快扣 (FAST) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, welcome to the Fastenal Company Q1 2017 Earnings Results Conference Call.

(Operator Instructions)

I'd like to introduce your host for today's conference, Ms. Ellen Trester, you may begin.

Welcome to the Fastenal Company 2017 First Quarter Earnings Conference Call.

This call will be hosted by Dan Florness, 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 a general 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 Florness.

Good morning, everybody, and thank you for taking some time today to listen to our first quarter 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 2 pages of commentary, which I believe are Pages 3 and 4 in the book, if you're looking at those pages.

Earlier this morning, and this is typical with every quarter end, at 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 first quarter of 2017, we came in at roughly 101% of goal, 100.7% is the exact number, but roughly 101% of goal.

And we hit or exceeded goal every month for the first quarter.

I mention that because part of growth is a mind-set, an attitude.

And I think we have a great mind-set 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 felt was noteworthy is, if you look across our 2,400 store locations, our 400-plus Onsite 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 first quarter, over 60% of our stores, about 62% of our stores grew.

The last time we did better than that was in the first quarter of 2015.

And I cite that because as we transitioned from the first quarter of 2015 to the second quarter 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 onto the flipbook here.

First item mentioned, demand gains drove daily sales growth of 6%, 6.2% annually.

Again our fastest growth since the first quarter of '15 so that 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 second quarter of 2015.

And that business grew, returned to growth in the first quarter.

And that business represents over 1/3 of our revenue, about 36%, 37%.

Our non-fastener 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 Fastenal, fasteners and non-fasteners.

Our pretax earnings grew 5.5%.

It's the fastest rate of growth for us since the second quarter of '15.

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 '17 and '18 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 a historically low number in 2016, expanded nicely in the first quarter, because our incentive comp expands as our gross profit dollars and our earnings dollars grow.

And so it expanded nicely, and that ate in to 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.

First 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'd talked about on our first quarter call.

Or -- excuse me, our January call.

And we didn't have the CSP 16 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 Manufacturers Supply Company, or Mansco.

It's about a $50 million distributor, so for the next 12 months, we'll enjoy about an extra point of growth from this acquisition.

Flipping onto our growth driver update on Page 2, some things I think are noteworthy.

We got to a nice start on our Onsite signings.

We signed 64 in the first quarter.

We currently have 437 active Onsite locations.

That's a 51% increase from the 289 we had at the end of last year.

And our goal remains to sign 275 to 300 Onsites 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.

That's a 17% increase from first quarter of last year.

I didn't go back and look at it in detail, but those -- it was either the early part of 2013 or during 2012 when vending initially exploded for us from the standpoint of we really gained 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 first quarter.

But again, very good traction as we enter the year and as 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 first quarter.

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 first quarter income statement is not going to reflect any of Mansco's revenues or costs, but our balance sheet will include the assumed working capital asset.

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 had covered on Slide 3, our total and daily sales in the first quarter of '17 were up 6.2%.

That's a nice acceleration from up 2.7% in the fourth 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 first quarter 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, 150 basis points benefit from holiday timing in the month in particular.

But again, we just continued 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 sub components 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 first quarter relative to the 53% to 54% pace they have 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% 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, et cetera.

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 first quarter last year.

Now 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.

First, net freight expense remained a challenge in the first quarter.

That said, I do want to note that the freight revenue actually rose on an annual basis for the first time since the first quarter of 2015.

On top of that, while the freight expense is a challenge, we did see the overall expense improve in the first quarter relative to where we were in the fourth quarter and the third quarter 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 in some of our non-U.

S. markets.

These 2 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 it to pricing, there was not any meaningful impact from that source in the first quarter.

Now our operating margin was 20.3% in the first quarter.

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, and it's a result of our being able to grow our revenues with a 1.7% decline in our FTE headcount.

Now we did add almost 200 new employees in the first quarter over the fourth.

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 first quarter of last year, and that includes 23 this first quarter.

And that's resulted 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 it was a 23%, 24% increase in the price of diesel and unleaded fuel in the period versus last year.

The incremental margin in the first quarter 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 million in operating cash in the first quarter.

Now first 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% of the quarter's net income, which is above last year's 131.9%.

Better earnings contributed as did working capital, which I'll address in a moment.

The net CapEx was $19.1 million, 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 million, up nearly 39%.

We used the proceeds to pay down $93 million -- or to pay $93 million in dividends.

We obviously acquired Mansco, and we still were able to lower our debt in the period by $25 million to $365 million 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 fourth quarter of '16.

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 first quarter, 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 were making for CSP 16, so we had an easy comp there.

The second quarter of 2017 should have seasonally lower operating cash flow, but better earnings and 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 million due to less spending on the DC automation and the leased lockers.

That's all we have for our formal presentation, and with that, we'll turn it over to the operator for questions.

(Operator Instructions) Our first question comes from David Manthey with Baird.

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, 2 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 80-20 rule here, products you sell every day, not manufactured or modified products, but just sort of general products available for sale.

Could you just 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 to 25% plus contribution margin.

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 Holden out a little with that question just given my years.

First off, David, if you've known from prior conversations, the range of margins in our business are quite dramatic, depending on, are you selling something that's a relatively low value, a 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 palette 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 fastener product line runs in the 50s.

Our non-fastener 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 and 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 a piece of it over time because -- we've talked about our Onsite strategy and what that means.

