The Pantry Inc. F3Q09 (Qtr End 06/26/09) Earnings Call Transcript

Aug. 4.09 | About: The Pantry, (PTRY)

The Pantry Inc. (NASDAQ:PTRY)

F3Q09 Earnings Call

August 4, 2009 10:00 am ET

Executives

Berry Epley – Vice President and Corporate Controller

Pete Sodini – Chairman and Chief Executive Officer

Frank Paci –Chief Financial Officer and Secretary

Tom Murnane -- Lead Director

Analysts

John Heinbockel – Goldman Sachs

Bryan Hunt – Wells Fargo Securities

Ben Brownlow – Morgan Keegan

Mark Miller – William Blair

Ivy Jack – Barclays Capital

Simeon Gutman – Canaccord Adams

Anthony Lebiedzinski – Sidoti & Company

[Megan O'Hare] - BMO Capital Markets

Mike Smith – Kansas City Capital

Operator

Welcome to the third quarter 2009 The Pantry Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Mr. Berry Epley, Vice President Controller.

Berry Epley

As you know, earlier today we announced financial results for the third 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 Beverly Gainey in our office at 919-774-6700 extension 5217 and she will see that you get what you need.

Before we begin today, I would 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 are 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 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 most directly comparable financial measuring put 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, Frank Paci our CFO, and Tom Murnane our Lead Director. I will now turn the call over to Pete.

Pete Sodini

As you all know, we reported a net income for the third quarter of $43,000 or approximately breakeven on a per share basis compared to $10.7 million or $0.48 per share a year ago. Our results were impacted by weak retail gas margin, adverse economic conditions, and increased tobacco excise taxes.

On the gasoline side, our results are not surprising in light of our exceptionally strong performance earlier this year. You may remember that we reported an all-time record gasoline gross margin in the first quarter due to unprecedented declines in oil and gasoline prices.

We fully expected that sometime during the year there would be naturally some bounce-back and we would see oil prices retrace at least a portion of their huge decline earlier. And that's exactly what happened in the third quarter as oil moved from a low of approximately $46 a barrel to as high as $73 per barrel before easing slightly at the end of the quarter.

As you all know, when oil and gasoline prices are rising, our margins tend to get squeezed and we wound up with a $0.093 per gallon margin for the third quarter. Putting this in perspective, we still have a $0.153 per gallon margin for the first nine months of fiscal 2009.

In addition, market conditions were much more favorable for the first few weeks of the fourth quarter before tightening recently. So overall, even with a soft third quarter, we still expected the year with the gasoline margins at well above our long-term average.

Our gas gallon comps improved slightly during the quarter. Retail gallons sold in comparable stores were down 0.5% in the third quarter, much better than 6.4% decline in the second quarter. And our performance again was significantly impacted by diesel. Comparable diesel sales were down 15.1%.

Excluding diesel, our comp gallons sold were up 1.4%, much stronger than our 4.4% decline in the second quarter. We saw some improvement in the year-on-year weighted average miles driven in our market from a negative 2.6% in the second quarter to only a negative point three-tenths of a percent in the April/May period. However, our markets are continuing to trail the national average. Comps for our merchandise sales were up two-tenths of a percent for the quarter and were clearly dampened by the overall recessionary economy, particularly in the southeast.

As we've noted on previous calls, unemployment is significantly higher in our markets on average than in the U.S. as a whole. The weighted average unemployment rate in the U.S. in the states where we operated increased to 10.4% in the third fiscal quarter, up from 9.6% in the previous quarter and 5.9% in the third quarter a year ago.

Our merchandise results were also significantly affected by the increase in fed cigarette taxes under the SCHIP legislation that took effect April 1. This increase in taxes adversely impacted our cigarette unit volume and we believe this is having a spillover effect on the volume in other merchandise categories.

Even though we've taken a substantial price increase on tobacco products on a percentage basis, our tobacco margin is down from a year ago and our merchandise margin has fallen as we expected and discussed on our call three months ago. Frank will go into more detail on the whole tobacco category.

On a positive note, we're pleased to complete our previously announced acquisition of 38 stores from Herndon Oil on the final day of the third quarter. Located primarily in the Mobile, Alabama market, these stores nicely complement our existing store base by filling in a gap in our regional market presence. The acquisition included the real estate underlying 32 of the 38 properties. The store characteristics are similar to those of our average store in size and in volume.

The acquisition also includes six stores with operating Subway units. As we implemented many of our merchandise programs, especially on the food service side, we think there may be a significant potential upside in the performance of these stores and continue to believe this acquisition will make a positive net contribution to company earnings in 2010.

And now, I'd like to turn the meeting over to Frank to review our numbers in greater detail.

Frank Paci

Total revenues for the quarter were approximately $1.6 billion, down 34% from last year's third quarter primarily due to the huge year-over-year decline in gasoline prices. Our total gross profit of $201.1 million was down 6.1% from a year ago. Merchandise gross profit declined 3.5% while gasoline gross profit was off 13%.

