LESCO, a provider of products for the professional green and pest control industries, announced sales for the quarter ending Sept. 30, 2006, grew 4.1 percent to $165.4 million from $158.9 million in the comparable period a year ago.
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Gross profit was 20.3 percent of net sales, or $33.6 million, compared to 23.5 percent of net sales, or $37.3 million, in the third quarter of 2005. The decline in gross profit was primarily due to the following: a $1.8 million decrease in product margin from higher raw material costs for urea used in blended fertilizers and combination products; a $1.8 million decline in grass seed product margin from cost increases that could not be passed through to customers due to pricing commitments; and a $6.8 million increase in indirect supply chain costs.
Due to the outsourcing of manufacturing, warehousing and distribution services completed in 2005, the company anticipated $4.4 million of the third-quarter increase in the indirect supply chain costs; however, the additional $2.4 million reflects a de-leveraging effect on the Company's supply chain agreements resulting from lower-than-expected sales. The gross profit decline was partially offset by $2.3 million of gross profit generated from incremental sales on a quarter-over-quarter basis. Third-quarter 2005 gross profit results included a $3.8 million charge for the Company's supply chain transaction and parts distribution outsourcing.
"The environment has been challenging for LESCO as raw material cost pressures have led to a significant decline in our gross profit," said Jeffrey Rutherford, president and c.e.o. "For 2006, the market cost of urea, a second derivative of natural gas, has been significantly lower than our cost incurred under contract, which has caused a more competitive pricing environment. When our contract expires by the end of 2006, we anticipate purchasing urea closer to market cost, which should allow us to improve our competitive pricing position in the industry while achieving more desirable product margins."
The Company reported a third-quarter 2006 net loss of $2.3 million, or $0.25 per diluted share, versus a net loss of $16.2 million, or $1.82 per diluted share, in the same period in 2005.
Third-quarter 2005 operating results were reduced by $19.0 million related to the sale of the Company's supply chain assets and $3.8 million for a markdown charge to restructure the parts sourcing model and product offering.
Nine-Months 2006 Results
Net sales for the nine months ending Sept. 30, 2006, were $447.2 million versus $447.1 million in the comparable period a year ago. Gross profit was 22.6 percent of net sales, or $101.2 million, in the first nine months of 2006, compared to 24.9 percent of net sales, or $111.6 million, in the first nine months of 2005. The company reported a net loss of $4.0 million, or $0.44 per diluted share, for the first nine months of 2006 versus a net loss of $11.1 million, or $1.25 per diluted share, in the same period in 2005.
Results for the first nine months of 2005 include $23.1 million for costs related to the sale of the company's supply chain assets and its outsourcing of parts merchandise and $0.5 million for settlement costs related to a vendor contract termination.
Stores Segment Operating Results
The Stores Segment includes operating results of the company's Service Centers and Stores-on-Wheels vehicles as well as field management costs. The Stores Segment net sales for the quarter ended September 30, 2006, increased 6.9 percent to $152.4 million from $142.5 million in the same period a year ago. Service Center net sales increased 10.8 percent, or $12.8 million, and Stores- on-Wheels net sales decreased 11.6 percent, or $2.9 million. Comparable Service Center sales increased 2.7 percent.
The disbanding of LESCO's sales representative program in 2005 continues to have a negative effect on sales in 2006. Service Center sales to customers previously called on by sales representatives declined $1.9 million, or 1.7 percent, in the third quarter of 2006 from the same period in 2005. Stores-on-Wheels sales were negatively impacted $2.7 million, or 11.0 percent.
Gross profit was $32.1 million, or 21.1 percent of net sales, in the third quarter of 2006 compared to $38.7 million, or 27.1 percent of net sales, in the same period in 2005. A $6.6 million decrease in gross profit was due to a $2.9 million decline in product margins of fertilizer and seed and an incremental $6.7 million of indirect supply chain costs, which were partially offset by $3.0 million of gross profit from increased sales. Indirect costs are allocated to the segments based on cost of product sold; consequently, the Stores Segment received a higher allocation due to its higher percentage of total cost of product sold this quarter versus the same period last year.
