MSC Industrial Direct Co Inc (MSM) 2013 Q1 法說會逐字稿

Good morning and welcome to MSC's fiscal 2013 first-quarter results conference call.

All participants will be in listen-only mode.

(Operator Instructions).

After today's presentation, there will be an opportunity to ask questions.

(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.

Thank you, Denise, and good morning to everyone.

I'd 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 home page at www.mscdirect.com.

During today's presentation, we will refer to financial and management data included under the section Operations 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 US 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.

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 CFCs, 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's 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've articulated to you -- remains firmly in place.

I'm 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've been through many cycles together, and will lead the business through any environment with an eye towards executing 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 a 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 metalworking business and by extending it into additional markets.

We would extend the business in a low-risk, high-reward way, and began 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 gross and operating margin percentages, as they are in early stages.

Vending and M&A are two examples.

Adding to the near-term moderation in operating margin percent would a couple of infrastructure and productivity investments that are critical to our future, such as Davidson and Columbus.

We indicated that for FY13 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 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 of evaluate our performance, a little over one quarter into our fiscal year 2013, I'm 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 significantly 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 a gross margin at our guidance of 45.9%, thanks to 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 read-throughs over 20%, with only mid-single-digit revenue growth.

I'll 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 nonmanufacturing 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've 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.

E-commerce 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 site easier to use, faster, and more intuitive.

They are also impressed with the enhanced functionality.

And we continue to see e-commerce 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 continue 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 fiscal cliff resolution.

They went hand-to-mouth when it came to MRO supplies, ordering what they absolutely needed and avoiding any investment for the future.

That dynamic, along with the 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've 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 paths has passed and life has gone on.

There is at least a 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 are 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.

Specifically, Q2 guidance assumes that there's no improvement 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.

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 nonrecurring 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 our ability to successfully manage our operating expenses while maintaining a strong gross margin.

Breaking down the sales growth, we continued to experience growth from our investment programs.

Of the 5.8% ADS growth in the first quarter, about 3 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 brands 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've reduced spending in a number of areas, but the most significant areas included 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 have 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 remain 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 was a bit weaker as we typically make two payments.

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've 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 FY13, our CapEx was approximately $17 million.

This included an increase in vending and $3 million associated with the Davidson facility.

As we mentioned last quarter, we expect CapEx in FY13 to be elevated, and likely to 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've taken a mid-year price increase in our fiscal Q2 two 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 nonrecurring 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 initiatives.

As mentioned earlier, we are proactively taking actions that slow down the growth of our operating expenses as we continue 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 controls, but also the significant impact of not having a fiscal Q2 mid-year price increase similar to last year.

The impact of the similar price increase would have contributed approximately $0.07 at the EPS level.

Thanks, and I'll turn it back to Erik.

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've laid out for you over the past several calls.

In the near-term, we face 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'd like to thank our entire team of associates for their dedication and their strong execution of our plan.

And I'll now open the line for questions.

(Operator Instructions).

Matt Duncan, Stephens Inc.

Good morning, guys.

The first question I've got is just on the guidance, really, and the 1% growth at the midpoint of the range.

It sounds like, basically, all you're doing is taking what you've 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 lift at all at this point?

Matt, so let me actually take those in -- the two questions.

The first is related to the guidance; and, yes, 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, yes, implied in our forecast is similar conditions to what you saw in December.

Regarding January, it's 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 quote-unquote normal, we have three days under our belt.

So for those three days, the color I would give you is, yes, we did see a lift from December in average daily sales.

But we typically see a lift in average daily sales coming into December -- 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.

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 is some expenses that are coming in that you can't do anything about.

But I'm curious if you have 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 what can you tell us on that front?

Yes, Matt, it's Erik.

Before going specifically to cause, let me just put a little more color on our Q2 guidance.

I'll tell you that the Company, the team -- I 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 here between making sure we are 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 a formula that looks something like this.

We have weak demand 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 the 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.

Well, Erik, to be clear, if 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 it were to play out that way.

Correct.

Okay.

That's correct, Matt.

And to be clear, what we are basing our forecast off of is what we saw in December.

And also, to be clear, we saw through the back -- through 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 baked into our guidance assumptions for January, February.

