BEACON ROOFING SUPPLY INC - Quarter Report: 2006 June (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-Q

 

 

FOR THE TRANSITION PERIOD FROM              TO             .

 

COMMISSION FILE NO.: 000-50924

 

BEACON ROOFING SUPPLY, INC.

(Exact name of Registrant as specified in its charter)

 

978-535-7668

(Registrant’s telephone number, including area code)

(former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x   NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o   NO x

As of August 1, 2006, there were 43,821,508 outstanding shares of the registrant’s common stock, $.01 par value per share.

 

 

BEACON ROOFING SUPPLY, INC.

Form 10-Q
For the Quarter Ended June 30, 2006

INDEX

					Page
Part I.			Financial Information		3
Item 1.			Financial Statements (Unaudited)		3
			Consolidated Balance Sheets		3
			Consolidated Statements of Operations		4
			Consolidated Statements of Cash Flows		5
			Notes to Consolidated Financial Statements		6
Item 2.			Management’s Discussion and Analysis of Financial Condition And Results of Operations		12
			Overview		12
			Results of Operations		12
			Seasonality and Quarterly Fluctuations		17
			Liquidity and Capital Resources		17
			Cautionary Statement		20
Item 3.			Quantitative and Qualitative Disclosures about Market Risk		20
			Interest Rate Risk		20
			Foreign Exchange Risk		20
Item 4.			Controls and Procedures		20
Part II.			Other Information		21
Item 6.			Exhibits		21
Signature Page					22
Index to Exhibits					23

 

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BEACON ROOFING SUPPLY, INC.
PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Consolidated Balance Sheets

		(Unaudited)			(Unaudited)			(Note)
		June 30,			June 30,			September 24,
		2006			2005			2005
		(Dollars in thousands)
Assets
Current assets:
Cash		$	1,129		$	3,224		$	—
Accounts receivable, less allowance for doubtful accounts of $5,891 at June 30, 2006, $4,148 at June 30, 2005, and $4,104 at September 24, 2005		189,791			122,412			123,345
Inventories		181,484			99,852			82,423
Prepaid expenses and other assets		39,034			20,893			22,656
Deferred income taxes		11,324			3,226			4,339
Total current assets		422,762			249,607			232,763
Property and equipment, net		57,950			30,924			31,767
Goodwill, net		270,034			107,631			108,553
Other assets		58,735			13,881			13,904
Total assets		$	809,481		$	402,043		$	386,987
Liabilities and stockholders’ equity
Current liabilities:
Cash overdraft		$	—		$	—		$	6,107
Borrowings under revolving lines of credit		—			66,912			—
Accounts payable		154,177			92,147			70,158
Accrued expenses		78,676			39,204			29,146
Current portions of long-term debt and capital lease obligations		28,271			6,341			6,348
Total current liabilities		261,124			204,604			111,759
Borrowings under revolving lines of credit		199,288			—			63,769
Senior notes payable and other obligations, net of current portion		46,511			20,156			20,156
Deferred income taxes		20,661			9,182			10,890
Long-term obligations under capital leases & other, net of current portion		6,715			1,782			1,668
Commitments and contingencies
Stockholders’ equity:
Common stock (voting); $.01 par value; 100,000,000 shares authorized; 43,820,467 issued in June of 2006, 40,272,770 in June of 2005 and 40,367,360 issued in September of 2005		441			268			269
Undesignated preferred stock; 5,000,000 shares authorized, none issued or outstanding		—			—			—
Additional paid-in capital		201,993			141,512			142,173
Deferred compensation		—			(172		)	—
Treasury stock (349,292 shares in June of 2005 and September of 2005)		—			(515		)	(515		)
Retained earnings		66,789			21,624			32,050
Accumulated other comprehensive income		5,959			3,602			4,768
Total stockholders’ equity		275,182			166,319			178,745
Total liabilities and stockholders’ equity		$	809,481		$	402,043		$	386,987

 

Note: The balance sheet at September 24, 2005
 has been derived from the audited financial statements at that date.

The accompanying Notes are an integral part of the Consolidated Financial Statements

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BEACON ROOFING SUPPLY, INC.
Consolidated Statements of Operations

Unaudited
(Dollars in thousands, except per share data)

