Fastenal Co (NASDAQ: FAST) Q1 2023 earnings call dated Apr. 13, 2023

Corporate Participants:

Taylor Ranta Oborski — Financial Reporting and Regulatory Compliance Manager

Daniel Florness — President and Chief Executive Officer

Holden Lewis — Senior Executive Vice President and Chief Financial Officer

Analysts:

Chris Dankert — Loop Capital Markets — Analyst

Steve Volkmann — Jefferies — Analyst

Ken Newman — KeyBanc Capital Markets — Analyst

David Manthey — Baird — Analyst

Nigel Coe — Wolfe Research — Analyst

Pat Baumann — J.P. Morgan — Analyst

Jacob Levinson — Melius Research — Analyst

Tommy Moll — Stephens — Analyst

Chris Snyder — UBS — Analyst

Presentation:

Operator

Greetings. Welcome to the Fastenal 2023 First Quarter Earnings Results Conference Call. [Operator Instructions] Please note that this conference is being recorded.

At this time, I’ll turn the conference over to Taylor Ranta of Fastenal Company. Taylor, you may now begin.

Taylor Ranta Oborski — Financial Reporting & Regulatory Compliance Manager

Welcome to the Fastenal Company 2023 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 one hour, 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 1st, 2023 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.

Daniel Florness — President & Chief Executive Officer

Thank you, Taylor, and good morning, everybody, and welcome to the first quarter Fastenal earnings conference call. The — this call is a little different for Holden and I today, because we are — we’re at the site of our Customer Expo that just finished up yesterday. And we’re really pleased with the event, a lot of great customer engagement. One thing nice about the event this year is, some of the natural things that — that were occurring, obviously, two years and three years ago, we didn’t have an event because of COVID. Last year, we had an event, but we — we had to limit the attendance and also because of international travel, we had to limit the attendance. This year we didn’t have those restrictions, so we had a great event.

And there were four areas of focus to the theme of the event this year. One was continuing to accelerate our customers’ digital transformation to give them better visibility to what is happening inside their four walls, inside their facilities.

The second one was really securing their supply chain. The world has seen a lot of change and a lot of impacts to supply chains over the last several years and really allowing our customers the opportunity to think about their supply chains continually in a more strategic way as we move forward.

The third was powering productivity. A lot of this digital transformation, understanding the elements of your supply chain, it’s also about bringing productivity to your — whether it’s your production floor or some element of your operation, we provide the tools to do that.

And then the fourth piece was understanding our customers’ goals and sharing with them ways that we can serve their goals when it comes to their journey in ESG. And I think those four points resonated well throughout the event.

Now moving on to the quarter. So, first quarter, we had earnings per share of $0.52, an increase of 10.5% over last year. The team had really strong expense management during the quarter, and pleased with the incremental margin we were able to produce. Despite the fact that, as you saw in our monthly numbers, the March daily sales came in a bit softer. We’re in now our fifth month of ISM below 50, and it had ticked down in March and we’re seeing that in our business, particularly in the fastener side, the OEM piece of the business. And — but despite that, really impressed with our team’s ability to manage through it.

As we’ve talked about in prior years, we’ve done a really nice job of managing pieces of our business if we compare to pre-COVID and post-COVID, and I’m sorry for that beeping in the background, my laptop is herein. But if you look at operating costs as a percentage of sales, in the first quarter of 2019, operating costs were 27.8% of sales. In the first quarter of 2023, they were 24.6%. And it’s really about all the changes we’ve made to the organization, A, our average branch is larger today than it was back in 2019, more of our business is coming from Onsite. We’ve done nice job of digitizing our business to bring efficiencies to it and you see that shining through.

The other piece is, as we understand better, our engagement with our customer and their needs and our supply chains have improved globally. We’ve also been able to not only lower our days on hand of inventory from what we were seeing one year ago as we in six months because we deepened our inventory, but where our business was pre-pandemic. So, we’ve taken about three weeks worth of inventory out of the network over that entire time frame, and really impressed with our team’s ability to do that.

Finally, if you manage your business well, manage your expenses well, managing your working capital well, the distribution business, you see that show up in your cash flow. So, our operating cash flow was $389 million which was 132% of earnings and was 70% higher than a year ago. And so about $160 million of additional operating cash that we generated in the quarter. Our capex — net capex is very similar in both periods. So a very strong free cash flow, which puts us in a position to invest in the business or return to our shareholders. And we continued that pattern, and was able to pay out a nice dividend in the first quarter. And then last night, we just announced the second quarter dividend of — of about $200 million a quarter we’re paying out right now in dividends.

Moving to Page 4 of the flipbook. So, Onsite, we signed 89 in the quarter. Active sites finished at 1,674, so about a 16% increase from first quarter last year. If you ignore the transferred sales that come from the branch when we open an Onsite, our Onsite business grew about 20% Q1-to-Q1, so strong performance. We remain steadfast in our intention to sign 375 Onsites to 400 Onsites this year. Number was a little bit weaker in the first quarter and most of that we saw in March. And — but when I think of the engagement going on at the event here the last several days, I feel good about where we’re going to be in the next six months.

If I look at FMI Technology, an incredibly strong performance by the team this quarter. We’ve talked in the past about this idea of we’ve built infrastructure to support a 100 signings per day. And during COVID, our numbers dropped from the upper-70s, low-80s neighborhood as we built-up towards that ability to sign a 100 a day. We dropped down on to 60s and that’s only better way back. Last year in the first quarter, we signed 83 a day. This year in the first quarter, we signed 92 per day. In the month of March, we signed 99 per day. So really strong performance by the team. And you can see that continuing to expand in our platform.

Our FMI for the quarter was 39.4%. In the month of March, we broke 40% for the first time ever. And really pleased and we feel good about our goal of signing between 23,000 and 25,000 for the year. As we’ve seen in prior quarters, we continue to see really strong growth in eCommerce. Recall that last fall that broke 20% of revenue for the first time. I believe this quarter, we’re at about 22%.

