強鹿 (DE) 2006 Q2 法說會逐字稿

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  • Operator

  • Good morning and welcome to the Lesco second quarter 2006 conference call and webcast.

  • [OPERATOR INSTRUCTIONS]

  • Portions of the presentation and other statements relating to sales and earnings expectations, new service centers opening and profitability, the company's ability to implement its sales representative strategy and other statements that are not historic 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 today's press release along with the company's Securities and Exchange Commission report, including, but not limited to the Form 10-K for the year ending December 31st, 2005.

  • In addition, some of the information that will be discussed today may include non-GAAP financial measures.

  • A presentation of the most direct comparable GAAP measures and a [reconsolidation] of the differences between the non-GAAP financial measures and the compare GAAP measures are described therein and are included in the company's press release and is available on the Lesco website at www.lesco.com.

  • I would now like to turn the conference over to Jeff Rutherford, president and chief executive officer.

  • Please go ahead, sir.

  • Jeff Rutherford - President and CEO

  • Thank you, operator, and thank you for joining us today.

  • With me today are Bruce Thorn, chief operating officer, Rich Doggett, senior vice president of sales, and Mike Weisbarth, chief financial officer, as well as other members of our senior management team.

  • We are obviously disappointed with out results for the second quarter.

  • As discussed in our call three weeks ago, the majority of the sales shortfall in the store segment was the result of reduction in sales from customers who previously supported -- were previously supported by our sales representative model, which was disbanded during the first half of 2005.

  • The business that the sales reps brought in, which was primarily from golf and larger regional lawn and landscape customers, is very relationship driven and the transition away from the sales rep model disrupted many of these relationships to a much larger extent than was expected.

  • We have and continue to make progress on costs and working capital management and in new service center openings.

  • We need to bring the same discipline and planned approach to managing our sales group and driving sales volume at appropriate margin.

  • Sales rep organization will be managed on the basis of customer gross profit contribution across transacting segments.

  • These reps will be encouraged and compensated to increase productivity from the square footage in our service center and our fleet of Stores-on-Wheels.

  • Our [extensive] stores network is one of Lesco's competitive advantages, but we have not maximized its full potential.

  • We have determined that we want to initially place sales reps in 20 key markets and we have already signed on 17 people to fill these positions.

  • Many of these reps are from within our organization.

  • They are former reps who most recently have been in positions in service centers, Store-on-Wheels and field management.

  • They bring with them extensive selling experience and customer relationships that will be vital - a vital part of rebuilding this model.

  • In order to maintain good customer service levels, there will be a transition period while certain individuals shift from their current roles.

  • Our focus remains on our high return store model.

  • The performance of our newer service centers provides us with the necessary validation that we are pursuing the proper strategy.

  • We generated 39 million in revenues and $1.6 million in pretax earnings for the first six months of this year through the 98 service centers that we opened going back to 2003.

  • Year to date, our new service centers have performed in line with our expectations, with the exception of the class of 2003 that has been affected by the change in our sales rep model.

  • With the expansion of our sales rep model and as the newer stores begin to mature, we anticipate that there will be many opportunities for improvement, for expanding gross profit dollar per square foot, along with overall operating profit improvement.

  • During the quarter we opened 13 new service centers, bringing the total to 19 new locations in 2006.

  • We continue to expect to open up to 40 new service centers this year.

  • In 2007, however, we anticipate a reduction in new service center openings.

  • With the launch of our sales rep initiative and the necessary changed management process, we may pull back on a number of new service center openings but it won't be fewer than 20.

  • Long term we remain committed to our strategic direction to increase our service center base at 10 to 15% annually.

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

  • Mike Weisbarth - CFO

  • Thanks, Jeff.

  • Morning, everybody.

  • Hopefully you've had an opportunity to go through the details of our second quarter results released earlier this morning.

  • For the second quarter of 2006 our consolidated results were earnings of $8.9 million, or $0.95 per diluted share, compared to earnings of $15.9 million, or $1.71 per diluted share last year.

  • As a reminder, we maintain a full valuation allowance for our net deferred tax assets and net operating loss carry-forwards, so we don't have a reported tax provision or benefit net of the valuation allowance adjustments.

  • So if we assume a 29% tax rate, we would have reported earnings of $0.58 per diluted share for the second quarter compared to adjusted earnings of $1.08 per share in 2005.

  • And as a reminder, the $1.08 earnings in 2005 excludes a $0.03 per diluted share impact for the settlement costs and were related to the termination of a vendor supply arrangement.

  • The profit decline is directly attributable to the lower sales volume, which was down 4% from the same period last year, some market pricing pressures that we have incurred and incremental selling expense for our new service centers and Stores-on Wheels.

  • In our stores segment, net sales increased 1.5% for the second quarter to $167 million from 165 million in the comparable period a year ago.

  • Service center sales increased 2.5% and Stores-on Wheels sales declined 5.2%.

  • Our service centers achieved 4.6% growth with our lawn care and landscape customers.

  • However, without the support of our sales representatives, our golf customer sales declined nearly 14% in service centers.

  • Gross profit as a percentage of net sales was 24.9% compared to 28.8% in the same period in 2005.

  • We did anticipate a decline in segment gross profit dollars on a year over year basis as well as percentage due to incremental indirect supply chain costs from outsourcing the manufacturing and distribution functions.

  • However, since the majority of these indirect costs are relatively fixed, they de-leveraged with the decline in sales volume.

  • We have segregated these costs in our segment financial disclosure to provide greater visibility as to their effect on our results.

  • What you will notice in the supplemental schedule in our earnings release is that not only did the indirect costs increase quarter over quarter, as anticipated, but since they are allocated based on cost of product, the stores segment is absorbing a greater portion of these costs.

  • We've also experienced a more competitive pricing environment in our fertilizer product category.

  • This, coupled with higher product costs, including a reduction in supplier rebates, has led to a gross profit decline in our stores segment.

  • The pricing under our urea sourcing contract for this year is currently higher than prevailing market rates, which has contributed to this pricing pressure and margin contraction.

  • Stores segment selling expense increased $2.1 million on a comparative quarter over quarter basis.

  • The 48 net new service centers and 17 new Stores-on-Wheels that we've added since the first quarter of 2005 have contributed an incremental selling expense of $1.8 million, along with expenses associated with expanding our field management team to support our store growth.

  • This investment resulted in a short-term de-leveraging impact, which we expect will dissipate as our store base matures and as we recapture some market share through our sales rep strategy.

  • Merchant discount expense increased 20 basis points on a year over year basis to 1.8% of net sales, primarily due to higher discount rates, as well as a change in our customer credit mix.

  • Our customers are beginning to pay more with bankcards versus cash or check or even our private label credit.

  • In our direct segment, net sales were $14.6 million for the second quarter versus $25.2 million during the comparable period last year.

  • The change is attributable to the company's decision in early 2005 to disband its direct sales structure.

  • Gross profit as a percentage of sales increased 30 basis points to 13.9%.

  • While we've been successful in improving customer profitability in the direct segment, the shift in allocation of indirect supply chain costs to the stores segment has led to the gross profit rate improvement on a quarter over quarter basis.

  • General and administrative expense declined 20% to $4 million, partially due to the transition of certain functions to PCS from the sale of our supply chain assets.

  • There was no net corporate merchant expense as we recovered discounts that were previously overcharged.

  • Excluding the amount recovered, we incurred $450,000 of expense in the second quarter this year compared to $660,000 for the same period in 2005.

  • Pre-opening expense was flat on a year over year basis at $0.5 million.

  • Turning to our balance sheet, as of June 30th our cash and equivalents was $19.9 million versus $8.5 million at the same time last year.

  • We had no debt on the books this year compared to $3 million of debt at the end of the second quarter 2005.

  • We are very comfortable with our balance sheet and continue to believe we are well positioned with the flexibility necessary to further invest in the growth of our stores and our sales force.

