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OPERATOR
Good morning, and welcome, ladies and gentlemen, to LESCO's second-quarter earnings release conference call and Webcast.
At this time, I would like to inform you that this conference is being recorded, and that all participants are in a listen-only mode.
At the request of the Company, we will open the conference up for questions and answers following the presentation.
Safe Harbor portions of this presentation, and other statements relating to sales and earnings expectations, new service center openings and profitability, the Company's ability to impose price increases and other statements that are not historical information are forward-looking statements, and, as such, reflect only the Company's best assessment at this time.
Investors are cautioned that forward-looking statements involve risks and uncertainties, and that actual results may differ materially from such statements, and that investors should not place undue reliance on such statements.
Investors are cautioned that forward-looking statements involve risks and uncertainties, that actual results may differ materially from such statements and that investors should not place undue reliance on such statements.
Factors that may cause actual results to differ materially from those projected or implied in the forward-looking statements include, but are not limited to, the Company's ability to add new service centers (technical difficulty) which can be affected by local zoning and other governmental regulations; and its ability to find favorable store locations; to negotiate favorable leases; to hire qualified individuals to operate the service centers; and to integrate new service centers into the Company's systems; competitive factors in the Company's business, including pricing pressures, lack of availability, or instability in the cost of raw materials, which affects the cost of certain products; the Company's ability to impose increases on customers without a significant loss in revenues; potential rate increases by third-party carriers, which affects the cost of delivery products; potential (ph) regulations; the Company's ability to effectively manufacture, market and distribute new products; the success of the Company's operating plans, regional weather conditions and the condition of the industry and the economy.
For a further discussion of risk factors, investors should refer to the Company's Securities and Exchange Commission reports, including, but not limited to, Form 10-K for the year ended December 31st, 2002.
I will now turn the conference over to Mr. Jeffrey Rutherford, Senior Vice President and Chief Financial officer.
JEFFREY RUTHERFORD
Thank you, operator.
Based on that Safe Harbor, we must be paying our attorneys by the word.
I would like to welcome everyone to LESCO's second-quarter conference call.
This morning, we released second-quarter results.
A copy of this release can be accessed through our Website at www.LESCO.com.
Our PowerPoint presentation supporting today's conference call is also available on our Website.
Before I turn the call over to Michael Dimino to discuss second-quarter sales and margins (ph), I would like to very briefly reference the charges from 2002 that have been referenced both in the release and in the PowerPoint presentation.
In 2002, we took, in the second quarter, a $9.6 million charge for inventory liquidation.
We decided to sell certain underperforming assets, resulting in a $12.1 million charge to adjust both assets' net book value to look liquidation values.
In the first half, we took severance charges for management changes of 3.9 million, 1.8 million in the second quarter.
And finally, in the first quarter of 2002, we took charges for the refinancing of debt of 4.6 million and a write-off of impaired goodwill of $7.3 or $4.6 million net of tax.
As I'm sure everyone is aware, regulatory guidelines require us to report on a GAAP basis, including these charges, and when we reference pro forma, to present a reconciliation to GAAP, we have provided those reconciliations for the second quarter and first half of 2002 in our earnings release, and in the PowerPoint presentations for this conference call.
And when we reference expenses in the conference call, we will be referencing excluding those charges.
With that, I would like to turn the call over to Michael Dimino to discuss the second-quarter 2003 sales and gross profit results.
MICHAEL DIMINO
Thank you, Jeff.
In order to do that properly, I think I need to take you all back just a couple of steps.
First of all, the year began with us having three basic initiatives that we wanted to accomplish.
If I explain those initiatives, you'll understand better, I think, the numbers that we have in the presentation today.
We wanted to open new stores.
We added new selling individuals and we added sales.
We added cost infrastructure to our hub system, in order to support the new stores and our sales reps.
All of those things were designed to grow the business.
Growing the business is something that we believe we can do, based on the industry that we are in, and the products that we have, and it had not been done in the years prior.
We're trying to return the Company to profitability and return it to growth -- again, goals that we can accomplish.
This year, we discovered that we weren't getting the sales increase that we would like, primarily due to the horrible weather in the Northeast and the lack of performance from these assets that we added in.
For instance, on our hub assets, we changed our delivery methodologies and we added expense there in order for our salesmen to have more time selling and less time delivery and working on deliveries and having the hubs do some of that work.
