Fastenal Company — Q2 2015 Form 10-Q Summary
Business context and reporting period
Fastenal distributes industrial and construction supplies through approximately 2,700 company-owned locations, primarily serving manufacturing and non-residential construction customers in North America. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2015, with comparisons to the corresponding 2014 periods.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $997.8 million | $949.9 million | $1.951 billion | $1.826 billion |
| Net earnings | $140.4 million | $130.5 million | $268.0 million | $242.4 million |
| Diluted EPS | $0.48 | $0.44 | $0.91 | $0.82 |
| Gross margin | 50.3% | 50.8% | 50.5% | 51.0% |
| Operating margin | 22.6% | 21.8% | 22.0% | 21.1% |
| Operating cash flow | $81.0 million | $79.6 million | $261.2 million | $222.9 million |
- Q2 sales increased 5.0%, while six-month sales increased 6.8%. Currency movements, primarily involving Canada, reduced reported sales growth by approximately 1.0 percentage point.
- Q2 net earnings rose 7.5% and diluted EPS increased 9.1%; six-month net earnings rose 10.5% and diluted EPS increased 11.0%.
- Operating income increased 9.2% in Q2 to $225.8 million and 11.4% for six months to $429.6 million. Management cited expense discipline and operating leverage despite lower gross margins.
- Gross margin declined because of customer and product mix changes and lower supplier incentives. Management stated that supplier incentives accounted for approximately half of the sequential gross-margin decline from Q1 2015.
- Cash and cash equivalents were $121.2 million at June 30, 2015, compared with $114.5 million at December 31, 2014. Accounts receivable were $537.7 million and inventories were $876.7 million.
- Capital expenditures were $88.0 million for the first six months, compared with $97.6 million in the prior-year period. Net cash used in investing activities was $83.9 million.
- Total line-of-credit borrowings were $330.0 million at June 30, 2015, including $79.6 million classified as current and $250.4 million as noncurrent. The new unsecured revolving facility provides $500.0 million of capacity and expires March 1, 2018; the effective interest rate was approximately 1.1% at quarter-end.
- The company paid $164.7 million in dividends during the first six months and declared a third-quarter dividend of $0.28 per share. It repurchased 6.0 million shares during the first half for approximately $250.4 million and had authorization for an additional 4.0 million shares.
Material changes versus the prior comparable period
- Sales growth decelerated materially from 12.1% in Q2 2014 to 5.0% in Q2 2015; monthly daily-sales growth declined from 12.0% in January to 3.7% in June 2015.
- Fastener sales were flat year over year in Q2 2015, compared with 5.5% growth in Q2 2014. Non-fastener sales grew 9.0%, but this was below the 17.1% growth recorded in Q2 2014.
- Manufacturing customer sales growth slowed to 3.8% in Q2 2015 from 11.2% in Q2 2014, while non-residential construction growth slowed to 1.6% from 7.5%.
- Management attributed weakness primarily to customers connected with the oil and gas industry, broader industrial softness, price deflation in fasteners, and foreign exchange effects. Management indicated that oil-and-gas-related activity showed signs of stabilization late in the quarter.
- Operating and administrative expenses increased only 0.2% in Q2 and declined as a percentage of sales to 27.7% from 29.1%. Selling transportation costs declined approximately 20.7%, aided by lower fuel costs.
- Store employees increased 9.4% year over year and total employees increased 7.7%, while average full-time-equivalent headcount increased 4.4%, reflecting management’s effort to add selling capacity while controlling hours and other costs.
- FAST Solutions industrial vending devices increased to 50,620 from 43,761, a 15.7% increase. Sales to customers using industrial vending represented 40.9% of total sales, and sales to those customers grew 8.6% in Q2.
- The company opened eight stores and closed 26 stores during the first six months. Store locations totaled 2,616 at June 30, 2015, compared with 2,637 at December 31, 2014.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected approximately 20 store openings for full-year 2015 and anticipated moderating capital expenditures relative to net earnings while continuing investments in industrial vending and distribution capabilities.
- Management characterized the prior short-term gross-margin expectation as approximately 51%, while noting that gross margin may decline over time as average store size and large-account activity increase.
- Key risks include economic weakness in manufacturing and commercial construction, continued energy-sector weakness, competitive pricing pressure, product and customer mix shifts, foreign exchange changes, commodity and fuel prices, weather, inventory and receivables management, hiring and retention, adoption and execution of industrial vending, cybersecurity, product liability, and interest-rate exposure.
- Management reported compliance with the credit facility’s financial and negative covenants. No litigation matters were considered probable or reasonably possible to have a material adverse outcome as of June 30, 2015.
- Operating lease residual-value guarantees totaled approximately $65.3 million; management considered the likelihood of a material funding obligation remote, and related accruals were immaterial.
- The company had approximately $87 million of cash held by non-U.S. subsidiaries, with no significant restrictions on repatriation disclosed.
- The effective date of the new revenue-recognition standard was deferred to January 1, 2018. The company had not selected a transition method or determined the impact on its financial reporting.
Important facts for investors to verify
- Whether the apparent stabilization in oil-and-gas-related demand continues and whether monthly sales growth improves from the June 2015 level.
- Whether gross margin remains near management’s approximately 51% short-term expectation despite lower fastener mix, larger accounts, and reduced supplier incentives.
- The sustainability of operating leverage while store and total employee counts continue to expand.
- Cash-flow coverage of dividends, share repurchases, capital expenditures, and debt repayment, particularly given the increase in borrowings.
- Execution, returns, and customer adoption associated with the 50,620-device FAST Solutions installed base.
- The effect of foreign exchange, steel-price deflation, fuel costs, working-capital growth, and the eventual adoption of the new revenue-recognition standard.