Fastenal Company (FAST) Q1 2018 Earnings Conference Call Transcript

Fastenal Company (NASDAQ: FAST)Q1 2018 Earnings Conference CallApril 11, 2018, 10:00 a.m. ET

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Fastenal Company's First Quarter 2018 Earnings Results Conference Call. At this time, all lines are in a listen-only mode. Later there will be a question-and-answer session and instructions will be provided at that time. Now I'd like to turn the conference over to Ellen Stolts. Please go ahead.

Ellen Stolts -- Financial Reporting and Regulatory Compliance Manager

Welcome to the Fastenal Company 2018 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 will 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 simulcast on the internet via the Fastenal Investor Relations homepage, www.investor.fastenal.com. A replay of the webcast will be available on the website until June 1, 2018 at 12:00 a.m. Central time.

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As a reminder, today's conference call may include statements regarding the company's 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.

Dan Florness -- President and Chief Executive Officer

Good morning, everybody, and thank you for joining our first quarter conference call. To sum up the quarter, I believe we had a good quarter in the first quarter of 2018. We had some unusual weather as the quarter laid out and we had the distinction of ending the quarter on Good Friday, which while a business day is often a muted business day. Last year, if you recall, Good Friday was in the month of April.

Weather hit us hard in the quarter. And probably the best way to convey the impact of weather is to think about it from the standpoint of what my kids endure during the winter and that is days that school is closed because there's no bus running. And to think about it from the context of our semi fleet and the number of routes we run and the impact on those routes. So we run about 4,800 routes per month. So in the quarter, we ran about 14,500 routes across our branch and on-site networks throughout North America.

In the first quarter of 2017, we had about 200 routes that were cancelled. So just under 1.5% of our routes were cancelled due to weather impacts. In the first quarter of 2018, the number of cancelled routes increased by 65% to 332, so about 2.3% cancelled. Much of that product ends up getting to the branch on a different route or maybe through a third party. Unfortunately that's usually a more expensive trip. Some of that product ends up not being sold because the customer was shut down that day or their business was impacted in some way.

Three geographic areas jump out for me when I think of the first quarter. The first one, and this probably doesn't surprise anyone on the call, Scranton, Pennsylvania, which services basically from Pittsburgh up through New England and down into the Maryland/D.C. area. They had a 50% -- excuse me, they represented 50% of our cancellations in the quarter. And their cancellation rate was about three times what it was a year ago. And for those of you who live on the East Coast, you're probably not surprised by that comment.

Interestingly enough, about 7% of our cancellations occurred in Atlanta, Georgia. Routes covering down into Florida, west toward Mississippi and Alabama, and north into the southern part of the Carolinas. Normally that area has no cancellations. So about 7% of our cancellations were there. Probably the only area that had improved weather from a year ago was our Seattle, Washington DC or the Pacific Northwest. Their cancellations were 1%. Unfortunately we do a lot more business in the other areas than we do in the Pacific Northwest.

I feel the 13.2% to be solid growth. Our pre-tax growth, and I'll talk about pre-tax more than net earnings because of the noise of the Tax Reform Act, pre-tax earnings grew about 10%. Frankly, not horribly impressive in the context of a 13% sales growth. Similar to, speaking of tax reform, similar to the fourth quarter of 2017, we realized a P&L benefit of the Tax Reform Act. About 85% of our business occurs in the United States so anything that changes the tax rates in the United States is incredibly meaningful to our business. That lifted our quarter. It provided about a $0.10 benefit to our quarter and our earnings per share grew about 31% on that 10% pre-tax growth.

Growth drivers. Despite the fact that I'm not overly impressed with our 10% earnings growth, I'm incredibly impressed with our growth drivers in the quarter. But more to that when I get to Slide No. 4. I'm still on Slide No. 3.

Leverage. It's all about gross profit. I think we're doing a respectable job managing our operating expenses. There's always things we can improve upon. But it's about gross profit. And this quarter, despite the fact that our gross profit is down roughly 70 basis points from a year ago, I think there's some really good stories within the number and there's some things we need to fix. When I think of our growth drivers and I think of on-site, we're doing a very nice job of managing our gross margin within that business within Fastenal despite the fact there is inflation going on and despite the fact we're rapidly ramping up that business. I think we're managing that very well and our gross profit was pretty steady from Q1 to Q1.

