Good day, ladies and gentlemen, and welcome to the Fastenal Company Q1 2017 Earnings Results Conference Call. I'd like to introduce your host today's conference, Ms. Ellen Tresley. You may begin.
Welcome to the Fastenal Company 2017 First Quarter Earnings Conference Call. This call will be hosted by Dan Clornis, our President and Chief Executive Officer and Holden Lewis, our Chief Financial Officer. The call will last for up to 45 minutes and we'll start with overview of our quarterly results and operations with the remainder of the time being open for questions and answers. Today's conference call is a proprietary Fastenal presentation and is being recorded by Fastenal. No recording, reproduction, transmission or distribution of today's call is permitted without Fastenal's consent.
This call is being audio simulcast on the Internet via the Fastenal Investor Relations homepage, investor. Fastenal.com. A replay of the webcast will be available on the website until June 1, 2017, at midnight Central Time. As a reminder, today's conference call may include statements regarding the company's future plans and prospects. These statements are based on our current expectations, and we undertake no duty to update them.
It is important to note that the company's actual results may differ materially from those anticipated. Factors that could cause actual results to differ from anticipated results are contained in the company's latest earnings release and periodic filings with the Securities and Exchange Commission, and we encourage you to review those factors carefully. I would now like to turn the call over to Mr.
Dan Flores. Good morning everybody and thank you for taking some time today to listen to our Q1 earnings call. The you will note 2 meaningful changes to our method of reporting from prior quarters and I attribute that to our CFO and our Chief Accounting Officer really challenging the format which we convey the information. You will find a much more abbreviated press earnings release document. And then something new is we have a short slide deck to supplement the earnings call to help on some of the talking points.
I hope you find it useful. My comments are going to primarily center on the first two pages of commentary, which I believe are Pages 34 in the book, if you're looking at those pages. Earlier this morning, and this is typical with every quarter end, 7 this morning Central Time, had a call with our regional leaders and our national leaders, talk a bit about the quarter, give them some insight a little bit about what we're going to cover on the call, but really just give some insight on the quarter. I want to touch on a couple of points that were mentioned in that call and then we'll dig into the slide deck. The first one and for those of you that have covered Fastenal for any period of time, you know that we are a sales centered organization, a growth centered organization.
That's been our DNA for 50 years and 2017 does mark our 50th year in business. The first one centers on establishing goals and hitting goals. In the Q1 of 2017, we came in at roughly 101 percent of goal, 100.7% is the exact number, but roughly 101% of goal. And we hit or exceeded goal every month of Q1. I mentioned that because part of growth is a mindset and attitude.
And I think we have a great mindset and a great attitude of going forward of serving our customers at a high level and challenging each other to grow and grow every day, every month, every quarter. And so very pleased with that. The second item that I thought was noteworthy is, if you look across our 2,400 store locations, our 400 plus on-site locations, look at our business in general, you always have customers that are going through different aspects in their business cycle. We might be growing handsomely with that customer because we're picking up market share. We might be growing nicely with that customer because their business is expanding or we might be contracting with that customer because their business is contracting.
And that is true of every one of our stores. So in any given month, a percentage of our stores grow and a percentage of our stores don't. In the Q1, over 60% of our stores about 62% of our stores grew. The last time we did better than that was in the Q1 of 2015. And I cite that because as we transition from the Q1 of 2015 to the Q2 of 2015, the oil and gas market of which we had a meaningful presence, collapsed in North America collapsed globally, but collapsed in North America and our business suffered as a result.
So it's good to see us participating from a store to store perspective in growth in a way we did before the oil and gas business dramatically slowed. Getting on to the flip book here. First item mentioned, demand gains drove daily sales growth of 6% 6.2% annually, again our fastest growth since the Q1 of 2015. So my earlier comments go hand in hand. Our fastener sales, which are really indicators of the economy in all honesty, have struggled ever since the Q2 of 2015 and that business grew return to growth in the Q1.
And that business represents over a third of our revenue, about 36%, 37%. Our non faster business grew at 9.5% and in the month of March grew almost 12%, so double digit growth. So very pleased with the trends in our business as it relates to both aspects of Fasteners and Non Fasteners. Our pretax earnings grew 5.5%, so fastest rate of growth for us since the Q2 of 2015. We achieved 20 basis points of operating expense leverage.
