Pantry Inc. F1Q09 (Qtr End 12/31/08) Earnings Call Transcript

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 |  About: The Pantry, Inc. (PTRY)
by: SA Transcripts

Pantry Inc. (NASDAQ:PTRY)

F1Q09 Earnings Call

February 3, 2009 10:00 am ET

Executives

Barry Epley – Vice President & Corporate Controller

Peter Sodini – President & Chief Executive Officer

Frank Paci – Senior Vice President & Chief Financial Officer

Steve Ferreira – Senior Vice President of Administration

Analysts

John Heinbockel – Goldman Sachs

Brian Hunt – Wachovia

Karen Howland – Barclays Capital

Karen Short – Friedman, Billings, Ramsey & Co.

Ben Brownlow – Morgan Keegan and Company

Anthony Lebiedzinski – Sidoti & Company

[Eric Wallenere] – William Blair

Operator

Good day ladies and gentlemen and welcome to the First Quarter 2009 The Pantry Inc. Earnings Conference Call. My name is [Erica] and I'll be your coordinator for today.

(Operator Instructions) I would now like to turn the presentation over to your host for today's call, Mr. Barry Epley, Vice President Controller. You may proceed sir.

Barry Epley

Good morning everyone and thank you for joining us. As you know, earlier today we announced financial results for the first quarter of our 2009 fiscal year. If anyone does not have a copy of the release and would like one faxed or emailed to them, please contact Selby Qewing in our office at 919-774-6700, ext. 7002, and she'll see that you get what you need.

Before we begin today, I'd like to point out that certain comments made during this call, may be characterized as forward-looking statements under the Private Securities Litigation Reform Act of 1995. Generally speaking, comments regarding the company or management's beliefs, expectations, targets, goals, plans, outlook or predictions of the future are forward-looking statements.

These statements involve a number of risks and uncertainties that could cause actual results to differ materially from the anticipated results implied by these forward-looking statements. These risks and uncertainties are detailed in The Pantry's filings with the SEC and in our earnings release issued this morning.

We refer you to the SEC's Web site or our site at thepantry.com for these and other documents. We also will discuss certain non-GAAP financial measures today that we believe are helpful to a full understanding of our financial condition.

Certain of these non-GAAP financial measures were also included in the press release that we issued this morning. We therefore, refer you to our press release posted on our Web site, which includes a presentation and reconciliation of each non-GAAP financial measure to the most directly comparable financial measure included in the press release, and an explanation of why we believe these measures provide useful information to our investors and how they are used by management.

With us today are The Pantry's Chairman and CEO, Pete Sodini, and Frank Paci, our CFO. I'll now turn the call over to Pete.

Pete Sodini

Thank you, Barry and good morning. We're pleased to report today a record quarter, in terms of range per share, EBITDA, and operating cash flow. Obviously, we had the winds at our backs with an extremely favorable environment in the energy market as oil prices fell almost continuously throughout the quarter, from $107 a barrel to $34 a barrel.

As a result, we achieved a gas gross margin of $0.0258 per gallon, and reported diluted earnings of $1.77 per share. EBITDA was $111.9 million and we generated approximately $89 million in operating cash flow.

Our results were exceptional; they were achieved during a period where we saw continual weakness in comp store volumes and a challenging gross merchandise margin environment.

Clearly our business is not immune to the intense pressures on the consumer. We have seen miles driven across the country down, despite the display of dropping gasoline prices, with the southeast down more than the average for the country; just anecdotally, as of the November DOT report, miles driven in the southeast are down 6.1%, compared to a year ago, versus 5.3% for the total country.

For the quarter we saw comparable gasoline gallons down 7.2% and comparable merchandise sales down 3%. We believe these results are somewhat misleading, due to the extreme gasoline shortages that we experienced in the first two weeks for the quarter. Just for perspective purposes, 72% of our gasoline product comes over a pipeline, versus 28% water terminal. It was a pipeline plantation in Cologne out of Texas where the major problems occurred.

We consider these weeks as no-comparable and only look at the final 11 weeks of the quarter, our buy-ins improve with comp store retail gallons down 5.1% and comp store merchandise sales down 2.7%.

Another factor weighing in the performance of our gas line is our diesel business. With the slowing economy, truck traffic was down significantly and our diesel gallons were down 18.3% in quarter one. This decline contributed 150 basis points to the decline in our total gasoline gallon comps.

