36.6%.
Cash and cash equivalents were $137.1 million at March 31, 2018, compared with $116.9 million at December 31, 2017. Total debt was $405.0 million, including $270.0 million outstanding under a $700.0 million unsecured revolving credit facility. The company was in compliance with its debt covenants. Letters of credit outstanding totaled $36.3 million.
Operating cash flow declined primarily because of increased accounts receivable and inventory. At March 31, 2018, net accounts receivable totaled $688.6 million and inventories totaled $1,134.9 million, increases of 19.8% and 12.7%, respectively, from March 31, 2017. The company paid $106.4 million in dividends during the quarter and declared a quarterly dividend of $0.37 per share payable May 23, 2018.
Material changes versus the prior comparable period
- Sales growth was driven primarily by higher unit sales, supported by stronger market demand and growth initiatives, with pricing contributing approximately 50 to 100 basis points of sales growth.
- Fastener daily sales increased 11.8%, while non-fastener daily sales increased 14.5%. Fasteners represented 35.0% of sales versus 35.6% in the prior-year quarter.
- Gross margin contracted because of product and customer mix, the lower-margin contribution of the Mansco acquisition, and higher transportation costs.
- Operating and administrative expenses improved to 28.9% of sales from 29.2%, despite higher employee, occupancy, transportation, technology, and Mansco-related expenses.
- Net interest expense increased to $2.7 million from $1.7 million, primarily because of higher average interest rates and a slightly higher average debt balance.
- The company signed 36 new national account contracts, 100 new Onsite locations, and 5,679 industrial vending devices. Active Onsite locations increased 55.1% year over year to 678, and installed industrial vending devices increased 14.2% to 73,561.
- The company closed 49 branches and opened no branches during the quarter. Public branch locations declined to 2,329 from 2,480 at March 31, 2017.
- Q1 2017 included a $57.9 million cash acquisition payment for Manufacturers Supply Company, while Q1 2018 had no acquisition cash payment.
Outlook, commentary, risks, and unusual items
Management stated that its 2018 net capital expenditure expectation remained approximately $149.0 million, primarily for hub-network capacity, distribution center improvements, equipment, and potential future expansion. The filing does not provide formal full-year revenue or earnings guidance.
Management described general business activity as favorable and cited an average first-quarter Purchasing Managers Index of 59.7 in 2018 versus 57.0 in 2017. Growth initiatives remain focused on national accounts, Onsite locations, industrial vending, and branch-network optimization.
The company adopted the new revenue recognition standard effective January 1, 2018, with no significant impact on results, cash flows, or financial position. Adoption of the Tax Act resulted in an estimated transition tax liability of approximately $7.9 million, including a $1.4 million discrete tax expense adjustment during the quarter. The company stated that additional IRS guidance could affect its estimates.
Key risks include economic weakness affecting manufacturing and commercial construction, competitive pricing pressure, product and customer mix changes, steel and energy cost inflation, transportation costs, foreign currency fluctuations, higher LIBOR, receivable collection and inventory forecasting, execution of vending and Onsite strategies, staffing, cybersecurity, defective products, and future tax-law changes. A one-percentage-point increase in LIBOR would have increased first-quarter interest expense by approximately $0.7 million.
The company expects adoption of the new lease accounting standard on January 1, 2019, to materially increase reported assets and liabilities. The filing states that no litigation matters were considered probable or reasonably possible to have a material adverse outcome as of March 31, 2018.
Important facts for investors to verify
- Whether sales growth and the expansion of Onsite and industrial vending locations continue without further gross-margin compression.
- Whether receivables and inventory growth normalize relative to sales and support improved operating cash flow.
- The final accounting effects of the Tax Act, including the estimated transition tax liability and deferred-tax measurements.
- Progress toward the approximately $149.0 million 2018 capital expenditure plan and its effect on liquidity.
- Exposure to LIBOR, fuel, steel, freight, and other commodity cost increases and the company’s ability to pass those costs to customers.
- The impact of the 2019 lease standard on reported assets, liabilities, and leverage metrics.
- Execution and profitability of the Mansco integration, branch closures, Onsite expansion, and industrial vending program.