Beacon Roofing Supply Inc

NASDAQ:BECN

Earnings Call Transcript 2020-Q2

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Beacon Roofing Supply's Second Quarter 2020 Earnings Call. My name is Aaron, and I will be your coordinator for today. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes.

This call will contain forward-looking statements, including statements about its plans and objectives and future economic performance. Forward-looking statements are only predictions and are subject to a number of risks and uncertainties. Therefore, actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including, but not limited to, those set forth in the Risk Factors section of the company's latest Form 10-K. These forward-looking statements fall within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 regarding future events and the future financial performance of the company, including the company's financial outlook. The forward-looking statements contained in this call are based on information as of today, May 7, 2020, and except as required by law, the company undertakes no obligation to update or revise any of these forward-looking statements.

Finally, this call will contain references to certain non-GAAP measures. The reconciliation of these non-GAAP measures is set forth in today's press release. The company has posted a summary financial slide presentation on the investors section of its website under Events & Presentations that will be referenced during management's review of the financial results.

On the call today for Beacon Roofing Supply will be Mr. Julian Francis, President and CEO; Mr. Joe Nowicki, Executive Vice President and CFO; Mr. Frank Lonegro, Executive Vice President.

I would now like to turn the call over to Mr. Julian Francis, President and CEO. Please proceed, Mr. Francis.

[Julian Francis, executive]

Thank you, Aaron, and good evening, everyone. Welcome to our second quarter 2020 earnings call. Given the unprecedented nature and impact of the coronavirus pandemic, we certainly appreciate you spending time with us and hope that you and your families are safe and healthy. I'm sorry if the acoustics are a little bit different this time. We're trying to do this call in a healthy and safe environment.

On the call with me is Joe Nowicki, our current CFO. And Frank Lonegro, who will take over for Joe after this earnings release cycle. We have 3 important topics to cover with you. First, the details are very encouraging second quarter results; second, the impact of COVID-19 on our business and the speed and comprehensiveness of our response; and third, demonstrated ability of our strategic initiatives to drive value in both normal and uncertain times.

Before turning to our results, I'd like to take a moment to express my appreciation to our employees. While we are an essential business, it takes the dedication and commitment of every one of Beacon's employees to deliver for our customers during these unique times. And I'm proud of every member of the Beacon team. They're working hard and working safely to ensure our customers have the building products they need to provide essential services to the end customer, particularly those who need critical home or property repair in this kind of uncertainty. Beacon will continue to do all we can to protect the health and safety of our employees, customers and communities.

Now turning to our second quarter results. I am very pleased with the top line and the earnings momentum we generated. In fact, absent the impacts of the pandemic, which emerged in mid-March, we very well could have been looking at an even better second quarter adjusted EBITDA, ahead of the record $39 million we did deliver. We originally expected this year to unfurl in 2 parts: a softer first half on post-hurricane weather comps, and the stronger second half on improving new residential construction and the growing repair market in both residential and commercial construction.

As you know, we have now withdrawn full year expectations, but COVID-19 aside, looking at our first half, we did what we said we would do. We've been able to show significant positive trends on the gross margin line. And during the second quarter, we delivered positive sales growth and attractive operating expense leverage.

Let me say a word about how each of our strategic initiatives drove value in Q2. In terms of organic growth in the quarter, we produced daily sales improvements of 0.5% versus last year, and we're on a much stronger mid-single-digit rate that's always better to experience impacts of the pandemic mid-March. I should also point out that we achieved those growth rates with a roughly 3 percentage point headwind from last year's hurricane demand in our mid-Atlantic and Southeast regions.

Adjusting those 2 regions for the year ago hurricane impact would mean 6 of our 7 regions generated sales increases during the second quarter, indicating broad-based strength and the benefits of our increased focus on sales activity. From a product perspective, the Q2 sales highlights was our nonresidential roofing category, where we delivered nearly 11% daily growth, representing our third consecutive quarter of year-on-year gains. And while the category sales have declined since COVID-19, underlying bidding and quoting activity has remained firm.

Next, in terms of our strategy to improve operations, you'll recall that we have intensified our focus on the performance of our bottom quintile branches. Despite external headwinds, this group of branches began to see operating income improvement during our second quarter. We have made progress on our gross margins during the past 2 quarters. During our fiscal first quarter, we were able to deliver sequential gross margin gains. And now with the stronger second quarter gross margin performance, we have produced year-over-year margin expansion.

Internally, we thought we would show a year-over-year improvement in the second half of this fiscal year, so we were actually tracking ahead prior to the coronavirus outbreak. Our market-based branch operating model that we term our On Time & Complete, or OTC, network is now in place in over 40 markets and continues to enhance our customers' experience and drive improved operating leverage for Beacon. This was evident in the network's year-over-year gains in delivery efficiency of 6% to 7% and variable cost improvement of 70 to 80 basis points for warehouse shipments.

In these markets across the country, we also continue to see examples where our central dispatch teams ensure our ability to serve our customers even when issues arise. And these markets now include Denver as we brought new a hub online there in March.

With respect to digital, in Q2, our sales team transacted through e-commerce were up 50% over the prior year period. While our focus on increased sales activity is critical regardless of how customers want to interact with us, we established our digital platform as a strategic initiative, and we are seeing improvement and continued growth. And with the recent heightened interest in a contactless sales process, we are well positioned to deepen existing relationships and gain market share.

Wrapping up the results at a high level in the first half of fiscal 2020, Beacon demonstrated that its strategic pivot from acquisition-based growth to organic growth is the right strategy for this phase of our journey. We are still in the very early stages of executing, but we're pleased with the progress we're making.

Shifting to COVID-19. Like everyone, we experienced rapid and significant impacts to our business, starting in mid-March. To understand and combat the impact, we immediately formed the crisis response leadership team. This group continues to meet daily to ensure that we have the latest internal and external developments and can plan and react accordingly.

