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Operator
Good afternoon, and welcome to Lesco's Third Quarter Conference Call and Webcast.
(OPERATOR INSTRUCTIONS)
Portions of the presentation and other statements relating to sales and earnings, expectations, new service center openings and profitability, the company's ability to impose prices, increases and other statements that are not historical information are forward-looking statements.
Investors are cautioned that forward-looking statements involve risks and uncertainties, and that actual results may differ materially from such statements.
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 are set forth in the Company's Securities and Exchange Commission report including, but not limited to, Form 10-K from the year ended December 31, 2003.
In addition, some of the information that will be discussed today may include non-GAAP financial measures.
Our presentation of the most directly comparable GAAP measure and a reconciliation of the differences between the non-GAAP financial measure and the comparable GAAP measure are described herein and are posted on the Lesco Web site at www.lesco.com.
A copy of the release and Power Point presentation related to today's call can also be obtained through the Company's Web site.
I will now turn the conference over to Michael DiMino, President and CEO.
Please go ahead, sir.
Michael DiMino - President, CEO, Director
Thank you, Michelle, and thanks all of you for joining us today.
With me today are Jeff Rutherford, Senior Vice President and Chief Financial Officer, as well as other key members of our management team.
Today we'd like to accomplish the following: number one, I'll provide an update on our business; two, Jeff will give a financial overview of our third quarter and reiterate our guidance for the full year; and then finally I will provide an update on our strategies and business outlook.
While it is generally not our practice to comment on monthly results or trends, but rather focus on quarterly results and long-term outlook, due to the unusual weather we endured during the third quarter, we thought it would be appropriate to do so.
The third quarter started out fairly strong, but due to the hurricanes, we slowed down as we reached the end of September.
The sequence of hurricanes and our sales recovery were as follows.
The first hurricane, Charlie, hit Florida on August 13.
By the end of August we had recovered from that storm and we were back on our planned sales.
Then September 4, Frances hit, and by September 15, we had again recovered and were back on plan.
And then finally, September - well, in the last sequence was September 16 and September 26 Ivan and Jeanne hit.
The bad news was that by the end of the quarter we had not recovered.
However, the good news is that by October 15 we were back on our planned sales, albeit with the associated calendar shift.
So, we caught up and we're happy about the recovery aspect of our business performance so far for the quarter into the fourth quarter.
As a result, third quarter net sales increased 3% while comparable service centers were down 1%.
We had strong fertilizer and equipment sales, but seed sales were flat.
The good news is that seed sales, so far in October, have been strong.
But I caution extrapolating, as this represents only a few weeks of our fourth quarter.
However, I believe the trend will be sustainable and should make up for September.
Therefore, this calendar shift should not affect full-year results.
Although for the quarter our top-line performance was less than desired, with weather playing a major role, we did our best to keep on top of our pricing and controllable expenses and, in fact, achieved a 43-basis-point increase in our gross profit margins.
This improvement was composed of a 31-basis-point improvement in product margin and a 12-basis-point improvement in distribution costs and leverage.
During the quarter we entered into a new urea contract, which will lock in our urea costs for substantially all of 2005.
The cost is approximately 14% higher than our 2004 urea costs.
This locking of cost allows us to set appropriate product pricing for '05, communicate that pricing to our customers and reasonably predict our 2005 product margins.
Jeff will go into detail about third-quarter expenses, including the charges related to our headquarters move, as well as from the damage we sustained as a result of the hurricanes.
As of September 30, our balance sheet showed dramatic improvement from a year ago.
We have no revolving debt outstanding and less than $6 million in long-term debt, which in turn lowered our interest expense.
Our new service centers are performing well and proving to be the best use of capital, allowing us to leverage our cost base and grow earnings over the long term.
We opened 26 new Lesco service centers through the end of the third quarter, including one in the third quarter.
In the fourth quarter we just opened our newest store in Roseville, California, which is our second to open in that state this year.
The 21 service centers opened in 2003 contributed 5.6 million to our net sales, as well as a four-wall pre-tax operating income of 480,000.
The class of '04 service centers generated 5.1 in net sales and four-wall operating profit of 200,000.
These positive results, and particularly the early success of our new stores, which have exceeded our expectations, gives us confidence that opening new service centers will provide the best return on invested capital over the long term.
