Fastenal Company 2019 Q2 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 3,200 in-market locations. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
The company 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 adoption had an immaterial earnings and cash-flow impact. A two-for-one stock split became effective May 22, 2019; historical share and per-share information was retroactively adjusted.
Key Financial Metrics
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Net sales | $1,368.4 million | $1,267.9 million | $2,677.7 million | $2,453.7 million |
| Gross profit | $641.2 million | $617.7 million | $1,265.9 million | $1,195.3 million |
| Gross margin | 46.9% | 48.7% | 47.3% | 48.7% |
| Operating income | $275.0 million | $269.0 million | $536.4 million | $503.5 million |
| Operating margin | 20.1% | 21.2% | 20.0% | 20.5% |
| Net earnings | $204.6 million | $211.2 million | $398.7 million | $385.5 million |
| Diluted EPS | $0.36 | $0.37 | $0.69 | $0.67 |
| Operating cash flow | Not separately provided | Not separately provided | $333.0 million | $311.6 million |
At June 30, 2019, cash and cash equivalents were $175.0 million. Total debt was $500.0 million, consisting primarily of $365.0 million drawn under a $700.0 million unsecured revolving credit facility and $135.0 million of senior unsecured notes. The company was in compliance with its debt covenants. Operating lease liabilities totaled $236.2 million.
Accounts receivable were $819.8 million and inventories were $1,345.7 million. Total assets were $3,756.4 million and stockholders’ equity was $2,503.7 million.
Material Changes Versus the Prior Comparable Period
- Q2 net sales increased 7.9%; six-month sales increased 9.1%. Daily sales increased 7.9% in Q2 and 10.0% in the first half.
- Q2 net earnings declined 3.1% and diluted EPS declined 3.2%. Excluding the $9.7 million one-time tax benefit recorded in Q2 2018, management estimated Q2 2019 net earnings and diluted EPS would each have increased 1.5%.
- Six-month net earnings increased 3.4% and diluted EPS increased 3.7%. Excluding the $8.4 million one-time tax benefit in the first half of 2018, management estimated growth of 5.7% in net earnings and 5.9% in diluted EPS.
- Gross margin declined 180 basis points in Q2 and 140 basis points for the first six months. Management attributed the pressure primarily to product and customer mix, price increases lagging product-cost inflation and tariffs, and higher transportation costs.
- Operating expenses improved as a percentage of sales to 26.8% in Q2 from 27.6% and to 27.3% for the first half from 28.2%.
- Interest expense increased due to higher average interest rates and debt balances. The six-month effective tax rate was 24.6%, compared with 22.6% in 2018, reflecting the absence of the prior-year discrete tax benefits.
- Capital expenditures increased substantially. Net cash used in investing activities was $119.6 million, compared with $53.9 million in the prior-year period.
- Receivables increased 11.7% and inventories increased 15.7% year over year, reflecting sales growth, expanded national-account activity, vending and Onsite investments, inflation and tariffs.
Guidance, Outlook, Commentary and Risks
- Management expects the ongoing tax rate, absent discrete items, to remain approximately 24.5% to 25.0%.
- 2019 net capital expenditures are expected to be $195.0 million to $225.0 million, primarily for hub capacity, industrial vending devices and vehicles.
- The company maintained 2019 targets of 23,000 to 25,000 industrial vending-device signings and 375 to 400 new Onsite locations.
- As of June 30, 2019, Fastenal had 85,871 installed industrial vending devices and 1,026 active Onsite locations. It signed 51 national account contracts, 94 Onsite locations and 5,439 vending devices during Q2.
- Management reported slowing industrial activity and softer conditions in oil and gas, heavy machinery and smaller construction customers. It also noted that sales growth moderated from 2018 and from Q1 2019.
- Additional pricing actions were taken in Q3 2019 to address broader cost pressures and tariffs imposed on China-sourced products in May 2019.
- Key risks include economic downturns, weakness in manufacturing or commercial construction, pricing competition, tariffs and commodity costs, freight and energy inflation, foreign exchange, interest-rate exposure, inventory and receivables management, execution of vending and Onsite strategies, hiring and retention, cybersecurity, product liability and legal or reputational matters.
- A one-percentage-point increase in LIBOR would have increased first-half 2019 interest expense by approximately $1.8 million. The company does not use interest-rate swaps for its floating-rate debt.
- Management reported no litigation matters considered probable or reasonably possible to have a material adverse outcome and no material change in previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether margin pressure from tariffs, product mix, customer mix and freight costs persists or improves following Q3 pricing actions.
- Progress toward the 2019 vending-device, Onsite-location and capital-expenditure targets.
- Trends in manufacturing activity, customer demand and sales growth following the reported macroeconomic slowdown.
- Inventory and accounts-receivable growth relative to sales, including payment timing and national-account exposure.
- Floating-rate debt costs, revolving-credit utilization and compliance with debt covenants.
- The sustainability of quarterly dividends, including the $0.22 per-share dividend declared for payment in August 2019, and any future share repurchases.