Within our vending business, about a 12-year-old business for us, again similar to the story in on-site, we're doing a nice job managing our gross margin there. In fact, we saw a slight uptick in our vending in the local business, offset a little bit by the national accounts. But very nice job there. I think we're doing a nice job managing our gross margin in the national accounts. Again, I say that in the context. As you all know, there's meaningful inflation going on in our business and if we don't stay ahead of it, we can run into some problems on the gross margin line.

But two things that stand out for me, which in my estimation cost us about $3 million this quarter, center on habits at the local level. And that's habits within our fastener business. So as you all know, about 50% of our business is national account. And if you add large regional accounts on to there, that number moves closer to 60%. Within our local book of business, we do a fair amount of fastener business. It's about 15% of our revenue that's completely priced and driven locally. And then we have a sizable number in non-fasteners as well.

In the non-fasteners, our margin there is treading water and we're doing a nice job managing that component. In the local fastener business, we are seeing inflation in that product. Unfortunately in that business, we're not matching the inflation in our sales price and we gave up about 130 basis points of gross margin, 130 to 140, in that 15% of our revenue. That's disappointing because that's a habit and that's a habit we need to fix. The good news about it is it's something that's very fixable in our business. It takes our attention.

So this morning I had a call with our leaders throughout the business. I congratulated them on a nice quarter. I also congratulated them on hitting goal for the quarter and 2 out of 3 months in the quarter. The month of January we were just shy of goal because of weather. But we did a nice job growing the business. I challenged them on our fastener pricing at the local level. I challenged them on our freight that we charge at the local level. Fuel prices, as you all know, are going up and that impacts us like it does everybody else. We're losing a little bit of ground on the freight component. I also challenged them on accounts receivable. We added about two days of accounts receivable during the quarter. It impacted our cash flow, the last point of Page 3. But all in all, I'm pleased with the results of the quarter except a couple of components within gross margin.

So up into Slide 4, if you are an investor in Fastenal, Slide 4 is a pretty darn encouraging page. I think it speaks a lot to the potential that is Fastenal and our strengths as far as being an industrial distributor within our marketplace. In the first quarter, we signed 100 on-sites. You know, if I give that context, back in 2015 -- these are rounded numbers -- we signed about 75. 2016, we signed about 175. 2017 we signed 275. In 2018, the number I have in my head is 375. I think Holden's stated range is 360 to 385 to give it some bookends. But I'm please to say three months into the year, our 2000 goal is intact on our challenge to sign 360 to 385 on-sites in the year. And I feel really good about that.

In market locations, we just topped above 3,000. 3,007 to be exact. What I like about that is we're growing our capabilities. We're growing our footprint. We had a number of years where we were contracting our footprint and I talked about that in the President's letter to this year's annual report. Very excited about what we're seeing there. And that's obviously been driven by our on-site expansion.

We signed 5,679 vending devices in the quarter. A nice way to start the year. Equally impressive, the number of our removals is declining. We removed 18% fewer devices in the first quarter than we did in the first quarter of last year. So we're signing more, we're pulling fewer out. It's a nice combination. Similar to my comments on the on-site goal, our 2000 goal is intact. Our goal is to sign 21,000 to 23,000 devices during the calendar year.

Product sales through vending, not surprisingly, grew north up 20% in the quarter, driven by improvements in the existing devices out there as well as the new ones we've added.

National account sales grew 17% in the quarter. Well done to the national account team in growing our relationships with customers around the planet. Well done to our branch and on-site network to serve that business and to everybody else for supporting them in their efforts.

Speaking of around the globe, if I look outside the United States -- inside the U.S. and in Canada, we had some weather impacts during the quarter. But if I look at the rest of the world, and this includes Canada, we grew our business 25% in the first quarter of 2018. We leveraged it and grew earnings even faster. Canada grew its business in the 20s, Mexico grew its business in the 20s, and the rest of the world grew even higher. So really impressive performance throughout our international operations.

When I think about the business, as you all know, starting several years ago we really began to invest heavily in what are now the growth drivers of our business. And there's a price to that. You see it, and Holden will touch on it when he looks at operating expenses. Our labor costs continue to rise. Some of that because of adding resources, some of that because of inflation, some of that because of incentive comp. expansion.

