Fastenal Company 10-Q Summary
Business Context and Reporting Period
Fastenal distributes industrial and construction supplies through more than 2,500 company-owned stores, primarily serving manufacturing, maintenance and repair, non-residential construction, government and other commercial customers. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2011, compared with the corresponding 2010 periods.
The company completed a two-for-one stock split effective May 20, 2011; historical share and per-share amounts were adjusted accordingly.
Key Financial Metrics
| Metric | Six Months 2011 | Six Months 2010 | Three Months 2011 | Three Months 2010 |
|---|---|---|---|---|
| Net sales | $1,342.3 million | $1,092.0 million | $701.7 million | $571.2 million |
| Gross profit | $699.6 million | $563.6 million | $366.2 million | $297.7 million |
| Gross margin | 52.1% | 51.6% | 52.2% | 52.1% |
| Operating income | $278.8 million | $202.3 million | $150.1 million | $111.8 million |
| Operating margin | 20.8% | 18.5% | 21.4% | 19.6% |
| Net earnings | $173.7 million | $125.2 million | $94.1 million | $69.2 million |
| Diluted EPS | $0.59 | $0.42 | $0.32 | $0.23 |
| Operating cash flow | $101.3 million | $119.5 million | $27.0 million | Not separately provided |
Six-month sales increased 22.9% and second-quarter sales increased 22.9%. Net earnings increased approximately 38.7% for the six months and 36.1% for the quarter. The effective income tax rate was approximately 37.3% in the second quarter versus 38.3% in the prior-year quarter; management estimated a 37.9% rate for the second half of 2011, absent discrete events.
At June 30, 2011, cash and cash equivalents were $89.4 million, marketable securities were $26.2 million and total current assets were $1.172 billion. Current liabilities were $204.4 million and stockholders’ equity was $1.354 billion. Fastenal reported no borrowings outstanding under its $8 million line of credit, which was scheduled to expire August 26, 2011. The filing does not identify other debt.
Six-month capital expenditures were $56.3 million, compared with $32.2 million in 2010. Free cash flow, defined by management as operating cash flow less net capital expenditures, was approximately $44.9 million before proceeds from asset sales. Cash dividends paid were $112.0 million, up 90.0% from the prior-year period. Approximately $16.0 million of property and equipment commitments remained outstanding at June 30, 2011.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven primarily by higher unit volume, stronger older-store sales, store additions and a stronger Canadian dollar. Inflationary pricing had a limited effect on sales growth.
- Daily sales at stores open more than two years increased 19.4% in the second quarter and 18.7% for the first six months. Manufacturing customer sales increased 18.5% in the second quarter, while non-residential construction sales increased 15.8%.
- Gross margin improved modestly, reflecting better organizational gross profit and vendor volume allowances. Industrial production growth continued to shift mix toward a lower-margin business, although management stated that operating income performance was similar because related operating expenses were lower.
- Operating and administrative expenses declined to 30.8% of sales in the second quarter from 32.5% in the prior-year quarter, supporting operating-margin expansion. Payroll, transportation and fuel costs increased with higher activity and fuel prices.
- Accounts receivable increased 27.2% year over year to $357.2 million, and inventories increased 16.6% to $608.7 million. Management attributed the working-capital expansion to sales growth, large-account and international growth, store openings, product expansion and some inflation.
- Operating cash flow declined despite higher earnings because of increased investments in receivables and inventory. Investing cash use increased primarily due to higher capital expenditures.
- The company opened 75 stores and closed seven during the first half of 2011. Management’s stated full-year target was 150 to 200 new stores.
- Industrial vending activity expanded significantly: 2,103 machines were included in contracts signed during the second quarter, and cumulative installed machines reached 4,009 at quarter-end.
Guidance, Outlook, Risks and Unusual Items
- Management continued to pursue its “pathway to profit” strategy, emphasizing sales personnel, store growth, higher average store sales and industrial vending. It revised its profitability framework and believed a 23% pre-tax earnings margin could be achieved with average store sales of approximately $100,000 to $110,000 per month by 2013.
- Management expected to fund expansion primarily through operating cash flow and available cash, with borrowing capacity as a secondary source. The board indicated an intention to continue quarterly dividends, subject to future financial needs and other relevant factors.
- Key risks include economic weakness, volatility in manufacturing and commercial construction, steel and fuel-price inflation, foreign currency movements, working-capital requirements, recruitment and retention of sales personnel, execution of store expansion and industrial vending adoption.
- A California fastener supplier filed an Arkansas federal lawsuit alleging violation of an exclusive distribution arrangement and claimed alleged damages of $180 million. Fastenal stated that the prospect of material liability was remote. A trial was scheduled for November 21, 2011; a summary judgment motion remained pending.
- Unrecognized tax benefits were $4.3 million at June 30, 2011, and management did not anticipate a significant change over the following 12 months. The company also recorded a $1.1 million loss-on-disposal reserve related to pickup-truck operating leases.
- The board declared a $0.13-per-share dividend on July 11, 2011, payable August 22, 2011. The company reported effective disclosure controls and no material change in internal control over financial reporting.
Investor Verification Checklist
- Verify whether sales growth and strong same-store trends were sustained after June 30, 2011, particularly in manufacturing and non-residential construction.
- Monitor inventory and receivables growth relative to sales, cash conversion and free cash flow.
- Assess the effect of steel, diesel and gasoline inflation on gross margins and operating expenses.
- Track execution against the 150-to-200-store opening target and the profitability objectives under the pathway-to-profit strategy.
- Evaluate industrial vending contract growth, installation rates and the contribution of vending customers to total sales.
- Review the status and potential financial exposure of the $180 million litigation claim.
- Confirm the status of the $8 million credit line after its scheduled August 26, 2011 expiration and the company’s ongoing dividend capacity.