And one thing about our business is we have a tremendous amount of incentive comp, a tremendous amount of investments we make periodically in our business. In 2015, we made dramatic investments. And as the economy weakened late in the year, we pulled those investments back. In 2016, it was a lot about righting the ship, lowering some operating expenses, improving some operating expenses to set us up for into 2017 2018 and beyond. I'm pleased by the fact that we had 20 basis points of operating expense leverage.
When you consider the fact that incentive comp, which that was an historically low number in 2016, expanded nicely in the Q1, because our incentive comp expands as our gross profit dollars and our earnings dollars grow. And so it expanded nicely and that ate into some of it. And our profit sharing contribution that goes to our employees in general expanded nicely from Q1 to Q1. Despite those natural headwinds, we obtained operating expense leverage. Very strong cash flow.
1st quarter is always strong for us as it is for everybody in our industry because of the absence of a large tax payment, but very pleased with it. Our capital spending is at a lower level as we've talked about on our Q1 call or excuse me, our January call, and we didn't have the CSP-sixteen investment driving our inventory increase. In fact, if you remove the acquisition we did during the quarter from December to March, our inventory essentially held flat. Speaking of acquisition, on the last day of the quarter, we closed our acquisition of manufacturer supply company, Romansco. It's about a $50,000,000 distributor.
So for the next 12 months, we'll enjoy about an extra point of growth from this acquisition. Flipping on to our growth driver update on Page 2, some things I think are noteworthy. We got off to a nice start on our on-site signings. We signed 64 in the Q1. We currently have 4 37 active on-site locations.
That's 51% increase from the 289 we had at the end of last year. And our goal remains to sign 275 to 300 on sites this year. That's a huge goal. Last year, we signed 176, which was more than doubling of the year before where we had signed 80. We also signed 5,437 vending units, a 17% increase from Q1 of last year.
I didn't go back and look at it in detail, but it was either the early part of 2013 or during 2012 when vending initially exploded for us from the standpoint of where we're to gain traction, it's probably the last time we've signed over 5,000 vending devices in a quarter. So very, very pleased with our start to the year. Our goal is to sign 22,000 to 24,000 for the year and very pleased with that. Probably the only challenge we had is every year there's a certain number of machines that we pull out and we pulled out some machines in the Q1. But again, very good traction as we enter the year.
And the sales of product through our vending machines grew double digits again. National accounts grew over 9% during the quarter. We've talked in previous quarters about sales to our top 100 customers. 64 of our top 100 customers grew with us. So that helped our national account number.
Probably the one challenge point that I see when I look at that is if our if national accounts represent roughly half our business and our business grew at 6% and national accounts grew at 9%, it means the other half of our business is growing in the low single digits, 3% or so. That's a challenge and you see that challenge shine through a little bit in our gross margin. The one positive in that though is as we exit the quarter, that group of local other customers changed from growing around 3% to about 5.5%. So a nice way to finish the quarter. And one of the things that's driving that number up a bit is the CSP investments we made last year.
And that group of products are growing about 10.5% in the Q1. With that, I'll turn it over to Holden.
Great. Thank you, and good morning. Before jumping into the quarterly results, I do want to remind the listeners that, as Dan said, we closed the acquisition of MANSCO on March 31. So what this means is our Q1 income statement is not going to reflect any of Mansco's revenues or costs, but our balance sheet will include the assumed working capital and assets. So bear that in mind and we'll call out where necessary when we're removing that information.
But flipping over now to Slide 5. As Dan has covered on Slide 3, our total EndDaily sales in the Q1 of 2017 were up 6.2%. That's a nice acceleration from up 2.7% in the 4th quarter. We do estimate that the benefit of the shift of Good Friday from March into April this year was about a 50 basis point benefit to the quarter. But regardless, even adjusting for this, the Q1 was the strongest that we've seen in the last 2 years.
And frankly, that strengthening was also evident through the quarter with March finishing up 8.4%. Now that does probably include about 100 basis points to 150 basis points benefit from holiday timing in the month in particular. But again, we just continue to see acceleration during the period. On Page 5 of the presentation, first, the point is that the backdrop against which we're operating, it really did continue to improve in the quarter. The Purchasing Managers Index in the U.