That expense did not and has not created the type of sales increase that we would like, so we are now putting those expenses on a diet, and we are moving forward in making sure that that system is working, providing service but making sure it is not doing more than it was designed to do, and in fact, we can save money and expense there.
The new sales reps -- again, we probably have a situation where of the ways to grow, new stores or new sales reps, the new stores are clearly the most successful method of the three methods that we chose.
And we will continue to invest in that method.
The new sales reps have not been as successful as we would like them to have been, and they are expensive, and it is irresponsible for us do not do anything about that, considering the tough start with the Northeast and the urea situation.
So, with that said, I want to go through the second quarter and year to date, and make sure you understand where we are at.
First of all, our second quarter is our largest quarter, on a seasonality standpoint.
If you're looking at our slide, it's slide number 5.
It reminds you all again that we do have a very seasonable business, and this is our biggest quarter.
We are up in sales 3.7 percent for the quarter, and that breaks down into lawn care and golf, lawn care being up 5.7 percent for the quarter, golf being down 2.1 percent.
That is also part of our problem in the first half of the year -- in addition to the Northeast getting off to a slow start, golf has gotten off to a slow start across the country.
But lawn care continues to be a very productive area for us, and represents 70 percent of our total business.
In the second quarter, by geography, you can see that our Northeast zone is now performing a little bit more respectively, at a 3 percent growth rate.
Last quarter, if you remember, this same slide showed that that zone was down 9 percent over prior year.
It's just too big of a zone for us to come back from, and thus our re-forecast to earnings, et cetera.
So we're seeing good success in the mid-central, transition other areas of the country, the West still being -- growing slowly.
But the Northeast is a big zone for us, and to have it only grow at 3 percent for the quarter and be flat for the year is disappointing to us.
Second-quarter sales by product indicates that our fertilizer and combination products are up 2.2 percent, our control products up 1.7 percent, equipment up almost 7 percent and turfgrass and seed -- turfgrass seed is up 15.1 percent.
We're seeing rises in other growth.
Our pest control business is up slightly, so overall, the mix is still a good mix for the company in our products.
Gross profit -- there is two stories to tell on gross profit.
We are up slightly in dollars that are generated -- gross profit dollars generated because of sales volumes being up for the quarter, but our margins have gone down 70 basis points.
Here, we discovered a problem with our pricing flexibility.
We are able to pass price increases along to our customers; however, we were not enforcing the correct disciplines in our pricing methodologies, and our salesmen were able to flex the raised prices back down to meet different situations.
We have removed that pricing flexibility, and we have now seen a significant improvement in gross margins for the month of July.
However, we are still up against a large urea increase that's coming up for the rest of the year, and we believe we are going to have a difficult time maintaining margins for the rest of the year, even though we have improved or repaired the flexibility in the pricing system.
Jeff, do you want to cover expenses?
JEFFREY RUTHERFORD
From an expense perpective, I would like to reference our three primary expense categories -- warehouse and delivery, selling expense and general and administrative.
From a warehouse and delivery perspective, during the first half of 2003, we established and converted to our restructured hub network.
The revisions that we made have added fixed costs to the network, plus we had startup costs which in combination with sales volume increases resulted in a $2 million increase in our expenses.
This is an area we continue to monitor.
Bruce Stone (ph) and his people are evaluating that network on an interim basis, and on a continuous basis, and we are looking for the best process, the best network to deliver our goods to our customers.
We are not satisfied with these results, but they are explainable through the fixed costs and through the startup costs.
And we are seeing -- I don't think I'm doing anything that I shouldn't be doing, but we are seeing better results (multiple speakers) sales for July and going into the third quarter.
Selling expenses had several factors resulting in there, incremental costs and selling expenses.
First of all, new stores -- and we will talk a little bit more about new stores toward the end of this conference call, but 800,000 of that increase in selling expenses was attributable to new stores.
There was a change in the timing of our commission program, the payments in our commission program, and sales volume, which resulted in a $500,000 increase in our commission expenses for the second quarter.
Then, finally, at the end of last year, we added additional direct sales personnel, and that program has been revised, as Michael mentioned, and resulted in a cutback of direct sales positions.
Those reductions represent approximately $2.9 million of annual costs that we have removed.
We've added a certain amount of costs, and then we removed 2.9 million of them.