		Three Months Ended June 30,						Nine Months Ended June 30,
		2006			2005			2006			2005
Net sales		$	407,102		$	248,451		$	1,069,384		$	619,757
Cost of products sold		306,794			188,738			807,609			468,328
Gross profit		100,308			59,713			261,775			151,429
Operating expenses (includes stock-based compensation expense of $833 and $175 for the three months ended in 2006 and 2005, respectively, and $2,166 and $520 for the nine months ended in 2006 and 2005, respectively)		67,829			39,482			191,228			108,389
Income from operations		32,479			20,231			70,547			43,040
Other expense:
Interest expense		4,845			1,459			13,157			3,535
Loss on early retirement of debt		—			—			—			915
		4,845			1,459			13,157			4,450
Income before income taxes		27,634			18,772			57,390			38,590
Income taxes		10,580			7,443			22,651			16,099
Net income		$	17,054		$	11,329		$	34,739		$	22,491
Net income per share:
Basic		$	0.39		$	0.28		$	0.82		$	0.57
Diluted		$	0.38		$	0.28		$	0.79		$	0.55
Weighted average shares used in computing net income per share:
Basic		43,799,489			39,784,937			42,598,829			39,631,596
Diluted		45,003,474			41,176,503			43,900,509			41,047,854

 

The accompanying Notes are an integral part of the Consolidated Financial Statements.

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BEACON ROOFING SUPPLY, INC.
Consolidated Statements of Cash Flows

		Nine Months ended June 30,
		2006			2005
		Unaudited
		(In thousands)
Operating activities:
Net income		$	34,739		$	22,491
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		17,143			6,354
Stock-based compensation		2,166			520
Loss on early retirement of debt		—			915
Unrealized gain on interest rate collar		(709		)	—
Deferred income taxes		92			381
Changes in assets and liabilities, net of the effects of businesses acquired:
Accounts receivable		(4,481		)	(17,299		)
Inventories		(35,359		)	(22,767		)
Prepaid expenses and other assets		293			(64		)
Accounts payable and accrued expenses		51,871			18,772
Net cash provided by operating activities		65,755			9,303
Investing activities:
Purchases of property and equipment, net of sale proceeds		(11,152		)	(6,974		)
Acquisition of businesses, net of cash acquired		(285,701		)	(36,880		)
Net cash used in investing activities		(296,853		)	(43,854		)
Financing activities:
Borrowings under revolving lines of credit		135,305			22,114
Borrowings (repayments) under senior notes payable, and other		47,080			(2,737		)
Repurchase of warrants		—			(34,335		)
Repayments of junior subordinated notes		—			(17,986		)
Repayments of subordinated notes payable to related parties		—			(29,442		)
Net proceeds from sale of common stock		51,576			104,212
Proceeds from exercise of options		1,500			—
Deferred financing costs		(2,228		)	(342		)
Income tax benefit from stock-based compensation deductions in excess of recognized compensation cost		5,264			—
Net cash provided by financing activities		238,497			41,484
Effect of exchange rate changes on cash		(163		)	(15		)
Net increase in cash		7,236			6,918
Cash overdraft at beginning of year		(6,107		)	(3,694		)
Cash at end of period		$	1,129		$	3,224
Non-cash transactions:
Capital lease additions		$	4,951		$	1,228

 

The accompanying Notes are an integral part of the Consolidated Financial Statements

5

 

BEACON ROOFING SUPPLY, INC.

Notes to Consolidated Financial Statements (Unaudited)

1.   Basis of Presentation

Beacon Roofing Supply, Inc. (the Company, which may be referred to as we, us or our) prepared the consolidated financial statements following accounting principles generally accepted in the United States (GAAP) for interim financial information and the requirements of the Securities and Exchange Commission (SEC). As permitted under those rules, certain footnotes or other financial information required by GAAP for complete financial statements have been condensed or omitted. The balance sheet as of June 30, 2005 has been presented for a better understanding of the impact of seasonal fluctuations on our financial condition. Certain prior-year amounts have been reclassified to conform to the current-year presentation.

In management’s opinion, the financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. The results for the three-month and nine-month periods ended June 30, 2006 are not necessarily indicative of the results to be expected for the twelve months ending September 30, 2006 (“2006”).

The Company’s fiscal year ends on the close of business on the last Saturday in September of each year. Except for the fourth quarter of 2005, each of the Company’s 2006 and 2005 quarters ends on the last day of the respective third calendar month.

We completed our initial public offering (“IPO”) on September 22, 2004 and received the net IPO proceeds on September 28, 2004. In connection with the associated early retirement of debt paid with the proceeds, we recorded a $0.9 million loss in the first quarter of 2005.

On December 16, 2005, the Company sold two million shares of common stock in a public offering at $27.50 per share (prior to the stock split discussed below). Selling stockholders also sold shares in the offering. The net proceeds to the Company from this offering, after all associated expenses, totaled approximately $51.6 million and were used for the pay down of revolver borrowings. The Company did not receive any proceeds from the sales by the selling stockholders.

In May of 2006, our Board of Directors declared a three-for-two common stock split, which was paid in the form of a stock dividend on June 12, 2006 to the stockholders of record at the close of business on May 31, 2006. Accordingly, all share and per share data and the related capital amounts for all periods presented reflect the effects of this split. The Company’s treasury stock was retired in May, 2006.

You should also read the financial statements and notes included in our 2005 Annual Report on Form 10-K. The accounting policies used in preparing these financial statements are the same as those described in that Annual Report.