To your point, if we're wrong -- and we certainly would hope we are, and there's upside to it -- yes, things would look better.

Okay.

And 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 -- the tax plan in place?

As you look out for the balance of calendar 2013, what kind of market do you think you're going to be in?

Matt, it's a great question, and I will definitely put the disclaimer that we'd never professed to be economists.

So what I can capture for you is what we hear.

And it's a lot of mixed feedback.

As we said, there's definitely some signs of life here.

Looking out into 2013, there is some reasons 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, customers recognize that at least January 1 has come and gone; the country has survived; there's a tax deal in place.

So there's 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 are still some lingering concerns for sure about the federal spending and debt ceiling.

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 it's tough to say.

Okay.

Thanks for all the color, Erik, I appreciate it.

Sure, Matt.

Robert Barry, UBS.

Hey, guys, good morning.

I wanted to ask about the vending and the contribution to revenue.

I guess it's from customers with vending, is the way you disclose it.

I guess that had been tracking at 4, and now it's 3. To what extent does that step-down reflect a deceleration in signings or installs versus the business that's happening at the customers with vending?

Rob, so couple of things.

One, you are correct in how we define vending.

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're seeing, it's definitely the latter, not the former.

And what I mean by that is the growth contribution going forward had been about 4 points the last couple of quarters, to about 3 points in Q1, is a function of the water level coming down in customer spend.

No question about it.

In terms of how we're 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 we look out, there's an embedded share gain there that, as the economy turns, gives us more upside.

Just a little more color on that, I think what's going on with our vending program that we've 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've 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're seeing is, customers are really focused on cost reduction, cash flow, and improving cash flow in their plants.

And they're coming to us wanting our vending solutions to help them take costs out.

Excellent, great.

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'm clear.

It looked like in the first quarter, price contributed about 3 points to the gross.

As we are thinking forward, is that going to continue at about 3 points, but where it might have gone higher in the past, it's just not going to go higher?

Or is it actually going to be less than 3?

So, Rob, regarding price contributions, so what we gave you -- Jeff had described the mid-year.

What we wanted to do was 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 one -- the impact, the realized impact, of that increase.

For Q1, our Big Book increase that we announced last time, what we had said was it was between 3.5% and 4%.

I wouldn't draw the assumption -- what we don't break out for you, for competitive reasons, is our price realization.

But the 3.5% to 4% doesn't automatically translate into 3 points of growth.

What I would say, going forward -- what you're 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 advice environment.

So, the growth contribution from pricing, it's really a function of what happens in the environment.

Yes.

I was just thinking that $16.5 million that you report in the stats and thinking about that, how much it contributed to growth year over year.

That's how I came up with my 3. Okay.

Maybe if I could just sneak one more in, on the cost.

Of the strategic investment you mentioned, and the cost equation or the margin equation, is strategic investment going up in 2Q versus 1Q?

Is that contributing at all to the margin pressure sequentially?

Or is it really just an absence of the price hike and the volume?

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

Yes, the strategic investment.

Erik had mentioned that what the equation looked like in 2Q and it included some strategic investment that you're not going to defer.

Which is fine; I think that makes sense.

But is that -- whatever you're spending there -- is that higher in 2Q than it was in 1Q?

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

Got you.

Okay.

Thank you very much, guys.

Hamzah Mazari, Credit Suisse.

Good morning.

Thank you.

The first question is on -- you spoke about how you viewed 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?

If things got better, do you start ramping up the sales force again?

Or what are the priorities after vending and e-commerce?

Or do you just throw more money into vending and e-commerce?

Hamzah, it's Erik.

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 is, as 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 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 plowing into the existing drivers or would it be some others.

And tough to give you they 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 salesforce 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 to the future.

So it would likely be a combination of the two.

Fair enough.

And then 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?

Yes, Hamzah, overall, I would say the M&A funnel is pretty full.

We have a lot of good, constructive dialogues 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 2008 or 2009, 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.

Great.

And then the last question from me on -- any comments you guys have on where your inventory levels are?

Do you think they are in a good place, given what you're seeing in the market right now?

And any thoughts on customer de-stocking?

Is that -- you talked about some of that accelerating.

Any comments there would be helpful.

