強鹿 (DE) 2006 Q3 法說會逐字稿

Good morning, and welcome to Lesco's Third Quarter 2006 Conference Call and webcast.

[OPERATOR INSTRUCTIONS]

Portions of the presentation and other statements relating to sales and earnings expectations, new service center openings and profitability, the company's ability to implement its sales representative strategy 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 today's press release along with the company's Securities and Commission reports, including, but not limited to, Form 10-K for the year ended December 31st, 2005.

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

These non-GAAP financial measures have been identified and described in the company's press release, which is available on the Lesco website at www.lesco.com.

I will now turn the conference over to Jeff Rutherford, President and CEO.

Thank you, Operator, and thanks to all of you for joining us today.

With me today are Bruce Thorn, our chief operating officer, and Mike Weisbarth, the chief financial officer, as well as other members of our senior management team.

Rich Dogget is not here with us today.

He's at the Pest Management Industry Show in Dallas meeting with customers and that's where he should be.

But if you have questions concerning sales issues and other things going on with sales, we will give our best answer to those questions also.

While our business remained challenging during the third quarter in light of a competitive marketplace and higher raw material and supply chain costs, we are encouraged that we are moving in the right direction on our key long term growth initiatives, including the service center model and the rebuilding of our sales rep model.

That said, we do not feel that our results from a financial perspective are acceptable.

But we have communicated that we will take -- it will take time before we see meaningful contributions from the rebuilding of our sales force.

We know we must have the team in place to start rebuilding and developing our new relationships with customers as soon as possible for us to realize the benefits down the road.

Therefore, we have and will continue to incur additional costs that will depress our results.

As we discussed in July, we believe that in 2006 the accounts that were handled by sales reps back in 2004 before the program was disbanded will produce sales nearly $60 million less than what they would have -- what we would have expected if the sales rep program would have remained in place.

We are committed to rebuilding our position in this portion of the model but know it's going to take time.

We also incurred a decline in gross profit in the third quarter that will carry through into the fourth quarter.

The decrease in product margin is due to higher raw material costs for urea, a second derivative of natural gas used in our blended fertilizer and combination products, and a decline in grass seed product margin from cost increases that were not passed through to customers for whom we had established -- already established pricing.

It has been our strategy the past three years to lock in to contracts to purchase commodities, in particular urea, and while we benefited greatly from favorable pricing in 2004 and 2005, we incurred a significant reversal this year.

Our contractual costs have been higher than market costs, which has caused a more intense competitive pricing environment, in particular from those who are buying urea at spot market.

When our contract expires by the end of 2006, we anticipate purchasing urea closer to market costs, which should allow us to improve our competitive pricing position in the industry while maintaining a desirable product margin.

The lesson we unfortunately have learned the hard way is that our expertise is in adding value for our customers at the store and rep level, is not in forecasting the future costs of commodities.

In fact, the experts who advise us regarding the decision to lock urea prices were obviously wrong and -- as were a lot of other people about natural gas.

Markets tend to be efficient over time and based on that promise, we need to align our costs closer to true market costs to the underlying commodity and implement a flexible pricing structure that will result in a higher margin business over time.

On average, our urea costs were more than 20% higher than the market for the quarter and we are currently not anticipating much relief between now and year-end.

We are buying urea based on a contract that was negotiated in 2005 when outlook for urea pricing was expected to be at or well above our $280 per ton contracted cost.

The market price has been below our cost all year.

In fact, recently the urea was at $195 a ton for a short period of time.

And although earlier this year there were indications that costs were expected to increase in the second half of the year, that didn't happen.

Additionally, we have experienced gross margin contraction that resulted in seed product pricing.

With certain customers we entered into short-term commitments to sell seed based on our assumptions for anticipated seed cost.

This year the fescue grass seed harvest turned out to be softer than we had expected, resulting in higher seed costs.

However, since we had already entered into a number of pricing commitments with customers, we have and will continue to honor those contracts.

Again, our business is not to speculate on commodity pricing but to serve our customers and supply them with their turf care needs.

Therefore, we anticipate adjusting our approach or attempting to adjust our approach to pricing commitments in order to provide more flexibility to better reflect actual market costs.

Additionally, we have not benefited from the outsourcing agreement we completed in 2005.

The advantages of the arrangement for Lesco are based on an assumption of increasing revenues.

Since our revenues are going to be relatively flat this year, we've not been able to leverage our agreement.

While all of these issues will contribute to the loss we are expecting to incur this year, there is one additional area that will also impact our 2006 results, a shift in sales through our early order programs, or EOPs, from the fourth quarter this year to the first half of 2007.

Historically, the green industry and Lesco have provided customers certain incentives to purchase their products in October through December for their needs the following spring.

During EOP we have offered incentives such as price discounts for our customers to take product early, extended payment terms at a cost to us, and in come cases further price discounts to assist our customers in paying for storage to take the product early and warehouse it over the winter months.

Based on market research, including significant numerous discussions with our customers, we now believe that our customers will not be making early purchases as aggressively as they have in the past.