2.   Earnings Per Share

We calculate basic income per share by dividing the net income by the weighted-average number of common shares outstanding. Diluted net income per share includes the dilutive effects of stock awards. As discussed in Note 1, the Company sold two million additional shares of common stock in December 2005 and completed a three-for-two stock split on June 12, 2006.

The following table reflects the calculation of weighted-average shares outstanding, adjusted for the stock split, for each period presented:

		Three Months Ended June 30,				Nine Months Ended June 30,
		2006		2005		2006		2005
Weighted-average common shares outstanding for basic		43,799,489		39,784,937		42,598,829		39,631,596
Dilutive effect of employee stock options		1,203,985		1,391,566		1,301,680		1,416,258
Weighted-average shares assuming dilution		45,003,474		41,176,503		43,900,509		41,047,854

 

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3.   Stock-Based Compensation

Effective September 25, 2005, the Company adopted Statement of Financial Accounting Standards (“SFAS”) 123R, Share-Based Payments, using the modified-prospective transition method.  Prior to 2006, the Company accounted for stock awards granted to employees under the recognition and measurement principles of Accounting Principles Board Opinion No. 25,  Accounting for Stock Issued to Employees, and Related Interpretations.  As a result, no compensation expense was previously recognized for stock options granted to employees after the Company’s IPO because all such stock options granted had exercise prices equal to the market value of the Company’s stock on the date of the grant.

Under the modified-prospective transition method, compensation expense recognized in the three-month and nine-month periods of 2006 included: (a) compensation cost for all unvested share-based awards granted prior to September 25, 2005, based on the grant date fair value estimated in accordance with SFAS 123,  Accounting For Stock-Based Compensation, and (b) compensation cost for all share-based awards granted subsequent to September 24, 2005, based on the grant date fair value estimated in accordance with SFAS 123R. Results of prior periods have not been restated. SFAS 123R also requires the Company to estimate forfeitures in calculating the expense related to stock-based compensation. The impact of estimating forfeitures upon adoption was not material.  In addition, SFAS 123R requires the Company to reflect the benefits of tax deductions in excess of recognized compensation cost to be reported as both a financing cash inflow and an operating cash outflow upon adoption. The excess tax benefit classified as a financing activity would have been classified as an operating inflow if the company had not adopted SFAS 123R.

Compensation cost arising from stock options granted to employees and non-employee directors is recognized as expense using the straight-line method over the vesting period. As of June 30, 2006, there was $5.7 million of total unrecognized compensation cost related to stock options.  That cost is expected to be recognized over a period of 2.9 years.   As a result of adopting SFAS 123R, the Company recorded stock-based compensation expense of $0.8 million ($0.5 million net of tax) and $2.2 million ($1.3 million net of tax) for the three and nine months ended June 30, 2006, respectively.  Included in this total stock-based compensation expense was incremental expense of $1.4 million ($0.8 million net of tax) for options granted during the nine months ended June 30, 2006. The incremental expense for options granted during the third quarter was less than $0.1 million.

The following table illustrates the effect on net income and earnings per share for the three and nine months ended June 30, 2005 as if the Company’s stock-based compensation had been determined based on the fair value at the grant dates for awards made prior to 2006, in accordance with SFAS 123:

Unaudited		Three Months ended			Nine Months ended
(Dollars in thousands, except per share data)		June 30,2005			June 30,2005
Net income, as reported		$	11,329		$	22,491
Add: stock-based compensation, net of tax		105			312
Less: stock-based compensation expense determined under fair value method, net of tax		(256		)	(920		)
Pro forma net income		$	11,178		$	21,883
Basic earnings per share:
As reported		$	0.28		$	0.57
Pro forma		$	0.28		$	0.55
Diluted earnings per share:
As reported		$	0.28		$	0.55
Pro forma		$	0.27		$	0.53

 

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The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants issued in the first three quarters of 2006 and 2005:

 

Expected life of the options granted and expected volatilities are based on the expected life and historical volatilities of the stocks of comparable public companies and other factors.  Estimated annual forfeiture rates of 0.0 - 8.0% were utilized in valuing the options granted in the first three quarters of 2006.

The following table summarizes stock options outstanding as of June 30, 2006, adjusted for the stock split, as well as activity during the nine months then ended:

 

At June 30, 2006, the weighted-average remaining contractual life of options outstanding and exercisable was 7.4 years and 6.5 years, respectively. As of June 30, 2006, there were remaining options to purchase 2,017,274 shares of common stock available for grant under the Company’s 2004 Stock Plan.