On the merchandise side, total revenues increased 0.5% with comparable store merchandise sales up 0.2%. Our overall merchandise margin for the third quarter was 35%, down 150 basis points from a year ago. Approximately 90 basis points of the decline resulted from the impact of the tax changes on cigarettes, and approximately 40 basis points was from our grocery category which includes other tobacco products also impacted by tax changes. Despite the margin decline driven by lower cigarette gross margin, cigarette gross profit dollars were relatively flat compared to last year's third quarter.

As Pete mentioned, our merchandise results were significantly impacted by the $0.62 per pack increase in federal cigarette taxes. For the quarter, our cigarette unit sales were down in the low double digits as we expected, and this was offset by an increase in average revenue per unit of more than 25%. We are continuing to fine tune our strategy in cigarettes to determine the right competitive positioning in this key category.

In addition to the federal tobacco tax increase, our results were slightly affected during the quarter and will be to a much greater extent going forward by increases in state tobacco taxes. Kentucky increased its cigarette tax by $0.30 per pack in April, Mississippi by $0.50 in May, and Florida, which has 26% of our stores, raised the cigarette tax by $1 per pack on July 1.

Based on our revised guidance, you can see we expect further decline in merchandise margin from changes in the cigarette taxes and pricing in Q4. We believe the impact could be as much as 50 to 80 basis points sequentially from Q3, including approximately 30 basis points from incremental LIFO costs.

In addition, gross profit has been negatively impacted by sales declines in our packaged beverage business, primarily in take-home carbonated soft drinks but also in immediate consumption. The softness we are experiencing in this category is reflective of general trends in the packaged beverage industry. We've been working with our suppliers and recently increased our promotional activity in an attempt to improve our volume in this category.

In the gasoline business, retail gallons sold for the quarter increased 0.3% overall but were down 0.5% in comparable stores. As we note our gas gallon counts, excluding diesel, were up 1.4%. Total gasoline revenues for the quarter declined 41.2% primarily due to a 40.4% year-on-year decrease in the average retail price per gallon from $3.72 a year ago to $2.21 in this year's third quarter.

Our retail gross margin per gallon was $0.093 compared with $0.107 a year ago. The gross margin a year ago was reduced by three-tenths of a cent per gallon by losses incurred in our gasoline hedging program.

As you know, we report our gas margin net of credit card fees and equipment maintenance costs, which were 4.4% per gallon in this year's third quarter compared $0.062 cents a year ago but up from $0.04 in the second quarter. Credit card utilization was at 60% down from 61.9% in the prior year but up sequentially from 57.5% in the second quarter.

Store operating expenses for the quarter were $125.4 million down 0.6% from a year ago despite increases in facilities and insurance. We continue to achieve significant savings in labor costs, which were down approximately 5% on a per store basis in the third quarter, as a result of our ongoing initiative to better align staffing with store sales volumes.

General and administrative expenses were $27.8 million up $5.6 million or 25% versus the prior year, $4.6 million of the increase is attributable to three categories of expenses. The first includes about $2 million in one-time expenses primarily related to Pete's retirement and improvement costs for a new CEO.

In addition, it was a negative year-on-year swing of just over $2 million in real estate gains and losses, which are included in our G&A expense. A year ago we had miscellaneous gain in the third quarter of about $1.6 million while this year we incurred a miscellaneous loss of $500,000. Finally we have $500,000 in additional expense this year due to some accelerated investing of stock-based compensation.

Appreciation and amortization expense was $27.4 million up 0.4% from a year ago. Net interest expense for the quarter was $20.9 million down 4% from last year's third quarter. We had a pre-tax loss for the question of $330,000 compared with pre-tax income of $17.1 million in last year's third quarter.

Net income was $43,000 or $0.00 per share compared with $107 million or $0.48 last year. EBITDA for the quarter was $48 million compared with $66.1 million a year ago, and operating cash flow was $41 million.

Earnings for the first nine months for fiscal 2009 are up significantly from a year ago. Earnings per share for the nine month period were $2.06 compared with $0.40 per share in the first nine months a year ago. EBITDA for the nine month period was $209.6 million, an increase of 31.2% from a $159.8 million in the corresponding period last year.

Our financial results have enabled us to generate a $148 million in operating cash flow for the nine month period. As part of our ongoing strategy in balancing growth with deleveraging the business, we've used this cash flow to acquire 41 stores and reduce our debt in lease financing obligations by $52 million.

Despite these uses of cash, our cash balance has only declined $1.8 million from the start of the fiscal year, and we believe our liquidity position remains excellent with $215.4 million in cash on hand. In addition, we have approximately $143 million in availability under our revolving credit facilities after considering outstanding letters of credit. Capital expenditures for the first nine months of 2009 were $58 million and we now estimate that our CapEx for the full year will be between $90 million and $100 million.

