Company News

Pantry's Turbulent Third Quarter

A soft economy, cigarettes create headwinds, while foodservice momentum builds

CARY, N.C. -- The Pantry Inc. had a rough third quarter, but considering the circumstances, the 1,655-store chain kept its bearings and has opportunity for stability and growth ahead, company execs report.

"Our fiscal third quarter was notable for the amount and diversity of challenges with which the business was confronted," said president and CEO Terry Marks in a third-quarter earnings conference call with analysts on Tuesday. He noted growing unemployment in The Pantry's key markets, slumped construction activity and higher fuel prices--as well as the impact of Altria's [image-nocss] Marlboro Leadership Price (MLP) program on cigarette prices--as providing the biggest headwinds.

Net income was $19 million or 84 cents per share, compared to $18 million or 80 cents per share in third-quarter 2010. Comparable-store merchandise revenue fell 1.5%, compared to a 7.7% increase in the prior year. Merchandise gross margin dropped 0.2 points to hit 34%, while fuel gross profit dipped $300,000 to reach $80.1 million compared to a year ago. Cash flow from operations grew $13.2 to hit $96.6 million in the third quarter. Debt net of cash fell $75 million between the end of the second and third quarters to reach $1.03 billion.

"Though the confluence of these events posed very real challenges as is evidenced by the topline softness in the quarter, management throughout the company remained undistracted and focused on driving foodservice growth, flexing expenses and rolling out Program Fresh to new markets, making meaningful progress against all three, while also managing to deliver earnings before interest, taxes, depreciation and amortization (EBITDA) of $84.7 million, a slight increase to last year's previous record-high third quarter," said Marks.

Other highlights from the call:

Program Fresh: The Pantry is continuing its rollout of the Program Fresh store offering in the Gainesville, Fla., market, and will tackle another market--to be named later--in September. The chain is targeting markets based on their relative importance to the overall business, the amount of differed maintenance required and most of all, those where it has critical mass and wants to build a capability to defend it from the competition. Marks said The Pantry remains on track to roll the program out to 400 stores by calendar year's end.

He noted no change in the rate of growth for Program Fresh, although compared to non-Fresh sites, these locations have seen foodservice category sales expand more than 20%, and an increase in the category's share of sales by 130 basis points year over year. Raleigh, Charlotte and Birmingham, Ala., are seeing the strongest momentum.

The Pantry also continues to add new elements to the Fresh Program after proving their mettle in individual markets. For example, a new pastry program performed so well in Birmingham that it is being rolled out to Charlotte and Raleigh Fresh sites, and included in future rollouts.

Fuel outlook: Retail fuel gallons dropped 6.9% overall in the third quarter, and 9.3% in comparable stores. Margins, meanwhile, grew to $0.166 per gallon in the third quarter from $0.155 in the same period of the prior year. Fuel revenues rose 25.3% to $1.8 billion thanks mostly to a 34% jump the average retail price per gallon from $2.75 in third-quarter 2010 to $3.69 in third-quarter 2011. Fuel gross profit of $80.1 million was hit by a $5.4 million year-over-year jump in credit-card fees.

"Almost half of the gallon declines compared to the prior year were driven by 150 stores that we knew had a lower correlation of gallon change to inside sales change," explained Marks, who described it as a quarter with "a lot of moving parts" and noted that other publically traded c-store chains reported declines in the single to double digits. After The Pantry changed its pricing strategy in early July, site volumes "bounced back immediately."

From a profit perspective, fuel CPG was up 2.7 cents compared to a year ago, CFO Mark Bierley noted, "so we're all in balance for delivering a quarter in aggregate that was slightly above a really strong quarter last year."

In-store sales: Comparable-store merchandise sales dropped 1.5% in the third quarter, or 0.3% excluding cigarettes. Total merchandise gross profit was $160 million, for a dip of $500,000 versus third-quarter 2010.

The Pantry enrolled more than 700 of its 1,655 stores in Altria's MLP program at the start of third-quarter 2011. After analyzing results by store each week, the retailer concluded that "we would be much better served to get off of the program in all but little over 100 of our stores and return to offering consumers a value with the two three-pack purchase, which is what we were doing prior to the program having been launched in April," Marks said, noting that since returning to its former program, profitability, margins, sales comps and market share have improved.

Beyond cigarettes, the rest of the store's sales performance was "flattish," Bierley said, with the exception of The Pantry's quick-service restaurant (QSR) operations, ATMs and packaged beverages.

Promotional Activity: In-store traffic began leveling off later in the third quarter and became positive over the final six weeks as the chain began to see the impact for its Salute the Troops summer promotional program, which had a goal of raising $1 million for the USO, National Guard and Wounded Warrior Project. The program has actually generated $1.5 million, with a month to go.

The program provided an umbrella of sorts for two foodservice promotions: the Roo Cup and a hot dog with 20-ounce fountain drink for $1.50 offer. Both were "designed to train the consumer to come to our stores for on-the-go meals and snacks, and create organizational confidence in our ability to execute companywide foodservice activities," said Marks. The hot dog and drink program in particular has been growing "well into double digits" as the chain enters the fourth quarter.

At the same time, The Pantry has made an effort to defend certain categories under competitive pressure--for example, the chain sacrificed margin on beer in the third quarter to protect its share, and was able to grow it sequentially as a result.

Store sale: The Pantry is currently sifting through the bids that arrived last week as part of its 114-store divestiture program, being coordinated by NRC. While Bierley described the bids as "pretty consistent" with those it received in a store sell-off in 2010, and The Pantry as "pleased with the level of interest," he expected most sales to close in 2012.

Total store operating and general and administrative expenses in third-quarter 2011 fell $0.9 million compared to the same period a year ago to hit $155.3 million. This chain credited a continued focus on improving its cost structure, partially offset by a $1.9 million unfavorable variance in the current year from net gains and losses on real-estate transactions.Headquartered in Cary, N.C., The Pantry is the leading independently operated convenience store chain in the southeastern United States and one of the largest independently operated convenience store chains in the country. As of August 8, 2011, the company operated 1,655 stores in 13 states under select banners, including Kangaroo Express, its primary operating banner.

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