Just like we talked about our vending strategy or we talked about our non-fastener strategy, 10 and 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 bands -- oh, excuse me, brands.

The other one is having a strategy for our exclusive brands.

Today in the non-fastener world, exclusive brands are about 20% of our revenue.

If you 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.

Our next question comes from Ryan Merkel with William Blair.

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 Onsite 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 talked about a lot.

I called out the freight a little bit because again, while freight was a bit of a drag in the first quarter, 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 fourth quarter, some of that reflected the fact that the fourth quarter was an extremely strong period.

And we went and looked at a couple of things.

I mean, one thing we looked at was, fourth quarter of '16 was up 40 basis points over the third quarter.

If you look back historically at what fourth quarters typically do against third -- sorry it's 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 first quarter 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 EBs and things of that sort.

And yes, we're -- 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 fourth quarter -- or excuse me, third quarter, we were at 49.3%.

Here in the first quarter, we're at 49.4%.

I always look at fourth quarter as being noisy, whether it's up or down.

The other thing is, if you look at our -- the $60 million in growth we've had in the last 12 months, 50% of that came from either Onsite 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 weighting.

When I look at the margin in the first quarter, the only thing that I'm troubled by is there's about 10 to 15 basis points in there that I find just, personally, frustrating.

But I think we're executing quite well.

Okay.

Well, that's helpful.

So if few things go your way, your framework for 25%, 30% incremental margins at mid-single digits, high single-digit growth, that's still plausible for this year.

But you do need the freight and you probably need mix helping you a little bit.

Is that fair?

Well, I mean, next 2 quarters, our comps change quite dramatically.

And -- because we still were in a -- if you think of what was going on in 2015 and the early part of '16, we were getting traction on the Onsite 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 '16 is kind of that one of those half -- last high watermarks.

And again, every year I ignore Q4, whether it's a good or bad number, because I don't think it's indicative much of anything.

So 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 and 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.

Our next question comes from Scott Graham with BMO Capital Markets.

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&A expenses, is there a way to look at this with sales, whether you're sales is basically 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&A.

And then sort of a higher level or, let's say, low- to mid-single, does that switch between those 2 lines?

Can you kind of maybe sketch out how you look at that?

So again, the guidance that we've sort of given on that is, if we hold gross margin stable, then we think that we can get those types of incremental margins just by leveraging the SG&A as we grow.

So when we envision discussing those incremental margin levels, I mean, that really talks about leveraging our SG&A more so than the gross profit.

And again, it's -- we saw some good signs of that.

The -- 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 we 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 the 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're 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 or 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 into 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 the follow-up question essentially, is on share repurchases.

Is there a point in time, is there a -- I'm sure you've worked this carefully through an ROIC analysis and all that.

Is there some type of trigger for share repurchases in '17 that you envision?

I'll respond on that one.

We have no trigger place 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 -- excuse me, our dividend release that went out last evening.

It's a good 10-year history to give you a perspective on that.

No secret to anybody on 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 -- 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 part -- amount of cash through dividends.

And recall that, I mean, last year, we had the leased locker program show up, which is not somethings 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 used some of those resources to acquire a great company.

And...

When you say Q2 won't be as high, you're talking about the cash relative to earnings.

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.

Our next question comes from Robert McCarthy with Stifel.

One housekeeping item, which Holden, 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 than the one you've published, right, that's going to be taking into account the 5-year average from '12 to '16 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.

One 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've included 2011 to 2015.

As the calendar rolled forward, so did our 5-year average into 2012 to 2016, and that's what we're focusing on now for a benchmark.

Perfect.

Okay.

I just want to make sure that people saw that.

Now I guess, in terms of -- on the fastener side of the house, what's your expectation for -- could you review, and I do apologize if you already kind of walked 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 where we could see some price on the fastener 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 costs 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.

I mean, just looking at the math, would it be -- would there be any way that those price action, say, the inflation did rear its -- well, 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?

Well, in the short-term?

Well, sure it would.

Yes.

So there's enough juice there for that to occur?

Yes, but keep in mind, our inventory turns twice a year, roughly.

So it would be a short-lived event.

All right.

And then last question because I know you've got 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 feel about the month 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 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 were 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.

Would you read much 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, would we expect further deceleration in April?

In the quarter, it -- the shift cost us about 50 basis points.

In March, it cost us about 150.

Right.

No, but it did cost you let's say -- yes.

It's probably around 5 -- it's probably around 1/3 of a day, if you think about it, Rob, historically.

So it gave us probably around $5 million lift in March, and you probably give it back in April.

Right.

Our next question comes from Robert Barry with Susquehanna.

I wanted to follow up on this op 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?

That's why we talk about with the presumption that we hold gross margins stable.

Now as Dan alluded to, gross margins were 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 said I think that there were 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 Onsite signings.

We -- Onsite signings take some folks in the store, and we 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 in 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 something 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 '15 and into the first part of '16.

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 some buckets so I can think about them easier.

25%, 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's the next the 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 Onsite model quite meaningfully.

We're turning on our new website up in Canada.

So there's things that we're turning on that are sizable investments.

Those investments we've been making and have been going through our P&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.

We 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.

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 given us some lift.

We are giving ourselves some lift.

Thank you.

Thank you.

Ladies and gentlemen, that does conclude today's presentation.

You may now disconnect, and have a wonderful day.