As Pete noted during the quarter, we completed the Herndon Oil acquisition adding 38 stores to our portfolio. For the year-to-date, we've now acquired 41 stores, opened three new stores, and closed 18 stores. You'll see in our Form 10-Q filed later today, we've included pro forma financial results for the year-to-date acquisitions which show $0.15 per share in accretion from these transactions. However, we remind you the pro forma disclosures in the 10-Q were designed to show the affect the acquisitions would have had on results reported, not the affect it will have going forward.

The 10-Q also disclosures that subsequent to the end of the third quarter we're able to settle a dispute with one of our gasoline providers that will allow us to recognize a pre-tax gain of approximately$5 million in our fourth quarter of fiscal 2009. This benefit is included in our gas margin guidance range for the year.

In this morning's press release we updated our guidance ranges for fiscal 2009. The most substantial changes relate primarily to the acquired stores and the higher state tobacco taxes in Florida and Mississippi, which were not incorporated in our previous guidance. As a result of these changes, we've increased our target range for merchandise sales to between $1.65 billion and $1.66 billion and have reduced our expectation for merchandise gross margin to between 35.4% and 35.7%.

We now expect the retail gas margin to range between $0.144 cents and $0.154 cents per gallon for the full year. We anticipate retail gasoline sales to be slightly higher than our previous forecast between 2.06 billion and 2.07 billion gallons.

Total store operating and general and administrative operating expenses for fiscal 2009 are expected to be between $617 million and $621 million down slightly from our previous range despite the additional costs from the acquired stores and the inclusion of the one-time CEO transition expenses.

Appreciation and amortization expected to be between $106 and $108 million with net interest between $84 million and $85 million, excluding the one-time gains earlier in the year from the extinguishment of debt. None of these estimates include any future acquisitions.

With that, we'll turn it over to the operator and take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Heinbockel – Goldman Sachs.

John Heinbockel – Goldman Sachs

The merchandise comp looks like it slipped back a little bit from the prior quarter. Is that more tobacco utilization or soft drinks, the rest of the store or what?

Frank Paci

One of the things it's certainly softer and we talked about it is the package beverage category soft drinks, especially the take-home. We had very aggressive promotion last year. This year, with some of the cost increases that we've seen in that area, we're basically running about $1.00 higher per pack and we've seen a big decline in volume as a result of that. So it's really being weighed down the package beverage business as one of the big pieces that's dragging that down.

John Heinbockel – Goldman Sachs

You think that will take time to cycle or you think that's going to be more seasonal with regard to you'll see more promotional activity because volumes are down and volumes will pick back up?

Frank Paci

Well, we've already gotten a little bit more promotional on that. But again I think some of this, its difficult to separate how much of this is the general economy and how much of this is kind of overall industry trends, especially in the carbonated soft drink area and in our take-home.

Our take-home business wasn't a high margin business. It was a relatively low margin business for us but we think it did drive some traffic. Like I said, we've gotten a little bit more promotional in that but certainly its going to impact us from a seasonality standpoint more in Q3 and Q4 than it will in other parts of the year.

John Heinbockel – Goldman Sachs

Now on the excise tax, so volumes are down, low double-digit. You said average selling price is up to mid-20s. So your revenue is up double digit, correct, for tobacco?

Frank Paci

Yes.

John Heinbockel – Goldman Sachs

Now did you see a material shift from cartons to packs in the last three months?

Frank Paci

Yes, you're seeing a shift from cartons to packs and we also have multi-pack specials that we have. You've seen a lot of people who may have been coming in and buying a carton, you know coming in and buying a 2-pack special or a 3-pack special.

John Heinbockel – Goldman Sachs

The gross margins on packs versus cartons could that be as much as 2 to 1 or not that high?

Frank Paci

It's not that high.

John Heinbockel – Goldman Sachs

But [inaudible] gross profit dollars though are still down pre and post excise tax even with the double-digit increase in sales.

Frank Paci

Cigarette gross profit dollars are relatively flat. That also includes some, a little bit of a negative hit from LIFO from cigarettes as well.

John Heinbockel – Goldman Sachs

So the excise tax being negative its sort of a wash, I guess, directly more the impact on other kinds of spending in the store.

Frank Paci

Yes, I think, again, one of the tough parts is how much of this – I mean if you look at the unemployment numbers in some of our areas, especially some place like South Carolina where you've seen big increases in unemployment, obviously, you're seeing some weakness in customer demand there. You've also got the negative trend on cigarettes and that can be affecting some of our traffic. So I think there's multiple contributors there.

But margin, gross profit on cigarettes is relatively flat, despite all the stuff that's going on. Now, like I said, we continue to look at our strategy there and say, okay great. If you look beyond the cigarette category, what should we be doing with that category in general, in terms of how that affects the other merchandise as well?

