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Edited Transcript of BECN earnings conference call or presentation 3-Feb-20 10:00pm GMT

Q1 2020 Beacon Roofing Supply Inc Earnings Call

PEABODY Feb 6, 2020 (Thomson StreetEvents) -- Edited Transcript of Beacon Roofing Supply Inc earnings conference call or presentation Monday, February 3, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joseph M. Nowicki

Beacon Roofing Supply, Inc. - Executive VP & CFO

* Julian G. Francis

Beacon Roofing Supply, Inc. - President, CEO & Director

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Conference Call Participants

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* Elad Elie Hillman

JP Morgan Chase & Co, Research Division - Analyst

* Garik Simha Shmois

Loop Capital Markets LLC, Research Division - MD

* Jay McCanless

Wedbush Securities Inc., Research Division - SVP of Equity Research

* Keith Brian Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Kevin William Hocevar

Northcoast Research Partners, LLC - VP & Equity Research Analyst

* Michael Glaser Dahl

RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products

* Philip H. Ng

Jefferies LLC, Research Division - Senior Research Analyst & Equity Analyst

* Trey Grooms

Stephens Inc., Research Division - MD

* Truman Andrew Patterson

Wells Fargo Securities, LLC, Research Division - Associate Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to Beacon's First Quarter 2020 Earnings Conference Call. My name is Josh, and I will be your conference 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, February 3, 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 will be Mr. Julian Francis, President and CEO; and Mr. Joe Nowicki, Executive Vice President and CFO. I would now like to turn the call over to Mr. Julian Francis, President and CEO. Please proceed, Mr. Francis.

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [2]

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Thank you, Josh, and good evening, and everyone, welcome to our first quarter 2020 earnings call. Following the completion of my first full quarter as Beacon's CEO, I'm excited to share our progress against the goals we've set for ourselves. I'll start with a few comments about Q1 and then get right into a strategy review update before passing to Joe for financial details and fiscal year 2020 guidance.

I'm pleased to report the first quarter in line with our expectations despite a weaker market environment, both sequentially and year-over-year. We talked on our last call about seasonally difficult comparisons due to year-ago reroof demand associated with hurricanes. So although our sales were down, we believe we tracked with the market.

We also talked about expecting an about flat gross margin profile sequentially during the first quarter period with flat results representing good performance during a quarter that typically see sequential decline in that metric. We outperformed on this with gross margins of 24.5% in the first quarter, which is up marginally compared to Q4 2019.

I'm pleased with our ability to execute on a critical indicator that we focused on. I was also pleased to see growth in our commercial roofing business with a second consecutive quarter of year-on-year growth. Although modest, this represents a positive trend in an important part of our exterior products business that has recently underperformed. Our adjusted operating expenses came in higher-than-anticipated on additional health care costs and other timing-related expenses. Joe will elaborate on these in his comments.

In summary, Q1 represented performance in line with our expectations. I'm particularly encouraged with our gross margin progress, although there is clearly improvement to be made in many areas.

Now let me talk about the strategic work that we're doing, which is really what will drive our future performance. On the last call, we signaled a strategic shift was underway with a pivot from large-scale acquisition integrations to focus on our current operations. The recent history of our company has been acquisition-driven growth. It's been important for us to build scale in order to establish our competitive position for the future.

Going forward, our scale represents competitive advantage that we must capitalize on to enable us to grow faster than the market. By investing in sales and service models that benefit our customers so that they choose to make us their preferred supplier, we can outperform. It will also enable us to use our assets more efficiently and control our expenses to drive operating leverage.

Where Beacon is most successful, we differentiate our offer with strong customer relationships and an ability to serve their unique needs every day. We also built strong partnerships with suppliers who rely on us to position their products advantageously in the market, supporting innovation in product and service to benefit our customers. We were able to provide value to our customers with strong supplier partnerships and create opportunities for us to grow together. So that Beacon becomes a significantly different distributor from others and the distributor of choice, we are increasing customer interaction, improving operations, partnering with our suppliers and differentiating our service proposition.

The strategic review I launched upon joining Beacon is focused on improving the sales and operating performance at our network of exteriors and interior branches and enhancing the overall customer experience using our scope and scale to differentiate our offering in the market. While the review is not yet final, we have moved ahead on several fronts. The strategic review work is making clear to me that as Beacon integrated 40 companies over the years, we've missed some opportunities. Now with major acquisitions behind us, we are determined to grow organically and expand our position. It is critical that our sales team is more active in the marketplace, asking for orders and following up with the service in order to drive top line growth.

As I mentioned on our last call, we have the opportunity to grow our residential and commercial customer lists organically. From my first days with the company, I've been impressed with the team's drive to win. They are committed to developing their skills and increasing customer interactions, and we will provide tools to support them. We will expand the use of advanced analytics and pricing tools to segment our customer base and target the most profitable opportunities. The development and deployment of these tools is underway and I believe will enhance our capabilities, ensuring consistency in our execution.