And then finally, if you roll all those pieces together, our Digital Footprint came in at 54% of sales versus 47% a year ago. And in the month of May — March, excuse me, we hit 55% and our goal is to drive that to 65% later in the year. Time will tell if we’re able to accomplish that. With a long-term goal of we believe that number is about 85% of our business is going through some type of Digital Footprint.

With that, I’ll turn it over to Holden.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Great. Thank you, Dan. Before diving into the details of the quarter on Slide 5, I wanted to build a little bit on Dan’s earlier comments in his prepared remarks, to offer a little bit of perspective on the overall state of our business. You recall, simultaneous with the onset of the pandemic in 2020, Fastenal accelerated it’s technology deployment and shifted the structure and priorities of our sales effort. Those actions are adversely affecting short-term sales, though we continue to grow our Onsite in FMI basis as well as our Digital Footprint penetration, and we continue to achieve historical levels of market outgrowth. This also adds an incremental annual mix-related gross margin pressure.

However, those changes need to be weighed against the benefits to the rest of our business. Relative to the pre-pandemic business, we have begun to generate meaningful labor productivity and reduce the cost footprint of our facilities. As a result, the incremental margin from the first quarter of 2019 to the first quarter of 2023 of 24% is appreciably greater than what we saw from the first quarter of ’15 to the first quarter of ’19 of 16.2% and we’ve improved our capacity for leverage over time.

At the same time, from the first quarter of ’19 to the first quarter of ’23, our inventory days have declined from 175 days to a 154 days despite inflation and supply chain disruption, and our receivables days have fallen from 56 days to 55 days, despite growth in our national accounts mix. The Blue Team has sharpened our differentiation in the marketplace while sustainably improving the leverage ability of our cost structure and lowering our asset intensity. We’re a stronger, more productive business today than we were prior to the pandemic. And that is very clear in these first quarter 2023 results. So, let’s jump into those.

Daily sales increased 9.1% in the first quarter of 2023. February storms had a modest 20 basis point to 40 basis point negative impact, while currency was a 70 basis point drag. There are several other items affecting sales.

First, pricing continues to moderate. It contributed 290 basis points to 320 basis points to growth in the period, down approximately 290 basis points from the first quarter of 2022 and down approximately 60 basis points from the fourth quarter of 2022. This trend is not a surprise and will likely continue through 2023.

Second, we continue to see weakness in several major retailer customers, our international business and our construction and reseller businesses. These dynamics are unchanged since the third quarter of 2022. Our retailer customers have tightened their belts with respect to facilities and labor, which also affected our non-North American business, along with a strong dollar and geopolitical events. Softer construction reflects the conscious decision we made to position our branches to focus on larger key accounts, which is contributing to better labor leverage.

Third, manufacturing and large accounts continued to perform strongly, reflecting investments in Onsite and changes to our branch structure and sales roles. Even so, we did see a downshift in broader market activity in March as represented by slower DSR growth of 6.8%, including just 2.3% daily growth in fasteners.

Now, one month does not make a trend, it’s too early to have a good read on April, and we don’t have a lot of forward visibility. We do continue to anticipate that we will outgrow our marketplace, which frankly isn’t growing right now. However, the quarter did finish on a softer note.

Now to Slide 6. Operating margin in the first quarter of 2023 was 20.2%, up from 20% in the prior year. The incremental margin — the incremental operating margin was 22.7%. Gross margin was 45.7%, down 80 basis points from the prior year. This decline is entirely due to product and customer mix as we experienced widening sales growth outperformance of non-fasteners over fasteners and Onsites over non-Onsites. Price cost was still negative year-over-year but narrowed meaningfully versus the fourth quarter. The remaining gap is largely in our other products category where pricing actions in the first quarter of 2023 only went into place in February. While in fasteners, lower costing eliminated the negative price cost we experienced in the second half of 2022.

GAAP expenses were higher with inbound shipments declining as we adjusted our stocking to reflect a smoother supply chain. And then on the other side of the ledger, contribution to margin from freight was better than anticipated. We saw annual and sequential declines in both container costs and containers purchased on the import side and record freight revenues allowed for good leverage of our captive fleet expenses. These dynamics are likely to persist for the next couple of quarters.

On the operating expense side, we generated 20 basis points of leverage from occupancy costs as branch closings over the past 12 months produced a slightly lower facility expense. We generated 80 basis points of leverage from payroll expenses. Total incentive pay for the company in the first quarter of 2023 was the second highest on record for a first quarter. However, with pre-tax growth in the first quarter of 2023 being roughly one-third of the pre-tax growth in the first quarter of 2022, total incentive pay for the company was down high single-digit.

Other operating expenses benefited from lower bad debt costs, lower selling related transportation costs and higher profits from asset sales, which was largely offset by higher costs for IT, general insurance and sales related travel. Putting it all together, we reported first quarter 2023 EPS of $0.52, up over 10% from $0.47 in the first quarter of 2022.

Now turning to Slide 7. We generated $389 million in operating cash in the first quarter of 2023, or approximately 132% of net income in the period. I’ll provide a bit more color in a moment, but this improvement in our conversion rate reflects working capital swinging from a significant use of cash in the first quarter of 2022 to a source of cash in the first quarter of 2023. This strong cash flow allowed us to reduce debt in the period, putting net debt at 10.9% in the first quarter of 2023, up slightly from 10.4% in the first quarter of 2022, but down from 14.9% in the fourth quarter of 2022.

