The Pantry F4Q07 (Qtr End 9/27/07) Earnings Call Transcript

Nov.15.07 | About: The Pantry, (PTRY)

The Pantry, Inc. (NASDAQ:PTRY)

F4Q07 Earnings Call

November 15, 200710:00 am ET

Executives

Barry Epley - Corporate Controller

Peter J. Sodini - Chairman of the Board, President, ChiefExecutive Officer

Frank G. Paci - Chief FinancialOfficer, Senior Vice President Finance

David M. Zaborski - Senior Vice President-Operations

Analysts

Karen Holland - Lehman Brothers

John Heinbockel - Goldman Sachs

Anthony Lebiedzinski - Sidoti & Company

Karen Short - Friedman, Billings, Ramsey

Eric Wolinya - William Blair

Brian Hunt - Wachovia

Peter Aryk - AIM

Operator

Good day, ladies and gentlemen, and welcome to the quarter four 2007 The PantryIncorporated earnings conference call. My name is Michelle and I will be yourcoordinator for today. (Operator Instructions) I would now like to turn thepresentation over to your host for today’s call, Mr. Barry Epley, CorporateController.

Barry Epley

Good morning, everyone and thank you for joining us. As youknow, earlier today we reported our financial results for the fourth fiscalquarter and our full 2007 fiscal year. If anyone does not have a copy of therelease and would like one faxed or emailed to them, please contact MelindaWilkerson at our office at 919-774-6700, extension 5242, and she’ll see thatyou get what you need.

Before we begin, I would like to point out that certaincomments made during this call might be characterized as forward-lookingstatements under the Private Securities Litigation Reform Act of 1995.Generally speaking, comments regarding the company or management’s beliefs,expectations, targets, goals, plans, outlooks, or predictions of the future areforward-looking statements. These statements involve a number of risks anduncertainties that could cause actual results to differ materially from theanticipated results implied by these forward-looking statements.

These risks and uncertainties are detailed in The Pantry’sfilings with the SEC and in our earnings release issued this morning. We referyou to the SEC’s website or our site at the pantry.com for these and otherdocuments.

With us today are The Pantry’s Chairman and CEO, PeterSodini; Frank Paci, our CFO; and Dave Zaborski, Senior Vice President of Operations.I’ll now turn the call over to Pete.

Peter J. Sodini

Thank you, Barry and good morning. In way of an overallcomment or observation, it’s been an interesting quarter. Let me give you a fewmetrics that we think were critical. We started the quarter off with crude at$70.68 a barrel, ended the quarter at $82.08, hit a high 11/06 of $96.70.Gasoline stocks continue to trail last year, the dollar is weak, and tensionsin the Middle East continue, with particularly Northern Turkey, Iraq, and thecontinuing speculation of whether we are going to do anything in Iran.

All of these things play in the commodity market, all thesethings impact us and got us off to a rather disappointing quarter.

Net income in earnings per share were substantially below lastyear’s levels. These declines reflect the unusual condition in the oil andgasoline markets since Labor Day this year. Natural gas -- normally gas pricesweaken as demand drops at the end of the summer vacation period. However, thisyear oil and gasoline prices moved up rapidly to historic levels. As a result,we saw our gas margins squeeze to a below average level of $0.105 a gallon,well under the above average of $0.174 in the fourth quarter a year ago.

We expect the results to be down in the quarter this yearbut not to the levels we’ve experienced.

With a poor gasoline margin performance in this quarter, aswell as in Q1 earlier in the year, our full year results are disappointing.During the year, the cost of crude increased by almost 36%, which obviouslycaused compression in our gasoline margins.

I would add that the market environment has continued to bechallenging so far into our first quarter, and we expect that at this time ofyear, we would normally begin to see gasoline margins normalize but it isunclear when that will occur.

On the bright side, we saw merchandise comps improve toequal their best levels [in the year] in the fourth quarter. Comp storemerchandise revenues were up 2.8% for the quarter and total merchandise revenuerose above 16%. We believe 2.8% is a pretty solid number, considering thecontinued weakness in Florida where we have our greatest concentration ofstores.

If we exclude Florida stores, where comps were flat for thequarter, the rest of our system delivered comps of 4% in the quarter and 3.3%in the full year.

We continue to execute well against our variousmerchandising initiatives, adding elements such as our proprietary Bean StreetCoffee, chill zone quick service restaurant. We opened our 93rd Subway during thequarter and we’ve also successfully integrated all of our acquisitions from thepast year, as we expected.

And as we expected, the acquired stores turned in strongermerchandise margins sequentially in the fourth quarter.

Merchandise margins at our 60 Petro Express stores which weacquired in April improved by 75 basis points between the third and fourthquarter and are on track per our model.

Speaking of acquisitions, it’s easy to lose sight of thefact that fiscal 2007 was a very successful year for our acquisition program.We acquired a total of 152 stores during the year, compared with 113 in fiscal 2006. Because thesestores are larger on average and generating higher volume than our existingstore base, those 152 stores have the equivalent of well over 200 of ouraverage stores.

We remain very pleased with the overall quality of thestores we acquired last year from the standpoint of the prime locations, theirstrong merchandise and gasoline volume, and the opportunities they provide forfuture growth.

On balance, these were excellent strategic acquisitions andwe continue to believe that they significantly enhance our long-term earningspower. You can get a sense of that from the 16% increase in our totalmerchandise revenues and the 18% increase in our retail gasoline gallons in thefourth quarter.

