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MSC Industrial Direct Co., Inc. (NYSE:MSM)

F1Q13 Earnings Call

January 10, 2013 11:00 a.m. ET

Executives

Erik Gershwind - CEO

Jeffrey Kaczka - EVP and CFO

John Chironna - VP of IR and Treasurer

Analysts

Matt Duncan - Stephens Inc.

Robert Barry - UBS

Adam Uhlman - Cleveland Research Company

Ryan Merkel - William Blair & Company

Sam Darkatsh - Raymond James & Associates

Holden Lewis - BB&T Capital Markets

Brent Rakers - Wunderlich Securities

Hamzah Mazari - Crédit Suisse AG

David Manthey - Robert W. Baird

John Baliotti - Janney Montgomery & Scott

Derek Jose - Longbow Research

Operator

Good morning and welcome to the MSC’s Fiscal 2013 First Quarter Results Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Mr. John Chironna, MSC’s Vice President of IR and Treasurer. Please go ahead, sir.

John Chironna

Thank you, Denise, and good morning to everyone. I would like to welcome you to our fiscal 2013 first quarter conference call. An online archive of this broadcast will be available one hour after the conclusion of the call and available for one month on our homepage at www.mscdirect.com.

During today's presentation we will refer to financial and management data included under the section operational statistics, which you can find on the Investor Relations section of our website. Let me take a minute to reference our Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. This call contains forward-looking statements within the meaning of the U.S. securities laws, including guidance about the expected future results, expectations regarding our ability to gain market share and expected benefits from our investment and strategic plans. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in the earnings press release and the risk factors and the MD&A sections of our latest quarterly report on Form 10-Q filed with the SEC, as well as in our other SEC filings.

These forward-looking statements are based on our current expectations and the company assumes no obligation to update these statements. Investors are cautioned not to place undue reliance on these forward-looking statements. In addition, during the course of this call we will refer to certain adjusted financial results which are non-GAAP measures. Please refer to the tables attached to the press release and the GAAP versus non-GAAP reconciliation in the Investor Relations section of our website which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures.

I would now like to introduce MSC Industrial Direct's new Chief Executive Officer, Erik Gershwind. Erik, please go ahead.

Erik Gershwind

Thanks, John. Good morning everyone and thank you for joining us today. Also with me on the call is Jeff Kaczka, our Executive Vice President and CFO. In addition to meeting with many of you over the past three months, John has been taking a deep dive into our business visiting our CSCs, call centers, branches and customers. We look forward to his increasing participation both on these calls and in investor events going forward.

As I take the reins as CEO of MSC, there is two messages that I want to get across to you on today's call. First, the enduring strategic vision for this business. The one that David and more recently that I have articulated to you, remains firmly in place. I am committed to executing upon the mission that has always driven this company. And second, this management team has its hands firmly on the wheel. We have been through many cycles together and will lead the business through any environment, with an eye towards executing on our vision, but always mindful of balancing short and long term interests.

With those two objectives in mind, I thought this call would be a good opportunity to summarize what we’ve told you about the strategic direction for our company. We told you that we see an enormous growth story in the large, highly fragmented market that we compete in that’s now in the early stages of consolidation. We would capitalize on that growth opportunity by building on our leadership position within our core metal working business and by extending it into additional markets. We would extend the business in a low risk, high reward way and begin with penetrating other MRO product lines into our existing customer base. That would naturally take us to end markets outside of durable manufacturing as we grow, all the while taking small, measured steps on their own that when put together, add up to something big.

We explained how we would execute on this growth roadmap through a core set of programs that bring extremely high customer value or stickiness and that would produce good financial returns for MSC. Vending, e-commerce, private brand expansion and sales force expansion are all part of the organic growth formula and those would be supplemented through strategic and opportunistic use of M&A.

We reaffirmed that as we grow, we continue to see long term opportunity for incremental margin expansion in the business. But in the near term, we would expect to see temporary pressure on our margins due to a few growth programs that are near term dilutive to our growth and operating margin percentages as they’re in early stages. Vending and M&A are two examples.

Adding to the near-term moderation and operating margin percent would be a couple of infrastructure and productivity investments that are critical to our future such as Davidson and Columbus. We indicated that for FY '13, we expected incremental margins to be lower than historical averages at any given growth rate. At roughly 10% growth rates, we produced read-throughs in the mid-teens and we expected that if revenue growth went up or down, read-throughs would move accordingly and that the pricing environment would influence those read-throughs at any given level of growth.

At the same time, we assured you that we would remain good stewards of your capital by carefully watching our spending as changes in the landscape occurred. We also assured you that we have been through occasional step functions like this before, just as every Company has and we came out of them with explosive earnings growth. MSC has compounded topline and bottom line growth of 14% and 15%, respectively since our IPO. As we look to the future, the opportunity is only getting better.

As I evaluate our performance a little over one quarter into our fiscal year ’13, I am very pleased with the progress against that strategic backdrop. Our Q1 performance is reflective of our success in executing our strategy. We produced revenue growth of nearly 6% in a significant eroding demand environment due to extreme uncertainty and caution over the pending fiscal cliff. Our share gain initiatives continue to fuel above market growth. We produced the gross margin at our guidance of 45.9%, thanks to the strong price realization that demonstrates the power of our model in good times or bad.

And finally, we demonstrated exceptional cost control resulting in adjusted re-throughs over 20% with only mid-single digit revenue growth. I will now turn to some specifics for the quarter.

Growth in the manufacturing business was 6.2% on an average daily sales basis and continues to demonstrate our share gains. Growth did however progressively slow during the quarter consistent with the macro trends that I just mentioned. Growth in the non-manufacturing business was approximately 4.9% on an average daily sales basis compared to last quarter’s 7.9%. Our government business was a bright spot. We saw a significant lift in ADS through September due to the government’s fiscal year-end spend, and growth over prior year continued in October and November.

Let me say a few words regarding our growth initiatives. While we have clamped down on discretionary spending, we continue to forge ahead on select strategic investments. Customers with vending continue to contribute significantly to our growth and delivered approximately 3 points of sales growth in the first quarter. The slowdown in total growth contribution from the prior quarter’s 4 points, is reflective of the general softening everywhere and is simply a matter of the water levels coming down on customer spend.

In fact if anything, demand for our vending solution is growing as our Q1 signings exceeded our own internal targets. This is encouraging to us because it should translate into revenue growth and share gain when the economy improves. Ecommerce is another key growth initiative. As we have described on past calls, we continue to invest. Including a new search function, improvements to our product information, and a new transactional platform. Regarding the new site customer feedback has been very positive as we undertake the rollout process. Customers tell us that they find the new sit easier to use, faster and more intuitive. They are also impressed with the enhanced functionality, and we continue to see ecommerce increase as a percentage of sales as Q1 reached 42.8% up 50 basis points from last quarter. We see plenty of runway to take this number higher as the new site reaches full adoption in the coming months.