Year-over-year accounts receivable was up 7.3% on higher customer demand and an increase in the mix of larger key account customers, which tend to have longer terms and this was partly offset by an improvement in receivables quality. Inventories rose 3.2%. Inflation was not a material contributor to inflation growth in the period. Further, as indicated earlier, normalization of global supply chains is allowing us to unwind a layer of inventory that we intentionally built-up in late 2021 and early 2022, to manage what had been significant product bottlenecks. We believe the process of rightsizing inventory will continue through 2023, with additional releases of cash as the year progresses.

Net capital spending in the first quarter of 2023 was approximately $31 million. Our range for net capital spending in 2023 remains $210 million to $230 million and our first quarter spending being behind that pace reflects timing of expenditures. Over the course of 2023, we expect higher spending on hub investments, fleet equipment and IT equipment.

With that operator, we’ll turn it over to you for questions and answers.

Questions and Answers:

Operator

Thank you. We’ll now be conducting the question-and-answer session. [Operator Instructions] Thank you. And our first question comes from the line of Chris Dankert with Loop Capital Markets. Please proceed with your questions.

Chris Dankert — Loop Capital Markets — Analyst

Hey, good morning, guys. Thanks for taking the question.

Daniel Florness — President & Chief Executive Officer

Good morning.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Good morning.

Chris Dankert — Loop Capital Markets — Analyst

I guess first-off, thinking about your conversations with RVPs right now, how do they feel about adding FTEs or kind of management there? Just how are we thinking about labor management today and growth kind of going forward?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

You know, we’ve talked about labor management with the RVPs really coming into this year. And the premise was, when you look at where the PMI is, when you look at the trend in industrial production, we need to be looking forward and really have a plan to be cautious about hiring.

Now in January and February, I will tell you that demand grew pretty healthy and I think that we added people sort of related to that. In March, obviously, we called out that demand softened a little bit. I would also point out that our hiring ads softened a little bit in March as well. We’ve always talked about how we — we can react fairly quickly to changes that we’re seeing. And so, the message to the field has been, you have to be prepared to adjust for a downshift in demand.

And again, that’s not a message we just conveyed. We entered the year having that same conversation. And I think that they have been really responding by adding resources where they need to add it, by adding the right resources. We continue to see the mix of part timers growing in the overall piece of our business, right. Where we’ve added full timers, a significant portion of those were made in India, right.

So, I think that the organization is focused on the right metrics to understand what they need to be doing from a labor standpoint. I think they’re executing on that. And I was encouraged that as demand slowed down in March, so did the — so did the hiring ads, so I think we’re doing the right things.

Chris Dankert — Loop Capital Markets — Analyst

All right. That’s great color. Thank you so much on that. And then again, just thinking about the CSP growth seems to be lagging a bit more relative to the rest of the business here. Does that change any of the calculus around the pace of closures there or kind of how you’re positioning the business from a channel approach perspective?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

By CSP growth, what are you referring to?

Chris Dankert — Loop Capital Markets — Analyst

Just the non-national accounts piece of the business, obviously under growing national accounts and then Onsite, I guess, my assumption is, most of that is the more traditional branches, correct?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

So, remember that our traditional branches are — they support not only the local businesses that you’re referring to, but they do support the national accounts business as well. But, yes, I think you’re referring to that non-national accounts sector on our release. So, thank you for that clarification.

When you think about what’s happening in sort of the construction and reseller, traditionally there has been a lot of smaller customers there, right. I mean, what confused me is when you talked about CSP, right, CSP was our old stocking model that we began to unwind a few years ago. That CSP was intended to draw in that smaller local construction customer, provide them a high degree of service in the local market and things of that nature. And our priorities in the branches have shifted a little bit, trying to move that customer online and then creating a sort of time to focus on some of those larger customers in the market.

And I can’t say that I’m surprised by what we’re seeing. I think that the relative weakness you see in construction relative to manufacturing, which is again is part of what we’re trying to achieve, I think that that is really — though that’s really related to the difference you’re seeing in the national accounts versus the non-national accounts growth as well. So, I think those things are all related.

Does that get to your question?

Chris Dankert — Loop Capital Markets — Analyst

Got it. That does. I’m able to understand. Thanks so much for the detail there. I’ll leave it there and then best of luck on the quarter, guys.

Daniel Florness — President & Chief Executive Officer

Thank you.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Thank you.

Operator

Our next question is from the line of Steve Volkmann with Jefferies. Please proceed with your question.

Steve Volkmann — Jefferies — Analyst

Great. Thanks, guys. Can I just pull on that thread slightly one more time, Holden. How long do you think that transition takes in the construction type business where you sort of you know move away from some of these smaller customers? I assume that’s a process that lasts a year or two. I don’t know, how long do you think that goes on?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

I don’t love the phrase move away from those type of customers. The truth is, we’re trying to service limited through different model. But setting aside the semantic, you know I suspect — just looking at how that cadence has played out in the preceding, call it, 15 months, I suspect that we’ll probably have some softness in that area, that transition period will probably last the bulk of this year. I think as we get into Q4 and into next year, I think you begin to sort of lap those comps and I think we’re probably in a position where it doesn’t represent the drag on our business that it does today.

So, I think you’re right to look at it as a transition because I think that’s what it is. And once we lap that transition, I think the growth that you’re seeing today in those manufacturing customers, in those large customers, that’s going to really begin to shine as we sort of work through that transition over the next two quarters or three quarters.

Daniel Florness — President & Chief Executive Officer

If — also if you think of the chart we’ve shared in January of each of the last several years, we talk about branch consolidations. We’re near the end of that process. So, if you think about — if you think just about our customer segments, so the customer where we’re highly engaged from a Digital Footprint perspective, we are their supply chain partner, those customers rarely if ever come into one of our facilities. They probably don’t even know where we’re located. And so, if you’re in a market, you consolidate a few locations, you are actually moving further away from this other segment of customer. And so if you look at where we get to then at that ultimate branch count, we’re probably a year away of being at that point. And that ties right into Holden’s comment as well.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Yes. And so looping that back to Chris’ comment earlier, pardon the pun, I failed to mention that. I mean that’s another reason why those smaller customers have been relatively weaker as well, because a lot of times when you go through that branch consolidation Dan indicated, that’s the customer that know why he was visiting that location that would have otherwise been there, so that’s an element of that as well.