But what I'm really excited about is the resources we've added into our growth drivers in the last two years. So we've added roughly 160 people into our national account team, half of that dedicated solely to implementing new business, including on-sites. 15% of that number is selling resources. Most of that in what we call the TSR, Territory Sales Rep, a quarterback for the national account business in a given geography. 15% of that increase was for construction center personnel. We're seeing double digit growth in our construction these days. 15% of that in our safety personnel. We're seeing great growth in our safety products.

If I look outside of national accounts, we added 225 people roughly in the last two years to support our vending initiative, most of those in the district business units but quite a few actually took over hosting operations and continue to expand our footprint into deploying devices. We added resources into on-site, e-com, about 15 into both. We added resources into our government business. E-com, which we'll touch on a bit next week at our Investor Day, it's a small part of our business but we're really seeing impressive results within that component as well because of our local and same-day delivery capabilities. It puts us in a unique spot. We also added roughly 50 people into IT. Those resources are dedicated to being able to roll out new products for our branch site network and our customers faster, to increase the bandwidth, and a handful of folks to improve the security within our systems.

So I think we're making investments in the right places. Really impressed with what the team is doing. We just need to execute a little bit better on our local fastener business and our freight. With that, I'll turn it over to Holden.

Holden Lewis -- Chief Financial Officer

Great. Thank you, Dan, and good morning to everybody. Jumping over to Slide 5, as Dan stated, total and daily sales were up 13.2% in the first quarter. Some deceleration from up 14.8% daily sales growth in the fourth quarter but it is a third straight quarter of at least low-teens growth for the company.

We believe that pricing contributed between 50 and 100 basis points in the period. Mansco added another 120 basis points. Bear in mind that this quarter represents the completion of Mansco's first full year as a member of Fastenal's family. In that period, it did achieve the revenue and earnings that we had originally anticipated it would. It plans to build on that performance in the next 12 months but be aware, with the transaction anniversary in the second quarter, we'll no longer be breaking out its contribution specifically.

From a macro standpoint, the PMI averaged 59.7 in the first quarter and industrial production continued to expand at a low- to mid-single digit rate. Manufacturing end-markets continued to lead our growth, with strength in heavy and general manufacturing as well as manufacturing going into transportation and building verticals. Construction was up 9.6% in the first quarter but after a weather-impacted January, we saw growth return to the 10% to 11% range.

From a product standpoint, we sustained recent quarters' growth levels in both fasteners and non-fasteners, though in the last two quarters we have seen meaningful acceleration in safety, which grew nearly 20% in the first quarter.

From a customer standpoint, national accounts were up 17.3%, with 78 of our Top 100 accounts growing. Growth to non-national accounts was steady with mid- to high-single digit growth and nearly 66% of our branches grew in the first quarter. That's a new high for this cycle.

In terms of market tone, the quarter started with weather disruption and finished with Good Friday moving up from April of last year. But in between, conditions remained healthy. Sentiment in the field remains constructive and the good demand of the past few quarters appears to be carrying into the second quarter of 2018.

Now over to Slide 6. Our gross margin was 48.7% in the first quarter. That's down 70 basis points versus the first quarter of last year. The usual factors that we've talked about were present here. Relative growth in national accounts and non-fasteners certainly affects the mix. Mansco tends to operate at a lower gross margin. And as Dan touched on, freight remains a challenge. We began to realize pricing in the period to offset the inflation we've discussed. And while that effort continued to gain traction through the quarter, it was uneven and not yet where it needs to be to offset the various elements of pressure in the marketplace. However, we would expect additional gains in the second quarter in our pricing actions.

Our operating margin was 19.8% in the first quarter. That's down 50 basis points on a year-over-year basis. The 70 basis point decline in gross margin was partially offset by 20 basis points of operating expense leverage. If I look at those pieces, we achieved 50 basis points of leverage over general corporate expenses and occupancy-related costs. The latter was up 7.7%, with the largest variables being growth in vending and non-branch occupancy expenses. Selling transportation-related expenses were up 12.3%, which were equally attributable to higher fuel costs and related to an increase in our branch fleet during the period. Our employee-related costs were up 14.4%. That reduced our leverage by 20 basis points. This continued to reflect Mansco's headcount, an increase in our total FTE headcount of up 6% and up 7.4%, respectively, and that excludes Mansco, and significantly higher incentive compensation across the organization, reflecting our better growth.

