Beacon Roofing Supply Inc (BECN) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Beacon Roofing Supply Fiscal Year 2006 Third Quarter Earnings Conference Call.

[OPERATOR INSTRUCTIONS.]

On this call, Beacon Roofing Supply may make forward-looking statements, including statements about its plans, and objectives, and future economic performance. Forward-looking statements are subject to a number of risks and uncertainties. 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 Factor section of the Company's latest Form 10-K.

I would now like to turn our call over to Mr. Robert Buck, President and CEO of Beacon Roofing Supply. Please proceed, sir.

Thank you, Cheryl. I'd like to welcome everyone to our third quarter earnings call. I'm very pleased with these results, and before I turn the call over to David Grace, our CFO, I'd like to emphasize and highlight a few points for you at this time.

Number one, we're very pleased with the continued growth of our residential segment. With all the news recently about housing starts, and recent announcements by the large builders, I now hope everyone sees the importance of re-roofing in our industry, and the importance of geographic diversity of Beacon, which is very important to us.

Our gross margins also improved in the quarter, showing the importance of size in this business. Operating expenses in our existing markets continued to decrease as a percent of sales, which is a very large tribute to our hardworking people and the productivity of them.

Also, operating expenses on a pro forma basis, incorporating our large acquisition of Shelter, are 17.9% versus 18.5% of last year. The performance of Shelter continues to exceed our expectations. I couldn't be more pleased with all three divisions of Shelter and the leadership of that company.

Now, the growth rate and the possibility of Shelter, which does not include any acquisition since we bought them, is above our target that we set for ourselves at the time of the acquisition.

Our business plan and growth model is being executed as promised. For example, new branches are on deck to be opened in our existing regions. The acquisition pipeline is very full, and I'm excited about those opportunities. And our organization is getting stronger which is necessary for us to sustain our growth organically, our growth target of 5% to 10%, and make acquisitions that add 10% to 15% to the top and bottom line.

So I'm very confident of our long-term growth goals of 15% to 25%. I'm pleased to report that our fourth quarter started strong and remains very strong and above our stated organic growth goals of 5 to 10%.

I'll turn this call now over to David, and then we will open it up for questions as soon as he's finished. Thank you.

Thanks, Bob. Good morning. I'll first discuss our results for our third quarter of fiscal 2006, which ended on June 30, 2006, and then I'll briefly discuss our year-to-date results.

Net sales increased 63.9% to a record $407.1 million in 2006 from $248.5 million in 2005. Our existing markets achieved internal growth of $13.3 million or 5.4%, while our acquired markets contributed $145.5 million of the revenue increase.

The internal growth in our existing markets was comprised of residential roofing growth up 11.8%, a contraction in non-residential roofing growth of about 1.5%, and complimentary products grew at 4.8%.

We estimate that inflation contributed about 4% to 6% of the total sales increase, with similar price increases in both roofing product roofs, our complimentary products saw inflation towards the lower end of that range, due in part to the mild winters during our second quarter.

It rained well above normal during the third quarter. Sales growth was weakest along the east coast, especially in New England. Of our product roofs, non-residential roofing products were the weakest in these areas.

We experienced strong growth in the southeast, mid-west, central plains, and gulf areas, which also helped boost our acquired market performance above our expectations. On a pro forma basis, again illustrating our continued geographical diversification, our overall internal growth rate including all material acquisitions, would have been 9.2% in the third quarter.

We have opened six new branches since the third quarter of 2005. We've also acquired 62 branches since that time, and today we operate a total of 148 branches as of the end of the quarter. We had 64 business days in both 2006 and 2005. Sales per day averaged approximately $6.4 million in 2006 versus $3.9 million for 2005.

Our third quarter gross profit increased 68% to $100.3 million in 2006 from $59.7 million in 2005. Our existing market, which included JGA for the third quarter, had gross margins of 25% for 2006 as compared to 24.2% for 2005.