With respect to our headquarters co-location in Davidson, North Carolina, we continued to make progress during the quarter and remain on-track to complete construction in 2013. And with our new customer fulfillment center in Columbus, Ohio, we also remain on track to break ground on the facility in the spring of 2013, keeping pace for a late 2014 opening.

Turning to the environment. Conditions and activity levels have continued to soften since we last reported. After a slight uptick in the September and October ISM readings, November returned to a level of contraction and is more consistent with what we heard from customers. Last quarter on our call, we described the environment as a holding pattern due to the uncertainty surrounding the election and the fiscal cliff resolution. And since then, despite getting the election behind us, the holding pattern continued to escalate. In fact, it built to a near paralysis in December as our customers like everyone else waited to see the outcome of the fiscal cliff resolution.

They went hand to mouth when it came to MRO supplies, ordering only what they absolutely needed and avoiding any investment for the future. That dynamic along with a holiday season that was particularly weak due to the timing of Christmas and New Year’s on a Tuesday, produced a very soft December. In addition to a softening demand environment, we have seen the same dynamics on the pricing front. Very limited in the way of opportunities. Price increases from our suppliers have been and are projected to be very selective, and in general, customers are watching their own spend and prices very carefully.

I would note that when looking ahead, there is some cause for optimism. For one thing, the fiscal cliff has passed and life has gone on. The recent [lease tax] deal in place, and while much work remains to be done on federal spending, at least some uncertainty has diminished. Additionally, December’s ISM reading of 50.7 and its positive tone regarding the pricing environment are encouraging signs. Should they continue or better yet build momentum, it would bode well for our business.

With all of that as the economic backdrop, our visibility to forecast the coming couple of months is extremely limited. We’re just days removed from the fiscal cliff tax deal so it’s too early to say what the impact will be. Like everyone else, our customers are still digesting the news and what it means to their business. As a result, our forecasting assumptions are based on our actual experience over the past month or two. Specific movement in current conditions and no change in the pricing environment. We make these assumptions because while the signs for optimism that I mentioned do exist, it’s simply too murky to forecast using anything other than our most recent revenue trends.

So with those assumptions in place, we would expect the following. Revenues would be between $563 million and $575 million and diluted earnings per share on an adjusted basis to be between $0.86 and $0.90.

With that, I’ll turn things over to Jeff to discuss the financials in greater detail.

Jeffrey Kaczka

Thanks Erik and good morning everyone. Overall we had a strong first quarter and we’re pleased with the way we’ve begun our fiscal year, despite the uncertain economic times that Erik described. For the first quarter, compared to the same period last year, sales grew 5.8%, just above the low end of our guidance.

Our adjusted EPS, which excludes our non-recurring costs associated with the co-location of our headquarters in Davidson, North Carolina, was $1.01, up 6.3% or just below the top end of our guidance range. The primary contributing factors were ability to successfully manage our operating expenses while maintaining a strong gross margin.

Breaking down the sales growth, we continue to experience growth from our investment programs. Of the 5.8% ADS growth in the first quarter, about three points came from customers within our vending program and approximately 1.5 points came from the ATS acquisition. The remaining growth came from other volume and pricing. Our gross margin of 45.9% was right on target and included about 20 basis points of dilution from acquisitions and another 50 basis points related to our vending program, partially offset by pricing actions and the impact of our strategic gross margin programs, including private brand and improved discount management.

Our operating expenses came in roughly $4 million better than we guided for the quarter, which led to the strong 18% adjusted operating margin we achieved in Q1. I’d also like to point out that our adjusted incremental margin was 21.6%. Both the strong operating and incremental margin performance were the result of aggressive and careful management of our spending. We reduced spending in a number of areas, but the most significant areas including variable compensation, professional fees and travel and entertainment.

I’d also like to mention that from September 2011 through July 2012, we added more than 300 new associates. However, as we saw growth rates slowing, we put the brakes on and that kept our overall headcount basically flat since then, since July.

Lastly, the tax provision for Q1 came in at 38.2% as expected.

Turning to our balance sheet, our Q1 metrics remained strong. DSOs were 46.8 days, up slightly from Q4, reflecting normal seasonal patterns. Inventory turns were 3.3, similar to Q4 levels and were as expected.

Regarding cash flow. Our cash flow conversion for Q1 was outstanding as we converted 141% of our net income into cash flow from operations. In fact, our cash flow from operations for our fiscal first quarter nearly doubled from the same quarter a year ago as we managed our working capital closely, particularly in terms of inventories and receivables.

Historically, our Q1 cash flow benefits from the lack of any large federal tax payments, while the Q2 is a bit weaker as we typically make two payment and this same pattern should hold true this year as well.

We had approximately $234 million in cash and cash equivalents at the end of Q1. Over the last couple of years we have seen annual operating cash flow conversion over 90% and I would expect to be in a similar range this year. As you may have noticed, we paid our regular quarterly dividend of $0.30 per share early this quarter. This was in lieu of the quarterly dividends historically paid towards the end of January.

In regard to capital expenditures, for the first quarter of FY ’13, our CapEx was approximately $17 million. This included an increase in vending and $3 million associated with the Davidson facility. As we have mentioned last quarter, we expect CapEx in FY ’13 to be elevated and likely be in the $100 million range driven by infrastructure investments of nearly $50 million in Davidson and Columbus combined in addition to increased spending related to our vending program.

Let me turn now to our guidance for Q2. Our anticipated sales growth at the midpoint will be 1%, reflecting our assumption of a continued soft demand environment. We expect gross margin for Q2 to be in the range of 45.2%, plus or minus 20 basis points. Gross margin is expected to be down sequentially due to the seasonal product mix as well as vending and purchase cost increases with no pricing actions taken. Historically, we have taken we have taken a mid-year price increase in our fiscal Q2 to offset the natural downward pressure that occurs throughout the fiscal year, but right now the current environment is not conducive to such actions.

In Q2, we expect operating expenses will increase at the midpoint of guidance by approximately $5 million versus Q1, excluding non-recurring costs. This reflects a number of unavoidable increases related to the beginning of the calendar year, such as payroll taxes and moderated salary increases of approximately $3 million, as well as a $1.3 million increase in depreciation, primarily associated with our vending and web development initiative. As mentioned earlier, we are proactively taking actions that slowed down the growth of our operating expenses as we continued to invest in key growth initiatives.

And regarding our tax rate, we expect it to continue at the 38.2% level. Finally, I would like to emphasize that our adjusted EPS guidance of $0.86 to $0.90 reflects not only the low growth market environment and of course our tight expense control, but also the significant impact of not having a fiscal Q2 mid-year price increase similar to last year. The impact of a similar price increase would have contributed approximately $0.07 at the EPS level. Thanks, and I will turn it back to Erik.

