FASTENAL CO quarterly report, Q1 FY2012

Fastenal Company — Q1 2012 Form 10-Q Summary

Business context and reporting period

Fastenal distributes industrial and construction supplies through approximately 2,600 company-owned locations, primarily serving manufacturing and non-residential construction customers. The filing covers the unaudited three months ended March 31, 2012, compared with the first quarter of 2011. The company had 2,611 stores at quarter-end and 296.1 million common shares outstanding at April 10, 2012.

Financial performance and condition

Metric	Q1 2012	Q1 2011	Change
Net sales	$768.9 million	$640.6 million	20.0%
Gross profit	$394.2 million	$333.4 million	18.2%
Gross margin	51.3%	52.0%	Down 70 basis points
Operating income	$161.0 million	$128.7 million	25.2%
Operating margin	20.9%	20.1%	Up 80 basis points
Net earnings	$100.2 million	$79.5 million	26.0%
Diluted EPS	$0.34	$0.27	25.9%
Operating cash flow	$132.2 million	$74.3 million	77.9%

Sales growth was primarily volume-driven, with limited benefit from inflation. Daily sales increased 20.0%; sales at stores open more than two years increased 17.4%.
Manufacturing customer sales grew 20.3%, while non-residential construction customer sales grew 17.1%.
Operating and administrative expenses increased 13.8% but declined to 30.3% of sales from 32.0%, producing operating leverage.
Income tax expense was $60.9 million, and the effective tax rate decreased to approximately 37.8% from 38.2%.
Cash and cash equivalents were $198.9 million at March 31, 2012, compared with $117.7 million at December 31, 2011. Marketable securities totaled $27.2 million.
Total assets were $1.813 billion and stockholders’ equity was $1.539 billion. The filing reports no outstanding borrowings under the company’s $8 million line of credit.
Accounts receivable increased to $386.9 million and inventories to $647.9 million at quarter-end. Operational working capital increased 14.7% year over year, below the 20.0% sales growth rate.
Capital expenditures were $28.2 million; net cash used in investing activities was $27.3 million. Operating cash flow less capital expenditures was approximately $104.0 million before asset-sale proceeds.
Financing cash outflows were $24.2 million, including $50.2 million of dividends, partially offset by $26.0 million from stock-option exercises and related tax benefits.

Material changes versus the prior comparable period

Revenue, operating income, net earnings, and diluted EPS all grew substantially, with operating income and net earnings growing faster than sales.
Gross margin declined 70 basis points year over year but improved from 51.2% in the fourth quarter of 2011. Management attributed the sequential improvement mainly to seasonal vendor volume allowances and improved freight utilization, partly offset by rising fuel prices.
Fastenal expanded its store base from 2,522 locations at March 31, 2011 to 2,611 at March 31, 2012. Average monthly sales per store increased from approximately $74,421 to $86,449.
FAST Solutions industrial vending contracts increased significantly: 4,568 machines were signed in Q1 2012 versus 1,405 in Q1 2011, and cumulative installed machines increased to 9,798 from 7,453.
Customers using vending solutions represented 17.8% of total net sales, compared with 8.9% in the prior-year quarter.
Fuel costs increased, with average Q1 diesel prices up 8.9% and gasoline prices up 9.6% year over year. Total vehicle fuel costs were approximately $10.6 million.
The company adopted new comprehensive-income presentation requirements in Q1 2012. Management stated that the adoption changed presentation only and did not affect results.

Guidance, outlook, commentary, risks, and unusual items

Management expected 2012 store openings to grow at approximately 4% to 6%.
Management considers a 51% to 53% gross margin to be the normal range and stated that the company’s pathway-to-profit objective is approximately 23% pre-tax earnings as a percentage of sales. Management believes this objective may be achievable at average store sales of approximately $100,000 to $110,000 per month.
Management described FAST Solutions industrial vending as potentially transformative and targeted signing more than 2,500 machines per quarter, or an annualized rate of at least 10,000 machines.
Key risks include cyclical weakness in manufacturing and commercial construction, inability to recruit or retain qualified sales personnel, pressure on gross margins, rising fuel and steel costs, inability to pass freight costs to customers, slower vending adoption, competitive replication, foreign-currency movements, and changes in dividend capacity.
A California fastener supplier’s litigation claim, originally alleging approximately $180 million in damages, remained subject to appeals. Fastenal had obtained summary judgment and stated that the likelihood of a material liability was remote.
The company disclosed approximately $46.6 million of operating-lease residual-value guarantees, but stated that the likelihood of funding the guarantees was remote except for a $0.6 million disposal reserve.
Unrecognized tax benefits were $5.5 million, and management did not expect a significant change during the following 12 months.
On April 17, 2012, the board declared a $0.17-per-share dividend payable May 30, 2012. The board expected to continue quarterly dividends, subject to future financial needs and other relevant factors.
No stock repurchases occurred during the quarter; authorization remained for up to 1.8 million shares.
Management reported effective disclosure controls and no material change in internal control over financial reporting.

Investor verification points

Verify whether sales growth remains primarily volume-driven and whether manufacturing and construction end-market trends continue.
Track gross margin against the stated 51% to 53% normal range, including the effects of product mix, vendor incentives, freight utilization, steel prices, and fuel costs.
Assess whether operating expense leverage is sustainable as store, personnel, distribution, and vending investments continue.
Monitor FAST Solutions machine signings, installations, customer sales penetration, and profitability contribution.
Evaluate receivables and inventory growth relative to sales and the resulting working-capital cash requirements.
Confirm continued cash generation is sufficient to fund capital expenditures, expansion, and quarterly dividends without significant borrowing.
Follow the pending litigation appeals and any change from management’s assessment that material liability is remote.
Review future dividend decisions, store-opening rates, and the company’s ability to maintain its pathway-to-profit objectives.