The increase in gross margin was a result of a product mix shift towards more residential roofing products, which have higher gross margins inclusive of their regular and seasonal vendor buying programs.

Our overall gross margin increased slightly to 24.6% as compared to 24% in 2005, due to those same factors. Also an increase in vendor rebates as a percentage of sales, due mainly to our increased purchasing power from our growth and a slightly higher gross margin in our acquired markets prior to those factors.

Gross profit in our existing markets increased $5.3 million and grew at 8.9%, slightly ahead of their respective sales growth. Operating expenses, as a percentage of sales in our existing markets, decreased to 14.9% in 2006 from 16% in 2005, as we continue to leverage fixed costs over increasing net sales and also due to the inclusion of JGA's lower operating costs as a percentage of sales.

Overall, operating costs as a percentage of sales increased to 16.6% in 2006 from 15.9% in 2005, due to our acquired markets higher operating costs as a percentage of sales, primarily at Shelter, partially offset by favorable performance, as I just mentioned, in our existing market.

Total operating expenses increased $28.3 million or 71.6% to $67.8 million in 2006 from $39.5 million in 2005. Acquired markets made up $28.9 million of the increase, while existing markets saw operating expenses decrease $0.6 million or 1.6%.

The existing markets operating expense decrease is primarily related to savings in professional fees, dental insurance, and our provision for bad debts, offset by increases in payroll and related costs and selling expenses. The increases in our variable expenses were within our expectations considering the increased sales volume and the additional branches opened since 2005.

Included within our operating expenses is $0.8 million in stock based compensation in 2006, as compared to $0.2 million in 2005. We expect to incur stock based compensation of approximately $0.9 million in the last quarter of fiscal 2006.

As a result of all of the foregoing, our 2006 third quarter income from operations increased 60.5% or $12.3 million to $32.5 million from $20.2 million in 2005. Operating margins at our existing operations increased to 10.1% in 2006 from 8.2% in 2005, while our overall operating margins decreased slightly to 8% from 8.1%, due to the inclusion of our acquired markets lower operating margins.

Interest expense increased $3.3 million up to $4.8 million in 2006 from $1.5 million in 2005. The increase is from the rise in interest rates and from our increased borrowing to finance our acquisitions, partially offset by market value gains from our interest rate collars.

Income tax expense was $10.6 million in 2006 compared to $7.4 million in 2005. We've estimated our fiscal 2006 effective income tax rate to be 40.5%, which was decreased to 38.3% for the quarter, due to a reversal of previously accrued income taxes of $0.6 million compared to $0.5 million in the previous year for expiring purchase accounting reserves.

We also experienced -- we expect our effective rate to return to 40.5% for our fourth quarter of fiscal 2006. As a result of all I've mentioned, our third quarter net income increased 50.5% to $17.1 million as compared to $11.3 million in 2005.

Diluted net earnings per share were $0.38 compared to $0.28 in 2005, an increase of 36%. Just as a reminder, we executed a 3-for-2 stock split in June of 2006.

Now a brief discussion of our year-to-date results from the nine months ended June 30, 2006. Sales increased 72.5% or $449.6 million to a record $100.07 billion, an increase of $619.8 million in 2006 from 2005.

Our acquired markets contributed $377.2 million of this increase, while our existing achieved internal growth of $72.4 million up 13%. We estimate inflation contributed 4% to 7% of this increase. Our total gross profit increased 72.9% to $261.8 million in 2006 from $151.4 million in 2005.

Our overall gross margin increased slightly to 24.5% as compared to 24.4% in 2005, mainly due to increased margins in our existing markets which saw their margins increase to 25.6% in 2006 from 25.4% in 2005.

Increase in our year-to-date gross margin was due to the factors I mentioned above for the third quarter and a slightly gross margin in our acquired markets prior to those factors.

Existing markets selling, general, administrative expenses as a percentage of sales decreased to 16.5% from 18%, as we continue to leverage this cost over increasing net sales.