At June 30, 2006, the aggregate intrinsic value of options outstanding and options exercisable was $41.1 million and $35.6 million, respectively.  (The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option.)  The weighted-average grant date fair value of stock options granted during the nine months ended June 30, 2006 and 2005 was $10.13 and $5.35, respectively. The intrinsic value of stock options exercised during the nine months ended June 30, 2006 and 2005 was $15.8 million and $5.3 million, respectively. At June 30, 2006, the Company had $7.8 million of excess tax benefits available for potential deferred tax write-offs related to option accounting.

4.   Comprehensive Income

Comprehensive income consists of net income and other gains and losses affecting stockholders’ equity that, under GAAP, are excluded from net income. In our case, these consist of foreign currency translation gains or losses as follows:

Unaudited		Three Months Ended June 30,						Nine Months Ended June 30,
(Dollars in thousands, except per share data)		2006			2005			2006			2005
Net income		$	17,054		$	11,329		$	34,739		$	22,491
Foreign currency translation adjustment		1,077			(275		)	1,191			853
Comprehensive income		$	18,131		$	11,054		$	35,930		$	23,344

 

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5.   Acquisitions

C&S Roofing Materials, Inc. D/B/A Pacific Supply Company

On January 10, 2006, we purchased certain assets of C&S Roofing Materials, Inc. D/B/A Pacific Supply Company (“Pacific”), a distributor of roofing and other building products with four locations located in Orange and Los Angeles counties in California.  This purchase was funded through our U.S. revolving line of credit. A total of $2.0 million of cash remains in escrow for post-closing indemnification claims and is included in other long-term assets. Pacific had net sales of $53 million (unaudited) for the year ended December 31, 2005. We have included the results of operations for Pacific from the date of acquisition and applied preliminary purchase accounting, which, along with final purchase price adjustments, resulted in recorded goodwill of $26.8 million as follows (in 000’s):

 

Mississippi Roofing Supply, Inc., Sunbelt Supply LLC, & Alabama Roofing Supply LLC

On January 17, 2006, we purchased certain assets of Mississippi Roofing Supply, Inc., Sunbelt Supply LLC, & Alabama Roofing Supply LLC (together the “Supply Companies”), three affiliated distributors of roofing and other building products with two locations in Alabama and one in Mississippi. This purchase was funded through our U.S. revolving line of credit. A total of $3.8 million of cash was in escrow at June 30, 2006 for post-closing purchase price adjustments and indemnification claims, of which $3.0 million is included in other current assets and $0.8 million is included in other long-term assets. The Supply Companies had combined net sales of $76 million (unaudited) for the year ended December 31, 2005. We have included the results of operations for the Supply Companies from the date of acquisition.  The purchase price has been adjusted for the preliminary financial performance for the year ended December 31, 2005.  We have applied preliminary purchase accounting, which, along with certain purchase price adjustments already made for the final working capital levels and the preliminary 2005 financial results and paid in July 2006, resulted in recorded goodwill of $52.2 million as follows (in 000’s):

 

SDI Holding, Inc.

On October 14, 2005, we purchased 100% of the outstanding stock of SDI Holding, Inc. (“Shelter”), a distributor of roofing and other building products with 51 branches in 14 states at the time of the acquisition. This purchase was funded through our U.S. revolving line of credit. Based upon Shelter’s final performance for the 2005 calendar year, the sellers qualified for an earn-out payment of $6.4 million, which was paid in June of 2006.  Shelter had net sales of $342.4 million (unaudited) for the year ended December 31, 2005. We have included the results of operations for Shelter from the date of acquisition and applied preliminary purchase accounting, which, along with final purchase price adjustments, resulted in recorded goodwill of $79.6 million as follows (in 000’s):

 

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Supplemental Pro Forma Information - Unaudited

The unaudited pro forma summary information below for the nine months ended June 30, 2006 and the three and nine months ended June 30, 2005, gives effect to the acquisition of Shelter as if the acquisition had occurred at the beginning of those periods and is after giving effect to certain adjustments, including amortization of the intangible assets subject to amortization, interest expense incurred as a consequence of the increased borrowings under our credit facility, and related income taxes. The aggregate impact of the inclusion of Pacific and the Supply Companies on the pro forma net income and net income per share presented below was not material and therefore has not been presented. Had the impact from Pacific and the Supply Companies been included in the pro forma net sales below, total pro forma net sales would have been $370.5 million for the three months ended June 30, 2005 and $1.12 billion and $923.5 million for the nine months ended June 30, 2006 and 2005, respectively. The unaudited pro forma summary information is not necessarily indicative of the financial results that would have occurred if the Shelter acquisition had been consummated at the beginning of those periods, nor is it necessarily indicative of the financial results which may be attained in the future.

The pro forma summary information is based upon available information and upon certain assumptions that the Company’s management believes are reasonable. As mentioned above, the Shelter acquisition is being accounted for using the purchase method of accounting. The allocation of the purchase price is preliminary. Final amounts could differ from those reflected in the pro forma summary information and such differences could be significant.

