UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended March 31, 2005

or

Commission File No. 0-13147

LESCO, Inc.

Registrant’s telephone number, including area code
(216) 706-9250

     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 þ No o

     Number of Common Shares, without par value, outstanding on May 2, 2005: 8,893,664.

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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 — UNAUDITED

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 nation’s leading provider of lawn care, landscape, golf course and pest control products to the $6 billion professional green and pest control industries. Products distributed include turf control products, fertilizer, combination fertilizer and control products (combination products), grass seed, pest control products and equipment. The Company currently distributes products through 279 Service Centers, 98 Stores-on-Wheels®, 30 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 cost of product 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 and the portion of merchant discounts not 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:

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Note 2. Summary of Significant Accounting Policies

     1. Principles of Consolidation: The consolidated financial statements include the accounts of LESCO and its subsidiaries after elimination of intercompany transactions and accounts.

     2. Earnings per Share: The Company presents both basic and diluted earnings per share (EPS) amounts. Basic EPS is calculated by dividing net loss by the weighted average number of common shares outstanding during the quarter. Diluted EPS is based upon the weighted average number of common shares and common share equivalents outstanding during the quarter utilizing the treasury stock method for stock options. Common share equivalents are excluded from the EPS computation in periods in which they have an anti-dilutive effect. Stock options for which the exercise price exceeds the average market price over the period have an anti-dilutive effect on EPS and, accordingly, are excluded from the calculation.

     Weighted average stock options of 327,944 for the three months ended March 31, 2005, and 173,120 for the same period in 2004, were excluded from the diluted EPS calculation because they were anti-dilutive due to net losses.

     3. Stock Options: The Company uses the intrinsic-value method of accounting for stock-based awards granted to employees and does not issue options below market price on the date of grant and, accordingly, does not recognize compensation expense for its stock-based awards to employees in the Consolidated Statements of Operations. 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:

     4. Accounts Receivable:

     Accounts receivable consist of the following :

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     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 product.

     LESCO utilizes GE Capital Financial Inc., dba GE Business Credit Services (“GEBCS”), for the Company’s private label business credit program. Under its Credit Agreement with GEBCS, 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 Statement 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 initial term of the Credit Agreement is through December 30, 2008 with automatic three-year renewals unless either party terminates at least six months prior to the end of the expiration of a term.

     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) are recognized as accounts receivable by the Company, along with a corresponding borrowing from GEBCS. All of these balances were subsequently collected by GEBCS and there is no remaining balance at March 31, 2005. Sales activity on recourse accounts subsequent to December 30, 2003 is not recognized on the Company’s balance sheets. 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:

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     Inventories are valued at the lower of cost (First In, First Out cost method) or market. Consignment inventory is considered purchased at time of sale while, concurrently, cost of product is recognized. Procurement, warehousing and distribution costs to bring the products to market are capitalized to inventory on hand and expensed to distribution cost when the inventory is sold. A markdown reserve is provided for markdown of inventory to net realizable value. Shrink reserves are recorded for 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. Leasehold improvements are depreciated over the life of the initial lease term, which typically is five 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 were transferred to a third party logistics provider based in Columbus, Ohio.

     The Company currently retains certain properties of demised operations that are being held for sale. There is $49,000 recorded as an asset for these properties. All future costs incurred to prepare these sites for sale, including environmental testing and environmental remediation costs will be capitalized up to the realizable market value of each respective property. Other assets held for sale of $274,000 were sold in 2004 incurring a $264,000 loss on sale.

     In January 2005, LESCO announced that it retained Western Reserve Partners LLC to continue and advance its exploration of supply chain alternatives, including the possibility of the disposition of all or a portion of its distribution and manufacturing assets that had a net book value of approximately $15 million at March 31, 2005. The Company's goal is to sell these assets to a financial or strategic buyer and enter into a long-term supply contract with the buyer before the end of 2005.