The incremental margin in the first quarter was 16%, while the second quarter incremental margin will likely be challenged by a difficult gross margin comparison, the anniversary in 2Q '18 of the Mansco acquisition and the incentive compensation reset should generate better leverage for us in the second half.

Putting it all together, the first quarter earnings were $0.61, up 31% from the first quarter of '17. In the absence of tax reform and the lower rate it provides us, EPS would have been $0.51 and growth would have been 10%.

To give you a quick update on tax reform, having had more time to evaluate the impact, we now expect our ongoing tax rate will be between 24.5% and 25% absent any discrete events that may arise from changes in the application of the law or other ongoing activities.

Flipping over to Page 7, Slide 7, we generated $160 million in operating cash in the first quarter, which is 92% of net income. This is a lower conversion rate than we typically see in the first quarter. Part of this is just math, as our lower tax rates benefited the P&L in the first quarter but has not yet flowed to the cash flow statement. The other piece, however, relates primarily to those accounts receivable, which I'll cover in a moment. We continue to anticipate good cash flow in 2018 based on good earnings growth and the cash flow benefits from tax reform that will begin in the second quarter of '18.

Net capital spending of $32 million increased in the first quarter of 2017 on expansion and upgrades at our hubs and corporate property. Our 2018 target for total net capital spending is unchanged at $149 million. We increased funds paid out in dividends by 15% to $106 million and reduced our debt by $10 million. We finished the quarter with debt at 15.7% of total capital, consistent with last year at a level that provides ample liquidity to invest in our business and pay our dividend.

The picture for working capital is mixed. Inventories were up 12.7% in the quarter. Inventory on hand fell 5 days, which we view favorably in light of inflationary pressures and plans for additional inventory investments in the field through 2018. Receivables grew 19.8% in the first quarter and days there expanded by 3.5. Days outstanding naturally expands as we experience relative growth from our national accounts and international businesses. However, in the last two quarters, this has been compounded by customer payments being pushed out past the quarter-end. We have seen no meaningful change in hard-to-collect balances and so this is an area that we will work to improve upon the balance of the year.

That's all for our formal presentation. And with that, operator, we'll take questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, if you do have a question at this time, please press "*1" on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press "#". We do ask that you limit yourself to one question and one follow-up. As well, to prevent any background noise, we do ask that you please place your line on mute once your question has been stated.

Once again, ladies and gentlemen, that is "*1" to ask a question. Our first question comes from Robert Barry with Susquehanna. Your line is now open.

Robert Barry -- Susquehanna -- Analyst

Hey, guys. Good morning. So you mentioned price only partially offsetting freight and product cost inflation. Is that dynamic only in the local fastener business or is it broader? And when do you think you can get to at least neutral on that price/cost dynamic?

Holden Lewis -- Chief Financial Officer

I'll handle that one. In the case of the fastener business, that's local. And keep in mind, when I talk about local, I'm talking about where the pricing decision is made, as far as what level of price. And so this is local business.

When I talk about freight, that includes both local business and national account business. So it includes all aspects of our business. But the decision on whether or not to charge freight is typically made locally. There might be some contractual limitations on certain sales but generally speaking that's a local-made decision. So I would both of them in the bucket.

In regards to how quickly we can correct upon it, the freight on is a challenge. Because in many of our growth drivers, vending is an example of a growth driver, on-site is an example of a growth driver, our propensity to charge freight is typically lower. Especially in the case of vending, it's non-existent for the most part. There are challenges to engage with the customer of doing back hauls of freight. And I often see examples of that. On a recent trip, I saw, interestingly enough, down in Indianapolis, three pallets, large pallets, and they each had a truck cab on it from a vintage truck that was being shipped from a scrapyard in Minnesota out to the East Coast. And that's an example of back hauls we do in our system to offset.

The freight one is going to be challenging in the short term. The fastener one, that's about habits and we can change habits tomorrow.