As an essential business that continues to operate through this pandemic, the health and safety of our employees, customers and communities is the primary concern for our organization. With operational health and safety at the core of Beacon culture, we rapidly engaged and prepared the organization to confront the unique challenges of COVID-19 in order to ensure a healthy workplace. We are following all CDC guidelines, enacting social distancing measures, disinfecting branches regularly, utilizing PPE and requiring field employees to remain home if they come in contact with or show any symptoms of the virus. Our nonbranch personnel are working productively from home, and travel has been largely eliminated.

Our branches have been declared essential businesses in all markets we serve. We are open for business and helping sustain the livelihoods of our employees, customers and suppliers. What we've seen in April is a distinct difference between the heavily and not so heavily affected geographies. There are 10 areas where the case numbers are high, and there are specific governmental restrictions in place on construction-related activities, for instance, California, Michigan, New York, Pennsylvania and Québec. The impact on our business has been fairly severe in these markets with year-over-year sales declines of 40% to 50% in April. We don't know exactly when these restrictions will ease across every market. However, we have seen some cautious rollbacks during recent weeks in Pennsylvania, Michigan and the Bay Area.

Obviously, this is not a guarantee that business in these more heavily impacted locations will immediately improve, but we have seen early indications of positive daily sales trends. So we are hopeful as each state revisits the extent of the restrictions in the coming weeks.

The other 46 jurisdictions where we operate in the U.S. and Canada showed mid- to high single-digit sales declines during April. These areas represent approximately 70% of our overall sales. These modest declines highlight the recession-resistant revenue characteristics of our business. While we are not immune from the impacts of COVID-19, a heavy portion of our business is repairing aged and damaged roofs. About 70% to 75% of overall sales and more than 80% of our roofing business is R&R-based and largely nondiscretionary. This provides an important level of protection during soft economic environments.

As we mentioned in our press release, we have taken significant cost and liquidity actions in response to the pandemic. On the cost side, we have reduced our labor costs through broad-based efforts, including the reduction in hourly workweek, [ certainly ] both field and management employees, temporarily reducing salaries in executive and other leadership positions, restricting travel and other discretionary expenditures as well as taking a significant number of underutilized trucks off-line, reducing maintenance expense.

With respect to liquidity, we have severely curtailed capital expenditures, improved working capital metrics by reducing inventory and drawing down on our revolver. As a result, our balance sheet cash position is strong, and we are continuing to evaluate actions to provide liquidity and flexibility.

Now with regards to our strategic initiatives, I have to say that all 4 of them are serving as pillars for success even in radically changed circumstances. First, on organic growth. With our sales force largely working from home, we've had to resort to electronic forms of communication, and phone-based activity has climbed substantially.

Utilizing our CRM tools, our sales team has been diligently following up with our contract with customers to ensure they know we are open for business, and we stand ready to help them. Our dedicated outsized sales team has been making upwards of 9,000 calls per day to listen to what we can do to help customers. Based on feedback, we have developed webinars on subjects such as providing no-touch customer experience, handling the storm season with social distancing and homeowner financing. The benefits of maintaining this level of activity will be felt immediately and continue long after the current crisis is behind us.

Second, our focus on operational performance. The rigor we established to review branch performance prior to COVID-19 remains valid now. The metrics we've built around operational efficiency, headcount and inventory management are just as important in a recessionary environment as they are in a growth environment. At the beginning of the fiscal year, we intended to focus primarily on the lower quintile branches. With the advent of the pandemic, we are using the same approach across the network, and it's bearing fruits. While normally adding the headcount at this time of year, we have reduced by more than 10% across the company and in more of the most severely impacted branches. In many cases, we are still seeing substantial gains in revenue per hour worked, which we believe will help us now and in the future.

Third, our On Time & Complete network. This sets us toward realigning and expanding the cooperation of our 200 exteriors branches, serving more than 40 major markets, has been invaluable during COVID-19. First and foremost, leveraging the local network of branches, OTC helps us ensure that our customers receive highly reliable service and delivery schedules. If we experience a temporary branch closure, we can continue to serve our customer from another branch within the network. That reliability is hugely evaluable for customers and is a major differentiator for Beacon. When the economy recovers, this model will also allow us to meet increased demand more efficiently by leveraging the equipment resources and inventory across our network of branches.

Lastly, our digital platform. Speaking as a leader in e-commerce in the building products distribution space with online functionality that continues to outperform our competition. And in these days of social distancing, use of our solution continues to increase. And we expect these new customers to remain loyal users long after current conditions have passed.

Now more than ever, contractors want to order products on a 24/7 basis through Beacon Pro+ and many of them want to limit visits to the branch. The same principle exists for contractors bidding projects with homeowners. By using Beacon 3D+ that allows digital construction measurements to be taken without accessing the roof, contractors can minimize interactions with homeowners during the bidding phase.

The effectiveness of these strategies into very different demand environment has provided an early glimpse of how good Beacon can be. We're excited about what we are seeing and look forward to illustrating that as the economy reopens.

Now I will pass the call over to Joe to provide details on our cost actions and an update on our financial position.

[Joseph Nowicki, executive]

So thanks, Julian, and good evening, everyone. I want to echo Julian's earlier comments, our people are doing an incredible job in this environment, not only managing through COVID-19, but also continuing to maintain a heightened focus on their day-to-day business. I'm certain it'll benefit in the long term and will position us to outperform our peers.

Now I want to talk through our actions around operating costs. While our second quarter operating cost management was excellent, we reacted quickly as the threat from the pandemic became more clear. Our finance operations and executive teams quickly developed a wide range of scenarios for demand and then matched up a corresponding cost actions we need to implement. At this time of the year, we start hiring employees and expand overtime hours to address the seasonal demand uptick. Given the coronavirus outbreak, we significantly pulled back on these hirings. We've also reduced many hourly employees at 32-hour work week and made similar 20% more larger adjustments to many salaried personnel. We've also made furloughs across our entire organization.