Last month, I had the opportunity to announce our new branding at our annual managers' meeting. It was exciting to share that we are unifying our company under the Beacon Building Products brand to reflect our portfolio of exterior, interior, solar and weather-proofing products. This move reflects our ability to supply customers with a broad range of both residential and commercial building products and the unique service offering across North America.

Beacon's customers will benefit in many ways. Our research has shown that as customers expand their businesses, they want a recognized and trusted partner who makes it simple for them to grow across the region or across the country. On a local level, customers want to do business with a known market leader they can rely on.

Internally, this is a new chapter for our employees, who will all now proudly represent Beacon from coast to coast. Team is already rallying around a common brand and common goals. While the 40 legacy company names have had an important role in our history and success, there is a shared belief in the value of coming together to better serve our customers.

I also talked previously about operational performance and how I tend to think about our branch network in quintiles. All branches have operational improvement opportunities that are being addressed continuously. We have intensified our focus on the bottom quintile. Each branch is unique but often has common cause for underperformance such as footprint, market access and operational capabilities. To improve the profitability of these locations, we are beginning to have in-depth reviews among local, region and corporate leadership to determine the appropriate actions and establish plans for each individual location.

While it's important to recognize these changes won't occur overnight, where we have developed and executed against the plan, we do see upticks in core metrics. I believe there is an opportunity for mid-single-digit improvement in operating income from these branches alone, resulting in $30 million to $60 million in incremental annual adjusted EBITDA performance. Capturing this as well as improved performance at the remaining 400-plus branches is a core strategic imperative that will yield significant improvements over current results.

We've also been reviewing how to capitalize on our market scale and scope to enhance and differentiate our service offering. Ultimately, our ability to serve customers in a way that brings more value to them is how we differentiate ourselves in the market. Our operating model is one that puts customers in market at the center of our business by networking branches together in major MSAs to be more responsive. This network, now called Beacon's On Time & Complete or OTC network, shares inventory, fleet, equipment and employees in a manner that materially raises customer service. Our network's central dispatch base is now live in 30 markets, with more than 20 additional markets planned for the remainder of 2020.

The results are very encouraging. Aside from the customer service benefit, we have seen average delivery miles decline by 12% in Q1 year-over-year. Inventory metrics are also showing improved results with approximately an additional full turn achieved in 14 of our more mature OTC markets. We will open a hub location in the important Denver market in Q2 and have identified 10 to 15 additional areas that could best utilize this customized concept over the next several years. We believe there is an opportunity for $50 million to $100 million positive impact on inventory balances from the more efficient turns, in addition to cost savings associated with the more efficient use of our assets.

Finally, I'll highlight our continued commitment to transact with customers the way they prefer, be that at our sales counter, by phone or online. What we do see is that their adoption of our digital solution continues to grow. We have talked previously about a $1 billion annual goal for e-commerce sales. I see the majority of our customers wanting to conduct at least a portion of their business with us in a digital fashion. There is currently a window for us to create preference for our digital solution, which we believe translates to improved customer retention.

Customers also order larger baskets with an improved mix of products on the Beacon Pro+ platform. We are targeting to exceed 10% of sales on Beacon Pro+ this fiscal year, up from mid-single digits last year. We are the clear leader in this value-added area and are investing in upgrades and expanded functionality to maintain that leadership. As an example, this month, we are launching Beacon Pro+ for our interiors customers. Being able to utilize our solutions through every aspect of a job's life cycle, including quoting, ordering and final payment, is a unique distinction from our competitors.

In summary, our strategic review is not yet fully complete, but I believe it is uncovering the true potential of Beacon to grow both top and bottom line. Our scale advantage will allow us to expand margins by improving our sales and service model, reduce costs to serve via efficient use of our assets and generate more cash through inventory optimization and improved financial performance. Our strategies are designed to help our customers build more with superior service levels throughout the contractor life cycle. I'm enthusiastic about what the future holds.

I will now pass the call over to Joe to provide additional details on the first quarter and our view of 2020.

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [3]

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Thanks, Julian, and good evening, everyone. First, I'll provide additional color on our quarterly results, and then I'll conclude with details on our fiscal 2020 outlook.

Overall, organic daily sales decreased 2.7% during the fourth quarter. The period has 62 selling days, the same number as the prior year quarter. As we highlighted during our last quarterly call, the year-gone hurricane impact tied to Irma, Michael and Florence made for challenging quarterly comparisons within our Mid-Atlantic and Southeast regions. These 2 regions were down 14% and 5%, respectively, during the quarter. It's important to note that organic growth in our 5 geographic regions unaffected by hurricane comparisons was essentially flat during the quarter.

Total residential roofing recorded a 4.1% sales decline in the first quarter, levels, we believe, to be in line with the overall distribution market. We delivered much stronger performance when excluding the 2 hurricane-impacted regions. In the 5 other regions, residential roofing increased 3.5%. Volume growth, we view, is more indicative of core demand during the quarter.