Pete Sodini

John, just anecdotally on the economy thing, we're running in a range with the national economy is still last I saw under 10% high nines, in states like Alabama, Florida, Georgia, North and South Carolina and Tennessee, we're in double digits with the highest double-digit being in the state of South Carolina, which as of June was 12.1%. So this economy, along with all the taxes we've taken on the cigarette category, it's hard to discern how much is coming from where, but clearly they're both impactful.

John Heinbockel – Goldman Sachs

Where do we sit on the acquisition climate here? I imagine a lot is for sale, maybe not a lot of it is any good, but how much is out there, is the pricing right, how much could you or would you want to bite off here?

Pete Sodini

I think the pricing I think clearly has come down. We don't see, quite honestly, we haven't seen a lot of reason that is exciting and thus we're not out aggressively beating on bushes. We are and have been only interested in the southeast market, as in the past, and we'll patiently wait and see what evolves. I think since a number of these states are being impacted substantially worse than the rest of the nation, it's reasonable to assume that over the next six to nine months that there may be some attractive merchandise on the market. But right now, we don't see a lot of it.

John Heinbockel – Goldman Sachs

Is the major oil company divestitures, how attractive is that to you?

Pete Sodini

Well, if you look at what – up to present, it hasn't been very attractive to us at all. The largest block, I think, of divestitures that are coming downstream would probably be the Exxon assets and those are pushing out looking more like availability somewhere around the first of January, but that's my date not necessarily Exxon's date.

Just general what we glean as you recall, originally they were talking about on the market early the first calendar quarter this year. It slipped and slipped and now it looks more like early first calendar quarter next year. That could change. Obviously, some of those divestitures will be a market that is targeted that we've had interest in.

Operator

Our next question comes from Bryan Hunt – Wells Fargo Securities.

Bryan Hunt – Wells Fargo Securities

Pete, I just want to talk more about markets and economic situations. Talking to a couple of operators in Florida, they were early to go into the recession and it seems like the rest of the nation's catching up. Can you talk about maybe your store performance down there, as well as maybe the performance of your stores in major resort areas, what's happening on a year-over-year basis?

Pete Sodini

Clearly, let's take your second question, the resort venues are being impacted significantly. I had an article this morning out of the Orlando Sun talking about hotel rates and costs and clearly Orlando, Disney World has been impacted significantly. We anticipated and we have seen softness in resort venues in other places, Hilton Head, Charleston, Myrtle Beach.

Based on early poll data we saw we weren't surprise, but we were hoping that it would be better. But it is soft there, people are not traveling as much, they're clearly not spending the kind of money they would formerly have spent a couple or three years ago during the summer season, so we've gone through that.

Bryan Hunt – Wells Fargo Securities

Are those locations dragging your gallon performance and your comps performance down relative to the rest of the pool?

Pete Sodini

To some extent, yes, and I think whoever made the commentary, whoever you were talking about we saw a similar pattern a year ago when Florida appeared to be a softer result but general economy still "healthy". So we're fortunately in the market area of Florida where we're not as impacted as we might be.

Florida, in general, is running higher unemployment and the housing market is in, some areas, in horrible condition, but those are areas that we are not in generally South Florida, Miami-Dade, Ft. Myers area, coming up along Boca Raton and West Palm, those areas have certainly been impacted. Orlando and the central state has been impacted, but then you work yourself further north and you don't see the disastrous situation in housing prices in a lot of the market. So we're blessed by where we happen to be in Florida.

Frank Paci

Bryan, we've seen improvement in our gas gallons in Florida, as well. I mean, some of that is kind of what we've expected because, as you know, at the end of 2009 all of the Florida underground tanks have to be upgraded. So we've completed most of our upgrade so we're starting to see some benefit from that positively on our gas gallons in Florida.

And I think some of the people that have waited until the last minute they may be down as well, so we're seeing some benefit in Florida there. And I think we expect that, as you move into next year, there will be some places that will just get out of the gas business, and you'll continue to see some benefit in Florida kind of a little bit disproportionate to the economy from the gas gallon standpoint.

Pete Sodini

There's going to be permanent displacement in Florida. It is difficult. There are no state statistics you can gravitate to because, obviously, decisions as to whether or not an individual owner chooses to put in, spend $200,000 approximately to upgrade his facility with no apparent return, other than the ability to keep operating, we won't know that until after December. But there are a lot of indications that this is going to take a lot of marginal players out of the game in Florida and those locations will hopefully go into alternative use of something other than gasoline, so it could have a bit of a purifying impact.

Bryan Hunt – Wells Fargo Securities

Given that, I would say this quarter was a little lower than most people expected on the fuel margin side and you didn't budge your guidance much, it appears that this quarter is off to a good start on the fuel margin front. Is that a fair assessment of why you didn't move your guidance on the fuel margin side?

Pete Sodini

I think we looked at, we certainly were cognizant of where we were at point in time and that had some impact on it, yes.

