Fastenal Company — Q2 2013 Form 10-Q Summary
Business Context and Reporting Period
Fastenal distributes industrial and construction supplies through approximately 2,700 company-owned stores, strategic account locations, in-plant operations, manufacturing, and industrial vending solutions. Customers are concentrated in manufacturing and non-residential construction. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods.
Financial Performance and Liquidity
| Metric | Six months 2013 | Six months 2012 | Three months 2013 | Three months 2012 |
|---|---|---|---|---|
| Net sales | $1.654 billion | $1.574 billion | $847.6 million | $804.9 million |
| Net earnings | $230.1 million | $212.5 million | $121.0 million | $112.3 million |
| Diluted EPS | $0.77 | $0.72 | $0.41 | $0.38 |
| Gross margin | 52.3% | 51.4% | 52.2% | 51.6% |
| Operating margin | 22.2% | 21.6% | 22.7% | 22.2% |
| Operating cash flow | $213.9 million | $190.4 million | $53.6 million | Not provided in the filing text |
- Six-month sales increased 5.1%; second-quarter sales increased 5.3%. Management reported daily sales growth of 5.9% for the first half after adjusting for one fewer business day.
- Six-month net earnings rose 8.3% and second-quarter net earnings rose 7.7%. Diluted EPS increased 6.9% for the first half and 7.9% for the quarter.
- Operating cash flow represented 93.0% of first-half net earnings. Investing cash use was $89.7 million, including $92.6 million of property and equipment purchases. Financing cash use was $79.8 million, principally dividends of $89.0 million.
- Cash and cash equivalents were $122.9 million at June 30, 2013, versus $79.6 million at December 31, 2012. Marketable securities were $0.4 million.
- Accounts receivable were $436.5 million and inventories were $725.1 million at June 30, 2013. Combined operational working capital increased 9.3% year over year to $1.162 billion.
- There were no borrowings outstanding under the $125 million credit facility at June 30, 2013. One undrawn letter of credit totaled $29.25 million. The company briefly borrowed and repaid $30 million during the quarter.
- The effective income tax rate was approximately 37.4% for the first half of 2013, compared with 37.5% in the prior-year period.
Material Changes Versus the Prior Comparable Period
- Growth moderated materially from 2012, when first-half and second-quarter sales increased 17.2% and 14.7%, respectively. Store locations opened more than two years grew daily sales 4.2% in the first half and 3.6% in the second quarter, versus 14.5% and 11.8% in 2012.
- Fastener sales grew only 1.7% in the first quarter and 1.9% in the second quarter, while non-fastener sales grew 10.8% and 8.5%, respectively. Fasteners represented 43.1% of sales in 2013 versus 45.4% in the first half of 2012.
- Manufacturing customer daily sales growth slowed to 7.0% in the first quarter and 5.9% in the second quarter, compared with 20.3% and 15.8% in 2012. Non-residential construction growth slowed to 2.9% and 0.7%, compared with 17.1% and 12.7%.
- Gross margin improved year over year, but second-quarter margin declined sequentially from 52.3% in the first quarter to 52.2%. Management attributed the sequential decline to weaker transactional pricing discipline, fastener weakness, and construction weakness.
- Operating and administrative expenses increased 6.1% for the first half and 6.0% for the second quarter, outpacing sales growth in the quarter. Occupancy expense increased substantially, primarily because of industrial vending equipment, distribution infrastructure, and utilities.
- Capital expenditures increased to $92.6 million from $51.0 million, driven primarily by industrial vending and distribution automation.
- The company signed approximately 11,000 vending machines in the first half, 20% more than in the prior-year period, but deliberately slowed second-quarter installations to emphasize installation quality. Installed machines totaled 29,549 at quarter-end.
- No stock repurchases occurred during the first half. Stock option exercises generated $7.1 million of cash proceeds.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- Management expected to open approximately 55 to 80 stores in 2013, representing approximately 2.0% to 3.0% growth.
- Management described a normal gross margin range of 51% to 53% and continued to pursue its “pathway to profit” strategy. It believed a pre-tax earnings margin goal of approximately 23% could be achieved with average monthly store sales of approximately $100,000 to $110,000.
- Management planned continued investment in industrial vending, store-based inventory, fastener growth, under-performing locations, distribution automation, and a highly automated facility supporting vending replenishment.
- Key operating risks include weaker manufacturing or commercial construction activity, global and U.S. economic-policy uncertainty, poor weather, competitive pricing pressure, steel and fuel price volatility, foreign exchange movements, difficulty recruiting and retaining personnel, and slower adoption of industrial vending.
- The company identified potential risks to its industrial vending first-mover advantage from weaker customer adoption or competitors developing comparable platforms.
- Residual value guarantees on vehicle leases totaled approximately $52.4 million, although management considered the likelihood of funding the guarantees remote; a $73,000 disposal reserve was recorded.
- Unrecognized tax benefits totaled $7.7 million, and management did not expect a significant change during the next 12 months. No material litigation matters were considered probable or reasonably estimable.
- On July 9, 2013, the board declared a $0.25 per-share dividend payable August 23, 2013. The filing states that quarterly dividends were expected to continue, subject to future board determinations and the company’s financial needs.
Important Facts for Investors to Verify
- Whether the slowdown in fastener, manufacturing, and construction demand was temporary or persisted into subsequent quarters.
- Whether gross margins remained within the stated 51% to 53% range as pricing discipline, product mix, steel prices, and vendor incentives changed.
- Whether industrial vending generated sufficient incremental sales and returns to justify the increased occupancy expense and capital investment.
- Whether operating cash flow continued to fund capital expenditures, dividends, and store expansion without sustained reliance on borrowings.
- Whether receivable and inventory growth remained consistent with sales growth and did not create working-capital or obsolescence pressure.
- The pace and profitability of new store openings, distribution automation, and the planned vending-replenishment facility.
- Subsequent changes in economic conditions, fuel and steel prices, foreign exchange rates, tax matters, contingencies, and the company’s dividend policy.