Thanks.

Yes, Hamzah, this is Jeff.

I'll take the piece on our inventories.

Again, we manage our inventories or receivables very closely.

And you see it's been kind of in a tight band, 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 reduce 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.

Yes, and Hamzah, regarding -- so your other part of the inventory question was regarding customer inventories.

That's right.

Yes, so what we've been seeing and describing is -- if you go back over cycles of time, pre-2008, customers were keeping -- not paying a lot of attention to cash.

Inventories were really high.

2008, 2009 -- we saw this really extreme de-stocking.

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.

But they were somewhere in the middle of the peak and trough.

And that is 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 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.

That, to us, 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.

Great, thank you.

Adam Uhlman, Cleveland Research.

Good morning.

Yes, I was wondering if we could dig in to the sales trends just a little bit more.

It would seem as if there's still a little bit of a hangover impact from Sandy, and you could see it coming through the Northeast sales numbers.

I'm wondering, month-to-month, how you guys have been seeing demand up in your neck of the woods progressing, and if you have any updated stab in the dark at what the revenue hit has been that you've been experiencing.

Yes, Adam, it's Erik.

Let me start.

The demand environment, I think we've covered already, which is we saw pretty rapid deceleration of the demand environment through the calendar year, leading to a crescendo in December for sure.

Regarding our revenue trend -- 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.

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 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, net negative for us.

So, meaning that the loss of business from customers being shut down 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 a 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, or last year specifically.

Right there, that's about 4 points of growth.

So that would take you from the 6% in Q1 to about 4 points of growth on an adjusted basis in December.

And then your next question would be, okay -- well, then, how are you going from -- your guidance obviously implies a smidge for January-February, you are a smidge over 1%.

If you're 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 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 4% to basically a little over 1% for January and February.

So, the implication being our assumptions are really the same in January and February that they've been in December regarding the economy and share gain.

Okay, that's a helpful walk.

Thanks.

On the pricing side, where you don't appear to be as confident in your ability to get that extra price, I'm wondering what customer types or product categories you might be seeing that in.

I would assume it's in the durables category.

But any color you could provide there would be helpful.

Sure, 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 a moderate, versus a strong, what are we referring to?

And there's a couple of things we look at.

One is, we'll look at what's happening on our supplier aside.

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'd 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.

Okay, thank you.

David Manthey, Robert W. Baird.

Hi.

Good morning, guys.

First off, Erik, yes, thanks for walking down the growth rates; that all makes sense.

But if you peel back the onion, then, and you say, well, the tone of business in terms of underlying demand, given the fact that you're talking about the lack of a selling day, which is 4% or 5%.

And then you've got this ATS lapping and the price and 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'm not trying to put a happy spin on this, but the way you're talking about things decelerating, it sure doesn't sound like, on a volume basis, that things are decelerating that much.

Am I reading that right?

So, Dave, yes, let me be clear -- I think it is a good read.

Let me be clear that 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're a few days into the month here.

We're giving you our best guess based on what we saw in December.

So by definition, the way we are forecasting our guidance is we are assuming on a line here, a straight line in 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 and a deceleration was from September through December.

And specifically, since we 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 Affect, December was at about 4 points.

The differential there would be economy.

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-none decision that you have absolutely ruled out at this point?

Or is it something you could still feather in?

Or how does that work?

When you implement one of these, is it something you can do over time?

Or is the decisions made now, and it's done?

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 a 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?

Sure.

So I would not view this as a one-and-done opportunity, but something that is sort of iterative.

We continue to pressure test.

Right, okay.

And then final piece on that, in terms of the environment not being conducive to price increases, from what you said, it sounds like you're taking price increases -- and what we're hearing too, just normal beginning-of-year price increases from the vendors.

If the market is not really conducive of price increases, why are you taking these and not pushing back on them, and netting out to 0 that way instead of eating it?

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 they 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, in the margin walk, purchased cost impacting gross margins sequentially, Q1 to Q2 -- realize that's what we are realizing in the P&L.

And it's a function of increases that were negotiated, agreed upon, way back quarters ago, 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.

Got it.

Okay, thanks very much.

Ryan Merkel, William Blair.

Thanks.

Good morning, everyone.