The decline on merchandise margins primarily is driven by three factors, increase in cost of certain categories, a slightly unfavorable mix shipped away from some higher margin categories, and some increased promotional activity, primarily in our cigarette category.

While sales have been solid in our lower margin beer and cigarette categories, a softening economy has adversely impacted sales in higher margin discretionary areas, such as candy, general merchandise, and coffee, and in our service category, especially car washes. Frank will provide some additional details later.

We have already taken some actions to adjust prices in areas where we feel present opportunities – that present opportunities to enhance margin and continue to explore other avenues to improve margins, without impacting sales. One of the areas where we see additional opportunities is our food service business.

We believe we can continue to improve our food service offering and performance and have recently recruited a VP of food service to spear head this effort. We expect that over time we will be able to enhance our store growing, step up food program, continue to expand our Subway food franchise, and rationalize our food service offerings across our network. Growing out our food service business, which averages a gross margin of excess of 50%, should enhance our overall margin.

As I noted, we're very pleased to be able to generate so much cash over the past two quarters. We reduced our debt by a little over $26 million during the quarter, and ended the quarter with approximately $255 million in cash and cash equivalents.

While having a substantial amount of cash puts us at an enviable position, it also obviously raises the questions of what we'll do with the cash.

In the current credit environment, we want first to insure that we have adequate liquidity and navigate through headwinds in the economy. We continue to evaluate our options and have taken a conservative approach to employing our excess cash. We generate attractive returns and to deliver our business.

Our options include buying back debt at a discount, generating additional EBITDA through attractive price tuck and acquisitions. As an example, during the first quarter we repurchased more than $1 million at face value of our convertible bonds, for less than $600,000. We have the ability to purchase more debt if we feel that conditions are appropriate.

In view of the current challenging retail environment, we're exploring all opportunities to increase the efficiency within our business. By increasing our efficiency and improving our balance sheet, we believe we are positioning the business to prosper when the economy turns around.

Now I'd like to turn the meeting over to Frank, who will review the numbers in greater detail, Frank.

Frank Paci

Thanks Pete, and good morning. Over revenues for the quarter were obviously affected by the big drop in gasoline prices and declined 17.5%, to approximately $1.6 billion. Our gross profit was up 32.7% from last year's first quarter to $268.8 million. [Margin net] gross profit was down 5.2% but our gasoline gross profit increased 131.7%

On the merchandise side, total revenues were down 1.3% and comparable merchandise sales declined 3%. Merchandise gross margin for the quarter was 35.5% compared with 37% in last year's first quarter. Higher costs in our grocery category, including candy and coffee, caused a 100 basis point drop in margin and a higher level of promotional activity in cigarettes caused a 30 basis point drop, with improved package beverage margins slightly offsetting these margin declines.

The sales mix shift away from the grocery and services category toward lower margin category of cigarettes and beer, was somewhat offset by growth in food service but still contributed to a 40 basis point reduction in margin.

In the gasoline business, retail gallon sold for the quarter were down 5% overall, and down 7.2% in comparable stores. Total gasoline revenues for the quarter were down 21.5%, primarily due to the 16.8% decrease in the average retail price per gallon. From $2.92 a year ago, to $2.43 in this year's first quarter.

Our retail gross margin per gallon was $0.258 up sharply from the $0.106 per year ago. As most of you know, we report our gas margins net our credit card fees and equipment maintenance costs, which were $0.046 per gallon in this year's first quarter, compared to $0.048 per gallon a year ago.

We also saw credit card utilization decline from 63.9% to 60.7% sequentially, while being up only slightly from a year ago.

[So our] operating expenses totaled [$130.6] million, a $4.5 million increase versus last year. During the quarter, we took advantage of the favorable gas margin environment to spend an incremental $1.8 million in store repairs and maintenance, focused on improving the appearance of some of our stores, and $900,000 to upgrade [back-ups] computers in some stores.

In addition, store expenses were adversely affected by increases in utility costs, tax and license fees, and incremental costs associated with the roll out of our new POS system. These cost increases were partially off set by improved cash controls, lower insurance costs, and lower store labor costs. Our lower labor costs reflect the implementation of a new labor scheduling program that helps us better match our labor deployment to our sales volume.

