01—Abstract
Summary
Summary of the 10-K filed February 25, 2004. Cited figures are marked; the original filing is the authoritative source.
Fastenal Company (FAST) closed 2003 with net sales of $994.9 milliona, up 9.9% from $905.4 million in 2002 (12.0% growth excluding the divested Do-It-Yourself business).
Net earnings rose 11.4% to $84.1 millionb, and diluted EPS was $1.11 versus $1.00 in 2002. Gross margin slipped to 49.2% from 49.5%, but operating and administrative expenses fell to 35.5% of sales from 37.0%, which drove the faster earnings growth. Management attributed the margin pressure to lower vendor incentive savings tied to slower inventory growth, large low-margin accounts, and product mix.
The company's growth engine remains its store network, which reached 1,314 locations after 151 openings in 2003, with guidance for 12% to 16% annual store growth (160 to 210 new stores in 2004). Stores more than five years old grew only 3.3% in 2003, while younger stores grew faster, and management noted that new stores typically take nine to 12 months to reach their first profitable month. The main capital-intensive initiative is the Customer Service Project (CSP), which shifts inventory toward stores and raised store inventory by $28 millionc in 2003.
Inventory growth was held to $16 million net, and operating cash flow recovered to $90.6 milliond from $17.6 million in 2002. The balance sheet remains very strong, with $71 million in cash and marketable securities, no bank debt outstanding on the $15 million credit line, and total stockholders' equity of $576.7 million.
The company declared a semi-annual dividend of $0.15 per share and paid $0.21 in 2003, up sharply from $0.05 in 2002. Key risks noted in the filing include economic cyclicality (especially for mature stores), execution risk from the CSP rollout, gross margin pressure from vendor incentive trends, and foreign expansion, which remains small at under 5% of sales.
02—Key points
Key Highlights
- Net sales grew 9.9% to $994.9 million in 2003; excluding the divested DIY business, growth was 12.0%, with December daily sales up 16.9% year over year.
- Net earnings rose 11.4% to $84.1 million, and diluted EPS increased 11% to $1.11, driven by operating expense leverage (35.5% of sales versus 37.0% in 2002).
- Gross margin declined to 49.2% from 49.5% due to lower vendor incentive savings after slower inventory growth, large low-margin accounts, and product mix changes.
- The store network expanded to 1,314 sites with 151 openings in 2003; management plans 160 to 210 new stores in 2004 and sees potential for about 2,200 stores in the U.S. and Canada.
- Operating cash flow improved to $90.6 million from $17.6 million, and the company reduced distribution center inventory by $21 million while investing $28 million in CSP store inventory.
- The balance sheet is conservative, with $71 million in cash and marketable securities, no outstanding borrowings on the $15 million credit line, and stockholders' equity of $576.7 million.
- The semi-annual dividend was raised to $0.15 per share (from $0.05 total in 2002), and 2004 capital expenditures are planned at about $35 million.
03—Questions
Frequently Asked Questions
How much of Fastenal's 2003 growth came from new stores versus existing stores?
Stores opened in 2003 contributed about $19.5 million, or 2.0%, of net sales, so most growth came from existing stores. Stores more than two years old grew 5.3% in 2003, up from 3.2% in 2002. Stores more than five years old grew only 3.3%, indicating that mature locations are more sensitive to economic cycles.
Why did gross margin decline even though sales and earnings grew?
Management cited three main factors: sales growth to large accounts and some large one-time sales at lower margins, an unfavorable product mix, and a slowdown in inventory growth since May 2003 that reduced savings from vendor incentive programs such as freight allowances and rebates. Management expected this pressure to continue into the first quarter of 2004, with improvement expected in the second quarter. The DIY divestiture, which had a roughly 30% gross margin, partially offset these pressures.
What is the Customer Service Project (CSP), and what are its financial implications?
CSP is a store format that stocks a broader inventory (about $55 per location core level) in a self-service display, aiming to shift the inventory mix from about 60% stores and 40% distribution centers to about 75% and 25%. In 2003, it added $28 million to store inventory, which was largely offset by a $21 million reduction in distribution center inventory. The project is intended to improve customer service and sales, but it requires significant upfront working capital and carries execution risk if conversions disrupt operations.
Is Fastenal's balance sheet strong enough to support its expansion plans?
Yes. At year-end 2003, the company had $49.8 million in cash, $45.9 million in marketable securities, and no borrowings on its $15 million line of credit, which expires June 30, 2004. Total assets were $651.5 million, and equity was $576.7 million. Management plans to fund expansion primarily through operating cash flow and existing cash, with minimal reliance on borrowing. Known contractual obligations total about $78 million, mostly leases.
What are the main risks to Fastenal's business identified in the filing?
The main risks include sensitivity to the broader industrial and construction economy, which affects sales at existing stores and the pace of new store openings; the time required for new stores to become profitable; gross margin pressure from changes in product mix and vendor incentives; execution risk from the CSP inventory rollout; difficulty attracting and retaining store staff; and foreign currency and trade exposure, mainly to the Canadian dollar. The company also notes that the DIY business was sold in 2002 and that it has limited operating history outside the U.S. and Canada.
04—Continue