Aside from reductions to employee costs, we've reduced T&E significantly, renegotiated many fixed contracts and reviewed certain facility consolidations. April month sales are experiencing sales declines of approximately 20% on a year-over-year basis, putting the April sales slightly above the monthly average produced during our recently completed second quarter.

With similar sales rates to Q2, we believe this offers an excellent basis for analysts and investors to more clearly understand what we've been able to accomplish from our OpEx perspective. On a sequential basis, our April month sales increased mid-single digits from the Q2 average. But at the same time, our adjusted operating costs have declined mid- to high single digits from the Q2 average monthly rate. This represents a major accomplishment for our organization. The pandemic has forced us to do more with less, and we're making better use of our OTC network efficiencies and enhanced productivity from our digital platform, along with many responsive cost actions we've taken.

While some of these cost actions are temporary, the current environment has also provided us with a unique perspective on our cost structure. And we're beginning to formulate a road map that will help improve our cost management during the eventual recovery. This certainly includes our lowest quintile branches, but there are also better understanding opportunities for productivity gains across our entire network, divisions and at the corporate level. We expect to exit the current slowdown in an even stronger operating cost position.

Next, I'm going to shift gears and provide a review of the balance sheet and update our liquidity position. Following our previously announced $725 million drawdown on our ABL, we ended March with $781 million in cash on hand. At the end of the second quarter, we also had an additional $197 million available on our ABL based on our quarter-end asset balances. We believe we have sufficient liquidity to weather the pandemic, although we're continuing to evaluate financing alternatives to ensure that we have the flexibility and liquidity to manage during elongated downturn.

We've also positioned ourselves to have favorable maturities on existing debt. The ABL matures in 2023, and our term loan B of senior notes don't mature until 2025 and 2026. We have a maintenance covenant only, which requires a fixed charge coverage ratio to be greater than or equal to 1. And at the end of the March quarter, this ratio stands at 2.4.

We ended the quarter with net debt of $2.8 billion, representing an attractive $210 million reduction relative to year ago levels. In addition, our average borrowing costs remain very competitive. We've taken rapid action with a number of key working capital items, both in the quarter but even more so during the month of April. Inventory was flat sequentially versus Q1, but as you know, this is typically at the time of the year we're building inventory.

Additionally, as you're thinking about the backdrop, throughout most of the quarter, we were experiencing solid levels of demand. So flat sequential represents very solid inventory management, leading to a modest year-to-year improvement in turns. But we've been even more aggressive with curtailing our inventory position in April as we have reduced inventory by approximately $90 million relative to the March quarter end. We also remain very focused on accounts receivable.

Our collections remain strong. DSOs have remained consistent, and our bad debt expense is comparable to the average experience of second quarters the past 2 years. Despite the economic slowdown, we have seen no material impact in this area.

Now I want to quickly address several other significant items impacting our financial statements. As released in mid-January, Beacon is in the process of rebranding and speaking of building products. An exciting announcement for the company and one that will truly unifies our platform and improves the overall customer experience. The noncash accelerated asset amortization of $142.6 million was recorded during the current quarter. This impact is excluded from our adjusted net income and adjusted EBITDA calculations.

Second, you will note that our other expense line item is lower than is typical. That has benefited from 2 unique items. The first relates to a favorable $5.6 million class action lawsuit settlement, which is included within adjusted EBITDA and adjusted net income calculations. The second item is a $5.3 million refund attributable to a true-up resulting from the 338(h)(10) election tied to Allied. This amount is excluded from our EBITDA and adjusted net income. But notably both items resulted in positive cash flow benefits.

Before I wrap up, I want to introduce Frank Lonegro to our investors. As you know, I will soon start the next chapter of my life, and Frank will step in as the new Chief Financial Officer of Beacon.

Frank and now have -- Frank and I have now spent a fair amount of time working together, appropriately socially distanced, of course. He's also very busy getting to know the other executives on our leadership team and meeting with all of his direct reports. He comes to Beacon with an incredible resume and diverse range of financial and operational leadership responsibilities at CSX. And it's clear to me that he is a great fit for Beacon at this point in the company's journey and that he and Julian will complement each other very well. We have a good transition plan in place, and I know it will go seamlessly.

Jim and Brent are anxious to introduce them to everyone on this evening's call, and we'll be scheduling introductory calls and meetings as time and social distancing rules allow.

I now want to pass off the call briefly to Frank before we move into Q&A. Frank?

[Frank Lonegro, executive]

Thanks very much, Joe. It's been a true pleasure working with you over the past 3 weeks. And I wish you all the best in your upcoming retirement. I'm obviously very excited to be joining Beacon. There are many attributes that made this an attractive opportunity for me, both personally and professionally.

On a personal level, for my wife and I and our 3 boys, this is a bit of a homecoming and puts us much closer to our families in Maryland. From a professional perspective, finding a company with great people and a great future was key, and I found that in Beacon. I'm excited to be working with a great leader and thinker in Julian and a very strong and collaborative executive team. That team, combined with an extremely knowledgeable and engaged Board of Directors set an operational strategy in place a couple of quarters ago that really resonated with me. I see tremendous opportunity to drive shareholder value here at Beacon. We're an essential business and have a durable business model, as you've seen during COVID-19. We're focused on delivering great service for our customers so we can grow with them. We're focused on doing that more efficiently, and we're focused on driving better returns and cash flow.

All of those elements were highly attractive to me, especially given my background at CSX. My first few weeks have confirmed that the operational aspects of building products distribution and freight transportation are quite similar. I'm excited about the opportunity and eager to help Julian and the team capitalize on the strategic momentum they've generated in the first half of 2020. I look forward to connecting with each of you during the coming weeks and months and working with you to help Beacon achieve what we all believe it can.

Operator, we're now ready to open the lineup for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of David Manthey with Baird.

[David Manthey, analyst]

First off, I'm just wondering if you can give us your expectations for the coming year for 2 items. One is shingle pricing and the other -- you mentioned housing starts improving in the back half of the year. Julian, could you give your outlook for single-family starts?