And we should see, obviously, reduced selling expenses going forward with that move.
From G&A cost perspective, we're relatively flat year over year.
Our debt is back down to 2002 levels, so we were a little high in the first quarter, but we are back down to 2002 levels, resulting in the flat interest expense to prior year.
All these factors together contributed to net income of 6.7 million or 7 cents a share.
For the first half -- we're not going to spend a lot of time going through the details of the first half.
We have gone through the quarter and we'll certainly take questions on the first half versus the second quarter.
But sales increased 2.7 percent to $267 million, with net income of (indiscernible) or 11 cents a share.
From a balance sheet perspective, although inventories are higher at the second quarter than they were at the second quarter last year, and that's due to new stores and seasonal build (ph) of certain product lines, our working capital, adjusted for restructuring reserves, is relatively flat year over year, resulting in our borrowings being under our debt facilities remaining flat.
So we are projecting forward and forecasting for the end of the year for inventories to be slightly up over last year.
I think they are going to be something approximating $2 million up over last year.
But we are also forecasting -- as we mentioned at the end of the first quarter, I believe -- to be free cash flow neutral during 2003.
And that would include capital expenditures of approximately $5 million.
Now, I would like to turn the call back to Michael to discuss our store expansion program.
MICHAEL DIMINO
The store expansion program has gone very well.
Of the things we did this year, that's the thing that's a home run; that's the success.
And we will be concentrating our efforts in the future on expanding the new stores because we get a tremendous return on our invested capital there.
There has been a lot of articles lately regarding our industry and the fact that the lawn care side is growing, and that these stores service that lawn care business and they also service the golf business, to an extent.
And it's a very lucrative concept for us.
We will open 21 service centers this year.
Currently, we have opened 17, two more are to open in the very near future.
The stores are all performing better than we anticipated.
We have shared the model with you of the stores that were opened by LESCO from 1992 to 1998.
That model indicated that sales increased appreciably each year, to the point where the stores hit about 1.2 million at their maturity rate, and they broke even in two years.
We're seeing stores currently, of the 17 stores, that are trending well above the first-year sales, and specifically approximately a forecast of 511,000 on average per store versus a $378,000 first-year average.
Breakeven, which occurs in the second year in some of our new stores, will occur this year, so we are are very excited about that.
Losses will be less than our first year by 28,000, and then we believe that we have a very good shot at ensuring that the return on invested capital occurs -- gets to maturity a lot faster.
So it's an unmitigated success.
There is absolutely nothing to hold us back next year, in terms of adding new stores.
That's the direction the Company needs to go, while at the same time continuing to trim expenses on the SG&A side to make sure that the whole effort here is to get maximum return for our shareholders.
We feel very good about the things we have accomplished this year, and the things we have learned.
We also believe that we will continue to do a better job monitoring our pricing, now that we have discovered the flexibility issue that had to be removed.
We will continue to ensure that our costs are passed along to our customers when it's appropriate to do so.
And we will do a good job returning the Company to profitability and maintaining its profitability.
So, we'd like to take questions and answers now, and we have a lot of exciting news about the new stores, actually.
So with that, we will open it up for questions.
OPERATOR
(CALLER INSTRUCTIONS).
Robert Kosaowski (ph), Sidoti & Company.
THE CALLER
I'm just kind of curious with this new pricing flexibility you found, are you a little bit more bullish on your gross margin assumptions?
Maybe a month ago or so, you said about 32.5 percent would be a good thing to look for, for the entire year.
I am curious what you are looking at now that the pricing is a little bit more favorable than you had thought.
MICHAEL DIMINO
I think we want to do -- say it, Jeff (ph).
JEFFREY RUTHERFORD
We're not going to revise our guidance for the back half of this year.
But we will say that we would hope that we would do better in our gross margin.
We're not going to revise the 15 cent guidance, but we want to see how this plays out on the pricing model.
MICHAEL DIMINO
The month of July has gone very well, from that standpoint.
We have clear data that the margins at the cash register have done the right thing, after we've removed the flex.
Now, that's one month. (multiple speakers).
It's premature to say that that is going to be the trend for the rest of the year, but we are bullish about that.
Other than the fact that we're not going to revise guidance, but other than what we have already given.
THE CALLER
I am curious if you can give us a little bit more detail on the new distribution process you guys are doing, and why it kind of hit up (ph) a lot in this quarter.