Bryan Hunt – Wells Fargo Securities

Then switching to merchandise, other than package beverage and cigarette tonnage being down, if you want to look at it that way, are you seeing any other categories where you're materially weak? It sounds like with some of the resort venue and discretionary spending down that you may have lower sales on some of your discretionary items.

Pete Sodini

If you go through and look at some of the major vendors that are important in our business, I think Frank covered some of it in his presentation, people like Anheuser Busch, their category – what others would immediately jump out?

Frank Paci

For us, one of the areas is the grocery category, so you've got like packaged sandwiches and some of the alternative sweet snacks, some of that impulse kind of items. I think you are seeing people who are being a little bit tight with their money on some of that stuff, so.

Pete Sodini

Right, and if you look at the QSR side business, it's soft nationally. Ours is no different than that. People are being more cautious on how they're spending their dollars.

Operator

Our next question comes from Ben Brownlow – Morgan Keegan.

Ben Brownlow – Morgan Keegan

I was hoping you could give a little bit more color on the work force management initiative where you are with that and your expectations for the minimum wage increase and if that will have any impact.

Frank Paci

As far as the minimum wage increase, our impact is around $400,000 annualized we're about $8,000 a week impact on that so very minimal on the minimum wage. Work force management project is still ongoing. We're getting ready to launch in our first quarter of fiscal year 2010 our Phase II which will get to a by hour management of our sales we'll get down to management by hour.

Right now we're still managing by day on making sure that our hours are in line with our sales and our day parts. But what we anticipate to be fully rolled out to be probably the end of our fiscal year 2010 is what we're looking at to be fully implemented, up and running complete workforce management. That's where we will integrate our scheduling tool, along with our time and attendance, and task management will all be implemented and rolled out.

Ben Brownlow - Morgan Keegan

When will you be done with Phase II?

Frank Paci

Phase II we will launch in our first quarter of fiscal year 2010.

Ben Brownlow - Morgan Keegan

Where there any LIFO charges, you may have already broken this out, but were there LIFO charges in the quarter?

Frank Paci

Yes, there is certainly additional LIFO on the cigarettes offset by actually fairly low LIFO in the other categories because you're not seeing the big inflation in the other categories. So when we had done our initial look at this stuff we certainly had anticipated the additional LIFO charges on cigarettes.

We probably hadn't anticipated a little bit of the benefit that we're getting in some of the other categories which is why if you look at what we've done with our guidance, we've pulled kind of the top end of our margin range down because of some of the additional cigarette taxes that we're seeing in Florida, but the bottom of our range has stayed relatively constant because of that improved LIFO picture that we saw in Q3.

Operator

You're next question comes from Mark Miller – William Blair.

Mark Miller - William Blair

I was hoping that you could elaborate a little bit more on the margin decline you saw I think 40 basis points outside of cigarettes, and how much of that is due to your pricing actions relative to just the merchandise mix and presumably weaker sales on QSR and discretionary.

Frank Paci

Well, the grocery doesn't include QSR. In the grocery, one of the big drivers was our moist tobacco, smokeless tobacco products we all have those in our grocery category so not unlike cigarettes we saw some increases in cost in those areas. And so that kind of weighed down on that in addition there is still inflation in that category in some of the like candy areas and other areas like that that is causing some margin deterioration there.

Mark Miller - William Blair

The annual range 30 basis points I guess implies 120 basis point range in the fourth quarter approximately for merchandise gross margins. What would have to happen for you to be at the high end, in other words I guess margins being even up a little bit sequentially in the fourth quarter. And then for the low end of the range, what would be the things you're looking at that might actually, if my math is right, cause the margins to be down year to year?

Pete Sodini

One of the big things that's in there is how does the mix affect that because as we talked about we're looking at trying to figure out what is the right mix in terms of volume and pricing that we're looking at in our main categories. So depending on how successful some of those programs are how that would swing the mix one way or the other.

Particularly in the cigarette category, obviously, with Florida still early days in terms of what's going to happen to our volume in those areas and we're also looking at other markets where for example Mississippi where we've seen big declines in the business, what can we do to adjust those. So we'll be continuing to work on those during the quarter, so that's why we've kind of got a broad range in there some of that is rounding as well.

Mark Miller - William Blair

Can we just take a moment to talk about outside of the economic affects and some of these legislative changes tax affects, what are the biggest drivers the company has to try to stabilize to improve the margins. You can just kind of remind us where you're at with private label, what are the other things that over time you think can move the needle higher you think?

Pete Sodini

Well, certainly one of the areas that we're looking at is the foodservice area and how do we expand that. I mean that tends to be a positive in terms of growing the gross margin in that area. We have seen some softness in that area. We're looking at our supply cost certainly in our chicken deli operations. We're looking at consolidating suppliers and seeing some improvement from that area.