  • Although we are comfortable, we are not content and we will continue to evaluate opportunities to improve our working capital.

  • We have spent $1.4 million to repurchase over 90,000 shares under our stock repurchase program.

  • However, we currently expect to invest our cash in service centers and personnel as we view them as vital to our continued growth.

  • We frequently evaluate how best to deploy our capital based on current market conditions as well as our business needs.

  • Finally, we are continuing to maintain the 2006 guidance that we provided you during our update three weeks ago at the beginning of July.

  • At this point in time I'll turn the call back over to Jeff for some concluding comments.

  • Jeff Rutherford - President and CEO

  • Thanks, Mike.

  • While this quarter was challenging, we have identified the problem and have already begun implementing the solution by reinstating our sales rep program.

  • We know that to create value in our model we need to leverage the investment in our service center square footage.

  • We do this by maximizing gross profit dollars per square foot, which means driving sales volume.

  • We continually challenge ourselves as to what we can sell in our stores to drive higher gross profit dollars.

  • The sales reps are a key component of this effort because of the service and relationships they provide customers and we know that it is a correct choice to bring that role back into our model.

  • We are committed to creating an organization that delivers premium customer service and, candidly speaking, getting to that point requires continuing to improve our company culture.

  • We are working on that every day to make sure we are [inaudible] this customer focus that treats its people correctly and allows our sales force to manage their business as if it were their own.

  • We have made progress achieving these goals thus far in 2006 and this improvement must continue.

  • Everything starts with the commitment -- the commitment to customers.

  • That's why we are bringing back the sales reps; combined with our service centers and Stores-on-Wheels, we have an unbeatable model.

  • In fact, we have a model that should dominate the markets we serve.

  • By doing that, Lesco will achieve its potential and maximize the value it offers to customers, employees and shareholders alike and that's what we intend on doing.

  • Now we are happy to answer any questions you might have.

  • Operator

  • [OPERATOR INSTRUCTIONS]

  • Question comes from the line of Greg McKinley from Dougherty & Co. Please proceed.

  • Greg McKinley - Analyst

  • Good morning.

  • Jeff Rutherford - President and CEO

  • Hi, Greg.

  • Greg McKinley - Analyst

  • A couple of quick questions.

  • Can you guys just give us a little background on when the decision was made to disband the direct sales force and now we're re-pursuing that?

  • Can you give us a better understanding what's different about this effort than the way that was run previously?

  • So why -- what is it that we're doing this time that's going to make that channel a real contributor to the success of the company?

  • Jeff Rutherford - President and CEO

  • We talked about it a little bit three weeks ago, but historically, let me just take you back in the way sales operations were managed prior to 2006.

  • We had -- we basically as a company had two sales reporting models.

  • One was a financial model that most investors, and, Greg, you would be used to it, it's based on transacting location.

  • And the sales group or a majority of the sales group had what was called account-based sales analysis and the two systems were not integrated.

  • The account base was tracking accounts, customer accounts, so if you weren't in our account base you really weren't tracked, you were picked up on the transaction side.

  • And quite frankly, the two never integrated.

  • And they weren't integrated, accounts were double-tagged and so forth, and if you added up all of the sales on the account base it wouldn't reconcile to transaction base.

  • What we changed at the end of 2005 and what we're using in 2006 is an integrated model that's more of a matrix reporting.

  • We track everything.

  • We still track everything transactionally and report things transactionally, but on a matrix basis we can monitor any group that we want to.

  • For example, every day we come in, we look at transactional sales, and down the left-hand side of the matrix we look at who owns the account.

  • So we can look at any point in time at what's being transacted through service centers and whether it's a service center-owned account, which the majority of them in service centers are, or whether it's a Store-on-Wheels account transacting in the service center, a national account transacting in the service center, and we can track how much in sales reps accounts are transacted in service centers and we can do that for Stores-on-Wheels also.

  • Greg McKinley - Analyst

  • Okay.

  • Jeff Rutherford - President and CEO

  • So at any point in time we can call up a matrix that says for this store, for this Store-on-Wheels, here's how much they're transacting directly off the truck and here's how much their account is transacting in a service center.

  • So when we bring back these sales reps -- and they're coming back, 17 of them are in transition time periods and one is already out there.

  • One guy we brought back from a competitor is already out there transacting; we can track his account's progress.

  • And that's what he's going to be judged upon --

  • Greg McKinley - Analyst

  • Yes.

  • Jeff Rutherford - President and CEO

  • -- his market's progress.

  • We never had those tools --

  • Greg McKinley - Analyst

  • Okay.

  • Jeff Rutherford - President and CEO

  • -- previously.

  • If we would have had that and we would have known -- by the way, when the decision was made, Greg, to disband the group, all their accounts were reassigned back in 2005, so we lost track of what happened to those accounts.

  • Greg McKinley - Analyst

  • Oh, okay.

  • Jeff Rutherford - President and CEO

  • In the last, well, now it's been the last two months we have gone back and recreated all that data.

  • We've gone back to 2004, we found a file on 2004 and we rolled all that data forward.

  • So we know what effect this has had on us.

  • That's how we know what the effect of all the sales reps -- going back to 2004, the accounts that they touched accounted for approximately $180 million of our sales.

  • We've tracked that through and we could see what the decline was in their accounts in 2005 and what happened in 2005 is we lost all the [direct business].

  • We were still getting the store business.

  • What happened this year when we looked at those accounts, we're starting to lose -- we're starting to lose the store business, which --

  • Greg McKinley - Analyst

  • So, why did that take a while to unfold?

  • It was just eventually those relationships were courted by maybe the direct salespeople that you used to have as employees who were now working for competition and they worked their way to competitors?

  • Is that the reason it took a while to come out of the stores?

  • Jeff Rutherford - President and CEO

  • Well, I think it took a while -- yes, I think that's one reason.

  • But the relationship is deteriorating with the customer.

  • Greg McKinley - Analyst

  • Yes.

  • Jeff Rutherford - President and CEO

  • Customer was coming in to our stores but as they were being -- as they were being courted by, it could be our ex-employees or any competitor, we weren't there with the relationship and the relationships deteriorated and that's what we found out.

  • Greg McKinley - Analyst

  • Oh, okay.

  • Jeff Rutherford - President and CEO

  • And it's not -- we talk a lot about it on the golf side, but it's not only the golf side.

  • It's the lawn and landscape side of the business, too, that's deteriorated.

  • Greg McKinley - Analyst

  • Yes.

  • Jeff Rutherford - President and CEO

  • That's why we have to bring these guys back.

  • That's why they -- and we know that better than -- we haven't heard a lot of negative in the field about bringing back all of our customers and suppliers have basically said what a lot of investors have said, no kidding.

  • Greg McKinley - Analyst

  • Yes.

  • Let me ask just a couple of other questions on different topic.

  • On comparable store sales, I know you indicated that that 2003 and older classes of stores are the ones most impacted because those were built at the time that the direct sales force was really part of driving customers there and the new stores have been less reliant on direct sales to drive customers into their locations.

  • What -- and you said that since 2003 those classes of stores are doing just fine.

  • Can you share with us what kind of comp those are producing?

  • Jeff Rutherford - President and CEO

  • Which class are you referring to?

  • Greg McKinley - Analyst

  • Oh, just generally stores that are newer, the ones not pressured by the direct sales.

  • Mike Weisbarth - CFO

  • Yes, Greg, this is Mike Weisbarth.

  • I would comment really only on the '04 class because those are the only other ones that are in our comp group --

  • Greg McKinley - Analyst

  • Okay.

  • Mike Weisbarth - CFO

  • -- okay, because that's the way we define our comp store sales is that they have to be open for at least 12 months and --

  • Greg McKinley - Analyst

  • Sure.

  • Mike Weisbarth - CFO

  • -- then starting that they're going to be open for an entire fiscal, which is also calendar year.