Erik Gershwind

Thank you, Jeff. As I assume the role of CEO, I could not be more excited about the future of our company. We remain on track to execute on our vision for growth and on the strategic objectives that we have laid out for you over the past several calls. In the near term, we faced the headwinds of an extremely cautious and uncertain environment. Regardless though of how things play out in Washington and on Main Street, you can count on us to remain steadfast in our commitment to market share gains and to serve as responsible stewards of your capital.

Finally, I would like to thank our entire team of associates for their dedication and their strong execution of our plan, and I will now open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question will come from Matt Duncan of Stephens Inc. Please go ahead.

Matt Duncan - Stephens Inc.

The first question I have got is just on the guidance really, and the 1% growth at the midpoint of the range. It sounds like basically all you are doing is taking what you have experienced in December and extrapolating that forward. But I’m curious, through this point in January, is that same revenue growth trend holding or are you seeing a lift at all at this point?

Erik Gershwind

Matt, so let me actually take those – the two questions. The first is related to the guidance and yeah, what we wanted to lay out in the prepared remarks is the fact that right now visibility is so limited. We’re just coming off of resolution of fiscal cliff. So for forecasting purposes, the only thing we have to lean on is our recent trends. So we gave you the December growth rate which was just a shade above flat. So yeah, implied in our forecast is similar conditions to what you saw in December. Regarding January, certainly – so the first thing I’ll comment on January is we really only have three days under our belts in January, despite the fact that the calendar would suggest we have a little more you have to realize last week was still a partial holiday week for many. So in terms of resuming to “normal” we have three days under our belt. So for those three days the color I would give you is yeah, we did see a lift from December in average daily sales, but we typically see a lift in average daily sales coming in from December to January and it wasn’t all that different from normal. So the trends that we’ve seen so far are baked into our guidance.

Matt Duncan - Stephens Inc.

Okay. That’s helpful. And then on the operating margin, it looks like you’re assuming about a 200 basis point sequential decline there, Jeff and I appreciate the color you laid out. There are some expenses that are coming in that you can’t do anything about, but I’m curious if you’ve taken a look at additional cost reductions to offset some of that and maybe squeeze a little bit bigger earnings number out. It sounds like the guidance is probably not assuming much of that. But just what can you tell us on that front?

Erik Gershwind

Matt, it’s Erik. Before going specifically to cost, let me just put a little more color on our Q2 guidance. I’ll tell you that the company, the team feel great about the progress that we’ve made on executing on discretionary cost cuts and as I said in the remarks, this is really a balance year between making sure we’re responsible stewards of our shareholders capital by taking costs out, but not sacrificing on things that we think are critical to the future. Regarding Q2, so what you’re seeing in Q2 is a function of formula that looks something like this. We have weak demands environment plus weak pricing environment plus forging ahead on select strategic investments, plus clamping down on discretionary. And you’re seeing what that picture produces and it’s showing earnings slightly down. What I want to contrast that to is Q1 which so take – what was the formula in Q1? It would be a moderating and weakening demand environment, but certainly not what we’ve seen in December and what we’re forecasting for Q2, a moderating price environment with those same other variables. So I think what it demonstrates is the sensitivity to the model. So slight change in either demand environment or pricing environment or better yet both and it produces a very different picture.

Matt Duncan - Stephens Inc.

So Erik, to be clear, do you see an acceleration in January and February from the trend that you saw in December that your guidance is based off of, you would in theory get more leverage at the operating income line and do better than your EPS guidance if they were to play out that way.

Erik Gershwind

Correct. That’s correct, Matt and to be clear, what we’re basing our forecasts off of is what we saw in December and also to be clear, we saw through the back – our Q1 in December, a decelerating environment. So December was progressively worse as the fiscal cliff paralysis heightened, progressively worse than it was say September, October, November and that’s what’s baked into our guidance assumptions for January and February. To your point, if we’re wrong and we certainly would hope we are and there’s upside to it, yeah, things would look better.

Matt Duncan - Stephens Inc.

Okay. The last thing for me and I’ll hop back in queue. Looking beyond the very short run with the lack of visibility, as you guys talk to your customers, talk to your feet on the street, what are you hearing in terms of tone from those customers now that we have at least got the tax relief pulling out the tax plan I guess in place. As you look out for the balance of calendar ’13, what kind of market do you think you’re going to be in?

Erik Gershwind

Matt, it’s a great question and I will definitely put the disclaimer that we never profess to be economists. So I can certainly – what I can capture for you is what we hear and it’s a lot of mixed feedback. So as we said, there’s definitely some signs of life here. Looking out into ’13, there is some reason to be cautiously optimistic and we talked about them. The uptick in the ISM in December and we noted the pricing commentary, that’s certainly a cause for optimism if that were to continue or better yet, improve. And certainly as you said, you know customers recognize that at least January 1 has come and gone, the country has survived. There is a tax deal in place. So there is reasons to be cautiously optimistic.

The flipside is, a lot of our customers are really still digesting what the tax changes mean to them, mean to their bottom line and what impact that will have on their ability to invest. There is still some lingering concerns for sure about the federal spending and debt feeling. Anybody that touches in any way defense related are particularly twitchy right now as you probably read. So it’s really a mixed bag and I would describe it as some signs of life and cause for optimism but it’s so early that’s it tough to say.

Operator

Our next question will come from Robert Barry of UBS. Please go ahead.

Robert Barry - UBS

I wanted to ask about the vending and the contribution to revenue, I guess it’s from customers so its vending, is the way you disclose it. I guess that had been tracking at four, right now it’s three. I mean to what extent does that step-down reflect a deceleration in signings or installs versus kind of the -- just the business that’s happening at customers with vending.

Erik Gershwind

Rob, still couple of things. One, you are correct in how we define vending. So when we give you the growth contribution for vending, it’s the contribution from customers where a vending unit is installed. In terms of what we are seeing, it’s definitely the latter not the former. And what I mean by that is the growth contribution going from what had been about four points for the last couple of quarters, to about three points in Q1. It’s a function of the water level coming down in customers spend, no question about it.

In terms of how we are executing the program, I would say if anything, it’s picked up in Q1. We actually came in ahead of signings in Q1. So as we mentioned on the call encouraging to us because as look out, there is an embedded share gain there that as the economy turns, gives us more upside. And just a little more color on that. I think what's going on with our vending program, what we have described, is the adoption level has been really high with customers. It’s bringing value to customers. And I think the reason Q1 ticked up above our expectations on signings, is a function of the slowing environment.

We have always talked about, in a slowing environment where customers are really cautious about their spend, we tend to do well and our value prop really thrives. I think what you are seeing is, customers are really focused on cost reduction, improving cash flow in their plants. And they are coming to us wanting our vending solution to help take costs out.

