Fastenal Company 2019 Q3 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 more than 3,200 in-market locations. The filing covers the quarter and nine months ended September 30, 2019; financial statements are unaudited.
Fastenal adopted ASC 842 lease accounting on January 1, 2019, recognizing $227.5 million of operating lease right-of-use assets and $228.3 million of lease liabilities. The company also completed a two-for-one stock split effective May 22, 2019; historical share and per-share data were restated.
Financial Performance and Key Metrics
| Metric | Q3 2019 | Q3 2018 | Change |
|---|---|---|---|
| Net sales | $1,379.1 million | $1,279.8 million | 7.8% |
| Gross profit | $651.1 million | $615.8 million | 5.7% |
| Gross margin | 47.2% | 48.1% | Down 90 bps |
| Operating income | $281.9 million | $262.3 million | 7.5% |
| Operating margin | 20.4% | 20.5% | Down 10 bps |
| Net earnings | $213.5 million | $197.6 million | 8.0% |
| Diluted EPS | $0.37 | $0.34 | 8.0% |
| Metric | Nine Months 2019 | Nine Months 2018 | Change |
|---|---|---|---|
| Net sales | $4,056.8 million | $3,733.5 million | 8.7% |
| Operating income | $818.3 million | $765.8 million | 6.9% |
| Net earnings | $612.2 million | $583.1 million | 5.0% |
| Diluted EPS | $1.07 | $1.01 | 5.1% |
| Operating cash flow | $590.3 million | $496.2 million | 19.0% |
Q3 net sales growth reflected higher unit sales and pricing actions. Management estimated that pricing contributed approximately 90 to 120 basis points to Q3 sales growth. U.S. revenue was $1,182.0 million and foreign revenue was $197.1 million.
Operating and administrative expenses declined to 26.8% of sales from 27.6% in the prior-year quarter. Net interest expense increased to $3.5 million in Q3 from $3.0 million, while the nine-month expense increased to $11.1 million from $8.6 million.
Q3 income tax expense was $64.9 million, representing a 23.3% effective rate. Discrete tax benefits of $3.6 million benefited Q3 2019 results; excluding discrete items, management estimated net earnings and diluted EPS growth of 7.2% and 7.3%, respectively. Management expects the ongoing tax rate, absent discrete items, to be in the lower portion of a 24.5% to 25.0% range.
Cash Flow, Balance Sheet, Debt, and Liquidity
- Cash and cash equivalents were $191.2 million at September 30, 2019, compared with $167.2 million at December 31, 2018.
- Operating cash flow was $590.3 million for the first nine months, equal to 96.4% of net earnings.
- Net cash used in investing activities was $179.1 million, including $184.3 million of property and equipment purchases.
- Net capital expenditures were $179.3 million, up 101.9% from the prior-year period. Management maintained its 2019 net capital expenditure expectation of $195.0 million to $225.0 million.
- Total debt was $445.0 million at September 30, 2019, down from $500.0 million at December 31, 2018. Debt consisted primarily of $310.0 million drawn under the revolving credit facility and $135.0 million of fixed-rate notes.
- Fastenal had a $700.0 million unsecured revolving credit facility expiring November 30, 2023, with $36.3 million of outstanding letters of credit. The company reported compliance with all applicable covenants.
- Accounts receivable were $817.3 million and inventories were $1,354.7 million. Inventory increased 13.4% year over year, primarily to support vending and Onsite initiatives, higher service levels, inflation, and tariffs.
- Cash dividends paid during the first nine months totaled $372.3 million. The board declared a $0.22-per-share dividend payable November 22, 2019.
Material Changes Versus the Prior Comparable Period
- Sales growth slowed from 13.0% in Q3 2018 to 7.8% in Q3 2019, and management stated that economic activity weakened during the quarter. The Purchasing Managers Index averaged 49.4 in Q3 2019 versus readings above 50 indicating growth.
- Fastener daily sales growth slowed to 3.0% in Q3 from 6.7% for the first nine months. Weakness spread from oil and gas to heavy machinery, industrial manufacturing, and smaller non-residential construction customers.
- Gross margin declined because of product and customer mix, product-cost increases from inflation and tariffs that outpaced pricing, and higher freight costs. Management said these adverse effects moderated during Q3.
- Industrial vending devices increased to 88,327, up 12.2% year over year. Active Onsite locations increased to 1,076, up 30.0% year over year. In-market locations increased 4.3% to 3,222, despite branch closures.
- Management reduced its 2019 vending-signing expectation to approximately 22,000 units from a prior goal of 23,000 to 25,000 because slower economic activity lengthened the sales cycle. The Onsite signing goal remained 375 to 400 locations.
- Operating lease assets and liabilities were newly recognized under ASC 842, materially increasing reported assets and liabilities without a material effect on earnings or cash flow.
Outlook, Commentary, Risks, and Unusual Items
Management expects continued investment in hub capacity, vending devices, vehicles, and Onsite locations. It also intends to continue evaluating pricing actions to offset product-cost inflation and tariffs. Management noted that slower market activity could continue to affect vending adoption, Onsite performance, and sales growth.
Key risks include economic weakness, particularly in manufacturing and commercial construction; competitive pricing pressure; product and customer mix changes; tariffs, commodity costs, freight costs, and foreign currency movements; inventory and receivables management; interest-rate exposure from LIBOR-based borrowings; execution and customer acceptance of vending and Onsite strategies; cybersecurity and product liability risks; and difficulty controlling operating expenses.
Foreign currency fluctuations reduced first-nine-month reported sales by an estimated $14.3 million, although the estimated earnings effect was immaterial. A one-percentage-point increase in LIBOR would have increased first-nine-month interest expense by approximately $2.6 million. No litigation matters were considered probable or reasonably possible to have a material adverse outcome.
Investor Verification Checklist
- Verify whether the Q3 slowdown in manufacturing and related markets persisted after September 30, 2019.
- Monitor gross-margin recovery and the ability to pass inflation, tariff, freight, and other product costs through to customers.
- Assess whether vending and Onsite growth meets management’s revised vending and unchanged Onsite targets.
- Review inventory and accounts receivable growth relative to sales growth and cash conversion.
- Confirm 2019 capital expenditures, debt reduction, dividend commitments, and available revolver capacity.
- Separate reported earnings growth from the benefit of discrete tax items and track the normalized tax rate.