  • The '04 stores are still achieving double digit comps.

  • Greg McKinley - Analyst

  • Okay.

  • Mike Weisbarth - CFO

  • Okay?

  • Low teens, low to mid teens.

  • Greg McKinley - Analyst

  • Okay, so -- and inflation is part of that, maybe 5% of that, but I guess what I really wanted to hear is that if you're talking mid teens and let's say 5% that's inflation, you're getting at least 10% of traffic and you're drawing traffic to these stores.

  • Mike Weisbarth - CFO

  • Yes, and that's even high for the inflation side.

  • Greg McKinley - Analyst

  • Okay.

  • Mike Weisbarth - CFO

  • It's below 5%.

  • Greg McKinley - Analyst

  • Okay.

  • And then I wonder if you could just comment on finally the strategy of building the service centers, just for my background, is that requiring you to change your customers' behavior?

  • In other words, have customers in this industry historically gotten used to you going to them with product and now, building up these service centers, they're coming to you to buy the -- is there any sort of dynamic shifting there?

  • Jeff Rutherford - President and CEO

  • There is a little bit in that we do see when we open a service center that's close to a customer, a customer -- our customers generally are not going -- they don't want to drive more than five miles.

  • They'll drive up to 10 miles to get to a service center.

  • So as we build stores, we'll shift a customer, and there's [playing] cannibalization, we'll shift a customer from store -- service center A to service center B. And generally when we get closer to their place of business we get a higher percentage of their spend.

  • So those are the customers who are coming in the stores, so their behavior has changed a little bit.

  • What we've also seen, as we open service centers closer to golf courses for example, they may stop at a store and pick up product on the way home, a superintendent.

  • I've heard that from superintendents myself.

  • When we open a -- one of the stores we opened in 2003 was on the east side of Cleveland.

  • I've heard from superintendents on the east side of Cleveland that they'll talk to their Store-on-Wheels sales rep who may be on the other side of the market, say I need a certain product, and just pick it up on the way home at the service center.

  • But that's not the preferred method of servicing those type of customers.

  • What we do is when we have that service center there, because of the matrix relationship between Stores-on-Wheels and service centers, they'll make sure -- they'll run the product over to the golf course.

  • Greg McKinley - Analyst

  • Yes, okay.

  • Jeff Rutherford - President and CEO

  • So as we expand square footage, we have an advantage over competition in that we have multiple locations within any given market.

  • Most of our competition in the -- for example in the golf business, has a warehouse somewhere they're shipping product out across a marketplace.

  • We in essence have multiple warehouses that we're just not taking advantage of.

  • And the models -- and we need to share this with everybody.

  • The model's more integrated than we realize and we realize it now in 2006 when we changed the way we look at sales and when we look at it every day, we understand the integration.

  • A majority of our sales in a service center are service center accounts, but there are also Store-on-Wheels accounts in there that are transacting through stores and they're national accounts.

  • And we -- and our model, going back to what I said earlier, is about leveraging that square footage.

  • It's about driving volume and gross profit dollars through that square footage.

  • That's how we're going to create value.

  • That square footage is fixed.

  • The amount that we can drive through any service center is really dependent upon how many times we can turn the inventory and that's -- and as service centers grow, that's why we need more locations.

  • So, what it's about is driving as much sales through that service center as we possibly can.

  • National accounts are important to that model in driving gross profit dollars to those service centers and sales reps are.

  • Whatever it takes that is not going to cost us incremental money that we can drive volume through those service centers is going to create value for us.

  • And that's what, going back to your first question, that's why a bad decision was made in 2005.

  • If we just concentrated on gross profit percentage, that's how bad decision can be made.

  • And I'm not saying anything that any retailer in the world wouldn't tell you, that retailing is about leveraging gross profit dollars across square footage.

  • Now, we're not a retailer per se, we're retail-like.

  • But our model is about driving gross profit dollars per square foot.

  • And however we do that is going to create value for everybody.

  • And we missed a key component.

  • We had it and we gave it away.

  • We're going to get it back.

  • Rich is doing a good job.

  • Rich and I have been, as late as yesterday, meeting with candidates for positions.

  • And as I said publicly as far back as February I believe, yes, I'd like them all to come back if they want to come back.

  • So, we want anybody who's a good salesperson, we'll take them, because we have the square footage, we'll drive sales, we'll drive gross profit dollars per square foot, and we'll get back to where this model should be.

  • There's no one in this industry that should be able to compete with us.

  • The only reason that anybody can compete with us, even on the direct side of the business, is because we let them.

  • And it's time -- it's time to stop letting people push us around.

  • And today's the day.

  • We're going to bring these sales reps back and we're going to dominate in the markets we're in.

  • Greg McKinley - Analyst

  • Thanks, guys.

  • I do have a couple of others but I'll let some other people take a turn and I'll jump back in.

  • Thank you.

  • Operator

  • Our next question comes from the line of [John Woltheiser] from Paradigm Capital Management.

  • Please proceed.

  • John Woltheiser - Analyst

  • Yes, good morning.

  • This is just a real quick one.

  • I think that three weeks ago you said with rolling out the direct sales force again you didn't think there would be an incremental cost, but we're early on in that decision.

  • Is that changing as you get further into the process?

  • Jeff Rutherford - President and CEO

  • Well, there's obviously incremental spend, but they'll pay for themselves.

  • I'm perfectly confident that when we bring salespeople back they'll pay for their incremental cost.

  • John Woltheiser - Analyst

  • Without a quarter or two lag or anything like that, you're saying?

  • Jeff Rutherford - President and CEO

  • Well, you know, December, the fourth quarter is a big selling season --

  • John Woltheiser - Analyst

  • Okay.

  • Jeff Rutherford - President and CEO

  • -- for golf and we need to get prepared for that.

  • And then even -- then we get back -- we'll be down in January and February but then the spring will be here before we know it and 2007.

  • We need to get people back and be prepared for the fourth quarter selling season and the golf and then prepare for spring of next year.

  • This is a good time for us to bring these people back and transition them into positions.

  • John Woltheiser - Analyst

  • So the suggestion that you may slow down the rate of new stores next year has nothing to do with absorbing costs of the direct sales force?

  • Jeff Rutherford - President and CEO

  • No, it's a management [attention] and the changed management that we're going through.

  • We're going to be going through some changes here and we're not saying that it's definitely going to be reduced.

  • We're saying that we're considering it but it won't be fewer than 20.

  • John Woltheiser - Analyst

  • Okay, good.

  • And then --

  • Jeff Rutherford - President and CEO

  • We've got 20 right now that are on the -- that are ready to go for 2007.

  • Not all of them are signed leases but we're ready to go.

  • That's the fewest we're going to open.

  • And really, what we'll -- we've had to slow ourselves down to get down to 20.

  • So we're just saying that because that's a possibility but it's still being -- it's still being debated.

  • John Woltheiser - Analyst

  • Good, good.

  • Thanks for the clarification.

  • Jeff Rutherford - President and CEO

  • Sure.

  • Operator

  • And our next question comes from the line of [Rob Frankfurt] from [Catalyst Asset Management].

  • Please proceed.

  • Rob Frankfurt - Analyst

  • Yes, hi.

  • Good morning.

  • My question is the share buyback, I'm not sure if I understood what your comments were about that.

  • Are you still continuing to do share buyback?

  • Mike Weisbarth - CFO

  • Well, the share repurchase program is still alive.

  • We obviously aren't buying today.

  • We're still blacked out.

  • But that'll be something we'll evaluate on an ongoing basis.

  • Rob Frankfurt - Analyst

  • You're blacked out until when?

  • Mike Weisbarth - CFO

  • Next week sometime.

  • August, August 1st.

  • Rob Frankfurt - Analyst

  • Okay, so -- but the comment you made was that you've got other things to spend on.

  • Mike Weisbarth - CFO

  • Well, we always have other things to spend money on.