Our general administrative expenses were $26.5 million, up $3.5 million versus last year. G&A expenses were $1.9 million higher this quarter due to a change in the timing of our employee stock compensation expense, and also reflects increases in compensation expense and higher bank fees.

Depreciation and amortization expense was $26.9 million, up less than 1% from a year ago. Net interest expense for the quarter was $21 million, down about $600,000 from last year. Net interest includes a gain of approximately $470,000 on the extinguishment of the $1 million of principle from our convertible debt during the quarter?

Pre tax in the income for the quarter was $64 million up sharply from the $5.3 million in last year's first quarter. The tax rate was 38.3% compared with 39.3% a year ago. Debt income was $39.4 million or $1.77 per diluted share, compared with $3.2 million or $0.15 per share last year.

EBITDA for the quarter was $111.9 million, more than double the $53.6 million from a year ago. Operating cash flow was $89 million.

As Pete's already mentioned, we finished the quarter with $254.8 million in cash and cash equivalents, up from $217.2 million at the end of the fiscal year in '08.

We're pleased with the increase in cash, since at the same time we also reduced our debt by $26.1 million and spent $26 million on capital improvements this quarter. Our capital spending target for fiscal 2009 is between $105 and $110 million.

With a strong first quarter performance, and our debt reduction, our position relative to all of our applicable debt covenants improved substantially. From a liquidity standpoint, in addition to the cash on the balance sheet, we have approximately $136 million available under our revolving credit agreement, after considering outstanding letters of credit.

We did not make any acquisitions this quarter. We had one new store opened and six stores were closed as their leases expired. We expect to open approximately four new stores in fiscal 2009.

In this morning's press release we provided updated guidance rangings for fiscal 2009. The most substantial change is that we've increased our range of retail gas gross margin to $0.14 to $0.16 per gallon, from the $0.125 to $0.15 per gallon we had previously, based on our strong margin performance in Q1.

We've also tightened up several of our other ranges by reducing the high end of previous expectations. We now expect total merchandise sales to be between $1.6 and $1.63 billion, retail gasoline sales to be between 2 and 2.05 billion gallons. Merchandise gross margins are projected to be between 36% and 36.3%. Store operating and general administrative expenses for fiscal 2009 are expected to be between $615 million and $625 million, with a midpoint $5 million less than our previous expectations.

We now estimate depreciation and amortization at $105 million to $108 million, with net interest projected at $85 million to $88 million. None of these estimates include any potential acquisitions.

With that I'll turn it over to the operator and we'll take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of John Heinbockel – Goldman Sachs. You may proceed.

John Heinbockel – Goldman Sachs

Pete, can you speak to the issue of price elasticity under your format, your customer base both gasoline and merchandise, because you might have expected, as gasoline prices come down and maybe gallons sold might pick up a little bit. We haven't' seen that yet, will we see that in this economy as price elasticity is kind of out the window, and same thing inside the store. Do you think as we see moderating inflation that volumes will move in a more positive direction?

Peter Sodini

John, let's talk about the gasoline for a moment. We got into this situation with dramatically increased costs in gasoline, went up to, north of $3.00 to $4.00. What we saw, and this is confined to major metro areas like Charlotte, as an example, is we found consumer's reaction to the $3.90s and $4.00 and $4.05 a gallon, was to switch to public transportation.

I think the numbers and I'm going from memory, but it seems to me in the Charlotte market, as the costs accelerated up this summer, [ridership] was up somewhere in the range of 17 to 20%. We've seen that in other markets. That we assumed was a normal reaction to a very high cost product. We would have anticipated if someone had asked that question then, if gasoline dropped back to levels that we now see, that we would have seen a consumer coming back driving cars.

The national data belies that fact, and the only thing we can assume is that at least in the interim though retail gasoline prices are down, there seems to be very little elasticity in terms of the consumer behavior.

We've been tracking in the Southeast, except for the month of November, which is the latest month reported, we've been tracking highest in the nation on a regional basis and in the most recent November report we were second highest at 6.1% decline, comparable with California passing us at least for November to 6.3% decline.

So, it's a very unusual consumer we see out there. We have not seen, particularly if you take out the three or four weeks where we had tremendous dislocation in terms of gasoline supply, adjusted merchandise sales in this environment, I think we're are around 2% if you take out those first three weeks which, where product was very scarce. We didn’t think that was particularly bad and quite frankly with the slowing economy, we weren’t the least bit surprised by that.