In fact, the customer would much prefer to buy closer to the time of application to avoid the need for costly warehousing and costs associated with having to buy early to receive incentives.

Therefore, in conjunction with our vendor partners, we have extended our EOP program into 2007 and we estimate that up to $15 million in sales could shift from the fourth quarter of 2006 into the first half of 2007.

With all this going on, our core business remains solid as our service centers had a net sales increase of 11% and we're up 2.7% on a same store sales basis, a significant improvement form last quarter's results when we reported a decline in comparable sales.

Additionally, sales through our store segment grew approximately 7% during the quarter.

Furthermore, our mature stores, those open before 2003 and which have been most impacted by the discontinuation of the sales rep model, are showing positive sales growth of nearly 2%, even though they experienced a 70% decline in golf customer sales.

Overall, our service center owned accounts, which are those whose customer relationship is maintained by service center personnel and generally only transact in service centers, were up 13% for the quarter.

This more than offset the 6% decline in sales to accounts historically maintained by Stores-on-Wheels operators and golf sales reps.

In fact, store segment sales from customer accounts that used to be serviced by prior sales reps declined 11% during the quarter and are down [9%] year-to-date through September 30th.

The 107 service centers we have added since the beginning of 2003 continue to perform at or above our modeled expectation.

We've made solid progress in reinstituting the sales rep model and have now placed 34 reps in key markets.

We have 25 reps focusing on the golf channel and nine reps targeting customers in lawn and landscape channel.

Approximately 20% of those reps have been hired from outside our organization.

While we are encouraged by the direction, again, I want to remind you, as we have previously conveyed, that we expect to take -- it to take two to three years to reestablish the lost customer relationships and rebuild sales across all selling channels.

We continue to believe that our concentration on further developing the store segment will drive sales growth and improve operating margins going forward.

As we have continued to refine our model, we remain focused on our organic sales growth and driving gross profit dollars.

With relatively fixed real estate and operating costs, a substantial amount of store expenses are leverageable and expanding same store sales growth should improve our return on sales.

On the expense side we continue to control operating costs and manage working capital but we know we still have room for improvement.

We are working on solutions to help drive down those costs.

We have also taken the necessary steps to maximize the potential of our extensive store network, which is one of Lesco's competitive advantages.

Our focus remains on the store model, which provides a high return on investment.

With the expansion of our sales rep model and as the newer stores begin to mature, we anticipate that gross profit per square foot will increase and leverage the fixed costs of our operating model, thereby improving overall financial results.

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

Thanks you, Jeff, and good morning, everybody.

Hopefully you've had an opportunity to go through the details of our release that we sent out earlier today.

For the third quarter in 2006 the company's consolidated results were at a net loss of $2.3 million, or $0.25 per diluted share, compared to a net loss of 16.2 million, or $1.82 per share, last year at this time.

The 2005 results include $2.23 per diluted share impact for costs related to the sale of supply chain assets and $0.34 per diluted share impact for the markdown charge to restructure our part sourcing model and our product offering.

The year-over-year profit decline net of charges is primarily attributable to a decrease in product margins in our fertilizer and grass seed categories due the factors that Jeff discussed, along with anticipated higher indirect supply chain costs because we're not leveraging those costs on declining sales.

Additionally, incremental selling expense for our new service centers and Stores-on-Wheels have contributed to our third quarter loss.

In our store segment, net sales increased over 6% for the third quarter in 2006 to $152 million from $143 million in the comparable period a year ago.

Our service center sales increased nearly 11% while our Stores-on-Wheels sales declined 12%.

Our service centers achieved almost 13% growth with their lawn and landscape customers.

However, without the support of the sales representatives that Jeff mentioned, our golf customer sales within service centers declined 6% and close to 10% in our Stores-on-Wheels.

Gross profit as a percentage of net sales on the store segment was 21.1% compared to 27.1% in the same period last year.

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

However, costing and pricing pressures on fertilizer and seed products reduced our gross profit more than previously expected for the store segment.

Our third quarter indirect supply chain costs include $4.4 million of expected cost and an additional $2.4 million due to increased and estimated cost allocations related to the outsourcing of our supply chain services.

Store segment selling expense increased $2.1 million on a comparative quarter-over-quarter basis.

The 48 new service centers and four new Stores-on-Wheels that we've added since the second quarter of 2005 contributed incremental selling expenses of $2 million.

We did plan for this increase in selling expenses and continue to track in line with our full year expenses -- expectations for these expenses.

Merchant discount expense increased 20 basis points on a year-over-year basis to 1.9% of net sales due to higher discount rates, as well as a change in our customer credit usage mix since customers are paying for an increasing amount of sales with national bank credit cards rather than cash, check or private label credit.

Now, onto our direct segment.

Our direct segment net sales were $13.1 million for the third quarter versus $16.4 million during the comparable period last year.

The change is primarily attributable to the loss of bulk product sales.

In 2005 we sold $2.6 million in bulk excess products.

We, however, no longer participate in these revenues since the sale of our manufacturing assets, which were sold in the fourth quarter of last year, and these sales generally come out of those manufacturing facilities.

Gross profit as a percentage of sales decreased 320 basis points to 11.6%.