  • Rob Frankfurt - Analyst

  • Yes, but every company has things to spend on, so you have to prioritize what you spend on.

  • Mike Weisbarth - CFO

  • Right.

  • Rob Frankfurt - Analyst

  • So my question is with the stock down where it is, you were buying earlier and you -- I assume you have a vision as to what your business is doing.

  • Mike Weisbarth - CFO

  • Right.

  • Rob Frankfurt - Analyst

  • So if you were buying earlier when the stock is at a higher price, I just want to understand the mindset about buying today, or not today but next week.

  • Jeff Rutherford - President and CEO

  • Okay, well, that's a good question.

  • If you go back to where we thought we would be from a cash flow perspective, obviously with the drop in sales we're off that cash flow projection.

  • And we are dropping sales.

  • And by the way, I'll just say it, that the drop in sales from the -- well, here's what we're anticipating.

  • The drop in sales from the accounts that used to be supported by the sales rep program in EBITDA is costing us somewhere between 10 and $15 million of EBITDA.

  • So that has changed now that we've internalized that and have identified it, because it happened very quickly in the second quarter, as you could see the drop, we have to reassess where we're at and how -- what is our excess cash for stock buyback.

  • Rob Frankfurt - Analyst

  • Okay, so talk to me about this idea of the 19 million of cash and no debt on the balance sheet.

  • Is that a seasonal thing where tomorrow it might be a completely different number?

  • Jeff Rutherford - President and CEO

  • Well, yes, it's from a seasonality perspective, our -- the place we borrow money is in February and March of every year, as we build inventory for spring.

  • So we know where the pinch point is and that's where we have to work backwards as to what excess cash is.

  • Rob Frankfurt - Analyst

  • Okay, so does the company have any looming liquidity crisis as a result of this transition?

  • Jeff Rutherford - President and CEO

  • No.

  • Rob Frankfurt - Analyst

  • Okay.

  • Jeff Rutherford - President and CEO

  • We have adequate liquidity.

  • Rob Frankfurt - Analyst

  • I guess the question is, is adequate liquidity enough to go and borrow money to buy stock?

  • I mean, I'm seeing a company without debt and with cash in the balance sheet and I understand you have other things to spend on, I guess it's a question about the return on investment for your choices between Store-on-Wheels and retail stores and share buyback.

  • So that's what I'm trying to get at, what's the analysis behind that and --

  • Jeff Rutherford - President and CEO

  • Well, the analysis is -- I mean you understand that it's related to the return on invested capital and cost of debt capital is probably less than the cost of equity capital and you're asking why we don't leverage the balance sheet to buy back stock, right?

  • And everything associated with that is being evaluated, but I'm not -- no decision is made and I'm not going -- even if we -- whatever it is, we're not going to telegraph it.

  • And we're going to continue to evaluate our capital structure and use of capital and relate it to the opening of the stores or to buy back a stock and I think that's what we were trying to say is we're evaluating the situation.

  • The program's still out there, but we're not going to commit to anything today.

  • Rob Frankfurt - Analyst

  • Okay.

  • So, I'll move on.

  • Question about the sales force that you've been able to retain.

  • Are you paying them a higher compensation level than they were making a year ago when they were working with you guys in that same capacity?

  • Jeff Rutherford - President and CEO

  • I'm not going to comment on individual's compensation, but I will say --

  • Rob Frankfurt - Analyst

  • Just in general.

  • Jeff Rutherford - President and CEO

  • I'll say in general we're paying market.

  • And I'll tell you one of the problems.

  • We have a sales force and I'll tell you that one of the reasons that they left.

  • If you go back to our sales, our salespeople at the end of 2004, we had approximately 75 sales reps and 77 Store-on-Wheels sales reps and 60 of those, of approximately 152 sales reps back in 2004, so 60 of those during 2005 left the company and were working for somebody else.

  • And there's a reason that they left.

  • It's because they were good.

  • And because we do a good job of bringing the right people in, training them, giving them tools to be successful, and other people want -- and actually that's a good thing.

  • I'm glad other people want our employees.

  • We just have to make sure we treat them well, pay them market rates, give them the tools to be successful, and they'll want to work for Lesco.

  • Rob Frankfurt - Analyst

  • So you're saying that they probably [weren't] making market rates privately, then?

  • Jeff Rutherford - President and CEO

  • That's possible.

  • Rob Frankfurt - Analyst

  • Okay.

  • Talking about the -- you had mentioned that you're paying above, I believe the term is, above spot price for your raw materials?

  • Jeff Rutherford - President and CEO

  • For urea?

  • Rob Frankfurt - Analyst

  • Yes.

  • Jeff Rutherford - President and CEO

  • Yes, we're in a contract for all of 2006.

  • We're above -- if you can get urea, we're above the spot market for urea.

  • I think spot market in New Orleans today is 220.

  • Rob Frankfurt - Analyst

  • And you guys are paying?

  • Jeff Rutherford - President and CEO

  • 280.

  • Rob Frankfurt - Analyst

  • Okay, and how long -- is there any way to unwind that?

  • Jeff Rutherford - President and CEO

  • Well, we're going to have to muscle through it this year and we're in -- and Bruce Thorn and his team are in the process of entering into a new contract for 2007.

  • That'll happen sometime in the fourth quarter.

  • Rob Frankfurt - Analyst

  • And maybe you could just give us a little background on how the company found themselves in the situation where they're paying above spot by that wide a margin?

  • Jeff Rutherford - President and CEO

  • Urea is the second derivative of natural gas and although it isn't -- there isn't a perfect function between the two, it is the primary raw ingredient.

  • So a decision was made to enter into a contract based upon natural gas futures and with the drop in natural gas we've gone -- we've gone upside down on that contract.

  • What we're going to do is learning from that is we entered into that agreement I believe in September or early October last year.

  • We'll never into that long an agreement.

  • We're going to -- unless it's just obvious where we should be from a hedge perspective.

  • We're looking at six-month agreements going forward.

  • Rob Frankfurt - Analyst

  • Okay.

  • So --

  • Jeff Rutherford - President and CEO

  • So we'll never be extremely favorable to market or extremely negative to market.

  • We'll always be closer to the market.

  • Rob Frankfurt - Analyst

  • Okay, so last year you entered into it in September or so for the calendar year '06?

  • Jeff Rutherford - President and CEO

  • That's right.

  • Rob Frankfurt - Analyst

  • So we'll continue to see this throughout '06?

  • Jeff Rutherford - President and CEO

  • Yes.

  • Rob Frankfurt - Analyst

  • Okay, so is there -- do you have a sense of what your competitors' pricing is?

  • Jeff Rutherford - President and CEO

  • Yes.

  • I mean their --

  • Rob Frankfurt - Analyst

  • Their costs.

  • Jeff Rutherford - President and CEO

  • Their cost versus -- we know what their prices are, right.

  • Rob Frankfurt - Analyst

  • Yes, that I understand.

  • But their costs.

  • In other words, are they -- they have a competitive advantage this year?

  • Jeff Rutherford - President and CEO

  • There could be certain regional competitors that probably have, especially on straight fertilizer, have a cost advantage for a short period of time.

  • And probably less so in combination products where then urea is less of a factor in pricing because the major component of that is probably going to be the chemical that's supplied to the fertilizer.

  • But straight fertilizer, where we're seeing margin pressure, that's going to be true.

  • Rob Frankfurt - Analyst

  • Okay, and two more questions for you.

  • The manufacturing transition, has that worked out smoothly and has there been any supply interruptions or cost issues or quality issues or anything else?

  • Jeff Rutherford - President and CEO

  • Well, we sold them a network that we used to own and it basically has operated as we sold it.

  • And there's hiccups in supply lines, their fault, our fault, and no ones fault kind of things.

  • But I'm happy with the relationship.