[Julian Francis, executive]

Well, David, thanks for the question. And I'll start with the second portion first. We don't really do forecasting the single-family housing starts, we tend to take blue chip. But I would tell you that, as I said earlier, we planned a year in which we expected to see improving housing starts through the year and particularly see some uptick in the second half of the year, and that would allow us to see growth in the second half of the year and, in particular, be able to sort of repair the margins throughout the year. Obviously, we don't have a crystal ball, but everything we would hear from the market suggests that new residential markets will certainly slow down. We don't know the extent to that, but we would certainly anticipate a slowdown in new residential starts for at least the next several months. I think that's generally the indication from the builders. And with regard to pricing, I think that we've seen a relatively stable pricing environment today. And I think we're -- we feel like we're in good shape as we approach the rest of the year.

[David Manthey, analyst]

Okay. And second, just could you provide us with growth rates by month in the quarter? I think there was some variability last year. Could you just give us an idea of what those growth rates were quantitatively?

[Joseph Nowicki, executive]

Sure. This is Joe. I can give you a rough feel on the monthly same-day organic growth. January was up a little over 1%, February was up almost 5%, and March was down about 4%. But keep in mind, with March, there's really -- there was a difference between the first half of March and the second half of March as well, too. First half of March, we had substantial growth. So it was good growth in the first half. And then in the second half, of course, when you started to see the impact of COVID, you saw a decline in volumes in the second half, tied very much to how we describe the April numbers.

[Operator]

Your next question comes from the line of Kathryn Thompson with Thompson Research.

[Kathryn Thompson, analyst]

The first question is kind of a near term. Second is going to be a little bit bigger picture. But first, when we talk to a variety of our industry contacts along the construction value chain, year-over-year comps are really meaningless in the current market. And most are focused on sequential weekly order trends starting in early March. And really answering the basic question is this week better than last. What we are seeing is the fourth week of March -- of April, rather, the week at April 12 -- 20th, you started to see a break in that downward trend. Understanding you're having huge variances in markets, what are you seeing in terms of the changing momentum and weekly trends as you track your business?

[Julian Francis, executive]

Kathryn, thank you for that question. I think it's incredibly relevant. And you're right, I mean, the year-over-year comparisons are difficult to make sense. Sequentially, we keep a very close eye on what we're seeing. I would say, obviously, through April, we did see continued sort of week-over-week slowdown. Until about mid-April, it started to stabilize. So I concur with what your other contacts have seen, and we saw some sequential improvements towards the end. I'd say they were very modest but encouraging. I would also say that you're absolutely right that it is very, very regional and very geographic. I'm really cautious about drawing any conclusions from anything we see in those numbers. I think that might be too early. I think that -- as we mentioned over the last call to David, who brought up new residential construction, I think we saw backlogs being worked through. And as those backlogs start to dry up, I think that there's some more outlook that could be on the downside. But obviously, as markets start to open up and construction restrictions relax, hopefully, we'll see improved activity. But generally, I concur with what your other contacts have said.

[Kathryn Thompson, analyst]

Okay. Second question is just a bigger question post-COVID. I think we all, including our businesses, have made significant changes to adapt to the current environment. But there are some changes that will probably be more permanent than not out of necessity, but just in terms of saying, well, maybe we could do our business typically, that will certainly help the cost structure. When you look at your business, what are some of the changes made in COVID that will probably be more permanent? And what type of -- maybe put into buckets in terms of savings, maybe not in dollars term, but broadly, how that contributes to the business on a go-forward basis?

[Julian Francis, executive]

Thanks, again, for the question. I think there's a couple of things that have really struck me. I mean, first, it's the necessity. Because of the inability to get around and sort of see the branches. The ability to communicate effectively with common metrics is absolutely essential. So developing the right narrow set of metrics to get at the critical issues has been really important. And I think we've done a really nice job there. But that also necessitated sort of improved look at not just headcounts, but how we use hours at the branches and how we manage day-to-day hours and the ability to respond quickly to the changing daily sales volumes. That has been a really important one that I think will be long-lived. So really branch operating metrics.

I think the second would be around sort of corporate overhead. The one thing that I think every company is facing right now is how do you go back to sort of normalized level of travel and expense? How -- what does that look like in the future given what we're experiencing now and the needs to keep people at home and safe versus traditionally? This has been a value-to-value business. So that's another area where I think we'll be examining it.

And then probably the last bucket, something we've been pushing now for several years is really around the impact of digital. I do think this will be an accelerator of the move to digital transformation, contractors ordering via the websites, via the apps. Our ability to get contractors in and out of the branches quickly and efficiently. I think there've been some innovations, quite honestly, in our branches that we've seen in how to do that effectively. And I think the combination of sort of touchless, contactless interactions will not go backwards from where we are today, and we'll probably move forward. And I think that we've taken a leadership position in the industry on that, and I'm convinced that, that will continue.

[Operator]

Your next question comes from the line of Trey Morrish with Evercore ISI.

[James Morrish, analyst]

So I guess picking up on that last point you made about digital. You talked about digital being up in the first quarter, up 50% year-on-year, pretty great growth there. But I'm wondering if you could talk about what you've seen in digital sales in April? If you've seen a further acceleration from that? Or if those sales have fallen noticeably less than your -- either over the phone or in-person sales?

[Julian Francis, executive]

Thanks for the question, Trey. No, I think they're sort of in line. I'll be personally honest, it's difficult to tease out everything because certain customers that would traditionally buy from us online aren't necessarily operating at the same level. So we've got different levels. I think what we're seeing is more customers trying for the first time to get online and to place the orders online and to kind of avoid coming into the branches and do that. So we're certainly seeing not just the sales volume, which I think is difficult to pick up, but it's also just in terms of the total number of customers that are doing it as well.