Overall, SG&A expenses as a percentage of sales increased to 17.9% in 2006 from 17.5% in 2005, due to the higher operating cost as a percentage of sales in some of our acquired markets, partially offset by the positive performance of our existing markets and the inclusion of JGA's lower SG&A expenses.

Overall, SG&A expenses increased $82.8 million or 76.4% to $191.2 million in 2006 from $108.4 million in 2005. Included in the year-to-date, SG&A is $2.2 million of stock-based compensation in 2006 as compared to $0.5 million in 2005.

As a result of the foregoing, 2006 income from operations was $70.5 million, an increase of 63.9% from $43 million in 2005. As a percentage of net sales, operating income decreased slightly to 6.6% from 6.9%, mainly due to the inclusion of our acquired companies' lower operating margins.

Interest expense increased $9.7 million to $13.2 million in 2006 from $3.5 million in 2005. We also recorded $0.9 million loss on early retirement of debt in 2005. Income taxes increased to $22.7 million in 2006 from $16.1 million in 2005.

Our year-to-date 2006 effective income tax rate is 39.5% as compared to 41.7% in 2005. As previously discussed, we had a lower effective tax rate for our third quarter, but we expect the fourth quarter's effective tax rate to return to approximately 40.5%.

As a result of all I've mentioned, our net income for the first three quarters of 2006, increased 54.5% to $34.7 million from $22.5 million in 2005. Net income as a percentage of sales was 3.2% as compared to 3.6% for 2005.

Diluted net income per share was $0.79 compared to $0.55 in 2005, a 44% increase. Year-to-date cash flow from operations was $65.8 million during 2006 compared to $9.3 million during 2005. Our internal sales growth in acquisitions drove our income from operations to $70.5 million in 2006 from $43 million in 2005.

Inventory levels, exclusive of the effects of businesses acquired, increased by $35.4 million mostly due to six new branches opened since June 30, 2005, and the anticipation of a continued strong sales growth rate and the summer building season. Inventory turns exclusive of our acquired companies have increased slightly in 2006 as compared to 2005.

The cash impact from the growth of inventory was more than offset by a $51.9 million increase in accounts payable and accrued expenses, exclusive of the effects the businesses acquired. Our accounts payable increased due in part to more favorable payment terms, including the beneficial impact of transitioning our existing market payment terms to our acquired markets in year-to-date 2006.

The numbers of days outstanding for our overall accounts receivables based upon sales for the first three quarters, has decreased by several days in 2006 as compared to 2005. We've also seen a similar decrease in DSOs in our existing market.

In 2006 our revolvers have increased by approximately $135.3 million. We also received approximately $47.1 million net of repayments from the refinancing of our senior notes, and received the net proceeds of $53.1 million from our secondary offering in option exercises.

The cash provided by these financing activities was primarily used to finance our $285.7 million in acquisitions and $11.2 million in capital expenditures. During the quarter we made a $6.5 million final earn out payment to the former owners of Shelter and have possibly settled the EBITDA in working capital adjustments for the former owners of Mississippi Roofing and Alabama Roofing for which we will make a $5.4 million payment in July.

To re-cap, the key results for our third quarter -- sales increased 63.9%. Internal growth was 5.4%. We increased our gross margin in our existing markets by 80 basis points. Operating margins in our existing markets increased to 10.1% in 2006 from 8.2% in 2005.

Diluted net earnings per share was $0.38 compared to $0.28 in 2005, which represents a 36% increase. For year-to-date, cash flow from operations increased $56.5 million to $65.8 million. Diluted net income per share was $0.79 compared to $0.55 in 2005 which represents a 44% increase. Bob?

Thank you, David. We'd like to open it up for questions now, so please proceed.

[OPERATOR INSTRUCTIONS.] Our first question will come from the line of Michael Rehaut of JP Morgan. Please proceed.

Hi. Good morning, guys.