JEFFREY RUTHERFORD
I think the question is, what have we done to the distribution system?
THE CALLER
Yes.
JEFFREY RUTHERFORD
Basically, what we did is we tried to alleviate our store personnel from having to do a lot of heavy lifting -- literally heavy lifting - of getting product to customers.
And in the first half of the year, we spent an awful lot of time and money actually doing that for them out of the hubs.
That expense was created.
We actually moved more pallets than we have ever moved before in the first half, directly through customers.
That service did not garner us the extra selling time and provide the extra sales dollars that we thought we would get, nor was it easy to capture the expenses on that from the customer.
So what we have done, basically, is we have returned the system to similar to the way it's been for the last 40 years, where a lot of the local deliveries take place out of the stores, and we have done some work to ensure that the direct shipments to customers have new rules, so that we're doing full truckloads and the type of thing.
COMPANY REPRESENTATIVE
Let me just add to that -- (multiple speakers) -- after swallowing a lot of the outside warehousing into our new hubs and so forth, the first thing was getting it into the right stocking assortments.
Initially, we had some issues with making sure we had the right stocking assortments.
We are feeling very confident now that we are in that mode that we have got the right product in the right place to improve the service regionally.
On top of that, we continue to do good deliveries out of our hubs to our customers and replenishments to our service centers.
We have gotten a lot better in our routing optimization with the new network and, like Michael and Jeff mentioned, June and July is trending very nicely.
But we had some hurdles to get over in the beginning of the year.
MICHAEL DIMINO
The transition from the old system cost us a little bit more than we anticipated it costing.
We have got those things back under control, and we are feeling good about the numbers that we're seeing on those expenses -- the distribution and warehouse expenses for June and July.
Again, we want to make sure that trend continues before we change any planning or outward numbers to you all.
COMPANY REPRESENTATIVE
The last thing we want to do is sacrifice any service to our customers.
OPERATOR
Rick Nelson (ph), Morgan Joseph.
THE CALLER
Could you elaborate further on the impact of natural gas prices on not only the cost of fertilizer, but how you have had to deal with those higher costs and how it has affected basically your cost of goods and what you have been able to pass on?
Could you give a little bit more detail?
MICHAEL DIMINO
Sure.
First of all, natural gas pricing for us has gone up, because we had product lock-down for the first half of this year, and we know that pricing has gone up.
There was a lot of people thinking that pricing was going to come down, and that was something that we have not seen, and it doesn't look like it will come down for the near future, just based on the winter that's coming up and the short supplies.
We have known about that situation and we have raised our prices.
We have raised our prices three times this year, in order to accomplish the passing along of the cost increase to our customers.
Two of those price increases did not stick, again, because of the flexibility of our system.
That flexibility has been removed, and the third price increase seems to be sticking.
So I think we have learned a little bit more about some of the structure of the Company, but the urea situation, as it goes up -- those costs need to be passed along to the customer.
It is a commodity; everybody knows it's happening when it happens, and it's difficult to change the direction that that curve has gone in over the last ten years.
Jeff, do you want to anything to that?
JEFFREY RUTHERFORD
No, and I think, just to put it in perspective, I believe we said in the release it was $30 to $50 a ton increase over prior years.
And if you want to convert that to a typical bag of fertilizer, what you do is it would be about 2.5 cents per pound, and the average 50-pound bag has something close to 25 pounds of urea.
So we're looking at around a 50 to 60 cent increase in cost per bag at that high end of $50 a ton.
And what happens is -- and we have talked to everyone about this, the investors -- that we do not have storage capabilities to haul urea.
And what we were doing, as we were going out with a six-month commitment and locked pricing from manufacturers.
So we knew in the first half of the year what our increases were going to be.
Mike has referenced that our intention was to pass price increases through in the first half, and we had problems holding those prices.
In fact, although we have had in increase in fertilizer cost, we have not had an increase in pricing, in just straight fertilizer.
Our intention -- and what happens, based on our internal people and what we're looking at from research and other components was that net gas (ph) futures were going to come down in the summer months, and we realized in the late second quarter that was not going to happen.
And we then had to go out and enter into an agreement for the second half of the year at higher than what we expected coming into the year, and that has resulted in yet another price increase.
And that, coupled with our issues relative to our pricing model and the flexibility of that pricing model resulted in our deteriorating margins.