As to when the consumer will be back, we’re assuming that going forward that there aren’t – it’s going to be a slow return and thus we’re looking at all outlooks of expense and overhead to compensate for and operate at these temporarily reduced levels of comp sales and comp gallons, and I think you’ll see that over the near term.

Frank Paci

John, I think the other thing that’s difficult is that it really wasn’t until the end of October that gasoline prices this year were lower than gasoline prices last year. So even though they’re down substantially from what they were during the summer on a comp basis, it was really kind of when you got into November that you started to see the sharp decline versus last year.

Obviously, as you go throughout the year our comparisons against prior year numbers when you get to our Q3 and Q4, obviously get a lot easier because that’s when you realize how the lines drop off. So I think that you’ve got a combination of affects, which is if you look at anything in the retail world you see a big decline in some of the more discretionary retail items.

Obviously consumers feeling some pressure not sure exactly when that’s going to be but I think as you get the easier comparisons you see some.

John Heinbockel – Goldman Sachs

So if you know if price elasticity has for now, kind of disjointed because of the macro, do you then get less promotional because it won’t work to kind of drive traffic and sales and protect margins? Is that the approach to take so the top line is weaker but the margin that you get on it is better?

Frank Paci

I think that is a reasonable assumption if you assume that – what it would take to move retail numbers in a real meaningful sense. I think and you see that I think in a lot of other retail enterprises now, I think people will still be promotional, but I think that you have got to frame that with some realism, and realism is that it may well be too costly to move large mass of people and move those numbers up in the near term.

John Heinbockel – Goldman Sachs

All right. And then finally what can you guys do, I mean my sense is that you’ve got SG&A reasonably close to the bone there is there more big things to be done? And if volumes are going to be weaker, does that open up some more opportunities in the stores or elsewhere to right size some of your costs?

Peter Sodini

I think you’ve got to assume that we’ve gone through focally every – virtually every expense account, margin account in more detail than we’ve ever done before. Out of that we will spun some positive impacts.

Barry Epley

Yes. I think John if you look we’ve already taken our expense guide down by an average of $5 million if you take the midpoint. And that’s with, because we had the extra gas margin we spent some money in Q1 that was kind of above what we had originally contemplated going into the year.

So certainly it’s one of our expectations that we’re going to get as much efficiency as we can in operating the business.

Operator

Your next question comes from the line of Brian Hunt – Wachovia.

Brian Hunt – Wachovia

Thank you. Pete I was wondering if you could address you know fuel margins, maybe on a go forward basis. It looks like the industry and your competitors really took the cream off the top here and generated a ton of profitability.

Do you feel like one, the combination of refinery shut downs and strikes, as well as these really high margins in this most recent quarter are going to lead your competitors to be a little bit more aggressive on pricing in the near term, or could you just give us understanding what the temperament is out there?

Peter Sodini

I wish we could do the normal present the normal, reserve to inclination which would be to poll them, but there is a whole bunch of laws that preclude that. We’ve never been able to – and remember also, over 50% of our competition operates one store and what that statistic tells me is very compelling.

So we – it’s very hard to assume how they’ll react. Often times, as we’ve exemplified as most of the early quarters last year they react slowly. We, I think would be really speculating if we assumed anything other than that their normal inclination should be to be realistic, in terms of how to react to what is a very dower environment, I mean they like us have never seen an environment like this.

There are very few people who were living in the '30s, in the late '20s and '30s so and the world has changed obviously dramatically. So we are going quarter by quarter, month by month and making adjustments as we see the market on the most current basis.

So I don’t have a great deal insight on what competitors are doing. I assume they all read the newspapers. I assume they all listen to the economic news and the daily news, hard to escape if they read a newspaper and continue to see job layoffs, hat affects the psychology, I would think both the retail customers as well as the retailer.

Ideally, you have got to assume people are rational on both sides of the equation and people would get – retailers would get more prudent but we’re not – we’re certainly not betting on that.

Brian Hunt – Wachovia

It appears the majority of the refinery shut downs are the spot market players. Can you tell us whether sport market rack prices are higher than they are for what you do under contract and do you feel that puts them at a disadvantage in the market going forward?