S, which still represents 88% of our revenue, that averaged and improved to a pretty healthy reading of 57% in the period. Industrial production returned to growth with an even stronger showing from key subcomponents like primary metal, fabricated metal and machinery areas that are more pertinent to our business. And this broadening of industrial demand was reflected by the fact that, as Dan alluded to, a significantly greater number of our stores were actually growing in the Q1 relative to the 53% to 54% pace that had been set through 2016. This general improvement showed up in other metrics that we track. Again, our fastener line returned to growth, finishing up 0.8% in the quarter.
Growth at our largest customers, as reflected by the national accounts, accelerated to be up 9% in the quarter, and that included up 11.5% in March. Growth among our manufacturing customers accelerated to be up 6.4%, and our construction customers also returned to solid growth being up 4.4% in the quarter. The tone from the regional vice presidents mirror these improvements. There remains a great deal of enthusiasm around oil and gas. And during the quarter, the outlook for the general manufacturing space and the construction space also improved even as the quarter wore on.
The only laggard we could see would be manufacturing that's going into transportation markets, things like heavy duty truck, rail, etcetera. But other than that, frankly, on the whole, customer demand strengthened and broadened throughout the quarter, and we remain encouraged about the near term trend. Now flipping over to Slide 6. Our gross margin was 49.4% in the first quarter, which is down 40 basis points versus the Q1 last year. And we've discussed before the ramifications of the relative growth in our non fastener and large customer mix in the short and intermediate term.
And that dynamic probably explains about 30 basis points of the decline in gross margin this quarter. The remaining drag can be attributed to a couple of things. 1st, net freight expense remained a challenge in the Q1. That said, I do want to note that the freight revenue actually rose on an annual basis for the first time since the Q1 of 2015. On top of that, while the freight expense was a challenge, we did see the overall expense improve in the Q1 relative to where we were in the Q4 and the Q3 of last year.
So again, that was an impact on our gross margin, but we saw some signs of improvement there. Secondly, we did incur some costs in the period related to an inventory tracking initiative that we have in some of our non U. S. Markets. These two things were partly offset by growth in the sales and margin of our Fastenal Brands products.
But collectively, if you take the impacts of these latter items, they were relatively modest. And frankly, if we ignore mix and just look at our fastener and non fastener lines, margins were actually stable to slightly higher in the period. As it relates to pricing, there was not any meaningful impact from that source in the Q1. Now our operating margin was 20.3% in the Q1. That's down 10 basis points on a year over year basis.
But again, given that our gross margin was down 40 basis points, frankly, we believe our organization did a really nice job leveraging operating expenses in the period. I'm looking at a couple of numbers to make the point. Employee related expenses were up 3.7%. This is well below sales growth and that's despite the increase in bonus comp that Dan referred to. It's a result of our being able to grow our revenues with a 1.7% decline in our FTE headcount.
I know we did add almost 200 new employees in the Q1 over the 4th. And frankly, if demand remains strong, we would expect that headcount to keep rising. However, we are committed to being disciplined with the headcount and continuing to leverage this line. Occupancy related expenses were only up 1.2% in the quarter. Now we've had 146 net store closures since the Q1 of last year and that includes 23 this Q1.
And that's a result in the flattening of the store occupancy expense. The modest increase in cost then is mostly attributable to vending growth. The higher selling transportation related expenses were influenced by really was a 23%, 24% increase in the price of diesel and unleaded fuel in the period versus last year. The incremental margin in the Q1 was 18.5%. However, we had been able to had we been able to hold the gross margin steady, this would have been well north of 20%.
And we continue to believe that assuming a stable gross margin, we can achieve 20%, 25% incremental margins at low to mid single digit growth and 25% plus incremental margins at mid to high single digit growth in 2017. Flipping to Slide 7. We generated $210,000,000 in operating cash in the Q1. Now 1st quarters are seasonally stronger as the period's tax is not due until April, but by any measure, this was a record for any quarter. The amount also represents 156.8 percent of the quarter's net income, which is above last year's 131.9 percent.
