Fastenal Company — Q3 2011 Form 10-Q Summary
Business context and reporting period
Fastenal is a North American distributor of industrial and construction supplies operating through more than 2,500 company-owned stores. Its primary end markets are manufacturing and non-residential construction. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2011, compared with the corresponding 2010 periods.
All historical share and per-share data reflect the two-for-one stock split effective May 20, 2011.
Financial performance and liquidity
| Metric | Three months ended Sept. 30 | Year-over-year change | Nine months ended Sept. 30 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $726.7 million | 20.4% | $2.069 billion | 22.0% |
| Gross profit | $377.4 million | 20.7% | $1.077 billion | 22.9% |
| Gross margin | 51.9% | Up 0.1 percentage points | 52.1% | Up 0.4 percentage points |
| Operating income | $155.2 million | 28.8% | $434.0 million | 34.4% |
| Operating margin | 21.4% | Up 1.4 percentage points | 21.0% | Up 1.9 percentage points |
| Net earnings | $96.8 million | 29.1% | $270.5 million | 35.1% |
| Diluted EPS | $0.33 | Up $0.08 | $0.91 | Up $0.23 |
Operating and administrative expenses were 30.6% of sales in the quarter and 31.1% for the first nine months, compared with 31.8% and 32.6%, respectively, in 2010. Management attributed margin improvement to recovering transactional, organizational, and vendor-incentive gross profit, partially offset by a lower-margin mix from strong industrial production sales.
Nine-month operating cash flow was $194.2 million versus $166.3 million in 2010. Capital expenditures were $92.5 million, producing approximate free cash flow of $101.7 million before other investing items. Dividends paid were $150.4 million, and cash decreased by $32.6 million to $111.0 million. Marketable securities totaled $26.2 million.
At September 30, 2011, total assets were $1.651 billion and stockholders’ equity was $1.409 billion. Current assets were $1.217 billion versus current liabilities of $218.9 million, implying a current ratio of approximately 5.6. The filing reports no outstanding borrowings under the company’s $8 million line of credit; the line expires August 4, 2012. The company stated that expansion plans would be funded primarily from operating cash flow and available cash, with borrowing capacity used to a lesser degree.
Material changes versus the prior comparable period
- Sales growth remained strong, driven primarily by higher unit sales at existing stores and, to a lesser extent, new stores. Inflationary pricing had a limited effect.
- Daily sales increased 18.8% in September 2011 versus September 2010. Nine-month daily sales increased 18.0% at stores open more than two years, 17.2% at stores open more than five years, and 14.9% at stores open more than ten years.
- Manufacturing-customer daily sales increased 18.3% in the third quarter, while non-residential construction-customer daily sales increased 15.8%.
- The fastener product line declined to 46.5% of quarterly sales from 49.2% in the prior-year quarter; other product lines increased to 53.5%.
- Store count increased to 2,566 from 2,453 a year earlier. The company opened 94 stores and closed 18 during the first nine months.
- Industrial vending expanded materially: cumulative machines installed reached 5,732 at September 30, versus 1,803 a year earlier. Customers using vending solutions represented 13.3% of third-quarter sales, compared with 6.4% in 2010.
- Accounts receivable increased 19.7% year over year to $361.1 million, while inventories increased 13.2% to $618.1 million. Management stated that inventory growth was below sales growth, improving inventory utilization.
- Capital expenditures more than doubled to $92.5 million from $42.6 million, primarily due to industrial vending, distribution-center expansion, information systems, fleet, stores, and manufacturing investments.
Guidance, outlook, risks, contingencies, and unusual items
- Management reduced its estimated 2011 new-store openings to 115–125, or approximately 4.6%–5.0%, from the previously indicated 150–200, citing a moderating Purchasing Managers Index and the success of industrial vending. Expected 2012 store growth was approximately 4.0%–6.0%.
- Management maintained a long-term objective of approximately 23% pretax earnings as a percentage of sales, but revised the expected average monthly store sales needed to reach that objective to approximately $100,000–$110,000 by 2013.
- Management estimated a 2011 effective income tax rate of approximately 37.9%, absent discrete events.
- Key operating risks include economic weakness, manufacturing and commercial-construction cycles, steel and fuel price inflation, foreign-currency movements, employee recruitment and retention, execution of the store and sales-force strategy, and adoption of vending technology.
- A California fastener supplier’s lawsuit alleged damages of $180 million. The court granted Fastenal’s second summary-judgment motion in full on August 24, 2011, but the supplier appealed on September 8, 2011. Management considered a material liability remote.
- The company declared a quarterly dividend of $0.14 per share on October 12, 2011, payable November 22, 2011. Future dividends remain subject to board approval and financial needs.
- Unrecognized tax benefits were $4.4 million at September 30, 2011; management did not expect a significant change over the next 12 months. An $0.8 million loss-on-disposal reserve related to pickup-truck operating leases was recorded.
Important facts for investors to verify
- Whether strong sales growth and existing-store productivity continued after the September 2011 quarter as manufacturing and construction indicators moderated.
- Whether gross-margin improvement can be sustained amid steel-price inflation, fuel costs, competitive pricing, and lower-margin industrial production sales.
- The returns and cash-flow impact of substantially higher capital expenditures, particularly for industrial vending and distribution infrastructure.
- Whether receivables and inventory continue to grow more slowly than sales and support the company’s working-capital objectives.
- The pace, economics, and customer adoption of industrial vending, including whether the reported sales growth translates into durable profitability.
- The outcome of the supplier litigation appeal and any potential effect on liabilities or earnings.
- Future dividend decisions, the company’s effective tax rate, and the availability of its unused credit facility.