The decline in gross profit on a quarter-over-quarter basis was primarily due to the increased supply chain costs along with pricing pressure on our urea-based products.

Selling expenses increased in the direct segment for the third quarter resulting from contractual marketing expenses along with the costs associated with adding sales reps during the quarter.

Within our corporate costs, selling expense declined $600,000 for the quarter versus the third quarter 2005 as we continue to manage our year-over-year reductions in selling expense in the corporate segment.

General administrative expenses for the third quarter declined to $4.3 million from 4.8 million in the same period last year, mainly due to a $400,000 benefit from a favorable arbitration judgment.

Corporate merchant discount expense was flat at $700,000 and pre-opening expense was also flat on a year-over-year basis at $0.5 million.

Turning to our balance sheet, as of September 30th, 2006, our cash and cash equivalents was $16.8 million versus 7.3 million at the same time last year.

Now, this year at the end of the third quarter we had no debt compared to $13.5 million of debt at the end of the third quarter last year.

As we have previously disclosed through our SEC filings, in September we replaced and expanded our credit facility.

Our new facility with [National City Bank] has a $55 million revolving credit agreement, which replaces our prior $50 million line.

We anticipate that this expanded line will provide us with additional flexibility during our seasonally lower sales volume periods in the first and fourth quarters of the year.

For the year we have spent $1.5 million to repurchase over 95,000 shares under our stock repurchase program.

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

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

Finally, we're updating our 2006 guidance.

A number of things have changed since we last spoke to you after the second quarter and our outlook for the remainder of the year has changed.

Our updated guidance is due to revised outlook for the raw material cost environment for urea and seed and a shift in the timing of our early order program sales.

Due to the high visibility of urea costs and the competitive market, we are unable to maintain previous selling prices and correspondingly our historical product margin range.

While in prior years we were right on -- we were on the right side of the curve with our urea contracts, we expect that our product margins will remain pressured until our urea contract expires at the end of this year, after which time we anticipate purchasing closer to the spot market costs.

We now also expect our seed product margins are going to be less than what we previously anticipated for the back half of this year.

As Jeff mentioned earlier, the higher costs of our fescue seed blend, coupled with our pricing commitments to customers, is impacting the margin.

Based on all these factors plus EOP shift mentioned earlier, we now expect a net loss for our fiscal year December 31st, 2006 in the range of 16 to $20 million.

This is based on net revenue growth that's expected to be between 2 and 3% and gross profit rates of 22.3 to 22.8%.

And that would be in the store segment.

In the direct segment our net revenue decline is expected to be between 32 and 33% with a gross profit rate, including our distribution costs, of 14.1% to 14.9%.

Now, I realize this is a very broad range, but although we've estimated a $15 million shift in EOP sales, the uncertainty of the demand for early purchases is highly unpredictable at this point, as the majority of EOP purchases occur in mid-November through December.

So with that, I'll turn the call back over to Jeff for some concluding comments.

Thank you, Mike.

Our performance must improve and we are taking the steps to remove all the barriers that prevent our people from serving their customers, while increasing accountability in all support functions, which is mainly our corporate office.

Focus on expanding the proven service center model, the implementation of better processes for contractual commitments and the solution to drive sales by reinstating our sales rep program will contribute over the next few years to improve the company's financial results.

It's going to require patience and persistence but we are committed to the creation of value in our model and will make whatever changes necessary to do that.

It's critical for us to leverage this investment in our service center square footage in order to maximize gross profit dollars per square foot, which means driving sales volume.

But we must have their cost -- the cost side of our model aligned also.

Rather than trying to predict the movement of commodity prices, we intend to focus our efforts on the parts of the business where we have expertise and add value to our customers while delivering products that are priced competitively.

Making the assumption that markets are efficient and adding flexibility to our pricing structure will better align our selling price with our costs.

Our changes to EOP should contribute toward long-term margin improvements and though our results will suffer in 2006 from the expected shift in EOP sales, it is the right thing to do for our customers and for Lesco in the long term.

The store model is working.

We are making progress in rebuilding the sales rep model, which will only contribute to additional sales in the store model.

And our commitment to creating an organization that delivers premium customer service will result over time in the foundation for consistent delivery of improved results.

With that, we'll open up the call to questions.

[OPERATOR INSTRUCTIONS]

And your first question comes from the line of [Darren Hightman] with [Cook & Bealer].

Please proceed.

Good morning.

Hi, Darren.

Regarding your mature stores showing 2% growth, is that a change from earlier in the year?

Wasn't that negative?

Yes, it was.

It was negative low single digit negative comps, yes.

It's a pretty important inflection point.

I would assume that you would expect those comps to stay positive going forward?

Yes.

And then when you look out to 2007, I know you're not going to give guidance, but it should be a pretty clean year given all the things you've gone through this year and I guess I'm just wondering if you'll comment on how confident you are that you can post a profit in 2007.

Well, Darren, obviously we're not going to give guidance today, but what we've tried to do is lay out all the things that have been done to us or we've done to ourselves this year and whether those are going to be continuing items or not.