Robert Barry - UBS

Excellent, great. I mean I think that’s a really important point. So thanks very much for digging into that. Just one other one on price. I just wanted to make sure I am clear. I mean it looked like in the first quarter price contributed about three points to the growth. As we are thinking forward, I mean is that going to continue at about three points by -- where it might have gone higher in the past, it’s just not going to go higher? Or is that actually going to be less than three?

Erik Gershwind

Yeah. So, Rob, regarding price contribution, so what we gave you, Jeff, has described the mid-year. What we wanted to do is be able to explain for you looking into Q2. At this point we don’t see a mid-year price increase whereas last year we had when the impact -- the realized impact of that increase. For Q1, our big book increased that we announced last time when we had said it was between 3.5% and 4%. I wouldn’t draw the assumption here. What we don’t breakout for you for competitive reasons is our price realization. But the 3.5% to 4% doesn’t automatically translate into three points of growth.

What I would say going forward -- what you are seeing is a function and really a difference between what the model produces and what we think is achievable in a moderate to strong pricing environment. And I think we characterize Q1 as a moderate pricing environment. We would have characterized, if you asked us about the last couple of years, a strong pricing environment. Right now, with everything we see coming in the windshield, we characterize Q2 as a weak pricing environment. So the growth contribution from pricing, it’s really a function what happens in the environment.

Robert Barry - UBS

Yeah. I mean I was just taking that fixed (inaudible) knowing in that you have poured in the stats and thinking about that, how much it contributed to growth year-over-year. And that’s kind of how I came up with my theory. Okay. Maybe if I could just sneak one more in on the cost, I mean are the strategic investments you mentioned in the cost equation or the margin equation, is strategic investment going up in Q2 versus 1Q ? is that contributing at all to the margin pressure sequentially or is it really just absence of the price taking the volume?

Jeffrey Kaczka

Are you talking the product cost or the strategic investment in the OpEx line Rob?

Robert Barry - UBS

Yeah, the strategic investment. Erik had mentioned that what the equation looked in 2Q and it included some strategic investment that you’re not going to defer which is fine. I think that makes sense. But in that, whatever you’re spending there, is that higher in 2Q than it was in 1Q or?

Jeffrey Kaczka

Sequentially it’s up a little bit in Q2 over Q1.

Robert Barry - UBS

Got you. Okay, thank you very much guys.

Operator

Our next question will come from Hamzah Mazari of Crédit Suisse. Please go ahead.

Hamzah Mazari - Crédit Suisse AG

Good morning. Thank you. The first question is just on, you spoke about how you view this as sort of a short term holding pattern that has accelerated. If it goes the other way and things got better, how quickly do you turn the tap back on spending and which areas do you start spending on first? Things got better, do you start ramping up the sale force again or what are the priorities after vending an e-commerce? Or do you just throw more money into vending and e-commerce?

Erik Gershwind

Hamzah, it’s Erik. So I think a couple of things and it’s a good question because certainly as we’ve said, baked into our guidance here is an assumption that things continue. So the first thing we addressed with Matt. If things get better there is going to be more earnings that read through pretty quickly. We would look to certainly balance as we’ve said, this is always about a balance between short and long term. So your question is if things got better, would we look to ratchet up strategic investment? Likely we would. We would do it in a balanced way and your question is, would it be ploughing into the existing growth drivers or would it be some others and it’s tough to give you a for sure until we get there, but likely a combination of both. So we have a few really active investments on the table now. You mentioned a couple, vending and e-commerce, private brand being another and certainly the one you mentioned in sales force expansion, would that likely be a place that should things get better where we’d like to invest for sure. It’s one that we’ve said for a while is a growth driver for us and we think a critical piece for the future. So it would likely be a combination of the two.

Hamzah Mazari - Crédit Suisse AG

That’s fair enough. And then just on – as you think about M&A, have you seen valuations and expectations of what people view their business as being worth go down with the uncertainty you’re seeing? Or has that not really changed at all?

Erik Gershwind

Hamzah, overall I would say the M&A funnel is pretty full. We have a lot of good constructive dialogs going on and it’s still a good environment. Given that a lot of the change here happened relatively quickly over a few months and given how cloudy things are, I would say that things are still pretty robust and we would not characterize it the way, just going back to another period of time, of ’08 or ’09 where people felt like oh my god, things are falling apart. I would describe this time as just more uncertainty about not knowing which way things are going to go. So to that end the M&A funnel and discussions and valuations remain pretty robust.

Hamzah Mazari - Crédit Suisse AG

Great. And then just a last question for me. Any comments you guys have on where your inventory levels are? Do you think they’re in a good place given what you’re seeing in the market right now? Any thoughts on customer destocking? You talked about some of that accelerating. Any comments there would be helpful. Thanks.

Jeffrey Kaczka

Hamzah, this is Jeff. I’ll take the piece on our inventories. Again, we manage our inventories receivables very closely and you see it’s been in a tight bend with about a 3.5 turns figure over a long period of time and even with the deceleration in the growth rates we were able to stay in that and actually reduced inventories in this past quarter. We will continue to manage to that and keep a close pulse on the demand environment and adjust our inventories accordingly.

Erik Gershwind

Yeah, and Hamzah, regarding – so your other part of the inventory question was regarding customer inventories?

Hamzah Mazari - Crédit Suisse AG

That's right.

Erik Gershwind

Yeah. So, what we've been seeing and describing is, if you go back over cycles of time. Pre '08, customers were keeping, not paying a lot of attention to cash. Inventories were really high. '08-'09, we saw this really extreme destocking, and coming out of the last couple of years of recovery mode what we saw was customers adding back to inventory levels certainly below where they were at their minimum, but not back to really high levels that they were somewhere in the middle of the peak and the trough. And that's kind of how we see our customers having operated over the past couple of years.

What I would tell you right now is what I described particularly in December. The more fiscal cliff kind of took over the news and what was on everybody's minds, the more our customers' went to living hand to mouth. So they were still ordering. Activity levels were still solid. But ordering only what they absolutely needed which would imply that they were not adding to their inventories or banking on anything coming. So look that's what is another one of those reasons to be cautiously optimistic that if and when things do turn, that it should be encouraging because inventory levels will be relatively low.

Operator

The next question will come from Adam Uhlman of Cleveland Research. Please go ahead.

Adam Uhlman - Cleveland Research Company

I was wondering if we could get into the sales trends just a little bit more. It would seem as if there is still a little bit of a hangover impact from Sandy and you could see it coming through the Northeast sales numbers. I'm wondering, kind of month-to-month, how you guys have been seeing demand just up in your neck of the woods progressing? And if you have any updated stab in the dark at what the revenue spend that you've been experiencing?