Peter Sodini

Well I mean, if you get into a crisis period, spot market always react the quickest, so to that extent I would say you’re right, and also the smaller people who are buying on the spot day to day, so to speak, if you get into product shortages are going to be impacted the most severely. That’s always been the case in hurricanes or any other type of interdiction.

Brian Hunt – Wachovia

Okay and my last question is the new ship legislation and taxes on cigarettes are undeniably going to impact volumes consumed. Do you think they’re, one can you give us an idea what you all may be anticipating for declines in volumes given the big tax per pack per increase, as well as, do you think that is going to lead to any pick up in smokeless tobacco and have you seen that kind of dichotomy over the last year or so?

Peter Sodini

Let me just talk about the proposed tax and Frank and Mark can chime in. We’ve been in markets in states where we’ve seen $0.50 plus increase in terms of cost of cigarette. We think we have a good – and I recognize I think this one is 61 isn’t it.

Yes. So if you assume that that's the surrogate 50 is a surrogate, or 61, you in the short term are going to see a fair amount of that pass through in some markets, all of it pass through and you’re going to see an initial decline in unit consumption.

And margins, I think it’s reasonable to assume on the first year basis they’re going to be impacted because you’re not, there’s not an inclination of mark up the cost for the margin, but commission more just a straight pass through.

We think that we have a good track on that. Frank, why don’t you just throw something in?

Frank Paci.

Yes. I mean there’s the policy industry optimists that are out there, we’re anticipating obviously there’s going to be a decline some of the conventional wisdom says you could see as much as well 1% volume decline per $0.10 pack increase.

If you look at our volume, based on this year we estimate that you could see anywhere from a $1 million to $3 million impact in margin. None of that stuff is in our guidance yet; we’re waiting to see what the final shape on the bill looks like.

But it'll be interested to see how it all gets executed out in the market place. So, it’s a little bit speculative at this point in time, but it’s something certainly that we’re looking at, because it will have an impact on the business.

Brian Hunt – Wachovia

Right. I’ll get back in the queue, thank you.

Operator

Your next question comes from Karen Howland – Barclays Capital.

Karen Howland – Barclays Capital

I was wondering if you could talk about why perhaps you didn't actually repurchase more your debt outstanding? I think last time I looked the converts are still trading at a considerable discount, and I recognize the desire for financial flexibility, but it's my understanding that you could only actually repurchase somewhere in the R30 million area. How come it wasn't a little bit more?

Barry Epley

Karen one of the issues with the converts, because there's an equity piece on that you can only buy them during open windows, and because of between the fourth quarter and near the quiet period at the beginning of our fourth quarter results, we only had a relatively small window. If you look at those securities they're very lightly traded. We didn't want to effectively move the market with what we were doing. So, we kind of did what we could do during the short window that we had. So, I mean that's really what it was.

Karen Howland – Barclays Capital

And is there a reason that you can't buy back the other debt that's out there?

Barry Epley

No, there's not a reason we can't do that.

Karen Howland – Barclays Capital

So, is it reasonable to assume that you'll continue to pursue that strategy?

Barry Epley

As we've said, certainly we have the ability to continue to do that.

Karen Howland – Barclays Capital

And I know the second quarter is typically a low gas margin quarter. I think on average it's usually running at about $0.10 to $0.105. Is there any reason to think that this quarter would be different than that?

Barry Epley

No there's nothing that would say that there's going to be anything different from normal in this time.

Karen Howland – Barclays Capital

And so the trend so far in the first quarter wouldn't deviate too far from there? I'm sorry, in the second quarter.

Peter Sodini

It's very early, Karen, in the quarter. I think you certainly reflected the second quarter in our annual forecast. You're 100% right that it is normally a soft quarter. I think it's maybe one exception.

Frank Paci

Yes, we saw obviously we only have like five weeks in on it so.

Peter Sodini

So, it's normally done because of miles driven, and in normal basis goes down in many of our markets during this quarter, that makes it kind of a dull quarter and margins have always been a little tighter than the other three quarters of the year. If you'd have asked us last quarter how we see it, given the best insight we've got right now, we wouldn't see normally the second quarter being any different from the past, in terms of what gross margin would look like.

Karen Howland – Barclays Capital

Okay great, thanks for that, and in summary, the food service initiative that you have, can you go into a little bit more detail as far as timing when you see that actually being – how do you plan on rolling that out? What sort of opportunity do you see timing with that?