     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. 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. Availability under the Facility is determined by a borrowing base formula calculated on eligible inventory. As of March 31, 2005, there was $46.5 million available under the borrowing base formula, with unused borrowing capacity of $18.4 million. At March 31, 2005, the Company had borrowings of $24.8 million on the facility. 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 $3.3 million were outstanding as of March 31, 2005. 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 the fixed charge coverage ratio. The Company was in compliance with the Facility covenants as of March 31, 2005.

     8. Asset Rationalization and Severance Expense

     Major components of the remaining reserves and accruals for asset rationalization and severance expense as of March 31, 2005 and December 31, 2004 are as follows:

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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 nation's leading provider of lawn care, landscape, golf course and pest control products to the $6 billion professional green and pest control industries. 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, grounds and gardens along with pest management professionals.

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

     Gross sales for these sectors for the first quarter of 2005 and 2004 were as follows:

     The separation of our customers into these two sectors is important as distribution to the sectors is vastly 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, industry-wide 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 279 Service Centers and direct sales associates with products specifically targeted to the Lawn Care sector. We estimate the market for our consumable Lawn Care products at $6.0 billion of which $2.8 billion is in the professional sector and $3.2 billion is in the consumer sector. Independent research indicates that organic growth in the industry is expected to exceed 7% 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 during the near future, nor do we believe our opportunities are as great in this sector as they are in the Lawn Care sector. Over the past few years, the industry has experienced a decline in annual rounds of golf played, which has decreased the budgets of golf course superintendents. The ability to capture incremental market share is limited as distribution of products to the golf industry is dominated by a few national and regional distributors. However, we anticipate that we will be able to extend our presence in under-serviced markets, as we implement a more efficient and lower cost Stores-on-Wheels operating model, which we believe will allow us to expand our fleet and our customer base. We currently operate 98 Stores-on-Wheels.

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RESULTS OF OPERATIONS

Sales: The following table provides supplemental detail of sales by customer sector and transacting selling locations:

     Service Centers: Service Center gross sales reflect sales transacted through our 275 Service Centers in operation as of March 31, 2005, including one new Service Center opened during the first quarter 2005. The total increase of 0.3% reflects a same-store sales (excluding stores opened in 2005 and 2004) decrease of 4.1% and an increase of 4.9% from new (2005 and 2004 openings) Service Center sales of $3.4 million. The comparable-store sales decrease was due to the extended cold weather and snowfall in March 2005, which delayed sales into April. Same-store sales for the first two months of 2005 increased 3.3%. We plan to open 30 to 35 Service Centers in 2005. Below is a summary of first quarter 2005 and 2004 Service Center Sales by period opened:

     Other Selling Locations: All other gross sales reflect sales transacted through our direct sales programs and our Stores-on-Wheels. The decrease of 9.7% is attributable to the year-over-year decline in sales to retail and international customers along with a 17.0% decrease in sales to customers in the golf industry as inclement weather has also delayed the start of business with golf customers located in Northeast and Midwest regions of the country. We continue to evaluate the return on investment relative to our contract accounts and have instituted disciplines to assure contracts meet acceptable return thresholds. This program has, on occasion, resulted in lost contract sales, and we will continue to cull national account sales that do not produce an acceptable level of return on our investment.

     Agency Sales, Freight Revenue and Customer Discounts, Rebates and Sales Adjustments: The Company has entered into agency agreements with certain of its suppliers whereby the Company operates as a sales agent of those suppliers. The suppliers retain title to their merchandise until it is sold by the Company and determine the prices at which LESCO can sell the suppliers’ merchandise. As such, the Company recognizes sales on a net basis and records only its product margin as revenue. Therefore, the $0.3 million of agency sales for first quarter 2005 represent the portion of gross revenue that exceeds the Company’s net product margin. Freight revenue, which represents fees charged to customers in sales transactions for shipping and handling, remained relatively flat on a year-over-year basis. Customer discounts and rebates declined slightly in the first quarter of 2005 compared to the same period in 2004 as the Company remains stringent on its qualifications for its customers to obtain rebates.