Erik Gershwind

Yeah, Adam, it's Erik. So, let me start. I mean the demand environment I think we've covered already, which is we saw a pretty rapid deceleration of the demand environment through the calendar year, leading to a crescendo in December for sure. Regarding our revenue trends, let me put a little more color on what's happening with the growth rate and hopefully this will help connect the dots, we'll do a bit of a walk for you here. So, we came in with Q1 growth basically where we thought it was on the lower end of the range but just a shade under 6%. So call it 6% of growth.

In there, we had on the last call -- and if you remember, the last call was like days removed from Sandy. And what we had said was at that point we were estimating, I think it was about $2 million to $3 million in total impact, a net negative for us. Meaning that the loss of business from customers being shutdown would more than offset any upside we saw. That was about how it shook out. So, you have Q1 at 6%. So question one is, okay, you go from 6% to just about flat in December, what happened? And I think important to point out, more significant even than Sandy was the December holiday effect this year. We find that when our modeling shows looking back over extended periods of time, when the holidays fall on the Tuesday, it's the worst of all scenarios.

So the incremental holiday, what we call the Tuesday effect, was worth about a full day’s bookings in the month of December compared to another year, last year specifically. So, right there. That's about four points of growth. So that would take you from the six in Q1 to about four points of growth on an adjusted basis in December. And then your next question would be, okay, well then how you’re going from -- your guidance obviously implies a smidge for January and February, your smidge is over 1%. If you are guiding to 1% for the quarter and December came in at 0.3%, what's the difference there?

And so the walk there is, on an adjusted basis ex the Tuesday effect of December is at about 4, the difference from 4 to 1 is essentially made up of two anniversaries, One is the anniversary of the ATS West acquisition which was late January of 2012. And the second anniversary is the one that Jeff mentioned in the prepared remarks, which was the anniversary of last year's mid-year price increase. That walks you right from the four to basically a little over one for January and February. So, the implication being our assumptions are really the same in January and February as they've been in December regarding economy and share gain.

Adam Uhlman - Cleveland Research Company

Okay. That’s a helpful walk. Thanks. On the pricing side where you don't appear to have confidence in your ability to get that extra price, I'm just wondering what customer types or product categories you might be seeing there, and I would assume it’s in the durables category, but any color you could provide there would be helpful?

Erik Gershwind

Sure. So I'll give you a sense of how we evaluate our pricing environment and when we make a call on it being our windshield says this is a weak pricing environment versus the moderate versus the strong, what are we referring to? And there is a couple of things we look at. So, one is we'll look at what's happening on our supplier side and what we see in our windshield on the supplier side, as we described, is very selective in the way of supplier price increases into the market, and particularly compared with the last couple of years where it’s been a frothier environment. So that's on the supplier side. The second thing we look at is what's happening on the customer side, how much are they focused on price? How much are they shopping? How much are they really clamping down on their own spending?

So we put those two things together and right now the picture I paint for you out of the windshield is that both on the supplier side, on the customer side, it's a pretty weak environment. However, the other thing I would say is like anything else and like we would say on the demand environment it's all subject to change in a hurry. The December ISM report had a little bit of sprinkling in of some positive tone on pricing, so should that continue things could change quickly. But for right now with what we see both on supplier and customer side we characterize it as weak.

Adam Uhlman - Cleveland Research Company

Okay. Thank you.

Operator

Our next question will come from David Manthey of Robert W. Baird. Please go ahead.

David Manthey - Robert W. Baird

Good morning guys. First off, Erik, yeah, thanks for walking down the growth rate, that all make sense. But I guess if you peel back the onion there and you say well, the tone of business in terms of underlying demand, given the fact that you are talking about the lack of the selling day, which is 4% or 5% and then you’ve got this ATS lapping in the pricing all that, the underlying volume demand, it doesn't sound like it’s changed all that much, even though the numbers are coming down here. I am not trying put a happy spin on this, but the way you are talking about things decelerating it shouldn't sound like on a volume basis that things are decelerating that much. Am I reading that right?

Erik Gershwind

So, Dave, let me be clear. I think it is a good read. Let me be clear then. It's really a delineation point I draw with the end of December because what we’re doing for January and February is to be honest we are few days into the months here, we are giving you our best guess based on what we saw in December. So by definition the way we are forecasting our guidance is we're assuming, on a line here, a straight line, an environment between December and then January and February, and that's obviously going to all be subject to what we see play out over the next few weeks. But where we did see a change in the deceleration was from September through December and specifically, since we've reported to you on our last call, we absolutely did see deceleration. So just to give you the walk there. So if we – Q1, all-in, was about 6 points of growth and what we're saying is on a holiday-adjusted basis, if you back out the Tuesday effect, December was at about 4 points, the differential there would be economy.

David Manthey – Robert W. Baird

Okay, right. So, much less. I got it. All right. And then on the price increase situation here, is a mid-year price increase, is that an all or a none-decision that you've absolutely ruled out at this point, or is it something you could still feather in or how does that work? I mean, when you implement one of these, is it something you can do over time or is the decision made now and it's done?

Erik Gershwind

Definitely the former, which is that it's not an all or nothing. We're giving you our best thinking in what we see in front of us now absolutely subject to change. There's been years in the past depending upon the environment where we've done mid-year price adjustments at different points. So certainly we'll reserve the right to in a month from now if as we look out the windshield we see a change in customer, competitor, supplier environment. Could we think differently about it? Sure. So I would not view this as a one-and-done opportunity, but something that's sort of iterative. We continue to pressure-test.

David Manthey – Robert W. Baird

Okay. And then a final piece on that. In terms of the environment not being conducive to price increases, from what you've said, it sounds like you're taking price increases just – and what we're hearing too, just normal beginning of year price increases from the vendors. If the market is really not conducive of price increases, why are you taking these and not pushing back on them and netting out to zero that way instead of eating it?

Erik Gershwind

Great question, and what I would tell you, I’m hoping right now that our product management team is on the line because their backs just got up when I heard that comment, because I will tell you we push back very hard on our suppliers, and our strategic partner suppliers, the ones who work with us and the ones that get preferential treatment are the ones that are going to absolutely work with us on any price increases.

So right now, what I'm describing to you is a very, very sparse environment in terms of increases coming through. When Jeff was talking about on the margin walk, purchase cost impacting gross margin sequentially Q1 to Q2 realize, that's what we're realizing in the P&L. And it's a function of increases that were negotiated, agreed upon, way back quarters ago, okay, in a different environment. But in this environment, if your question is, are we going to be extremely scrutinous of any increases that come in, absolutely.

Operator

Our next question will come from Ryan Merkel of William Blair. Please go ahead.

Ryan Merkel - William Blair & Company

Just two questions for me. So, just looking at your geographies again, it looks like the Southeast and the West held up better than the rest of the country. Is there anything you can share there as to why those two were better?

Erik Gershwind

Sure, Ryan. So, remember the West, what you're seeing there in part -- so there is some secular industry strength, but there is also the ATS West impact in Q1, that's going to elevate the West. The Southeast is just a function of some industry exposure. We talked about in the prepared remarks, government being a bit of a bright spot and the Southeast benefited from that as well. So, that's the color I'd put on it.

