Fastenal Company: Q3 2016 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 approximately 2,500 company-owned stores, national accounts, Onsite locations, and industrial vending solutions. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Financial performance and position
| Metric | Nine months 2016 | Nine months 2015 | Q3 2016 | Q3 2015 |
|---|---|---|---|---|
| Net sales | $3.014 billion | $2.946 billion | $1.013 billion | $995.3 million |
| Gross profit | $1.493 billion | $1.488 billion | $499.8 million | $502.2 million |
| Gross margin | 49.5% | 50.5% | 49.3% | 50.5% |
| Operating income | $613.4 million | $649.6 million | $203.0 million | $220.0 million |
| Operating margin | 20.3% | 22.0% | 20.0% | 22.1% |
| Net earnings | $384.7 million | $404.5 million | $126.9 million | $136.5 million |
| Diluted EPS | $1.33 | $1.38 | $0.44 | $0.47 |
- Nine-month sales increased 2.3%; daily sales increased 1.8% after a 0.4% adverse currency impact and a 0.7% acquisition contribution.
- Third-quarter sales increased 1.8% and daily sales increased 1.8%.
- Nine-month net earnings declined approximately 4.9%, while third-quarter net earnings declined approximately 7.0%. Diluted EPS declined by $0.05 in both periods, partly reflecting lower weighted-average shares.
- Operating and administrative expenses rose to 29.2% of sales for the nine months and 29.3% in Q3, compared with 28.5% and 28.4%, respectively, in the prior-year periods.
- Cash and cash equivalents were $147.0 million at September 30, 2016, compared with $129.0 million at December 31, 2015. Total assets were $2.730 billion.
- Operating cash flow was $381.3 million, versus $402.0 million in the first nine months of 2015. Capital expenditures were $162.0 million, versus $119.5 million, resulting in approximate operating cash flow less capital expenditures of $219.3 million.
- Total debt was $445.0 million at September 30, 2016, compared with $365.0 million at December 31, 2015. The company had a $700.0 million unsecured revolving facility, with $355.0 million outstanding and $36.3 million of undrawn letters of credit. Management stated that it was in compliance with debt covenants.
- Accounts receivable increased 1.2% year over year, while inventories increased 9.5% to $966.9 million, driven in part by CSP 16 inventory expansion, acquisition-related inventory, international growth, and Onsite growth.
Material changes versus the prior comparable period
- Fastener sales contracted 2.9% on a daily-sales basis in Q3 and represented 36.1% of sales, compared with 37.9% in Q3 2015. Non-fastener sales increased to 63.9% of sales from 62.1%.
- Non-fastener daily sales grew approximately 4.9% in Q3, supported by industrial vending and safety supplies. Safety supplies represented 15.3% of Q3 sales and grew approximately 10% in the first nine months.
- Gross margin declined 120 basis points in Q3 and 100 basis points for the nine months, primarily because of customer and product mix, including faster growth in lower-margin large-account and non-fastener business, as well as certain CSP 16 setup costs.
- Operating income declined 5.6% in Q3 and 5.6% for the nine months, reflecting lower gross margin and higher operating expenses.
- Interest expense increased to $4.7 million for the nine months from $2.1 million, primarily reflecting higher debt levels.
- Fastenal opened 35 stores and closed or consolidated 99 stores during the first nine months. Management expected approximately 40 store openings for full-year 2016.
- Installed industrial vending devices increased 12.8% year over year to 60,400, excluding approximately 11,000 lockers deployed under a customer lease arrangement that did not generate product revenue.
- The company issued $75.0 million of senior unsecured notes in July 2016: $40.0 million at 2.00% due in 2021 and $35.0 million at 2.45% due in 2022.
Outlook, management commentary, risks, and unusual items
- Management described the North American industrial economy as soft, with continued weakness in heavy equipment, manufacturing, construction, and energy-related markets. Q3 top-100-customer sales declined 0.8%, with 50 customers growing and 50 contracting.
- Management expected approximately 40 stores to open in 2016 and approximately $190 million of net capital expenditures for the year. Capital spending was elevated by industrial vending lockers and distribution-center automation, together expected to add roughly $91 million to 2016 spending.
- Management continued to target 200 Onsite customer locations in 2016; 133 had been signed and 100 were operational at September 30.
- The board declared a fourth-quarter dividend of $0.30 per share, payable November 22, 2016. The indicated 2016 quarterly dividend rate was $0.30 per share, compared with $0.28 in 2015.
- Key risks include economic weakness, manufacturing and commercial construction exposure, pricing competition, product and customer mix changes, steel and energy prices, foreign exchange, interest rates, inventory and receivables management, adoption and execution of vending technology, personnel constraints, cybersecurity, technology and software dependencies, and unexpected capital requirements from future customer locker arrangements.
- A 1% increase in LIBOR during the first nine months of 2016 would have increased interest expense by approximately $3.0 million. The company does not routinely hedge the floating-rate exposure on its revolving facility.
- No litigation matters were considered probable or reasonably possible to have a material adverse outcome. The company stated that there had been no material change in its previously disclosed risk factors or internal control over financial reporting.
Important facts for investors to verify
- Whether weak manufacturing and construction demand persists and further pressures daily sales, fastener volumes, and top-customer performance.
- Whether gross-margin pressure from non-fastener and large-account mix continues, and whether operating expense growth moderates.
- Inventory growth, working-capital conversion, and the sustainability of operating cash flow relative to capital expenditures and dividends.
- Debt repayment plans, exposure to LIBOR, and liquidity before the revolving facility maturity on March 1, 2018.
- The revenue and return profile of the industrial vending and customer-locker programs, including the approximately 11,000 leased devices that generated no product revenue.
- Execution of the CSP 16 rollout, Onsite expansion, store openings and consolidations, and the planned 2016 capital-spending program.
- Potential effects of adopting the deferred revenue-recognition, lease, and share-based-payment accounting standards identified in the filing.