So unless we make a mistake in commodity pricing next year, we would hope that we would be selling more or buying more at a market price and improving margin.

The key to next year, there's a couple of keys to next year, but obviously one is the performance of the sales reps.

And we're not ready to make significant promises relative to sales reps, but we're ahead of schedule in bringing people back.

I think Rich Dogget and his team have done a very good job of tracking key people and we're positive about their ability to contribute.

That's going to be key to us turning the model to a profitable model in the short term.

We have other things that we're addressing from an operational perspective.

We're still not satisfied with our level of customer service relative to local delivery, whether -- relative to the ability to be in stock with product at the right time at the right store and so forth.

So we have other opportunities that could significantly affect our operating results, maybe not in the short term but in the longer term.

So we're not satisfied with everything we do.

And we kind of write these scripts for these calls and it sounds like everything's going well and so forth, and it is in the service centers, but we have opportunity throughout the organization.

And my frustration is our inability to capture those opportunities as quickly as we can.

We continue, as I said, to have customer service supply chain issues.

We have credit issues at times.

We still have [inaudible] issues.

We have a lot of opportunity to address our shortcomings and improve the operating results of this company.

The thing that does work, that no one here, at least in this room, can take credit for, is those service centers work.

Now, we did some things to those service centers relative to sales reps that pulled sales out of those service centers.

We're going to get that back in there.

But the one thing that absolutely positively works in this model are those service centers.

Our job is to remove the barriers from those people in the field from being able to service their customers.

And right now, quite frankly, I don't think we're doing a good enough job to do that -- of doing that.

Okay.

Thank you.

Your next question comes from the line of [James Bank] with Sidoti & Co. Please proceed.

Hi, Jeff.

Hi, Mike.

How are you guys?

Hi, James.

I just want to know; your top line seems to be working, I think your aggressive approach to the store expansion, all that seems to be doing it for you.

I guess -- and you just did speak quite a bit about 2007, but I guess -- I'm just not even going to ask that because I guess you can't really give any guidance on that whatsoever.

But I think the problem I'm having is you seem to still have some problems with de-leveraging, there still seems to be some [hidden] costs here.

Is this something that we might see into '07?

Is this going to be something where we might turn around and think, wow, maybe we shouldn't have gotten rid of the supply chain because all of a sudden now we're at the mercy of [inaudible] costs?

And on top of that -- well, why don't you just go ahead and answer that and then we'll get into the pricing structure because I'm not sure if buying urea at the market is necessarily the answer.

Natural gas will rear its ugly head again.

I'm just wondering if you will continue to hedge that stuff.

Well, let me answer the last question first.

If we ever are confident we're in a position that we could take a long -- a six-month position on urea because where we think urea pricing in particular is going and we can get good deals, we'll continue to do that.

I don't think we'll ever enter into an agreement for 100% again.

It just didn't give us very much room to move the market move.

But there is certainly -- we're not -- we could look at a third or two-thirds or a half over a six-month period of time.

The idea of entering into any long term commodity fixed costs like we did for 100% of our product really set us up either for great failure or great benefit because obviously a year ahead of time I don't think any of us can predict what natural -- none of us -- [you can say we will], there are very few people that would have predicted natural gas is where it is today a year ago today.

Absolutely.

And certainly the guys that were advising us didn't.

But that's the nature of the commodity business.

The question on the sale of the manufacturing facility is they are doing what we expect them to do.

In fact, it's not that -- it's not that their costs shifted significantly, which I think based upon our estimates it's slightly higher but it's less than $1 million or close to $1 million higher than what we had originally estimated for the model, it's that we're just not leveraging the relationship because we're not driving sales.

Now, if we can perform at the top line next year like we should, like the model would indicate, now we haven't completed our planning process, but the model indicates that we should have a good sales year next year.

If we do that, we'll leverage that relationship.

In fact, I met with [Bill Millowitz] from TCS last night and the model -- the relationship is working.

All relationships could be better.

We can do a better job of working with them.

We have -- we have the commitment from TCS.

They're going to work with us on some of our ideas to help remove some of the costs from the supply chain, to possibly streamline the supply chain more on the regionalized basis.

We're going to be piloting things; we're going to be trying some things with the help of TCS to do that.

And I'm perfectly comfortable with the management of TCS and ownership of [Platinum] that will work with us in doing that.

So I don't think that it was a mistake.

I don't think -- it's too early to call whether we should have kept manufacturing facilities or not.

Really what happens over the next three years will dictate whether that was a good decision or not.

If those guys -- quite frankly, if those guys are successful in going out and leveraging that model on their side and we participate on it, it'll be a homerun.

If not, it's really just a financing arrangement.

Okay.

Okay, that was very helpful.

Then I guess looking at next year and just hopefully assuming that some of these costs will begin to mitigate, can you just sort of discuss really the lawn care, professional lawn care and golf industry overall and what type of growth you're seeing there, what type of spending you're seeing from the golf courses and really what's going to benefit you at the top line there?

I'd start with golf.

We're probably the wrong guys to ask what's going on in the golf industry because obviously we got rid of our sales reps.