Better earnings contributed as did working capital, which I'll address in a moment. The net CapEx was 19,100,000 and that's down 34% on lower spending on CSP 16 and DC Automation. As a result, our first quarter free cash flow was $191,000,000 up nearly 39%. We used the proceeds to pay down $93,000,000 to pay $93,000,000 in dividends. We obviously acquired Mansco and we still were able to lower our debt in the period by $25,000,000 to $365,000,000 at the end of Q1.
Our debt to total capital at the end of the quarter was 15.6%, modestly below the 16.9% a year ago and 16.8% in Q4 of 2016. We view our balance sheet as conservatively capitalized with ample liquidity to continue to invest in our business and pay our dividend. In terms of the working capital, we're really comfortable with where the numbers came out. Receivables growth, if you exclude MANSCO, was up about 6.5% in the quarter, and that was consistent with the growth in sales. Inventory, if you exclude MANSCO, was up almost 3% in the Q1, but it was flattish sequentially.
And this reflects the absence of last year's heavy CSP related inventory investment. It also reflects though just greater productivity from our distribution centers and I think more energy enterprise wide focusing on this line. Payables, if you exclude Mansco, were down about 19%. Last year's payables reflected the aggressive inventory investment we're making for CSP 16, so we had an easy comp there. The Q2 of 2017 should have seasonally lower operating cash flow, but better earnings in the absence of CSP spending suggest good cash flow for the full year.
Similarly, we continue to anticipate lower CapEx in 2017 of approximately $120,000,000 due to less spending on the DC Automation and the lease lockers. That's all we have for our formal presentation. And with that, we'll turn it over to the operator for questions.
Our first question comes from David Manthey with Baird.
Hi, good morning. Thank you. Good morning, Dave. First of all, Holden, I think you said that gross margin within the fasteners and the non fasteners were each higher, but the mix was the thing that drove that 30 basis points of the gross margin degradation. Did I catch that right?
That's correct. If you look at just fasteners and non fasteners without considering sort of the mix of those, you had margins that were slightly higher in both cases.
Great. Okay. So as it relates to gross margins, two questions here. First, I'm wondering if you can help us understand the range of gross margin from sort of highest product to lowest. And not to get specific on what those percentages are, but just so we understand the delta between the high and the low.
And I'm thinking sort of the eightytwenty rule here, products you sell every day, not manufactured or modified products, but just sort of general products available for sale. Could you help us understand what the difference is between the high and the low? And then the second part of the question is, you mentioned that if you can keep the gross margin flat, you can get 25% plus contribution margins. Assuming that this mix shift that's going on is pretty much a secular trend given your growth initiatives. If you're able to keep gross margin flat, what would be the mechanism that would get you there that you haven't been able to achieve over the past several years?
I'm going to chime in and help hold on with that question just given my years. First off, David, if you've known from prior conversations, range of margins in our business are quite dramatic. Depending on are you selling something that's a relatively low value convenience pack item or something in our store that is I need it right now and price really doesn't matter, I just need that item to I'm basically brokering a transaction and I'm getting paid
a fee for brokering and
I'm buying a pallet of this product or something. So I mean, the ranges can be from the teens to 80%. I mean, if you really want to get crazy with it. But if you look at the bulk of our business, you really have a range that goes from probably the mid-30s to the low-60s. And our faster product line runs in the 50s.
Our non faster products as a group run-in the 40s. And that kind of gives you some semblance of it. And you can see that play out when you're looking at a lot of our competitors in where their gross margins are relative to the products they sell. And the only wildcard I'd throw into that would be the fact that in our industry, we're a little bit unique in that we have one of the lowest cost structures for freight. And we all sell a product line that by and large, a lot of items have relatively low value per pound.
So freight becomes a big deal and that's a structural advantage we have for years to come. If you look at some of the things that we have done or can do to manage to offset a piece of that mix shift. And I think it's just that we will be able to offset piece of it over time because we've talked about our on-site strategy and what that means just like we talked about our vending strategy or we talked about our non fastener strategy 10 20 years ago. All those things over time lowered our gross margin. And the way we offset it, one is by better sourcing, one is by structurally challenging ourselves to lower our trucking costs.