Unaudited		Three Months Ended June 30,			Nine Months Ended June 30,
(Dollars in thousands, except per share data)		2005			2006			2005
Net sales		$	339,376		$	1,085,206		$	838,859
Net income		$	12,369		$	34,199		$	21,193
Net income per share:
Basic		$	0.31		$	0.80		$	0.53
Diluted		$	0.30		$	0.78		$	0.52

 

JGA Corp.

On December 15, 2004, we purchased 100% of the outstanding stock of JGA Corp. (“JGA”), a distributor of roofing and other building products with eight branches in Georgia and Florida at the time of our acquisition. This purchase was funded through our U.S. revolving line of credit. A total of $1.3 million of cash remains in escrow for post-closing indemnification claims and is included in other current assets. JGA had net sales of $74 million (unaudited) for the year ended December 31, 2003. We have included the results of operations for JGA from the date of acquisition and applied purchase accounting, which resulted in recorded goodwill of $9.7 million and $11.4 million of other intangible assets.

Other Recent Acquisitions

On November 23, 2005, we purchased certain assets of Easton Wholesale Company, Inc. (“Easton”), a distributor of building products located in Easton, Maryland. On September 1, 2005, we purchased certain assets of Commercial Supply, Inc. (“CSI”), a distributor of building products located in western Massachusetts. On April 26, 2005, we purchased certain assets of Insulation Systems, Inc. of Virginia (“ISI”), a distributor of roofing and other building products with two branches in Virginia.

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6.   Debt

Effective October 14, 2005, the Company and its lenders in connection with the purchase of Shelter (Note 5) amended and restated the senior secured credit facilities (revolving lines of credit and term loans). The amendment extended the maturity date of the facilities to October 14, 2010, lowered the interest rates charged, increased the revolving lines of credit and term loans to totals of $230 and $80 million, respectively, and extended the installment schedule of the term loans so that the final payment is due on October 14, 2010. In addition, the amendment expanded the criteria for acquisitions which do not require lender consent and included an option of increasing the revolving lines of credit by an additional $50 million, which was exercised in January 2006 (see below). The amendment also increased the amount of allowed annual capital expenditures to 1.5% of net sales.

In January 2006, the Company and its lenders agreed to increase the revolving lines of credit by the additional $50 million to a total of $280 million and amend the term loans to provide for additional loans of $10 million, resulting in a total of $90 million. The lenders also agreed to waive certain minimum availability levels related to the January 2006 acquisitions. None of the other terms of the revolving lines of credit and term loans were changed.

The borrowings under the amended facilities continue to be collateralized by substantially all of the Company’s assets and are subject to certain operating and financial covenants, which, among other things, restrict the payment of dividends. The senior secured credit facilities have numerous restrictive covenants, including required fixed charge coverage ratios.

7.   Foreign Sales

Foreign (Canadian) sales totaled $29.2 and $68.2 million in the three and nine months ended June 30, 2006, respectively, and $25.2 and $60.3 million in the three and nine months ended June 30, 2005, respectively.

8.   Financial Derivatives

The Company enters into interest rate derivative agreements, commonly referred to as swaps or collars, with the objective of reducing volatility in our borrowing costs.  At June 30, 2006, there were two interest rate collars outstanding that effectively convert the variable LIBOR component on a portion of our term loans to a fixed rate.  The first collar has a notional amount of $75 million, expires in November 2008, and has a floor rate of 4.33% and a cap rate of 5.85%.  The second collar has a notional amount of $75 million, expires in January 2008, and has a floor rate of 4.54% and a cap rate of 5.09%.  The combined fair market value of the agreements resulted in a recorded asset of approximately $0.7 million at June 30, 2006, which was determined based on current interest rates and expected trends.  Since these instruments do not qualify as hedges, changes in the unrealized gain or loss are recorded in interest expense.  The differentials to be paid or received under the terms of the agreement are accrued as interest rates change and are recognized as an adjustment to interest expense related to the debt.

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ITEM 2   Management’s Discussion And Analysis Of Financial Condition And Results of Operations

You should read the following discussion in conjunction with Management’s Discussion and Analysis included in our 2005 Annual Report on Form 10-K. Unless otherwise specifically indicated, all references to “2006” and “YTD 2006” refer to the three months (third quarter) and nine months (year-to-date) ended June 30, 2006, respectively, of our fiscal year ending September 30, 2006, and all references to “2005” and “YTD 2005” refer to the three months (third quarter) and nine months (year-to-date) ended June 30, 2005, respectively, of our fiscal year ended September 24, 2005.

Overview

We are one of the largest distributors of residential and non-residential roofing materials in the United States and Canada. We are also a distributor of other complementary building products, including siding, windows, specialty lumber products and waterproofing systems for residential and non-residential building exteriors. We purchase products from a large number of manufacturers and then distribute these goods to a customer base consisting of contractors and, to a lesser extent, general contractors, retailers and building material suppliers.