This substantial growth in our revenue base positions uswell to deliver much stronger results when conditions in the gasoline marketturn to our favor.

As we’ve earlier discussed, we continue to remain selectiveas we review potential acquisition opportunities given current marketconditions. We continue to look at a lot of merchandise, a lot of deals, andfully expect to complete some additional acquisitions in fiscal 2008, but thenumber is likely to be well below the fiscal 2007 total.

We’ve also successfully opened 16 new large format stores infiscal 2007 and expect approximately 15 new large format stores in fiscal 2008,including new stores with full size Krystals and full size Bojangles, that lastone being in Jacksonville, Florida.

During the second half of fiscal 2007, we carefully reviewedour options for improving our efficiency and completed restructuring program inQ4. This program essentially eliminated a layer of field management and webelieve it actually strengthened our overall management core because quite afew of the managers in positions we eliminated only after the [inaudible]filling open positions in store management.

Our restructuring will generate significant cost savings andenhance our ability to leverage our cost structure in fiscal 2008 and beyond.

Now I would like to turn it over to Frank Paci, our CFO, toreview the numbers in greater detail. Frank.

Frank G. Paci

Thanks, Pete and good morning, everyone. Total revenues forthe fourth quarter were approximately $2.0 billion, up 19.9% from last year’sfourth quarter. Total gross profit for the quarter was down slightly, about 1%.While merchandise gross profit was strong, up 16.1%, total gasoline grossprofit declined by 29% from an unusually high levels of a year ago.

On the merchandise side, total revenues rose 16.3% andcomparable merchandise sales increased 2.8%. The merchandise gross margin was37%, in line with a year ago and up 40 basis points from the third quarter.Margin was down 20 basis points from a year ago due to the impact of the Petroacquisition, which we’ve talked about before, runs somewhat lower margins thanour average stores, and 30 points due to lower cigarettes category.

These impacts were offset by improved margin in our grocerycategory, which contributed 30 basis points, and 20 basis points fromimprovement due to a larger mix of food service sales.

In the gasoline business, retail gallons sold for thequarter increased 17.8% overall, with a 0.3% in comparable stores. Totalgasoline revenues for the quarter were up 20.9%. The average retail price pergallon was $2.76 per gallon, the same as a year ago, even though the averageprice was the same as a year ago, last year at this time prices were falling,where this time they were rising. That obviously impacts our margin.

Our gross margin per gallon was $0.105 compared with $0.174a year ago. As most of you know, we report our gas margins net of credit cardfees and equipment maintenance costs, which were $0.046 a gallon in this year’sfourth quarter compared to $0.045 a year ago.

You’ll notice in our press release that we have broken outstore operating expense and corporate overhead expenses. Store operatingexpense rose 13.9% and general and administrative expenses were up 9%, a goodperformance relative to the growth of 16% and 18% respectively in merchandiserevenues and gas gallons, retail gas gallons.

Interest expense and depreciation and amortization chargeswere up significantly, primarily due to the acquisitions in the first half ofthe year. Interest expense was $22.7 million, an increase of $8.4 million overlast year’s fourth quarter, while depreciation and amortization of $27 millionwas up $5.9 million from a year ago.

Pretax income was $8.7 million compared with $43 millionfrom last year’s fourth quarter. Net income was $5.6 million, or $0.25 a share,compared with $26.7 million or $1.17 per share a year ago.

EBIT on the fourth quarter was approximately $58.5 millioncompared to $78.5 million a year ago.

Just a few highlights for the full year -- total revenueswere about $6.9 billion, up 15.9%, merchandise sales increased 13.7% overalland 2.3% on comparable stores. Our merchandise gross profit for the year was up13.1%. However, gas gross profit was down about 20%.

Retail gas gallons for the year increased 15.6% but ourgross margin per gallon of $0.109 was down $0.05 from the $0.159 from a yearago. Net income for the year was $26.7 million or $1.17 per share, compared with$89.2 million or $3.88 per share in fiscal 2006.

EBITDA for the year was $214 million, compared with $278.9million last year.

I would like to point out here that in accordance with GAAP,our sale leasebacks result in a $458 million in lease financing obligations onour balance sheet. This accounting treatment affects the comparability of ourEBITDA and enterprise value calculations to those other retailers.

The rent payments due under our lease financing obligationshit our P&L as interest and depreciation and not as rent, and as a resultare included in our EBITDA calculation under conventional definitions.

If you treat these sale lease back obligations as if theywere operating leases, you would reduce EBITDA by subtracting sale leasebackrent and also remove the lease financing obligations from our capitalstructure. We have shown this effect, which we are calling adjusted EBITDA, inour reconciliation table in the press release. We believe this reconciliationallows for a more direct comparison with other retailers that do not have leasefinancing obligations.

In fiscal 2007, our adjusted EBITDA was $178.1 million,compared with $254.2 million in fiscal 2006. Even though adjusted EBITDA isbelow our EBITDA, if you remove the lease financing obligations from ourenterprise value calculation, our enterprise value to EBITDA multiple issignificantly lower using the adjusted EBITDA methodology.

Sale leaseback rent was $35.9 million in fiscal 2007, and isprojected to be approximately $46 million in fiscal 2008.

Capital expenditures for 2007 were $146.4 million on a grossbasis and $110.2 million on a net basis, net of certain sale leaseback proceedsand other transactions. For fiscal 2008, we expect our net capital expendituresto be approximately $110 million, in line with last year’s investment, eventhough approximately $18 million is planned to be spent on store systemupgrades this year.