Commercial roofing generated positive daily sales growth for the second consecutive quarter. We believe this accomplishment represents a significant positive for Beacon following 4 quarters of a sales decline. Our Q1 results are also more consistent with the overall market growth rate, providing further evidence that the disruptive elements associated with Beacon's large acquisitions are increasingly behind us.

An important part of our commercial roofing strategy involves our dedicated commercial sales centers. As a refresh, these centers handle all commercial roofing needs at a single location, including quoting, engineering, project support and order fulfillment. We're currently at 27 locations and have plans to add to this over the coming quarters and to eventually operate this model at all major MSAs. In some cases, we have opted to use one of our existing branches and dedicate it entirely to commercial roofing, but in other locations, the operations are carved out within an existing branch structure. We see this approach is providing a more efficient operating model for commercial roofing customers and also one that closely aligns with our broader OTC network.

Complementary product sales declined 3.1% in the quarter, the result of modest volume declines and deflationary pricing in select categories, including steel studs, lumber and wallboard. As a reminder, complementary products are more cyclical than roofing with higher exposure to both new construction and discretionary spending. Single-family starts were soft earlier in the year and only began to recover in the September quarter. Consistent with our traditional lag relative to starts, we also began to see volume declines stabilize in the quarter. This trend bodes well for future quarters.

Now I want to speak about our first quarter margins. As Julian noted, we're pleased to produce a 20 basis point gross margin increase sequentially. The gain was entirely tied to an improvement in price/cost execution. As a historical reference point, seasonal declines in GM are normal between Q4 and Q1. In fact, during the past 5 years, we have averaged a 30 basis point decline. This further highlights our GM accomplishment for the quarter.

We've been working diligently to recover from the price/cost impacts of the spring/summer 2019 inflationary environment that was coupled with lower demand. While we're not where we want to be with gross margins, we're certainly moving in the right direction and the first quarter performance raises our confidence for the second half fiscal 2020 margins.

Adjusted operating costs were $342.1 million, up from $336.4 million in the year-ago quarter. The year-to-year increase is primarily due to incremental investments in our fleet, coupled with the shift in timing and other expense items. Increasing fleet investments is a key focus for Beacon and supports our industry-leading service levels. The new capital expenditures made at the end of last year resulted in higher depreciation expense in the current quarter.

Additionally, we incurred higher-than-anticipated timing-related costs for some fleet repairs, health care costs and customer-specific event expenses that we do not believe will repeat at the same level going forward. It's also important to note that the cost actions we took in the fourth quarter helped us substantially reduce the inflationary pressures we experienced on our wages and facility costs.

We remain committed to driving positive adjusted operating leverage over the remaining quarters of 2020, and we'll get there through our overall focus on continuous improvement, coupled with the strategic initiatives around OTC and branch operational improvement that Julian previously reviewed.

Now moving on to the balance sheet and cash flows. We had excellent cash flow performance during the first quarter with operating cash used improving by more than $200 million year-over-year driven both by timing-related factors and performance improvement. In addition, I'd highlight that our total debt declined more than $300 million versus the prior year quarter.

From fiscal 2017 to fiscal 2019, Beacon has averaged more than $300 million annually in free cash flow or operating cash flow less capital expenditures. And during the most recent trailing 12-month period, we continue to repeat this solid performance with $367 million of free cash flow. This type of execution has been a hallmark for Beacon since our IPO, and we have regularly posted positive operating cash flow during our time as a public company. We believe this remains an important differentiator for us.

To summarize our first quarter, we recorded a very important sequential improvement in gross margins, along with a significant year-to-year reduction in total debt. In geographies not impacted by hurricane comparisons, we saw a more stable sales performance, and our overall sales growth rates were in line with the market.

Last, I want to provide our 2020 expectations. We are comfortable with the current range of The Street's sales and adjusted EBITDA estimates for fiscal 2020. We continue to forecast flat full year market demand and believe we will modestly outperform the overall market. We expect the market to be driven by lower storm demand offset by higher repair and remodel and increased new construction.

During our last call, we emphasized that the year would unfold in 2 parts: a softer first half as a result of lower hurricane demand and a much stronger second half on improving repair and remodel and new construction. Within that flat market environment, we're still confident the second half will deliver year-to-year adjusted EBITDA gains to higher gross margins as a result of a less inflationary environment and higher demand and also favorable operating cost leverage driven by the initiatives we previously reviewed.

One final comment related to the rebranding announcement that Julian discussed. We wanted to remind you that the relevant cost information was all outlined in the 8-K filing that coincided with the January announcement. Remember that we will exclude all of these costs from our future adjusted non-GAAP disclosures.

I will now turn the call back to Julian before we move to questions. Julian?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [4]

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Thanks, Joe. It all comes back to what differentiates one company from another in the distribution business. We want to have strong relationships with customers and ability to serve them in a unique way that helps them grow in order to be their distributor of choice. And we want to build on our strong relationships with our valued suppliers. We have much more work to do to demonstrate our full potential. By focusing on organic growth and expanding our service proposition while driving operational performance, the foundation for solid top and bottom line growth this year is in place.