  • I think they have a very good leadership in turf care. [Bill Millets] over there is very committed to customer service.

  • He views us as a customer.

  • It's not a contract to him.

  • We're his customer and he's very responsive to our needs.

  • And we've had hiccups along the way but overall it's [functioned as] we believe.

  • If you look, and Mike Weisbarth alluded to it, we basically break out those indirect costs in the segment information in today's release and you could see the indirect costs associated with it and it's where we thought it was going to be.

  • And we expect them and I'm confident in saying that they will continue to improve service to us.

  • But overall to answer your question, it's going about as planned.

  • Rob Frankfurt - Analyst

  • Okay.

  • And last question for you, is there any confusion in customers' mind that there is three points of contact, Store-on-Wheels, retail and now indirect sales force again versus maybe I assume the competitors maybe just have one point of contact?

  • Jeff Rutherford - President and CEO

  • Actually, the customers like that contact.

  • There's going to be individual customers that are going to say, "Look, I only want one person to call on me."

  • But what we've heard more than that is, "We miss the sales rep and we like the guy -- we like the Store-on-Wheels, but we miss your sales reps, we miss somebody who's going to come out."

  • And going back to what we talked about three weeks ago, the Store-on-Wheels, this is especially true of the golf customer, then we'll get to lawn landscape customer, the golf customer, the Store-on-Wheels is on a route so they can only spend so much time at every golf course because they're calling ahead, they're on a route, they're on a schedule, so they have to keep moving.

  • But a sales rep is less bound to a route and the sales rep, when they get a call, can to a golf course and walk the course with the customer, with the superintendent, and spend time with the superintendent and build that relationship.

  • That's what we're missing.

  • We're missing the relationship, we're -- and because we're not there, somebody else is doing it.

  • And that's where we're getting cut off.

  • Same is true of lawn and landscape, especially for the larger regional customers that were used to being called on by a sales rep who would sit down, help them plan out their buying and negotiate pricing.

  • Now they're not -- they're probably, unless the regional manager's doing that, they're probably not getting called on.

  • But other people are calling on them and they're building relationship and that's how the stores, either Store-on-Wheels or service center, are getting cut off by the competition because we've lost that relationship.

  • I haven't heard yet from any customer that it's not a good idea to bring the sales rep back because the sales rep brings a higher level of service for them.

  • And go back to the numbers.

  • Going back to Greg McKinley's question about the decision to disband.

  • It wasn't necessarily thought through from a financial aspect, nor was financial aspect involved in that decision.

  • There have been financial analysis done on bringing them back and that's when I've talked about a more disciplined approach to this.

  • We know what it's going to cost us to bring them back and we know what their potential contribution is and we can track their business to see that they're contributing.

  • And by the way, that's how they're going to be compensated, too, the high end on their incentive comp will be based upon their business performance year over year.

  • Rob Frankfurt - Analyst

  • Is there any one or two competitors that have taken the lion's share of those sales numbers?

  • Jeff Rutherford - President and CEO

  • No, not -- they've gone to a lot of regionals, they've gone to a lot of smaller customers and some big and [inaudible], it's pretty much scattered.

  • Rob Frankfurt - Analyst

  • Okay.

  • Thanks very much, guys.

  • Jeff Rutherford - President and CEO

  • Sure.

  • Operator

  • And our next question comes from the line of [Paul Resnick] from [Sutton Associates].

  • Please proceed.

  • Paul Resnick - Analyst

  • Good morning.

  • Jeff Rutherford - President and CEO

  • Hello, Paul.

  • Paul Resnick - Analyst

  • Sorry, I got a little late to the call.

  • With regard to TCS, certainly from a service standpoint you seem pleased with how that relationship is going.

  • Jeff Rutherford - President and CEO

  • Well, [inaudible] improve, we're not -- we're always looking at improving customer service.

  • Paul Resnick - Analyst

  • But with regard to their own game plan, I had understood that they viewed the acquisition of your facilities perhaps as a starting point to -- and then the goal would be to fill out capacity by adding customers.

  • And I was wondering whether that would be a right view of what the game plan was and, if so, how they're doing?

  • Jeff Rutherford - President and CEO

  • I'm not going to disclose anything for [Platinum Equity], but let's just go back theoretically and think about it is that we're in an industry, blended fertilizer industry, both on the consumer and the professional side of blended fertilizer that has a tremendous amount of capacity.

  • And I could say from our side that we spent time as a company before we sold those assets, looking at how we could participate in -- within the industry in capacity rationalization.

  • And one of the problems is that all the companies that are basically have the capacity to some extent are public companies and none of them wanted to own the plants.

  • So, that's why we ended up doing a deal with Private Equity.

  • So if it can be done, I'm confident that Platinum Equity and the folks at TCS are the guys to do it.

  • Paul Resnick - Analyst

  • Okay.

  • Thank you.

  • Jeff Rutherford - President and CEO

  • Sure.

  • Operator

  • And our next question comes from the line of [Darren Hightman] from [Coke & Baylor].

  • Please proceed.

  • Darren Hightman - Analyst

  • Good morning.

  • Jeff Rutherford - President and CEO

  • Hi, Darren.

  • Darren Hightman - Analyst

  • I wondered if you could quantify the impact of the above market contract you have for purchasing urea on gross margin percent?

  • I mean if you were buying urea at spot, I assume your gross margins would be higher, [6] some amount.

  • Can you tell us what that would be?

  • Jeff Rutherford - President and CEO

  • Darren, what you'd have to do is, and it's just mathematical, you take $60 a ton and convert it into what urea percentage would be per ton and multiply it by what we transacted during the months.

  • So how much did we consume, guys?

  • And if you take -- it's 100,000-ton contract?

  • Mike Weisbarth - CFO

  • It's 160,000-ton contract.

  • Jeff Rutherford - President and CEO

  • Assume that ratable for every month.

  • But, Darren, the thing is we're -- I mean that's just on the input side.

  • Assume we're going to stay at the same price and that's gong to be the effect.

  • Darren Hightman - Analyst

  • Right, I figured the pricing, selling price is set by the spot market, so -- well, I just thought you might know it, whether it -- is it 50 basis points, 100 basis points, less than 50?

  • I guess I'm just wondering what the magnitude is for '06 on your gross profit margin.

  • But if you don't have -- I mean that's okay if you don't have it.

  • Mike Weisbarth - CFO

  • Hang on, Darren.

  • I'd say it probably cost us $1 million a month.

  • Darren Hightman - Analyst

  • A million a month?

  • Mike Weisbarth - CFO

  • Could.

  • Jeff Rutherford - President and CEO

  • But --

  • Darren Hightman - Analyst

  • When it's upside down --

  • Jeff Rutherford - President and CEO

  • -- hasn't been that upside down all year.

  • Darren Hightman - Analyst

  • Right, so --

  • Jeff Rutherford - President and CEO

  • But if it ran that for the month and we consumed -- it's probably not 15,000 tons a month, so if you assume ratable for the month, say it's 13,000 tons times $60, that's $800,000.

  • So if that's the position we were in for the entire month and we were upside-down $60 a ton and we consumed and sold 13,000 tons and we could -- and our pricing would have been the same, all things equal, it's $800,000 for the month.

  • Darren Hightman - Analyst

  • Okay, and how many months do you think, -- I mean I'm not that familiar with urea spot market so I guess I don't know how many months you might be upside down on that contract.

  • Jeff Rutherford - President and CEO

  • We'll be upside down on the contract the second half of the year.

  • Darren Hightman - Analyst

  • Okay.

  • Jeff Rutherford - President and CEO

  • Unless something significantly changed, like hurricanes change a lot of that --

  • Darren Hightman - Analyst

  • Right.

  • Jeff Rutherford - President and CEO

  • -- and those kind of things.

  • But all things equal, right now and assuming where we're at for the month of July being upside down in the market, and if you could get 13 -- there's a lot of factors in there, Darren.