Ryan Merkel - William Blair & Company

Okay. And then second question. Just some [clue] on your investment spending plans for this year. You are still planning on going forward with all of the investment. You are not pulling any of it back with the recent slowdown we've seen?

Erik Gershwind

We are -- so we're forging ahead on what we've talked about on this call. So what I would say is, if your question is, have we moderated, yeah, we have moderated. So there has been certain investments that we've chosen to part for now until things clear up. And then even of the investments that we've listed that we've made, there have been some -- and I'm not going to call it out just for competitive reasons, I'm not going to get too specific -- but some on the list where we've said we're going to forge ahead but we're going to do it at a slower rate of spend.

Ryan Merkel - William Blair & Company

Okay. So, then maybe a follow-up to that, because before you had kind of said we needed 10% organic growth, we could do about 13%, 14% incremental margins. You did about 20% this quarter on about 4% organic. So, it sounds like there is some room there with -- if we're stuck in low-single digit core growth land that you can put up still a little bit better EBIT margins because you pulled back some of the investment. Am I hearing that right?

Erik Gershwind

Ryan, yeah. And I think what Jeff referred to, Q1 was we thought a pretty good story. What I would say is the growth guidance, I'd really look at Q1 at 6 points of growth. When we had talked about the re-through framework of 10 points of growth will be about 14% re-throughs, we were thinking all in growth. So, I view it as 6 points got us over 20% re-throughs. The story there, so you have a few things going on. One is, we forged ahead on strategic investments. We moderated for sure. But two was a significant clampdown on discretionary spend, and that's in place. That's still in place. So despite the OpEx lift Q1 to Q2, Jeff, wanted to give you the walk to explain to you that there is no change in the discipline on discriminatory spend. So, I think the real story, Ryan, the difference if you're trying to reconcile of why Q1 was really good, Q2 looks soft, the difference is, a, demand environment change; and b, pricing environment change. And those two levers, you move those variables and you get a different picture.

Operator

Our next question will come from Sam Darkatsh of Raymond James. Please go ahead.

Sam Darkatsh - Raymond James & Associates

Most of my questions have been asked and answered. The one that's left from the pricing standpoint assuming that you don't end up getting the mid-year price increase, I think, Jeff, you mentioned that there was a $0.07 negative impact on gross margins for Q2. I would imagine if you don't get it, that would continue to constrain gross margins going forward in the back half. Would you still see some gross margin bleed down Q2 to the rest of the year, or how should we look at gross margins in this current environment back half?

Jeffrey Kaczka

Yeah, let me give you a little color on that, Sam, because it's a good question. In the absence of a mid-year price increase we always see pressure on gross margin from Q1 to Q2 and a big part of that is a seasonal mix, okay. And you see the 70 basis point decline in gross margin, Q1 to Q2, in the absence of the price increase. Again, one of the headwinds there is the seasonal product mix, as well as the cost increases, the product cost increases as we – even though we haven't given guidance for Q3, as we look to Q3, that headwind from the mix actually goes away and some of the product cost increase moderates. So, I wouldn't expect that the downward draft on gross margin would be as great in Q3 as it is in Q2. Now, then as we go into Q4, of course, we face a little bit more of a seasonal product mix question again. However, there is a lot of factors that could change including the pricing environment.

Sam Darkatsh - Raymond James & Associates

But if I heard you right, you said the downward draft sequentially wouldn't be as dramatic, but it still would be in existence though, excluding a price increase?

Jeffrey Kaczka

Because of the overlap of not having that mid-year price increase, correct.

Sam Darkatsh - Raymond James & Associates

Got you. And then, I know this has been talked about, Erik, and I apologize for asking difficult or pointed questions because all my good ones were taken up earlier, but it seems as though in December something really happened on the pricing side, not just from an overall volumes or tone of demand, because you mentioned that your fourth quarter price realization was really strong and then was there some sort of a C change or some sort of a catalytic event or something that happened in December specifically that you can point to, either competitive price action that you didn't see coming or it just seemed a bit out of nowhere?

Erik Gershwind

Sam, it’s Erik. So first of all no need to apologize for the pointed question. That’s what these calls are for. Regarding pricing, I would not describe it as a switch went on or a switch went off, but rather a continued progressive erosion in the environment through the back half of the year. The other thing to remember is we did have strong realization on an increase that was timed with our big book a few months ago. So as we look out the windshield, we’re mindful of the fact that we just did an increase several months ago. Now in a frothy pricing environment, doing another mid-year sequentially months later is not an issue at all, but in this environment we are a lot more mindful of it.

So I would not describe it though as one change that occurred overnight, but continually week by week as things got worse in the environment, we saw it becoming more and more difficult. That combined with a lot of the way our industry has cued off of is what happens on the manufacturer side. So as we move and get closer to the industry tends to move – you see a lot of visibility into what's happening on the manufacturer side in the month of January. So the closer we got to the month of January, the more confidence we had in our assessment of the supplier environment.

Sam Darkatsh - Raymond James & Associates

Very helpful. Thank you gentlemen.

Operator

Our next question will come from Derek Jose of Longbow Research. Please go ahead.

Derek Jose – Longbow Research

Hi. I was wondering if you could talk about the metalworking market and just how the midlevel is doing against your top level Kennametal brand and if there is any dynamics there that have been changing over the course from say September to December.

Erik Gershwind

Derek, this is Erik. So when you refer to the midlevel versus the Kennametal, so you mean on our product offering, our metalworking product offering?

Derek Jose – Longbow Research

Yes.

Erik Gershwind

Okay. So I'll start by saying, I mean, looking at the metalworking market, absolutely from a demand perspective has been impacted like everything else has. So the deceleration that I described absolutely applies. I'll tell you we feel great in the metalworking market about our share position, about the leadership position that we have and in part that leadership position is a function of a really strong product offering and really strong supplier relationships. What I would tell you is that our performance with Kennametal remained strong. Kennametal is a key partner to us. Our product strategy is one of a supermarket approach, which means that we're going to carry, in any given category, multiple brands. So our performance has been good with Kennametal, but we also do business with several other suppliers. We also have and I think this may be what you're referencing, our own private branded offering that's being doing really well. What I would tell you there is, for the most part the private branded offering is a complement and is not intended to compete with and take business from a brand like Kennametal. It's got a different price point and value equation, and really we see it as a supplement not instead of.

Derek Jose – Longbow Research

But some of the other branded products, maybe not at the high level of the Kennametal, are those products, say, growing faster, becoming a larger share of your metalworking sales versus your top level Kennametal brand?