I mean I say that sarcastically because -- but because we took ourselves backward in the golf industry because we eliminated those sales reps.

I mean we shot ourselves in the foot and we're bringing it back.

I'd say from the golf industry perspective what's going on is there obviously isn't going to be tremendous expansion in acreage in the golf industry and I don't know what the current statistics are, but between new golf course openings and closings, it's probably going to be relatively flat for the coming period.

Okay.

So the industry is not growing, so really what the challenge is for golf course superintendents, they're really being challenged, depending on the course, to be better business people because they don't -- the golf industry isn't expanding and golf in general grounds are not going to take off.

Depending on region, they'll increase in certain regions but relatively flat to a little down.

So revenues or fees or dues, whatever you want to use, are going to be a little bit compressed.

So if you go to the Golf Course Superintendents Association information, what they're helping superintendents do are becoming better business people.

So superintendents are constantly looking at how can they do things better to control costs within the golf course.

And I would say that based upon that, I wouldn't expect a significant increase in spending on consumables within the golf industry.

What we need to do, and our opportunity is between our network of service centers, Stores-on-Wheels and now back with sales reps, we can offer them an opportunity to help their business through leveraging our infrastructure and utilizing our private label chemicals and in our branded chemicals with our more efficient means of getting it to a golf course.

And so we want to partner with golf courses to help them achieve their business objectives and that's what we were lacking when we didn't have the sales reps.

From a lawn and landscape perspective, the business just continues to grow.

As the baby boomers age and as people are time constrained and all, from work and from children and grandchildren perspective, and they're willing to outsource that, that portion of the industry continues to grow.

We anticipate it's going to grow on the consumables around 4% or so industry-wide.

And obviously that piece of the business, James, is really -- and we don't do a real good job of explaining, but within our service center, when we talk about service center, transactional sales of service center accounts, that's really the growth piece for us.

That's the customer that comes in when we expand service center, that's the customer that if we're more involved in the industry and with the local lawn and landscape people, they'll -- and that's what really lawn and landscape sales reps are expected to do, will drive sales in there.

That piece in the quarter grew --

13%.

...13%, so the -- we think the industry's growing at 4%.

That piece of the industry grew 13% just in the third quarter, so that's the power of the model --

Right.

...what we're doing well is really that store model.

Now, and I'll say it again, we're not doing a good job of supporting those stores like we should be, but those stores and the people in the stores are doing a good job of driving sales.

Okay, okay.

And you spoke about consumables.

Any type of growth rate you could put on the equipment side, even though that is a smaller part of what you do.

But you sell from your service centers, but is there any number you might be able to put on that that we could expect in the next -- ?

In just power equipment?

Yes, the riding mowers you offer at your service centers and al the other power equipment that you have.

Well, we differentiate equipment between application equipment, so the application equipment, the spreaders and the sprayers, pretty much follow the consumable.

Right.

So they'll grow with the consumables and as we expand stores, that grows and so forth, so that's been -- that continues to be a good business for us.

From a more equipment perspective, it's relatively flat for us.

Your know...

Okay.

...are obviously other people in the industry are doing a better job than we are in power equipment.

Okay.

And we need to do a better job there, too --

Okay.

...quite frankly.

We have -- we are flat on an expanded store count, which is we have some new people in to run that piece of the business for us and we expect to do better next year.

Okay.

All right, well, terrific.

That's all I have.

Thank you.

Your next question comes from the line of [Paul Reznik] with [Dutton Associates].

Please proceed.

Good morning.

Hi, Paul.

Hi.

On the same store sales, that is an improvement.

Any particular thought about what drove the better same store sales?

Well, we're starting to stabilize the issue of the sales reps, Paul.

Those comp stores really got hit hard by the absence of the sales reps.

You've got to remember, within our service centers, and I just talked to James about the fact that we have -- the very important piece in our service centers are the service center accounts and that's the smaller and regional lawn and landscape customer.

And then the other components of a service center from an account perspective are golf and then national accounts.

That's how we break it down.

And national accounts is growing at about the industry growth of lawn and landscape within our stores.

What happened is we're growing in that -- those service center accounts, we're participating in industry growth in the national accounts and we're negative in golf.

What happened in the mature stores is they've fairly saturated their lawn and landscape customer base.

And if you take a major piece out of their business, they're going to negative comp.

So what happened when the sales reps were discontinued, this year our competitors came in and were taking sales that should have been transacted at those services centers and they went negative.

And really those service centers are not suited to drive golf sales.

That's not what they're designed for.

They're there to service the service center customers and then support the golf sales rep customers, the lawn -- the sales rep customers in the national accounts.

And so if you -- if we pull out a piece of that business like we pulled out golf, they are fairly defenseless as far as being able to get that business back.

I mean they do, but that's not really -- those stores and the people in those stores are really not designed to go out and build relationships with golf course superintendents.

It happens, but it's not by design.

So when we pulled out that golf business, they went negative comp and they had a hard time making up for those lost sales.

What we're seeing now is they're starting to make up for those lost sales.