Steve Volkmann — Jefferies — Analyst

Right. Got it, yes. Apologies for the semantics. I was struggling for something better unsuccessfully. But can I switch slightly, when you talk about some of the deceleration that you’re seeing, it’s kind of an interesting dynamic, do you have visibility? Do you think your customers are destocking because the supply chains are now better? And so that might be part of what we’re seeing or do you think it’s actual sort of end-market slowdown? And the other overlay that’s interesting is that you would think that production rates would actually kind of go up at your customers as supply chains normalize rather than down. So, I’m just curious if you have any visibility into any of that and then I’ll pass it on.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Yes. So, the feedback from the regionals was really touched on both things that you’ve brought up, Steve. One is, they didn’t talk about how as supply chains normalize, you’re seeing suppliers of product begin to shave back their production simply because their customers can now — they may have tried to hold extra product and now they can sort of back that up a little bit. So there’s an element of adjusting to the supply chain. But I also did get a number of comments from regionals that they are also seeing our customers just tighten their wallets a bit, both in terms of capital spending as well as operating expenses. And so, I think, there’s a little bit of both of those things — those dynamics playing out.

Daniel Florness — President & Chief Executive Officer

The other piece from an inside perspective, if you think about our business from a product line and product use perspective, if I go back to January, so OEM fasteners is 20%, 22% of our revenue, kind of low-20s. That business was growing around 13.5% in January. In March, it grew 7%. So that is production dropping off.

If I contrast that with safety, for example, our safety business grew stronger in March than it did in January. Now, I honestly haven’t given that, I mean, not at this show in the last few days. I don’t know if there was a comp issue, because some of the safety was being pushed around a little bit because of some COVID activity, but that’s a case of — that business has been — it’s a lot little bit in February, that I know was a comp issue with last year. But I don’t believe January and March had a comp issue. I think that ties a bit into the strength we’re seeing in our vending deployment. If I look at remaining products, that did also fall off a little bit and there will be some production in those as well, but particularly in the metalworking.

Steve Volkmann — Jefferies — Analyst

Yes. That’s great color. Thank you, guys.

Daniel Florness — President & Chief Executive Officer

Thanks, Steve.

Operator

Our next question comes from the line of David Manthey with Baird. Please proceed with your questions.

Daniel Florness — President & Chief Executive Officer

Dave, if you’re talking, you’re on mute.

Operator

All right. Moving on, our next question is from the line of Ken Newman of KeyBanc Capital Markets. Please proceed with your questions.

Ken Newman — KeyBanc Capital Markets — Analyst

Hey, good morning, guys.

Daniel Florness — President & Chief Executive Officer

Hey, Ken.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Good morning.

Ken Newman — KeyBanc Capital Markets — Analyst

Hey. Holden, I’m curious if you could just talk a little bit more on the fastener sales trends in March, obviously a bigger sequential slowdown here and the comp for April looks pretty similar. I guess, two minor questions here. One, I guess, should we assume that the fastener volumes were negative in the month? And two, how do we think about the net margin impact to that part of the portfolio since — I think it’s typically accretive to mix, but you also called out lower shipping container costs?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Yes. With regards to sort of the volume side versus the price side, the — I think, the…

Daniel Florness — President & Chief Executive Officer

Yes. Volume wise, it was slightly — slightly negative.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

It would be, it would be. So, I think that that’s an element. And again it’s our most cyclical line. Dan referenced sort of the commentary about the OEM fasteners in particular. I mean, today, OEM fasteners represent about 62% of our fastener business. And so when you get a slowdown of some sort in a period, it’s going to affect the volumes on the fastener side of the business.

Now, you’re right, it tends to be a higher margin line. And so to the degree that fasteners grow slower than the rest, that does have an adverse mix impact. I think that’s always been the case, cycle-to-cycle, it’s something we talk a lot about, about sort of mix impact. When the fall off is in the fastener — the OEM fastener component of fasteners, the mix impact is different than if it’s in the MRO piece could be the OEM fasteners do not have a higher gross margin than our overall company gross margin, the MRO fasteners do.

Ken Newman — KeyBanc Capital Markets — Analyst

That’s helpful color. Got it. And then, I guess, for my follow-up here, you know, I’m curious if you could — I mean, last quarter you talked to maybe the need to renegotiate pricing with some of your big vendors because of steel prices as well as transportation costs. You’ve obviously — you talked a little bit about transportation using a bit, but the product have also kind of stayed in here in recent months. I’m curious if you have any update on the color for price cost negotiations on higher steel material?

Daniel Florness — President & Chief Executive Officer

We are acutely aware of steel pricing and shipping costs, and that’s our covenant with our customer. We’re going to find the best quality, best price, best reliability supply chain for their business. There are always robust conversations going on. But we also operate in a very dynamic marketplace. So, we’ve been seeing fastener prices stabilize for a number of months now. We’re seeing that come through in our cost of goods and that also helps our gross margin in the short-term, because we’re seeing, we were getting squeezed a little bit six months to nine months ago, a little bit of that squeezing is lessening right now and you’re seeing that shine through in our numbers as well.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

And I think there was conversations. I think, we’ve always talked about how our — our objective was to talk to those customers about the timing of our costing. And we understood, as Dan said, we have a covenant to sort of adjust as appropriate. And I think our customers have been great working with us to understand when our products is going to be coming through at a lower cost, etc. So we’ve always kind of felt that as you get to that second quarter, there’ll probably be more activity around that and adjustments to be made. I still think that that’s probably the case that those are sort of second quarter, third quarter type activities. But again, what you should be getting a sense of is, we’re trying to time any declines that we may have to have in pricing to our customers with the declines that we see in costing. And so, I’d certainly understand the concern. But again, we’ve — I think we’ve done a good job sort of matching price and cost. I think that the team has done a great job on this side of the cycle as well, then the objective is to be price cost neutral.