And with that, we're ready to open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Keith Hughes with SunTrust Robinson Humphrey.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [2]

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Two questions. First, your commentary on hitting The Street views for the year. The Street is about -- assuming EBITDA here, it's about $508 million, came in, get that below where The Street was first. Where do you expect to make that up? Is that still a second half phenomenon when you think it will start to accelerate year-over-year? Or how is that going to play out?

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [3]

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Keith, this is Joe. Yes, great question. And yes, we believe it's a second half phenomenon. Where you really see it start to improve a lot is in the second half of the year. As we've mentioned, in the first half of the year really, you have the impact of the hurricanes and the storm demand, which probates more pressure on it. And the second half of the year is when we really believe we'll see some of the increasing improvement, not only in the market conditions but also in some of our performance for the reasons we highlighted with some of the initiatives going on as well, too. So that's correct.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [4]

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Okay. And then second question, where do you think you stand on inventory right now? It's -- inventory was up a little bit year-over-year, sales down. I don't know which product that's in. Where do you think you and the channel inventory is now?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [5]

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Keith, this is Julian. So it's a great question. So on a dollar value, our inventory is up. I think as we look at inventories overall, certainly our volume of inventory is down. Remember, we did have an inflationary environment last year. So that did drive some of the overall difference.

I would say that I think the question is also related to kind of where we were relative to last year. We do believe that last year, there was some elevated inventory as we left the calendar year. We did not participate in any additional large buys towards the end of the year. We think there were likely some additional purchases out there. But I think overall, I think the inventories -- certainly, our inventories, we believe, are well positioned and evenly balanced for the outlook going forward.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [6]

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Okay. And if I could sneak one final one in, just a technical question on the dividends for the preferred shares. Joe, I know you reported loss this quarter with all the charges. If you exclude those, would you assume the dividends are paid and unconverted? Or how would that look if we did an adjusted EPS look?

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [7]

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Not quite sure I follow the question, but I'll give it a shot, Keith. I think you're trying to get at what an adjusted EPS number would be. Is that your question?

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [8]

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Correct. Correct. Would we assume that converts are -- the preferred shares are converted or not converted?

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [9]

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I think as -- well, as you know, as we talked about, our focus is really going to be about adjusted EBITDA going forward. That's where we're putting all of the focus and attention on our numbers. We did provide, as you saw in here, the adjusted net income numbers in the press release at $28.3 million. In the footnotes, you'll also see the share count numbers. So in the income statement, it has common. And then in the footnotes of the income statement, it shows the preferred shares to it. Traditionally, in the past, what the analysts have done for this quarter would have been added those share counts.

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Operator [10]

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Your next question comes from Trey Grooms with Stephens.

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Trey Grooms, Stephens Inc., Research Division - MD [11]

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So just a couple for me. One is the gross margin. Joe, you mentioned that you're confident in the second half gross margin improvement. Can you go a little bit deeper into what's driving that confidence? I know you had a little bit of an outperformance here in 1Q. But as we look into the second half, just some of the things that you're expecting there, if you could maybe go a little deeper into some of the moving pieces there, maybe your price/cost scenario you're baking in. Just any of the moving factors there that we could maybe get a little more color on.

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [12]

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Sure, you bet. I'll provide you a little bit more kind of detail in there. I think you're right. If you look at last year's performance in '19, you started to see the kind of negative price/cost impacts in the back half of the year. So we'll have that on the favorable side this time.

And keep in mind, last year, it was driven by some of those inflationary environment, coupled with low demand, right? So this year, how we've positioned it, our view is you're going to see a lower inflationary environment as we go into that third and fourth quarter period with what we believe, based on the market conditions, looks like better demand as well, too. Putting those 2 pieces together is why we believe we'll see a much stronger price/cost position kind of going into the back couple of quarters. That's what drives our optimism.

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Trey Grooms, Stephens Inc., Research Division - MD [13]

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Got it. Okay. And with the comment of comfortable with the sales and adjusted EBITDA numbers that are out there for consensus now, as we're kind of looking at the free cash flow for this year, over the last few years, you've had some pretty wide swings in working capital. Some to the plus side, some not. But you've had some improvement in inventories you talked about. As we just look at working capital and we're trying to kind of triangulate into what all this means for free cash flow this year, how should we be thinking about the working capital piece of the free cash flow? Could it be a tailwind for you guys this year, possibly, with some of the benefits you're seeing? Or just if you could help us out with any of that, Joe?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [14]

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So Trey, it's Julian. Overall, the working capital position, we believe, will improve through the year. That's a major focus area for us. I talked about it in our remarks, about our ability to drive that lower. And that is something that remains a big focus area for us. I do think that overall, we will see that as a tailwind for the remainder of our fiscal year and then going forward as we implement against our strategic initiatives.

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Trey Grooms, Stephens Inc., Research Division - MD [15]

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And just housekeeping on this, any update on how we should think about CapEx for this year?