At year-end, cash and cash equivalents were $75.5 million,compared with $120.4 million at the end of fiscal 2006. We also have availableapproximately $168 million of our revolving credit facility after adjusting forletters of credit. In addition, we have delayed draw option on our loanagreement we negotiated last spring, which gives us the right to add up to $100million to our term loan, with the same attractive pricing and other terms on afully committed basis at any time through the middle of May.

Now I would like to review our guidance for fiscal 2008. Weremain comfortable with our previous outlook for merchandise sales, whichcontinue to be relatively strong so far this first fiscal quarter. We alsocontinue to expect the retail gasoline margin for the year to be between $0.11and $0.13 per gallon, even though margins for the first quarter to date continueto be challenging.

The rapid increase in gasoline prices has softened demand.We believe that if prices remain high, comparable store gas gallons for theyear could be flat to down slightly, with total retail volume of about 2.2billion gallons. However, through additional targeted expense reductions, wethink we may be able to offset most of the shortfall in gas gallons.

Now I will turn it back to Pete for final comments.

Peter J. Sodini

On balance, fiscal 2007 was clearly a difficult year for usin a very challenging gas environment, and those conditions have continued sofar into 2008. We’re not staying still in face of these conditions. We arecurrently testing the ethanol blend in several locations and expect to beginrolling it out across our store base in the months ahead. However, we wouldcaution everyone that we are pursuing this as much for defensive purposes asfor offensive.

In the current price differentials between ethanol andgasoline in the marketplace, we expect competitors will be exploring ethanolblending as well and we don’t want to be at a competitive disadvantage.

We also continue to explore alternatives to try and hedgeenergy costs in this uncertain environment. We continue to believe thatPantry’s fundamental strength as a consolidator in the industry has not beenmaterially diminished over the past year.

As the leading independent convenience store chain in theSoutheast, we remain well-positioned for future growth, both organically andthrough acquisitions, as we have the financial strength and flexibility toexecute that strategy.

And with that, we would like to turn the call back to theoperator and take any questions you might have.

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question comes from theline of Karen [Holland] of Lehman Brothers.

Karen Holland -Lehman Brothers

On the acquisitions, Pete, it seems like your tone haschanged somewhat from the last conference call, where it seemed like you wouldnot be, or you would really be pulling back on acquisitions, whereas thisconference call you said you would be opportunistically looking at them, don’texpect it to be as high as it was, the number of acquisitions as high as it wasthis year, but certainly we’ll be making some. Am I right with thatunderstanding, that you seem a little bit more open to it?

Peter J. Sodini

I think the answer is no, and to the extent we convey that,it’s a mis-conveyance of feeling. We continue, and I think the message was thatit would be the same as the last quarter, we continue to be interested inselective acquisitions, particularly those that fit into the existing markets.We’ve looked at them. Obviously we haven’t done anything appreciably thus farbut we’ll continue in the vein of continuing to look.

I don’t, as the press release indicates, I don’t see uscoming anywhere near the acquisition that we experienced last year, whichreally was an exceptional year, particularly in numbers and also particularlyin terms of the quality assets that we acquired.

So the answer is no, we are not trying to convey an image ofbeing more bullish on acquisitions this year than last.

Frank G. Paci

I think last time, the comments were misinterpreted that wewere pulling back.

Peter J. Sodini

Probably because we used that word.

Frank G. Paci

Yeah, no, I understand that but I think frankly, we’vealways continued to look at them but the real point was that we were trying tobe more selective in what we are looking at, so --

Peter J. Sodini

From what perspective it yields, there are we think an awfullot of people out there selling and as there’s always been in the pastsituations, there are an awful lot of things out there that we wouldn’t beinterested in buying. So it would have to be very selective and of extremelyhigh quality for us to spend the time to do a full evaluation.

Karen Holland -Lehman Brothers

But you are seeing more people open to selling now?

Peter J. Sodini

Oh, gawd, yes. I mean, just look at what’s happened to thecrude markets and the gasoline markets and you can appreciate why.

Karen Holland -Lehman Brothers

Of course. Turning over to your comments on ethanol, lookingat the price differential, I know you said that -- I’m sure a lot of yourcompetitors are also going to be going out and buying the ethanol blend. Youdon’t believe that there would be any benefit that would come from being ableto buy 10% or so of the product at a considerable discount, as far as how itwould impact the margins?

Peter J. Sodini

I think there is absolutely a significant benefit for buyingethanol because of the price differential with gasoline. We also assume that someof our other competitors also have good mathematical facility and will probablybe doing the same thing.

In the Southeast, because of the pipeline, because of thefact that ethanol can’t travel up the pipeline, so it has to come in eitherover the water or on rail, the logistics are not well developed here, and thusyou haven’t seen -- I think what you will see is a transitional movement toethanol blends over the next probably 12 or 14 months.

If we were the only one doing it, we would say that it wouldbe a boom to our earnings but the facts are others are getting into it and weall will get into it because the 10% blend right now with the ethanol pricingis extremely attractive.

So we weren’t trying to play down the impact of it, but moreto be conservative as to the [inaudible] impact because quite frankly, we don’tknow. We don’t know what other people’s plans are, what their transition plansare. We know what ours are at the moment and we will continue to phase it in. Ithink by within a year we’ll have it in a high percentage if not all of ourstores.

Karen Holland -Lehman Brothers

And would that be going just for the private label gasolinethat you sell?