So, our costs will continue to go up in the second half, as we buy into this urea commitment, but our expectation is that we're going to be able to pass a certain amount of those costs through to our customers.
THE CALLER
Does this mean also that you will be focusing more on preserving or improving your margins, as opposed to just building revenue?
MICHAEL DIMINO
I think that, really, that's a good point, because a lot of our need to revise guidance is because of that margin miss that has been created this year.
So we are going to spend a lot of time on watching that margin situation.
It sounds silly; it sounds like something you should do every day.
We do do it every day; we look at it every day.
The issue was, again, if you think about since January, we have had three price increases, we kept studying what was wrong and why we weren't getting any requisite rise in average sell prices.
So the thing that seems to work very good is when we invest in the new stores.
That's where we get solid performance in all areas.
So yes, we will worry about the margin, and we're going to worry about those new stores.
And again, we're going to focus on trimming back any and all expenses that don't contribute to those two initiatives.
JEFFREY RUTHERFORD
The other fact is that, in the marketplace, if you are a leader of a market, you have some obligations as a leader of the market.
And one of ours would be to price our product correctly.
And if costs are going up, then we have to take the stand that we're going to pass those costs through and maintain some level (ph) margins.
MICHAEL DIMINO
We have all done a careful study of the urea situation, and we believe we have been buying it as well as you can buy it -- in fact, better than most -- over the last several years.
The problem is it does go up and down, and we're always trying to stay beneath it, no matter where it's at.
And we have done that; we have charts and graphs and data to prove that.
The issue really comes down to, since that's going to be what it is, because it's very hard to control the actual urea, it's about us being able to maintain our growth in margin by making sure that our pricing system works correctly.
And unfortunately for us, as the new management team, we discovered in a timeframe when urea was going up just exactly what was going on.
We weren't waiting around; we raised prices in advance, but those prices didn't stick.
Now we have discovered what that problem is, and we believe we have got a good handle on it.
We know what to do and we know how to do it, and our guys, our salesmen, are reacting very, very well.
They are adjusting.
There are certain customers that we need to adjust, but all in all, we are seeing the margins rise, although it's only a month, at the cash register, and we feel good about that.
We just need to make sure we can pass those cost increases along as they occur, and we think we can.
OPERATOR
Mack Spencer (ph), Winfield Capital.
THE CALLER
That was a long answer.
JEFFREY RUTHERFORD
Yes, it was.
THE CALLER
So mine is shorter.
How many reps does the 2.9 million in annual savings from the 61 incremental sales reps represent?
MICHAEL DIMINO
How many were reduced?
THE CALLER
Yes.
MICHAEL DIMINO
42.
JEFFREY RUTHERFORD
42 were taken out.
THE CALLER
42 of 61, so that's two-thirds (indiscernible) of that program?
JEFFREY RUTHERFORD
Right.
THE CALLER
Now I'm going to ask you for a little longer answer.
That's a major change in direction from a program that we heard about that was front-end-cost-loaded a year ago.
Can you expand a little bit on that?
I might have missed a sentence or two on the call.
JEFFREY RUTHERFORD
It's just the process that the return on those guys -- there is a return on those guys, but it's taken a long time to get it.
The stores are returning faster than we thought, and the model just can't deal with too many things being invested in it at once.
So, given the choice, the issue has to come down in the new stores.
The new stores are more profitable.
What we did is we took the people that were good and we put them back in the stores, and we have cut any muscle or any significant people.
It's the newer folks that backfilled in the stores were the ones that were let go in the situation.
THE CALLER
Is that a source of managers for the new service centers you are opening?
JEFFREY RUTHERFORD
Yes, absolutely.
OPERATOR
(CALLER INSTRUCTIONS).
If there no further questions, I will now turn the conference back to Mr. Rutherford.
JEFFREY RUTHERFORD
We would like to thank everyone for participating in the call.
Mike and I will be, certainly, available to anyone for the remainder of the day and the week and the time ahead, if anyone should want to contact us directly.
We look forward to talking to everyone when we report in the third quarter.
OPERATOR
Ladies and gentlemen, if you wish to access the replay for this call, you may do so by going to Lesko's Website at www.LESCO.com.
This concludes our conference for today.
Thank you all for participating, and have a nice day.
All parties may now disconnect.
(CONFERENCE CALL CONCLUDED)