Dan Florness -- President and Chief Executive Officer

I'll just sort of chip in to give you a little bit of color. If I think about the RVP commentary that came through to us over the course of the quarter, it improved as the quarter went on from January to February to March. So I think that the confidence in the field grew and the achievement in the field grew as we went along, which is what we would have expected to see. I would also tell you that if I think about the month-to-month contribution of pricing, it also grew as we went through the quarter. So we've talked before about having to rebuild that muscle memory. Obviously for us and our model, these conversations are very much sort of customer-to-employee. And I think there are signs that we're building up that muscle memory through the quarter and we just need to make sure that we continue to bulk up as we go into the second quarter and that's the expectation.

Robert Barry -- Susquehanna -- Analyst

Got it. I guess just a follow-on to that, given there's a lot of talk about tariffs raising product costs, in particular on some of your products. Just given what sounds like a pretty tough pricing environment, I mean, what's the thought on the ability to pass those through or fully being able to pass those through?

Holden Lewis -- Chief Financial Officer

Well, to be clear, I don't think that it's a pretty tough pricing environment. We are getting pricing. It's just the rate at which we're getting it. Again, I think that the sentiment around how the RVPs are feeling about that environment has only gotten better as the quarter has gone on. So I don't think that I would characterize the pricing environment today as tough. It's just a matter of at what pace we're gonna be able to put it through.

As it relates to tariffs, however, if you think about 232, the increase in steel and aluminum, that would primarily have a direct impact on our manufacturing business, which does source that. If I think about the Section 301s.

Dan Florness -- President and Chief Executive Officer

That's 5% of our revenue.

Holden Lewis -- Chief Financial Officer

Yeah, which is 4% or 5% of our revenue on the manufacturing. If I think about the Section 301 tariffs, we looked into what products are captured in that and there are some. I think we've identified about $11 million or $12 million in annual cogs that would be affected directly by that. There would no doubt be some others that come through masters. But we're talking about metal nuts, we're talking about pallet jacks, and a few other items. And so there really was no impact on tariffs in Q1 in our business. Most of what would be affected directly seems fairly modest. I think our bigger question is what impact does it have on our customers at the end of the day. And as I said, in Q1 there really was nothing there. To the extent that it contributes to either a more inflationary environment, we'll have to respond to that as we've talked about. To the extent that it creates issues for our customers, we'll have to respond to that. But no impact yet and I think that it's sort of a "wait and see" kind of a situation.

Dan Florness -- President and Chief Executive Officer

I'll just chime in a little bit as well to support Holden's answer. And that is historically our ability to pass on things like this, a tariff, a duty, etc., the marketplace gets that and is able to pass that through. The wild card in all of it is what impact it has not to our ability to price but to volumes. What impact does it have for the customer? Does it impact their ability to export product? Does it impact the profitability within their business on what products they sell? That's the unanswerable question. But the marketplace gets the fact that the costs are going up.

Robert Barry -- Susquehanna -- Analyst

Got it. Thank you. Very helpful.

Operator

Thank you. Our next question comes from Robert McCarthy with Stifel. Your line is now open.

Robert McCarthy -- Stifel -- Analyst

Good morning, everyone. I have two questions because that's all we're allowed in the time we're allowed. So thank you for taking that. I guess following up with tariffs, you mentioned 301. Could you just confirm, you just think it's a very limited set of SKU and product that is gonna be affected by this? And could you just let us know broadly how much you do source from China in terms of your underlying cogs or general sourcing?

Dan Florness -- President and Chief Executive Officer

First off, we touched on that. We have identified what we know so far. Keep in mind that the number Holden cited looks at product we're directly sourcing that we believe is impacted. But on top of that is product that we're sourcing from others that would be impacted. And that one's a more difficult one to quantify because with many of our suppliers, if I think of both branded and some of the non-branded products, many of our suppliers, their source of origin can fluctuate. So they might -- a lot of fasteners come out of Taiwan and China and a lot of that production has moved into China over the last 15 to 20 years. No different than 40 and 50 years ago, a lot of that production had moved from Japan into Taiwan and other parts of Southeast China -- or Southeast Asia, excuse me.