  • Could you get enough urea?

  • That's one of the reasons we enter into these contracts is to assure that we have a reliable source of urea because you can't always get it because what happens in urea is the ag consumes it all in the spring, right, and then people shut down production and there's all kinds of production issues.

  • One of the reasons we do these contracts is not only from a hedge perspective, and maybe we got too aggressive with the hedging, is to make sure we're gong to have a reliable source of urea for any point -- for our needs, we can [inaudible] what our needs are.

  • And that -- I still believe in that.

  • We've probably -- we did, we got a little ahead of it and we got ourselves upside down in the marketplace in the back half of this year.

  • We were okay in the first half for the most part, but we're going to be upside down in the market.

  • Darren Hightman - Analyst

  • Well, did you benefit in the first half?

  • Jeff Rutherford - President and CEO

  • We were probably a little bit, but we were probably more on market.

  • Actually we probably benefited more last year than we did --

  • Darren Hightman - Analyst

  • Okay, so it sounds to me like for the year, being upside down on this contract is going to cost you about 5 or $6 million of gross profit.

  • Jeff Rutherford - President and CEO

  • Well, if it continues the way it is, that's right.

  • Darren Hightman - Analyst

  • Based on the way things are today, okay.

  • Then the other -- the second question I had is also based -- or had to do with the gross margin or gross profit and that is that you didn't meet volume requirements for your suppliers, so you didn't get some price breaks that you expected.

  • Now, what I'm wondering is if going forward when you're negotiating for next year's pricing, I assume that you're using 2006 sales levels as a base and so it won't be that challenging to meet those thresholds to get more favorable pricing next year.

  • Is that a fair way to look at it?

  • Jeff Rutherford - President and CEO

  • Well, they're probably all on this call.

  • So I'll just give them the heads up, yes, we're going to use the 2006 --

  • Darren Hightman - Analyst

  • Well, yes, I mean that only makes sense.

  • So I guess I should have started out by asking, and maybe you can't disclose this, but what -- how big of impact did that have on your gross profit margin?

  • Jeff Rutherford - President and CEO

  • Well, one of the things, and you can see this, Darren, we broke out the effect of the indirect supply chain and that's one piece of our model, that's the TCS piece.

  • But we really need to leverage that and we leverage that with volume and we had to shift between the direct because of the way it's allocated and so forth.

  • But then what you're directly asking a question about is rebates.

  • It's about 30 to 40 basis point effect.

  • Darren Hightman - Analyst

  • okay, that's what I wondered, okay.

  • Thanks a lot.

  • Jeff Rutherford - President and CEO

  • All right, Darren.

  • Operator

  • And our next question comes from the line of Alan Weber from Robotti & Company.

  • Please proceed.

  • Alan Weber - Analyst

  • Good morning.

  • Jeff Rutherford - President and CEO

  • Hello, Alan.

  • Alan Weber - Analyst

  • I have a question.

  • A year ago or so you had service centers, Stores-on-Wheels and the direct sales, right, and there'd be some overlap of customers.

  • And from your earlier comments it's not clear to me if there was then kind of a confusion over who would be credited with the sales, you know for their compensation.

  • Jeff Rutherford - President and CEO

  • Well, there was confusion.

  • More than likely it was a lot of people got credit for their sales and we did it unconsciously.

  • Now we've set up the matrix so we know exactly who's getting credit for what sale and how the relationships interact.

  • We have --

  • Alan Weber - Analyst

  • [inaudible - microphone inaccessible]

  • Jeff Rutherford - President and CEO

  • -- customers -- Alan, we have customers who would buy direct, buy it through Stores-on-Wheels and buy through service centers.

  • They'll use all three means of transacting.

  • Alan Weber - Analyst

  • But one of the things that I'm -- I hear -- I understand what you're talking about how the customer really will appreciate your bringing back the direct salesperson, but I guess I'm looking -- I'm trying to understand from kind of your employees for their compensation, you bring back the direct sales and I'm assuming like last year, the year before, some direct salespeople left because obviously they thought they could make more money elsewhere, and you bring them back, I can see how you think it increases your revenues, but then are you back to the same spot with kind of who's going to get allocated and then you're trying to then -- do you run the risk of alienating some of your employees?

  • Jeff Rutherford - President and CEO

  • No.

  • No actually, the way we're going to do it is -- and there's a couple of pieces to this.

  • Number one, from a cultural perspective, we're -- I'll take it back and I think I've said this before on calls is that way back when we did some surveying of our people and the good news is that, this is back in November and December of 2005, the good news is that 90% of our people are happy with what they're doing.

  • Man, that's great.

  • They are in a profession; they're doing what they like.

  • And obviously the sales reps wouldn't have generally been in there.

  • But I know sales reps like what they're doing, every one that we talked to, like selling and that's why -- and they're good at it and that's why they're in the business.

  • But back in November and December of last year only about -- the inverse of that were happy with who they were working for.

  • We've worked hard to change that, to appreciate employees.

  • And it's not all just about pay; it's about how they're treated.

  • I'll tell you, the number one gripe that our employees had was their inability to satisfy their customer needs, number one.

  • By far the number one issue our people had was what -- they felt that they were prevented from providing service to their customers.

  • We are working hard on that.

  • We're working hard on refocusing not on corporate leadership, but focusing on customer needs.

  • And we still have a ways to go relative to customer service levels and so forth of really focusing the customer -- or the company back on the customer.

  • That's not a problem in the field; it's probably more a problem at the corporate level.

  • So that's a cultural side of this.

  • To answer your question relative to who gets credit is basically, if you break it down, the way the compensation -- incentive comp works is the service center is evaluated on their transactions.

  • Generally their customers don't transact anywhere else.

  • They're basically transacting in service centers.

  • Then you have the golf customer, the Store-on-Wheels customer, the sale rep customer.

  • So what we were going to do, and we're already doing this at Stores-on-Wheels, is that we take their transacting P&L, what they transact off -- what they transact off their Store-on-Wheels and their costs associated with that, we run a [four wall] P&L, then we'll go back into it, we have the means now to go back into the service center or even over to the direct side, and pick up their accounts they're transacting elsewhere and calculate the incremental gross profit associated with that.

  • And now -- we call that their account-based P&L and that's what we evaluate for their compensation.

  • We'll do the same for the sales reps, we do the same for national accounts.

  • So we have now we have the ability to bridge between transacting P&Ls and account-based P&Ls that we've never had that before.

  • So we recognize the fact that there are going to be times -- and we want this, we really want as much of our revenues to come through the service centers as possible because full truckload in the service center is always going to be the least expensive way for us to get product in the market.

  • And when you get it into the store, generally speaking, under gross profit everything's fixed cost, the rent's fixed, the payroll's generally fixed, other than incentive comp.

  • So we want -- when we look at our sales, we want sales to migrate to the stores.

  • But we understand that we can't force the customer to do that.

  • So customers are going to want to buy chemicals off of Store-on-Wheels and they're also -- when they want to they're going to want to get something out of the store.

  • That's okay.

  • We've got the reporting system now on the operations side to track that and give them proper credit for that.

  • That's the least of our concerns is tracking that now and making sure people get proper credit for sale.

  • Alan Weber - Analyst

  • Well, it's not -- okay, I don't mean just tracking it, I meant really just kind of a cultural way because since there's been -- there was a management change a few years ago, you changed a lot of things at the stores, you added sales reps and you took them away, now you add them back, and it just -- as an outside investor it's impossible to know whether the employees think there really is kind of a direction, which is a lot more important than kind of what investors think to some extent because that's harder to change.

  • Jeff Rutherford - President and CEO

  • I hope they understand.

  • I guess the best way to answer that question is go to the store and ask them because we try -- we're not the best communicator in the world, we're working on that too, that's part of our cultural issue.

  • But I hope that our employees believe we have a direction.