Peter J. Sodini

No, I think if you look at ethanol in other marketsthroughout the U.S., you’ll find that all the brands go to the -- in this case,10% blending and they are all again in varying stages of transitioning to thatso that they can do the injection attheir terminals and then offer a 10% ethanol blend to their consumers. I thinkunbranded will have it as well as brand, and the question is timing as to sortof who gets to third base first.

Karen Holland -Lehman Brothers

And you all wouldn’t actually be doing the blendingyourself, you actually would just be buying the blended product, so youwouldn’t have to actually build out any infrastructure, it would just be amatter of changing --

Peter J. Sodini

I wouldn’t assume the latter, that we wouldn’t be -- wewouldn’t be building any material infrastructure. It does not require amaterial infrastructure to blended ethanol, but there are some terminals thatwe will be doing our own blending, yes. But the capital requirements to supportthat is not a material item, and we may well only end up with someonepartnering with us in that enterprise.

Frank G. Paci

And there is some R&M expense in converting a station toethanol, but that will typically run through our gas margin and ultimately beoffset by any kind of benefits from that, so --

Peter J. Sodini

Very quickly offset, I mean in some cases, for instance, ona high volume location, probably a couple, three [days] cover, will cover about$2,400 a store to clean up tanks and get them prepped for the ethanol.

We have had ethanol mandated in the Richmond market. Wedon’t have a lot of stores there but we’ve been in that market with ethanol,E10 blend for now going on two years. We think we know it. It’s not a particularlydifficult item to, or risky item to handle and we’ve had virtually no problemswith it in Richmond. We would expect no problems with it in the remainder ofour chain, say for the normal transition type of problems we have in gettinginto the category.

Karen Holland -Lehman Brothers

Okay, great. I’ll past it on to someone else and get back inthe queue. Thanks so much.

Operator

Your next question comes from the line of John Heinbockel ofGoldman Sachs.

John Heinbockel -Goldman Sachs

Sure. A couple of things; is there anything that’s changingin the gasoline market today that would --

Peter J. Sodini

Well, I think we put out a range in gasoline CBG of $0.11and $0.13. We are still comfortable with that range. To find out if anything isreally changing, you have to -- this is a fragmented industry and you have toget inside the minds of a lot of people who make decisions on different basis.Since we don’t have general meetings on the subject of pricing with ourcompetitors, it’s a little difficult to anticipate how they view the market.

All I can tell you is this; that there is no magic in thisbusiness and the kind of margin that we experienced in Q4 is not one that Iwould think anyone would rhapsodize over.

John Heinbockel -Goldman Sachs

So if we end up at staying at $100 a barrel, you can still-- there’s nothing structurally different that you couldn’t earn 11 to 13 onthat versus $50 a barrel?

Peter J. Sodini

The only structural change, John, is the [jumps] aren’t asobvious as the credit card impact, if you assume a corresponding higher retailgasoline, that goes up and that [all] has to be pushed through to get tonormalized margins, but save for that, I don’t see it -- that it’s going tomaterially change our world.

Frank G. Paci

I mean, if anything,if you think about cents per gallon on a percent margin basis, it’sridiculously low at $100 a barrel.

Peter J. Sodini

We actually run graphs here, but we rarely talk about theCBG, but where we look at gasoline margin as a percent of gasoline revenue, andit is so abject and pathetic that it makes one nauseous, but it’s about lessthan 4% now, which doesn’t make any sense whatsoever.

John Heinbockel -Goldman Sachs

You made the comment that first quarter to date, the marginsremain under pressure and I know you don’t want to focus people on short-termstuff, but would it be fair to take that to mean that that is below the low endof your full year guidance or not, it’s better than that?

Peter J. Sodini

I think there’s been some [Opus] data published, and thereare a lot of people publishing [Opus] data now on a weekly basis where theylook at our margins, KC's margins, Circle K’s I believe and others, and therewas certainly some weeks, if you stipulate that their numbers are reasonable,where we were below our guidance, yes.

John Heinbockel -Goldman Sachs

You also talked about the offsetting, maybe 100 million lessgallons sold on the expense side. Can that be offset by what you’ve alreadydone, or will it be offset by moves that you have yet to make beyond therestructuring?

Frank G. Paci

Some of that is some of the benefits of the restructuringbut we continue to look at all of our expense categories, look at opportunitiesthat we have in improving our efficiency and we think there are additionalopportunities that we can pursue.

John Heinbockel -Goldman Sachs

Because you were talking about basically taking 100 milliongallons out, about $10 million, $11 million, $12 million of gross profit comingout, correct?

Frank G. Paci

That would be right.

John Heinbockel -Goldman Sachs

And the restructuring alone is worth about $6 million? Sothat may get you some of the way there, but you are saying there are otherthings you are going to tweak as you go forward here?

Frank G. Paci

That’s correct.

David M. Zaborski

We’re looking at every expense line out there on the upsideand we’re having some [inaudible].

John Heinbockel -Goldman Sachs

And is the opportunity, is it more in the stores orbackstage?

Frank G. Paci

It’s in both places.

John Heinbockel -Goldman Sachs

But just the -- if you look at the -- I would think you arefairly lean corporately, in that corporate category as opposed to storeexpense, or no?

Frank G. Paci

Yeah, no, and absolutely I think Dave’s guys have been doinga great job in terms of looking at all the different expense categoriesobviously the bulk of our expenses are at the store level and they’ve beendoing a great job of looking at those categories and trying to figure out wherethey can make a difference.

When you’ve got 1,600 stores, it doesn’t take a lot on a perstore basis to make a big difference across the chain.