So there are other sources of supply. But the issue you run into is the speed at which you can change other factors that might be going on in other countries within the Pacific Rim. Most of the fasteners sold in this country are made outside of North America. So it's not an issue that's unique to us. It's an issue that's unique to that product line. Within our non-fastener product, the percentage would be lower but still a sizable piece is made. I hesitate to quantify it because there are multiple sources of supply and we aren't always privy to upstream, those sources of supply, when we're an end-product.

But the other dynamic is this thing moves rapidly. Sometimes you have to try to follow it by the latest Tweet and we prefer not to manage our business that way.

Holden Lewis -- Chief Financial Officer

But be aware, Rob, we actually have seen the list of things that we understand to be affected now. So we have something on which to sort of make a judgment, if you will. And if I look at that list, there's probably 25 things on it. Iron or steel nuts is 85% of that. So there is a list of things out there that are supposedly affected by that. That's why we're able to give some judgment based upon.

Robert McCarthy -- Stifel -- Analyst

Yeah. No, I have the documentation right here in terms of the list. The essence of the question, and I don't want to preclude my second question so this is a follow-up to the first question, very briefly is, yeah, that's Section 301 that was kind of enumerated. But the fact of the matter is it sounds like it could be a greater effect, kind of similar to oil and gas in '14 where you had headline exposure mid-single digits but the penumbra of the effect could be greater, I guess is my point.

Dan Florness -- President and Chief Executive Officer

Time will tell. There's still plenty of unknowns. What's No. 2?

Robert McCarthy -- Stifel -- Analyst

Yeah, No. 2 is just a very simple question. I mean, obviously gross margin, you cited and enumerated the various -- growth is good but the challenge is the mix in gross margin and that structural mix, given the last couple years you've been -- the first quarter gross margin typically is one of the higher gross margins of the year and then typically is above the average gross margin for the year, do you think that's gonna continue according to whole year or do you think there's opportunity for you to expand sequentially gross margin this year? Or have we put in the high for gross margin for this year particularly versus the average?

Holden Lewis -- Chief Financial Officer

Well, the question of expanding gross margin, I mean, we build a hole in Q1. Q2, I can tell you, is going to be a very difficult comparison based on how we performed last year. So that would be difficult. But if we're talking just sequentially, there is a path to be able to achieve a gross margin that is comparable to slightly below where we are in Q1. Right? So I think if you look at the history, it's not uncommon to see 30 basis points or what have you down from Q1 to Q2, etc. There is a path to do somewhat better than that. But that path does rely significantly on our ability to continue to build up our sort of pricing momentum. And that's kind of the wild card we are going to be playing through in Q2.

Again, we like the signals. We've certainly given a clear message as to what we need to do going forward. And if we can deliver and execute on that as we fully expect to do so, there's a path to have margins that are comparable to maybe modestly below where we finished in Q1 and perhaps do a little bit better than the normal seasonal pattern, if you will.

Robert McCarthy -- Stifel -- Analyst

I'll follow up offline. Thanks for taking the questions.

Operator

Thank you. Our next question comes from David Manthey with Baird. Your line is now open.

David Manthey -- William Baird -- Analyst

Hey, guys, good morning. First question. Dan, you said you were happy with the return on the investment in your growth drivers but you were disappointed by the profit growth in the first quarter. When you look at the core expense leverage in addition to the changing secular mix of the business and gross margin pressure you must mentioned, are we at an inflection point here where we'll get back to 20% to 25% contribution margin? Or are you happy with faster sales growth and maybe a contribution margin in the teens? It seems like we've been leaning that way in the last couple quarters.

Dan Florness -- President and Chief Executive Officer

You know, as our business was ramping up in 2017, our willingness to invest in our growth drivers expanded. And that's why I touched on some of the headcount we've been adding behind the scenes to really support this. And knowing full well that I frankly didn't expect coming into the first half of this year -- I'm talking about operating margin when I talk about this. I'm removing the noise of tax reform. I fully expected our incremental margins to drop below 20% and into the upper teens. And, ironically enough, if we wouldn't have had this fastener issue in the quarter, the old "would have, could have, should have," but we would have been in the low 20s.