Barry Epley

Yes we purchased additional hot dog grills. We've been actually upgrading some of our promotional materials, hot toppers and stuff like that which has already rolled out. And it's been a big operational focus issue for our operations side. We have additional stores that we're planning to put in extra grills in which should be happening during Q2, and there are additional stores that don't have hot dog grills in that will be getting grills, which will be later in the quarter. So, we should have that fully implemented by the end of Q2.

Karen Howland – Barclays Capital

And so it sounds like it's not necessarily a change in strategy in food service continuing the hot dog grills, QSRs, but more just continued roll out of stuff.

Barry Epley

Yes I think it's greater focus. It think there will be opportunities in terms of from the efficiency in terms of operations efficiency, I think there are opportunities that we haven't maximized on the sales basis in stores, whether that's in Subway selling cookies and things like that. Also from a cost management standpoint, we're in the process of negotiating national supply contracts which we haven't had in the past in our chicken deli programs.

So, it's really kind of just similar to what we've been doing in our other areas in operations, increasing that focus and improving our efficiency and execution in trying to cash for some additional opportunity off the traffic that we've got coming into our stores.

Operator

Your next question comes from Karen Short – Friedman, Billings, Ramsey & Co.

Karen Short – Friedman, Billings, Ramsey & Co.

A couple housekeeping questions, I just want to clarify, [Tidos] and '10 is a 53-week year isn't it?

Barry Epley

That's correct.

Karen Short – Friedman, Billings, Ramsey & Co.

And on your CapEx can you give an allocation of a CapEx the $105 million to $110 million?

Frank Paci

Yes we can. When you look at the CapEx as we've talked about, typically you've got somewhere in the neighborhood of $50 million or $60 million in replacement capital. I want to say replacement maintenance CapEx. Then you've got new stores as a relatively minor amount, approximately $11 million, and then remodelings, you're talking about roughly $16 million, and then you've got the expenses we've got for our corporate office building is in the $12 to $14 million range that's in there.

Karen Short – Friedman, Billings, Ramsey & Co.

And that's moving ahead. That's the new headquarters?

Frank Paci

Yes and so I mean I think that's the majority of it, so.

Karen Short – Friedman, Billings, Ramsey & Co.

And the component that drops off would be upgrade of the fuel tanks?

Frank Paci

That will drop off as we get through the end of 2009.

Karen Short – Friedman, Billings, Ramsey & Co.

And that's how much?

Frank Paci

That's roughly $10 million a year.

Karen Short – Friedman, Billings, Ramsey & Co.

Okay, so then on your unit growth for this year, are you planning on any more closures this year?

Frank Paci

Well we estimate closures to be roughly 20 stores a year. So, a lot of that's occurring is we have stores that we have leases on that are coming up for expiration. Some of the stores are Florida stores where it doesn't make sense for us to spend the money to upgrade the tanks because that's a $200,000 shot. So, if it's a relatively low-performing store, at that point in time we'll close those stores.

But yes they're cash flow positive now, but they don't make sense for us to reinvest in those. Just a clarification on the capital, we've already spent $8.5 million to purchase the buildings. That's already in our first quarter's capital spending.

Karen Short – Friedman, Billings, Ramsey & Co.

Okay and then what are your preliminary thoughts on net unit growth, so including acquisitions in new stores and closures for 2010?

Frank Paci

Well I mean typically we don't plan acquisitions. So, we'll obviously look at that opportunistically, but right now we're not planning on a whole lot of new stores obviously. Depending on what happens in the market conditions and what's available from an acquisitions standpoint, that's what we'd be looking at.

Karen Short – Friedman, Billings, Ramsey & Co.

Okay, and then there was some article about the, I guess some of your competitors I guess closing down because they can't get the funding I guess to upgrade the fuel tanks in Florida. Can you just elaborate on that a little bit on what you're seeing from a landscape perspective in Florida, because of this fuel tank issue?

Peter Sodini

Yes I think we've seen some, Karen, and I think that's a 1231 requirement, and potentially these folks are running out of time, and the State is indicating they're not going to extend the timeframe because I think they are 100% honest when I say that. And I think we'll have a better read on that in Q3 and Q4, because especially right now we can't tell whether or not they comply with the law or don't say for major remodel renovation going on.