Erik Gershwind

I would tell you that it largely depends on the product category. For the most part, what we are seeing is two dynamics in our business. One, private brands, which would tend to be a lower price point than industry brands, and we've been talking about this, are growing as a percentage. So they are gaining traction. At the same time, though, the key strategic brands that we partner with, so the industry brands like a Kennametal, for instance, where we have a strong partnership and go to market strategies, they are also benefiting disproportionately. So the areas that those two buckets are taking share from is from the rest of our portfolio.

Derek Jose – Longbow Research

Okay. And can you talk about price realization in the metalworking segment in terms of -- obviously, Kennametal has had some increases and I'm just curious if you are able to -- if those are higher than average or lower than average price realization categories?

Erik Gershwind

Derek, in general we don't -- I mean, one thing for competitive reasons is we don't break out in detail our price realization. I would tell you that it's been pretty strong for a while and despite what we described as a decelerating environment, our realization was pretty strong in Q1. I would not split out though, I mean no significant differences to call out between any of the product categories.

Derek Jose – Longbow Research

Okay. And then just, can you kind of breakdown your ecom versus non-ecom revenues? If you look at it, ecom revenues for the quarter were basically, roughly flat -- or sorry, non-ecom revenues were roughly flat. And if you strip out the acquisition and you strip out a price contribution like what you mentioned, it seems that what you're left with is a negative contribution from market share and kind of core volume. Can you kind of talk about how that played out in terms of market share versus core volume growth or decline, and then how you expect that to play out in second quarter?

Erik Gershwind

Yeah. So I think if you look at the revenue equation and it maybe, if where you're going as you say, okay, if I take a growth rate and I back out share gain initiatives like vending and M&A and ecom, and pricing, does that mean all else was down? My answer would be yeah. I mean absolutely, particularly in a month like December, we saw extreme softening through the end of the calendar year. So, yes, and it doesn't surprise us given the customer sentiment and given the holding pattern we've been as a country.

Derek Jose – Longbow Research

And that's mostly a contribution from the core market itself, not necessarily any share loss gain?

Erik Gershwind

No. We feel pretty good about our share story, Derek. I mean, we've talked to you guys a bunch of times about how we measure share gain. Nothing has changed in how we're measuring it, and from every data point we look out, we feel very good about our performance.

Operator

Our next question will come from Holden Lewis of BB&T. Please go ahead.

Holden Lewis - BB&T Capital Markets

Could you talk a little bit about -- I guess I want to ask a little bit more about the inventory and the balance sheet only because if you look at it, even though you are seeing some pretty good weakness in overall level of demand, your inventories haven't come off that much from the levels that they were at in the second half of the fiscal year. And now you are talking about sort of sub-seasonal growth in fiscal Q2, if that comes to pass. I mean it just seems like there would be scope to reduce inventories further and boost cash flow further as well for at least the next quarter or two. Is that wrong or….?

Jeffrey Kaczka

Holden, it’s a balance and we keep a pulse on the demand environment and of course we have service levels that we need to fulfill and we always do. Again, where we've been in that tight band of inventory turns, we've responded. Inventories have been down I think $6 million or so quarter-over-quarter. We'll just keep a close pulse on that. Periods of slowing growth actually do generally result in improved cash and reduced inventories for us. So, we're not going to give specific guidance. Going out what I would tell you is we're generally in that tight bend of inventory turns.

Erik Gershwind

Holden, just to add just a little more commentary and Jeff mentioned it about the balance here between bringing inventory down and raising cash flow and also protecting our services he mentioned, in times like this, when there is uncertainty in our customer base and when there is softness, history shows that our value prop becomes even more important. It's absolutely critical that we deliver on that and have inventory on the shelf, because what happens is customers want to bring cash down. They want to lean on distributors for next day delivery. So it's critical that we not tinker with service. That said, as Jeff said, we're going to keep our pulse on the environment. You've seen from us in the past in a much more extreme environment than this, but go back to '08, '09, you've seen from us, we can respond. If things really continued to decelerate, we can respond pretty quickly.

Holden Lewis - BB&T Capital Markets

Okay. And then, so getting into the cash that's being generated from all of this, historically you've done the odd special dividend here and there and you've done it when you've had I think less cash than what you have on the balance sheet right now. Is there some reason that you're not going back to that special dividend well? Is it reflecting your M&A pipeline or how should we view this pile of cash and what you're likely to do with it?

Jeffrey Kaczka

Yes. As you know, Holden, the balance sheet and the strong cash position allows us to remain financially flexible and in uncertain times, that's certainly a benefit. Our priorities consistently are reinvesting in the business for organic growth. The quarterly dividends, you saw that we raised the dividends 20%. We accelerated them into December. We do these occasional special dividend share repurchases and then opportunistic M&A. We'd love to put our strong balance sheet to work on the right opportunity in terms of M&A, but it has to be the right opportunity.

Holden Lewis - BB&T Capital Markets

Okay. And then just wanted to ask also lastly, when you look at your number of active clients, I guess I was surprised that it went down in the quarter. It seems like over the past six or eight quarters or so, you've been seeing that number gradually tick up as I think you have resolved maybe a culling process, but I'd like to get just maybe the short-term feel for that, but also a little bit longer term. You talked about share gains, but we've had a very long-term down drift in this number of active clients which I'd assume that that was kind of a trend that would eventually reverse itself, but along the lines of gaining share you'd be growing that again at some point. Can you give some color as to short-term what you are seeing, but also just the confidence in long-term growth of share gains when that number just didn't seem to budge long-term?

Erik Gershwind

Holden, it’s Erik. I would tell you that. So let me address the short-term question first. To be honest, it caught us by surprise a little bit during the quarter. It moved quickly. We've had about 10 quarters in a row where the number has been flat or up. As we've told you guys for a while, it's not our primary measure really because of the culling process that you’ve described and the evaluation of potential of accounts as really the biggest driver. So the number ticked down more than we would have expected. I think really a reflection of what's happened on the economy. When you look on to the covers there on how its moved, the patterns to a lesser degree, but in terms of a pattern, very similar to what we saw in '08 and '09. In terms of what I mean by that is the bands of customers in terms of dollars with us, in terms of size of business and potential and profile very similar, meaning small accounts and very small – very low potential.

So really speaks to economy by all signs we can measure and that was why we think there was a fairly quick move. As we've talked about, it's not a huge needle mover for us and the primary reason is – two reasons. Number one, when we look at the current base of the 300,000 plus accounts and look at the embedded market there and the potential for growth, it's enormous, the runaway is huge. And the second thing is the process is not yet complete of – we’re continually adding to that account base with high potential accounts and continually culling, because in smaller, low potential, many cases individual accounts that happened to find their way to us.

Operator

Our next question will come from John Baliotti of Janney Montgomery & Scott. Please go ahead.

John Baliotti - Janney Montgomery & Scott

Thank you. Erik, I guess, obviously, the current environment not a fun one, but I think you've pointed out in the past, and I think a lot of people have looked at this and said, this is probably one of your best opportunities for share gain. Is that fair?