[James Morrish, analyst]

Got it. And then talking about your inventory. You said it was down in April sequentially by about $90 million. And just looking back over the last, call it, 1.5 years or so, you've had about -- that's fairly stable inventory turns on a trend [indiscernible] basis. So I'm just wondering how much are you looking to get your inventory down. If sales end up staying down 20% on the quarter, would you imagine your inventory also declining sequentially by that much? Would you want to bring it down even further or less than that expecting a rally or a bump in demand going forward after this lull?

[Joseph Nowicki, executive]

Yes. This is Joe. That's a great question. I probably think a lot about -- this ties right to our strategy we've been talking about for a while now around utilizing our [indiscernible] the OTC networks more effectively to help drive improvements in our inventory. I think you're seeing that start to play out here. The $90 million was a great kind of step in that direction. Do we think there's some more improvement even if the volumes stay at the current levels that they're at? Probably some, but we're going to continue to manage it, as Julian said, on a region-by-region basis. There are some of our regions that are doing very well. We want to be sure they have the appropriate products to be able to ship to the marketplace. But the teams have done an excellent job managing the inventory levels down. I think there's a little bit more room for improvement as well, too. So you'll see us keep focused on that. Yes.

[Operator]

Your next question comes from the line of Ryan Merkel with William Blair.

[Ryan Merkel, analyst]

So 2 questions from me. First off, can you talk about the health of your roofing contractor customers? Are they able to stay fully employed? And I'm just wondering if labor could be a constraint for the foreseeable future?

[Julian Francis, executive]

So Ryan, we've got varying degrees in -- we have not seen a significant uptick in terms of the financial problems with our customer base. So I think it's been very stable. They've all made personal decisions about whether to continue to work or whether to stay at home. And obviously, again, it varies greatly by geography. And as to the labor situation, I'll just say with the demand down as it has been, it's really difficult to gauge today if there will be any sort of additional constraint due to labor. Obviously, labor has been one of the challenges for the construction industry over the last several years. Today, I think it's more of how can you work safely on a job site, and I think that going forward, one of the challenges will be how we're going to be able to develop new processes to deal with an environment in which social distancing, access to people's homes is much more restricted. So I think that rather than labor, I think it's a process that may have an impact in the near term and perhaps stretching out.

[Ryan Merkel, analyst]

Got it. That's helpful. And then my second question, what drove the 11% growth in nonres? Was it something onetime? Or is this the effect of your new sales efforts?

[Julian Francis, executive]

Ryan, I'm glad you asked that question. Look, this is the third consecutive quarter that we've returned to growth. I think it's a renewed focus on that piece of our business. I think that through the acquisition of Allied and the way that works in terms of moving accounts, moving suppliers and vendors around in different markets, I think there was probably a distraction. I think we've gotten back to the core of the business. I think it's performing really well. And I think it's really a broad-based effort to focus on that piece of the business and take advantage of advantages that we have and things that we're good at. So I think it's more a renewed focus and certainly not just a one-off large job or something like that.

[Operator]

Your next question comes from the line of Seldon Clarke with Deutsche Bank.

[Seldon Clarke, analyst]

As it relates to the commentary you had about the sequential progression of sales versus costs, when you take a step back and you look at the normal progression from 2Q into 3Q, you do see a pretty significant step-up in profitability. So could you just give us a sense of how this is trending versus maybe normal seasonality and what you're seeing from a price-cost perspective as well?

[Joseph Nowicki, executive]

Sure. I think the first part of your question is really trying to get at that decremental margin kind of impact of what we'll see in the business based on what we described. So let me give you a little bit more on that. I'll frame it up by -- Julian has talked about mentioning how we set our initial guidance in place for 2020 back in November of last year. First half of the year would be challenged a bit by difficult storm and hurricane comp and then the second half of the year will be more favorable as we saw year-over-year volume gains and GM improvement. And we reported out that we did quite well in the first half of the year, met our commitments above and beyond. So as we sit here today, we know the second half of the year will be a little bit different. So we've withdrawn our initial guidance, but I can give you a little bit more direction on the decremental margins based on the actions we've taken. Depending on the level of volume declines, we believe our decremental margins will be in the range of 15% to 25%. To give you a little more input, and we mentioned that April volumes were down about 20%. And based on what we're seeing in April right now, our decremental margins were better than the midpoint of that range. So hopefully, that gives you a sense of how to think about our cost structure and the actions we've taken and the benefits that we'll see kind of going forward in that regard.

[Seldon Clarke, analyst]

Okay. Is there any impact from price in there or COGS?

[Joseph Nowicki, executive]

No. There is none.

[Seldon Clarke, analyst]

Okay. That's really helpful. And then I guess, just continuing on that same question. What would -- if you're trending towards the better end of that range in April, what would you need to see to -- for decrementals to shake out closer to that 25% range? Is it timing or the extent of the decline or the length of decline? Like what would get you to that 25% range?

[Joseph Nowicki, executive]

It's more the extent of the decline or the length of decline, as I just mentioned, it's really more volume dependent than anything else.

[Seldon Clarke, analyst]

Okay. So they have to get worse than 20%?

[Joseph Nowicki, executive]

Yes.

[Operator]

Next question comes from the line of David MacGregor with Longbow Research.

[David S. MacGregor, analyst]

Sorry about that, I was on mute. I wanted to start off by asking about the quintiles. And you've talked in the past about your 5 quintiles, and I think the lowest quintile, you thought you could get $30 million to $60 million of EBITDA. In this changing environment, I guess, I just wanted to check back with you again and get your latest thinking in terms of the opportunity you should think through those tiers. Is it still $30 million to $60 million at the lowest tier? Do you think the opportunity might be getting a little bit better? Do you think the time line upon which you can realize these benefits is maybe accelerating a little bit? If you could just talk about how your thinking there is changing with the environment.