But I think until we run the course I mean there's discussion about a bill in North Carolina that would have a small increase in additional cigarette taxes as well. Until we kind of run this course on where all the states end up on this stuff, there is just going to continue to be pressure on margin percent. But as we talk about right now the gross margin dollars and the cigarette category are relatively flat.

Mark Miller - William Blair

Can you just give us some color on trends you've seen I guess in July relative to the June period? Would you say it's fairly similar to what we've seen? I'm talking about the merchandise comps or have you seen any improvement or did it soften?

Pete Sodini

They've been relatively similar to what we've seen.

Operator

You're next question comes from the line of Ivy Jack – Barclays Capital.

Ivy Jack – Barclays Capital

Question for you regarding resorts, can you tell me what percentage of your locations are located near resorts? And then also other quick question, are there any trade down opportunities in the [box]? I know you talked about the smokeless tobacco product is that not a higher gross profit dollar product per say than say cigarettes?

Pete Sodini

I think the first question is a 32% of our stores are in resort coastal, what we call coastal areas. And, yes, you are right I mean one of the things we are seeing is we are seeing people trade down from the cigarette category and seeing some growth in cigars and in smokeless tobacco products, which tend to have a higher margin. Obviously one of the issues is they also have tax increases as well. So in general while their higher margin than cigarettes, they're lower margin than they use to before April 1. So we are seeing that and we're also seeing some nice volume growth in that category.

I mean that's another thing within the grocery category the smokeless tobacco and cigars tend to be a lower margin than the average grocery category. So as those sales have grown within the grocery category, they've actually pulled the overall grocery category margin down.

So part of what we talk about what is going on in the grocery category there is actually a bunch of things going on in terms of higher sales lower margin products pulling your percentage margin number down, but you're actually seeing growth in that smokeless and cigar business as people kind of look for ways to enjoy tobacco at a lower cost than what you were seeing from cigarettes.

Ivy Jack – Barclays Capital

Frank I heard you talk this was a while ago, about how weather had also had an impact on the business. I don't know if it's possibly, but is it possible to maybe try to isolate some of the weather and kind of all the rain that you were seeing. I think this was in Florida around May.

Frank Paci

Yes, it's difficult to look at it but certainly if you look at our trend, our May numbers were much softer than our April and June numbers were. So I think there was some impact, it's very difficult to quantify that, but certainly May was a much softer month for us.

Ivy Jack – Barclays Capital

On acquisitions, certainly there are benefits that you get from scale, but can you also talk about whether or not there's also benefits in terms of operational expertise in terms of just being able to run the business a little bit better?

Pete Sodini

Clearly, that was present from the day we started acquisitions. We have systems advantages over a lot of the smaller independents. We certainly have, if you get any expense categories within the store operating statement, we have advantages that accrue to us there and cost of sales type advantages going in, and generally as well as gasoline if they happen to be branded or even unbranded. So I think that consistently has accrued to us in these acquisitions that will accrue to us in Herndon acquisition and in just about anything else we do.

Operator

Your next question comes from Simeon Gutman – Canaccord Adams.

Simeon Gutman - Canaccord Adams

Can you just comment on what your internal expectations for CPG for the quarter were and I recognize it's a moving target and it's not indicative of your forecasting, whether or not where CPG comes. But I'm curious if there were other factors that play something other than wholesale retail, such as the refining spread or maybe more aggressive retail pricing in your markets.

Pete Sodini

Are you talking about quarter 3?

Simeon Gutman - Canaccord Adams

Yes, quarter 3 that you just reported.

Pete Sodini

Yes, all above, I think the biggest driver was we saw crude oil and gasoline move quickly up the scale, was not unanticipated but difficult to identify a specific time and when that's going to happen. It did happen and we went up as high as crude advertise $3 a barrel during those timeframes. The low during the quarter I think was in the high 30s, 38 maybe briefly. So we always get caught in the escalating market. We felt we were going to get one whether it was quarter 2 or quarter 3 – quarter 3 or quarter 4, is a little hard to discern.

Simeon Gutman - Canaccord Adams

It was basically the traditional interplay that did it there was nothing else external to that?

Pete Sodini

Well, like I say, the reason you can tell that is if you look at our previous guidance, we had a 14 bottom on the previous guidance and you see we've actually increased our bottom on the guidance. So, yes, I mean if you look at our historical range, $0.09 is not outside the kind of historic norm to see those kind of swings and roundabouts in margin. So and to answer that question, yes, I mean I'm not sure we were surprised at that at all given the guidance that we have.

Simeon Gutman - Canaccord Adams

I guess connecting that thought to a prior statement regarding the fourth quarter CPG range, even logging in that $0.09 I think still if you look at what you did in the first quarter, there's still a pretty wide range for the fourth quarter. You can still model it out and get to within that range that you're guiding. So I guess there is still a little bit of potential cautiousness even if we come closer to the low end of the full year guidance, is that fair?