Hi, Mike.

Hi, Mike.

Just had a couple of questions on the top line. I was wondering if you could give any more detail in terms of what drove the slow down in non-res. You talked about the tough comp, but there was a tough comp last quarter as well.

Was it all -- was it mostly in the east coast or the northeast? And if you could also describe a little bit more in terms of the sales growth, and you said we're pretty strong in most of the other regions.

Yes, we can do that. Commercially it is concentrated in the northeast. The tough comparisons -- New England last year, third quarter, was I think 36%, but the other regions are doing fine. Canada is growing very well. We have a region in the mid-Atlantic that is growing extremely quickly. Texas and the southeast, those are all growing extremely well, in the third quarter.

Now everyone, on a year-to-date basis, is doing well, but I'm just mainly addressing the third quarter.

Bob, would you say that those other regions you mentioned were above, were double digits organic growth?

Yes, three of them were.

Okay.

Now, remember our long-term goal was 5% to 10%, so when I talk about the regions growing that fast, it's above our targeted goal, so -- and the weather, Michael. David did do a study -- we're not -- this is not the weather channel, but we took the last 60 days of the quarter, which would be May and June, and put on a chart every day where the rain exceeded a quarter-of-an-inch.

And by the -- just as an aside, every associate, employee that works for Beacon will be surprised I'm talking so much about the weather, because I tell them never worry about the weather. But having said that, we did take rain, any day where the rain was over a quarter-of-an-inch, and you'd be surprised how many were over a quarter of an inch in the northeast, as well as up and down the east coast.

And then we looked at the impact on sales subsequent to that day, compared that to the average daily sales for the period, and we did that calculation. And we think it cost us 1.5 to 2% growth rate, so we went through that scenario. But as I look up and down all of our regions, we were mainly affected in the northeast.

Thanks, Bob. And you had also mentioned that in the first month of this quarter, you've rebounded to above the 5% to 10% target?

Yes.

Can you give us an idea what the trends were throughout the quarter? Were they worse in May and June because of the rain?

Yes.

Okay. Next question, then I'll get back in the queue. In terms of acquisitions, you mentioned that you're still -- you're focusing on that and you have a good pipeline. Are those more, looking for some more both-on-ones or are some of the bigger ones in priority right now to add more hubs versus spokes?

Certainly I don't want to telegraph too much of what we're doing, but the acquisition pipeline is very full. And again, acquisitions that we are most desirous of are ones that bring us new geography, which is what the pipeline represents.

So these are a combination of our switch pod of $60 to $100 million deals, as well as deals a little bit bigger than that. So I'll leave it at that, that the pipeline is full. They represent new geography and we're excited about it. Does that help?

Yes, thank you.

Thank you, Michael.

Our next question will be from the line of Michael Cox. Please proceed sir.

Good morning. Thanks a lot for taking my questions.

Good morning, Michael.

Good morning, Michael.

My first question is I was wondering if you could comment on -- I don't want to get too specific on the regions here, but in areas where we are experiencing some slower housing market trends, and I guess I'd look at your California exposure now in southern California, because I just wonder if you could talk a little bit about what you're seeing there or other markets where notably in housing market activity has slowed somewhat.

That's a very good question. Let me talk about generally our residential segment and how well it's been doing. I think everyone can remember that for the last, probably the entire fiscal year, maybe even a little bit sooner, the national news talks about housing, new housing going down and housing starts in all the news.

I think even this morning Toll Brothers talked about a slight decrease. Our residential roofing growth every quarter this year has been double digit, way above our targets. It has started strong in the fourth quarter as well. We have -- actually New England is doing well in residential, which augments the tough comparisons in commercial.

So we're doing very well in residential throughout the United States, some better than others, but all doing extremely well, and we've done well every quarter. So I've talked a lot in previous calls about residential re-roofing, commercial re-roofing, and the defensive nature of our industry is supported with these numbers, and we're excited about it.