And those are things we've done very effectively over the last 20 years. A third one is continuing to grow our exclusive brand offerings. And so it's really a case of looking at it and saying, here are our branded supplier offerings and working closely with those brands to grow that business. But over time, maybe narrow some of those brands. The other one is having a strategy for our exclusive brands.
Today in the non fashion world, exclusive brands are about 20% of our revenue. If we were looking at that a decade ago, it was probably 10% of our revenue. And I really don't see a reason why that can't be closer to 30 at some point in time. So it's continuing to challenge and carve out different pieces. And you can bring a cost savings to your customer and improve your gross margin at the same time.
That's helpful, Dan. Thank you and best of luck over the next 50 years.
Thank you.
Our next question comes from Ryan Merkel with William Blair.
Hey, thanks. Good morning, guys.
Good morning, Ryan.
So I'm going to follow-up on Dave's question. I guess we're all sort of wondering, you mentioned that mix was a 30 basis point year over year headwind. So should we assume that that continues for the rest of the year? Or is there something that you're thinking about that could lessen that
impact? I think the given where our mix is going, I think you could look to us every year to probably have a headwind like that. I mean, our growth drivers, when you think about on-site and safety and vending and things like that, I mean, they lend themselves to that. So do I think that given where we're seeing our growth that that is a reality each quarter of this year it is. Now as Dan alluded to, we still hope that there are some things that are going to contribute to somewhat better gross margins.
Exclusive brands is something we talk about a lot. I called out the freight a little bit because again, while freight was a bit of a drag in the Q1, there were some signs that perhaps the freight picture is getting a little bit better. And hopefully, as we go into Q2 and Q3, we'll make further strides on that to help us sort of dig into that more structural decline, if you will. So I think the answer is yes, that structural mix issue is certainly there. But we think that we have means by which to dig into that, if you will, and improve.
Also bear in mind that we're coming into the Q1 gross margin. When we think about the decline versus the Q4, some of that reflected the fact that the Q4 was an extremely strong period. And we went and looked at a couple of things. I mean, mean, one thing we looked at was Q4 of 2016 was up 40 basis points over the 3rd quarter. If you look back historically at what 4th quarters typically do against 3rd sorry, it was 5 I'm sorry, 50 basis points against it.
If you look back historically at what Q4 typically looks like against Q3, it's been more like a 60 basis point decline. And last quarter, we called out, we didn't deleverage the trucking network as much as we historically perhaps have. And we had a number of other things that were small individually, but added up that just went our way. And so I think a better way to think about the quarter about the Q1 number is, historically, if you look at how Q1 plays out versus the prior year's Q3, we were actually up 10 basis points versus last year's Q3. And historically, we're down a couple of 20 basis points or so, again, the preceding 5 years.
So we believe that we should be able to dig more into that structural decline than we did this quarter. But we feel like we're making some progress on the freight, on the EVs and things of that sort. And yes, we don't view this as a degradation in our margin picture by any means. I'll just add
a couple of thoughts to that. So Q4 excuse me, Q3, we were at 49 0.3%. Here in the Q1, we're at 49.4%. I always look at 4th quarter as being noisy, whether it's up or down. The other thing is, if you look at our the $60,000,000 in growth we've had in the last 12 months, 50% of that came from either on-site or vending.
And so there's a certain weighting that goes in there and we need to be executing better every day to offset a piece of that waiting. When I look at the margin in the Q1, the only thing that I'm troubled by is there's about 10 basis points to 15 basis points in there that I just personally frustrating. But I think we're executing quite well.
Okay. Well, that's helpful. So a few things go your way, your framework for 25%, 30% incremental margins at mid single digit, high single digit growth, that's still plausible for this year, but you do need to freight and you probably need mix help you a little bit. Is that fair?
Well, I mean, next two quarters, our comps changed quite dramatically. And because we still were in a relative if you think what was going on in 2015 and the early part of 2016, we were getting traction on the on-site model. We were correcting some getting some traction and fixing some things and some customers were improving from the standpoint of our vending model. So if you think of the growth that's been occurring in the last 12 months and how that compares to the components of our business that were there in the 12 months prior to that, Q1 of 2016 is kind of that one of those half last high watermarks. And again, every year I will I ignore Q4, whether it's a good or bad number, because I don't think
it's indicative of much of anything. But yes, the commentary around the incremental margins is really to try to make a point that we believe from an operating expense standpoint that we can leverage those lines. And that's despite the fact that we are as we grow, obviously, we have that shock absorber effect coming from incentive comp and that sort of thing. But the point about the sort of the leverage in those incremental margins is, we feel that we can continue to leverage those lines. And we did a nice job leveraging those lines in Q1 and we think that we'll continue to do a good job leveraging those lines.