David M. Zaborski

In the short term, without any acquisition activity, we’vebeen able to focus specifically on by-line expenses and we’ve had some success[in that].

Peter J. Sodini

I think that’s key, John, because we enacted here last yearwith large stores, with stores that certainly we didn’t want to mess up thetransition on, and that is a huge diversion, even though you continue to try torun the rest of your business, because of the volumes, because of the desire toget these across smoothly. They came across smoothly. They are performingconsistent with what our model would have hoped for, but it was a huge diversion,particularly for ops.

And also, your whole finance function, your whole analyticalfunction -- it’s a difficult task to integrate 200 high volume stores in arelatively short timeframe, or the equivalent of 200 stores.

So yeah, it was a diversion. I think we’ll benefit, as wedid in 2003, I think we’ll benefit from the absence of diversion because as wesuggested earlier, though we are interested in doing acquisitions, they aregoing to have to meet a high threshold.

John Heinbockel -Goldman Sachs

And one final thing; let’s say acquisition activity is goingto be more modest, profitability improves. Would you expect debt levels to be adecent amount lower a year from now than they are today, and I assume that willpositive impact interest?

Frank G. Paci

I wouldn’t make that assumption. I think that as we’ve said,we think we will do acquisitions. Obviously if we don’t do acquisitions, on anet basis we probably be less debt but in my mind, that would be money that wewould be reserving on our balance sheet as cash for future acquisitions,because we certainly will be doing acquisitions. The question, as you know, younever know when a good deal is going to come up.

So to me, on a net debt basis, if we didn’t do anyacquisitions, we’d obviously have more cash on the balance sheet but wewouldn’t be paying down debt, so --

John Heinbockel -Goldman Sachs

All right. Thanks.

Operator

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

Anthony Lebiedzinski- Sidoti & Company

Yes, good morning. I was wondering if you guys haveconsidered accelerating the number of quick service restaurants, or perhapsdoing some other prepared food programs to less the volatility from the fuelmargins?

Peter J. Sodini

Yes, we have. I mean, and we would have had the same answera year ago and the year before that. We could ratchet up the number of our QSRfranchises rapidly right now, but the fact is we’ve been very selective in thefranchises that we want to align ourselves with. You saw in the release that weopened our 93rd Subway during the quarter. That is still our preferredfranchise and thus we move along, we’ve moved along reasonably. There’s acouple of new ones in our game plan for next year and we’ll see how they workout.

We love the QSR business but we need something that alsoworks in a C-store environment. David.

David M. Zaborski

We’re looking at two angles. We expect to have a very goodyear with Subway this year on new store development. Like Pete said, we have acouple of full scale restaurants coming up with a Krystal’s and Bojangles withdrive-throughs that we think are going to derive some very high volumes.

But we are also looking at our store base that cannot have aQSR restaurant in it and we think there is an opportunity to improve the foodservice in the stores that can’t have a national brand in them. We are going toput some energy behind that in the next couple of quarters.

Anthony Lebiedzinski- Sidoti & Company

Okay, thank you very much.

Operator

Your next question comes from the line of Karen Short withFriedman, Billings, Ramsey.

Karen Short -Friedman, Billings, Ramsey

Just following on the ethanol conversation a little bit, doyou have a sense of what, I guess how many stores will actually be able to getthe benefit of the government tax credit as well? Maybe just explain a littlebit how that would work.

Peter J. Sodini

We believe since we are controlling the process, we believe-- as I sit here I think all of them will qualify for government tax credit,yeah.

Karen Short -Friedman, Billings, Ramsey

Okay, so how many stores do you think might be offering theE10 by the end of the year, by ’08?

Peter J. Sodini

By the end of fiscal ’08?

Karen Short -Friedman, Billings, Ramsey

Yes.

Peter J. Sodini

I don’t want to be evasive, but let me answer it this way;as many as we can get done and transitioned, and as rapidly as we can do it.But as I said, the logistics in this part of the country are not well developedon ethanol and it is a bit more cumbersome, although it is moving rapidlybecause of the opportunity and the fact that big oil has generally lagged inthe Southeast in terms of ethanol converted into any of their terminals -- theyare in process but they are behind -- we’ve seen a lot of entrepreneurial verveout there and new business start-ups and everybody and their brother seems tobe a broker on ethanol.

So you have to ferret through that process and get somebodythat’s reliable, somebody that’s large, but we’re going to do as manyconversions as we can get done.

Karen Short -Friedman, Billings, Ramsey

Okay, great. And then maybe just if you can elaborate alittle bit on the hedging comment. You know, obviously you said you arecontinuing to look at it -- maybe can you elaborate a little bit more?

Frank G. Paci

I think obviously the hedging area is one of those areasthat we don’t want to increase the volatility that we already have in ourbusiness by doing something like that, and I think there is -- so the reason weare spending time studying it is because we want to make sure that we are 100%certain of what we are doing and that it is going to be a benefit to thebusiness as opposed to a detriment to the business.

So at this point in time, we continue to study it but we haven’tat this point made a decision as to whether to do it or not.

Karen Short -Friedman, Billings, Ramsey

Do you have a timeframe involved where you may be able toreach a conclusion?

Peter J. Sodini

I think it’s reasonable to assume that we will ultimatelyget there and with a product and a strategy that makes sense. Timeframes aresometimes hard to forecast but I would say we would be disappointed if weweren’t in hedging by our year-end.

Karen Short -Friedman, Billings, Ramsey

Okay, and is there a percent of the volume that you canconsider would be hedge at the cents per gallon type or --

Frank G. Paci

I think at this point in time, for competitive reasons, weare just going to continue to study that and decide what we want to do.