I still firmly believe, when I look at this business over a period of years, and we are in a transition period of really investing heavily in a fundamentally different growth driver in our business, as we're in that, if you look at it over time, there's no reason why gross margin can't be in -- the incremental margin within the gross margin line can't be in that lower half of the 40s. So 43% to 45%. And that our incremental spend can't be closer to 20%. Which would put us into, optimistically, at 25%. Pessimistically, lower half of the 20s, incremental margin.

And if we're growing 6, 7, 8 points faster than anybody else out there and we're taking market share and we're doing things that are natural for our business, and that create a more defensive of a business from the standpoint of competition from others, I think that's a win for our shareholders. Right now, like I say, we're investing heavily in that transition. And unfortunately we stubbed our toe on local pricing this quarter. But I think that's fixable. I think that's fixable fast.

Holden Lewis -- Chief Financial Officer

And, David, just so you know, the gross margin is certainly part of it but the other piece, if I look at our operating expenses -- bear in mind that through Q1, the blending in of Mansco, that obviously has an impact on the incremental margins. The reset of incentive comp. I know it seems like we started talking about that a year ago. We did. The good news is you get into Q2, Q3, Q4 and that reset begins to anniversary as well.

I take some encouragement from the fact that we got 50 basis points of leverage over corporate at occupancy. We did not get much over the headcount side. But as we do begin to anniversary that reset in Q2 and beyond, I think that there is potential there to get more leverage out of the SG&A than what you've seen to this point. And so the growth drivers, we're gonna continue to invest in those. But there are pieces of our P&L that we should leverage to a greater degree, certainly into the second half of this year, than we have to this point as this cycle and our growth matures.

David Manthey -- William Baird -- Analyst

Okay. Thank you. That's very helpful. And second question is on the freight impact on gross margin. I went back and looked and this has been an issue for you at least back to the end of 2016 and an irritant here. When does this get fixed? Can you fix it? And can you just describe what the source of the issue is? Is it that you're using third party and not internal logistics or what's going on there and can it be fixed?

Dan Florness -- President and Chief Executive Officer

A number of things there. It's not external versus internal. We probably had a little bit of that in the quarter because of the weather but that's not the fundamental issue, Dave. If I look at it, we lost about 20 basis points of gross margin strictly on the pricing aspect of where we're charging it. I'd say a third of that is because of our growth drivers pulling it down. The other two-thirds is our propensity to execute. And I think sometimes we fall victim to, we convince ourselves that the marketplace doesn't allow people to charge freight anymore because that's what you read in the headlines every day. That's not true. The marketplace will allow you to charge freight when you're providing a value.

I believe the propensity to charge freight in this environment goes up because every time I turn around, I read an article about folks can't add trucks and drivers and capacity fast enough and so freight is becoming more expensive. And we have a structural advantage there and we need to price for that. So I believe it's fixable. But the challenging aspect is our growth drivers aren't our true friend when it comes to this aspect. They're a great friend when it comes to growing our business but they do hurt it on the face of it. And there we need to challenge ourselves with saying, OK, we don't charge freight here. I bet this customer is shipping product out. Can we ship some pallets of product out for them?

And that's why, when I go to our big cross top facility down in Indianapolis, I'm always curious of what I see when I'm down there. Because it tells me if we're engaging in doing that. Because if our customers are having a hard time finding capacity to ship pallets and we have capacity to ship their pallets, I think we can marry that up and fix a piece of the problem there. But it's a component of what Holden's talked about, the gross margin impact of our growth drivers and the natural drop we're gonna see each year in our gross profit. That's a component of it.

David Manthey -- William Baird -- Analyst

Alright. Thanks very much.

Dan Florness -- President and Chief Executive Officer

Thanks, Dave.

Operator

Thank you. Our next question comes from Adam Uhlman with Cleveland Research. Your line is now open.

Adam Uhlman -- Cleveland Research -- Analyst

Hi, guys. Good morning. Hey, could we start with, Dan, you just mentioned 20 basis points of the impact on gross margin. Could you walk through the remainder of that, the decline of gross margin, between mix and Mansco and the rest of it?

Holden Lewis -- Chief Financial Officer

Yeah. Mansco was probably about 10 to 20 basis points' impact right down the middle there. I would say mix this quarter was also sort of in that 10 to 20 basis point impact. I think that transportation was about 20 basis points of impact. And those would give you the biggest pieces of the 70 basis point decline year-over-year.