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [16]

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Sure. We're still trailing towards pretty much that 0.9% to 1% of sales number towards our CapEx expenditures during the current year. Now I'll caveat that all as, as Julian said, we're working through a lot of great stuff right now on some of these strategic initiatives, specifically on the OTC. We're seeing some great gains, as Julian talked about, in regards to our improvements with decreases in the miles driven per order, all that, which is really going to help us. I don't know if it will be as much this year, but going forward, this certainly should have a benefit on our CapEx numbers, lowering them.

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Trey Grooms, Stephens Inc., Research Division - MD [17]

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Okay. And another one quick housekeeping. Just as we're looking at adjusted EBITDA, is there any other cash charges in adjusted EBITDA that could weigh on the free cash flow number that we need to be aware of as we look at that this year?

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [18]

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From a cash charge perspective, not much at all. You saw some of the branding costs, but they were pretty minimal, right? Our branding rollout from a cash perspective might be this -- that $5 million number we had talked about. Outside of that, our integration costs from the acquisitions have pretty much gone away. You'll see as the Q comes out tomorrow, we actually have just existing markets in all of it. So you won't see acquisitions even noted in there. So it's good. So that will also have less of you'll see from cash from the acquisition. So nothing too significant from a cash perspective that will impact it.

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Operator [19]

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(Operator Instructions) And your next question comes from Truman Patterson with Wells Fargo.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [20]

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First, just wanted to talk about your adjusted OpEx. I believe it was up about 90 bps year-over-year. This is even after, I believe, you all removed the $25 million in annual costs. Could you just walk us through what's happening there? Are you may be paying up for employees to keep them in the branches, et cetera? But what's going on there? And then also, how should we think about your ability to lever the OpEx line in 2020?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [21]

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So Truman, this is Julian. Thanks for the question. I did say in my comments that we were a little disappointed with our overall OpEx performance in the quarter. We did see that as being something that's not so much a surprise but were higher. We believe a lot of it is associated with timing-related issues. There are some things in there that we talked about, some additional depreciation associated with fleet. We think that a newer fleet ultimately translates into lower maintenance expense.

The other thing that -- there are a couple of other things in there. One was we did have some higher health care costs to come through. I think that's a frustration for not just our business but all businesses. We changed our medical plan starting in the new calendar year. So we think there's some opportunity for us to address that head-on.

In addition, our maintenance costs are what I'll describe as counter-seasonal. So as we see the market slow down, our branches tend to put the vehicles into more maintenance to make sure that we're ready for the pickup. We saw a little bit of that move from what we believe was future quarters and sort of pulled back into this quarter. So we would expect to be able to get that back in line over the coming quarters. So we do think that there's leverage in that area as well.

So overall, there were a couple of things. Like I said, we maintain that we are committed to getting operating leverage this year from our operating expenses. Certainly, I think that as we've seen the sort of labor rate inflation impact, I think that this is where our operational continuous improvement initiative becomes critical to our future performance. We have to be able to offset that with productivity. I think we've lagged in that area a little bit recently.

But again, that's where, I think, improving at our branch level, focus on continuous improvement, focusing on productivity at a branch level, is critical to our future performance. And it is something that we are determinedly focused on to ensure that we maintain that in line and actually drive it down overall over the next several years as a percent of sales.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [22]

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Okay, okay. And then on a follow-up. I believe you all said you're targeting bringing your bottom quintile branches up to normal operating levels. And I believe you mentioned it was a $30 million to $60 million EBITDA tailwind potentially. Could you just give us a little bit of color on that of how you're going to go about targeting that?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [23]

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Yes. Again, this is Julian. So as I said, we tend to think about this in terms of quintiles. But certainly, we see the bottom quintile of our performance of about 100 branches or so as a significant opportunity. Obviously, they're below our average operating margin. So the ability to improve their performance.

I also said in my prepared remarks that we do see some very unique situations. So we do have to go down and get at individual reasons at each of the branch levels. But there are these underlying causes that we believe are somewhat common. And so are we in the right position in the market? Do we have the right scale in that market to compete successfully? Do we have the capabilities and the right talent in those markets to drive the results forward?

So what we're doing differently is we've asked the local operating teams to really think very carefully about providing the resources necessary to those 100 or so branches to really drive that improvement. So -- and I said -- you're right, I did say we see sort of $30 million to $60 million of operating improvement once we get at all of these initiatives. But it's really branch by branch. It doesn't happen overnight. But I think the additional focus, tools, resources, training, upskilling, focusing, branch management training on the ability to improve those specific branches is a significant opportunity.

And I also said that we've been doing this now for a few months. And we are seeing improvements in the overall metrics of those branches. So we believe that we're seeing the early indications that we are -- do have the ability to affect the outcomes at these branches as well.

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [24]

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This is Joe. The piece I would add on there, Truman, to what Julian just mentioned is by the level of focus that's getting is right from the highest levels of the organization right on down. And I think that level of focus is really having impact. People see it. They understand it. It's been talked about throughout the organization. And as Julian said, we're starting to see the impact already. So it's great.