With that, I'll turn over the call to Jeff and he'll cover this quarter in depth.
Jeffrey Rutherford - CFO, SVP, Secretary, Treasurer
Thank you, Michael.
As Michael said, I will review the results for the third quarter of 2004, as well as update our guidance for the full year.
Due to the seasonality of Lesco's business, the third quarter is generally the second most important quarter of the year, typically generating approximately 28% of full-year sales.
For the third quarter, net sales increased 3% to 152.7 million from 147.7 million in the third quarter of 2003.
Lawn care growth sales improved 7% to 112.6 million versus 105.2 million in the year-ago period, while golf growth sales were 40.8 million compared to 42.9 million last year, a decline of 5%.
Total service center sales increased 6.2% to 107.4 million from 101.1 million for the 2003 and 2004 service centers contributing a total of 10.7 million in revenue, up from the 3.7 million from the 2003 service centers in the year-ago period.
For the quarter, comparable sales were down 1%.
However, comps were positive for the quarter through August, but were negative 2.5% in September.
Between the hurricanes and after effects of rain in the Southeast and Midwest, seed sales, which are normally strong in September in preparation for the fall season, came to a near halt and did not return to expected levels until October, after the end of the third quarter.
But we already know that this shift should not affect full-year sales expectations.
Gross profit on sales increased to 26.6% of net sales or $40.7 million compared to $38.7 million or 26.2% of net sales in the year-ago quarter, a 40-basis-point improvement year-over-year.
Product margin was $52.8 million compared to 50.6 million in the third quarter of 2003, resulting in a gross product margin of 34.6% versus 34.3% in the third quarter of 2003.
The improvement was due to our ability to pass through cost increases through increased pricing, thus maintaining product margin.
Distribution costs for the quarter were 12.1 million or 7.9% of sales compared to 11.9 million or 8.1% in 2003.
Selling expense was $23.5 million in the third quarter of 2004 versus $20.5 million last year, rising to 15.4% from 13.9% of net sales.
New service centers, which we described as service centers opened in 2003 and 2004 selling expense was 2.3 million in 2004 versus 0.8 million in 2003.
In the third quarter of 2004, there were 273 service centers operating versus 245 in the year-ago period.
Excluding new service centers, selling expense was 21.2 million versus 19.6 million, an increase as a percentage of net sales of approximately 130 basis points to 14.9% from 13.6%.
So, the majority of this increase was expected and budgeted for for service center payroll and benefits.
General and administrative expense for the quarter was 7.1 million compared to 7.3 million last year, a 30-basis-point reduction to 4.6% of net sales.
This is attributable to cost savings recognized from tightened expense controls along with the strategic outsourcing of customer financing through GE Business Credit Services.
These reductions offset the increase in expenses related to the Sarbanes-Oxley related costs, management bonus and rising employee insurance benefits.
We had a credit on our preopening expense line of $62,000 compared to an expense of $130,000 for the same period a year ago as we had overexpensed in the prior quarter for new openings and benefited from a reversal in the third quarter.
During the quarter we opened one store for our year-to-date total of 26, and we have opened one additional new service center in the fourth quarter.
Last year we opened 21 through the end of the third quarter and finished the year with 21 new service centers.
As we announced in the second quarter, as well as in our October 14 update, we are in the process of relocating our corporate headquarters to an approximately 40,000 square foot facility in downtown Cleveland from our current 94,000 square foot facility in Strongsville, Ohio, thereby shedding unused space and its related costs while reducing our lease to a 5.5-year lease from the 11-year lease remaining on our Strongsville location.
Our move should be completed by mid-November.
The total relocation costs are estimated at $7.5 million.
In the third quarter we recorded 4.9 million in costs related to the move and should incur the remaining approximately 2.6 million balance in the fourth quarter.
We will begin to realize the long-term cost savings of this move in 2005, which should be accretive to earnings on an annual pre-tax basis by approximately $1 million.
Also, as previously disclosed, we lost approximately $1 million of bulk urea and sulphur-coated urea inventory, which was being stored at a third-party terminal located adjacent to the Ohio River.
The product, which was stored in domes, was lost when the domes were not sealed by a third party ahead of the flooding of the river.
In addition, our Florida blending facility sustained roof and siding damage from high hurricane winds.