And yes, if the gross margins cooperate, and we do have some easier gross margins to compare against in Q2, Q3. But if the gross margins are stable, then we think that we can get the kind of incremental margins that we've spoken about.
Got it. Understood. Thank you.
Our next question comes from Scott Graham with BMO Capital Markets.
Hey, good morning.
Good morning, Jason. Obviously, a little bit more
on this operating leverage thing. So if you were to sort of sketch out how you generate operating leverage, gross income versus your O and A expenses, Is there a way to look at this with sales, whether your sales base where it is and where the trends are going, mid to high single, does that give you is that more of a gross margin thing, leverage or SG and A and then sort of a higher level or let's say low to mid single, does that switch between those two lines? Could you kind of maybe sketch out how you look at
that? So again, the guidance that we sort of given on that is if we hold gross margins stable then we think that we can get those types of incremental margins just by leveraging the SG and A as we grow. So when we envision discussing those incremental margin levels, I mean that really talks about leveraging our SG and A more so than the gross profit. And again, it's we saw some good signs of that. We talked a little bit about how employment grew and occupancy grew from a cost standpoint.
But if you really look at it, when we think about like sales per head, for instance, that was up 10% during the quarter, right, because we grew revenues nicely on slightly lower FTE. And that's those are sort of the keys to how we get the type of incremental margins that we hope to get. But the discussion that we've had was really wanted to address our ability to leverage our operating expenses and intending to hold gross margin flat. So if we can achieve significant improvements in our gross margin, I think that that's additive. But again, that's working against the structural mix that we've spoken about.
Yes. I guess I get that Holden, but where I guess where I'm coming from on this is that if you're putting more stuff in a box or putting more boxes in a truck, there should be gross margin leverage on that too, right?
Well, that would be the leverage on the freight side in that you're having better utilization. First off, we have really excellent utilization of our trucking network today. And so it's not so much about you putting more boxes into a truck. It's those boxes you're putting into the truck, what customer are they going to? What's the nature of the business?
If it's a box an item that's going into a vending machine and it's a maybe it's a safety product, it's going to have a different margin profile than if it's a box of fasteners that's going to an MRO user. And so it's really depending on what that box is destined for. The other thing
to remember is as a distributor, the very large majority of the cost that runs through COGS for us is simply the cost of the product. So there may be pieces within COGS that we can get leverage on. But at the end of the day, the very large majority of what goes through cost on COGS is going to be the cost of the product.
Okay. Got you. And then follow-up question essentially is on share repurchases. Is there a point in time? Is there I'm sure you work this carefully through and ROIC analysis and all of that.
Is there some type of trigger for share repurchases in 2017 that you envision?
I'll respond to that one. We have no trigger price that says we'll buy back or we won't buy back. That's a conversation we have with our Board on a regular basis. We have not been in the market for some time. Historically, we've preferred to use our excess cash from the perspective of investing in the business, investing in our growth.
And if in periods where we're not growing enough to use up all the cash we generate, because the cash we generate is quite attractive. History has said the bulk of that cash we return to our shareholders in the form of dividend. That's just the way we've structurally handled over time. Our earnings our excuse me, our dividend release went out last evening, gives a good 10 year history to give you a perspective on that. No secret to anybody in this call, our stock carries an attractive multiple.
And the periods where you've seen it, we've had some periods where the multiple fell off and we took some excess cash or we took some we incurred some borrowings to buy back some stock. But we focus our energy we really focus our time and energy on growing the business long term because we think that's in the best interest of our shareholder. And in the short term, we return a fair amount of
the cash through a dividend. And recall that, I mean, last year we had the lease locker program show up, which is not something that's expected to begin the year. And our first priority is to use our resources to be able to grow. And so we had a very nice quarter in Q1 by any measure. Q2 won't be as high.
And we use some of those resources to acquire a great company.