[Julian Francis, executive]

Thanks for the question, David. I don't think we've seen sort of a point of view in terms of a difference in the scale. I do think that what we are learning in this environment may help us accelerate. We did see gains out of that bottom quintile in the second quarter, which was encouraging. It wasn't everything it needs to be, but it wasn't 0, we could see it in our results. And that gives me an indication that we are able to get at it. I think that in this environment, the focus becomes all of the branches. I mean, right now, obviously, with the sales relatively flat, we're looking at effectively an extended winter scenario. And it's very difficult to create operating leverage with the flat sales. So we're trying to drive efficiencies as best as can at the branches, but at all of the branches rather than just the ones that we were focused on the bottom quintiles. I think we're certainly learning some new operating measures that we are going to be able to put into those lower quintile. I think hopefully, I'd like to see that benefit us so that we get into the upper end of that guidance we provided before in the $30 million to $60 million range. But I think that, that's still sort of the range that I think we're in.

[David S. MacGregor, analyst]

That's helpful. Second question is just on the OTC program. And I think you'd indicated on the last call that you were live in 30 markets and you planned on additional 20 by year-end. I guess the same question, again, can you accelerate there? And if so, what are the P&L impacts?

[Julian Francis, executive]

Yes. I mean, this environment is particularly difficult. I mean, one of the things that we're required to do to really implement -- fully implement our OTC model is to establish like we did in Denver and some new operating locations, some large hubs in some of these markets. We just opened one, as we said, in Denver. Obviously, in the current environment, in order to preserve cash, we put some of that on hold. So that would likely slow down in the near term. So I don't see any significant impact, except from a capital expenditure standpoint. We've probably slowed down some spending there. So I don't think we have any near-term impact from OTC and certainly no intent to accelerate in the current environment.

[Operator]

Your next question comes from the line of Keith Hughes with SunTrust Robinson.

[Keith Hughes, analyst]

Two questions. First, your answer to a question earlier on the sequential improvement or bottoming of business since mid-April. I've heard that on multiple earnings calls here in the last week or 2 public earnings call.

[Julian Francis, executive]

Keith, sorry, you're very quiet. We cannot hear you.

[Keith Hughes, analyst]

Is that better?

[Julian Francis, executive]

Yes. That does seem to be better.

[Keith Hughes, analyst]

Sorry about that. I'll start again. Your talk of the sequential changes since about mid- April in your business. We've heard that on multiple public conference calls in the last week or 2 from your wider peer group. That also did seem to coincide with some of the payments of the federal government to consumers, particularly the $1,200. Is there any sense that, that's helped support demand in the last couple of weeks? Any sort of talk in the channel on that?

[Julian Francis, executive]

Keith, I'd be really hard-pressed to say that we could tie any of that demand to the kind of the payment checks. It's really difficult to tease any of these pieces out of the data right now. I mean we typically be seeing a seasonal lift. So was it improved weather on the West Coast, was it better weather in the south, was it storms that hit Ohio. It would be really, really difficult for me to say we could tie it to $1,200 check.

[Keith Hughes, analyst]

Okay. I guess, second question on the nonresidential, with some really good numbers here in the quarter. Any sort of sense on what's happening on some of the longer-term project quotes, any changes on that? I'm sure near-term work has clearly been delayed. But my question here is more on the longer term.

[Julian Francis, executive]

Yes. So I mentioned it in my prepared remarks that we've seen bidding and quoting pretty much hold up. Obviously, I think people are trying to work through, as I mentioned earlier, process. We are seeing restrictions on job sites. I think that roofing tends to be early in the cycle. Our interiors business tends to be later in the cycle. We're seeing probably a difference between those 2 as well. So I think that overall, I think the bidding, the quoting there, again, I go back to process and there's no doubts that we are going to see delays in production, and so projects stretch out. So I think that's the big unknown for me right now as to how that stretches out. And do we get back to a more normal schedule over the next 6 to 12 months.

[Operator]

Your next question comes from the line of Jay McCanless with Wedbush.

[James McCanless, analyst]

Can you hear me now?

[Julian Francis, executive]

Barely.

[James McCanless, analyst]

Okay. Is that better?

[Julian Francis, executive]

A little bit, yes.

[James McCanless, analyst]

Yes. Sorry about that. So the first question I had was the debt that you'll pull down from the ABL, what does annualized interest expense look like?

[Joseph Nowicki, executive]

Sure. We've been running approximately -- in the second quarter here, we are about $33 million in interest expense. And the third and the fourth quarter looks like we'll go up a few million dollars or more from that number from where we're at. So we'll be in that $35 million, $36 million range. Does that help?

[James McCanless, analyst]

Yes. Absolutely. And then the second question I had is the 20%, and I maybe ask Keith's question in a different way. With what we're hearing and seeing about potential Class A rents being under pressure, just wondering if that 20% decline that you saw in April sales, if it's more heavily weighted to nonres or to one segment of the business versus another?

[Julian Francis, executive]

Jay, I think that we would say it's more geographic-based than anything else. It remains -- those markets more heavily impacted by the virus are the ones that we're seeing the biggest declines in. And it happens across the board. So that is both commercial and residential construction. I would say we've probably seen a slower pickup in some of the residential markets. But early on in this crisis, we did see some commercial work get pulled forward. So there's a little bit of a lift, I think, because of that. But it's really difficult to say that it's one segment of the market. It's geographic is the difference.

[Joseph Nowicki, executive]

And Jay, by the way, just as -- this is an FYI, Jay. Those interest expense numbers, those were our adjusted interest expense numbers. So if you're trying to look at a GAAP statement versus adjusted, that was adjusted. So just FYI.

[Operator]

Your next question comes from the line of Mike Dahl with RBC Capital Markets.

[Unknown Analyst]

This is actually [ Chris ] on for Mike. So my first question is just going back to inventory. Can you just give us an update where inventories are in the channel? And if there's a need for additional rightsizing in your view?

[Julian Francis, executive]

Yes. [ Chris ], we're constantly reviewing our inventory position. Certainly as a reaction in the first few weeks of this crisis, I think our focus was on cash generation, making sure if sales were going to decline that we could adjust our inventory appropriately and make sure we were in a good cash generation position. We've accomplished that. We're in a good position. We do think there's additional opportunity to take more inventory out. But I would tell you, we're probably now going to make sure that we're adjusting to market conditions as well. As we see -- if we do see market growth, we'll make adjustments there. As we see markets move backwards, we'll make adjustments there. So I would tell you that early on into this, I was very focused on getting our inventory into a position where we could weather no matter what this was going to throw at us, and we were in a good cash position.

