Fastenal Company — 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 and non-residential construction customers in North America. This unaudited report covers the quarter and nine months ended September 30, 2010, compared with the corresponding 2009 periods.
Financial performance and liquidity
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Net sales | $603.8 million | $489.3 million | $1.696 billion | $1.454 billion |
| Gross profit | $312.6 million | $244.6 million | $876.2 million | $745.7 million |
| Gross margin | 51.8% | 50.0% | 51.7% | 51.3% |
| Operating income | $120.5 million | $76.4 million | $322.8 million | $224.8 million |
| Operating margin | 20.0% | 15.6% | 19.1% | 15.5% |
| Net earnings | $75.0 million | $47.6 million | $200.2 million | $139.8 million |
| Diluted EPS | $0.51 | $0.32 | $1.36 | $0.94 |
| Operating cash flow | $46.8 million | Not separately provided | $166.3 million | $253.2 million |
- Q3 sales increased 23.4%; nine-month sales increased 16.7%. Growth was primarily volume-driven, with approximately 0.8 percentage points of nine-month growth from the stronger Canadian dollar and approximately 0.5 percentage points from the Holo-Krome acquisition.
- Q3 net earnings rose 57.6%, while nine-month net earnings rose 43.2%. Diluted weighted-average shares declined to 147.4 million from 148.5 million.
- Operating cash flow for the first nine months declined 34.3% year over year, principally because sales growth increased accounts receivable and inventory requirements. Year-to-date operating cash flow represented 83.1% of net earnings.
- Capital expenditures were $42.6 million during the first nine months, and net cash used in investing activities was $38.4 million. The filing does not present a separately labeled free-cash-flow figure.
- Cash and cash equivalents were $172.6 million at September 30, 2010, versus $164.9 million at December 31, 2009. Marketable securities totaled $29.8 million, including $24.6 million current and $5.2 million non-current.
- The filing reports no outstanding borrowings under the company’s $8 million line of credit at September 30, 2010. The filing does not identify material funded debt.
- Current assets were $1.117 billion and current liabilities were $177.1 million, indicating substantial reported liquidity. Accounts receivable were $301.7 million and inventories were $546.1 million at quarter-end.
- Dividends paid during the first nine months totaled $120.9 million, or 60.4% of net earnings. No share repurchases occurred during the period.
Material changes versus the prior comparable period
- Sales recovery accelerated across the business. Q3 daily sales at stores open more than two years increased 20.2%, compared with a 24.2% decline in Q3 2009.
- Manufacturing customer daily sales grew 30.6% in Q3, while non-residential construction customer daily sales grew 6.3%. Manufacturing represented approximately 50% of historical business, and construction approximately 20% to 25%.
- The gross margin improved 180 basis points in Q3 and 40 basis points for the nine-month period. Management attributed the recovery from 2009 partly to the end of deflationary effects, although Q3 margin was below Q2 because of a greater mix of lower-margin industrial production sales and limited inflation.
- Operating expenses declined as a percentage of sales to 31.8% in Q3 from 34.4% in the prior-year quarter. Employee-related expenses increased faster than sales, reflecting higher commissions, bonuses, hours worked, and profit sharing.
- Accounts receivable increased 26.1% year over year and inventory increased 9.6%. Inventory increased approximately $37 million during the first nine months, contrary to management’s original goal of holding inventory flat for 2010.
- The company ended Q3 with 2,453 stores, up 4.3% from Q3 2009. Average store FTE headcount increased 5.1% year over year to 7,450, and total average FTE headcount increased 6.4% to 10,822.
Guidance, outlook, commentary, risks, and unusual items
- Management intended to open 80 to 95 stores during the second half of 2010; 45 stores were opened in Q3, and the stated second-half target remained unchanged.
- The “pathway to profit” strategy emphasizes higher sales per store, selective store expansion, outside sales personnel, variable cost management, and improved working-capital efficiency. Management’s goal of approximately $125,000 in average monthly sales per store was expected to be delayed by approximately two years because of the economic downturn; Q3 average store sales were $71,600 per month.
- Management identified economic conditions, industrial production, construction activity, store-opening opportunities, steel-price inflation or deflation, fuel prices, employee costs, customer mix, inventory growth, and the ability to generate free cash flow as key variables affecting results.
- The Department of Justice was pursuing potential claims related to a discontinued 2000 GSA contract. The DOJ’s settlement offer was $8.5 million, while Fastenal had offered $2.75 million and accrued that amount. The matter could result in settlement or litigation seeking treble damages and penalties; an unfavorable outcome could exceed the recorded reserve.
- A California fastener supplier filed an Arkansas lawsuit alleging violation of an exclusive distribution arrangement and claimed alleged damages of $180 million. Fastenal’s motion to dismiss was denied, but management considered a material liability remote based on available information.
- Operating leases included residual-value guarantees totaling approximately $13.2 million at expiration; management considered the likelihood of funding the guarantees remote, other than a $1.3 million disposal reserve.
- Unrecognized tax-benefit liabilities were $1.7 million at September 30, 2010. Unrecognized stock-option compensation expense was $17.4 million, expected to be recognized over a weighted-average period of 5.79 years.
Important facts for investors to verify
- Whether the strong sales recovery in manufacturing and construction markets remained sustainable after Q3 2010.
- Whether inventory and receivables growth converted into operating cash flow or created working-capital pressure.
- Subsequent gross-margin performance, particularly the effects of industrial production mix, steel prices, vendor allowances, and inflation or deflation.
- Progress and final resolution of the DOJ/GSA matter, including any settlement above the $2.75 million accrued reserve or litigation exposure.
- Developments in the Arkansas supplier litigation despite management’s assessment that material liability was remote.
- Whether the planned 80-to-95 second-half store openings and the pathway-to-profit targets were achieved.
- The filing’s statement that disclosure controls were effective and that no material change occurred in internal control over financial reporting.