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Operator [25]

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Your next question comes from Kevin Hocevar with Northcoast Research.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP & Equity Research Analyst [26]

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Wondered if you could talk about -- on the gross margin side. So up 20 basis points sequentially. Normally, there's a little bit of a fade from the September to the December quarter. What actually drove -- it sounds like price/cost was the main driver there. Could you give some color on -- was it pricing? Were you guys able to go out and get little bits of prices here and there? Were you able to push back on the manufacturers? What was able -- what allowed you to get that? And could you kind of give us a progression of how that's trended? Did gross margins get better as you went through the quarter and you exited with a better gross margin, which bodes well for the March quarter? Wondering if you can give us some color -- a little bit more color on what's driving that.

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [27]

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Sure. This is Joe. I'll kind of dive into that one a little bit, Kevin, for you. So you're absolutely right. All of that sequential gain was primarily all the result of more favorable kind of price/cost in there. That really was the big driver. And it was a piece which we went into the quarter knowing we wanted to achieve and do so and got a lot of focus and attention through.

Traditionally, you're right. Normally, during this period, you'll see prices get a little bit kind of more constrained in there. And that's usually why you'll also see a little bit on the price/cost be a little bit more challenged during this quarter. The gross margins start to go down.

Our benefits were in both. We just saw a good quarter all around on the price/cost element to it, and it all came through a combination of price being better than we had normally seen and then also costs being better than traditional as well, too. So we put a lot of focus into it. It was a balance of both of those pieces that worked well in our favor.

Now again, it's not all where we want it yet. So let's be clear. We still have a lot -- some work to do on that one. But it's clearly trending in the right direction. There were no real trends kind of by product line. There were no real trends kind of by month either that would give me an indication that it was trending one way or another. It was just pretty solid, consistent performance across the product lines and right through the whole quarter as well, too. We kept the focus right on it and it worked well.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP & Equity Research Analyst [28]

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Okay. Got you. And then in terms of -- back to the bottom quintile targeting here. Looking of a $30 million to $60 million over time in terms of savings, what -- are there investments that you need to make? Like will there be maybe costs that come first and then the benefits come later that you need to make? And is that $30 million to $60 million you expect to benefit, is that a net number after any type of investments that you might need to make in terms of whatever it might be staffing, whatever? Just wondering if you could talk about the costs associated with achieving those targets.

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [29]

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Thanks for the question, Kevin. This is Julian again. So I don't see any additional cost. I think the way we would target these is moving costs perhaps we would have spread across all the branches, particularly around things like training, the resources, refocusing them more on those branches to give those branches the best opportunity. I don't see a large, unique investment. All of our branches are now on our systems. There may be some areas where we would invest in some improved opportunities at an individual branch. I don't see that as a significant opportunity -- a significant drag on our costs in any way.

I think that we will see some additional costs associated with investing in our OTC network early on, as I mentioned, Denver. But that should have a broad impact on that market and improve operations in that market anyway, including some of the underperforming branches that might be there. But fundamentally, I would say it's a reallocation of resources versus additional resources. And that $30 million to $60 million is a gross number. But like I said, I don't see a particular cost associated other than redirecting resources that we're already deploying.

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Operator [30]

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Your next question comes from Garik Shmois with Loop Capital.

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Garik Simha Shmois, Loop Capital Markets LLC, Research Division - MD [31]

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A question just on complementary. Is this the only segment that you saw a weaker pricing? And I think you cited some softness in steel studs and wallboard. And given the improvement in demand or at least expected with the lag, what would your outlook be on the pricing side? Would you anticipate it firming? Or would there be continued deflation moving forward?

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [32]

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Yes. First, I'll take the question in regards to the complementary piece and what we saw in there. The interesting part on that decline in revenue on complementary, it really was in just a few key areas. It wasn't across the board. As I mentioned, we saw it in steel studs. We saw it in lumber. We saw it in wallboard. So just a few key categories where you saw slight volume declines plus also some of the pricing as well, too, that fell into both of those 2 categories.

So on the -- so that was it. It was very focused that way. Second part of it, our go-forward look to it. I don't know if we have a specific view at this point in time on what we would expect those categories to kind of do going forward. They're all weighing different elements of what happens to price right now for the spring session. So I think it's still a little bit too early to comment on that right now.

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Garik Simha Shmois, Loop Capital Markets LLC, Research Division - MD [33]

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Okay. And just following up on gross margins, and I know you're not providing quarterly guidance. But if you look at the historical trend, Q1 to Q2, you do tend to see about, call it, 100 basis point sequential decline in gross margin. That would get you roughly flat year-on-year. Is that a fair assumption to use in the second quarter? Or is there something that might be different this time around?

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [34]

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Yes, you're right. That's traditionally the trajectory that you see between the first and the second quarter. So I don't think that's an outlying assumption and the market seemed pretty similar.

