UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

or

For the transition period from                   to                   

LESCO, Inc.

Registrant’s telephone number, including area code
(440) 783-9250

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o No þ

Number of Common Shares outstanding on May 7, 2004: 8,697,694.

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Table of Contents

PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

LESCO, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED

See Notes to Consolidated Financial Statements.

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LESCO, INC.
CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements.

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LESCO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

See Notes to Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Description of Business and Segment Information

     LESCO, Inc. (“LESCO” or “the Company”) is the largest provider of products for the professional turf care segment of the green industry. Products distributed include turf control products, fertilizer, combination fertilizer and control products (combination products), grass seed and equipment. The Company distributes products through 256 Service Centers, 71 Stores-on-Wheels, 74 direct sales representatives and other direct sales efforts. The Company operates nine distribution hubs, three fertilizer blending facilities and a grass seed processing plant.

     Segment Information: The Selling and Support segments reported below are the segments of the Company for which separate information is available and for which operating results are evaluated regularly by the Chief Executive Officer in deciding how to allocate resources and in assessing performance.

     The Company maintains separate operating statements (Four-Wall P&Ls) for each selling location. These Four-Wall P&Ls include the sales and operating expenses necessary to operate the individual selling locations. The Selling segment operating results reflect the aggregate Four-Wall P&Ls of the selling locations adjusted for costs of zone and regional management, sales commission expense, working capital interest charge and the portion of merchant discounts and provision for doubtful accounts not previously charged to the Four-Wall P&Ls.

     The Support segment represents the operating results and invested capital of all non-selling locations including manufacturing facilities (blending facilities and seed processing plant), distribution hubs and the corporate office.

     Below are the unaudited results for the Selling and Support segments for the three months ended March 31:

Note 2. Summary of Significant Accounting and Reporting Policies

     1. Principles of Consolidation: The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to rules and

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regulations of the Securities and Exchange Commission. The statements reflect all adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of the results for interim periods. For further information, refer to the audited financial statements and footnotes thereto for the year ended December 31, 2003 included in the Company’s annual report on
Form 10-K.

     The Company’s consolidated financial statements for the three months ended March 31, 2004 and 2003 included in this Quarterly Report on Form 10-Q have been prepared in accordance with the accounting policies described in the Notes to Consolidated Financial Statements for the year ended December 31, 2003 which were included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (File No. 0-13147) on March 29, 2004. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Form 10-K referred to above. Certain reclassifications have been made to prior year amounts to conform to the current presentation. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for the year due to the seasonal nature of the Company’s business.

     2. Earnings Per Share: The Company presents both basic and diluted earnings per share (EPS) amounts. Basic EPS is calculated by dividing net loss, less the preferred dividend in 2003, by the weighted average number of common shares outstanding during the quarter. Diluted EPS is based upon the weighted average number of common and common equivalent shares outstanding during the quarter utilizing the treasury stock method for stock options. Common equivalent shares are excluded from the computation in periods in which they have an anti-dilutive effect, such as when the exercise price of stock options exceeds the average market price for the period or when the Company incurs a net loss for the period reported.

     A reconciliation of net loss applicable to common stock and the weighted average number of common and common equivalent shares outstanding is as follows:

     Weighted average stock options of 173,120 for the three months ended March 31, 2004, and 163,334 for the same period in 2003 were excluded from the dilutive EPS calculation because they were anti-dilutive due to net losses.

     3. Stock Based Compensation: The Company uses the intrinsic-value method of accounting for stock-based awards granted to employees and, accordingly, does not recognize compensation expense for its stock-based awards to employees in the Consolidated Statements of Operations.

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     The following table reflects pro forma net loss and loss per share had the Company elected to adopt the fair value approach of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation:

     These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future periods.

     4. Accounts Receivable

     Accounts receivable consist of the following:

     The Company earns product discounts under various supplier rebate programs, which are recorded as accounts receivable and a reduction to the cost of inventory when earned. When the related inventory is sold, the inventory valuation reserves are recognized as reductions to cost of sales.

     On December 30, 2003, the Company sold a majority of its trade accounts receivable portfolio to GE Capital Financial Inc., dba GE Business Credit Services (“GEBCS”), for cash proceeds of approximately $57 million. In the first quarter of 2004, the Company sold additional accounts receivable to GEBCS for cash proceeds of approximately $3 million.