Ken Newman — KeyBanc Capital Markets — Analyst

Understood. Thanks for the time.

Daniel Florness — President & Chief Executive Officer

Thanks.

Operator

Thank you. Our next questions come from the line of David Manthey with Baird. Please proceed with your questions.

David Manthey — Baird — Analyst

Thank you. Good morning, Dan, Holden.

Daniel Florness — President & Chief Executive Officer

Hey, Dave.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Hi, Dave.

David Manthey — Baird — Analyst

Yes. In relation to that — to the prior answer, that’s exactly what I wanted to — to have you discuss just the general pricing methodology of how you’re trying to match your customer pricing relative to the actual COGS in your supply chain versus front running, any price increase or, I guess, lagging a price decline? And you addressed it to a large extent, but I just want to be clear on that. Your container prices are down, steel prices are up a little bit and you’re saying that fastener prices are mostly stable today. So, you’re not anticipating any major changes when you look at 2023 as we sit here today?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

As we sit here today, I would say, no, we’re not. Again, we — that we might need to adjust pricing is not a surprise. We know where that would have to happen, it’s actual. Again, we have pretty good visibility in our costing. And so we really do try to align those two things. And so, as you know, we really didn’t have a point through the period of inflation where our pricing was ahead of our costing and that was deliberate.

As we got towards the flip side of that cycle, we actually got a little bit behind from a price cost standpoint, just because as much pricing as we put through to respond to the marketplace, it just wasn’t quite enough given how dramatic the — sort of the cost side was. And also we’re seeing, so as we talked about two quarters ago, we started talking about two quarters ago, we wound up having negative price cost on the fastener side. And we anticipated at the time that costing would catch-up to our pricing and that’s largely where we got to this quarter. But going forward, the idea is to — and this is the conversation we’ve been very explicitly having with customers, there will be cases where we have to reduce the price based on the variables we talked about, but we should be able to largely track that with our costing.

Daniel Florness — President & Chief Executive Officer

If you break our business into three components, Dave, to Holden’s point, on the fastener side, I think, we’ve done a really nice job managing through it. Part of the lumpiness to it, it was some of the — some of the changes were pretty extreme. If I look at safety, we have great visibility to demand. Over half of that business has gone through a vending device, so you really understand that business and we’ve been able to manage through that quite well.

We did adjust some pricing here in — as Holden touched on, during the quarter on our remaining product lines, because there we probably weren’t — we’ve put so much attention on the half of our business that’s fasteners and safety and we were probably not as focused on the other half of the business as we should have been and we did some corrections there. So, we did raise some prices on the non-fastener, non-safety piece during the quarter.

David Manthey — Baird — Analyst

Thanks, guys. My dog and I appreciate the answer.

Daniel Florness — President & Chief Executive Officer

Thanks, Dave.

Operator

Our next questions come from the line of Nigel Coe with Wolfe Research. Please proceed with your questions.

Nigel Coe — Wolfe Research — Analyst

Thanks. Good morning, everyone. I know, the freight is quite small portion of your revenues, but you called out the growth of 14% or so. Obviously, very good margins. So, just wondering, given where LTL tonnage is trending right now, how — what did you do to kind of get that kind of growth rate? And it sounds like you’re expecting this to continue going forward. So just wondering, what’s driving that kind of growth?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

You know, I think, sometimes you can be guilty of over time of — you focused on — there’s enough energy in the room to focus on a handful of things and sometimes things fall off that focus. I would say, if anything, we were probably a little bit guilty of that in recent years on the freight side equation. And part of that, I attribute it to me from the standpoint of what are the things you talk about, what are the things you push folks on. And when things get really chaotic, sometimes we have to pivot and say, hey folks, we need to put some energy into this because this is the we [Phonetic] problem that we need to fix.

And so, it’s more of a case of, I’d say we’re probably reverting to some of the freight pricing habits that we had three years and four years ago, that were maybe a little bit waning in the last several years. And COVID and all the other distractions of life came into play. The other element to it is, while we bought some focus on our ability to charge for freight, we are really good at using our own trucks for moving freight. So, we have those two dynamics going on. We’re probably back to where we should be on what we’re charging out and we’ve improved on how much goes through our own network. And that’s a nice one-two punch.

I think there is — I mean, there’s a number of things factoring in today, some of which are long-term sustainable, some of which are sort of in the here and now, but we’ve alluded a couple of times to an increase in planned spend. As more planned spend becomes a bigger portion of our business, it becomes easier for us to plan our own logistics, right. And so we have seen our third-party freight go down in part because of that trend. I think that’s going to continue.

We did or at least are in the process of executing some route consolidation and some rescheduling of routes, which I think will bring some efficiencies into the business, not just the — the ongoing continuous improvement of the business that I think will be sustainable. What you’re referring to though is important, because as our revenues have gone up and as we [Phonetic] focus there, the cost structure of our semis fleet is fairly stable. And so, as revenues go up, we actually leverage that fairly well.

The other piece in this quarter that occurred though is, one, container costs are down a lot. And that was a benefit. I think down something like 75% year-over-year, so that was a benefit. I would also point out that our container flow is down a lot this quarter because of the things we’re doing to sort of unwind some inventory. And so our container flow in the first quarter was also down 50%.

