UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

For the quarterly period ended September 30, 2004                         Commission File No. 0-13147

or

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 as of November 1, 2004: 8,709,694

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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 sells products through 273 Service Centers, 72 Stores-on-Wheels, the Internet, 76 direct sales representatives and other direct sales efforts. The Company operates eight 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 and nine months ended September 30, 2004 and 2003:

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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 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 and nine months ended September 30, 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 and nine months ended September 30, 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 income, less the preferred dividend in 2003, by the weighted average number of common shares outstanding during the three months and nine months ended September 30. 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 income applicable to common shares and the weighted average number of common and common equivalent shares outstanding is as follows:

     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 income and earnings 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 because 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 resulting in a pre-tax charge of $4.6 million in the fourth quarter of 2003. In the first nine months of 2004, the Company sold additional accounts for cash proceeds of approximately $6 million and recognized no gain or loss on the transactions.

     Concurrent with the December 30, 2003 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.

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     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.

     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 on credit recourse accounts and pays a fee to GEBCS to manage the credit recourse portfolio. LESCO did not recognize the initial sale of recourse accounts to GEBCS as of December 30, 2003. Therefore, 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 borrowing from GEBCS. Sales activity on recourse accounts subsequent to December 30, 2003 is not recognized on the Company’s balance sheet. A reconciliation of total recourse account balances to the receivable portion owned by the Company and recorded in the balance sheets is as follows:

     In the allowance for doubtful accounts, the Company provides for expected losses from all owned receivables and GEBCS-owned recourse 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, shrink and vendor discount reserves are provided for markdown of inventory to net realizable value, expected inventory shrink and earned supplier discounts of inventory remaining on hand.

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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.

     During the second quarter of 2004, the Company sold its Avon Lake, Ohio distribution facility for $1.5 million in cash. Based on the remaining net book value of the assets sold, this resulted in a loss on sale of less than $0.1 million. The distribution operations for customer orders previously fulfilled from the Avon Lake facility have been transferred to a third party logistics provider based in Columbus, Ohio.

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

     Depreciation expense is included in the following:

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     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% per annum, based on the level of borrowings, and requires the payment of a facility fee ranging from 0.4% to 0.5% per annum on the unused portion of availability. The availability under the Facility is determined by a borrowing base formula calculated on eligible inventory. As of September 30, 2004, there was $46.9 million available, with unused capacity of $36.3 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. Letters of credit in the aggregate amount of $10.6 million were outstanding as of September 30, 2004. Letter of credit fees range from 2.0% to 2.5% with an issuance fee ranging from 0.125% to 0.150%.

     The Facility requires the maintenance of certain covenants, with the only financial covenant being a fixed charge coverage ratio. The Company was in compliance with the Facility covenants as of September 30, 2004.

     8. Asset Rationalization and Severance Expense

     Major components of the remaining reserves and accruals for asset rationalization and severance expense as of September 30, 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

Note 3. Relocation of Corporate Headquarters

     During the third quarter of 2004, LESCO entered into agreements to relocate its corporate headquarters from its current approximately 94,000 square foot facility in Strongsville, Ohio to an approximately 40,000 square foot facility in downtown Cleveland, Ohio. The term of the Company’s new lease is five and a half years, and the Company expects to complete the relocation this year. A division of a public company (the Assignee) will assume the remaining 11 years of LESCO’s current lease at the Strongsville location.

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     Relocation costs are estimated at approximately $7.5 million including $4.8 million in tenant and landlord inducements, and $2.7 million in broker commissions, legal fees, letter of credit costs, move costs and fixed-asset write offs. During the third quarter, the Company recorded $4.9 million of expense related to this relocation. Beginning in 2005, the financial effect of the relocation is expected to be accretive to earnings on an annual pre-tax basis by approximately $1.0 million. The return on the cost to relocate is estimated at greater than 7%.

     LESCO remains liable under the lease if the Assignee fails to perform. The Assignee will be obligated to secure a $4.4 million letter of credit backing its performance under the lease, and LESCO will pay the Assignee approximately $100,000 annually for the remaining term of the lease to defray the cost of the letter of credit.

Note 4. Subsequent Events

     Subsequent to the balance sheet date, LESCO notified its supplier of methylene urea fertilizer that the Company will no longer operate under the terms of a supply agreement with the supplier. The five-year supply agreement between LESCO and its supplier was entered into in November 2002 and requires the Company to purchase annually 8,000 tons of methylene urea fertilizer from the supplier at a fixed conversion cost of $500 per ton plus the prevailing commodities market prices which were approximately $270 per ton for the first nine months of 2004. Management believes that it is advantageous to operating results to exit the supply agreement and currently estimates that the corresponding savings over the remaining term of the agreement will exceed the cost to exit the supply agreement. It is the Company’s intent to source methylene urea fertilizer from other available market sources.

     Subsequent to the balance sheet date, LESCO notified the issuer of industrial development revenue bonds related to the Company’s Martins Ferry, Ohio facility that LESCO is electing to call for its optional redemption of the bonds prior to their maturity date. There is no prepayment penalty for the early extinguishment of the $5.9 million debt. The Company expects to redeem these bonds during the fourth quarter of 2004.

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LESCO, INC.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Organization of Information

     This discussion 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 Segments
	•		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 three months and nine months ended September 30 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, the 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 273 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 $4.6 billion, and independent research indicates that organic growth in the sector is expected to be 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 $1.4 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 nine months of 2004. The ability to capture incremental market share in this industry is limited as distribution of our products to the 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 $107.4 million for the third quarter of 2004 reflect sales transacted through our 273 Service Centers in operation as of September 30, 2004, including 26 new Service Centers opened in the first nine months of 2004 (of which one opened in the third quarter) and 21 new Service Centers opened during 2003. The total increase of 6% over the prior year third quarter results of $101.1 million reflects a decline of nearly 1% in same-store sales (excluding the 47 new units) and an increase of 7% from incremental new Service Centers of $7.1 million. Comparable-store sales were affected by inclement weather conditions in the Southeast region caused by increased hurricane activity compared to the same period last year . Management estimates that the negative effect of weather conditions on comparable-store sales was 2% for the third quarter and 1% year to date. The sales growth for the quarter was predominantly generated in the fertilizer and combination product categories. For the first nine months, Service Center sales expanded 7% to $303.1 million from $282.5 million for the same period in 2003. The increase in sales revenues was produced from a 1% same-store sales advance coupled with a 6% sales lift, or $17.6 million, from incremental new store revenues. Similar to the third quarter sales growth, fertilizer and combination products provided the vast majority of the sales increase for the first nine months of 2004 compared to the same period in 2003. 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 27 Service Centers during 2004 of which 26 were opened in the first nine months of the year.

     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 $46.0 million for the third quarter of 2004, a 2% decline from the $47.0 million in sales for the third quarter of 2003. The inclement weather conditions in the Southeast region impacted third quarter sales as the Company’s other selling channels produced sales growth of 3% through the first half of 2004. For the first nine months of 2004, these other selling channels produced a 1% increase, led by fertilizer and combination products, to $136.4 million from $134.5 million for the same period in 2003. 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, transacts orders through the Internet 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

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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 72 LESCO Stores-on-Wheels in the third quarters 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.

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