強鹿 (DE) 2005 Q3 法說會逐字稿

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  • Operator

  • Good afternoon and welcome to LESCO's third-quarter 2005 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 up the conference for questions and answers following the presentation.

  • 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 price 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 reports, including, but not limited to, Form 10-K for the year ended December 31st, 2004.

  • In addition, some of the information that will be discussed today may include non-GAAP financial measures. A 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 posted on the LESCO website at www.lesco.com.

  • A copy of the release and PowerPoint presentation related to today's call can also be obtained through the Company's website. I will now turn the conference over to Mr. Jeffrey Rutherford, President and CEO. Please go ahead, sir.

  • Jeffrey Rutherford - President, CEO

  • Thank you and thanks to all of you for joining us today. With me today are Michael Weisbarth, our new Chief Financial Officer, Bruce Thorn, our Chief Operating Officer, as well as other key members of our senior management team.

  • Today, we would like to accomplish the following. I will discuss the progress on our strategic initiatives and our refined operating model, including the recent sale of our supply chain assets, as well as changes in our senior management team. Mike Weisbarth will give a financial review of our third quarter, as well as our updated guidance for 2005. Then I will offer some concluding comments before we proceed to Q&A.

  • On October 21, I became Chief Executive Officer, replacing Michael DiMino, whom, on behalf of the Board of Directors, I would like to thank for his nearly four years of contribution and leadership through the Company's transformation period.

  • Also on October 21, Bruce Thorn was promoted to Chief Operating Officer, Mike Weisbarth to Chief Financial Officer, Controller and Treasurer, and Kathleen Minahan to the General Counsel and Secretary position. All had previously held management positions within LESCO.

  • These changes to the senior management team come as a result of LESCO's transition to a store-focused model now that the sale of our supply chain assets is complete. I will elaborate on our new store strategy shortly, but first I want to discuss the changes to our management team.

  • LESCO now has a senior management team in place that has significant retail experience, including such retailers as OfficeMax, Gap and Target. We are confident this new team has the proper skill set to drive the Company's strategy forward.

  • In addition to the promotions we just discussed, in August we announced that we had hired Chuck Denny to be Senior Vice President, Store Operations and Sales. Chuck has 25 years of store operation and sales management experience, and we actually worked together at OfficeMax several years ago. Chuck will focus on the expansion of LESCO's Service Centers and Stores-on-Wheels, as well as implement fundamental store operating practices to better serve our customers.

  • In addition, we hired Michael Poole as our Vice President of Real Estate and Store Planning. Since the beginning of 2003, LESCO has opened more than 60 new LESCO Service Centers and intends to increase its total number of Service Centers annually by 10 to 15%.

  • LESCO's analysis of the turf care and pest management industries indicate there is potential for the Company to open at least 250 additional Service Centers over the next five years. Michael Poole has been responsible for opening new stores for many well-known retailers, including Talbots, and we expect that his experience and knowledge will lead to real estate and new store opening best practice being implemented throughout the LESCO organization.

  • Rounding out the leadership team is Kevin Wade, heading up our IT group, and Maureen Thompson, our leader in Human Resources, both of which have extensive retail experience.

  • This team has identified and is starting to implement several basic retailing strategies that should help us drive sales over time. As we have discussed before, utilizing standard stocking assortments and Plan-o-grams throughout all stores will provide a consistency and standardization in our offerings. While this is an elementary retail concept, we are only beginning to practice it at LESCO.

  • Excluding certain variations due to geography and based upon input from the field organizations, we are filling our Service Centers in a uniform fashion. As basic as it sounds, we think this approach goes a long way to building customer loyalty, as customers know they will find what they are looking for in our stores.

  • We are also enhancing the LESCO shopping experience through the use of visual merchandising, including clear signage and the aforementioned Plan-o-grams. These changes will help maximize our investment in our Service Centers and our Stores-on-Wheels by generating incremental revenue and gross profit opportunities.

  • We are also in the final stages of updating our pricing model. The new model provides consistency and simplicity of pricing across all segments of our Company. This new model was piloted in Cleveland in early 2005, and we received very positive feedback from our sales associates' success at the program. Subsequently, we started expanding the program across the entire country and expect it to be installed for fiscal 2006. The premise of this new model is to provide flexibility while ensuring the proper level of profitability and to reward customers for increased purchases.