So, it's a hard number to get a handle on. The real number is in somebody's mind and whether or not he or she decides that they're going to shut it up. We think there are going to be far more of them next time in the 99 part of the law, which was relatively cheap to compile it. This is, Frank pointed out, was $200,000 plus or minus whatever major environmental remediation you might have.

So, it's a big number and I think it's going to discourage an awful lot of these people, particularly in small older units from going across and converting. I think to that extent, we are optimistic in Florida that you could well lose a significant number of units.

Operator

Your next question comes from Ben Brownlow – Morgan Keegan and Company.

Ben Brownlow – Morgan Keegan and Company

I may have missed this. Did you quantify what the fuel shortages impacted comps in the quarter?

Barry Epley

Yes. We said that without the fuel – if you just take the last a lot of the weeks, if you know where the first two weeks which is – I mean, you had some impact in week three, but the real big impacts were in weeks one and two. You would have been at a 5:1 gasoline comp versus the 7:2 negative.

Ben Brownlow – Morgan Keegan and Company

And merchandise a similar kind of 2% movement there?

Barry Epley

No, merchandise was – and I think we may have talked about this in general that we really didn't see the merchandise business get hit as badly as the gasoline business is, and part of this gets into is it a relationship between gas and merchandise. So merchandise was -3 reported, but would have been minus 27 if you only take the last 11 weeks. So it was really only 30 basis points in terms of the impact on merchandise comps where it was.

Ben Brownlow – Morgan Keegan and Company

And then on the merchandise margin side, are the actions you're taking there to try to improve those margins, is that purely related to the food service and the supply, et cetera? Or are there other actions?

Barry Epley

No, I think part of this is we've certainly seen some response. I mean, one of the areas where we've gotten much more promotional is in the cigarette business. As we've talked about we've seen a decline in margin in that category, but we've actually – it's actually held up strong in terms of sales volume, and that's actually put some pressure on the margin in terms of mix. I think we've got some opportunities to kind of tweak some of those areas where we're driving big increases in volume, but we've taken some hits on the margin.

So I would look at this as kind of fine tuning in some of the categories, where we don't think we need to be as aggressive as we've been in the past and there's opportunities to actually grow our margin dollars without materially impacting our sales line, because one of the things you do, obviously, is you discount, you lose revenue per pack. So you could end up, you could end up switching your prices a little bit losing some volume, but picking up margin and really not impacting your sales significantly.

Ben Brownlow – Morgan Keegan and Company

Okay great, and one last question, are you seeing any price wars on fuel anywhere in the country?

Barry Epley

Yes. I know we've got a limited – there was a limited – every once in a while when you get a new store opened you'll see some things happen, but that's very limited. That's probably, just routine, you always have market dislocation for days – a few days at a time. It varies, as Frank said, but you're opening and major remodeling if somebody forgot to move a price, but we've seen nothing that indicates that there's any significant price wars or anything of that nature going on.

Operator

Your next question comes from the line of Anthony Lebiedzinski – Sidoti & Company.

Anthony Lebiedzinski – Sidoti & Company

Yes, good morning, a few questions here. I was wondering if you guys could comment a little bit more about diesel. I think this is the first time that you actually quantify the diesel comps, mentioned that that was down pretty substantially. How many of your stores actually sell diesel and sort of what's your outlook for the rest of the year specific to that and where you're seeing margins also?

Peter Sodini

Let me just address the first part. You're correct. We've never dealt with diesel specifically as category, in terms of comps. We felt compelled to do it this time because of what's happening with – what has happened obviously with truck traffic as relates to the slowing economy. It was a material number and I think if you look across the nation, 17% at least with people I've talked to, it's not – that range is not an unusual number diesel, that's a big number. What do we have, Steve?

Steve Ferreira

We've got – yes, we have a little over 1,000 stores that have all diesel, but if you look at really big –

Peter Sodini

Truck stops.

Steve Ferreira

Yes, bigger stores – it's closer to 200 of them have higher volumes in terms of the diesel. Now the reason we never broke it off before, is because typically it wasn't a big variance, but as we've started looking at the business, it's one of these things that we've seen which could be kind of a leading indicator in terms of the economy because, obviously as you're shipping less goods you're seeing a big decrease in truck traffic.

The other thing that's interesting about it is because the average fill on that is huge, it has a big impact in gas gallons, but doesn't have nearly as big of an impact on the merchandise side because per trip you're talking about much bigger than what you're doing to fill up a car.