We love the fact that we operate in three different segments, and not all three have to be gangbusters in order to hit our targets. And so we -- that's why we're pleased about the third quarter. Whether it's weather, commercial, or new housing starts, Beacon is still able to grow through all the cycles, and that's our objective.

And so the residential remains strong. It's been strong every quarter, and it's a tribute to our folks and also to the re-roofing aspect of this industry.

Okay, that's helpful, and in terms of that -- the complimentary products side of the business, would you view that as being, I guess, inline with the core roofing supply business in terms of a non-discretionary nature? Or would there be a little bit more discretion to some of those products, would you say?

That's hard to say, but re-roofing is really the most non-discretionary. As my CFO loves to say, 'If your roof leaks you will get wet.' But the complimentary products are doing well. They continue to grow and we're glad we're in that segment. Well, mainly because oftentimes it's the same contractor. So if he's not doing re-roofing, he's probably doing siding or decking or windows or something like that. So, that segment is doing well.

Okay. In terms of the vendor rebate program, the additional rebate dollars, is this a new run rate given your size and the run rate of your business at this point? Or were these are a function of pulling forward some rebate dollars that perhaps the hurdles you would have reached later in the year?

No, we're pretty conservative the way we calculate our rebates as far as the yearly goals are concerned. But as we've grown in size and become more important to our vendors, we will gather - garner some more rebates as a percentage of those purchases, and that's what's truly happening, in not only this quarter, but year-to-date since the new calendar year started.

As far as pull-forward, the only way we ever record our yearly gain is if we're well assured that we'll make that. Typically that does happen during June and September when we try to make a determination, but these are calendar programs, and we need to be conservative as we go forward, just in case we don't make those or make a mistake later in the year if we don't.

Okay. That seems fair. And then my last question -- I know you don't give guidance, but I was wondering if you would just comment on the expectations that are out there for the fourth quarter.

That's very clever, but we don't give guidance other than to say that what we see that people have written about us for the year, we are comfortable with. So, I guess in a sense, that's guidance. So we're comfortable if the numbers that are out there, both sales and profits and earnings per share.

Okay, great. I appreciate it. Thank you.

You're welcome, Michael.

You're welcome.

Our next call is from the line of [Erol Redman]. Please proceed sir.

Thank you. I just wanted to go back over the weather impact on non-residential sales. I have two types of questions. You indicated that certain regions were in double-digits above your plan, and that New England was down, but because of the weather. Can you help us understand -- and you said also, that the impact was 1% to 2% on corporate growth rate. I'm trying to figure out that if I just take New England, roughly how far down it was? That's the first question.

And secondly, if the non-residential was impacted by the weather as much as it was, why didn't that affect residential in the same geographic area?

Well, I'll take the last portion of your question first. In general, commercial jobs are much longer planned out. So if it rains one day and they can't get to the job, they can't necessarily be able to do that work because the residential job, you can't open up a full roof and start re-roofing it. It's a problem. Where most residential roofs, if there's a problem they can cover the roof temporarily and continue on the next day when it stops.

So, you have some of that. The other aspect is, as the second quarter was very strong, those commercial jobs that they may have finished up, you don't necessarily get a very quick turn around time where they start them again in the third quarter.

Okay. And then could you help us, just to get a general sense as to roughly how weak it was in New England, and roughly if you used the rest of the country, how strong it was in those geographies?

Okay. The strongest and you're talking, Erol, commercial?

Yes, I am.

Okay. The strongest region for us and we don't want -- and for competitive reasons, don't get too detailed on regions, but the mid-Atlantic was the strongest commercial area for us. Canada and the southeast were behind that.

New England was most affected by the weather, just by far, most affected with -- Peabody, if you remember on the news, was a flooded city. The roads were closed in New England and so forth. That region was most affected by the weather, no question about it, but the mid-Atlantic is the strongest part.

Okay. Well, thank you very much. I appreciate it.