Stores Segment selling expense increased $2.1 million on a quarter-over- quarter basis to $23.3 million, or 15.3 percent of net sales, from $21.2 million, or 14.9 percent of net sales, in 2005. The increase in selling expense is primarily attributable to the 48 new Service Centers and four new Stores-on-Wheels vehicles opened since the end of second quarter 2005. Merchant discount fees were $2.9 million, or 1.9 percent of net sales, during the quarter versus $2.5 million, or 1.7 percent of net sales, in the same period in 2005. This increase is primarily due to a continued shift in customer credit usage from private label to national bank cards and a rise in interest rates on a quarter-over-quarter basis for the private label customer portfolio.
Stores Segment earnings before interest and taxes was $5.9 million in third quarter 2006 versus $15.0 million for the same period last year.
Stores Segment net sales for the nine months ended Sept. 30 increased 5.3 percent to $403.9 million. Net sales increased 7.2 percent for Service Centers and declined 4.0 percent for the Stores-on-Wheels fleet. Comparable Service Center sales increased 0.4 percent for the first nine months of 2006.
Lawn and landscape customer sales increased 8.5 percent while golf customer sales declined 6.1% in this segment. Gross profit was $94.3 million, or 23.3 percent of net sales, for the first nine months of 2006 versus $106.1 million, or 27.7 percent of net sales, in the same period a year ago.
The $7.0 million increase in selling expense between comparable periods is mainly attributable to an incremental $5.5 million for new Service Center and Stores-on-Wheels vehicle openings in 2006 and 2005 as well as $1.3 million for expansion of the field management team. Merchant discount fees increased by $1.5 million, or 30 basis points, to $7.6 million and 1.9 percent of net sales, primarily due to a shift in customer credit usage to national bank cards. For the first nine months of 2006, earnings before interest and taxes was $19.6 million versus $39.9 million for the same period last year.
Direct Segment Operating Results
The Direct Segment includes the operating results of all non-store transactions. Direct Segment net sales were $13.1 million for the quarter ended Sept. 30 versus $16.4 million in the comparable period a year ago. The decline in gross sales was due primarily to the elimination of bulk product sales. In 2005, the Company sold $2.6 million in bulk excess products from manufacturing operations. LESCO no longer participates in this activity as the company sold all of its manufacturing facilities in the fourth quarter of 2005.
Gross profit was $1.5 million, or 11.6 percent of net sales, in the third quarter of 2006 compared to $2.4 million, or 14.8 percent of net sales, in the same period in 2005. The decline in gross profit was due to a $0.7 million loss from lower sales, $0.1 million from product margin decline and a $0.1 million increase of indirect supply chain costs.
Direct Segment selling expense during the third quarter of 2006 was $1.3 million, or 10.1 percent of net sales, compared to $0.8 million, or 5.0 percent of net sales, in the same period in 2005. This increased cost is primarily a result of contractual marketing expenses and the addition of direct sales representatives during the third quarter of 2006. Merchant discount fees were flat at $0.3 million quarter-over-quarter, and increased 10 basis points to 2.2 percent of net sales in the third quarter of 2006.
Direct Segment loss before interest and taxes was $0.1 million in the third quarter of 2006 versus earnings of $1.3 million in the comparable period of 2005.
For the nine months ended September 30, 2006, Direct Segment net sales declined to $43.3 million from $63.6 million for the first nine months of 2005. Gross profit was $6.9 million, or 15.9 percent of net sales, in 2006 versus $9.2 million, or 14.5 percent of net sales, in 2005. Selling expense declined $2.1 million from the same period in 2005, primarily attributable to the absence of direct sales representatives in the first half of 2006. Merchant discount fees decreased $0.3 million as sales declined from the same period in 2005, and increased 50 basis points to 2.9 percent of net sales due to the write off of customer service charges and late fees. Year-to-date earnings at Sept. 30 before interest and taxes was $1.6 million versus $1.5 million for the same period in 2005.
Corporate
The two operating segments are supplemented by Corporate costs incurred for support functions, including Corporate selling expenses, promotional merchant discounts, general and administrative expenses, and new store pre- opening costs. Total Corporate expense for the third quarter of 2006 decreased to $8.2 million from $32.1 million for the same period in 2005. The third quarter of 2005 reflects $22.8 million related to costs of the supply chain transaction and the outsourcing of parts distribution.
Corporate selling expense, composed of customer service, bids processing, product registration, and merchandising and marketing expenses, declined $0.6 million to $2.7 million in the third quarter of 2006 from the same period in 2005. Corporate merchant discounts expense was flat at $0.7 million. General and administrative expense decreased $0.5 million to $4.3 million from $4.8 million in the third quarter of 2005. Third-quarter 2006 general and administrative expense reflects a $0.4 million benefit from a favorable arbitration judgment. Pre-opening expense for the third quarters of 2006 and 2005 was flat at $0.5 million.