  • On October 11, 2005, we announced the completion of the sale of substantially all of our supply chain assets, along with its consumable inventory product stored at those locations, including fertilizer, seed, control products, combination products, pest control and the related products to an affiliate of Platinum Equity Turf Care Supply Corp. We also entered into a long-term outsourcing supply agreement with them.

  • The supply chain assets which were sold include all four of LESCO's blending facilities and the majority of the Company's warehouse and distribution centers. The specific transaction terms are confidential, with the exception of certain information that may be reported in the Company's regulatory filings.

  • The Company received $15 million in cash and $19 million in accounts receivable from Turf Care Supply Corp. Ultimately, we expect to harvest approximately 25 million in cash after settling all requirements associated with the transaction, including the outstanding accounts payable due to vendors for inventory.

  • We recorded a pretax charge related to the transaction of 19.8 million in the third quarter, which includes the loss on the sale of fixed assets, the markdown of inventory not purchased by the buyer and certain expenses associated with the transaction.

  • This divestiture allows us to devote more of our resources towards expanding our stores, the most profitable area of our business, where we believe we hold a distinct competitive advantage. The industry as a whole clearly holds excess blending capacity and turf fertilizer, and we maintain that by exiting the manufacturing sector, we can better manage our inventory levels without the risk that we might have to sell product at reduced margins when the market is at imbalanced supply levels.

  • We are confident that the sale to the Platinum affiliate and our concentration on stores will provide improved operating margins going forward. In addition, as we discussed on the last call, we have now disbanded the vast majority of our golf sales rep model, similar to the dismantling of our lawn care sales rep model two years ago.

  • While the incremental Stores-on-Wheels were rolled out too fast this year -- we added 38 new stores to the 73, or more than a 50% increase -- we have suffered some margin contraction versus the year-ago quarter. However, we are starting to experience the positive results we had anticipated that the additional stores would bring.

  • Service Centers continue to experience nice top-line growth. Total sales were up 10% and same-store same Service Center sales grew 5.9%, and are up 4.6% for the first nine months of the year. We opened 9 Service Centers this quarter in addition to the 11 earlier in the year. Geographically, they are spread out, as we added to our store base in the South, Southeast and Northeast. As stated last quarter, it is our intention to open 8 to 10 stores per quarter for the foreseeable future.

  • Both the Class of 2003 and 2004 are generating strong top-line growth, with the Class of 2003 delivering a 24% revenue gain for the third quarter and the Class of 2004 generating a 44% increase in sales versus a year ago.

  • The Company has also announced that the Board of Directors has approved a repurchase of up to 1.5 million common shares in the open market or through privately and negotiated transactions. The timing manner and amount of repurchases will be based on the Company's evaluation of market conditions, applicable legal requirements and other factors.

  • With that, I will turn the call over to Mike Weisbarth.

  • Michael Weisbarth - CFO, Controller, Treasurer

  • Thank you, and good afternoon everyone. As Jeff said, I will review the results of the third quarter of 2005 and walkthrough our updated guidance for the full year.

  • Concurrent with the sale of the Company's supply chain assets, we've revised our segment reporting. The Company will now report on two opening segments, the Stores and Direct Sales and a Corporate Expense segment. Now for our segment operating results.

  • Store Segment net sales, which include both Service Centers and Stores-on-Wheels, for the 3 months ended September 30, 2005, increased 10.4% to 142.6 million from 129.1 million on a comparable period a year ago. Service Center gross sales increased 10% and Stores-on-Wheels gross sales increased 18.3%. Comparable Service Center sales jumped 5.9% in the quarter.

  • Gross profit as a percentage of sales decreased 120 basis points to 27.8% from 29% due to a shift in our sales mix, the timing of our vendor rebates, some customer incentive programs and merchandise markdowns related to discontinued products. Store Segment selling expense increased $2.8 million on a quarter-over-quarter basis. This increase is directly attributable to the operating cost of the 21 new Service Centers and 38 new Stores-on-Wheels opened during the past 12 months and the associated cost of expanded field management necessary to support the additional units.

  • Earnings before interest and taxes for the third quarter in 2005 declined to 16.1 million versus 16.9 million last year. In our Direct Sales segment, our net sales declined to 16.2 million for the 3 months ended September 30, '05, from 23.6 million in the comparable period a year ago. The decline is directly attributable to the Company's decision back in March to discontinue our golf sales representative program. Earnings before interest and taxes for the quarter were $100,000 in the current year versus a loss of $700,000 in the prior year.