Thank you, Erol.

Thank you.

Our next question will be from the line of David Manthey with Robert Baird. Please proceed sir.

All right, thank you. The question in terms of where you said, what the current quarter has started out -- I'm not sure if you said within or above your targeted 5% to 10% growth rate overall.

I think -- what I said was above.

You said above?

Yes.

Yes.

Okay. Thanks. And then not to hammer you down here on granularity, but you're referring to the overall business or were you referring to res, non-res, complimentary, or how were you referring to that?

The overall business.

Overall business, okay.

Yes, internal growth, David, that's --

Organic growth.

Right.

That's organic, right. Okay. Then in terms of the -- I think the fear the people have out there, is that we're, even though you have until this point seen a downturn in residential, but there maybe at some point, weakness in some of your markets that will impact the residential business, and if the non-res stays weak, we would -- that's obviously a concern. Do you -- obviously with the weather being a major factor here, do you expect that non-res piece to snap back?

And, then if you'd just address the residential side. As you say, you've done okay to this point, but are there any signs on the horizon out there that things might be weakening up on the margin for you?

Okay. Our performance year-to-date is -- continues to be above our long-term goal of 5% to 10%, which incorporates all three business segments. So the difficult part, I think for everyone, it is understanding the 5 to 10%. And if we grow that 7.5% to 10%, to us that is gaining market share. That's doing well and fits in well with our long-term goal.

We don't see any weakness in our business because of housing starts, because re-roofing is so strong. So, we're hearing good reports on the commercial side. Manufacturers are doing well and have -- they're bullish for the future.

So I am bullish, but I still redirect everyone to - bullish means hitting our targets of 5% to 10% on a regular basis, and that's why we're doing so well this year, because we have regions that are above those goals, and that's part of the geographic diversity that we're getting.

If New England is soft, the southeast will be strong. If commercial is soft, residential will do well. And you have those permutations that really gives a really strong defensive nature to Beacon where we will grow through the cycle.

So, we like that aspect of our business, and you're seeing it unfold when other industries are not doing as well. This industry will do well. It's very steady, and that's why we like it.

Okay. Thanks. And then in terms of the weakness or the lack of growth on the non-res side, you've attributed that to weather. Did you say that the 1% to 2% was the growth rate of the company overall that was affected, or was that just in that segment?

No, that was overall, because it's hard for us to distinguish after the weather event which segment is mostly affected. Knowing the business, commercial is more affected by weather, but we did not further break it out, because again, I don't to emphasize weather. But we did not break it out by segment. So that's an overall effect.

Okay. And then finally, in terms of that comment then, if the weather -- not too over play it, but if the weather had an impact this quarter, you're up against tough comps, which we know, but did you see anything or hear anything from the customers?

It seems to me that this is a time in the cycle where non-res construction has really bloomed very well, corporate profitability is high. Therefore, companies would be in the market for this kind of capital expenditure. Any change in that cycle overall, sort of that longer term cyclical play?

No. No, we don't. Our company is still very bullish. I don't know how long that -- our visibility, David, again is not maybe as long as other industries, but based upon our outlook, and someone asked about our guidance for the year and so forth, we don't see the change. It's still very strong.

But again, when you report 24% internal growth in the second quarter, that's wonderful. But our objective -- that's not a normal number. But it happened because all three segments are doing well. All geographic areas were flying, and long term, that's not our expectation.

Our long-term expectation is to be a growth company both organically and with acquisitions. And when you do that, you mitigate natural swings in the economy, and I think that's what we like to say is we are not a -- we can be a seasonal company, but we don't think we're a cyclical company. And we will grow through the cycles, and that's why we give awfully strong guidance on what the expectation should be for organic growth and what the expectation should be for acquisition growth.

And that is very important for everyone to understand. It's a bullish statement, but it's a conservative statement to keep everyone focused on the long-term objective. And when we -- and if you take that 15% to 25% growth rate over a five year period, this is a substantial company doing extremely well over the next five to ten years.