We currently distribute up to 10,000 SKUs through 148 branches in the United States and Canada.  We had 2,512 employees as of June 30, 2006, including our sales and marketing team of 630 employees. In fiscal year 2005, approximately 90% of our net sales were in the United States. We stock one of the most extensive assortments of high-quality branded products in the industry, enabling us to deliver products to our customers on a timely basis.

Execution of the operating plan at each of our branches drives our financial results. Revenues are impacted by the relative strength of the residential and non-residential roofing markets we serve. We allow each of our branches to develop its own marketing plan and mix of products based upon its local market. We differentiate ourselves from the competition by providing customer services, including job site delivery, tapered insulation layouts and design and metal fabrication, and by providing credit. We consider customer relations and our employees’ knowledge of roofing and exterior building materials to be very important to our ability to increase customer loyalty and maintain customer satisfaction. We invest significant resources in training our employees in sales techniques, management skills and product knowledge. Although we consider these attributes important drivers of our business, we continually pay close attention to controlling operating costs.

Our growth strategy includes both internal growth (opening branches, growing sales with existing customers and introducing new products) and acquisition growth.  Our main acquisition strategy is to target market leaders in geographic areas that we presently do not service. Our October 2005 acquisition of SDI Holding, Inc. (“Shelter”) is one example of this approach. Shelter is a leading distributor of roofing and other building materials, currently operating 51 branches in the Southeast, Midwest and Central Plains regions of the United States, growing areas targeted by us for expansion.  In addition, we also acquire smaller companies to supplement branch openings within existing markets. Our November 2005 acquisition of Easton Wholesale Company, Inc. (“Easton”), which was integrated into our region in the Mid-Atlantic, is one example of such an acquisition.

Results of Operations

The following table shows, for the periods indicated, information derived from our consolidated statements of operations expressed as a percentage of net sales for the periods presented.

		Three Months Ended June 30,				Nine Months Ended June 30,
		2006		2005		2006		2005
Net sales		100.0	%	100.0	%	100.0	%	100.0	%
Cost of products sold		75.4		76.0		75.5		75.6
Gross profit		24.6		24.0		24.5		24.4
Operating expenses		16.6		15.9		17.9		17.5
Income from operations		8.0		8.1		6.6		6.9
Interest expense		(1.2	)	(0.6	)	(1.2	)	(0.6	)
Loss on early retirement of debt		—		—		—		(0.1	)
Income before income taxes		6.8		7.5		5.4		6.2
Income taxes		(2.6	)	(2.9	)	(2.2	)	(2.6	)
Net income		4.2	%	4.6	%	3.2	%	3.6	%

 

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In managing our business, we consider all growth, including branch expansion, to be internal growth unless it results from an acquisition. When we refer to growth in existing markets in our discussion and analysis of financial condition and results of operations, we include growth from existing and newly-opened branches but exclude growth from acquired branches until they have been under our ownership for at least four full fiscal quarters at the start of the fiscal reporting period. At June 30, 2006, we had a total of 148 branches in operation. For the quarter ended June 30, 2006, 86 branches (including JGA) were included in our existing market calculations and 62 branches were excluded because they were acquired during or after the quarter ended June 30, 2005. JGA is included in acquired markets for YTD 2006 since they were owned by the Company for only a portion of the four-quarter period that preceded YTD 2006. Acquired markets (see Note 5 to the consolidated financial statements) for YTD 2006 also include Pacific, the Supply Companies, Shelter, Easton, ISI and CSI, and for YTD 2005 represent the partial-year operating results for JGA.

Three Months Ended June 30, 2006 (“2006”) Compared to the Three Months Ended June 30, 2005 (“2005”)

Existing and Acquired Markets

For the Three Months Ended

		Existing Markets						Acquired Markets						Consolidated
		June 30,						June 30,						June 30,
		2006			2005			2006			2005			2006			2005
Net Sales		$	257,968		$	244,729		$	149,134		$	3,722		$	407,102		$	248,451
Gross Profit		64,416			59,130			35,892			583			100,308			59,713
Gross Margin		25.0		%	24.2		%	24.1		%	15.7		%	24.6		%	24.0		%
Operating Expenses		38,434			39,076			29,395			406			67,829			39,482
Operating Expenses as a % of Net Sales		14.9		%	16.0		%	19.7		%	10.9		%	16.6		%	15.9		%
Operating Income		$	25,982		$	20,054		$	6,497		$	177		$	32,479		$	20,231
Operating Margin		10.1		%	8.2		%	4.4		%	4.8		%	8.0		%	8.1		%

 