  • That's a challenge we take on every day as to how best to communicate and we're not great at it.

  • But I hope they understand that our direction is about -- is about customer focus, it's about driving gross profit dollars per square foot, it's about we understand how important a part sales rep, national accounts, Store-on-Wheels are to leveraging our model.

  • And our direction now is really towards let's dominate those markets and drive gross profit dollars per square foot.

  • And quite frankly, I don't think that was understood historically or a decision like what was made back in the beginning of 2005 wouldn't have been made.

  • Alan Weber - Analyst

  • Right, okay.

  • Jeff Rutherford - President and CEO

  • [inaudible - microphone inaccessible]

  • Alan Weber - Analyst

  • Okay.

  • Jeff Rutherford - President and CEO

  • That decision was based on driving toward a gross profit percentage versus driving gross dollars per square foot and show me -- show me anybody with fixed square footage that's concerned about gross profit percentage and you're probably talking about a company that doesn't understand their business.

  • Alan Weber - Analyst

  • Right, I agree.

  • Okay.

  • All right, thank you very much.

  • Jeff Rutherford - President and CEO

  • Sure, Alan.

  • Operator

  • And our next question comes from the line of [Joe Pevalich] from Schneider Capital Management.

  • Please proceed.

  • Joe Pevalich - Analyst

  • Hi, guys.

  • Jeff Rutherford - President and CEO

  • Hi, Joe.

  • Joe Pevalich - Analyst

  • Can you give me an update on current trends you're seeing?

  • Have things stabilized or do they continue to deteriorate and are you guys actively going out there and winning back customers?

  • Jeff Rutherford - President and CEO

  • Well, the sales -- by the way, the sales reps we have out there, I know they're winning back customers.

  • So as we get the sales reps on the road, and Rich hears it every day, so if you -- Rich, if you want to say anything.

  • But we're working hard to getting those guys back -- those people back on the road and transacting.

  • The trends we see, trends are the same that we're seeing -- that we talked about in golf.

  • I mean nothing is going to turn on a dime.

  • We're still -- when we pull up sales today, when we pulled up sales, we see that the same trend in the service center, the service center accounts are continuing to grow, the golf is continuing [to climb] today in service centers, and national accounts are where we expect them to be.

  • And we go to Stores-on-Wheels and we're seeing -- we're seeing pressure in golf and Stores-on-Wheels.

  • And when we go over to the direct business and sales reps, they're gone, I mean we're comping against only two or three sales reps, so it's the business isn't there anymore.

  • So what we -- what our expectation would be as we bring back these sales reps, there're going to be direct sales from sales reps where they're selling a fairway application or they're selling lawn and landscape, a big order for a regional buying group or a regional franchise group, and they'll sell direct business and we'll ship that direct from TCS plant or warehouse directly to customer.

  • But we're going to see that we're going to get some transacting back in Stores-on-Wheels and we'll see transacting back in the service centers.

  • That was the trend before they were disbanded.

  • We were seen -- they were -- when we go back -- hindsight is 20/20 and now that we have a better way to evaluate sales, we could see what the trend was.

  • We can see that what was happening as we were opening service centers and those sales reps were affected, we could see the growth.

  • And then we can immediately see when those sales reps went away, the direct business went away and then it started deteriorating in the stores.

  • So from a trend perspective, it -- we've got a couple of people out selling.

  • They're moving but there hasn't been a significant shift in trend.

  • Joe Pevalich - Analyst

  • Okay, thanks.

  • And then what's your expectations going forward for service center comps?

  • When do you expect them to be positive again?

  • Jeff Rutherford - President and CEO

  • Well, there is gong to be an effect at golf but I don't think we've given any guidance on comp yet.

  • Mike Weisbarth - CFO

  • No.

  • Jeff Rutherford - President and CEO

  • We'll take that under.

  • Joe Pevalich - Analyst

  • Okay.

  • And then final question I have is indirect supply chain costs kind of caught me by surprise.

  • I'm just trying to see what the outlook is going forward and shouldn't these costs be declining?

  • Jeff Rutherford - President and CEO

  • As a percentage of sales, certainly they should be.

  • You're asking why they're up?

  • Joe Pevalich - Analyst

  • Yes.

  • Jeff Rutherford - President and CEO

  • Well, why they're up is remember, that's the outsource, that's -- we sold that and you're going to see a related decline in corporate expenses because certain functions that used to be in our SG&A are now handled by our -- by TCS.

  • So we talked about this when the transaction occurred, there's going to be a shift in some of our corporate expenses up into theirs and there are profits in there too.

  • So our expectation is there's got to be an offsetting effect from decline -- SG&A costs at Lesco to pay for the incremental costs at TCS.

  • Now, what has to happen is we need to -- part of our model is to drive volume to leverage those costs.

  • Now, Paul Resnick brought it up earlier that the wildcard in there is if, because we're a majority of the volume through our partner, if they are successful in doing some things from an industry perspective, that would help leverage those costs and we wouldn't -- so that's the wildcard upside to that relationship.

  • Joe Pevalich - Analyst

  • I guess just following up here, sales are basically flat year over year, yet as a percent of net sales, indirect supply chain costs were 6.6% this year versus 4.7% last year.

  • Jeff Rutherford - President and CEO

  • Yes.

  • Once again, there's a shift of SG&A costs from us up into that line for TCS and there are profitabilities in there, too.

  • So what our goal would be is obviously over time if they're successful with their strategy, it would help us leverage those costs and if we drive sales, it helps us leverage those costs.

  • But in the interim, we expected a relationship between the reduction in the SG&A and the increase in those indirect costs.

  • Joe Pevalich - Analyst

  • Okay, so the 4 million in SG&A you had this quarter, we can kind of expect that going forward and then the indirect supply chain sales kind of picks up [net savings]?

  • Jeff Rutherford - President and CEO

  • That's right.

  • Joe Pevalich - Analyst

  • All right, thanks.

  • Jeff Rutherford - President and CEO

  • Sure.

  • Operator

  • And our next question comes from the line of Frank Byrd from Hawkshaw Capital Management.

  • Please proceed.

  • Frank Byrd - Analyst

  • Hey, good morning, guys.

  • Jeff, you didn't comment on the weather and I was just wondering to the degree, especially on the golf side of the business, weather may have impacted the results in the second quarter and then to any degree you could share what you're seeing so far n this quarter?

  • Thanks.

  • Jeff Rutherford - President and CEO

  • Thanks, Frank.

  • I thought you guys hated when we talked about the weather.

  • Frank Byrd - Analyst

  • Well, everybody blames everything on the weather, except you guys in this one quarter, and I'm hearing that from your competitors so that's hwy I bring it up.

  • Jeff Rutherford - President and CEO

  • You're right, I know.

  • Florida's been a challenge weather-wise this year because they've been in a level of drought and it has affected our sales in Florida.

  • But right I have to say, at least right now from a fungicide perspective, I'm not sure you could get a better weather pattern than right now for fungicides.

  • And that's one place where we really need sales reps, guys, I'll tell you that right now, to be out there pushing fungicides.

  • But so fungicide sales should be doing very well now.

  • But during the second quarter what happened in the -- let -- I'll spend a little bit of time on weather.

  • What happened this year in the first half of this year is that -- is that spring broke early in the northeast and it hurt our ice melt sales immediately, we dropped 2.5, $3 million by ice melt sales.

  • So hopefully it snows early this year, we can sell some ice melt.

  • But what it did is it pulled that [pre-emergency] into first quarter.

  • And what happened is it accelerated everything into the first quarter, in the first part of second quarter, then we hit -- we hit a period of time in mid late second quarter where we weren't -- we weren't getting what historically we'd have been selling.

  • And that first quarter issue may have masked some of these issues with sales reps and so forth.

  • But Florida has been a particular problem for us because of the drought in Florida.

  • And that's a big market for us and we have less than favorable weather conditions, particularly in Florida.