Just two questions for me.

Just looking at the 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?

Sure, Ryan.

Remember, the West, what you're seeing there in part -- 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.

Okay.

And then, second question, just so I'm clear on the investment spending plans for this year, you're still planning on going forward with all of the investment; you're not pulling any of it back with the recent slowdown we've seen?

We are -- so, we are forging ahead on what we've talked about on this call.

What I would say is, if your question is, have we moderated?

Yes, we have moderated.

There has been certain investments that we've chosen to park 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 have said, we're going to forge ahead but we're going to do it at a slower rate of spend.

Okay.

So then maybe I'll follow-up to that, because before you had kind of said, we needed 10% -- or at 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's 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?

Yes, Ryan, yes -- and I think what Jeff referred to -- Q1 was, we thought, a pretty good story.

What I would say is, the growth guides -- I'd really look at Q1 as 6 points of growth.

When we had talked about the read-through framework of 10 points of growth would be about 14% read-throughs, we were thinking all-in growth.

So I view it as 6 points got us over-20% read-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 high 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 discretionary spend.

So I think the real story, Ryan, the difference of -- if you're trying to reconcile -- boy, 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.

Right.

Okay, thank you.

Sam Darkatsh, Raymond James.

Good morning, Erik, Jeff.

Happy New Year.

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?

Yes, 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.

And you see the 70 basis point decline in gross margin, Q1 to Q2, and 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's a lot of factors that could change, including the pricing environment.

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.

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

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 sea change or some sort of a catalytic event or something that happened in December specifically that you can point to?

Either a competitive price action that you didn't see coming, or -- it just seemed a bit out of nowhere.

Sam, it's Erik.

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 are mindful of the fact that we just did an increase several months ago.

Now, in a frothy pricing environment, doing another mid-year, sequentially, a month later is not an issue at all.

But in this environment we're 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 is cued off of is what happens on the manufacturer's 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's 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.

Very helpful.

Thank you, gentlemen.

Derek Jose, Longbow research.

Hi.

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

Derek, this is Erik.

When you referred to the mid-level versus the Kennametal, you mean on our product offerings, in our metalworking product offering?

Yes.

Okay, so I'll start by saying in 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 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 remains 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 been 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.

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

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.

In 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, as a 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.

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?

Derek, in general, we don't -- one thing, for competitive reasons, 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 -- no significant differences to call out between any of the product categories.

Okay.

And then, can you break down your e-comm revenue versus your non-e-comm revenues?

If you look at it, e-comm revenues for the quarter were basically, roughly flat -- or, sorry, non-e-comm revenues were roughly flat.

And if you strip out the acquisition and strip out all price contribution like what you mentioned, it seems that what you're left with is a negative contribution from market share and core volume.

Can you 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.

Yes, so, I think if you look at the revenue equation, and maybe if where you're going is you say, okay, if I take your growth rate and I back out share gain initiatives, like venting and M&A and e-comm and pricing, does that mean all else was down?

And my answer would be yes.

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 in as a country.

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

No.

We feel pretty good about our share story, Derek.

We have talked to you guys a bunch of times about how we measure share gain.

Nothing has changed in how we are measuring it.

And from every data point we look at, we feel very good about our performance.

Holden Lewis, BB&T.

Good afternoon, now, thank you.

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're seeing some pretty good weakness and 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.

Now you're talking about some seasonal growth in fiscal Q2 if that comes to pass.

It just seems like there would be scope to reduce inventories further and boost cash flows further as well, or at least the next quarter or two.

Is that wrong?

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, 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 that we're generally in that tight band of inventory turns.

Yes, Holden, just add a little more commentary, and Jeff mentioned it about the balance here between bringing inventory down and raising cash flow, and also protecting our service, as 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 2008, 2009, you've seen from us -- we can respond if things really continued to decelerate, we can respond pretty quickly.

Okay.

Getting into the cash that's being generated from all 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 looking to do with it?

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.

Okay.

And then just one last one, 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 the culling process.

I'd like to get the 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 had assumed that that was 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're seeing?

But also the confidence in long-term growth and share gains, when that number just doesn't seem to budge, long-term.