Net Sales

Consolidated net sales increased $158.7 million, or 63.9%, to $407.1 million in 2006 from $248.5 million in 2005. Existing markets saw internal growth of $13.2 million or 5.4%, while acquired markets contributed the remaining increase of $145.5 million. A portion of the acquired markets’ business benefited from the Gulf Coast rebuilding that is occurring following Hurricane Katrina. We believe the current U.S. new home construction slowdown has not had a material impact on our sales to date, although we cannot predict the impact it may have on future operations. We opened one new branch in acquired markets during 2006 and three new branches in existing markets during 2005.  For 2006, our acquired markets had combined product group sales of $88.4, $32.2 and $28.5 million in residential roofing products, non-residential roofing products and complementary building products, respectively, while the product group sales for our existing markets were as follows:

For the Three Months Ended

		June 30, 2006					June 30, 2005
		Sales			Mix		Sales			Mix		Growth
		(dollars in millions)
Residential roofing products		$	112.6		43.6	%	$	100.7		41.2	%	$	11.9		11.8	%
Non-residential roofing products		86.1			33.4		87.4			35.7		(1.3		)	-1.5
Complementary building products		59.3			23.0		56.6			23.1		2.7			4.8
		$	258.0		100.0	%	$	244.7		100.0	%	$	13.3		5.4	%

 

Note: Total 2006 existing market sales of $258.0 million plus 2006 sales from acquired markets of $149.1 million equal $407.1 million of total 2006 sales. Our total 2005 sales of $248.4 million consisted of $244.7 million from existing markets plus $3.7 million from acquired markets. We believe the existing market information is useful to investors because it helps explain organic growth.

Our third-quarter existing market growth was due primarily to the following factors:

·              overall estimated price increases of approximately 4%-6% compared to 2005;

·              continued strong residential roofing demand across most regions; and

·              four new branches opened in existing markets since June 30, 2005.

Due, in part, to the mild winter during our second quarter and rainfall well above normal during the third quarter, sales growth was weakest along the East Coast, especially in New England. Of our product groups, non-residential roofing sales were the weakest in these areas. In last year’s third quarter, non-residential roofing sales in existing markets increased 33.6%.

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Gross Profit

For the Three Months Ended

 

Our existing markets’ gross profit grew 8.9% and contributed $5.3 million to the total gross profit increase, while acquired markets accounted for the remaining $35.3 million increase.  Existing markets’ gross margin increased to 25.0% in 2006 from 24.2% in 2005. This increase was the result of a product mix shift towards more residential roofing products, which generally have higher gross margins, inclusive of regular and seasonal vendor buying programs, and an increase in vendor rebates as a percentage of sales during 2006 resulting mainly from increased buying power from our growth. Our consolidated overall gross margin increased to 24.6% from 24.0% due to the same factors and less of an influence from JGA’s lower gross margin.

Operating Expenses

For the Three Months Ended

 

Our existing markets’ operating expenses declined $0.6 million, or 1.6%, to $38.4 million in 2006 from $39.1 million in 2005, while acquired markets increased $28.9 million, including $2.4 million for the amortization of intangible assets recorded under purchase accounting. The existing markets’ operating expense decline was due primarily to lower bad debt expense, insurance expense and professional fees, partially offset by increased payroll and related costs resulting from our increased sales volume and four new branches opened in existing markets since June 30, 2005, and higher selling expenses, including transportation costs. In addition, existing markets’ general and administrative expenses have benefited from leveraging certain expenses over a larger base, including our acquired markets. Stock option expense also increased $0.7 million in 2006 from 2005.

Existing markets’ operating expenses as a percentage of net sales dropped to 14.9% from 16.0%, primarily due to the leveraging of our fixed costs over the higher sales volume and the lower expenses discussed above. Overall operating expenses increased to 16.6% of net sales in 2006 from 15.9% in 2005, primarily due to higher operating cost percentages at Shelter and Pacific.

Interest Expense

Interest expense increased $3.3 million to $4.8 million in 2006 from $1.5 million in 2005. We amended our revolving lines of credit and term loans in connection with our acquisitions and increased our borrowings since the third quarter of last year. Interest rates also increased from the prior year, although the impact of the higher rates was partially offset by an increase in the market value of our interest rate collars.

Income Taxes

Income tax expense was $10.6 million in 2006, an effective tax rate of 38.3%, compared to $7.4 million in 2005, an effective rate of 39.6%. The reduction in our third quarter rate this year and the lower effective rate for 2005 compared to the YTD 2005 rate were due to reversals of previously accrued income taxes of $0.6 and $0.4 million in 2006 and 2005, respectively. We expect our fiscal 2006 fourth-quarter effective income tax rate to return to 40.5%.