     Concurrent with the sale, the Company and GEBCS entered a private label business credit program agreement (Credit Agreement). Under the Credit Agreement, GEBCS extends commercial credit to qualified customers of LESCO and funds the program sales, less program fees and discounts, within three business days. The Credit Agreement also provides the Company the option of extending deferred payment terms to customers through the payment of incremental promotional discounts. The in-transit funds are recognized by the Company as cash equivalents. The program fees and discounts and promotional discounts are recognized as merchant discounts in the Consolidated Statements of Operations. GEBCS is the exclusive owner of the program accounts and, except for the recourse account portfolio discussed below, bears all credit losses.

     The owned domestic credit accounts are accounts that did not qualify for sale to GEBCS or for the credit recourse portfolio. LESCO has retained the ownership and management of the owned domestic credit accounts.

     The Credit Agreement does not allow for the ownership of international credit accounts by GEBCS. As such, LESCO has retained the ownership and management of international accounts. All international accounts are denominated in U.S. dollars.

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     GEBCS has sole discretion under the Credit Agreement to approve or decline prospective account holders. LESCO may request GEBCS to include declined accounts in a portfolio of credit recourse accounts. LESCO bears all credit losses and pays a fee to GEBCS to manage the credit recourse portfolio. GAAP does not recognize the sale of recourse accounts to GEBCS. As such, all recourse receivable balances that existed at December 30, 2003 (the date of the GEBCS transaction) continue to be recognized as accounts receivable by the Company, along with a corresponding account payable to GEBCS. Sales activity on recourse accounts subsequent to December 30, 2003 are not required to be recognized on the Company’s balance sheet. A reconciliation of total recourse accounts receivable to the balance sheets is as follows:

     The Company provides for expected losses from all owned and recourse accounts in the allowance for doubtful accounts. Expected losses are estimated based upon the number of days the accounts are past due, historical loss experience of the Company, historical loss experience of credit portfolios with characteristics similar to the Company’s portfolio and the current business environment.

     5. Inventories

     Inventories consist of the following:

     Inventories are valued at the lower of cost (average cost method) or market. Consignment inventory is considered purchased and cost of product is recognized at the time of sale. Procurement, warehousing and distribution costs are capitalized to inventory on hand and expensed to distribution cost when the inventory is sold. Markdown and shrink reserves are provided for markdown of inventory to net realizable value, expected inventory shrink and earned supplier discounts of inventory remaining on hand.

     6. Property, Plant and Equipment

     Property, plant and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the respective assets. Buildings are depreciated over 15 to 20 years, and machinery, equipment and other depreciable assets are depreciated over three to 12 years. Expenditures for maintenance and repairs are charged to expense as incurred. Additions and improvements are capitalized.

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     Property, plant and equipment, net consists of the following:

     Depreciation expense is included in the following:

     7. Borrowings

     Borrowings consist of the following:

Revolving Credit Facility

     On December 30, 2003, the Company entered into a $50 million Revolving Credit Facility (the Facility) which replaced a prior credit facility. Borrowings under the Facility were used to retire the prior credit facility, including a term loan, buy-out an interest rate swap agreement and buy-back outstanding preferred stock.

     The Facility matures December 30, 2006 and is secured by inventory, owned receivables, equipment, investment interests, real property interests, and general intangibles including intellectual property. The Facility bears interest at LIBOR plus 2.0% to 2.5%, based on the level of borrowings, and requires the payment of a facility fee ranging from 0.4% to 0.5% on the unused portion of availability. The weighted average interest rate on the Company’s outstanding borrowings under the Facility on March 31, 2004 was 4.0%. Availability under the Facility is determined by a borrowing base formula calculated on eligible inventory. As of March 31, 2004, there was $50.0 million available, with unused capacity of $22.2 million. Letters of credit, up to a maximum of $20 million, are also available under the Facility and are considered outstanding borrowings when calculating the unused portion of availability, of which $10.2 million were outstanding as of March 31, 2004. Letter of credit fees range from 2.0% to 2.5% with an issuance fee ranging from 0.125% to 0.150%.

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     The Facility requires the maintenance of certain covenants, with the only financial covenant being the fixed charge coverage ratio. The Company was in compliance with the Facility covenants as of March 31, 2004.

     8. Asset Rationalization and Severance Expense

     Major components of the remaining reserves and accruals for asset rationalization and severance expense as of March 31, 2004 and December 31, 2003 are as follows:

     The Company anticipates utilizing the remaining asset rationalization accrual by the end of 2004.