Dan Florness -- President and Chief Executive Officer

And local pricing on fasteners.

Holden Lewis -- Chief Financial Officer

And so then obviously local pricing on fasteners and just general product inflation played a role and the fact that we didn't get as much as we needed to to begin to offset that. Right?

Dan Florness -- President and Chief Executive Officer

Adam, I'll add one tidbit there. So I cited when I was talking to Dave the fact that we've given up 20 basis points on our propensity to charge. We got about half of that back in leveraging of our network itself. So the gross margin impact was about 10 basis points for freight, 20 of it in pricing, 10 of it we got back because we still run a great fleet and we continue to utilize that fleet for moving products around the country. Even though our costs are up there, we're moving more tons of product.

Adam Uhlman -- Cleveland Research -- Analyst

Okay. Got you. And then just secondly, how should we think about the working capital for the rest of the year? I guess I was a little confused on exactly what's happening with receivables and why customers are pushing it in to the next quarter. Do you have any goals that you could share with us or other process improvements that you're putting into place to get the conversion to improve?

Holden Lewis -- Chief Financial Officer

Yeah. And to some extent, you don't want to overreact to something because, again, at the end of the day, what we're looking for is are we seeing issues with hard-to-collect product. And the fact is we're simply not. And so in the fourth quarter, we obviously called out receivables being a bit of a challenge. And I may have sort of believed that was primarily a function of the calendar and, in truth, it may have simply been our customers deciding to push out beyond the quarter. I don't know what the reason is for what looks to us to be a recent, somewhat, change in behavior. It's something that we'll have to kind of go back and check on and get our arms around.

But I think the important element of it is we don't have an increase in hard-to-collect receivables out there. Those numbers have remained lean and healthy. And so all we're seeing is we're seeing a pushback, which, if it's about being able to report a clean quarter as many of our customers are public and do so, you could be talking about days. At the end of Q4, we saw an inflow of payments at the beginning of January. I haven't had a chance to sort of look at how the beginning of the first quarter has played out yet and look at that statistic so it wouldn't surprise me if it's there. So it's something that's worth calling out because, obviously, it impacts those numbers. But I don't think that there's anything particularly worrisome there in terms of a corporate health standpoint, is I guess how I'll put it.

Dan Florness -- President and Chief Executive Officer

I'll throw a little adder onto that and then we're coming up on 45 minutes past the hour so this will be the last question. When I think of it, and putting my old hat on, you have customers that are growing faster than they've experienced in recent years. That growth in their businesses takes working capital. You have interest rates that are rising. It's probably not an unreasonable thing to see of people pushing, especially to do a little window dressing at the end of the quarter, to see payment patterns slow down. My challenge to our team is, guys, have a chat with your customer. We're business partners here. And to cut off your payments on the 22nd or the 20th through the 25th of March creates a lot of pain for us too.

And there's three assets in our business. There's fixed capital, which vending is typically placed inside their facility. There is inventory, of which, with on-site, we're placing dollars inside their facility. And there's accounts receivable. If I think of the value we bring to their business, of those three things, the first two add value. The third one doesn't. So don't do that to us. And let's push back a little bit using that. Because every dollar we have there is a dollar we can't have in inventory and fixed capital long-term. And we don't think that's good for our customers. So if they want to push some other supplier, they can do that, but don't do it with us because we have inventory and fixed capital inside of your facility in support of your business. We can't do all three.

With that, we're at 45 minutes past the hour. Thank you for participating in today's earnings call. Holden is hosting an Investor Day next week. I believe that's being broadcast on the internet.

Holden Lewis -- Chief Financial Officer

That'll be webcast.

Dan Florness -- President and Chief Executive Officer

Webcast. And, again, thank you for your support of Fastenal. Have a good day.

Operator

Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.

Duration: 44 minutes

Call participants:

Ellen Stolts -- Financial Reporting and Regulatory Compliance Manager

Dan Florness -- President and Chief Executive Officer

Holden Lewis -- Chief Financial Officer

Robert Barry -- Susquehanna -- Analyst

Robert McCarthy -- Stifel -- Analyst

David Manthey -- William Baird -- Analyst

Adam Uhlman -- Cleveland Research -- Analyst

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