Now I think those latter two issues, they are not necessarily the long-term issues, that’s adjusting to sort of things that appeared in the last couple of years. I do think that they will last for the next couple of quarters. But things like the planned spend, lower third-party freight, route consolidation, those sorts of things, I think those are going to continue to improve the business. The big variable will be demand, right, because our freight revenues aren’t different than our other revenues. If activity levels begin to drop, then freight revenue dollars may come in and then that stable — that stable cost base could work against you. And so I think demand is an open question there, but from an execution standpoint, there’s some great things going on with freight in the organization.

Nigel Coe — Wolfe Research — Analyst

Yes. No, that’s great. Thanks. Thanks, guys. And then just a quick one. We talked about the March sales now at some length. But you called out weather impacts in February, you didn’t call out anything in March, but some companies are blaming weather in March. So I’m just wondering were there any weather impacts that could maybe explain some of the weakness you saw towards the back-end of the month?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

No. We tried to raise our threshold of pain that we bother to mention. Can I find an RVP that thinks there were some weather in January, sure. Can I find just someone who thinks there was some in March, yes. It doesn’t rise to a threshold that’s worth discussing, that wasn’t true in February.

Nigel Coe — Wolfe Research — Analyst

Okay. That’s great. Thanks, guys.

Daniel Florness — President & Chief Executive Officer

And Nigel, for what it’s worth, as Holden was answering that first question, I did take a quick look. Our freight as a percentage of sales that we charged out in the first quarter of 2022 was identical to what it was in the first quarter of 2019. In the last two years, it had dropped off about 30 basis points.

Nigel Coe — Wolfe Research — Analyst

Okay. That’s great. Thank you.

Operator

Our next question comes from the line of Pat Baumann with J.P. Morgan. Please proceed with your questions.

Pat Baumann — J.P. Morgan — Analyst

Hi. Good morning. Thanks for taking my questions.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Hey, Pat.

Pat Baumann — J.P. Morgan — Analyst

Hi. How are you doing, Holden? Just a quick one on pricing first. I think there was a wide range on expectations, at least as I understood it, for your pricing coming into this year, maybe you were thinking it could be down 1 point or 2 point, or up 1 point or 2 point, depending on how things played out. I guess, I’m just curious after the first quarter and your actions in February and what you just said on kind of fasteners with regard to the input costing on that? What your expectations are now for this year on pricing? And then as a corollary to that, just thinking about your February pricing actions in the non-fastener, non-safety portion of sales, do you think that had anything to do with kind of the volume slowdown you saw there for the month of March?

Daniel Florness — President & Chief Executive Officer

I’ll touch on the last part of your question, and then I’ll let Holden handle the meat of it. But on that last part, if you think about what happened and what we’re just running through on those OEM fastener numbers, the drop-off from January to February was linked to our production business. Our OEM fasteners dropped in half as far as the route [Phonetic] from 13.5% to 7% growth. And so that — there was no pricing action there. And if you look at the remaining product lines, the drop-off actually occurred 30 days after, so I mean it was really about the production aspect of our business, not so much the other parts of our business.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Yes. I would agree with that. First, frankly those price increases went in sort of late in the quarter. And so I’m not sure that you would have seen a response like that you’re alluding to in such a tight window. But that said, we’re not really expecting that that’s going to be adverse those lines from a growth standpoint. Yes, so we just — we didn’t see that. I wouldn’t expect to see that.

As it relates to the overall pricing, remember the wide range I’ve given is because ultimately we — we don’t have a great deal of visibility as it relates to how much pricing we have to give away to customers because of contracts and things of that nature, right. And so my comment I think was, if demand softens and there’s a lot of pressure to sort of adjust price based on contracts, etc., then maybe our pricing is down 1 percentage point. If that doesn’t occur, because it hadn’t to this point, maybe it’s up 1 percentage point. And that was — that’s sort of the wild card from a pricing standpoint that sort of exists out there.

Again, unrelated to price cost, which regardless we think will be neutral, but that’s why there’s a wider range. And I think that that’s still the case and we talked a little bit on an earlier question about, I suspect as we get into 2Q and 3Q, we’ll be adjusting some pricing. I will say, however, that I’ve spoken to some people before about how I think pricing comes into that 0% to 2% range, probably in the lower half of it if nothing changes, but we have made some changes to our pricing in that other products area. And so what I would tell you is, if we never had to adjust fastener pricing, I suspect that our pricing this year would be in the upper half of that 0% to 2% range. But now the wildcard becomes what do we have to do with fastener pricing, if we give a bunch of that back in 2Q and 3Q, then that upper half of the range comes down and that’s the variable. We just don’t know the order of magnitude of impact of that yet. Hope that wasn’t confusing.

Pat Baumann — J.P. Morgan — Analyst

No, no, that’s helpful color. Maybe my follow-up would be around gross margin then for this year. I think you were expecting maybe 50 basis points to 100 basis points of contraction when we talked in January. It sounds like maybe pricing could be tracking a bit better, price cost maybe neutral, I don’t know, and the freight commentary was also — it sounded better. So wondering if you’re thinking any differently about that framework now?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Yes. So, again, price cost, most of the variables that were impacting gross margin didn’t surprise us, right. The degree that that mix is impacting, again when you think about how the quarter progressed, that didn’t surprise. If I think about the price cost elements of it, that’s playing out largely as we expected when we talked about it last quarter. Really the only variable that was a surprise was that freight piece. We simply executed fairly well. And again I do believe that most of the variables that benefited freight, I believe that those variables are going to be in place in 2Q and 3Q. So, freight may have increased my expectations around gross margin for the full year, but that’s really the one variable that played out differently than I expected it to, from last year — from last quarter’s conversations.

Pat Baumann — J.P. Morgan — Analyst

Okay. That’s helpful. Please one more and I will…

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

I think, didn’t we have two?

Pat Baumann — J.P. Morgan — Analyst

Yes. That’s great. Thanks. Thanks for the time. Appreciate it.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Thank you.