[Unknown Analyst]

Got it. Appreciate that. And then just for my second question. Going back to industry pricing, any early signs of price deterioration in light of the expected volume losses and asphalt tailwinds to come? Just any update on the competitive dynamics and then price in general.

[Julian Francis, executive]

Yes, sure. We've not seen to date any substantial moves in pricing. Nothing that I would consider unusual or odd behavior in the marketplace whatsoever.

[Operator]

Your next question comes from the line of Garik Shmois with Loop Capital.

[Garik Shmois, analyst]

I wanted to ask, just given the wide range in April sales that you're seeing within geographies restricted versus less restricted markets. Is there anything that we should be thinking about with respect to gross margins and how those have tracked in April from a geographic mix perspective?

[Julian Francis, executive]

That's a great question, Garik. It's something we do follow. Generally speaking, our North division and our interiors division have high gross margins, and they've been impacted to a greater degree by the virus. And so we will see some -- I would say, today, it's a relatively small impact. But my guess is that it's not 0. But it is -- there is some geographic difference related to the challenges in terms of delivery. So as -- what we're really watching is the new residential market is generally slightly lower-margin business as well. So as you look at that declining, that tends to impact the sales from the West division more than the Northeast. So there are things that are moving around inside of our P&L that we're watching very carefully. I would say, today, so far, the impact has been relatively small.

[Garik Shmois, analyst]

Okay. I guess my follow-up question also on gross margins. Could you provide any level of confidence, you made really good progress on improving gross margins, Julian, and your time that you've been at Beacon. So the items that you can control, excluding geographic mix, what is your outlook for gross margins moving forward, both in a recessionary environment and also when the world hopefully gets back to normal?

[Julian Francis, executive]

Yes. So our thesis on this year, as we've said a number of times now, was a weaker first half and a stronger second half. That we were hoping to sort of maintain our level of gross margin in the first half and then expand margins as we go into a better second half and more growth. Obviously, as we face a recessionary environment, it's something we're watching very carefully. So we would probably say that the expansion of gross margins today is probably a little bit behind where we would have anticipated being going forward. So obviously, there's some pressure there. But so far, I've been very pleased with, like I said, how we've held up. It's probably been a little bit ahead of what we're doing. And I think we are actually managing both our price-cost relationships very well today. And so I'm confident right now that we can maintain where we are, absent some substantial additional changes in the marketplace.

[Joseph Nowicki, executive]

The other part I would add is under -- when you're talking about under our control, we brought teams that have also done a great job of really continuing on our private-label-branded products throughout our network as well, too. And that I think also is another contributing factor that's helped us, plus, as Julian said, really good job of managing price cost continues.

[Operator]

Your next question comes from the line of Phil Ng with Jefferies.

[Philip Ng, analyst]

You talked about how there's a big divergence in terms of trends in April and some of these states that were more heavily impacted like Pennsylvania and places like that have actually resumed construction in a number of states like Georgia, Texas have reopened recently as well. So any color on the trends you're seeing, if you've seen a more noticeable pickup of late?

[Julian Francis, executive]

Yes, Phil. So as we mentioned, I think in answering Kathryn's question, we have seen a sort of slight uptick towards the end of April. I would tell you that I do think that some of that is related to the easing of restrictions in places like Michigan and Pennsylvania. I also think that there are 2 other dynamics happening. One is people are figuring out how to work in this environment. And they're figuring out that they can get back to work. And I do think that there is some element of that going on. The other thing is, I do think there's an element of these construction projects, despite the fact that they're opened, they're not normal. They are on job sites, both residential and commercial jobs, health checks, limited number of contractors on a job site at any particular time. So it's not something that you're just going to see go back to normal. There's still restrictions, despite the fact that they're open. So it's really difficult to tease out, but I would say that we are seeing some positive trends in those markets. It's just difficult to say it's because they've opened construction.

[Philip Ng, analyst]

Got it. That's super helpful. And I guess the last one for me. In this current environment, are you gaining share potentially at the expense of some of your smaller competitors that don't have some things that you're implementing like your software, your app? And have you seen some of these competitors shut down? And Joe, perhaps, from your experience in the past cycle, did some of that materialize for these smaller guys closing due to the downturn?

[Julian Francis, executive]

Phil, I do think that what we're seeing with our strategy, the activity of the sales force that we've emphasized. I'm really proud of the team working from home, making those thousands and thousands and thousands of calls every day. I really do believe that, that is having an impact. And the fact that we've been able to maintain our branches, most of them are open and working. And like I said, our branch team has done an absolutely amazing job and innovative job, punching holes in walls and putting windows in to act as ticket counters so that we can take orders, figuring out how we can use trays and tents out in the parking lots to enable pickup delivery. I think the inventiveness of our people in the field is absolutely leading to improved share position. I think they've been wonderful throughout all of this and have done so in a very safe manner as well. It's difficult to pin down the impact on some of the smaller competitors. I'm very confident that our position in digital is industry-leading. And I think that's something that you do not see. The smaller competitors have the ability to enact in any meaningful way. And so I'm sure that's going to have an impact both now and in the future.

[Joseph Nowicki, executive]

And I would add that OTC has gotten the same as well, too. Our investments and direction in OTC have helped us to increase our efficiencies and productivities at the branches as well, too, whether our underperforming quintile or even those at the top level. So they've been great.

[Operator]

Your next question comes from the line of Michael Rehaut with JPMorgan.

[Elad Hillman, analyst]

This is Elad on for Mike. First, I was wondering if you could help quantify the amount of cost savings you expect in 2Q from the cost actions you've taken. And I also wanted to clarify if any of these benefits were included in the better than 20% decremental margin you mentioned for April?