And When you say Q2 won't be a cycle, you're talking about the cash. In terms of the cash, correct.
Relative to earnings, just because of the double tax payments. But in Q1, we used the resources to buy a great company. And as a result, our leverage is in basically the same area that it has been for some time. And at this point, we prefer to kind of look for other opportunities internally to spend our resources on. And like it did last year, you never know when they're going to come up.
So that remains the priority and what we're looking for.
Okay. Thank you.
Our next question comes from Robert McCarthy with Stifel.
Good morning, everyone.
Hey, Rob.
Good morning. Hey. One housekeeping item, which I hold I think we discussed, but just on page 10 of your well applauded new slide deck, You have a new benchmark out. And just remind, I think, myself and investors, this is a new benchmark to the one you've published, right? It's going to be taking into account the 5 year average from 2012 to 2016 as opposed from 11 to 15.
Is that correct?
That's correct. In last year's documents, we had 2 benchmarks that we were referring to. 1 was sort of our historical way of looking at it, which looked at most years from 1998 and then the other one was sort of the 5 year average that last year would have included 2011 to 2015. As the calendar rolled forward, so did our 5 year average into 2012 to 20 16, and that's what we're focusing on now for a benchmark.
Perfect. Okay. I just want to make sure people saw that. And I guess in terms of on the faster side of the house, what's your expectation for could you review and I do apologize if you already kind of walk through this, your expectations for what you saw for price in the quarter in terms of growth? And then what are your expectations for the balance of the year in terms of what we could see some price on the faster side of the house?
Right. So pricing was not a meaningful factor in the quarter. Price is something that we just continue to review at this point. Now we obviously have seen some of our competitors take price increases. Many of them have talked about it publicly.
We've seen charts where prices for metals are clearly up. So it's hard to conclude anything other than the environment today is certainly more inflationary than it's been in quite some time. But that said, Fastenal has the advantage of being a FIFO company with a pretty long supply chain for fasteners. And that means it takes a while for cost to hit our COGS. And that gives us the ability to evaluate how durable the marketplace is for pricing.
And if you remember last year, there was a time or 2 where we thought pricing could occur and then it wound up not materializing for probably demand reasons. And so it's nice to be able to get that sort of look, if you will. I think the real question at this point is, if the marketplace, in fact, does look like it's going to be willing to accept pricing, is that something that we believe we can get to protect our margins and protect our place in the market? And the answer is, we think that we can, but we do have some time to evaluate it at this point.
Mean, just looking at the math, would it be would there be any way that those price actions, say, the inflation did while attractive head in this context for the balance of the year, do you think you could overcome the mix headwind to gross margins? Would that math work or not?
In the short term? Well, sure would.
Yes.
There's enough juice there for that to occur.
Yes. But keep in mind, our inventory turns twice a year roughly. So mean it would be a short lived event.
All right. And then the last question because I know you're going to move on to others on the call. Could you just talk about perhaps March in terms of your expectations kind of exiting February, taking into account the Easter shift, how you felt about the months and how you feel about kind of the prospects exiting the month?
We felt better and better, I think, as the quarter wore on.
And the month.
And yes, and the month wore on. The when I think about the feedback that we're getting from our regional vice presidents about their marketplace, We talked about how in December, we started getting some pretty stories about the oil and gas business that weren't translating on the ground. But by the time you got to February, you're starting to see the oil and gas business really sort of pick up again and showing itself in results. And frankly, through March, that continues to be the case, and I think there remains enthusiasm from that area. But what we began to see begin to gain some real excitement as we exited February and then into March was the manufacturing side and frankly the construction side.
There seems to have been a consensus that has come together through March from our regionals that construction is doing much better. And I think you can see some of that in the growth of the CSP products. I mean, the fact they grew 10% plus in the quarter, I think, tells you something about construction as well. So the even as recently as December, the marketplace didn't feel that great. But as we proceeded through the quarter and through the month of March, there was clear progress and improvement in the tenor of the marketplace.
Was your rebudget into the Easter shift going into April? I mean, how should we think about it? Was did it rob 200 basis points in March? Or it was actually more favorable March rather? Will we expect further deceleration in April?
In the quarter, the shift cost us about 50 basis points. In March, it cost us about 150 basis points. Right.