Frank Paci

Yes, that's actually that's very fair. I mean if you look at it, so far this quarter the numbers have been all over the place. I mean, you had first four weeks big drops in oil prices and the last two weeks you've seen big increases. So it's retraced kind of all the territory that it's dropped. So from here, as far as we're concerned, it's kind of anybody's guess as to what's going to happen for the last eight weeks of the quarter.

Pete Sodini

To go back to your earlier question, we don't see any major philosophical changes in our competitors in terms of how they price products.

Simeon Gutman - Canaccord Adams

Then this is touched on a number of ways but the gallon comp, yes, the absolute number is still negative but it's getting better, definitely at a better pace, or at least on a two year basis, on a better pace than the merchandise sales. We talked about the economic weakness maybe the customer's not there yet, but are there sort of some merchandising things you're not optimizing that you think you can take advantage of or is this just the hand that is being dealt by the economy?

Pete Sodini

I think up to this point it's largely the hand being dropped by the economy. I think we are happy with the results we've seen in gasoline the last couple quarters given all the metrics, on miles driven in the Southeast, which has been worse generally than the rest of the country.

So, yes, I think we've done well. If you particularly [isolate] diesel out of our gasoline business and look at pure gasoline comp to comp-to-comp to a year ago, we're fairly positive about what's been accomplished. People can appear to be very [focused] on them with their disposable personal income and we're seeing that across a number of categories in the stores.

And certainly the discussion we've had today on cigarette, the magnitude of those increases, which we certainly I don't think anyone's contemplated, that just puts more pressure on the disposable income and a lot of movement in numbers. People trading down the whole gamete, so it's very hard to get a good, solid pulse in this business until you get the full impact on what's going to happen, particularly with the cigarette category, that's a huge category for us and for this channel.

Simeon Gutman - Canaccord Adams

Lastly on the succession plan, I think the initial target was end of September, just in pure timeframe, does that sound reasonable? And I don't know if you're even involved in that whole process anyway.

Pete Sodini

Tom Murnane is our lead director and [inaudible].

Tom Murnane

Simeon, as you know, we announced several months ago that we would have a new CEO named and in place by the time he retires at the end of this fiscal year, which is the end of September. And I can report to you that the Board believes that our process is on track to meet that schedule, so really no change from that.

Operator

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

Anthony Lebiedzinski - Sidoti & Company

I was wondering if there was any way you guys could say what your merchandise same store sales were if you were to exclude the cigarettes?

Frank Paci

Well we've talked about, if you pull the cigarettes out, obviously cigarettes are a big piece of that you're looking around a negative 38.

Anthony Lebiedzinski - Sidoti & Company

As far as your guidance for retail gasoline sales, you increased that number versus your previous quarter back in May. How much of the increase in retail gasoline sales is from the acquisition that you just completed?

Frank Paci

Certainly, there's a decent amount that's from that but a lot of it came from, as you know Anthony, when we were coming into at the end of Q2, we ran a big negative gas gallon comps, so we weren't exactly sure where the gas gallons were going to go. So a large part of it was actually a pickup from Q3 gas gallons versus what we had forecast.

Anthony Lebiedzinski - Sidoti & Company

The gas gallon volumes that you are seeing now in July and early August, is there any way you can speak about that?

Frank Paci

Yes, the trend has continued to be better than it was earlier in the year.

Anthony Lebiedzinski - Sidoti & Company

Could you give us an update as far as where you stand with your covenants now as of this third fiscal quarter?

Pete Sodini

Yes, we had a significant cushion versus all of our covenants. Obviously, the way that covenants are calculated are on a rolling 12 basis. So if you look at our consolidated EBITDA, we've got more than $100 million cushion.

Anthony Lebiedzinski - Sidoti & Company

Also you guys earlier commented that a lot of marginal players in Florida, as far as the gasoline stations there possibly not looking to upgrade their underground storage tanks. Any idea as to how many of them are and what are the opportunities for you guys to expand your market share there?

Pete Sodini

Really there's no way to since they're not compelled by the state to pre-file that they're not going to change their tanks. You really just have to wait and watch and see who does or doesn't. There appear to be a lot of people who are either going out or are waiting pretty damn late in the year to start an upgrade because that's not a quick process, like a couple days. If you're into weeks, [mobile] weeks, by the time you get a permit and everything. So we're fairly saying that a lot of these small players will probably opt out.

Operator

Your next question comes from [Megan O'Hare] - BMO Capital Markets.

[Megan O'Hare] - BMO Capital Markets

I was hoping you could provide an update on the competitive environment?

Pete Sodini

Regarding what?

[Megan O'Hare] - BMO Capital Markets

Just what you're seeing in terms of any promotional activity from other stores and traffic, I guess.

Pete Sodini

Taking it from the top, one thing we certainly haven't seen is a lot of new competitive openings. I haven't seen any stats on it, but just visually, I don't think you're seeing those these days. I think the economic climate certainly hurt some.