Gross Profit on Sales:

     Product margin improved 130 basis points in the first quarter of 2005 compared to the like period in 2004. The product margin improvement was achieved through expanding margins in the Company’s combination, control and grass seed product categories. This expansion in product margin is despite a year-over-year comparative price increase for urea of approximately 14% for the first

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quarter of 2005. Urea, our largest single purchased product or raw material, is used as the nitrogen source for blended fertilizers and combination products. Urea is a second derivative of natural gas and its cost has increased with the increased cost of natural gas. Urea can represent approximately 8% to 10% of our cost of sales. For 2005, we entered into a contract with our urea supplier to fix the cost of a majority of our urea needs at a price reflecting the prevailing market. The new contract rate for urea purchases increased approximately 14% over the prior year contract rate.

     In the first quarter of 2005, our warehouse and distribution costs increased slightly over the same period in 2004. Due to the year-over-year sales decline, we deleveraged the fixed costs included in these operating expenses. As a percentage of net sales, these costs increased to 9.9% in the first quarter of 2005 from 9.3% for the same quarter in 2004.

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. Approximately $1.2 million of the $2.0 million increase in expense is due to incremental operating costs for Service Centers opened in 2005 and 2004. A portion of the remaining increase on a year-over year basis is due to various employee incentive and training programs targeted to enhance the Company’s focus on increasing sales and profitability.

     Merchant Discounts and Provision for Doubtful Accounts

     As a percentage of net sales, merchant discounts and provision for doubtful accounts expense increased 50 basis points year-over-year. In December 2003, we entered into a private label business credit program agreement with GEBCS and sold approximately $57 million of our trade accounts receivable portfolio to GEBCS and in 2004, we sold an additional $6 million of trade accounts receivable to GEBCS. For the first quarter of 2005, total merchant discount expense, including GEBCS, for normal payment terms was 1.5% of net sales. Promotional discount expense was an incremental 0.6% of net sales including approximately 0.3% for extended payment terms for certain customer accounts with the majority incurred for a single, large national sales account. In the first quarter of 2004, discount expense for normal payment terms was 1.4% of net sales while promotional discount expense was an additional 0.2% of net sales.

General and Administrative Expense:

     General and administrative expense increased by $0.5 million in first quarter 2005 to $7.8 million, or 7.9% of net sales, compared to $7.3 million, or 7.1% of net sales, in first quarter 2004. The increase in expense year-over-year is due to the timing of the incurrence of certain payroll taxes related to employee commissions and management bonus payments. Additionally, the Company has incurred incremental expenses for license fees to operate in various states along with initial costs related to the proposed transaction to sell its manufacturing and distribution assets. The increase in these costs was partially mitigated by an approximate $0.3 million savings in corporate headquarter expenses as the Company reduced its lease obligation for its corporate offices in the fourth quarter of 2004.

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Pre-Opening Expense

     Pre-opening expense decreased $0.1 million in first quarter 2005 compared to first quarter 2004 results. Pre-opening expense per new Service Center remained consistent between years. Pre-opening expense, which consists primarily of grand opening advertising, payroll, supplies, distribution and storage costs, is expensed as incurred and, thus, some costs were incurred in the first quarter of 2005 for stores that are expected to open in the second quarter.

Other Expense/(Income):

     The increase in other expense is primarily due to a minor loss that was incurred on the sale of assets that were no longer utilized in operating the business.

Interest Expense, Net:

     Interest expense, net remained relatively flat in the first quarter of 2005 as compared to the same quarter in 2004. While the outstanding debt at the end of the first quarter was higher in 2005 compared to 2004 and the interest rate was higher year-over-year, the average debt during the first quarter of 2005 was lower versus the same period last year.

