Fastenal Company — Q1 2010 Form 10-Q Summary
Business context and reporting period
Fastenal distributes industrial and construction supplies through more than 2,300 company-owned stores, primarily serving manufacturing and construction customers in North America. This unaudited quarterly report covers the three months ended March 31, 2010, compared with the same period in 2009.
Financial performance and position
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Net sales | $520.8 million | $489.3 million | 6.4% increase |
| Gross profit | $265.9 million | $258.6 million | 2.8% increase |
| Gross margin | 51.1% | 52.9% | Down 180 basis points |
| Operating income | $90.4 million | $78.4 million | 15.3% increase |
| Operating margin | 17.4% | 16.0% | Up 140 basis points |
| Net earnings | $56.0 million | $48.7 million | 15.1% increase |
| Basic and diluted EPS | $0.38 | $0.33 | 15.2% increase |
| Operating cash flow | $79.0 million | $93.5 million | 15.5% decrease |
| Capital expenditures | $8.1 million | $19.0 million | 57.2% decrease |
At March 31, 2010, cash and cash equivalents were $178.8 million, current assets were $1.03 billion, and total assets were $1.37 billion. Current liabilities were $162.3 million. No borrowings were outstanding under the company’s $8 million line of credit. The filing does not report funded long-term debt.
Inventory was $507.2 million, down from $508.4 million at December 31, 2009 and down 8.7% from March 31, 2009. Accounts receivable were $262.5 million, up from $214.2 million at December 31, 2009 and up 9.1% year over year. The company paid $59.0 million of dividends during the quarter and ended the period with $178.8 million of cash.
Material changes versus the prior comparable period
- Sales increased 6.4%, reflecting improving activity, particularly among manufacturing customers. Manufacturing daily sales grew approximately 15.7%, while non-residential construction daily sales contracted approximately 14.7%.
- Operating and administrative expenses declined 2.5% despite higher sales. Employee-related expenses declined 2.7%, although health-care costs increased 21.5% and fuel prices were materially higher.
- Gross margin declined because of prior competitive pricing pressure, deflationary inventory effects, and lower vendor incentives, although management reported sequential improvement from the fourth quarter of 2009.
- Operating margin expanded as expense reductions more than offset the gross-margin decline.
- Operating cash flow decreased primarily because accounts receivable increased with the recovery in sales. Management noted that first-quarter cash flow typically benefits from the timing of tax payments.
- The company opened 29 stores, closed five traditional stores, and converted one strategic-account store, ending the quarter with 2,392 locations versus 2,342 a year earlier.
- Average store sales increased to approximately $62,700 per month from $61,900, while store personnel FTEs declined 9.7% year over year and total average FTEs declined 9.1%.
Outlook, commentary, risks, contingencies, and unusual items
Management planned to continue increasing store openings, with a goal of returning to a 7% to 10% annual opening rate in the second half of 2010. The company also expected gross-profit components to improve during 2010 based on efforts to increase transactional margins, anticipated moderate inflation rather than 2009 deflation, and reset vendor incentive programs.
The “pathway to profit” strategy emphasizes higher average store sales, variable cost management, outside sales personnel, and improved working-capital efficiency. Management acknowledged that prolonged economic weakness could delay its goal of approximately $125,000 in average monthly sales per store by several years.
- Key operating risks include a prolonged economic downturn, weaker industrial production, continued weakness in non-residential construction, difficulty recruiting outside sales personnel, and failure to achieve planned store growth.
- Margin risks include additional deflation, competitive pricing pressure, changes in steel costs, vendor incentive levels, and the ability to pass through fuel and freight costs.
- Market exposures include interest rates, the Canadian dollar, steel prices, and gasoline and diesel costs. Foreign-exchange earnings exposure was described as immaterial at quarter-end.
- A supplier threatened litigation concerning an alleged exclusive distribution arrangement. Fastenal stated that the claim was unsupported and that the prospect of material liability was remote; related purchases were less than $1 million over the alleged period.
- Operating leases contain residual-value guarantees totaling approximately $15.1 million at expiration. Management considered the likelihood of funding the guarantees remote, except for a $1.8 million disposal reserve already provided.
- Unrecognized tax benefits were $1.6 million at March 31, 2010, and management did not expect a significant change over the next 12 months.
- On April 20, 2010, the company granted options covering approximately 265,000 shares at a $60.00 exercise price.
Important facts for investors to verify
- Whether manufacturing recovery continues and whether non-residential construction weakness worsens.
- Whether gross margin recovers as management expects, particularly through pricing, inventory costs, and vendor incentives.
- Whether the planned acceleration of store openings in the second half of 2010 occurs without weakening store-level profitability.
- Whether accounts receivable growth converts into cash and whether operating cash flow normalizes after seasonal tax-payment effects.
- The impact of higher fuel and health-care costs on future operating expenses.
- The status and potential financial exposure of the supplier dispute, lease guarantees, and unrecognized tax benefits.
- Whether the company maintains its strong cash position and dividend policy without increasing borrowings.