Operator

Our next question comes from the line of Jacob Levinson with Melius Research. Please proceed with your questions.

Jacob Levinson — Melius Research — Analyst

Hi. Good morning, everyone.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Good morning, Jacob.

Jacob Levinson — Melius Research — Analyst

I just realize it’s still very early days here, but just curious if you’ve heard anything coming out of the field in terms of the impact of credit stresses on either customers or some of your smaller competitors?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

No. We actually reduced — our bad debt expense was actually a benefit to our margin this quarter. We were just not seeing a significant — no, we’re not seeing anything in our business regarding that.

Jacob Levinson — Melius Research — Analyst

Okay. That makes sense. And then just quickly, the second one. I can see that you are still planning on spending that $200 million of capital spending this year despite the fact that the growth has come down a little bit. I mean, is that probably just a function of the fact that you haven’t been able get some things done over the last few years with all the volatility around COVID or is it really just a function of the fact that obviously 10% growth on a quarter is not exactly a recession?

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Well, it’s — hey, that’s a piece. The other thing is, we’re always adding infrastructure for what we need long-term. So, if you think about what’s going on right now, we’re expanding our distribution facility in Denton, Texas, and on the other side of the Dallas-Fort Worth area. We are building a distribution facility in Salt — in the Salt Lake market. And so we’re adding capacity because we have outgrown the capacity we have. If you think about our FMI, that’s quite strong right now. And that’s a capital item that we’re adding.

And then the last piece would be, if I think of where we’ve probably struggled the most in recent years to add would be on the vehicles side, because staff just wasn’t available. You couldn’t get — we couldn’t get our Dodge Ram pickups in the way we wanted to. We couldn’t get our semis the way we wanted to. That is loosening up now and so some of the capex is going into the transportation side. Recently, I was visiting one of our Onsite locations and I’m pleased to say that I received a picture here a week and a half ago, a bunch of Fastenal trailers being produced that are coming down the production line. And so those kinds of things we’re able to get better today than we could have six months and 12 months ago.

Jacob Levinson — Melius Research — Analyst

That make sense. Thank you, guys. I’ll pass it on.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Thanks.

Operator

Our next questions come from the line of Tommy Moll with Stephens. Please proceed with your questions.

Tommy Moll — Stephens — Analyst

Good morning, and thanks for taking my questions.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Good morning.

Daniel Florness — President & Chief Executive Officer

Hey, Tommy.

Tommy Moll — Stephens — Analyst

I wanted to start-off on opex. If I’m doing my math right, in the first quarter, employee-related expenses grew at less than half the rate of sales, which is great to see. I suspect you may walk us back from assuming that recurs here in the second quarter or the rest of the year. So to the extent you can frame, what you would anticipate for the second quarter that would be helpful and just any qualitative commentary for the year would be as well? Thank you.

Daniel Florness — President & Chief Executive Officer

Yes. I don’t know that I’m necessarily going to walk you back. I think it’s important to understand the source, right. I mean, the reason why we were able to leverage the way we did was because we’re just not growing as quickly this year as we grew last year. And so again, I wanted to emphasize that I think we had a healthy payout of incentive pay as a business in this quarter. It wasn’t as healthy as last year. And that’s not a surprise. But if I think about how the rest of the year plays out, we still have some pretty large numbers that we’re going to lap in the second quarter and the third quarter as well. And so I do expect that we’ll have healthy incentive payouts in the second quarter and third quarter.

We’ll see how the market plays out, but based on sort of how we grew in the most recent quarter. But I do believe that they will be lower than what we experienced last year. And so I think that we’re going to have for most of the year that element of lower incentive pay year-over-year that helps us in leveraging the sort of the payroll related expense. A good chunk of our incentive comp and we cover this in pretty good detail I believe in our proxy. But a good chunk of our incentive comp is tied directly to pre-tax earnings growth. So, if you think what was going on last year, Q1, Q2 and Q3 had a meaningful expansion of that incentive growth. Actually Q2 was the highest of the three, but I believe it was about $0.5 million higher in Q2 versus Q1. So, just nominally higher and then drops off in Q4. So, depending on what’s happening with our earnings growth relative to what was happening in the same quarter of the prior year, that gives us a bit of buffer here in the first quarter and presumably in the second and third. Unless the economy surprises us and it turns more positive and that would be a great problem to have.

Tommy Moll — Stephens — Analyst

Thank you. I appreciate the insight and wanted to shift my second question to a higher level strategic question. The framing you provided on the structural improvements in terms of leverage and asset intensity versus the pre-pandemic base was very helpful. And so, there’s clearly some progress on both of those initiatives. If you think about 2023, what are some of the key focus areas — the work that’s still ahead of you for this year. Are there any that you would draw our attention to that you’re really focused on driving through the organization at this point? Thank you.

Daniel Florness — President & Chief Executive Officer

Well, yes, if you think of that, the growth drivers come to mind first, that’s not what your question is, but for me growth drivers come to mind first of the structural changes we’re making as far as customer acquisition, both in the standpoint of physically what channel it’s going through, branch versus Onsite and then what tool are we using within the respective channel, FMI, etc., to serve at a really high level and a very efficient level our customer.

If I think about the things that impact our cash flow, we often talk about our covenant with our customer includes a number of things. One, finding great quality of product, great availability of product, reliability of product and great price. But one of those elements, the availability, we had to take a tremendous amount of working capital inventory onto our balance sheet over the last six months to 18 months. And if things were chaotic, it could be late [Phonetic] and actually go back several years, because we took on a lot of safety products back in 2020, but that piece have been worked through.

So when I think of this year, I envision a very, very strong cash flow year as we saw in the first quarter, because we can take not days but weeks out of our inventory on hand. We’re managing our accounts receivable relationships at a really strong level, and it’s basically with better CFO today than we did 10 years ago and things like that help.

