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The Pantry Records Significant Loss for Q1

CARY, N.C. -- The Pantry Inc. recorded a larger-than-expected first quarter loss, saying it was hurt by below-average fuel and grocery margins.

But initiatives meant to boost foodservice sales, merchandise margins and customer service have the chain's executives confident of an improved performance for the rest of the year.

For the first quarter ended Dec. 24, the c-store operator saw a net loss of $26.1 million, compared with a profit of $38.5 million last year. The chain's total revenue rose 6 percent to $1.74 billion compared to the period last year. Retail fuel revenue increased 6.2 percent, partly reflecting a 3.7-percent increase in the average retail price per gallon. Retail fuel gallons sold in the quarter increased 3.7 percent overall, and 0.8 percent on a comparable-store basis. Diesel sales were relatively flat. Total fuel gross profit, however, tumbled 56 percent to $57.3 million from last year's record high. Retail fuel margin averaged 11 cents a gallon.

The chain's EBITDA was $40.3 million and cash flow from operations was $21.5 million.

Merchandise revenues for the first quarter increased 7 percent overall and 5.2 percent on a comparable-store basis. Merchandise gross margin was 32.6 percent, down from 35.5 percent a year ago, primarily reflecting reduced margins on cigarettes and other tobacco products due to last year's tax increases, a mix shift toward other tobacco products and lower margins in the grocery category, the company said. Total merchandise gross profit for the quarter was $136.3 million, down 2 percent from a year ago.

"We are taking steps which we expect to improve our grocery margin in the coming quarter," President and CEO Terrance M. Marks said. "Despite our loss for the first quarter, we generated positive cash flow from operations.

"We have also made progress on our key strategic initiatives. This includes opening six nationally branded quick-service restaurants; raising standards to help ensure a fast, friendly and clean customer experience; and investing in information systems to strengthen our store management capabilities."

The chain is taking steps to improve grocery margins, Marks told analysts during a Webcast Tuesday. Margins were hurt by a slowing of coffee sales; a milk promotion that improved units sold, but negatively impacted margin dollars; and a sell down of DVDs and other items.

The company is taking steps to improve milk margins and coffee sales, including rolling out a new coffee program, details of which were not released.

Among the chain's strategic initiatives to provide customers with a "fast, friendly clean shopping experience" are a wide area network upgrade project, now 90 percent complete, that is improving card and payment processing and give the retailer increased capacity for integrated back office systems and decision-support capabilities; replacement of its legacy gas pricing system with new software that will improve automate fuel pricing and provide real-time analysis; and an upgrade of the stores' POS system, which will improve market basket analysis, provide product and shopper information and improve assortment, pricing and merchandising decisions.

The Pantry's executives are also focused on increasing the amount of time sales associates have to take care of customers and deliver fast, friendly service.

In the area of motor fuels, the company's executive team said it needs to get a better understanding of fuel pricing's impact on each location's business -- for instance on the number of gasoline customers who come into individual stores over time. "We can shift the curve by having a better understanding of the dynamic of what an acceptable competitive gap is, one way or the other, on a location by location basis," Marks said.

"With more than 1,600 locations, making daily pricing decisions and factoring in changing variables, to think we are perfectly optimizing all of those variables is not [realistic]. We definitely think there is an opportunity to improve the yield of the fuel business, but by pulling 1,000 levers better, not pulling one or two big levers."

This spring, the c-store operator will pilot a new foodservice program in no more than nine stores. The program will increase the chain's breakfast, lunch and snack offer and will include a reworking of menu, staffing and supply chain. Details of the program were not released, but the executive team said beyond new menu items, the chain is looking to improve value in the coffee and cold dispensed beverage categories, considered important destination items.

The extent of the new food-to-go program will be based on individual store footprints. "While we are piloting the foodservice initiative, we will pull out the coffee element and other areas where we can see quick wins, moving on them faster than we would going store by store with the full foodservice treatment," Marks said.

The Pantry's total store operating and general and administrative expenses for the quarter were $153.2 million, down 2.2 percent from a year ago.

The Pantry made a number of strategic decisions that resulted in impairment charges during the first quarter of fiscal 2010. First, the company began phasing out the Petro Express brand at 67 stores and converting them to the Kangaroo Express brand. The majority of Petro Express stores' gasoline is branded Chevron, which is pulling out of the metropolitan Charlotte, N.C. market. The gas brand also will be rebranded at these sites. The decision to phase out the Petro Express brand resulted in a pre-tax impairment charge of $21.3 million to write off the value assigned to the brand name at the time of the acquisition.

The chain is determining now the future its gasoline branding, either branding as a major brand or going with a private Kangaroo brand gasoline, the executives told analysts.

In addition, the company evaluated the pipeline of potential future store sites and identified certain land parcels it no longer intends to develop, which resulted in a reduction in carrying value. The chain also conducted its regular evaluation of operating stores and determined that the expected performance of certain stores required a reduction in carrying value. These evaluations resulted in pre-tax impairment charges of approximately $11.4 million.

A number of store closings took place in Florida, where the chain determined the investment needed to improve underground storage tanks would not provide a favorable return.

The company reiterated its previously disclosed guidance ranges for its expected performance (excluding potential acquisitions) in fiscal 2010, which is a 53-week fiscal year: Merchandise sales of $1.76 billion to $1.82 billion; retail fuel gallons of 2.17 billion to 2.22 billion; merchandise gross margin of 33 to 34.5 percent; and retail fuel margin per gallon of 11 to 13 cents. The retailer is reducing its projected capital spending from $100 million to between $80 million and $90 million.

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