Erik Gershwind

John, we've said it for a long time. Yes, I think you are absolutely right, just go back to the last downturn and see how we came out of it. And at that time David, (inaudible) called it a land grab. I think you are absolutely right. The share gain opportunity is enormous.

John Baliotti - Janney Montgomery & Scott

Yes. So, if you were seeing your customers -- obviously given your size, you've got some more of a cushion than some of the smaller guys that control a large part of the market. And I am just curious, is there anything anecdotal or anything you can share with us that either data wise or anecdotally that, that would indicate that the hand to mouth dynamic you saw from customers just had a greater impact on the small guys. I would imagine that, as you point out, inventory is a lever for you and you have the ability to hang on to that inventory, but like your customer is going after cash flow, protecting their cash flow, I would imagine some of the smaller distributors have no choice but to do the same. And I would imagine that there's got to be some input you're getting from your guys in the field that would support that?

Erik Gershwind

Yeah, it's a good question, John. I mean in terms of the confirmation, we get it a ton. We hear it from field, we see it on our own road trips and meeting with -- we hear it from customers. One of the best sources we really have for – and of good objective data, is our supplier network. because they are seeing point-of-sale performance across their entire channel, absolutely. So, if you go back to the last time there was a downturn in the dynamics that put pressure on the small locals, where the inability to carry products on the shelf, the inability to retain people, and the break in relationships that had been there for so long, all of those dynamics exist and then some.

And I think the then some is, technology is playing a bigger role in our business now than it was even three, four, five years ago. And the two examples I give of that are vending and ecommerce, that three, four years ago were there but not as big a presence as they are now, where you think about a local distributor under good times, let alone bad times, the ability to invest in capital, the capital outlay for a vending machine, they get squeezed. They just can't do it. And it’s (inaudible)

John Baliotti - Janney Montgomery & Scott

Right. So, given that your relationship with your suppliers, I'm sure a lot of little guys use similar suppliers. But it would seem that your relationship with those suppliers would be better now given that you are more of a potent storm relative to little guys. Is that -- you are hearing that at all?

Erik Gershwind

Yeah. I think, John, that's part of what I would describe in, anecdotally, what we hear from our suppliers. We become a really good alternative in times like this. I think that's absolutely right.

John Baliotti - Janney Montgomery & Scott

Just finally, you talked about how ISM ticked up a little bit and that's encouraging. And I'm trying to marry that up with the fall of last year where ISM ticked up even a little bit more but sales didn't necessarily reflect that trend. Do you think that that was being offset by the political landscape that you're talking about, the election, the debt crisis, all that was there? Do you think that was offsetting that tick-up in September and October of ISM?

Erik Gershwind

John, I really do. I think there's been, if you look back over the past few months, so much noise in the system that it's really tough to make heads or tails out of ISM readings versus what we're seeing when we go to accounts and how they're spending money versus what happened on the headlines in the news and the fear of investment. So, I think there's been an incredible amount of noise in the system and that's really reflecting the challenge that we face in forecasting Q2, and why we're kind of reverting back to what we'd actually seen in the business because there is just so much noise.

John Baliotti - Janney Montgomery & Scott

Do you feel that even though that we haven't completely resolved the problem and it kind of kicked it out another month, our customers incrementally feel better than they did going into the end of your negotiations?

Erik Gershwind

I think there is more cause for optimism. I think there is a lot of uncertainty still. So, I would say, uncertainty is still pretty high because people are still trying to make heads or tails of what exactly was the tax impact on my business, how do I need to cut investment in order to fund the business. And at the same time, knowing that the spending issue still looms. So, I do think there is a more of a cause for optimism, yeah, but a lot of uncertainty.

Operator

And our final question will come from Brent Rakers of Wunderlich Securities. Please go ahead.

Brent Rakers - Wunderlich Securities

Just, I think a couple of clarifications more than anything. Jeff, you talked about $0.07 was the impact from gross margins from not getting the price increase. Just to go back to what David asked earlier, that is a function essentially of you not increasing prices mid-year and your suppliers increasing pricing modestly to you. Is that correct?

Jeffrey Kaczka

The $0.07 is just the equivalent of if we did the similar price increase as we did last year, this year that would have been the impact on margin and our bottom line.

Brent Rakers - Wunderlich Securities

Could you maybe just quickly then walk me through the disconnect though? Why would the gross margins sequentially deteriorate to that degree unless there was some disconnect between what vendors are pricing to you and what you’re charging customers?

Jeffrey Kaczka

Again there is headwinds Q1 to Q2 that include the seasonal product mix change particularly in the month of December and then the natural flow of product cost increase that get reflected in our gross margin as you progress throughout the year from purchases that would have occurred earlier in the year.

Erik Gershwind

Brent, I think very important to realize, make a distinction here between the impact in margin in a given quarter from our pricing actions, versus any impact from what happens on the purchase side. There’s a big difference in timing. So what Jeff described sequentially from Q1 to Q2, any impact from purchase cost is the result of negotiations that happened in a very different environment that are in the P&L now. So that's why there is two separate issues between pricing and purchase cost.

Brent Rakers - Wunderlich Securities

And then maybe just somewhat interrelated, is there are lag effect to when you realize big book pricing to larger national account customers or is it fairly immediate across your customer set?

Erik Gershwind

There is a timeline to the realization. So it happens over a period of time where the bulk of it would be upfront and then there is a somewhat of a gradual flowing of the rest.

Brent Rakers - Wunderlich Securities

Okay. And then last question and I think you've talked around this a little bit, but you talk a lot about incremental and you talked about being back above 20%. If you use the base line revenue growth assumptions you’re talking for next quarter, how would you look at if revenues do come in excess of that, how would you look at the incremental on top of that? Are we talking back 15%? Will you spend that back through? Are you talking back more of this 20%, 25% number now?

Jeffrey Kaczka

Well, I think you can turn historically to what we delivered in this past Q1 and the previous quarter and that would give you a good indication of the range for the various levels of revenue growth. Of course we've tightened down a little more in terms of the discretionary spending and it gave us some positive upside. We're going to continue that in the quarter. So if we’re able to achieve somewhat higher levels of revenue, I would expect it falls through a little more easily.

Erik Gershwind

Brent, just on that point, I agree with Jeff, that you realize that if things changed in the revenue line in a hurry, the read through is pretty high because we couldn't react that quickly on incremental investment spending anyway. So I think it would be fair to say the read through would be pretty good if things turned for January and February.

Jeffrey Kaczka

Including the pricing environment.

Operator

Ladies and gentlemen, that will conclude our question and answer session. I would like to turn the conference back over to Mr. Gershwind for any closing remarks.

Erik Gershwind

Thank you very much. We appreciate everybody's interest and Happy New Year to all and we look forward to speaking to you next quarter.

Operator

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.

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