Yes, 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 told you guys for a while, it's not our primary measure, really because of the culling process that you described and the evaluation of potential of accounts as really the biggest driver.

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 under the covers there on how it's moved, the patterns to a lesser degree.

But in terms of a pattern, very similar to what we saw in 2008 and 2009.

In terms of -- and 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, it 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 runway 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 smaller, low potential, in many cases individual sort of accounts that happen to find their way to us.

John Baliotti, Janney Montgomery Scott.

Thank you.

Erik, I guess you know, obviously the current environment is not fun one.

But I think you've pointed out in the past, and I think a lot of people have looked at this, that this is probably one of your best opportunities for share gain.

Is that fair?

John, yes, we've said it for a long time.

And yes, I think you're absolutely right.

Just go back to the last downturn and see how we came out of it.

And at that time, David, years back, called it a land grab.

I think you're absolutely right.

The share gain opportunity is enormous.

Yes, so if you are 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.

I'm just curious, is there anything anecdotal or anything you can share with us that, either data-wise or anecdotally, that would indicate that the hand-to-mouth dynamic you saw from customers 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 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 you guys in the field that would support that.

It's a good question, John.

In terms of the confirmation, we get it a ton -- we hear it from the field.

But we see it on our own road trips.

We hear it from customers.

One of the best sources we really have for that good, objective data is our supplier network, because they are seeing point-of-sale performance across their entire channel.

Absolutely.

If you go back to the last time there was a downturn and that the NYMEX that put pressure on the small locals where the inability to carry products on the shelf; the inability to retain people; and to break in relationships that have been there for so long.

All of those dynamics exist and then some.

And I think the "and then some" is technology is playing a bigger role in business, in our business now, than it was even three, four, five years ago.

And the two examples I would give of that are vending and e-commerce; that three, four years ago where there but not as big a presence as they are now.

Where you think about a local distributor under on 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.

(Multiple speakers).

Right.

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 port in the storm relative to the little guys.

Are you hearing that at all?

Yes.

John, I think 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.

Finally, you talked about how ISM ticked up a little bit, and that's encouraging.

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 were talking about -- the election, the debt crisis, all that -- do you think that was offsetting that tick-up in September and October, of ISM?

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 reverting back to what we've actually seen in the business, because there is just so much noise.

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

I think there is more cause for optimism.

I think there's 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 this spending issue still looms.

So, I do think there's more of a cause for optimism, yes, but a lot of uncertainty.

Thanks, Erik.

Brent Rakers, Wunderlich Securities.

Yes, good afternoon, guys.

Just a couple clarifications more than anything.

Jeff, you talked about $0.07 was the impact from gross margins from not getting the price increase.

Just 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?

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

Could you maybe quickly, then, walk me through the disconnect?

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 are charging customers?

Again, there's 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 increases that get reflected in our gross margin, as you progress throughout the year, from purchases that would have occurred earlier in the year.

Yes, I think, 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 costs is the result of negotiations that happened in a very different environment that are in the P&L now.

So, that's why -- there's two separate issues between pricing and purchase costs.

And then, maybe somewhat interrelated, is there a lag effect to when you realize Big Book pricing to larger, national account customers?

Or is it fairly immediate across your customer set?

There is a timeline to the realization.

So it happens over a period of time, where the bulk of it would be up front, and then there's a -- somewhat of a gradual flow-in of the rest.

Okay, great.

And then, last question, and I think you've talked around this a little bit; but you talked a lot about incrementals, and you talked about being back about 20%.

If you used the baseline revenue growth assumption you're talking for next quarter, how would you look at -- if revenues do come in 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?

Or are you talking back more of this 20%, 25% number now?

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 have 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.

Okay, great.

Thanks a lot.

Yes, Brent, on that point, I agree with Jeff.

Realize that if things change 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.

Thank you, Erik.

Including the pricing environment.

Ladies and oh man, that will conclude our question-and-answer session.

I would like to turn the conference back over to Mr. Gershwin for any closing remarks.

Thank you very much.

We appreciate everybody's interest.

And look -- Happy New Year to all.

And we look forward to speaking to you next quarter.

So long.

Ladies and gentlemen, the conference has now concluded.

We thank you for attending today's presentation.

You may now disconnect your lines.