Okay. Thanks much, Bob.

You're welcome.

Thank you.

Our next question is from the line of Brent Rakers of Morgan Keegan. Please proceed sir.

Yes, good morning.

Good morning, Brent.

Just to maybe wrap up this, to tie up some loose ends in this non-res side. I guess, Bob, what you're implying, just to go ahead and say the number is, is it looks like about $5 million swing that you attribute to revenue just within the non-res segment in the northeast. Is that a correct statement?

Yes.

Good. And then I guess maybe the follow up to that is, and again it kind of ties to some of the other comments, but given the inflationary cost increase, that still suggests flat to downish trends there. Is there any other dynamic within the business that might have reduced that volume number there?

No. The place in -- as soon we say it's stabilizing, you find out that the pipeline in Alaska has a problem. It's very difficult for us to, not only calculate it, but estimate it. And the inflation that we're trying to calculate, at everyone's request, is a gross inflation number. It's an inflation number that a vendor may announce.

The net inflation maybe totally different. Because of our size we can negotiate rebates and buying programs throughout the year, so there's gross inflation and net inflation. What we're trying to disclose is gross inflation, so it's hard for me to predict what it might be in the next year.

And again, we tried to spend less time on that and more time on selling the building envelope, opening branches, making acquisitions, and growing at that 5% to 10% over any five year period. And so inflation is very difficult to predict, and at times for us very difficult to even calculate.

Bob, in light of that, I hate to ask the next question, but can you maybe give us a sense for what you're seeing in inflation in July and August on a year-over-year basis. Is it increasing anymore, any in kind of acceleration? You mentioned the Alaskan pipeline. Or is there any kind of slowing as you're lapping more and more difficult comparisons there?

I've not seen increasing at all.

Okay.

In general, Brent, since the beginning of January it's been pretty flat. A lot of the inflation incurred early on 12 months ago than it did for the last six months.

Okay.

I really don't think we need it to grow at 5% to 10%. Historically, the industry is not an inflationary industry, and the national numbers, in unit growth, is where we set our target. So the industry on units grows very consistently year-after-year, but inflation is always hard to try to predict.

Well, let me switch gears then. And you referred a number of times to the strong demand in the southeast and I guess on the gulf coast tide to the hurricanes. Any movement there from kind of where demand was last quarter, or if you maybe comment on visibility, or how much legs you think this recovery reconstruction side has for your business.

The southeast still does well, and that wasn't as impacted by storms as the gulf coast. The impact of Katrina is practically gone and not from a standpoint of reconstruction, but the big impact of people opening branches and a lot of shipment into those areas. So that's -- even Texas from the impact of Wilma, our Texas operations still are growing double-digits with no impact from storms.

Now, who knows where the storms will be this year. If they hit the Carolinas, Carolina will have an unbelievable year, and Texas will be back to the more normal organic growth rate. So storms happen. They'll happen every year someplace, either on the gulf coast or on the east coast, so we really -- its really hard to say, other than everything I hear from our folks down there is there's still a lot of work to do.

And I guess that was the -- maybe that was the question. I was -- it's still a very high level of kind of sustained demand because of the devastation from Katrina, correct?

Yes, there's still a lot of problems with insurance refunds and governmental money being released to that area. That area is not rebuilt, and it'll be years before it is rebuilt.

And then again switching gears again. I'm looking at some of your personnel numbers in the period and if you look at the sequential trend outside of the business sales force itself, it looks like it grew about 9.5% from Q2 to Q3, and then last year it only grew about 2%. Any sort of special additional positions added in the last three months?

That's a question I might not be able to totally answer. That's a detail that I will look at when you and I can talk about it offline. But no, whether you're looking at acquisitions and the fact that you have an increase in headcount.

Okay.

But the sales are on an annualized basis. So we can't answer that. Good question, but there's nothing that comes to mind inside the company. As a matter of fact, I think we do an outstanding job of that area.