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Nine Months Ended June 30, 2006 (“YTD 2006”) Compared to the Nine Months Ended June 30, 2005 (“YTD 2005”)

Existing and Acquired Markets

For the Nine Months Ended

		Existing Markets June 30,						Acquired Markets June 30,						Consolidated June 30,
		2006			2005			2006			2005			2006			2005
Net Sales		$	628,057		$	555,663		$	441,327		$	64,094		$	1,069,384		$	619,757
Gross Profit		161,067			140,992			100,708			10,437			261,775			151,429
Gross Margin		25.6		%	25.4		%	22.8		%	16.3		%	24.5		%	24.4		%
Operating Expenses		104,151			100,036			87,077			8,353			191,228			108,389
Operating Expenses as a % of Net Sales		16.5		%	18.0		%	19.7		%	13.0		%	17.9		%	17.5		%
Operating Income		$	56,916		$	40,956		$	13,631		$	2,084		$	70,547		$	43,040
Operating Margin		9.1		%	7.4		%	3.1		%	3.3		%	6.6		%	6.9		%

 

Net Sales

Consolidated net sales increased $449.6 million, or 72.5%, to $1.07 billion in YTD 2006 from $619.8 million in YTD 2005. Existing markets saw internal growth of $72.4 million or 13.0%, while acquired markets contributed the remaining increase of $377.2 million. A portion of the acquired markets’ business benefited from the Gulf Coast rebuilding that is occurring following Hurricane Katrina. We opened two new branches in existing markets during YTD 2006 and five new branches in existing markets in YTD 2005. We opened three new branches in acquired markets in YTD 2006.  For YTD 2006, our acquired markets had combined product group sales of $258.5, $94.5 and $88.3 million in residential roofing products, non-residential roofing products and complementary building products, respectively, while the product group sales for our existing markets were as follows:

For the Nine Months Ended

		June 30, 2006					June 30, 2005
		Sales			Mix		Sales			Mix		Growth
		(dollars in millions)
Residential roofing products		$	258.4		41.1	%	$	219.0		39.4	%	$	39.4		18.0	%
Non-residential roofing products		222.3			35.4		204.4			36.8		17.9			8.8
Complementary building products		147.4			23.5		132.3			23.8		15.1			11.4
		$	628.1		100.0	%	$	555.7		100.0	%	$	72.4		13.0	%

 

Note: Total YTD 2006 existing market sales of $628.1 million plus YTD 2006 sales from acquired markets of $441.3 million equal $1.07 billion of total YTD 2006 sales. Our sales for YTD 2005 consisted of existing market sales of $555.7 million, plus acquired market sales of $64.1 million, totaling $619.8 million.  We believe the existing market information is useful to investors because it helps explain organic growth.

Our YTD 2006 existing market growth was due primarily to the following factors:

·   overall estimated price increases of approximately 4%-7% compared to YTD 2005;

·   strong residential roofing demand across most regions;

·   high demand for complementary building products; and

·   moderate overall non-residential roofing demand, with strong growth in the mid-Atlantic and Texas regions.

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Gross Profit

For the Nine Months Ended

 

Our existing markets’ gross profit grew 14.2% and contributed $20.1 million to the total gross profit increase, while acquired markets accounted for the remaining $90.3 million increase.  Existing markets’ gross margin increased to 25.6% in YTD 2006 from 25.4% in YTD 2005 due primarily to the same factors mentioned above for the third quarter.  Our overall gross margin has also increased due to these factors and a higher gross margin in our acquired markets prior to those factors.  We expect our future quarterly overall gross margins to fluctuate from 24% to 26% depending primarily on our product mix.

Operating Expenses

For the Nine Months Ended

 

Our existing markets’ operating expenses increased $4.1 million, or 4.1%, to $104.1 million in YTD 2006 from $100.0 million in YTD 2005, while acquired markets accounted for the remaining $78.7 million increase, including $6.2 million for the amortization of intangible assets recorded under purchase accounting. The existing markets’ operating expense increase was due primarily to increased payroll and related costs resulting from our increased sales volume and four new branches opened in existing markets since June 2005.  Other significant changes came from higher selling expenses, including transportation costs, while professional fees and insurance costs declined in YTD 2006.  In addition, existing markets’ general and administrative expenses have benefited from leveraging certain expenses over a larger base, including our acquired markets. Stock option expense also increased $1.6 million in 2006 from 2005.

Existing markets’ operating expenses as a percentage of net sales dropped to 16.5% from 18.0%, primarily due to the leveraging of our fixed costs over the higher sales volume. Overall operating expenses increased to 17.9% of net sales in YTD 2006 from 17.5% in YTD 2005. Higher operating cost percentages at Shelter and Pacific were the principal causes of this increase, partially offset by leveraging our fixed costs over the increased sales.

Interest Expense

Interest expense increased $9.7 million to $13.2 million in YTD 2006 from $3.5 million in YTD 2005. We amended our revolving lines of credit and term loans in connection with our acquisitions and increased our borrowings since YTD 2005. Interest rates also increased from the prior year, although the impact of the higher rates was partially offset by an increase in the market value of our interest rate collars.

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