Fastenal Company — Form 10-Q Summary
Business context and reporting period
Fastenal is a North American distributor of industrial and construction supplies, serving primarily manufacturing and non-residential construction customers through approximately 2,700 company-owned stores, strategic account locations, in-plant locations, and industrial vending solutions. This unaudited filing covers the three and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net sales | $949.9 million, up 12.1% | $1.826 billion, up 10.4% |
| Gross profit | $482.7 million; 50.8% margin | $931.1 million; 51.0% margin |
| Operating income | $206.8 million; 21.8% margin | $385.7 million; 21.1% margin |
| Net earnings | $130.5 million, up 7.9% | $242.4 million, up 5.4% |
| Diluted EPS | $0.44, versus $0.41 | $0.82, versus $0.77 |
| Operating cash flow | $79.6 million | $222.9 million, versus $213.9 million |
Six-month net earnings margin was approximately 13.3%, compared with 13.9% in 2013. Gross margin declined from 52.3% to 51.0%, while operating margin declined from 22.2% to 21.1%. Management stated that second-quarter gross margin was pressured by product mix, end-market mix, and an emphasis on sales growth.
At June 30, 2014, cash and cash equivalents were $105.9 million, accounts receivable were $502.3 million, and inventories were $818.8 million. Total assets were $2.283 billion and stockholders’ equity was $1.868 billion.
The company had $70.0 million outstanding under its $170.0 million unsecured revolving credit facility, with $34.4 million of undrawn letters of credit. Management intended to repay the debt with cash within twelve months. The facility expires December 13, 2015, and the company was in compliance with its financial covenants.
Capital expenditures were $97.6 million in the first six months, primarily supporting information systems, vehicles, stores, manufacturing and warehouse equipment, industrial vending, and distribution automation. Dividends paid were $148.4 million, and the company repurchased $8.8 million of common stock during the first quarter.
Material changes versus the prior comparable period
- Sales growth accelerated materially: second-quarter sales increased 12.1%, compared with 5.3% in the 2013 second quarter; six-month growth was 10.4%, compared with 5.1%.
- Net earnings growth lagged sales growth because of lower gross margin and higher operating expenses.
- Operating and administrative expenses increased 10.3% in the second quarter and 9.6% for the first six months, but declined as a percentage of sales to 29.1% and 29.9%, respectively.
- Employee-related expenses increased 12.2% in the second quarter and 9.3% for the first six months. Average full-time-equivalent headcount increased 15.0% year over year in the second quarter and 14.4% in the first half.
- Accounts receivable and inventories increased 15.1% and 12.9%, respectively, from June 30, 2013, causing operational working capital to rise 13.7% to $1.321 billion.
- The fastener product line represented 40.6% of second-quarter sales, down from 43.1% in 2013; non-fastener products represented 59.4%, up from 56.9%.
- Industrial vending continued to expand. Installed devices increased to 43,761 at June 30, 2014, from 36,452 a year earlier, while 37.0% of second-quarter sales were to customers using an industrial vending solution, versus 30.0% in 2013.
- Foreign currency movements, primarily the Canadian dollar, reduced first-half sales growth by approximately 0.5 percentage points.
Guidance, outlook, commentary, risks, and unusual items
Management expected to open approximately 35 to 40 stores during 2014. It opened 17 stores during the first six months, closed 20 stores, and identified an additional 45 stores for closure during the second half. Most identified closures were near another Fastenal location; the company expected to retain most associated sales. An accrual for future commitments related to the identified closures was recorded in the second quarter and was not material.
Management described business momentum as improving during 2014. June daily sales growth was 12.7% overall, 11.4% at stores open more than two years, and 10.8% at stores open more than five years. Manufacturing, fasteners, non-fasteners, and non-residential construction all showed improved year-over-year trends during the second quarter.
Management expected short-term borrowings to support capital expenditures and dividends through the remainder of 2014 and possibly 2015. It expected current expansion plans to be funded by operating cash flow, cash on hand, and borrowing capacity.
Key risks include economic weakness in manufacturing and commercial construction, competitive pricing pressure, product and customer mix changes, fuel and steel price volatility, foreign currency fluctuations, severe weather, receivables and inventory management, hiring and retention of personnel, industrial vending adoption and execution, store-opening performance, cybersecurity, defective products, and changes in tax or real-estate conditions.
No litigation matters were considered probable or reasonably possible to have a material adverse outcome. The company reported no material change in risk factors or internal control over financial reporting. The company was evaluating the impact and transition method for the new revenue recognition standard, effective January 1, 2017.
On July 10, 2014, the board declared a $0.25-per-share dividend payable August 22, 2014. Management stated 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 sales growth can continue without further deterioration in gross margin or operating leverage.
- The conversion of strong earnings into cash as receivables, inventories, capital expenditures, dividends, and store investments continue to grow.
- The repayment timing and future use of the $70.0 million revolving credit balance.
- The financial and operational effects of closing 20 stores already closed and 45 additional stores identified for closure.
- Whether industrial vending growth produces expected revenue and profitability while installation, equipment, and personnel costs increase.
- Exposure to manufacturing and non-residential construction cycles, fuel and steel prices, foreign exchange, and severe weather.
- The eventual impact and transition method selected for ASU 2014-09, Revenue from Contracts with Customers.