The Florida damages amounted to approximately $360,000.
We recorded these two unfortunate incidents as hurricane and flood expense on our income statement.
We are going to do whatever is possible to recover these losses.
Merchant discounts provision for doubtful accounts expense was 2.7 million compared to 684,000 in the third quarter of 2003.
At the end of last year we sold our trade accounts receivable portfolio to General Electric Business Credit Services for $57 million and entered a private label business credit program with GE.
The higher merchant discounts are comparably offset by lowered interest and G&A expenses.
Although, due to timing, it's not always readily seen in the quarterly data.
It is more pronounced in the year-to-date financials where the merchant discounts were up 4.5 million, but interest expense was down 3 million and credit and debt-related G&A is down 1.4 million, primarily due to the outsourcing and refinancing.
Year-to-date total G&A is down approximately $1 million.
Other expenses were $50,000 compared to $33,000 in the third quarter of 2003 while other income was 94,000 versus 192,000 last year.
As previously discussed, interest expense was down significantly from a year ago, $149,000 versus 1.1 million, as we lowered our total debt to 5.9 million from 68.1 million while our cash flow from operations improved dramatically to 17.5 million from a use of cash of 0.8 million last year.
On a GAAP basis, earnings before income taxes was 1.1 million in the third quarter of 2004 versus 9.2 million in the third quarter of 2003, and net income was 1.1 million or 12 cents per diluted share compared to net income of 5.7 million or 66 cents per diluted share last year.
In terms of the income tax situation we are currently experiencing, our GAAP results do not reflect a tax provision related to the Company's third quarter 2004 operating gain because of the required accounting treatment for our deferred tax assets.
Assuming a 39% tax rate, which we used to compare year-over-year performance, and excluding the charges from the corporate move and hurricanes, we would have reported net income for the quarter of 4.5 million or 50 cents per diluted share compared to net income of 5.7 million or 66 per diluted share in 2003.
Now I will provide some highlights of our balance sheet.
The year-over-year variances demonstrated how our financial flexibility will strengthen as a result of last year's GE transaction and related refinancing.
Our accounts receivable balance dropped to 14.3 million compared to 81.6 million a year ago.
We reduced our long-term debt to 5.9 million from 10.3 million in September of 2003, and we have no outstanding balance on our credit facility versus 57.9 million last year.
Although we are pleased with the improvement we have made to our balance sheet overall, we recognize that our inventory levels are less than optimal and we need to do a better job in insuring that we have sufficient, but not an oversupply, of seasonal and non-seasonal products.
On a year-over-year basis, inventory has increased 5.6 million.
A majority of this increase or approximately 4 million is attributable to new service centers.
Their main increase and where we believe an inventory reduction needs to be realized is in the distribution hubs and plants.
We continue to address this opportunity while assuring we have sufficient product quantities to support sales, particularly seasonal sales.
To that end, we are now forecasting a year-end inventory to be at approximately $105 million, as we will begin our seasonal preemergent inventory build in the fourth quarter.
We believe that this build is absolutely necessary to support our spring preemergent sales.
In summary, our balance sheet remains quite healthy and our cash flow generation should enable us to self-fund our new service centers, which we consider the best means to achieve a consistent earnings growth over time.
In terms of guidance for the full year, we are reconfirming our previous guidance of earnings per share in the range of 40 to 50 cents, which includes full-year 2004 revenue growth of 3% to 6% and including a 1% to 2% increase in same-store sales.
This range excludes the estimated 1.4 million in damages related to the hurricanes, as well as the $7.5 million impact from the relocation of our corporate headquarters.
I will now turn this call back to Michael for a few words on our strategic outlook.
Michael DiMino - President, CEO, Director
Thanks, Jeff.
Nice work.
Before we turn the call over to Q&A, I wanted to leave you with some thoughts about our industry.
Let me comment first for a minute about the golf business.
Golf sales were a little disappointing in the quarter and will likely be on the low end of our full-year guidance.
Industry fundamentals have not really changed in the last several quarters, so we would be remiss to say that a turnaround is right around the corner.
However, we still make money in golf, albeit not as high of a return at the service centers, and continue to evaluate and test opportunities to improve golf's ROIC.
As far as the professional lawn and landscape industry, it is expected to grow at greater than 7% per year with the consumables portion of the industry growing at approximately 4%.
That's the piece that we primarily play in the consumables piece.
Our market share is currently 15% of that 2.8 billion professional, consumable industry.
We believe that we have penetrated less than 50% of the market in terms of possible service centers.
In other words, we think there are opportunities for over 500 service centers with 274 in our current portfolio.
We plan to open new service centers at an annual rate of 10% to 15% of our store base, and for 2005 we have already approved 15 locations and have approximately 100 more sites under review.
We want to open new service centers as early in the year as possible so that we can take advantage of the second and third quarter selling seasons, which are our most important periods of the year.
As I mentioned at the beginning of this call, we think the results we have seen so far with the service centers demonstrate that we are using our capital wisely and making progress towards our long-term goal of ROIC above 10%.
But our commitment to earnings growth is not limited to opening new service centers.
We intend to leverage our expenses at the corporate level and believe that, between G&A and our impending headquarters move, we are taking meaningful strides to keep overhead to a minimum while allocating as many resources as possible to our field operations.
We recently combined our operations and marketing merchandising groups under our Senior Vice President of Operations, Bruce Thorn.
For those of you that have not met Bruce, prior to joining Lesco he was at the Gap Stores and Sintas (ph), and for the past two years has been the head of our supply chain.
We believe that this structure will better align and support our expected store growth.
Although we are not a traditional retailer, we do have many characteristics of a retailer.
Furthermore, we will continue to be a dominate force and a large player in the category with tremendous market penetration opportunities.
We believe that the Lesco brand is at the vanguard of the professional green industry and our growth will result in the creation of long-term value to our shareholders.
With that, we'd like to open it up for questions.
Operator
(OPERATOR INSTRUCTIONS) Your first question, sir, comes from Robert Kosowsky of Sidoti.
Please proceed, sir.
Robert Kosowsky - Analyst
All right.
Good afternoon, guys.
It's Sidoti.
Michael DiMino - President, CEO, Director
How are you doing, Robert?
Robert Kosowsky - Analyst
I'm doing all right.
I was wondering what the cash costs of the facility or the headquarters of your relocation is going to be.
Jeffrey Rutherford - CFO, SVP, Secretary, Treasurer
Well, a predominate portion of that move is going to be cash costs.
It's comprised of some incentives for the party who is moving into our old facility along with our landlord in order for us to assign the lease.
There is a non-cash portion for the write-off of our furniture that won't be moving with us and lease hold improvements, but that's relatively minor, less than $400,000.
So, a majority of the move will be cash.
Robert Kosowsky - Analyst
OK.
And could you mention, I guess how was the competitive pricing in the quarter?
Did you guys raise prices during the quarter?
Michael DiMino - President, CEO, Director
We did raise prices, Robert, on especially nitrogen-related products.
Nitrogen is one of the sources of the fertilizer.
We have seen the competitors raising prices as well.
We tend to be the price leader, however.
So we're usually first and bigger and they tend to catch up.
We also have a lot of great surcharges that are out there.
I mean, the freight situation in the United States has been difficult; so, as Jeff said, we passed those along rather successfully so far.
Robert Kosowsky - Analyst
OK.
And do you guys think you will have as much success in 2005, given the fact that you guys have already locked in the urea sourcing compound?
Michael DiMino - President, CEO, Director
Yeah.
We've got our sales people in our stores pretty much working our customers with this.
We have letters and announcements going to our customers.
What they really like is to be told now what the '05 costs are going to be.
So, we're going to do that so that they can then charge their customers the appropriate application price.
So, each homeowner knows what it's going to cost.
They'd rather do that in the beginning of the year than incrementally during the year.
So, I think we will be successful in '05.
Robert Kosowsky - Analyst
All right.
Thank you.
Michael DiMino - President, CEO, Director
OK.
Robert, I was passed a note from Michael Weisbarth, our Controller, telling me that I was remiss to point out that the $1 million plus savings a year on the headquarters relocation is a cash savings.
Through infinity, actually, he told me.
Robert Kosowsky - Analyst
OK.
I'll put that in my model.
(OPERATOR INSTRUCTIONS)
Operator
Your next question, sir, comes from David Wolf (ph) of Peridian (ph).
Please proceed, sir.
David Wolf - Analyst
Hi.
I was just wondering about the increase in urea prices.
So, that - should we assume that that's an industry thing and everyone else will have to also increase prices to reflect that?
Michael DiMino - President, CEO, Director
Yes.
It is an industry thing.
I mean, the natural gas situation is a result of why nitrogen is so expensive, but we've done a very good job, we believe, of locking in a price for next year, for all of, for most of '05.
And it's going to be difficult for our competition to do as well, but that's theory right now.
So, they all have to deal with this increased urea pricing.
David Wolf - Analyst
What does the 14% increase in urea do to the pricing of the product?
Jeffrey Rutherford - CFO, SVP, Secretary, Treasurer
Well, what it takes is -- urea is generally somewhere between 8% and 10% of our total cost of sales.
So, assume it's at the high end.
You're looking at 140-basis-point increase in price to cover that cost.
The other thing about the contract, it assures us a source of urea for the next 12 months.
And at times in this industry, there can be problems sourcing the urea, particularly at our sites, urea for turf uses.
So, it not only locks in our price, it allows us to set pricing for our customers and it assures us a source of urea for the next 12 months.
David Wolf - Analyst
OK, good.
Thank you.
Operator
Your next question, sir, is a follow-up question from Robert Kosowsky of Sidoti.
Please proceed, sir.
Robert Kosowsky - Analyst
Yeah, I was wondering if you can give us a little update on the strength of the different regions in terms of sales.
Michael DiMino - President, CEO, Director
Well, as you can imagine, the Southeast region, because of the four hurricanes, their quarter wasn't as strong.
Steve, you want to mention that?
Steven Cochran - SVP of Sales
You want the results for the quarter, Robert?
Robert Kosowsky - Analyst
I guess for the quarter or nine months, whichever you guys have handy.
Steven Cochran - SVP of Sales
For the quarter we were very strong up in the Northeast.
This is Steve Cochran, by the way.
And we were very strong in the Midwest.
And then year-to-date we continue to be very favorable in the Northeast.
We're actually positive throughout the whole country, and our national account segment is positive as well.
So, all zones are operating in a favorable sales growth position overall.
Robert Kosowsky - Analyst
OK.
So, it seems like you guys would have hit the same-store sales comp that you had targeted.
Michael DiMino - President, CEO, Director
Well, we would have been close to what we've been running for the first half of the year, Robert.
Robert Kosowsky - Analyst
OK.
Thank you.
(OPERATOR INSTRUCTIONS)
Operator
Sir, I am currently showing no questions in the queue at this time.
Michael DiMino - President, CEO, Director
OK.
The only thing I want to just mention to you guys, if there's no other questions, is that we put out a really nice Power Point presentation.
It's on the Internet.
I think that there's some new updated information about our market size, just more clarity, specifically if you look on pages 24, 25, 26.
There's some real good data that you might be interested in, on page 27, about the consumable market size, which is the arena that we play in, and then all the other arenas that we play in.
And it also talks a little bit about some of our competition or related companies that are in our space and how they break down in the industry as well.
So, it's very interesting, it shows a lot of positive future for us in the lawn care industry, and that is exactly what our service centers are geared for; it's to support the lawn care industry.
So, we're going to continue to improve the golf operation and try to make it more profitable by doing some things that we think we can do to get more sales and improve expenses.
But the service center side and the lawn care side is just a very, very strong industry right now that we're participating in.
So, the Lesco model, overall, is moving in a very good direction.
The new stores are exceeding our expectations, doing a very good job for our shareholders, and our industry is doing very well.
So, we're going to continue in that vein and we're going to make sure that we execute well with the strategic direction.
We're very excited about what's happening right now.
Well, with that --
Jeffrey Rutherford - CFO, SVP, Secretary, Treasurer
Are you going to wish the rest --
Michael DiMino - President, CEO, Director
Yes.
I just want -- in case those of you in New York who don't want to hear this, I grew up in Boston and we are delighted about what's going on right now.
Jeffrey Rutherford - CFO, SVP, Secretary, Treasurer
With that, we'll end the call.
Thank you for participating.
Operator
Thank you, sir.
Ladies and gentlemen, thank you for your participation in today's conference call.
This does end the presentation.
You may now disconnect.
Good day.