Karen Short -Friedman, Billings, Ramsey

Okay, and then just an update on guidance. You hadpreviously given D&A guidance and interest expense guidance back in July. Ithink the D&A number was 102.7 and the interest expense was 94.25. TheD&A doesn’t seem realistic, obviously, given where you ended up thisquarter. Can you just maybe give us an update on those numbers?

Frank G. Paci

Yeah, we did, actually. We filed an 8-K this morning that weupdated those numbers, and we gave out ranges in the 8-K. The ranges for depreciationis $109 million to $113 million and interest is from 86 to 91.

I think that -- in some of those, because of the saleleasebacks, I think we had some of that in interest that should have been indepreciation, so --

Karen Short -Friedman, Billings, Ramsey

In the wrong buckets, okay.

Frank G. Paci

In the wrong bucket, so the total bucket is about the same.I think it was just misallocated between different buckets.

Karen Short -Friedman, Billings, Ramsey

Okay, and do you have a sense of the timing on where -- the$6 million kind of flowing into the O&A line, should we expect that to havealready begun in the beginning of the first quarter?

Frank G. Paci

Yes, some of that will show up right away because webasically made the changes in the organization at the end of the quarter, soyou should start to see some of the benefits right away in that.

The issue is it’s going to be difficult to see because ofthe, on a year-on-year comparison because obviously we are much bigger in termsof what we had last year, so expenses will still be up year-on-year but it willbe versus what the run-rate was.

Karen Short -Friedman, Billings, Ramsey

And the G&A component that you’ve broken out for thefirst time, is that something that should be kind of flattish throughout -- Imean, as an absolute dollar, shouldn’t fluctuate much from quarter to quarter?

Frank G. Paci

There will be some fluctuation from quarter to quarter withvolume, because certainly the labor line moves in concert with merchandise sales,so when we have lower seasonality, obviously we should have somewhat lowerexpenses, and when we have higher seasonality, we’ll have somewhat higherexpenses.

Karen Short -Friedman, Billings, Ramsey

I guess I got the impression G&A was just corporate.

Frank G. Paci

I’m sorry. I was thinking about total. No, G&A should berelatively flat.

Karen Short -Friedman, Billings, Ramsey

Okay, that’s great. Thanks.

Operator

Your next question comes from the line of Mark Miller withWilliam Blair.

Eric Wolinya -William Blair

This is actually Eric [Wolinya]. The first question I wouldlike to ask is just on the expense removal, I guess, in the fourth quarter. Youhad talked about it in the prior press release, trying to take out at least $6million in ’08. Can you just comment on how far you actually came along downthe line? Basically, what’s the annualized run-rate of the expense that youwere able to take out in the fourth quarter?

Frank G. Paci

I think we achieved that $6 million target.

Eric Wolinya -William Blair

Totally? Okay, and then looking ahead to ’08, specificallythe merchandise gross margin, could you talk about a little bit some of the --you have a lot of areas here that have influence, QSRs, private label,cigarettes, lotto and other ancillary items like car washes. Can you maybe talkabout where you see your merchandise margin moving from ’07 to ’08, and wherethe pressure points and positive areas may come from within thosesub-categories?

Frank G. Paci

So the guidance we’ve given is approximately 37% for theyear. Obviously as you look at it, what you’ve got is you’ve got higher margincategories like grocery, services and food service. And one of the things thatwe saw in this quarter, we saw them growing as a percentage of our mix, whichobviously helps drive margin up. So our anticipation is we’ll continue to seesome of those, certainly the grocery and the food service categories continueto grow, as well as services, because of car washes with Petro. That gives ussome benefit in the services area as well. So those categories should bepositives on margin.

The one that will probably be weighing down margin or bemost challenging will be the cigarettes area because we anticipate that therewill be continued pressure in terms of removal of some of the promotionalallowances that we’ve had there, and it’s unclear yet as to whether there willbe any increases in federal excise tax. But should that happen, that wouldobviously hurt our percentage margin in that category, but we think -- in thepast, we’ve been able to offset that and keep our penny profit per unit at arelatively constant level.

So to me, I think that’s what -- Dave, anything else you sayin that?

David M. Zaborski

I think we’ve had good growth in our grocery and foodservice categories. It’s mitigated somewhat by cigarettes. That’s going to be apermanent ongoing, but so far we’ve been able to offset -- we’ve been able tomore than offset the decline and the loss of margin.

Eric Wolinya -William Blair

And what do you know today about this promotion on thecigarette side? Is that pressure likely to hit first half of the year or isthere something that we see more in the second half, or the timing?

David M. Zaborski

The last time they made a material change in the [inaudible]rates were, material where it impacted everything, was back in December of lastyear. If big tobacco does what they do, I would expect that if they are goingto do something, it will be at the end of the year or the first of the year.

But one thing we’re pretty sure of, they will make anotherrate reduction, just a matter of when and how much and that will impactcigarette margin, which will pull the company down in proportion to that.

Eric Wolinya -William Blair

Okay, very helpful. Last two questions, thinking about ’08stores, historically you’ve closed about 15, 20 stores a year. Is thatsomething that we should look for again in ’08?

Peter J. Sodini

Yeah, I think that’s a reasonable number.

Eric Wolinya -William Blair

And then that level of closings, and you talked about in thepress release, 15 new organic stores, a few acquisitions -- basically I’m justtrying to get a sense, is there any chance that we could actually see youryear-end store count be down year over year, or is that not likely?

