Fastenal Company 2017 Q3 Form 10-Q Summary
Business Context and Reporting Period
Fastenal distributes industrial and construction supplies primarily through North American branches, Onsite locations, and industrial vending machines. The filing covers the unaudited quarter and nine months ended September 30, 2017, compared with the same periods in 2016. At September 30, 2017, the company had 2,418 public branches, 555 active Onsite locations, 69,058 installed industrial vending machines, and 20,242 total employees.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | Change |
|---|---|---|---|
| Net sales | $1,132.8 million | $1,013.1 million | 11.8% |
| Gross profit | $555.9 million | $499.8 million | 11.2% |
| Gross margin | 49.1% | 49.3% | Down 20 basis points |
| Operating income | $228.5 million | $202.9 million | 12.6% |
| Operating margin | 20.2% | 20.0% | Up 20 basis points |
| Net earnings | $143.1 million | $126.9 million | 12.7% |
| Diluted EPS | $0.50 | $0.44 | 13.6% |
| Metric | Nine Months 2017 | Nine Months 2016 | Change |
|---|---|---|---|
| Net sales | $3,302.0 million | $3,014.1 million | 9.6% |
| Operating income | $678.5 million | $613.3 million | 10.6% |
| Net earnings | $426.2 million | $384.6 million | 10.8% |
| Diluted EPS | $1.48 | $1.33 | 11.3% |
| Operating cash flow | $455.9 million | $386.9 million | 17.8% |
Nine-month gross margin was 49.4%, compared with 49.5% in 2016. Income tax rates were approximately 36.6% for the nine months and 36.7% for the quarter. Net interest expense increased to $6.2 million for the nine months and $2.5 million for the quarter, primarily because of higher average interest rates.
At September 30, 2017, cash and cash equivalents were $133.4 million, inventories were $1,047.0 million, and trade receivables were $632.1 million. Total debt was $440.0 million, including $300.0 million outstanding under the unsecured revolving credit facility. The company had a $700.0 million revolving facility, with $36.3 million of letters of credit outstanding, and was in compliance with its debt covenants.
Cash Flow, Capital Allocation, and Liquidity
- Operating cash flow was $455.9 million, equal to 107.0% of nine-month net earnings.
- Investing cash outflow was $138.2 million, including $82.7 million of property and equipment purchases and $58.7 million paid for the Mansco acquisition.
- Net capital expenditures were $76.5 million through nine months, down 51.4% from 2016. Management maintained its 2017 net capital expenditure expectation of approximately $127.0 million.
- Financing cash outflow was $301.2 million, including $277.1 million of dividends and $82.6 million of share repurchases, partly offset by $55.0 million of net debt proceeds.
- The company repurchased 1.9 million shares during the first nine months at an average price of approximately $43.43 per share. Remaining repurchase authorization was 4.4 million shares at September 30, 2017.
- The board declared a quarterly dividend of $0.32 per share payable November 22, 2017.
Material Changes Versus the Prior Comparable Period
- Sales growth accelerated substantially, supported by higher unit volumes, stronger manufacturing and construction demand, and growth initiatives. Price was not a material factor in the comparison.
- Third-quarter daily sales increased 13.6%; nine-month daily sales increased 10.1%.
- National account daily sales grew 17.3% in the quarter and 13.2% for the nine months.
- Active Onsite locations increased 47.6% year over year to 555, while installed vending machines increased 14.3% to 69,058.
- Public branches declined 5.0% year over year to 2,418 as the company opened five and closed 36 branches during the quarter.
- Operating expense leverage improved operating margin despite increased employee-related costs, health care costs, profit sharing, fuel expense, information technology spending, and the addition of Mansco personnel.
- Gross margin was pressured by product and customer mix, including relatively slower fastener growth, larger-customer pricing, lower-margin Mansco products, and hurricane-related disruptions.
- The March 31, 2017 acquisition of Manufacturers Supply Company contributed $40.4 million of nine-month sales and $4.6 million of net earnings. Total consideration, including estimated contingent consideration, was approximately $59.3 million.
- Total debt increased from $390.0 million at December 31, 2016 to $440.0 million, largely reflecting the $60.0 million Series C senior note issued to fund the Mansco acquisition.
Outlook, Commentary, Risks, and Unusual Items
Management attributed the stronger results to improved underlying market demand, higher fastener and non-fastener unit sales, and continued execution of national account, Onsite, and vending initiatives. The filing does not provide formal revenue or earnings guidance. It does state that 2017 net capital expenditures were expected to be approximately $127.0 million.
The company expects no material impact from adopting the revenue recognition standard in January 2018, although it was still evaluating the transition method and disclosure requirements. Adoption of the lease standard in January 2019 is expected to materially increase recorded assets and liabilities.
Key risks include economic weakness, reduced manufacturing or commercial construction demand, competitive pricing, product and customer mix changes, steel and energy price volatility, interest-rate increases, foreign currency movements, weather disruptions, execution and acceptance of vending and Onsite models, employee retention, inventory and receivables management, cybersecurity, technology and software dependencies, and product liability. A 1% increase in LIBOR would have increased estimated nine-month 2017 interest expense by approximately $2.1 million.
The filing states that no litigation matters were considered probable or reasonably possible to have a material adverse outcome. A contingent consideration obligation related to Mansco had a September 30, 2017 fair value of $0.6 million and could require payments of up to $2.5 million based on sales growth.
Important Facts for Investors to Verify
- Whether elevated sales growth persists after the favorable demand comparison and Mansco contribution.
- Whether product, customer, and acquisition mix continues to pressure gross margin.
- The conversion of Onsite locations and vending installations into sustainable revenue and return on invested capital.
- Working-capital requirements, particularly the growth of receivables and inventories relative to sales.
- Debt repayment plans, floating-rate exposure, and liquidity under the $700.0 million revolving facility.
- Actual 2017 capital expenditures versus the approximately $127.0 million expectation.
- The effect of the 2018 revenue standard and 2019 lease standard on disclosures, assets, liabilities, and reported results.
- Exposure to manufacturing and construction cycles, steel and fuel costs, weather events, cybersecurity, and execution risks.