I think Murphy announced about a month ago, Murphy Oil, that they were cutting back the number of their new stores they had contemplated putting in this year, so on the new store openings front, I think that's clearly been impacted as people just wait and see where these respective economies are going to go.

Frank Paci

But I think you have seen a lot of competition especially out-of-channel competition being very aggressive on promotional prices. I think, certainly, in our geography with the general softness, I think it's a pretty promotional environment out there. Like I say, from the C-store standpoint, nothing unusual but you've seen, I think we've seen grocery stores selling large packages of beer under cost and things like that. So there has been some increase I think in aggressiveness of out-of-channel competition.

Pete Sodini

Drug stores I'd also throw in that category.

[Megan O'Hare] – BMO Capital

Could you provide an update on your relationship with your vendors? Are you seeing or less support, in terms of promotional dollars?

Pete Sodini

I think our vendors have been working with us, as they always have. I think they're concerned about their categories and I think it's resulted, in some instances, them being more promotional. Everybody's trying to figure out the equation here that works in a market that has, in the southeast, been decidedly soft.

Megan O'Hare – BMO Capital

You've commented a bit on consumer behavior and I just wonder if you could provide some specific color on trading down within the store, if you're still seeing significant trading down within the cigarette category?

Pete Sodini

Well, Frank talked about one, which is the cigarette category, and it was anticipated you'd get some trading down from brand into lower priced stuff.

Frank Paci

Yes, you see people, things we talked about already, instead of buying carton buying singles or buying two packs. So, yes, there is certainly a lot of what I'll call trading down going on in the business.

Megan O'Hare – BMO Capital

Is there a significant margin difference between the cigarette categories?

Frank Paci

Yes, you actually make more margins at – you actually get a margin benefit as you trade down from a carton, but you lose volume sales. So you do have a period of adjustment as you comp against that, in terms of what I'll call delaying the pipeline, if you will so.

Megan O'Hare – BMO Capital

With the updated guidance, where do you assume gas prices will settle out for the year?

Frank Paci

We don't really kind of make an assumption about that. That's why, if you look at it, we've got some broad ranges in those numbers because it's obviously very difficult to predict. I mean, if you look at what's happening right now in the market, it seems to be driven by, as the stock market goes up and the dollar goes down, gas prices go up. But if you look at the fundamentals, the demand for gasoline and the inventory levels kind of aren't moving around, so you've seen some, again, increased volatility in that business without any real change in the underlying fundamentals in the business.

Pete Sodini

We weren't surprised by the rerunning up of crude to something like, I think this morning it's around $71, $72 a barrel. Now, I don't think that was a shock or a surprise. It is a little surprising that, most people think fundamentals of gasoline and crude wouldn't justify the ranges they're in now, but if you anticipate that the equities reflect where the general economy's going, I guess you can get there in terms of there's a distinct correlation lately of gasoline trading and crude trading upwards in the equities market.

Operator

Your next question comes from Mike Smith – Kansas City Capital.

Mike Smith – Kansas City Capital

I know that three or four quarters ago you had $0.16 a gallon profit and the next quarter you had $0.25 gallon profit, and then I notice that your same store sales pretty much flattened out after those two quarters. Could there be some elasticity at work here in that you weren't lowering your prices quickly enough during that period?

Frank Paci

During which period?

Mike Smith – Kansas City Capital

That would end up being the, well two quarters fourth quarter of last year and the first quarter this year is when you had the, I guess I'd call them above-average profits for gasoline on a [inaudible] per gallon. And then I notice that in the second quarter of '09 following that $0.26 profit, you had a 10 basis point drop in gallons sold and then followed that up with a 40 basis point improvement this quarter. I was just wondering if there's some elasticity. Did people maybe get angry because your prices weren't as low when you were making those significantly higher margins?

Frank Paci

No, I don't think there's any relationship whatsoever. I mean, if you look at it, you can look at the gas gallons a little bit on that. I mean we look everyday on how we're priced versus competition and there's really not a significant change on how we were priced versus competition during that period.

Mike Smith – Kansas City Capital

You hired somebody with a lot of QSR experience a quarter or two ago and I know that you were planning some switch of your franchising from your grills, and I just wonder could you give us an update on what more precisely is going on in that segment of the business?

Frank Paci

Yes, in terms of our grills, we don't do much franchising in our grills. We have our Subway, which is our largest franchisor that we've done and we continue to add Subways and we've also added Subways as part of the acquisition that we did. But in terms of our grills, we've rolled out hot dogs to additional stores, if that's what you're referring to, but besides that there's really been no major change.

Operator

There are no further questions at this time. I would like to now turn the call back over to management for closing remarks.

Pete Sodini

We appreciate everyone's participation today and we look forward to seeing you again when we report our next quarter. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may not disconnect. Good day.

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