  • For our Corporate Segment, general and administrative expenses were $6.1 million, or 3.8% of net sales, compared to 7.2 million, or 4.7% of net sales, in the third quarter last your. This is a 90 basis point improvement year-over-year. This improvement is due to the reduced corporate office expense, along with lower management incentive costs, insurance claims and payroll tax expense. We had estimated that the relocation of our corporate headquarters would save us $1 million annually, and so far, we are on track.

  • Corporate merchant discounts, which are predominantly the promotional extension of terms on our private-label credit programs, which are really designed to enhance customer loyalty, was $0.6 million compared to 0.2 million last year. Our interest expense was up slightly to $300,000 from $100,000 last year.

  • On a consolidated basis for the third quarter of '05, the Company reported on a GAAP base a net loss of $16.2 million, or $1.82 per diluted share, compared to net income of 1.1 million, or $0.12 per diluted share last year. Third-quarter operating results were reduced by $19.8 million, or $2.23 per diluted share, as a result of the cost of the supply chain transaction and an additional $3 million, or $0.34 per diluted share, for the charge to restructure the parts sourcing model and product offering.

  • For the third quarter 2004, operating results were reduced by 4.9 million, or $0.55 per diluted share, for costs related to Company's headquarters relocation and by $1.4 million, or $0.15 per diluted share, for costs related to hurricane and flood damage incurred last year.

  • Assuming a 39% tax rate, which is typically the rate we utilize to evaluate year-over-year performance, and excluding charges totaling $22.8 million related to the sale of the Company's supply chain assets and the change in its sourcing model for parts merchandise, the Company would have reported third-quarter 2005 results of $0.44 per diluted share. This compares to $0.50 per diluted share profit in the third quarter of 2004, after excluding charges of $6.3 million related to the corporate relocation expense and the hurricane and flood damage, and also assuming a 39% effective tax rate for last year as well.

  • Now for a glance at our balance sheet. As of September 30, 2005, we had $14.2 million of debt, consisting of 13.4 million of revolving bank debt and $800,000 of an interest-free forgivable loan from the City of Cleveland. This compares to total debt of 5.9 million in the third quarter of last year.

  • Cash and cash equivalents were 7.3 million versus 8 million at the same time last year. Inventory balance at September 30, '05, however, does not reflect the effect of the supply chain transaction and the related reduction of approximately $34 million of consumable inventory.

  • In summary, our balance sheet remains quite healthy. With the additional cash we received in the fourth quarter from the supply chain transaction, we will be better-positioned to enhance shareholder value by expanding our service center footprint, reducing our debt and repurchasing shares.

  • Our 2005 full year guidance includes revenue growth between 1 and 1.5%, with an expected 8% increase in Service Centers sales. The sales of other selling locations are expected to decline approximately 22 to $25 million, of which $16 million has already occurred in the first nine months, and this is resulting from the acceleration of the Company's strategy to reduce its sales representative model and to concentrate on our higher-profit Service Center and Stores-on-Wheels models.

  • For the full year, we estimate a diluted EPS range of 45 to $0.48. but this does exclude approximately 32 to $34 million in expected charges associated with the supply chain transaction, our parts merchandise strategy, some severance costs, accelerated merchandise markdowns and that settlement to KPAC that we paid back in the first half.

  • It's important to understand that the fourth quarter is our lowest sales volume quarter due to the seasonal nature of the green industry, and thus, LESCO has historically recognized a loss in its fourth quarter. In addition, we expect year-over-year comparisons will be tough, as we had a very strong fourth quarter in 2004.

  • However, we think there's potential to experience accelerated purchases by our customers in the fourth quarter of this year, ahead of expected price increases related to rising commodity and fuel costs that will be put into place beginning in 2006.

  • The Company also expects to record an approximate $4 million in charges in the fourth quarter related to the closing of three distribution hubs which were not purchased in the transaction, along with certain other remaining costs to the transaction. The Company also plans to further rationalize its product offering and expects an approximate $4 million markdown to be taken in the fourth quarter.

  • In addition, in conjunction with the previously discussed management changes, the Company will record a $1.5 million severance expense in the fourth quarter. All of these charges, though, are included in the 32 to $34 million range that I previously mentioned.

  • We expect to finish this year with 32 new Service Centers, with 20 opened in the first three quarters, and we have already opened an additional two sites so far in the fourth quarter. At this time, we expect to give full-year 2006 guidance on our fourth quarter conference call.