Peter J. Sodini

I would say highly unlikely.

Eric Wolinya -William Blair

Okay, and then my last question is just by my math here, Ihave you guys finishing the year at a debt-to-cap ratio of 77%. Can you maybejust talk about where you see that going by year-end ’08, year-end ’09? Andbroader speaking, what your comfort range is for debt-to-cap?

Frank G. Paci

Are you including the sale leaseback debt as debt, or --

Eric Wolinya -William Blair

Yes, including.

Frank G. Paci

To me, again this is part of why we had this discussionabout the sale leaseback, is that the way I look at that is again, from a GAAPstandpoint, they need to be on our balance sheet but the reality is that at theend of the lease, on those leases 15 years from now, if we don’t renew thoseleases, the debt goes away because the assets are still on our books and theassets are kind of counter-balanced by that debt.

So I think in my mind, the perception is that we are highlyleveraged because of that. I think you either need to look at us on an EBITDARbasis or you need to look at us and treat those like they were operating leasesin order to get a sense of it. So we are very comfortable at the level of debtthat we’ve got now if you exclude the sale leaseback debt. I don’t anticipatethat changing much over time.

Eric Wolinya -William Blair

Okay, great. That’s all I have. Thank you.

Operator

(Operator Instructions) Your next question comes from theline of Brian Hunt with Wachovia.

Brian Hunt - Wachovia

Thank you. Given your I would say somewhat probablydiscriminating -- been discriminating in the past, but should we assumesomething, any acquisition you make would be leverage accretive as well asearnings accretive? Would that be a fair assessment of the opportunities youhave in front of you?

Frank G. Paci

When you say leverage accretive, you’re talking about wouldreduce our leverage, is that what you’re talking about?

Brian Hunt - Wachovia

Yes.

Frank G. Paci

I think that again the way I’ve looked at it is that I’mcomfortable at the level of leverage that we have right now, so I wouldn’tassume a big change one way or the other, Brian.

Brian Hunt - Wachovia

Okay. Next question, it sounds like you may generate somefree cash this year potentially with CapEx as flat and probably lessacquisitions. What’s your appetite for buying back stock and what you arepermitted to do under your current RP baskets?

Frank G. Paci

Well, we currently have a stock buy-back that’s beenauthorized. We’ve bought back I think it was about 680,000 shares -- 693,000shares already, which has used up -- we have an authorization out there of $50million. From a bank covenant standpoint, we’ve got $35 million capacity duringa fiscal year, so we have a little bit less than the $35 million available thisyear because we used about 20 -- almost about $23 million of that last year, soyou’d have $27 million available right now for bank covenants. We could do upto $35 million.

Brian Hunt - Wachovia

Okay, and then, you say there’s an opportunity to offsetmaybe lower fuel volumes with some other cost savings initiatives. Is thereanything specifically you have done operationally coming into this year thatmaybe helped offset some of those pressures that you are seeing on fuel gallons?Such as, have you gone to prepay at every location versus cash in the past tolower your drive-offs? Or are there any other operational changes you’ve madethat are noteworthy?

David M. Zaborski

We’ve done a couple of things, just basics. We made a decisionabout 45 days ago to move to prepay gasoline in all stores, and that hasgenerated a substantial amount of savings to date with very little minimumimpact on volume.

We also decided in some areas where we were having a problemwith bad check charges that we would change the way we handle checks in certainlocations or not take checks in some areas, and that’s generated some level ofsavings.

But the biggest savings really is our focus on the[inaudible]. We were always very good at labor and we’ll even become better atlabor by store. R&M, it looks like we are getting better at R&M in theshort term. We’ve looked at our service contracts -- every single line you canlook at we’ve looked at and we started getting momentum about three months ago,and that momentum just continues to build.

Brian Hunt - Wachovia

All right. Thank you very much.

Operator

Your next question comes from the line of Peter [Aryk] ofAIM.

Peter Aryk - AIM

Good morning. Just getting back to the question aboutleverage, the bonds are still single B and increasingly the markets are puttingmore of a discount on companies with so much leverage. It sounds like you aresaying you are comfortable at these levels, just going sideways with leveragelevels. I even hear a little bit of talk about stock buy-backs. Is that theproper way to read this?

Frank G. Paci

What we’ve talked about is we’ve talked about we’recomfortable with the leverage as it is. From a stock buy-back standpoint, whatwe’ve said is we’re not going to borrow money to buy back stock, that we wouldonly be using excess cash flow if we were buying back stock.

We don’t anticipate that there will be much change in ourleverage.

Peter Aryk - AIM

Okay, and so leverage levels are pressuring a lot of othercompanies out there and you think that just your leverage is part of why yourstock is where it is? Do you think you’d see some multiple expansion if you’djust clean up the balance sheet a bit more?

Frank G. Paci

I think more of our stock being where it is has to do withwhat’s happened with gas margins in the past year and what’s happening in theenergy market today.

Peter Aryk - AIM

Okay, another question for you, just on acquisitions;there’s so many properties for sale, what sort of multiples of EBITDA are peoplelooking for?

Peter J. Sodini

Higher than they should be.

Peter Aryk - AIM

No doubt, but where does that put them?

Peter J. Sodini

I would say somebody jumping in that realm, that they’dprobably [inaudible] 6 and 6.5, [near the number] somewhere earlier, that thatwas a good number. I think they’ll wait a long while at 6 to 6.5.

I think sellers expectations are always higher than theyshould be and to the extent they can’t consummate a sale, then they have toadjust.

