Business Context and Reporting Period
Company: Fastenal Company
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and nine months ended September 30, 2008
Business Overview: Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies, operating over 2,300 company-owned stores. The company serves construction, manufacturing, and other industrial markets.
Key Financial Metrics
| Metric (in thousands) | Nine Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2007 | Three Months Ended Sep 30, 2008 | Three Months Ended Sep 30, 2007 |
|---|---|---|---|---|
| Net Sales | $1,795,466 | $1,542,613 | $625,037 | $533,750 |
| Gross Profit | $944,902 | $783,008 | $330,883 | $272,024 |
| Operating Income | $350,932 | $284,803 | $117,619 | $98,848 |
| Net Earnings | $217,169 | $176,431 | $72,909 | $62,142 |
| Diluted EPS | $1.46 | $1.17 | $0.49 | $0.41 |
| Cash from Operations | $173,730 | $160,428 | N/A | N/A |
| Cash & Equivalents (Sep 30, 2008) | $52,107 | N/A | N/A | N/A |
| Total Debt | $0 | N/A | N/A | N/A |
Margins (Nine Months 2008 vs 2007):
- Gross Profit Margin: 52.6% vs 50.8%
- Operating Income Margin: 19.5% vs 18.5%
- Effective Tax Rate: 38.2% vs 38.3%
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 16.4% for the nine months and 17.1% for the quarter, driven by higher unit sales from older store locations and new store openings, as well as price increases of 2% to 4% due to inflation in steel and energy costs.
- Profitability: Net earnings grew 23.1% (nine months) and 17.3% (quarter). Gross margin expansion was driven by direct sourcing improvements, freight initiatives, and sales force focus on margin.
- Legal Settlement: A $10 million legal settlement regarding overtime classification of Assistant General Managers was recorded in Q3 2008. This resulted in a pre-tax expense of approximately $8.2 million (net of bonus reductions), reducing operating income margins by approximately 1.3 percentage points for the quarter.
- Working Capital: Accounts receivable increased 19.5% year-over-year, partly due to two extra selling days in September 2008. Inventory increased 10.0%, which is lower than the sales growth rate, reflecting improved inventory management.
- Capital Expenditures: Investing cash outflows increased significantly to $75.0 million (vs $23.4 million prior year) due to the relocation of the Dallas distribution center and expansion of the Indianapolis master distribution center.
Guidance, Outlook, and Risks
- Strategic Initiative ("Pathway to Profit"): Management is shifting growth drivers from opening new stores (targeting 7-10% annual growth) to adding outside sales personnel to existing stores. The goal is to increase average store sales from $80,000 to $125,000 per month by 2012 to leverage fixed costs.
- Fuel Costs: Rising fuel prices (diesel up 49% and gasoline up 34.6% vs Q3 2007) increased vehicle fuel costs. However, the company's freight initiative has mitigated the negative impact on gross margins.
- Stock Repurchases: The company purchased 590,000 shares in the first nine months of 2008. As of September 30, 2008, approximately 1,410,000 shares remain authorized for repurchase.
- Risks: Key risks include economic downturns affecting construction and manufacturing, the ability to attract qualified sales personnel, changes in fuel and steel commodity prices, and the final court approval of the pending legal settlement.
Investor Verification Checklist
- Verify the final court approval status of the $10 million legal settlement and any potential additional costs.
- Monitor the execution of the "Pathway to Profit" initiative, specifically the growth in average store sales and the reduction in new store opening rates.
- Track the impact of rising fuel and steel costs on future gross margins, particularly if commodity prices continue to escalate.
- Review the effectiveness of working capital management, specifically the ratio of annual sales to accounts receivable and inventory, to ensure it meets the 3.0:1 target.
- Confirm the sustainability of the 2% to 4% price increases passed to customers in the face of economic weakness.