[Joseph Nowicki, executive]

Yes. This is Joe. I can't give you a specific number on the quantification of the dollars of savings. That's where I'm trying to go with the decremental margin piece to give you a sense of what our margin decrease would be based on the volume declines, right? But that's the biggest wildcard is knowing because many of them are variable with volume. So depending on what the volume decline is will give you a different number for what those savings are. So I think the best way to do the math, I was really looking from decremental margins in that 15% to 25% range. And then as I mentioned about April, where volumes were down 20%, we were a little bit underneath or better than the midpoint of that range. So that should give you a ballpark of how to determine it based on volumes.

[Elad Hillman, analyst]

Okay. And the second thing I wanted to know was just digging down to the commercial roofing sales in the quarter that were much stronger, up 11% on daily sales. And I think you mentioned some increased buying ahead of the crisis. Could you elaborate on that dynamic and its drivers and how commercial sales have played out since?

[Julian Francis, executive]

Yes. We've seen commercial sales remain relatively strong so far. Like I said, it's becoming increasingly difficult to access job sites. But some of the things that we saw in a lot of markets, whereas schools shut down early and the kids were sent home, we did see school work pick up. And so there was some pull forward of demand. Normally, that work gets done during the summer break. And we saw some of our contractors have to get on job sites a little bit earlier there. We saw a little bit of a dynamic that was sort of twofold. There were some hospital jobs where they wanted no one on the job site. So it kind of got pushed out, and there were some that needed the repairs done immediately so that they can keep operating. So we've seen a mix. But generally, I would say that we saw a little bit of pull forward because there was some school work that got done early on. And that seemed to be a trend amongst school boards to pull that forward as the -- ahead of sort of summer.

[Operator]

Your next question comes from the line of Kevin Hocevar with Northcoast Research.

[Kevin Hocevar, analyst]

Wondering if you could comment on working capital in terms of your cash flows. It looked like the March quarter was a pretty big use of cash when normally -- it's typically a pretty nice source of cash. And typically, the June quarter is a bigger use of cash. But I'm curious with your inventory management that you have going on, would you expect that to change this year? Just curious if you can comment on the inventory management you're doing, how that will affect working capital here in the June quarter and going forward?

[Joseph Nowicki, executive]

Sure, you bet. So first, on the March quarter end, you're right. A lot of this is timing related. So what you saw from free cash flow part was our AR balances were a little bit higher because of the sales coming into it at the end, and our DSO was just a little bit higher to it that caused a slightly higher AR plus the AP of it due to just some timing of our payments on the AP side, really caused a little bit more outflow on AP, which is really what caused that working capital decline, as you had mentioned. That was the biggest driver there. But you're right, if you fast forward to what we're seeing now in April and with the inventory decline, you can expect us to be even in a better position, a much position from a working capital perspective. We're managing the inventory very closely. As I mentioned, April down another $90 million, which is very uncommon for us this time of year. And then you couple that with, again, the AR balances, as I mentioned. We've been doing a great job on collections there. As Julian said, our customers have been great in working with, and our AR and collections are still doing quite well also. So you'll see some good improvements in our working capital as we go forward, yes.

[Kevin Hocevar, analyst]

Okay. And then in terms of April, down 20%, could you break that out between the 3 segments, how the 3 different businesses performed versus that? And do you expect April to be the low watermark for the quarter? Or do you think things get better? It sounds like things got a little bit better as we exited the quarter -- the month, but curious how you think if that's -- if April is a low watermark for the quarter or things get any better or worse from there?

[Julian Francis, executive]

This is Julian. I think it's really difficult to say that April is below watermark. If someone could make that promise to me today, I'd take it. Certainly, we're seeing good progress through the month of April. So that was certainly encouraging. But it's difficult to sort of suggest that, that would be kind of the low watermark. The other part of your question?

[Kevin Hocevar, analyst]

In terms of how did the segment perform versus that in 2020?

[Julian Francis, executive]

So again, I'll go back to -- it's really geographic. So certainly, the businesses, our interiors business has been impacted. We've got a really good business in the Northeast. We've got a good business in California and a good business in the Midwest. If you look at the Northeast and the West Coast for that business and you think -- those are big markets because it tends to be focused on commercial construction. So those are heavily impacted markets, it's really about geography, but I'd say that our exteriors business was equally hit in those markets. So it's not a type of business so much as it is geography. As we go forward, most new construction tends to happen in the southern part of the country. So we're watching that very carefully going forward. But I would continue to emphasize that it's much more about geography and those markets that are heavily impacted by the virus today that have had severe restrictions for a while. That's where the declines have really impacted us.

[Operator]

That concludes the questions. Now I would like to turn the call back over to Mr. Nowicki for his closing comments.

[Joseph Nowicki, executive]

Thanks. This is Joe, and I'll wrap up. And yes, this will be my last wrap-up. I want to thank everyone for joining our call. It's a particularly emotional one for me as I complete my service as the Chief Financial Officer here at Beacon. It's been 7 years that I will remember fondly as we transformed Beacon from a $2 billion roofing company into a $7 billion Fortune 500 building materials company. As I say it's not about the destination, but about the journey, right? And this journey was truly amazing. Most of the incredible talents mostly all due to the incredible talents of the people here at Beacon, our Board of Directors, our partners, shareholders and all of you on this call. I'm proud to have served all of you for the past 7 years. And now on to the next journey. As a company, Beacon remains very well positioned as a leader in the building products distribution industry. The strategic shift in our business began several quarters ago, and we've already demonstrated the progress is being made. With that said, though, we're just getting started. We will manage with discipline and focus during the coronavirus environment, and we will emerge even stronger on the other side. We hope that our employees, customers, suppliers and investors are all keeping safe and healthy, and we appreciate everyone's continued support during this difficult time. Thank you for listening in, and have a great evening.

[Julian Francis, executive]

Thanks, Joe.

[Operator]

This concludes today's conference call. You may now disconnect.