Fastenal Company — Q2 2010 Form 10-Q Summary
Business context and reporting period
Fastenal distributes industrial and construction supplies through more than 2,400 company-owned stores, primarily serving manufacturing, maintenance and repair, construction, government and other commercial customers. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2010; dollar amounts are in thousands except per-share data.
Financial performance and position
| Metric | Six months 2010 | Six months 2009 | Three months 2010 | Three months 2009 |
|---|---|---|---|---|
| Net sales | $1,091,955 | $964,241 | $571,183 | $474,894 |
| Gross profit | $563,571 | $501,153 | $297,658 | $242,505 |
| Gross margin | 51.6% | 52.0% | 52.1% | 51.1% |
| Operating income | $202,272 | $148,349 | $111,836 | $69,938 |
| Operating margin | 18.5% | 15.4% | 19.6% | 14.7% |
| Net earnings | $125,201 | $92,232 | $69,167 | $43,538 |
| Net margin | 11.5% | 9.6% | 12.1% | 9.2% |
| Diluted EPS | $0.85 | $0.62 | $0.47 | $0.29 |
- Six-month sales increased 13.2%; second-quarter sales increased 20.3%. Growth was driven mainly by higher unit volume, improving older-store sales, the stronger Canadian dollar and the December 2009 Holo-Krome acquisition.
- Six-month operating income increased approximately 36%; second-quarter operating income increased approximately 60%. Operating and administrative expenses declined as a percentage of sales to 33.1% from 36.5% for the six months and to 32.5% from 36.2% for the quarter.
- Operating cash flow was $119,527 for the six months, down from $167,552 in 2009, primarily because sales growth increased working-capital requirements. Capital expenditures were $32,211, producing approximate free cash flow of $89,556 before asset-sale proceeds.
- Cash and cash equivalents were $196,392 at June 30, 2010, compared with $164,852 at December 31, 2009. Marketable securities totaled $29,661, including $24,464 current and $5,197 non-current.
- Current assets were $1,088,486 and current liabilities were $166,164, indicating substantial short-term liquidity. Stockholders’ equity was $1,258,869.
- No borrowings were outstanding under the company’s $8 million line of credit at June 30, 2010. The line expired July 20, 2010, and management expected to renew it.
- Accounts receivable increased 23.0% year over year to $280,823, while inventories increased 0.6% to $522,214. Management considered the $14 million year-to-date inventory increase disappointing relative to its goal of holding inventory flat in 2010.
- The company paid $58,972 in dividends during the first six months. The board declared a $0.42-per-share semiannual dividend payable September 3, 2010.
Material changes versus the prior comparable period
- Sales growth reflected recovery from the severe 2009 recession-related contraction. Daily sales for stores open more than two years grew 17.7% in the second quarter versus a 24.2% decline in the prior-year quarter.
- Manufacturing daily sales grew approximately 29.8% year over year in the second quarter; non-residential construction daily sales grew approximately 0.5% after declining 14.7% in the first quarter.
- Gross margin improved sequentially from 51.1% in the first quarter to 52.1% in the second quarter, supported by improved transactional and organizational gross profit and the recovery of vendor volume allowances. However, first-half gross margin remained below 2009.
- The company opened 45 stores and closed seven during the first six months, ending with 2,407 stores. Store FTE headcount was 7,118, down 1.2% year over year, while total average FTE headcount was 10,300, down 1.2%.
- Holo-Krome, acquired in December 2009, and foreign-currency translation contributed to reported sales growth. The company did not repurchase shares during the first half of 2010.
Guidance, outlook, commentary and risks
- Management planned to open 80 to 95 stores in the second half of 2010, equivalent to an annualized opening rate of approximately 6.8% to 8.0%, while continuing to rationalize certain locations.
- Management expected continued improvement in transactional and organizational gross profit, partly because 2010 was expected to have some inflation rather than the significant deflation experienced in 2009. This is not formal earnings guidance.
- The long-term “Pathway to Profit” strategy targets higher average sales per store, greater expense leverage and improved working-capital efficiency. Management stated that economic weakness could delay its $125,000 monthly average-store-sales goal by several years.
- Key operating risks include prolonged economic weakness, industrial production declines, construction softness, steel-price deflation or inflation, fuel costs, foreign exchange, inventory growth, labor costs and the ability to execute store and sales-force expansion.
- A California fastener supplier filed suit alleging breach of an exclusive distribution arrangement and reportedly asserted an alleged claim of $180 million. Fastenal believes material liability is remote and filed a motion to dismiss.
- The Department of Justice is investigating alleged pricing and product-requirement noncompliance under a discontinued GSA contract. The DOJ offered to resolve the matter for $9.5 million; Fastenal offered $750,000 and accrued that amount. The matter could involve settlement or litigation, including potential treble damages and penalties, although management does not expect a material adverse effect on financial position.
- Vehicle leases include residual-value guarantees totaling approximately $14,433 at expiration; management considered the likelihood of funding remote, except for a $1,517 disposal reserve.
Most important facts for investors to verify
- Whether the recovery in manufacturing and construction demand continued after June 2010 and translated into sustainable same-store sales growth.
- Whether gross-margin improvement persisted as steel prices, vendor allowances and competitive pricing changed.
- Whether inventory growth remained controlled while sales expanded and whether working-capital investment continued to suppress operating cash flow.
- The renewal and terms of the expired $8 million credit facility, despite the company’s substantial cash and securities balances.
- The ultimate resolution and potential exposure from the DOJ/GSA matter, including any settlement above the $750,000 accrued amount.
- Execution of the planned 80–95 second-half store openings and the effect of expansion on operating expenses, productivity and cash generation.