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Operator [35]

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

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Michael Glaser Dahl, RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products [36]

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First question, I wanted to go back to the fiscal '20 guide for a minute. And I think there's a wide range of consensus out there. And I think to Keith's earlier point, 1Q came in a bit light of The Street. So are you saying look at the range and there's a ballpark in there that you're comfortable with? Or are you saying quite literally, look at what the prior average consensus was, and that's the number that you think you can achieve?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [37]

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So I think the way Joe characterized it in our comments was that we're comfortable with the current range of Street estimates in sales and EBITDA. So we're not -- we didn't say we were guiding to a specific one. We're saying we're in that range. And I believe that, that Street range is around the $490 million range to the $525 million range or something like that. So...

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [38]

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On EBITDA.

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [39]

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On EBITDA.

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [40]

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Revenue is $7.1 billion to $7.4 billion roughly is where I think The Street range is there.

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Michael Glaser Dahl, RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products [41]

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Okay. That makes sense. Just wanted to clarify that. And then the second question, I guess maybe just around the branding initiative. And I think it certainly simplifies things probably from your standpoint and to a certain degree from your customers and your other partners. I was wondering if you could talk through, aside from kind of a simplification exercise and go-to-market as kind of one team, one dream, are there any financial benefits to Beacon from doing this? And if so, could you kind of talk through what may or may not impact the P&L from this aside from the initial onetime costs, I mean?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [42]

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Sure. Thanks for the question, Mike. So a couple of areas, I think, that we'd like to determine. I think in the long run, certainly, we believe this is focused on growth. Certainly, our research indicates that as our customer base grows, there's the ability to go from region to region and be served. Anecdotally, we've always got a story of a customer that's moved into another region that was looking for Beacon and was unable to find it despite the fact that we had a branch in that location just under a different brand name. So we certainly believe that there is -- there's top line opportunity.

On the other side, I think that there's a couple of things from an investment standpoint. I mean, we had 40 different brand names. We had to make sure that the websites were maintained, that we were producing literature with all of that branding represented. And as that became not just a financial challenge but also a resource challenge, I mean, the number of people that have to work on that and maintaining it.

So while it's difficult to quantify specifics, we certainly see some cost benefit that should come through from the maintenance of all of those. And we would redeploy those resources into building our capabilities and differentiating in the marketplace. And we certainly see some benefit from that. So while we believe ultimately, top line is the most important for us in differentiating it and creating that scale across markets, we certainly see some opportunity to be efficient with our marketing spend as time goes on as well.

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Operator [43]

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Your next question comes from Michael Rehaut with JPMorgan.

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Elad Elie Hillman, JP Morgan Chase & Co, Research Division - Analyst [44]

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This is Elad on for Mike. I wanted to get into the drivers of the better cost outlook in the second half, and I was wondering if you're baking any benefits from the IMO regulations and the expected cost deflation in asphalt this year. And also, as asphalt prices do come down, how much do you think could flow through in terms of price reductions to manufacturers? And is there a tightening lag for when these potential benefits could flow through to your P&L?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [45]

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Thanks for the question, Mike. So our point of view on the year, as we said, that the first half of the year, we were looking at storm-related comps where the market would decline year-over-year. And as such, that creates -- obviously, that creates some headwind for us in terms of the sales volume. As going forward, we would characterize it as a more robust year in the second half of the year as the storm impact sort of works its way through the system and we get the benefit of what we believe is an improved repair and remodel market and new construction.

That coupled with what we believe would be a lower inflationary environment. I mean last year was a particularly challenging inflationary environment with several price increases coming through. Our ability to keep up with that was certainly a drag. That compressed our margins going forward. We don't see that happening. So a much better ability for us to both repair the margins that we currently have and maintain the margins that we want going forward. And like I said, not so much a deflationary environment but not an inflationary environment.

With regards to IMO 2020, I think we see that as probably a twofold impact. In the long run, it's a change in fundamental pricing potentially. But I just don't think that's how the economics work. So really, it's a short-term impact and is there going to be a rapid change in asphalt pricing. And I just don't think we see that coming through today either.

So I think we're going to see more difficult comps in the first half of the year. We're very pleased with our first quarter margin, where we thought we would see some -- we saw good performance representing flat sequential. In fact, we saw slightly better than that. That was good. We would expect to see the sort of traditional seasonal decline in the first quarter as the market is particularly soft and gates get reset. And then working our way into a more robust environment in the second half of the year with what we would expect is certainly lower inflation than prior year, we'll continue to work on our margins and our value proposition in order to drive our margins to an improved overall result.

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Elad Elie Hillman, JP Morgan Chase & Co, Research Division - Analyst [46]

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Great. And then I was also wondering on mix in the quarter, if there are any headwinds or tailwinds by products, geography, channels and also any mix expectations you have for the full year.

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [47]

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Sure. So for the first quarter on a year-over-year basis, there was a bit of a slight kind of mix negative kind of impact to us but not that material. Sequentially, not a big kind of difference from mix to it. So as I think about going forward for the rest of the year, I don't really foresee there being a big kind of mix shift impact in any of the future quarters, second through fourth in there. So I don't think you'll see much of a change in that regard to it.

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Operator [48]

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Your next question comes from Phil Ng with Jefferies.