Peter Aryk - AIM

Do you anticipate more C-stores just closing? Are the gasmargins enough of a pinch on the industry just to cut back supply like that?

Peter J. Sodini

I think you’ll see some marginal small units closing. Ithink the one thing that probably detracts from an increase in -- anacceleration in closing is that a lot of these small fellows own their buildingand land, and thus they can endure a lot of pain for a fair amount of time. Butit would not surprise me in the next six to nine months if you see some people,as happened in 2002, some people leaving the business, yeah.

Peter Aryk - AIM

Okay, and if you did find an acquisition where the priceworked and you liked it, you should have some cash build on the balance sheetcertainly, but the rest of it you would just borrow the money again and not useany equity component?

Peter J. Sodini

-- some cash and [conventional] sale leaseback activity.

Peter Aryk - AIM

Okay, so just more borrowing -- you wouldn’t see any need touse some equity, you’d just borrow the money for anything you bought?

Peter J. Sodini

Yeah, I think so. We’ve been comfortable in that modebefore. We’re still comfortable with it.

Peter Aryk - AIM

Okay, good. Thanks.

Operator

Your next question comes from the line of Karen Short ofFriedman, Billings, Ramsey.

Karen Short -Friedman, Billings, Ramsey

Sorry, just two follow-ups; first, that 6 to 6.5 multiple,is that pro forma or LTM on the acquisitions?

Peter J. Sodini

I would say no -- that would be their desired multiple offof their trailing 12.

Frank G. Paci

Honestly, the big question would be what is the trailing 12 in gas margins. You’d probably haveto adjust that from a pro forma standpoint.

Karen Short -Friedman, Billings, Ramsey

Okay, and then just following on this capital leasediscussion, can I take it to mean that you probably will not have theflexibility to move the capital lease onto the P&L to be treated asoperating? Is it pretty much status quo as capital lease for a while?

Frank G. Paci

That’s the status quo, absolutely correct.

Karen Short -Friedman, Billings, Ramsey

Okay, that’s it. Thanks.

Operator

(Operator Instructions) Your next question comes from theline of Karen Holland of Lehman Brothers.

Karen Holland -Lehman Brothers

When you were talking about ethanol before, you mentionedthat you expect to get the government tax benefit that comes along with that. Iwas under the impression that was only if you were actually blending ityourself, that you were buying the ethanol, that you got that I think it’s$0.50 per gallon tax benefit. Am I mistaken there?

Peter J. Sodini

We would be the -- we would envision that we would be the blenderof record, yes.

Karen Holland -Lehman Brothers

You would be? Okay, so it wouldn’t be that the product youare buying from let’s say the major oil corporate companies would be receivingthat tax benefit because they are blending it --

Peter J. Sodini

We haven’t bought any through that vehicle yet because ithasn’t been available through major oil companies. I think you can safelyassume that we will -- in some cases, a significant number of cases, we will bethe blender of record. There will be cases where we quite possibly could have astraight [formula allowance] of so many cents per gallon off of some number, amutually agreed upon number. There could be some situations where we are notgetting the federal tax credit but then if somebody else is getting it, it’sjust a negotiable item as to what the split is.

Karen Holland -Lehman Brothers

Okay, and then the $0.11 to $0.13 gas margin that you guyshave put out there, does that include any benefit from potentially blendingwith ethanol?

Peter J. Sodini

Nothing material, no. That is a range we’re comfortable withgoing into this year with market conditions as we saw them, which did notreflect any -- because the ethanol bit wasn’t -- timing-wise, a little[inaudible], so we didn’t want to get into putting some partial impact.

Whatever -- if there’s a positive [inaudible] in ethanol, itwas not anticipated in that range but conversely, that range also didn’tanticipate crude oil hitting $97 a barrel.

Frank G. Paci

I think it did.

Peter J. Sodini

Did it?

Frank G. Paci

Yeah.

Peter J. Sodini

So this year started off with a record high cost of productand one can say do you expect that condition to continue throughout the yearand margins be as suppressed as they are, I think we would be disappointed ifmargins continued in this depressing year-end mode.

It has been the history of this to be extremely volatile andthere are compensating periods for very bad periods. There always have been.Are we banking on it? No, but do we intrinsically believe there will come somevery good periods, where the true value of some of these assets we’ve acquiredwill be met? The answer is yes.

Karen Holland -Lehman Brothers

Perfect, and then just one final question; the storeopenings, the 16 organic store openings, do you think that will be spreadthroughout the year or will it be more front-end or back-end loaded?

Peter J. Sodini

I think they are fairly well spaced.

Frank G. Paci

We have a big number early on, but --

[Multiple Speakers]

David M. Zaborski

The rest of them are going to be later.

Karen Holland -Lehman Brothers

Okay, great. Thanks so much.

Peter J. Sodini

For [modeling] work, I figure maybe a little heavy on thefront of the year but the balance of it is spread pretty much over the year.

Operator

And that does conclude your question-and-answer session. Iwill now turn it to Peter Sodini for closing remarks.

Peter J. Sodini

We appreciate everyone’s participation. I think the questionswere excellent, and probably unexpected, given the results. We continue to beoptimistic and I think we have put things in place which are going to bepositive to our business and we will -- we anticipate other things happeningalso in our [inaudible]. So we will reconvene in a quarter and see where weare. Thank you.

Operator

Ladies and gentlemen, thank you for your participation intoday’s conference. This concludes the presentation. You may now disconnect.Have a great day.

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