  • The northeast, though, has had pretty -- other than the flooding in Washington and Baltimore and the rain, but generally speaking, this has been a pretty good season weather-wise for us.

  • Frank Byrd - Analyst

  • Got you.

  • And then so if your golf sales are down in the second quarter below your expectations, would you hazard a guess as to kind of what percentage of that shortfall may be attributable to weather versus the competitive issues?

  • I mean is it negligible, are we talking 10% or might it be a little bit more significant, maybe 25% or a third?

  • Jeff Rutherford - President and CEO

  • I don't think it's that high.

  • I know that from an industry perspective that there was a big pre-selling season last year in December that has affected the industry.

  • Sold a lot of fungicide last year in December that are probably being used right now.

  • It was driven by some of the industry participants.

  • So that probably is affecting it quite a bit.

  • But I would say it's not -- it's not greater than 10% of the problem.

  • I think we can -- we can focus most of our golf problem on the structural issues and the issue of selling.

  • But you're right, there was an effect in Florida in weather, there's an effect -- and there's an overall industry effect of the big pre-selling season last year in December driven by industry conditions and cost increases and so forth and that has affected sales this year.

  • Frank Byrd - Analyst

  • Got you.

  • And then with respect to the sales reps, you guys are targeting 30 reps, you referenced 17 are already signed on.

  • Can you give me some guesstimation in terms of how long it's going to take to get the 30 guys on?

  • Jeff Rutherford - President and CEO

  • Rich, what do you think?

  • Put Rich on the spot since you brought it up, Frank.

  • Rich Doggett - SVP Sales

  • To have the other ones committed and have the transitions I would say within the next 30 to 60 days.

  • Frank Byrd - Analyst

  • And then to be clear, how many of those would you estimate are going to be sourced externally, hiring guys back, or just salespeople new to the Lesco organization versus guys that used to be sales reps that had been redeployed to, say, regional manager type positions that are being brought back into the sales role?

  • Jeff Rutherford - President and CEO

  • We're thinking right now of the 30 that two-thirds will be people that we have in-house right now that are going to be put back in the positions they should have been in and that the others will come from outside.

  • Frank Byrd - Analyst

  • Okay, so you're saying up to 10 guys could be sourced from outside and you feel confident you can get those guys back within -- I'm sorry, Rich, did you say 30 days or 90 days?

  • Rich Doggett - SVP Sales

  • I said 30 to 60.

  • Frank Byrd - Analyst

  • 30 to 60, okay.

  • Great.

  • And then last question, is there any reason to believe that the gross margins next year, if you saw volumes rise either due to success in bringing volumes back in golf with the new sales reps and/or just the growth from the new stores, so as you kind of undo the de-leveraging effect that we saw in this past quarter combined with the urea issue raised earlier in the call, is there any reason gross margins couldn't be back to the level that you guys had got it to earlier in the year?

  • Thanks.

  • Jeff Rutherford - President and CEO

  • I think that's a reasonable assumption and we have to work through all the volume issues, we have to get a contract that's closer to market, and I think that's reasonable.

  • Frank Byrd - Analyst

  • Great, thanks.

  • Jeff Rutherford - President and CEO

  • Sure.

  • Operator

  • And we have a follow-up question from Greg McKinley from Dougherty & Co. Please proceed.

  • Greg McKinley - Analyst

  • Yes, thanks.

  • I apologize if I missed it, but just curious given what's transpired with the stock price, one of the questions I've been getting a lot of is wondering if there's any consolidation occurring in this industry, transaction activity, acquisitions, et cetera, and are there players out there who are looking to basically have a -- either increase the distribution arm that they already have or to acquire one?

  • Has any of that occurred?

  • Jeff Rutherford - President and CEO

  • No, not that -- of substance right now.

  • Greg McKinley - Analyst

  • Okay.

  • In terms of the product performance in the stores, I know one of the things you guys commented on in the last quarter or two was that equipment sales were particularly weak.

  • Is that a product category that has real good place in stores, you view it as an important offering in the store, or do you view it that maybe that's part of your square footage that you could put different product in?

  • Jeff Rutherford - President and CEO

  • No, I think that there's some opportunity in the equipment category for us.

  • I would say that I think that of all of our categories, that's the one we've probably done -- we've been least affected in.

  • And when I say equipment, not in the -- not in application equipment so much as power equipment.

  • Greg McKinley - Analyst

  • Okay.

  • Jeff Rutherford - President and CEO

  • I think there's opportunity there.

  • I mean you got to think about it that we touch -- a lot of users of equipment are coming into our stores for other product.

  • That's one area that we constantly challenge ourselves on, Greg, is that what can we do better to drive store sales volume.

  • I think there are other opportunities, too.

  • I think there's complementary product categories in landscaping that we need to look at always.

  • One of the things we're challenging [Paul McDunna] in his new role as channel vice president of lawn and landscape is what -- get out there and understand the industry and he understand the industry, what other products, complementary products are -- should we have.

  • And certainly power equipment's one of those.

  • We just have -- we have opportunity there, let's just say that.

  • Greg McKinley - Analyst

  • Okay.

  • Thank you.

  • Jeff Rutherford - President and CEO

  • Sure.

  • Operator

  • And our final question comes from the line of a follow-up for Darren Hightman from Coke & Baylor.

  • Please proceed.

  • Darren Hightman - Analyst

  • At the risk of beating to death the issue of share repurchase, I wasn't exactly sure what you were trying to communicate.

  • Were you saying that you need more time and information before you will know internally whether you want to buy back stock and that'll be based on your maximum cash needs in February and March of next year or are you saying you had the information and it's basically your policy not to let the market know ahead of time whether you will or will not be buying stock?

  • Jeff Rutherford - President and CEO

  • I'll say the latter's true.

  • And certainly it's always going to be a continuing debate within the organization and with the board.

  • Darren Hightman - Analyst

  • Okay, so, well, that's interesting.

  • You said -- I wondered if the board would have to be consulted again before you became active.

  • That's always an ongoing -- that's always an ongoing conversation?

  • Jeff Rutherford - President and CEO

  • We talk to our board continuously.

  • Darren Hightman - Analyst

  • Well --

  • Jeff Rutherford - President and CEO

  • Our Chairman was in this week.

  • We -- but it's not a problem on communication.

  • Darren Hightman - Analyst

  • Well, and that's not really what I was implying I guess, but at some point the board says we've approved this and so it's up to management's discretion without consulting the board under normal buyback circumstance --

  • Jeff Rutherford - President and CEO

  • Right.

  • Darren Hightman - Analyst

  • - -buy back stock every quarter [inaudible] so it's really up to the CEO and CFO.

  • So I guess -- so is that -- is that the case with you so that if you and Mike decided you wanted to buy stock once the blackout is over that you can do that?

  • Jeff Rutherford - President and CEO

  • Yes, I mean we would never buy back stock without the board approval.

  • You're saying once --

  • Darren Hightman - Analyst

  • Well, the board approval is in place.

  • I'm just wondering if it's still good.

  • Jeff Rutherford - President and CEO

  • Oh.

  • Darren Hightman - Analyst

  • I'm making this more complex than I wanted to.

  • Jeff Rutherford - President and CEO

  • I'm just not going to comment on it.

  • Darren Hightman - Analyst

  • Okay, that's fine.

  • Thanks.

  • Operator

  • And at this time there are no further questions.

  • I' would like to turn the call back over to Mr. Rutherford for closing remarks.

  • Please proceed.

  • Jeff Rutherford - President and CEO

  • Thanks, operator.

  • We want to thank everybody for their participation today.

  • We look forward to communicating how we're going to bring back our sales reps, how we're going to drive sales and the future direction of the company.

  • So thanks for your participation.

  • Operator

  • Thank you for your participation in today's conference.

  • This concludes the presentation.

  • You may now disconnect.

  • Have a wonderful day.