But it did cost
you, it was crazy.
Yes. It's probably around a 5 it's probably around a third of a day, if you think about it, Rob, historically. So it gave us a probably around $5,000,000 lift in March and you probably gave it back in April, right.
Forgive me for being so problematic on Easter. All right, thanks.
Our next question comes from Robert Barry with Susquehanna.
Hey, guys. Good morning.
Good morning.
Thanks for all the nice earnings day materials. I wanted to follow-up on this margin sorry, op leverage outlook. You keep referring to stable gross margin, but just given where the growth is coming from, it also sounds like we're going to continue seeing some gross margin pressure here for a little while. So is the bottom line that for now, op leverage is likely to be more in this high teens level or maybe even a little lower given the headcount has started to grow?
Yes. I mean, again, the motivation was to just emphasize the degree to which we think we can leverage operating expenses, right? So that's why we talk about it with the presumption that we hold gross margins stable. Now as Dan alluded to, gross margins are much higher in Q1 than they'll be in Q2, Q3. So we'll see what happens there.
But we remain committed to be able to achieve the leverage of the operating expenses. And we're going to just keep doing work to try to dig into the structural decline in the gross margin that you start with. And we certainly have had that conversation with our regionals and our folks. And so I think that there was some early signs within the freight side that maybe there's some progress there. So we're just going to have to keep working on improving the gross margin metric, but we do anticipate getting leverage.
With regards to the headcount, we would expect that to move up as demand goes up and also as we continue to accelerate our on-site signings. We on-site signings take some folks in the store and we'd like to backfill those and really get a lot of energy in that store to keep growing from the new base. And so as growth and our growth drivers continue to move up, then we would expect to add heads. But again, we saw some good productivity in Q1 and we're not just looking to give that productivity up. We got to do some things to support our growth, but we're not looking to begin to dilute that productivity by adding heads too quickly.
Got you. I mean, I don't want to beat a dead horse here, but just to connect the dots. I mean, it sounds like if gross margin is stable, you can lever in the 20s. If gross margin continues to move down, then we're probably levering in the teens. Is that fair?
A couple of things I'll throw in. It depends on what your top line growth assessment is. In previous calls, we've said south of 6%, 7%. It's difficult with the cost components we had coming out of 2015% and into the 1st part of 2016. That picture improves and lowers it some and that's why you saw our ability to grow our operating expenses roughly 5.5%.
And if you think about that, you have to take a look at what drove the operating expense increase when you look at Q1 to Q1. I often try to pull things into buckets, so I can think about them easier. 25% to 30% of that increase is incentive comp, whether it's in a commission in a store, a bonus paid to somebody outside the store, the profit sharing contributions, those things that are expanding as our profit growth improves, that's really what drives our labor cost increase right now. It's not so much about headcount because the headcount you're adding typically in a period like this, a lot of it is more on the entry level side. So you could manage through that.
If you think of what are the next what's the next biggest group of costs that drove our expense up. We've been it's no secret, we've been increasing our IT spend over a number of years. We have some pieces that are turning on actually this quarter that will help our store, our on-site model quite meaningfully. We're turning on our new website up in Canada. So there's things that we're turning on that are cycle investments.
Those investments we've been making and I've been going through our P and L. And the other component when I think of that second bucket that was a jump from last year was the fuel that Holden talked about. It's a big increase in our cost component. That piece of it normalizes in Q2, because last year from Q1 to Q2, fuel prices jumped up dramatically. So we'll lap that in Q2, but we haven't lapped it in Q1.
The final driver of increases is the continued success we're seeing in vending. When we add those vending machines, there's an expense that shows up in our occupancy around the cost of the equipment. So those things are really what's driving it. And outside of that, managing the expense really, really quite well. And so it puts us in a position when we go into the deeper part of the year, I believe, to be a little bit more optimistic.
All right, guys. Well, thank you
for all that color. Appreciate it.
Thanks, everybody. It's about 45, 46 minutes past the hour. Thank you for your interest in Fastenal. I'll close the way I started. I'm pleased quite frankly with the quarter from the standpoint of the business is executing better.
Our end markets are giving us some lift. We're giving ourselves some lift. Thank you. Thank you.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a