They're -- and we're trying to patch up what's going on in golf, but we're coming up on really an anniversary of the comp of those sales reps being away and what you're seeing is what those stores should have been performing and would have been performing had we not done what was done with the sales reps.

You say it's going to take two to three years to rebuild some of these relationships, what you're saying is that you're already seeing some benefit from having those 34 reps in place?

Yes, 25 of them are golf and I just have to say that they're all good people and we're going to spend time with them and Rich and his guys are doing a good job and Steve Vincent is running that -- is managing that golf sales rep group and Paul McDonough is managing the lawn and landscape sales rep group.

Those guys know the industry, they know their customers, they're motivated.

We did it before and I guess what I'm saying, we're going to do it again.

We have good people in there, we're not just taking people to take people.

We're looking for the right people, we're bringing them in and I expect that they're going to exceed our expectations.

I guess I can't expect them to exceed expectations, that doesn't make any sense.

But we have expectations, we have a model for them and I wouldn't be surprised if they do better.

The Stores-on-Wheels, now that was a total sales down 11.6%?

Yes.

And you've got actually more Wheels going out there?

I mean they're smaller trucks and -- ?

Right.

In conjunction with -- when the sales rep changes were made we added 38 Stores-on-Wheels and so we jumped from 73 to 111 and then we had three additional early this year that actually we had already leased so we put them out and found a place for them to operate.

So we have jumped from 73 to 114 and -- but most of them were there by third quarter last year.

Yes, they were.

They were there by third quarter last year, okay.

So they're comping against themselves now.

Okay.

And lastly, SG&A down year-over-year but up sequentially, anything in particular driving the SG&A costs up?

No, that was in our expectations, Paul.

We have certain seasonal expenses within SG&A as well.

Okay.

All right, Paul.

Thanks.

Bye.

Your next question comes from the line of Greg McKinley with Dougherty & Co. Please proceed.

Thank you.

Guys, wondering if you could just refresh my memory in terms of when you're talking about these urea contract costs and the desire to buy out a market rate going forward.

How's that going to -- when does your contract commitment expire and when would we expect to see you begin buying at a market rate?

And then can you talk to us a little bit about how that change is impacting price negotiations with customers as you settle on purchase terms for the next growing season?

Well, the -- when was the contract entered into?

Is that the first question?

Yes or when will you -- yes, when was it entered into and when will you begin buying off of the contract -- I mean not on the contract.

It was entered into -- for last year it was entered into in the third quarter --

Okay.

...of 2005.

I remember we first started discussing it around the July, early August timeframe.

And so it was entered into before the end of third quarter.

And then it expires by the end of this year.

Okay.

Last purchases will be in November?

November.

In November.

Okay.

And then so we'll be committing and purchasing at more of a market rate in December, but you're not going to see any of that come into -- in sales until next year.

Okay.

Because it'll be actually purchased by TCS, run through that network, blended, bagged -- or coated, blended, bagged, distributed, so sometime in the first quarter next year.

Yes, okay.

And then when you're dealing with your customers for next growing season, for instance you guys made mention of this early acceptance program which will be extended into the next year, so how are you planning on pricing product with them?

I guess the pricing is always going to be market driven with them and you're just hopefully reducing your costs by buying at a market rate now?

Well, yes, and what we'll be selling in early order program is the older urea, so it's going to be at 280 a ton.

Okay.

The thing we need to look at and we need to work with our customers, quite frankly, is working through the pricing issues.

If we have a substantial number of customers that want to lock in pricing --

Yes.

...theoretically we should lock in urea prices behind it.

And there may be customers who want to do that.

Maybe other customers that are willing to go into the market in particular next year where there's at least the anticipation is that urea costs will continue to decline or stay low, that they're willing to take a chance.

So I think that we have to be adaptable to customer's desires also.

Yes.

And if we have customers that want to come in and lock prices and are willing to commit to that, there's nothing wrong with us locking in a proportional amount of urea behind that --

Sure.

...but if everybody wants to go in and say, hey, we're going to take our chances in the marketplace --

[Then you need to do, sure].

...and they will go with us.

And in fact, what we bounce around is we have customers that want to just ride -- that say, hey, look, here's the cost, here's my price and here's the urea cost -- everybody knows what urea cost is.

The industry has done a very good job of educating everybody on what the cost of urea is.

And if people want to go in and just do it based upon agreed-upon price, based upon a two-month lag in urea costs, we'll entertain that, too.

So I think that we need to spend more time understanding what our customer needs are and balanced with what our needs are and we'll adapt accordingly.

Okay.

And then as you look at 07, then, as you indicated, when you sell product early next year it'll be product that you acquired under contract at the higher price.

So how should we think about the transition of cost of goods?

When will we see market-based pricing run through your cost of sales?

Will it happen late next year after -- I don't know.

It'll happen -- it'll start happening in the spring pre-emergent sale.

We start getting into pre-emergent fertilizers, we'll start seeing that new price.

Okay, that's helpful.

Thank you.

All right, sure.

Your next question comes from the line of John Walthausen with Paradigm.

Please proceed.

Yes, good morning.

I just had a couple of questions, one first of all on the cost of urea in the new year.

Wouldn't the normal accounting fee to mark it down to market because it's a commodity, so you're starting at market price at the beginning of the year?

Well, we're not really buying it as a commodity; we're in a fixed price contract for urea.

And we're still selling it at a profit; we're just not selling it at...

Okay.

...fair profit as we would if we had bought it at market.

Okay.

On a different thing on the reps, I think last quarter when you talked about hiring them, you posed that it wouldn't create any cost or any drag on the income statement.

As you've developed the program is that still the correct analysis?

Yes, we feel that these sales reps will pay for themselves.

So it's between lines but we'll have additional selling expense, and that's where our comments were today, but that they'll pay for themselves at the margins that they generate across all the segments.

So it's effectively built into that revised guidance.

Yes.

And it'll be built into any guidance going forward.

Right.

I mean presumably any sales guy pays for himself, but you mean without a lag where we'll see the payoff in next year's June quarter [inaudible - microphone inaccessible] in the March quarter or something like that?

I'm trying to get a better fix on that.

Well, there obviously is a time period where we've hired somebody on that they're not immediately making sales.

But we don't expect that to be a significant cost to us in the future.

And it's built in to whatever guidance we'd provide.

Right.

Okay.

Well, yes, but obviously you haven't guided for next year.

No, we haven't.

I'm trying to figure out here a little bit.

And I guess the other point you said, okay, we've done this before with the direct reps, we can do it again, but there seems to have been a flaw in the model last time around in that you weren't correctly measuring their productivity and hence you -- that's why you disbanded it.

My sense is you can't really manage a sales force unless you can manage -- unless you can measure the productivity.

Is that in place now or is it -- do we really know what they're contributing sales guy by sales guy, call by call?

Well, let me just say we've -- I guess I agree that historically we weren't measuring them correctly.

I agree with that.

I would say today, and if you listened closely you'd have heard a sigh from our CIO when you asked that question because we've changed that and we now have a means -- just historically, just to put this in a historical perspective, up until the beginning of this year we had two sales models within our organization.

We had a transactional sales model that tracked where sales were purchased, so service transactions, Stores-on-Wheels transactions, the direct business transactions, and then there was what was called -- referred to as account-based sales model that didn't run through a full P&L but tracked sales and product margins, I believe, and it was based on account ownership.

And the two -- and this was a frustration for this company I think for a relatively long period of time because the two were never reconciled and discussion of reconciliation, you might as well have asked people to reconcile Spanish to Mandarin Chinese because the -- it was an impossibility in everyone's mind.

Well, to Kevin Wade, our CIO's, credit, we found a way to do that at the beginning of this year.

We now took -- we took that model and it -- and we shouldn't get any great accolades because it's not-- I just took away his compliment.

But the point is, a sale is a sale, right?

The reason they didn't reconcile is because in the account-based sales they double tagged accounts and if you would have added up all the account-based sales it was greater than the whole.

So we've reconciled that out and we run P&Ls that way now, too, so if you look at a sales rep, we can take a sales rep, what their responsibility is, regardless of where their accounts are transacting, and run a P&L for them.

So we can measure their effect.

We do the same thing with Stores-on-Wheels.

Many of the Stores-on-Wheels accounts transact through service centers and we want them to.

In fact, we want, if you go back to the sales reps, we would love all of our sales reps accounts to transact at the service centers because that's going to be by far the most efficient way for us to get product to the marketplace.

Right.

But that's not going to happen.

They're going to transact -- the accounts are going to transact wherever it suits them to transact, not necessarily where it suits us to transact.

So if it makes sense for them to get product from the service centers, they're going to get product from the service centers.

If it makes sense for them to buy off the Stores-on-Wheels when it shows up every other week, they're going to do that.

If it makes sense for us to ship six tons of product into them, they're going to do that.

We can take their accounts or their responsibilities and we can run a P&L at every level now.

So if we were to have gone back and done that 18 months ago or whenever that decision was made to get back with the sales reps, we would have looked at those accounts and said is it reasonable that in this P&L for this sales rep that if we get rid of the sales rep that we're going to be able to hang onto those sales.

Now, it probably -- of course it wasn't reasonable and it wasn't reasonable then and it certainly wouldn't be reasonable now, even with our current accounting.

So what I'm telling you is we've worked through all this.

We've created the P&Ls to be able to track sales reps, to track Stores-on-Wheels, to track servicer centers and to track the regional businesses and roll it up and understand our business better.

And when we -- when these sales reps come back, we've already created the P&Ls to track their effectiveness in their market.

Okay, good.

And then final question is what's the plan for store openings next year?

We haven't given guidance on that either but what we said it won't be fewer than 20.

Okay.

Okay, good.

Thanks a lot, Jeff.

Sure.

And your next question comes from [Ed McCormick] with [Micah Partners].

Please proceed.

Hey, Jeff.

Hey, Mike.

Good morning.

Question for you on sort of the specific steps that the direct sales are winning back some of the -- some of the order flow from the golf courses.

Are they focusing on pricing because clearly the accounts were lost, so are they focusing on pricing, is it service, is it some other element that they can deliver to add value to the golf course customer to bring them back?

How do they get that customer back?

In specifically golf?

Yes.

Well, in golf it's really the relationship with the superintendent.

And that's the tough part of the sale, that's why we lost so much when the sales reps left.

And generally speaking, and I'm not speaking for all the golf industry, but generally speaking a given superintendent will buy from two to three sources.

And you -- and they're going to make their decisions who they're going to buy from early on.

And when I was out hearing from golf course superintendents and trying to explain what happened, what I heard a lot about was the thing that really was disturbing about what happened is in all the turmoil of suppliers to the golf industry, the golf industry generally, and this was one superintendent talking, could depend on Lesco to be there.

We were maybe not the -- didn't have the best customer service because, quite frankly, we have issues with local delivery of greater than two ton product and we're going to address that issue.

But we may not have the best customer service, we may not have the best pricing, but we were dependable and we were going to get the product to them.

So one day he woke up and his sales rep was gone and it was -- and now he's searching for another source, a dependable source for product for his golf course.

We need to get back in with these superintendents and show that we're going to be back in the industry, we're committed to the industry, we're committed to those superintendents, we're going to provide them the service, we're going to get them the Stores-on-Wheels to show up.

If they need product we're going to run product over from the service center.

That's how we provide service to the customer.

As I said, we have room for improvement, but we have to leverage our service centers, our Stores-on-Wheels and our sales rep relationships.

So it's not as easy as price.

Yes, price is important.

It's important for us to be competitively priced.

When we get $80 upside down on a ton of urea and those superintendents are buying by the ton, so if our urea is 46% nitrogen and you want something with a high nitrogen level, you could be paying 120, $150 more to us than if someone was selling to them at an adjusted market price.

So that matters.

So we have to get in, we have to be competitively priced and we have to leverage on our infrastructure to provide service and we have to be -- we have to regain the trust of the superintendents.

The good news is I haven't heard many of them say they don't want us there because obviously with us there, there is increased competition and there is an increased level of service.

So I don't think they want anybody to necessarily leave the market.

So with us there, I think that we're going to get -- we're going to start getting our share of the superintendents spend.

It's just going to take a little bit of time and a heck of a lot of effort.

Okay.

And does the decision to allow for more floating urea cost, does that give you advantages going back into the direct channel or how does that -- how does that tie back into re-igniting sales through that channel?

Well, we obviously need to talk to our customers about what their needs are.

Are they looking at locking prices, like I said earlier?

If a customer of ours wants to lock price, that's what we need to work through for the entire year and enter into a contract with us.

I think we're probably going to be willing to do that.

And then we need to decide whether we're going to take the risk or whether we're going to lock in some level of urea purchases, which we're -- we could do behind them and level out.

What we need to be more concerned about is what's the customer want to do and can we do what the customer is asking us to do.

And that's what our sales reps are out there doing, that's what our national account sales reps do.

They ask -- they're out there asking the customer, well, what do you want, what are your needs, because, really, if we're going to be successful selling to them, we need to solve their problems versus having them solve our problems.

So your hedging program will be tied to your customer conversations and [inaudible - background noise] that those customer indicate they would like a locked price, that's going to drive your hedging decisions going forward.

Well, that could be a piece of the decision or we really feel that the market is such that this is a good time to lock the price.

Okay.

But what I can tell you is I don't think you're going to foresee -- well, as long as I'm here, you're never going to see a point in time again where we're going to say it's a good idea to lock for 12 months 100% of our urea because I can't imagine there ever being a scenario like there was in the last couple of years where that would make sense.

Okay.

Especially with all the things going on in natural gas, with what's going on in the Gulf Coast and if those things come on line, none of us today can predict what natural gas prices are going to be down at next year.

And I'd point that if we had a, not a Katrina or a Rita, but a hurricane roll through the Gulf, I think your hedges would look a little bit more savvy [inaudible - background noise].

We had no major hurricanes hit the continental U.S.

That's a little different than the past couple of years.

One final question, to what extent is TCS having success in selling its excess capacity to other potential customers and therefore offering you an opportunity to get lower costs on that -- in that -- in their capacity?

I'm not going to comment on that.

And you could talk to them and they could comment if they would like, but it's probably a little early to expect too much from them.

Okay.

But I have full faith in the people involved that they're going to get something like that done.

Great.

Guys, thanks a lot.

Appreciate it.

Sure.

At this time there are no further questions.

I would like to turn the call back over to Jeff Rutherford for closing remarks.

I would just like to say in closing that I want to thank all the Lesco associates and especially those in the field who work hard every day.

And this certainly -- these financial results certainly are not reflective of the efforts they give in serving their customers every day and doing the best they can and doing the right things for the company.

To that note, we need to do a lot better job of supporting those people, giving them the resources they need to be successful, serve their customers and be successful and have a very successful business.

So I'm committed to doing that and I'm calling on all of our Lesco associates to make that same commitment so we don't have calls like this and continue to report lower than expectation results for a model that is actually a very good model.

And with that, I want to thank all the investors for their support and that we are available if they want to talk to us.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect and have a great day.