Fastenal Company — Q3 2014 Form 10-Q Summary
Business context and reporting period
Fastenal distributes industrial and construction supplies through approximately 2,700 company-owned locations, primarily serving manufacturing and non-residential construction customers in North America. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $980.8 million | $858.4 million | $2.807 billion | $2.512 billion |
| Gross profit | $498.7 million | $443.4 million | $1.430 billion | $1.308 billion |
| Gross margin | 50.8% | 51.7% | 50.9% | 52.1% |
| Operating income | $212.9 million | $188.6 million | $598.6 million | $555.5 million |
| Operating margin | 21.7% | 22.0% | 21.3% | 22.1% |
| Net earnings | $133.3 million | $119.4 million | $375.8 million | $349.4 million |
| Diluted EPS | $0.45 | $0.40 | $1.26 | $1.17 |
Q3 net sales increased 14.3%, while nine-month sales increased 11.7%. Daily sales growth was also 14.3% in Q3 and 11.7% year to date. Manufacturing daily sales grew 13.7% in Q3, fastener sales grew 9.9%, non-fastener sales grew 17.6%, and non-residential construction sales grew 9.3%.
Net cash provided by operating activities was $110.0 million in Q3 and $332.9 million for the first nine months, equal to 82.5% and 88.6% of net earnings, respectively. Capital expenditures were $143.5 million year to date, primarily supporting industrial vending, distribution automation, information systems, vehicles, stores, and manufacturing and warehouse equipment.
Cash and cash equivalents totaled $116.3 million at September 30, 2014, versus $58.5 million at December 31, 2013. The company had $105.0 million outstanding under its $230.0 million unsecured revolving credit facility, with $34.4 million of undrawn letters of credit. Management stated that it intended to repay the debt with cash within twelve months and was in compliance with its covenants.
Material changes versus the prior comparable period
- Sales growth accelerated materially from 2013, supported by higher unit sales, stronger older-store performance, and improved manufacturing and construction activity.
- Gross margin declined 90 basis points in Q3 and 120 basis points for the first nine months, primarily because of product and customer mix, pricing effects, and the emphasis on increasing average store sales.
- Operating and administrative expenses increased 12.2% in Q3 and 10.5% year to date, but declined as a percentage of sales in Q3 to 29.2% from 29.7%.
- Employee-related expenses, selling transportation costs, industrial vending investment, distribution infrastructure spending, and costs associated with store closures increased operating expenses.
- Operational working capital increased 12.3% year over year to $1.359 billion, including accounts receivable up 15.1% and inventories up 10.6%.
- The company closed approximately 40 stores during Q3 and planned to close an additional group of underperforming or overlapping locations. Management expected to retain most related sales through nearby stores; the associated lease-commitment expense was not material.
- Industrial vending installations increased to 45,596 devices at quarter end from 39,180 a year earlier. Customers using industrial vending represented 37.8% of Q3 sales, compared with 33.3% in Q3 2013.
- The company paid $0.25 per share in each of the first three quarters and declared a $0.25 fourth-quarter dividend payable November 21, 2014. It repurchased 600,000 shares during the first nine months at an average price of approximately $44.50 per share.
Guidance, outlook, commentary, risks, and unusual items
Management expected to open approximately 25 to 30 stores during 2014, after opening 22 through the first nine months. It also expected short-term borrowings to continue funding some capital expenditures and dividends through the remainder of 2014 and possibly 2015.
Management described sales trends as improving since late 2013, with particular improvement in light and medium-duty manufacturing and stabilization in heavy machinery markets. Severe winter weather had negatively affected early 2014 results, while foreign currency movements, primarily the Canadian dollar, reduced first-nine-month growth by approximately 0.4 percentage points.
Key risks include economic weakness in manufacturing and commercial construction, pricing pressure and product-mix changes, foreign exchange, fuel and steel costs, weather, inventory and receivable management, execution of the industrial vending rollout, competition and customer adoption of vending technology, hiring and retention of personnel, cybersecurity, product liability, and the ability to control operating expenses.
The company reported no litigation matters considered probable or reasonably possible to have a material adverse outcome. It had approximately $56.0 million of vehicle lease residual-value guarantees, although management considered funding under those guarantees remote. The company was evaluating ASU 2014-09, Revenue from Contracts with Customers, effective January 1, 2017, and had not selected a transition method or determined its impact.
Important facts for investors to verify
- Whether sales growth can persist while gross margin remains below management's stated normal range of approximately 51% to 52%.
- The effect of store closures and consolidation on retained sales, lease obligations, employee costs, and future store productivity.
- Whether industrial vending growth and installation quality justify the related capital and occupancy investments.
- Working-capital efficiency, particularly the growth of receivables and inventories relative to sales.
- Repayment timing for the $105.0 million revolving-credit balance and the effect of continued dividends, buybacks, and capital expenditures on liquidity.
- Exposure to manufacturing and non-residential construction cycles, foreign currency movements, fuel and steel pricing, and severe weather.
- The eventual accounting and disclosure effects of the new revenue-recognition standard.