Pre-Tax Earnings:

     In the first quarter 2005, the Company opened one Service Center location to augment the 48 new Service Center openings in 2004 and 2003. Management views new Service Centers as the primary method to leverage our cost base and grow earnings consistently over the long term. The Company currently plans to open 13-16 new Service Centers in the second quarter of 2005. Below are the operating results for the first quarter of 2005 compared to the same period in 2004 for all Service Centers opened during 2003, 2004 and the first quarter of 2005:

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     As a result of the foregoing factors, including the difficult weather conditions in March 2005 along with the operating results of new Service Centers opened in 2003, 2004 and the first quarter of 2005 that have not yet matured in their operating results, the Company had a pre-tax loss of $10.7 million for the quarter ended March 31, 2005 compared to a pre-tax loss of $7.6 million for the quarter ended March 31, 2004.

Income Taxes and Net Loss:

     The net loss for the first quarter 2005 was $10.7 million, or $(1.21) per diluted share, compared to a net loss of $8.0 million, or $(0.92) per diluted share, for the first quarter 2004.

     In accordance with the provisions of FAS 109, in the fourth quarter of 2003, the Company recorded a charge to establish a valuation allowance for its net deferred tax assets, including amounts related to its net operating loss carryforwards. The Company intends to maintain a full valuation allowance for its net deferred tax assets and net operating loss carryforwards until sufficient positive evidence exists to support a reversal of some portion or the remainder of the allowance. Until such time, except for minor state and local provisions and adjustments to federal tax refunds, the Company expects to have no reported tax provision or benefit, net of valuation allowance adjustments. In the first quarter of 2005, LESCO increased its valuation allowance $3.5 million. In the first quarter of 2004, the Company adjusted previously estimated federal tax refunds by $0.4 million and increased its valuation allowance an additional $3.3 million.

     For first quarter 2005, the impact of the valuation allowance decreased the Company’s income tax benefit, and increased its net loss by $3.5 million. Because the Company cannot recognize a tax benefit at its estimated 39% effective tax rate due to its current accounting for its deferred tax assets, its loss has been increased approximately $0.47 per diluted share. For the first quarter 2004, the Company’s loss per diluted share was increased approximately $0.38 due to the same tax circumstances as in 2005.

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BUSINESS SEGMENT RESULTS

     We manage LESCO’s business utilizing two business segments – Selling and Support.

Selling Segment

     We maintain Four-Wall P&Ls for each of our selling locations (Service Centers, Stores-on-Wheels, direct sales representatives and all other direct selling efforts). These Four-Wall P&Ls include the sales, cost of sales and operating expenses (including payroll, benefits, rent, utilities, freight in-bound to selling locations and out-bound to customers) necessary to operate the individual selling locations. The Selling segment operating results reflect the aggregate Four-Wall P&Ls of selling locations adjusted for costs of zone and regional management, sales commission expense and the portion of merchant discounts not charged to the Four-Wall P&Ls.

     We allocate resources, including working, fixed and leased capital, to existing and potential selling locations based upon projected sales and return on invested capital (ROIC). We define ROIC as the percentage calculated by dividing net operating profit after tax (NOPAT) by invested capital. For the Selling segment, we calculate ROIC as follows:

     Our measures of ROIC may not be the same as other similarly titled captions used by other companies. For example, we do not capitalize operating leases or utilize average invested capital over given periods.

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Selling Segment Operating Results

Support Segment

     The Support segment includes the operating results and invested capital of all non-selling locations including manufacturing (blending facilities and seed processing plant), distribution hubs (including in-bound freight costs to the distribution hubs), and corporate costs (including corporate management of sales, marketing, customer service, accounting and finance, human resources, information systems, etc.). We believe that these costs are essential to managing the selling locations and to managing a public company, but are not costs that directly translate into incremental sales or positive ROIC. Therefore, resources are only allocated to the Support segment if the result is a net reduction in expenses or the allocation is necessary for the maintenance of facilities, support of the expansion of selling locations, maintaining the corporate structure or is mandated by law or governmental order. Below is the non-GAAP, adjusted ROIC for the Support Segment which excludes various charges recorded in 2004 and 2003.

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