  • Now with that, I will turn the call back over to Jeff for some concluding thoughts.

  • Jeffrey Rutherford - President, CEO

  • Thank you, Mike. We are very fortunate to have Mike to step into the CFO position. And I'd have to say we've probably upgraded the position with Mike moving in there.

  • Before we turn the call over to Q&A, I wanted to make some concluding remarks. We are very happy that we have finally completed the transformation to a store-focused model. While it is critical that we execute on this new strategy, we believe that the streamlining of the business and focus on the growth of our store networks, which have proven to be the best use of our capital, is the right strategy.

  • The sale of the supply chain assets combined with the disbanding of our golf sales rep model, the addition of smaller and more cost-efficient Stores-on-Wheels, the ongoing improvements in our merchandising strategy and direct marketing initiatives position the Company for improved financial performance.

  • In the coming months, I plan to spend some time -- of my time in the field with our 900 team members that are heart (ph) of this business. And I am going to the field not to tell them what they are supposed to be doing, but for them to help me know what I'm supposed to be doing.

  • I am convinced this is a strong model, and that together we will expand our market share throughout the country over time. To that end, LESCO continues to gain market share in the consumables portion of the professional lawn and landscape industry as we exceed the industry average growth rate of 4%. The LESCO name stands for quality products and agronomic expertise, with more than 130,000 lawn care, landscape, golf course and pest control customers relying on us to service their needs.

  • We think we have the right leadership team in place, but more importantly we have approximately 900 employees in the field every day servicing our customers. Our associates are committed to contributing meaningfully to our growth and improving our Company's performance. Together, our leaders in the entire organization will help our Company prosper, which will result in the creation of additional shareholder value.

  • With that, let me turn the call back to the operator for Q&A.

  • Operator

  • (OPERATOR INSTRUCTIONS) Greg McKinley of Dougherty & Company.

  • Greg McKinley - Analyst

  • Good afternoon. Could you help me on a couple items? First of all, when we take a closer look at your Store Segment operating results and look at where margins moved during the year, year-over-year down a little bit, you said recognition of vendor rebate income, product markdowns, etc., when will some of these issues stabilize such that -- I would imagine with as your store base begins to age, there is some fixed cost components there that would leverage a little bit -- when would we start to see stabilization there?

  • Jeffrey Rutherford - President, CEO

  • Let's talk a little bit about what's in that segment and maybe I can help you understand that a little bit more, Greg.

  • In that segment are Service Centers, Stores-on-Wheels and the field infrastructure, which would be our regionals and zone management team. If you look deeper into that model, what you find is that the Service Center model is operating as we model it to operate, with some timing issues between the second and third quarter relative to vendor rebates and some incremental product markdowns that hit us late in the third quarter.

  • One of the things that we announced today is that in the fourth quarter, concurrent with the Platinum transaction, we will be accelerating certain SKUs into discontinued status. And what we experienced in the back half of the third quarter was the front end of those SKUs hitting discontinuance. We have a product life lifecycle program, and what we saw was that we had products coming in there of approximately $4 million that we decided that concurrent with the transaction we just accelerated into the discontinued. So we don't expect to see that type of recurrence of markdowns.

  • Now, the vendor rebates issue was a timing issue, and if you look at margin gross profit, year-to-date you'll see an improvement actually in gross profit.

  • Now, the other components of that Store Segment, the Stores-on-Wheels, we added 38 Stores-on-Wheels in the first half of this year. They did not perform as well as, obviously, the previous Stores-on-Wheels had been performing, and pulled down the model a little bit, especially in the first half. We're happy to say that they are coming back, and from a top rating (ph) dollar perspective in the third quarter, they are actually flat to last year.

  • Then on top of that, when we added -- we've added nearly 60 stores in the last 12 months -- there's field management that's required to oversee those stores. So we're spending more in regional, especially in our regional costs, because we need more. We've expanded from approximately 340 stores to nearly 400 stores. So we've added field management incrementally, and those people want to be paid, but those stores that they're supervising aren't necessarily generating operating margin. So by adding so many -- especially the 38 Stores-on-Wheels -- we set the model back for a period of time.

  • But we're happy to say and we are saying today that it's operating as we're modeling it; we set it back for a short period of time. And quite frankly, if we didn't believe that, we wouldn't have put those segments out there for people to review.

  • Greg McKinley - Analyst

  • On your Stores-on-Wheels, you added a lot of stores that maybe didn't quite meet your expectations right out of the gate. Was that initial challenges in terms of transitioning customers that were used to a direct sales model into the Stores-on-Wheels channel, or what caused that initial shortfall and why is it improving?

  • Jeffrey Rutherford - President, CEO

  • I'll tell you, Greg. Obviously, if we had to do it all over again, we wouldn't do it like we did it this year. What we did is we not only converted the big trucks to the small trucks, but we added 38 trucks and at the same time we disbanded our golf sales rep program. And really, it was too much for the model to handle at a single point in time.

  • Theoretically, the thought was that we were going to be able to move our sales reps into other positions and maintain their historical sales. And that didn't happen, as you can tell from our sales matrix. We lost those sales of approximately -- I think annual sales in golf sales reps are approximately $40 million. Now, we're getting nice lift, obviously, when you add 50% store growth, but we certainly are not going to pick up that 40 million. So in total, we set the model back for a period of time.

  • The good news is that those stores are starting to perform under Chuck Denny's tutelage and we really believe that through 2006, we are going to see improvement in that model, and we're not going to see significant additions to that model going into 2006. We did too much too quickly.

  • But the model is still a viable model, it is still performing. We had a few hiccups in personnel during these changes. We didn't pay enough attention to changed management as we should have. But the good news is it shows the resiliency of these models. These models, the two models in our stores, the Service Centers, the Stores-on-Wheels, are great models. And they continue to perform extremely well. And we really believe that the investment in those stores are going to be our future.

  • Greg McKinley - Analyst

  • Now, looking at your guidance, you're looking for 8% increase in Service Center sales for the remainder of this -- actually for the full year. And is my math right, assuming that implies something like a 4% comp increase at Service Centers and the second half?

  • Michael Weisbarth - CFO, Controller, Treasurer

  • Yes, that is correct, Greg.

  • Greg McKinley - Analyst

  • And then I wonder if you could comment a little bit about corporate G&A; it was down 90 basis points, I think, year-over-year, to about 3.8%. Can you give us a sense for how do you view fixed and variable costs there? Maybe they're substantially all fixed -- I don't know. And are there opportunities to reduce those expense dollars?

  • Jeffrey Rutherford - President, CEO

  • Well, number one, it's reduced because we've moved our corporate headquarters to smaller space, more efficient space. And quite frankly, management bonuses aren't being provided this year. Those two issues.

  • But fixed and variable -- now one thing we have to keep in mind, that as we transaction into the transaction with Platinum, there is going to be some movement of costs out of G&A. For example, today, we have our insurance costs associated with our plants that are in our G&A cost. So we're going to see some adjustment in that G&A line and then it's going to settle out, based upon what we need to have from a G&A perspective relative to what is essentially a 400-location multilocation unit that had to be supported by some level of HR, finance and accounting, legal -- although I hate to admit that we were spending money on legal costs -- internal audit costs and so forth.

  • So there is a certain portion -- we are going to hit that fixed portion. We don't plan on adding people or costs incremental to our sales growth. That is how we leverage the model. We want to have the right people at corporate, and we want to pay them so that they stay with us and do a good job. But that doesn't mean that every time we add a percentage of stores, we're going to add a percentage of cost (indiscernible).

  • Greg McKinley - Analyst

  • Okay. And then my last question -- and it gets back a little bit to the challenges of transitioning customers into the Stores-on-Wheels programs -- and that is your direct sales channel on the golf market. Given your changes and how you are selling product into that market, is that -- what are the revenue growth concerns that you have out in front of you? Is it continued attrition with that customer base in the golf market or what part of your revenue stream gives you the highest confidence or raises the most risks?

  • Jeffrey Rutherford - President, CEO

  • You know, Greg, if you look at our sales matrix that's attached in this -- it's hard to believe that we have such a long press release (indiscernible). I know everybody thinks that. But if you look at that under other selling locations, that is effectively our Direct Sales Segment sales. And what you see in there is that going forward, golf sales are going to be relatively small in that Direct Sales Segment.

  • We are transacting with golf courses now through our Stores-on-Wheels, which is a very efficient model for golf courses. And as we expand the footprint of our Service Centers, the golf courses are coming to our Service Centers, and that is how we're going to service them. We are not looking for significant growth in the golf business in that Direct Sales model.

  • Greg McKinley - Analyst

  • Okay. Very good, thank you.

  • Operator

  • Paul Resnik of Dutton & Associates.

  • Paul Resnik - Analyst

  • Two questions. First, on the parts merchandise strategy. I'd like you to explain that strategy again and also explain how the charge came about, the 2.9 million.

  • Jeffrey Rutherford - President, CEO

  • For the parts?

  • Paul Resnik - Analyst

  • For the parts, yes.

  • Jeffrey Rutherford - President, CEO

  • The parts strategy is that we were carrying too many parts, too many SKUs, at the Service Center level. And we believe that it's more efficient for us to carry approximately 200 part SKUs that are relatively high turning, good margin. And everything else should be on order and direct ship.

  • So what we did it is we packaged up all of our parts that weren't within these 200 SKUs, and we sold them at a discount to a parts distributor. And then going forward, we're going to be able to lower our (indiscernible) in that cost by just ordering exactly what we need.

  • Now those 200 may vary, may vary between where we have a mechanic and where we don't have a mechanic, and geography and so forth. But we are focusing our part business on those parts that and inventory than have high turn and are the right parts for us to carry, the charge associated with the discount associated with selling those at a discount to that buyer.

  • Paul Resnik - Analyst

  • You thought that was better than just riding (ph) that inventory sellout?

  • Jeffrey Rutherford - President, CEO

  • Well, the reason it was probably too heavy, it was probably in the wrong place. So in order to move it around and get it to the right place, we would have been losing from a service level and a cost level, and we just believed and -- we did the analysis -- we believed that we were just better off packaging it up and selling it at a discount.

  • Paul Resnik - Analyst

  • Secondly, on the shift now to the retail model, is that going to change somewhat the seasonality of earnings -- not of sales of sales (ph), but does that have an impact on earning seasonality?

  • Jeffrey Rutherford - President, CEO

  • On earnings seasonality? Not significantly, no.

  • Paul Resnik - Analyst

  • Okay. That's it.

  • Operator

  • (OPERATOR INSTRUCTIONS) David Bowe (ph) of Paradigm.

  • David Bowe - Analyst

  • I'm trying to understand the new segment reporting. I think the old segment reporting was Service Centers, which was actual Service Centers, and then other selling locations, which was Wheels selling centers -- the wheels selling centers, the trucks, and the direct sales. Is that right?

  • Jeffrey Rutherford - President, CEO

  • The old segments?

  • David Bowe - Analyst

  • Yes.

  • Jeffrey Rutherford - President, CEO

  • The old segments were really Selling and Support. And what we had there is we had everything in -- we had Service Centers, Stores-on-Wheels and Direct Sales in the Selling Segment. And we had Manufacturing, Distribution and Corporate Overhead in the Support Segment. What we do is, concurrent with the sale of our manufacturing distribution centers, we realigned our segments to better reflect how we are going to manage the business going forward.

  • The way we are managing the business going forward is through stores, which are our Service Centers and our Stores-on-Wheels, our Direct Business -- now let me just tell you a little bit about the Direct Business. The Direct Business is what's transacted directly with, basically, shipments out of our warehouse. We have accounts that would be considered Direct that also transact through Service Centers and Stores-on-Wheels. Those transactions are in the Store Segment. So it's kind of a matrix kind of relationship between Service Centers, Stores-on-Wheels and the Direct Business on certain accounts. And then we have the Corporate Segment.

  • So that is how we're managing the business going for it. Previous to that, we basically had selling units and manufacturing warehouse support units.

  • David Bowe - Analyst

  • Okay. And then, related to the ongoing contract with Platinum, how does that work? If Platinum's volume -- if they can sell to additional customers and their costs go down, do we participate in that in lower cost for us?

  • Jeffrey Rutherford - President, CEO

  • That's right. The way the deal works -- and our new General Counsel is right next to me -- so when she hits me, I will stop. The way the deal works is -- you think it through -- we gave them our capacity, and then we agreed to buy it back at cost plus an agreed-upon margin.

  • David Bowe - Analyst

  • Okay.

  • Jeffrey Rutherford - President, CEO

  • To the extent that they are successful at better utilizing the capacity or improving on distribution or any aspect of manufacturing distribution buying, we participate.

  • David Bowe - Analyst

  • Okay. Then why would they be able to run it better than we were running it?