Now, we are -- we have a management training program that we're very excited about that we're increasing. I think we're pretty much in line with increase in sales. David, do you have anything?

No, I mean if you want to send me what you're talking about.

Okay, okay. Yes, I'll do that offline and then just two more, last two questions. I was hoping you maybe could talk a little bit more detail about some of the positive traction you're seeing with Shelter, whether it's an improvement from systems or buy synergies or whatever.

And then also, David, if maybe you could comment a little bit about where you're comfortable with acquisitions in terms of where the balance sheet stands right now.

Regarding -- David will handle the balance sheet. My days and the balance sheet have long gone. Shelter -- they're doing extremely well, and I just want to remind everyone that many of those locations are in the mid-west and the central part of the United States, and they're doing real well in whatever measurements you want to look at compared to where we'd thought they'd be. And of course, before we purchased Shelter, we did a lot of scenarios about growth and profits to justify the purchase price and the completion of that deal.

So compared to our expectations we're doing real well. We also are looking at their performance versus what they did before we owned them. And that's why in David's commentary, we disclosed that if you take Shelter's growth, organic growth, because we have many acquisitions for Shelter, and put it into Beacon's organic growth, as if we had owned them during that period, our organic growth rate is approaching 10% in the third quarter.

So we are very pleased with that company. David will talk about integration. A very motivated group of folks -- the leadership is very strong. And I also think the fact that they are now part of Beacon, understanding that their future is secure and not owned, in other words, by a company that wants to polish it up and sell it in three or four years. They're now a part of the long-term growth pattern of Beacon.

I think it's a very motivated group of folks, and honestly we couldn't be more pleased, not just their growth rate, but what they're doing with profitability; how hard they're working with integration of computers, which is not easy; working hard on receivables; inventory turns. It's a very good group of people that we're excited about. And David talked about the balance sheet, which starts with acquisitions and our capacity and so forth.

Basically Brent, right now we're at about 1:1 debt-to-equity, so we have plenty of room to either refinance that facility if we need to, to provide some more capital. We have about $68 million currently in availability on our revolver, so we have plenty of room to make some acquisitions.

We're also generating, which you can calculate, so I don't have to go through a convoluted schedule to show you EBITDA or free cash flow, but we're generating some strong free cash flow since we've made these acquisitions, which will provide for that growth.

So I don't see any reason why we can't do the ones that we have in the hopper right now, unless it was a very large one, like Shelter again, which we have to do another event if we did something that size.

Great. Thank you very much.

Thank you.

I appreciate it.

Ladies and gentlemen, this concludes our question and answer session. I would now like to turn call back to Mr. Buck for his closing comments.

Okay. Again, like I always say every quarter, we really appreciate your interest, your support of Beacon, and let me just leave you with several points to emphasize.

One is the continued strong growth in residential is exciting to see. You're seeing improved gross margins, particularly in our existing locations. Operating expenses continue to decrease as a percent of sales.

I want to point out in the third quarter our existing locations reported double-digit operating income, which often people ask, 'What can the profitability of Beacon be,' and that gives you an example. In the third double-digit operating income, and that's a big tribute to our folks in New England who are a really delivering profit. The people in the mid-Atlantic, the Carolinas, which is an area I've mentioned almost every quarter, they continue to do well.

Shelter, I've said is above expectations. And the growth plan that we've talked about now for two years is being executed. New branches are on deck. The acquisition pipeline is full. Our geographic diversity is working. When it's raining in New England, it's probably sun-shiny in California, and so that's very important.

Our size is working for us. As we get bigger, our purchasing synergy continues to increase and maybe, lastly, our fourth quarter is very strong, which is always good to report.

So that concludes our third quarter earnings call. We're excited about what's happening, and we sincerely appreciate your confidence and support. Thanks very much.

Thank you.

Talk to you later. Bye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Good day.