But you put those things together, we’ve talked internally about what we call our drive to 35%. And what that is, if you looked at our internal financial statements, and these would sign through externally, two of the three would, we look at our accounts receivable business unit by business unit, we look at fully loaded inventory that’s local inventory as well as allocation of distribution inventory, and then we look at our local vehicles. We look at those three assets and we say an optimal place for us in a $175,000 a month branch, $200,000 a month branch is up 35%. That number is 35% of the annual sales.

And we haven’t been able to drive towards that in the last few years because of COVID, because of inflation, because of supply chain disruption. We’re going to continue moving down towards that path. I don’t know if Holden believes we can get to 35%, he is probably a 37% guy, but I believe we can get to 35%.

If international allows us, you know, makes Holden more right or me more right, and it’s — if we’re growing really well, I’m cool with either number. But it puts us in a position to really rationalize the inventory, because when you are — conceptually when you’re pulling inventory through a supply chain network and you have great visibility, 65% of our revenue is in this FMI footprint. We have great visibility we need, and you can manage that, setting aside the disruptions like you saw last year with, hey, it’s taking an extra 30 days to get it through — across the oceans through the ports and you needed to allow that.

Setting that kind of stuff aside, it’s an inherently more efficient model. Yes, and both from a working capital standpoint and from a human capital standpoint, and you’ve seen that change through in both our cash flow this quarter, you’re seeing a change through in our operating expenses, particularly the questions here about components of our people cost.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

And probably the only thing I’ll add to that is, I mean if you talk to our sales EVPs, a lot of the things that you’re seeing happen, it was taking advantage of things we’ve already installed, right, taking advantage of the changes to sort of the branches, taking advantage of the Digital Footprint, taking advantage of lift, new role specialization, all those things. We put those in place, but we haven’t necessarily maximized the benefit to our business yet. And I think that our sales EVPs believe that we’ll be more efficient two years, three years from now than we are today, that there’s still plenty of room to run on that.

I would say as well from an inventory standpoint, again we’re doing a lot of things to improve velocity in our system and things of that nature, but we still have a lot of import inventory that we can work-off. When we think about how far in the future we had to think about our purchasing behavior during the pandemic when constraints were there, we probably doubled our window for ordering.

Right now, if we went from four months to eight months, we’re right back down to seven months, there’s still more room to go to get closer to where we were pre-pandemic. I don’t know that we’ll get all the way there. Our fulfillment rates are higher. But there’s still a lot more room to go. And so again, we’ve become — our comments about where we are as a business wasn’t intended to say we’ve arrived. It was to make the point that where — we’ve progressed down a road nicely, but that road still has room to run.

Tommy Moll — Stephens — Analyst

Great. We’ll look forward to watching the progress. I’ll turn it back.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Thanks.

Daniel Florness — President & Chief Executive Officer

I think we have time for one more question if there is one left. I see it’s four minutes to the hour and we like to finish promptly. If there’s one more question, we’ll take it, or else we’ll wrap-up.

Operator

Sure, sure. The next questions come from the line of Chris Snyder with UBS.

Chris Snyder — UBS — Analyst

Thank you. You know, I guess, just maybe for the one question. Specifically, we’re looking for more color on the back half of March softness, it sounds like the month ended softer than it started. Just any end markets or product lines that saw negative rate of change throughout the month, because the ones you guys kind of called out was retail customers, international, construction, kind of stuff that’s been weak for the last three quarters. So did those just get weaker or did you see anything else kind of weaken as the month went on? Thank you.

Daniel Florness — President & Chief Executive Officer

We don’t have great visibility into specific end-markets for the most part. What I would tell you is…

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Within a month.

Daniel Florness — President & Chief Executive Officer

Yes, within a month. And certainly within manufacturing, it could be a little bit tricky within that particular bucket. But the — what I’ll tell you is, outside of our Texana [Phonetic] region, which we’re still fairly positive on overall demand.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

That’s Texas and Louisiana.

Daniel Florness — President & Chief Executive Officer

Yes, sorry.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

For the non-national folks

Daniel Florness — President & Chief Executive Officer

Yes, very oil and gas oriented, still a really good outlook there. And so I think that market is doing well. Frankly, the vast majority of our other regions all had some variation of things softened in March. And that just tells me it was pretty broad through the manufacturing space, not specific to any one market or what have you.

I had a little piece and this isn’t spend, this is an observation. So I had a lot of discussions with global operations and entities, customers of ours or potential customers of ours over the last two days. And there was tremendous interest at the event. There was quite a few people that said, you know, part of the reason we’re here is, we want to learn what you’re doing from a technology standpoint to help our business.

And one of the advantage is when there’s a breather, when there is a — when there’s less noise and less things you’re worrying about, all of a sudden, the things you haven’t done for the last 12 months or 24 months or 36 months, because the world kept repeating itself of trying to end, I think that’s positive for our ability to take market share. And even if the business itself — the customer — if you look at our — we talked about our top 100 customers, if you dial that in a little bit, you start looking at our top 10, that’s what really hurt us, is our top 10 customers were contracting from where they were six months ago and that’s economic. But our top, if you look at customers 10 through 50, they were growing. If you look at customers 50 through 100, they were growing nicely, because we’re picking-up market share. And that makes me more enthused, because long-term our success is from taking market share everyday.

The economy is going to do in the short-term what the economy is going to do. We have a healthy business, we generate more cash flow in a year like this, we’d rather be deploying the cash flow into the business. But in a year like this, maybe we return more to shareholders, but it’s a case of focusing on the long-term opportunity of business, and I’m as excited as ever.

With that, it’s on the hour. Thanks for your interest in Fastenal today. Everybody have a good — a great April.

Holden Lewis — Senior Executive Vice President & Chief Financial Officer

Thanks, everyone.

Operator

[Operator Closing Remarks]



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