Anthony Lebiedzinski – Sidoti & Company

And margins on diesel, can you comment on that specifically?

Steve Ferreira

Typically diesel margins have been closer to the $0.05 range as part of that. Now with the big drop that we've seen in diesel they've been relatively high recently, but historically.

Anthony Lebiedzinski – Sidoti & Company

And also I was wondering if you guys could give us any details as to what specific actions are you taking to lower your operating expenses.

Peter Sodini

What did I say we went – we have gone through over the past 45 days, every line item of P&L it relates to items that, some of them relate to items are absolutely de minimis, but are available and you can grab them whenever you're reducing subscriptions to magazines or what have you, to looking at reorganizing our business more efficiently. So it runs the entire gamut, including every component of margin and every operating department we've got, so it's a combined effort. I think it will bear meaningful fruit and beyond that I guess we'll only get into more detail.

Anthony Lebiedzinski – Sidoti & Company

And my last question is about the new point of sales system. Can you give us a little bit more details about that, and what kind of results do you expect once you have the POS system installed?

Steve Ferreira

One of the things we've got in terms of POS system additional opportunities to enhance margins. Right now our system doesn't have a lot of flexibility in terms of how we do single unit purchases versus multiple unit purchases. And in terms of ease of operation, it's easier to train the operations folks and when you've got 17,000 employees, obviously that's a big expense in the business. So I mean those are two of those, in addition from an administrative standpoint there's a lot less paper that we'll have to deal with at the corporate support center.

Operator

Your next question comes from the line of [Eric Wallenere] – [William Blair].

[Eric Wallenere] – William Blair

Couple quick questions here. I believe, Frank, you had mentioned you were going to spend about $16 million this year on remodels. How many stores roughly are you looking at?

Frank Paci

Well, we've got a couple different initiatives that we've got going on. Some of those are major remodels, and some of those are we're looking at certain markets where we're going to go out and do some image upgrades as well. So when you get down to it you're probably impacting somewhere in the neighborhood of 50 stores.

[Eric Wallenere] – William Blair

Fifty, OK. Next question, I'm also a little bit curious to know if you saw any change in consumer demand within the gasoline business, regular versus mid-grade versus premium gasoline, as retail prices have come back down. Have you seen the premium mid-grade volume pick back up at all?

Peter Sodini

Some relatively minor increases in your premium grade.

[Eric Wallenere] – William Blair

But nothing major.

Peter Sodini

Nothing we'd describe as major, no.

[Eric Wallenere] – William Blair

My last question is a little bit longer forward-looking. I believe in conference calls past you guys have talked about, in terms of your merchandise mix where private label would go to, I believe, roughly like 5, 6% of your sales you thought would be private label, and pretty much that would be the max that you would – that you kind of envision having with private label.

I'm not sure if those numbers include or exclude food service, but I'm curious to know what your latest thinking is now given that, as you said Pete, the world has changed and the consumers obviously changing their spending habits. I mean are you revisiting that level of private label of penetration inside the store?

Peter Sodini

We're – I would say range you're giving to upwards around 5% is still operative. I think if one believes that this economic condition were going to persist for a couple years, just looking at what some of the numbers that people like Family Dollar and others are reporting, has caused us to look at the possibility of do we really want to expand? Do we want to bring items into our store that have some velocity that they presently – people like that presently handle that we aren't, and I think you can expect a little experiment with some of them, just to see what reaction our consumer base has.

[Eric Wallenere]William Blair

What do you think would be the largest hurdle or impediment for you to actually move it up higher if you wanted to?

Peter Sodini

Well, I mean, we could private labelize a good chunk of the grocery shelves if we wanted to. The problem is velocity on some of the items like health and beauty care items and things of that nature we don't move a lot of, we're at destination stores. It's more accommodation for a customer who's driving in and has a problem be it a headache or what have you. So I think you're realistically limited and I think the outside objective of 5 to 6%, probably still a good one to reflect on.

[Eric Wallenere] – William Blair

Okay and just to be clear, is that – that's excluding food service. You're not including food service.

Peter Sodini

Yes, that was not including food service in that number.

Operator

And we have no further questions in queue. This concludes the question and answer portion of the call. Thank you for your participation in today's conference. This concludes the presentation; you may now disconnect and have a wonderful day.

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