  • Jeffrey Rutherford - President, CEO

  • Well, they have the ability -- what we found historically is that the other users of blended capacity are not necessarily that interested in doing it directly with LESCO. And we spent a considerable amount of time from a strategic perspective investigating that scenario. And what we found is that, in our opinion, an independent third party -- and we went through private equity capital to do it -- and their focus on their core competency of blending and distribution was better suited to utilize those assets than necessarily we were, who were a combination of a store business and a retail -- or a manufacturing business.

  • David Bowe - Analyst

  • Okay.

  • Jeffrey Rutherford - President, CEO

  • So we believe that they will be better able to go out and, who knows, maybe do some other deals or fill the capacity, and then we would participate in it.

  • David Bowe - Analyst

  • Okay, great. Thanks a lot.

  • Operator

  • Brian (indiscernible).

  • Unidentified Speaker

  • Good evening. Can you tell us what the costs associated with the three distribution hubs that are closing are?

  • Jeffrey Rutherford - President, CEO

  • You mean what type of costs they are?

  • Unidentified Speaker

  • Yes, can you quantify them?

  • Jeffrey Rutherford - President, CEO

  • The total that we said we were going to take in the fourth quarter was 4 million, and the costs included in there were the lease costs.

  • Unidentified Speaker

  • Yes. I'm sorry -- let me rephrase that. What are the annual costs that you expense associated with those three distribution hubs? That is, how much of '05's numbers are -- what would have been the normal recurring expenses associated with those hubs?

  • Jeffrey Rutherford - President, CEO

  • Brian, off the top of our head, I don't know that number. We're not prepared to give guidance on that yet, but --.

  • Unidentified Speaker

  • Okay. My second question is you've historically provided us store result data based on their class year. Is that something you're going to provide in the Qs or --?

  • Jeffrey Rutherford - President, CEO

  • What we need to do there -- and you're going to have to bear with us for a little bit -- because what we need to do is that is four wall -- we have those. In fact, we reference them in the narrative of the release.

  • What we need to do is before we file the Q, we need to make a call relative to whether we do the same kind of allocations that we do back into the Store Segment. There are some things that happen outside the four walls that we have allocated back into the Store Segment -- warehousing costs, inbound freight to warehouse, vendor rebates. Historically we haven't had employee commissions in there, and various other adjustments -- manufacturing variances and so forth.

  • Now that we don't have manufacturing and warehousing assets anymore, and we won't going forward, and that's basically going to be part of the cost of the product we purchase, we have to go back and redo all of that. And we weren't prepared for that with this release, and we will address that for the Q.

  • One way or the other, we will either give four wall information or we will give it with allocations back into it (ph).

  • Unidentified Speaker

  • Okay, thanks.

  • Operator

  • (OPERATOR INSTRUCTIONS) Gentlemen, you have no further questions. I apologize. You have one from Darren Hiteman (ph) of (indiscernible).

  • Darren Hiteman - Analyst

  • Would you or your team care to share with us what you think the ultimate operating margin is going to be for this new retail business model?

  • Jeffrey Rutherford - President, CEO

  • No. We will talk about the Iowa state football team, but I'm not sure we're prepared right now to talk about guidance on the store operating segment.

  • Darren Hiteman - Analyst

  • Well, I was thinking of companywide, but you probably knew that.

  • Jeffrey Rutherford - President, CEO

  • Well, do we know what we anticipate? Are we modeling? Yes. We are not prepared to give 2006 guidance right now.

  • Darren Hiteman - Analyst

  • Well, I was thinking more conceptually rather than any particular timeframe. We all can look at retailers that are out there and look at their operating margins. Is there any structural reason why you can't be an average retail business model?

  • Jeffrey Rutherford - President, CEO

  • Well, no, there is no reason why we are not. But you're not going to get me to commit to a number right now.

  • Darren Hiteman - Analyst

  • Okay, that is understandable. Thank you.

  • Operator

  • Rob Thomas (ph).

  • Jeffrey Rutherford - President, CEO

  • Hello?

  • Operator

  • You may go ahead with your question. Gentlemen, you have no further questions.

  • Jeffrey Rutherford - President, CEO

  • Thank you, operator. In closing, I just want to thank the investor community and the employees of LESCO for your time and support. We have started to take a big step forward and look forward to updating you on our progress on our next call to report year-end results. Thank you very much.

  • Operator

  • Ladies and gentlemen, this concludes your call for today. We thank you for your participation. You may now disconnect. Have a good day.