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Philip H. Ng, Jefferies LLC, Research Division - Senior Research Analyst & Equity Analyst [49]

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Organic growth has been a little more choppy for you guys. And appreciate a big part of your strategic focus going forward, Julian, to just kind of reaccelerate that element. Any big buckets you want to call out that would be a big driver? And do you see pricing being a larger element of that story? Or is it really more on the demand side?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [50]

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Thanks for the question, Phil. Both of those are important. I did say in my prepared remarks, there were 2 elements to it that I think you picked up on, I'm glad to say. The first was the overall activity level. I mean we've got 110,000 customers. A portion of that represents a significant opportunity for us to make sure that we're picking up the phone, calling those customers, asking for the order, staying after that order. So there's certainly that level of activity.

I also mentioned in my remarks that we would spend more time focused on analytics and deploying tools to enhance our overall pricing capabilities. We're both developing and deploying those tools today. I do think that overall pricing needs to be a significant focus for us in terms of top line growth. I think that we can do those in parallel. I think one of the things that we have to be ensured of is that we have to build our service proposition to be differentiated in order to really capture the value and build out our pricing capabilities along with that.

So it is -- certainly, pricing will be a focus area for us. Certainly, that's something I feel very comfortable with, with my history. And -- but also the activity level and driving top line, driving things into the funnel is a significant early opportunity for us.

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Philip H. Ng, Jefferies LLC, Research Division - Senior Research Analyst & Equity Analyst [51]

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That sounds excellent. And then just in terms of all this change you're looking to implement, will you require new talent from the outside to kind of execute your vision? And are you going to implement any new metrics, whether it's senior management or further down the chain in terms of properly aligning their comp, I guess, ultimately to your strategic goals?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [52]

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Yes, obviously. I mean first of all, our strategic review is initially about sort of defining and scoping what the opportunity is. And then the second piece of it, which we're really still working on, is sort of quantifying that opportunity. As we go through that final one, what I expect to come out of there are the focus areas and the metrics that will drive that. And naturally, we'll set a very high bar for the talent and in terms of both development of our talent internally and potentially bringing in additional talent to complement our current people.

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Operator [53]

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Your next question comes from Jay McCanless with Wedbush.

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Jay McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [54]

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The first one, what's the annual depreciation going to be?

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [55]

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I got that. I've written that before. I'm going to find that number for you real quick, Jay. So it looks like for the full year, I think the first quarter, we ran around $19 million in depreciation. We'll be somewhere around $76 million for the full year, depreciation. Amortization, second part of it, I'll read your mind on your second question here. So the amortization was roughly $45 million in the first quarter. And for the full year, it will be somewhere around $178 million.

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Jay McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [56]

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Okay. Great. And then my second question. With 4 months under your belt for the fiscal year, I would have expected maybe a little more certainty or a little more forcefulness around your guidance and how you're thinking about the rest of the year. Is my -- is the hesitancy I perceive around the strategic review and where you guys are going to go with that? Or are you seeing a more competitive marketplace as the spring season gets underway in certain parts of the country?

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [57]

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So Jay, this is Julian. I don't think we -- it's still very early in the year. I mean this is really the slow part of the year. And obviously, we're still working our way through winter in the northern states. I would say that overall, we've seen good activity. I think the way we would characterize the first 4 months of the year was kind of in line with what we anticipated.

I will say we did see quite a sharp slowdown around the Christmas time period, the holiday time periods, Christmas and New Year, that was driving that bounce right back. So I don't see anything in the first few months of the year that would indicate a more competitive environment in terms of -- I think the question you're asking, are we seeing that happen. I think we're seeing sort of the market we expected.

It's always a little difficult at this time of year to predict how the year is going to shape up. It's still very early. Obviously, we've laid out what we believe is a flat environment. We've said that we believe that The Street's estimates for sales and EBITDA are in line. And it's -- I would characterize it as kind of a fairly normal range for guidance for it.

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Joseph M. Nowicki, Beacon Roofing Supply, Inc. - Executive VP & CFO [58]

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Jay, one last -- a technical thing for you, by the way, this amortization number that I gave. That's case been our current level of all the kind of trade name amortization that we do. When we finalize the write-off of those trade names, that will change that amortization piece a bit, and we'll get to some new numbers out there. So stay tuned for that, when we'll finalize the write-off and get that amortization, I'll update you then.

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Operator [59]

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

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Julian G. Francis, Beacon Roofing Supply, Inc. - President, CEO & Director [60]

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Well, thank you all for joining our call. I really believe that our first quarter represents a step forward for Beacon, and we are well positioned as the building products leader in empowering our customers to build more. We are restoring our focus to our existing exteriors and interiors products business, where we really see substantial opportunity for both sales growth and margin enhancement. I really believe the future for Beacon is bright. We appreciate the continued support of our customers, suppliers and employees and from the investment community as a whole. So thank you for listening to us this evening. Have a great evening.

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Operator [61]

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This concludes today's conference call. Thank you for joining. You may now disconnect.