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9. Detail of Certain Balance Sheets Accounts

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10. Detail of Certain Statements of Operations Accounts

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LESCO, INC.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Organization of Information

     Management’s Discussion and Analysis provides a narrative on the Company’s financial performance and condition that should be read in conjunction with the accompanying consolidated financial statements. It includes the following sections:

	•		Overview
	•		Consolidated Results
	•		Business Segment Results
	•		Liquidity and Capital Resources
	•		Critical Accounting Policies and Estimates
	•		Forward Looking Statements

OVERVIEW

     LESCO is the largest provider of products to the professional turf care segment of the green industry. The professional users of our products include lawn care and landscape firms and the employees of a variety of commercial, governmental, institutional and industrial establishments, including golf courses, sod farms, airports, cemeteries, professional sports organizations, universities, schools, commercial properties and numerous other organizations that use in-house employees to maintain lawns and gardens.

     We track our customers through two customer sectors: Lawn Care and Golf.

     Gross sales for these sectors for the first quarter were as follows:

     The separation of our customers into these two sectors is important as distribution to the sectors is markedly different and their growth prospects vary significantly.

     Our Lawn Care sector includes all non-golf related customers and is dominated by lawn care and landscape firms. Historically, distribution of products into this sector has been fragmented and inefficient. We believe that our model of Service Centers and direct sales provides efficiency to the sector’s distribution channels through easily accessible, strategically positioned real estate where we provide agronomic expertise through our 256 Service Centers and direct sales associates with products specifically targeted to the Lawn Care sector. We estimate the market for our Lawn Care products at $7.0 billion, and independent research indicates that organic growth in the sector is expected to exceed 5% annually for the next several years due to the aging of the “baby boomers” and their increasing desire to contract lawn care professionals, the higher number of two-income families and continued time constraints on consumers.

     The golf industry is a smaller market (estimated at $1.2 billion) and is not expected to grow significantly in the near future, nor do we believe our opportunities are as great in this sector as those in the Lawn Care sector. Additionally, the industry has experienced a decline in annual rounds of golf being played, which has decreased the budgets of golf course superintendents, however, that trend appears to be moderating in the first few months of 2004. The ability to capture incremental market share is limited as distribution of our products to the golf industry is dominated by a few national and regional distributors. We anticipate that we will be able to expand our presence in under-serviced markets, but we are not planning any major expansion of Stores-on-Wheels or direct golf sales in the near future.

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RESULTS OF OPERATIONS

LESCO, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED

Sales:

     Service Centers: Gross sales for LESCO Service Centers® of $68.3 million reflect sales transacted through our 256 Service Centers in operation as of March 31, 2004, including nine new service centers opened in the first quarter of 2004 and the 21 new Service Center openings during 2003. The total increase of 10% over the prior year first quarter results of $62.0 reflects a same-store (excluding the 30 new units) increase of 5% and an increase of 5% from new Service Center sales of $3.4 million. The sales growth was predominantly generated in the fertilizer and combination product category. The primary products sold through Service Centers are turf care products, including turf and pest control products, fertilizer, grass seed and equipment. The Service Centers market and sell products principally to lawn care companies, landscapers, public and private golf courses, nurseries, municipalities, churches and condominium associations. The Company plans to open 25-30 Service Centers during 2004.

     Other Selling Locations: The Company also markets and sells products to private and public golf courses and other customers having large turf areas through direct sales programs and our fleet of LESCO Stores-on-Wheels®. Through these selling channels, the Company generated sales of $34.6 million, a 3.3% increase over the $33.5 million in sales for the first quarter of 2003 as the combination product category experienced favorable sales trends in this segment as it did for Service Centers. The Company’s direct channel markets and sells products to large national and regional lawn care customers utilizing sales representatives, markets products by mail order catalog, and participates in national and regional lawn care trade shows. A telemarketing sales group calls on inactive accounts and contacts customers not currently serviced by the Company’s outside sales forces. In addition, products are marketed internationally, principally through foreign distributors. The Stores-on-Wheels are well stocked with a wide variety of turf care products and golf course accessories, which are sold directly from the trucks. The Company operated 71 LESCO Stores-on-Wheels in the first quarter of 2004 and 2003. The primary products sold through this channel are turf care products, including turf and pest control, fertilizer, grass seed, hand held equipment and golf course accessories.

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     The following table provides supplemental detail of sales by customer sector and transacting selling locations for the first quarter of each respective year:

     Freight Revenue and Customer Discounts and Rebates: Freight revenue, which represents fees charged to customers in sales transactions for shipping and handling, remained flat year over year both in dollars and as a percentage of sales. Customer discounts and rebates declined from 1.4% of gross sales to 1.2%.

Gross Profit on Sales:

     Product margin has remained consistent in the first quarter of 2004 compared to the like period in 2003. Our largest single purchased product or raw material is urea, the nitrogen source for blended fertilizers and combination products. Urea can represent from approximately 7% to 9% of our cost of sales. Urea is a second derivative of natural gas and its cost has increased with the increased cost of natural gas. For 2004, we have entered a contract with our urea supplier to fix the cost of a majority of our urea needs at a price reflecting the prevailing market in late 2003; however, our year-over-year comparative price for urea increased approximately 30% for the first quarter of 2004.