Total corporate expense for the nine months ended Sept. 30, 2006, was $25.3 million versus $51.8 million for the comparable period in 2005. The 2006 results include a $0.5 million reimbursement of previously overcharged fees incurred for the extension of customer payment terms, net of certain customer service charges, and a $0.4 million benefit from a favorable arbitration judgment. The 2005 results include $23.1 million of supply chain and outsourcing expenses and a $0.5 million settlement terminating a vendor agreement.
Direct Sales Representative Strategy
As previously announced, LESCO is reinstating its direct sales representative model, which had been disbanded in the first half of 2005. In fiscal year 2005, sales from customer accounts that were previously called on by a sales representative declined $24 million, $16 million of which occurred in the first nine months of 2005. Those same customer accounts declined another $15 million in the first nine months of 2006. The Company estimates that, in 2006, these accounts will recognize sales at a level that will be nearly $60 million less than what would have been expected if the sales representative program would have remained in place. In response, LESCO has placed 25 golf and nine lawn and landscape sales representatives in key markets to enhance service levels to existing customers and extend its reach to new customers.
"During the quarter, we made solid progress in restoring our sales representative structure, and today we have 34 direct sales representatives," Rutherford said. "As we have communicated previously, time is needed to rebuild relationships with golf and lawn and landscape customers; however, it is very important to have sales representatives proactively engaging and assisting customers as they plan for their 2007 turf care needs. The re- establishment of the sales representative structure is fundamental to strengthening the performance of this Company as we move forward."
New Service Centers and Stores-on-Wheels
During the third quarter of 2006, the Company opened nine new LESCO Service Center stores. On Sept. 30, there were 332 Service Centers in operation, versus 294 at the end of September 2005. The 107 Service Centers that were opened from 2003 through the end of the third quarter of 2006 generated net sales of $27.1 million and pre-tax earnings of $1.6 million for the quarter. These 107 Service Centers generated net sales of $65.7 million for the first nine months of 2006 and pre-tax earnings of $3.3 million.
The Company expects to have 35 to 40 new Service Centers opened by the end of fiscal 2006. In 2007, the Company anticipates opening no fewer than 20 new Service Centers. Over the long term, the Company remains committed to increasing its Service Center base 10 to 15 percent annually.
On Sept. 30, there were 114 Stores-on-Wheels vehicles in operation, versus 111 at the end of September, 2005.
Early Order Sales Program
Historically, the green industry and LESCO have provided customers incentives to purchase products from October through December for their needs the following spring. This practice is known as an early order program (EOP). During its EOP periods, the Company has offered incentives such as price discounts for its customers to take product early, extended payment terms at a cost to the Company, and, in some cases, further price discounts to offset customers' costs for product storage.
Based on market research showing customers' preference to purchase products closer to the date when needed for application combined with current market conditions indicating no near-term increases to customers' purchase price, LESCO believes that its customers will not be purchasing as aggressively during EOP in 2006 as in previous years. In order to meet customers' needs and potentially reduce its extended payment term costs, LESCO, in conjunction with its vendor partners, has extended its EOP period into 2007 and estimates that $15 million in sales with related costs will shift from the fourth quarter of 2006 into the first half of 2007.
Revised 2006 Guidance
Based on current and expected business conditions, including pricing pressures on fertilizer, combination products, and seed, an anticipated shift in EOP sales from the fourth quarter of 2006 into the first half of 2007, and a de-leveraging effect on the Company's supply chain agreements resulting from lower-than-expected sales, the Company is lowering its fiscal 2006 operating results guidance to a loss of approximately $16 to $20 million.
Prior guidance was based on an expectation that urea market cost would increase to a level closer to LESCO's 2006 contract cost. Instead, the market cost of urea has remained significantly below LESCO's cost, and urea futures suggest that this trend will continue through the Company's contract expiration by the end of 2006. Therefore, this higher raw material cost and correlating market pricing pressure will impact the Company's gross profit rate for the remainder of 2006.
Additionally, higher-than-anticipated seed costs due to a soft harvest in fescue seed have resulted in reduced margins from sales commitments in the second half of 2006. The estimated shift of $15 million in EOP sales from the fourth quarter of 2006 into the first half of 2007 will further reduce 2006 sales and gross profit.