Fastenal Company — Q2 2016 Form 10-Q Summary
Business Context and Reporting Period
Fastenal is a North American distributor of industrial and construction supplies, operating approximately 2,600 company-owned stores and serving manufacturing, maintenance, repair and operations, and non-residential construction customers. The filing covers the three and six months ended June 30, 2016. The financial statements are unaudited.
- Store locations at June 30, 2016: 2,605.
- Industrial vending devices installed: 58,346, excluding approximately 3,000 devices deployed under a customer locker-lease arrangement.
- Total employees at period end: 20,324, up 4.1% from June 30, 2015.
- Fasteners represented 37.1% of second-quarter sales versus 38.7% in the prior-year quarter; other products represented 62.9%.
Financial Performance and Key Metrics
| Metric | Q2 2016 | Q2 2015 | Change |
|---|---|---|---|
| Net sales | $1,014.3 million | $997.8 million | +1.6% |
| Gross profit | $501.6 million | $502.1 million | -0.1% |
| Gross margin | 49.5% | 50.3% | -80 basis points |
| Operating income | $209.2 million | $225.8 million | -7.4% |
| Operating margin | 20.6% | 22.6% | -200 basis points |
| Net earnings | $131.5 million | $140.4 million | -6.3% |
| Diluted earnings per share | $0.45 | $0.48 | -6.3% |
For the six months ended June 30, 2016, sales were $2,001.0 million, up 2.6%; net earnings were $257.7 million, down 3.8%; diluted EPS was $0.89 versus $0.91; gross margin was 49.6% versus 50.5%; and operating margin was 20.5% versus 22.0%.
- Daily sales increased 1.6% in the second quarter and 1.8% for the first six months, after a 0.6% foreign-currency headwind for the first half.
- Second-quarter fastener daily sales contracted 2.4%; non-fastener daily sales increased 4.7%.
- Manufacturing customer daily sales increased 0.7% in the second quarter, while non-residential construction customer daily sales declined 1.7%.
- Income taxes were $76.3 million in the second quarter and $149.9 million year to date. The six-month effective tax rate was approximately 36.8%.
Cash Flow, Liquidity, Debt, and Capital Allocation
- Six-month operating cash flow was $248.1 million, down from $261.2 million; operating cash flow equaled 96.2% of net earnings versus 97.5% in the prior-year period.
- Capital expenditures were $88.7 million, and net cash used in investing activities was $85.9 million. Management expected approximately $200 million of net capital expenditures for 2016.
- Cash and equivalents were $155.5 million at June 30, 2016, compared with $129.0 million at December 31, 2015.
- Total debt was $430.0 million, consisting of $415.0 million drawn on a $700.0 million unsecured revolving credit facility and a $15.0 million note payable. Debt increased from $365.0 million at year-end 2015.
- The revolving facility expires March 1, 2018. Borrowings generally bear interest at LIBOR plus 0.95%; the weighted rate was approximately 1.4% at June 30, 2016. The company was in compliance with its covenants.
- Financing activities used $139.7 million, including $173.2 million of dividends and $59.4 million of share repurchases, partly offset by net borrowings and option proceeds.
- The company repurchased 1.6 million shares in the first quarter at an average price of approximately $37.15 and no shares in the second quarter. Remaining repurchase authorization was 1.3 million shares.
- The board declared a $0.30-per-share third-quarter dividend payable August 23, 2016.
Material Changes Versus the Prior Comparable Period
- Sales growth slowed materially from the prior year, while profitability declined because of lower gross margins, higher operating expenses, and weaker manufacturing and construction demand.
- Gross margin pressure reflected customer and product mix, including continued growth in lower-margin national accounts and non-fastener products, as well as fastener price deflation and CSP 16 inventory-related activities.
- Operating and administrative expenses increased to 28.8% of sales from 27.7%. Employee-related costs rose with higher headcount and health-care costs; occupancy costs increased primarily from vending equipment and distribution automation investments.
- Inventory increased to $985.1 million from $913.3 million at year-end 2015. Six-month cash flow was pressured by increased inventory investment associated with the CSP 16 initiative.
- Debt increased by $65.0 million from year-end 2015, reflecting borrowings used in part to fund capital expenditures, dividends, and share repurchases.
- Industrial vending remained a growth area: installed devices increased 15.3% year over year, but daily sales to vending customers grew only 2.7% in the second quarter, versus 8.6% in the prior-year quarter.
Guidance, Outlook, Commentary, and Risks
- Management expected 30 to 45 store openings in 2016, after opening 27 stores and closing or consolidating 34 during the first half.
- Management expected 2016 gross margin to remain in the 49.5% to 50.0% range and stated an internal goal of returning to 50.0%.
- Management expected approximately $200 million of 2016 net capital expenditures and planned to fund part of the spending with a private debt placement expected to close in late July 2016.
- Management expected plant shutdowns and slowdowns affecting manufacturing customers to continue into the third quarter.
- Key risks include economic weakness, manufacturing and construction demand, energy-sector exposure, pricing and steel deflation, foreign exchange, fuel costs, floating interest rates, inventory and receivables management, execution of vending and Onsite initiatives, hiring and retention, technology and cybersecurity, and potential customer demand for large vending deployments.
- A 1% increase in LIBOR during the first six months of 2016 would have increased interest expense by approximately $2.0 million.
- Canadian sales growth was affected by wildfires in Western Canada, which reduced second-quarter sales by approximately $1.1 million Canadian, or approximately $0.85 million U.S.
- No litigation matters were considered probable or reasonably possible to have a material adverse outcome. The filing reported no material change in previously disclosed risk factors or internal controls.
Important Facts for Investors to Verify
- Whether slowing daily sales, particularly in June, continued or worsened after quarter-end.
- Whether gross margin stabilized within management’s 49.5% to 50.0% expectation despite mix and pricing pressures.
- The amount, terms, and closing status of the planned private debt placement and its effect on leverage and interest expense.
- Inventory growth, working-capital efficiency, and conversion of earnings into operating cash flow.
- Industrial vending and Onsite customer adoption, including sales productivity and returns on related capital investments.
- The company’s ability to maintain dividends and planned capital expenditures while managing debt and subdued end-market demand.