     In 2003, we expanded our distribution network to provide support to our increasing base of Service Centers and to create efficiencies in our distribution channel and incurred approximately $0.4 million in network start-up costs in the first quarter 2003. In the first quarter of 2004, we have leveraged our distribution cost as a percentage of sales and realized cost savings as this network has begun to mature. We are experiencing more optimal shipping quantities and direct distribution routes resulting in lower costs. We expect to leverage our distribution costs as a percentage of sales for the full year in 2004 as compared to prior year results.

Operating Expenses:

     Selling Expense

     Selling expense includes all operating expenses of Service Centers and Stores-on-Wheels, direct sales, sales management, customer service and marketing expense. The increase of $1.1 million predominantly relates to new Service Center operating costs which increased $0.9 million in first quarter 2004 compared to new Service Centers selling expense for the same period last year. Total new Service Center expense in the first three months for 2004 was $1.2 million compared to $0.3 million for the like period in 2003.

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     Merchant Discounts and Provision for Doubtful Accounts

     As a percentage of net sales, these expenses increased 1.0% year-over-year. On December 30, 2003, we sold our trade accounts receivable portfolio to General Electric Business Credit Services (GEBCS) for $57 million and entered a private label business credit program agreement with GEBCS. In the first quarter of 2004, this arrangement has resulted in increased merchant discounts as we pay program fees and discounts to GEBCS of approximately 1.3% of sales; however, interest expense, provision for doubtful accounts, the general and administrative costs to service the in-house program and customer finance revenue have been significantly reduced as compared to the same period in 2003.

General & Administrative Expense:

     We have maintained essentially flat general & administrative expense in the first quarter of 2004, reducing it $0.1 million as compared to the same period in 2003. The cost savings recognized from tightened expense controls along with the strategic outsourcing of customer financing to GEBCS have virtually offset the increase in expense related to more stringent governance guidelines as well as management bonus and insurance expenses.

Pre-Opening Expense

     Pre-opening expense remained essentially flat in the first quarter 2004 compared to the same period last year. Pre-opening expense, which consists primarily of grand opening advertising, payroll, supplies and distribution and storage costs, is expensed as incurred. During the first quarter of 2004, the Company opened nine new Service Centers and prepared for 17 second quarter expected openings. Last year during the first quarter, the Company opened 10 new Service Centers.

Other (Expense)/Income:

     The decrease in net other income predominantly relates to our former joint venture. There was no income or loss recorded in the first quarter of 2004, as we sold our ownership in the joint venture in the fourth quarter of 2003, and $0.4 million of income was recognized in the first quarter of 2003.

Interest Expense:

     Interest expense declined $0.9 million in the first quarter 2004 versus the first quarter 2003 directly related to the sale of the Company’s accounts receivable portfolio to GEBCS. The sale of the portfolio has reduced the year-over-year outstanding borrowings on the revolving credit facility during the first quarter, and eliminated the interest rate swap agreement that was in place during 2003.

Pre-Tax Loss:

     In the first quarter of 2004, the Company opened nine new Service Center locations. In the first quarter of 2003, the Company opened 10 new Service Centers and for the full year in 2003 opened 21 new Service Centers. Management views new Service Centers as the primary method to leverage our cost base and grow earnings consistently over time. The nine Service Centers in the class of 2004 generated sales of $0.5 million in the first quarter while the 21 Service Centers from the class of 2003 generated $2.9 million in sales for a total of $3.4 million in revenues from new Service Centers. This compares to $0.2 million in revenue generated in the first quarter of 2003 from the 10 new Service Centers. The 2004 new Service Centers generated an EBIT loss of $0.4 million for the first quarter of 2004 while, for the same period, the 21 Service Centers opened in 2003 generated an EBIT loss of $0.2 million. Total EBIT

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loss from new Service Centers was $0.6 million in the first quarter of 2004. This compares to an EBIT loss of $0.5 million for the same period in 2003 for the 10 new Service Centers opened last year. Below are the operating results for the first quarter of 2004 compared to the same period in 2003 for all new Service Centers:

     As a result of the foregoing factors, including the operating results of new Service Centers, the Company had a pre-tax loss of $7.6 million for the quarter ended March 31, 2004 compared to a pre-tax loss of $9.2 million for the comparable period last year, an improvement of $1.6 million, or 17%.

Income Taxes and Net Loss: