Casey's General Stores - Earnings Call - Q1 2021

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to Q1 fiscal year 2021 Casey's General Stores Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star one on your telephone. As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Brian Johnson, Senior Vice President, Investor Relations and Business Development. Please go ahead, sir.

Brian Johnson (SVP of Investor Relations and Business Development)

Thank you, and good morning. Thank you for joining us today to discuss the results from ourQ1 ended July 31, 2020. I am Brian Johnson, Senior Vice President, Investor Relations and Business Development. With me today is Darren Rebelez, President and Chief Executive Officer, and Steve Bramlage, Chief Financial Officer. Before we begin, I'll remind you that certain statements made by us during this investor call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include any statements relating to expectations for future periods, possible or assumed future results of operations, financial conditions, liquidity and needs, the company's supply chain, business strategies, growth opportunities, performance at our stores, and the potential effects of the COVID-19 outbreak.

There are a number of known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from any future results expressed or implied by those forward-looking statements, including but not limited to our ability to execute on the strategic plan, the impact and duration of the COVID-19 outbreak and related governmental actions, or to realize benefits from that strategic plan, as well as other risks, uncertainties, and factors which are described in our most recent annual report on Form 10-K and quarterly reports on Form 10-Q as filed with the SEC and available on our website. Any forward-looking statements made during this call reflect our current views as of today with respect to future events, and Casey's disclaims any intention or obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.

Now, I'd like to turn the call over to Darren to discuss our Q1 results. Darren.

Darren Rebelez (President and CEO)

Thanks, Brian, and good morning, everyone. We're really excited to share with you our Q1 results. First, I'd like to recognize our performance is only possible because of the 38,000-plus team members we have who are running our stores, supporting our stores, working in our distribution centers, and creating new ways that Casey's can win each day with our guests. There's no truer reflection of our purpose: to make life better for our communities and guests every day. Thank you to the entire team for your dedication. I also want to share a few comments on something I didn't expect, but in a year of the unexpected, here's another one for the list. On 10 August a severe storm known as a derecho hit many areas in the heart of the Midwest and Casey's core footprint with little to no warning.

Thankfully, Casey's team members were all safe. However, many of them or our neighbors were set back by damage, power outages, or other challenges from the storm. Across the company, our teams swiftly responded to get our stores running so they could stay open and serve our communities in the wake of the disaster. In addition to keeping our doors open and shelves stocked, our teams prepared and delivered hundreds of pizzas to energy crews pulling long days to restore power, and we sent over 20,000 bottles of water to the local chapter of the American Red Cross. Casey's also donated $10,000 to two local food banks to support Eastern Iowa and Central Illinois, the areas where the derecho most impacted our neighbors and team members. I'm extremely proud of the efforts by everyone on the Casey's team to support one another, our impacted stores, and our communities.

Now, turning to this quarter's results. As you've seen in the press release, we achieved a record Q1 with diluted earnings per share of $3.24, a 40% increase over the prior year. The results were driven primarily by a stronger fuel margin versus Q1 last year, along with disciplined operating expense control. We ended the quarter with a very strong balance sheet with over $570 million in available liquidity and refinanced our senior notes in early August at very attractive rates. I would now like to go over our results and share some of the details in each of the categories. During Q1 in the fuel category, we continued to experience a favorable fuel margin environment.

Results were also amplified by the utilization of our price optimization and procurement capabilities, which enabled us to post an average fuel margin of $0.382 per gallon and drive gross profit dollars up 39% to $210 million. Same-store gallons sold were down 14.6% as volumes continued to be adversely affected by the pandemic. Although still currently trending negative, the business did see consistent improvements throughout the quarter on fuel volumes. The average retail price of fuel during this period was $1.98 per gallon compared to 2.63 a year ago. Total gallons sold for the quarter were down 11.2% to 550 million gallons. Our fuel pricing team did an excellent job remaining nimble in an ever-changing environment throughout the quarter, and that showed in our financial results. Additionally, our fuel procurement strategy continues to evolve, and we are currently at approximately 60% of our total fuel volume under contract.

Finally, we went over 8,500 accounts in Q1 on the Fleet Card program as we continue to grow our commercial fuel business. Moving to inside the store, total same-store inside sales were virtually flat for the quarter, ending down about 40 basis points with an average margin of 39.6%. You probably noticed in the press release that we are calling out inside sales as one category. We believe this allows investors to more accurately compare our business with our peers and also lines up with how we talk about the business internally. We will continue to provide the same level of data on the two categories that make up inside sales: grocery and other merchandise and prepared food and fountain. Like fuel, we experienced improving sales throughout the quarter as self-service restrictions began to loosen.

Total sales for grocery and other merchandise were up 6.4% to $731.9 million in Q1. Same-store sales were up 3.6%, and the average margin was 32.2% compared to 31.3% for the same period a year ago. Beer and alcohol continued to drive the category, and we're very happy to see the packaged beverage category recover relative to the start of the pandemic, driven by strong execution of our summer sales campaign. Total prepared food and fountain sales were down 8.5% to $270.8 million in Q1. Same-store sales were down 9.8%. The average margin for the quarter was 59.7% versus 62.2% from a year ago. This category has been under the most pressure since the crisis began. Consistent with other quick-serve restaurants who have recently reported, the breakfast daypart continues to be the most adversely impacted by the pandemic.

We ended the quarter with approximately 200 stores with some sort of food restriction and close to 50 stores with beverage restrictions. By comparison, at the end of Q4, we had over 700 stores impacted by such restrictions. Offsetting these pressures, whole pizza pies continued to perform well, up over 16% for the quarter. We believe our digital capabilities have supported this category through the crisis. Digital sales are up 162%, and 50% of our pizza orders are now taken via our app, website, or DoorDash Marketplace. I'd now like to turn the call over to Steve to go into some detail on the financial statements. Steve?

Steve Bramlage (CFO)

Thank you, Darren, and good morning. After completing my first full quarter with Casey's, I want to remark how uplifting it's been to see the company pursuing its mission as a critical community member after the derecho storm. I've also been very pleased to see how seriously the entire management team takes preserving the financial flexibility of the company during the pandemic while also ensuring that we're still pursuing growth opportunities that will improve our returns on capital in the future. Moving to Q1 results, revenue for the quarter was $2.1 billion, a decline of $522 million, or 20% from the prior year. This was primarily due to the decline in retail sales of fuel of approximately $542 million, driven by the lower number of gallons sold and the lower resale price of fuel.

Revenue from inside the store sales rose nearly 2% in the quarter to just over $1 billion. Lower traffic was partially offset by larger average basket sizes. Grocery and other merchandise sales increased by $44 million, while sales of prepared food and fountain fell approximately $25 million. Please note all as-reported figures are favorably impacted by approximately 2.5% more stores being operated on a year-over-year basis. We define gross profit as revenue less cost of goods sold, but excluding depreciation and amortization. Casey's had gross profit of $623.5 in Q1, an increase of nearly 58 million from the prior year. This is primarily attributable to higher fuel gross profit of $59 million, with a slight offset from a decline in inside the store gross profit of $2 million.

Our grocery and other merchandise gross profit increased $20 million, while prepared food and fountain gross profit declined $22 million. Inside gross profit margins were nearly 40%. Grocery and other merchandise margins were 32%, comparable to the prior year after adjusting for a nearly $7 million unfavorable inventory adjustment in the prior year that did not recur. Prepared food and fountain margins were nearly 60%, a decline of approximately 250 basis points from prior year. Lower volumes, ongoing self-service restrictions, and a 9% increase in cheese costs year-over-year to $2.12 per pound versus $1.95 per pound last year contributed to this decline. If costs remain the same as today, we would expect our average cost of cheese to be approximately $2 per pound the next two quarters, given that 70% of our purchases are currently fixed through the end of the calendar year.

The company did a tremendous job managing operating expenses throughout the quarter. Total operating expenses were up 2% to $386.1 million, primarily due to operating 53 more stores than this time last year, as well as $15 million in COVID-19-related costs that was offset by reduced labor hours. Same-store operating expenses, excluding credit card fees, were down nearly 6%, and same-store labor hours were down 15%. We are very pleased with how agile our store operations teams have been throughout the crisis as they continuously right-sized the store and labor hours to meet our guest needs. Depreciation in the quarter was up 10%. Excluding the one-time $4.1 million adjustment made last fiscal year, depreciation would have been up 3%, driven by CapEx over the last year. The effective tax rate for the quarter was 23.8%, which is comparable to the prior year.

Adjusted EBITDA for the quarter was $237.8 compared to 186.4 million a year ago, and that's an increase of 28%. Net income increased 41% to $120.5 million. Our balance sheet is in great shape, and we retain tremendous financial flexibility that will serve us well in the future, both in terms of managing through the pandemic and pursuing our strategic plan. At July 31st, cash and cash equivalents were $247 million, and we have the full undrawn capacity of our $325 million lines of credit, giving us ample available liquidity of $572 million. Our leverage ratio stands at 1.8x. Shortly after the quarter ended, we completed the refinancing of our senior notes that were due in August. The new senior notes are due in 2030 and 2032, and with coupons below 3%, we will have significant interest expense savings.

Furthermore, we do not have any significant maturities until 2025. For the quarter, the company generated $307 million in free cash flow, which is cash from operating activities less purchases of property and equipment. This compares to $77 million in the prior year and was driven by higher earnings, favorable working capital, and lower CapEx. Capital expenditures were $45 compared to 101 million a year ago as we consciously slowed spending in Q1 and faced longer-than-normal delays in permitting approvals from local authorities, both of which were due to the pandemic. The company has opened nine new stores so far this year. Our new store pipeline is 86 sites, including 20 of which are under construction right now. As a reminder, we expect new stores to generate double-digit returns on invested capital on average by their third year of operations.

Given the ongoing uncertainty around consumer behavior and traffic volumes from COVID-19, we're not yet ready to provide earnings guidance for this fiscal year. However, we will provide a few modeling aids for the year as follows. We continue to expect the effective tax rate for the year to remain in the 24%-25% range. Interest expense, now that we've completed the refinancing of the notes, should be slightly under $50 million for the year. We anticipate building approximately 40 new stores this year based on the current pace of approvals that we see locally. Before turning the call back to Darren, I just want to reiterate how strong we feel our position is financially to ride out the pandemic's challenges and continue to grow and pursue our strategic plan initiatives. Darren?

Darren Rebelez (President and CEO)

Thanks, Steve. We previously mentioned that sales volumes improved sequentially throughout the quarter. I think it'd be helpful to share what we have experienced so far in Q2. Overall, we continue to experience slow but steady improvement month by month across all areas of the business. For fuel, we have experienced negative same-store gallons in the mid to high single digits, while fuel margins are above $0.30 per gallon. Total inside sales continue to trend favorably sequentially in the mid single digits, and we continue to see ongoing improvement in our grocery and other merchandise category, which is trending up in the high single digits. Prepared foods continue to slowly improve sequentially, and we are currently trending down mid single digits. We expect operating expenses to increase commensurate with our store hours returning to pre-COVID levels.

We continue to execute on the strategic plan we disclosed back in January, and given the shift in consumer trends brought on by COVID-19, we have accelerated the implementation of several initiatives. If you recall, the pillars of our strategic plan to deliver top quintile EBITDA growth are reinventing the guest experience, creating capacities through efficiencies, and being where the guest is via disciplined unit growth. All of this is going to be driven by an investment in talent to strengthen the team and add capabilities to the business. With respect to the guest experience, we've made considerable progress to modernize the digital experience for our guests. We recently partnered with DoorDash and currently have their delivery service operating in 584 stores.

This move has expanded delivery to more guests, increased the number of days and hours that delivery is available, and has reached new guests that make their dining decisions based on what is available on the DoorDash Marketplace. We also recently completed a test of curbside pickup option for our guests. The test went well, and effective 18 August, we launched this option company-wide. Our guests can use the Casey's app to order from the store, and we have created a convenient "I'm here" button on their phone to notify the store to bring the order out to their car. The guest feedback from the test was impressive. Guests that used the service felt the experience met or exceeded expectations, enjoyed no or very short wait times, and stated they were likely to use the curbside pickup option again and recommend it to a friend or family member.

We also believe this capability will enable us to grab market share from other pizza chains and restaurants whose guests prefer a curbside pickup option. Our Casey's Rewards program continues to thrive, and through the end of August, we're currently at 2.7 million members. We experience higher transaction frequency with our reward members, and it's an effective way to deepen our relationship and understanding of our guests. This program is already enabling us to engage Casey's guests and influence guest behavior. We continue to add new capabilities for enterprise-wide efficiency gains. Our centralized procurement strategy is gaining momentum, and we recently hired a Vice President of Procurement to stand up the processes and leverage our scale more effectively. We expect to realize savings throughout our organization from indirect spend and capitalized costs to lower cost of goods.

The construction of our third distribution center in Joplin, Missouri, is progressing well and will further optimize our supply chain. This facility will initially supply approximately 500 stores, reduce miles driven by nearly 1.6 million miles per year, and will be immediately accretive. We expect to be open and operating during Q1 of next fiscal year. We refer to the unit growth pillar as being where the guest is. Our dedicated M&A team has ramped up their outreach efforts. So far this fiscal year, they have made an outreach to a large number of small and mid-sized targets, and we continue to believe that long-term industry dynamics will lead to future buying opportunities.

Steve already touched on the short-term delays we're experiencing with our organic growth from the pandemic, but I'm still very confident we will deliver on the 345 unit growth over the next three years outlined in our investor day back in January. We've also added talent to the leadership team to execute the strategic plan. I already mentioned our new VP of procurement, but we have also filled key positions for asset protection, human resources, and guest insights. These highly talented and diverse individuals are key to building out the capabilities we outlined back in January, and I can assure you they have hit the ground running. In closing, I continue to be extremely impressed with the progress made on our long-term strategic plan.

COVID-19 has brought about some short-term uncertainty and challenges, but the capabilities we have rapidly stood up have enabled the company to meet those challenges successfully and will also generate significant long-term value. We'll now open it up to questions.

Operator (participant)

Once again, ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes in the line of Karen Short from Barclays. Your question, please.

Kate Howard (Analyst)

Hi, good morning. This is Kate Howard on for Karen. Thanks for taking our questions. First, I wanted to talk about the in-store gross margins a bit more. Could you help us understand the flips and takes to prepared food margins and grocery margins going forward? In the context of grocery margins, we are a bit better than we had expected given the pressure seen last quarter from mix and assuming customer behaviors have not changed that much. What drove the incremental sequential pressure on prepared foods?

Darren Rebelez (President and CEO)

Yeah. With respect to the margins, we still had the unfavorable mix shift, but we were able to accelerate sales across the entire slate on grocery and general merchandise. Margins did improve a little bit over what we saw in Q4 of prior year. With respect to the prepared food and fountain margins, as we were going through the quarter, we did become a little more aggressive in our promotional activity to drive volume, particularly with our whole pies. We saw a little bit of compression there along with a $0.17 increase in cheese costs that put a little more pressure on that margin. Steve, [Cross talk] I do not know if you have a go over there.

Steve Bramlage (CFO)

Yeah. I think what I would add on the grocery side, I think our merchandising team has continued to be pretty savvy and asking some of our vendors to help us from a promotional standpoint over the course of the summer. I think we're using vendor support in that area a little bit differently than we have in the past, and that's helped offset some of the otherwise negative mix from larger package sizes, especially in the alcohol category. On the prepared food side, in addition to what Darren mentioned on the promotional side, we continue, as we're dealing with negative year-over-year volumes, the waste in the stores around a lot of the single-serve items continues to be a challenge for us in getting the right amount of product out for people to choose from in those particular categories. I think that's the other piece I would add.

Kate Howard (Analyst)

Okay. Great. Thank you. That's really helpful. I also just wanted to ask on the loyalty program. So 2.7 million members in the program currently. Can you talk about how the COVID environment has impacted that progress? With all this comprehensive data that you're able to capture, how will that shape how you do promotions in the future?

Darren Rebelez (President and CEO)

Yeah. Kate, this is Darren. I'm not sure that we could really draw a good comparison to what impact COVID has had because for the most part, we've operated the rewards program in a COVID environment exclusively. This has kind of been normal course for us. What I would say is that it's been really positive that our digital team has been able to continue to grow the rewards membership base even throughout the pandemic. You saw that increase pretty rapidly to over a million members early on, and then we got up to 2 million. Now we're over 2.7 million members. It really helps us in a couple of ways, especially with lower traffic.

It gives us the opportunity to reach out and connect with some of our most loyal guests and tailor offers directly to them to get them to come back into the store. We really see that manifest itself in our whole pie business, which has really grown positively and in mid-teens versus prior year. We continue to learn and test our way through different offers and different activities, but we're seeing good progress there.

Kate Howard (Analyst)

Great. Thanks so much.

Operator (participant)

Thank you. Our next question comes from the line of Ben Bienvenu from Stephens Inc. Your question, please.

Ben Bienvenu (Research Analyst)

Hey, thanks. Good morning, everybody.

Steve Bramlage (CFO)

Good morning.

Darren Rebelez (President and CEO)

Hey, Ben.

Ben Bienvenu (Research Analyst)

I want to start on operating expenses. Really nice progress there. You're showing significant improvement, helping to take some of the sting out of the challenge prepared food and fountain sales. Can you help us think about how you're managing OpEx? You said that you'd be looking to add some OpEx back as you've seen some sales recovery, but just generally, help us get in your head on how you think about that balance and what the appropriate relationship is between the OpEx and the in-store and/or the fuel contribution.

Darren Rebelez (President and CEO)

Yeah. Ben, this is Darren. I'll start off. I'll let Steve chime in as well. I think really early on in the pandemic, when things were shut down, we recognized that we didn't need to keep a lot of our stores open 24 hours simply because people couldn't get around. We started to restrict our 24-hour operations. Of course, there was a commensurate reduction in operating expense along with that. Also, with reduced traffic, our operations team was really nimble in terms of adjusting the in-store hours while we were open to better align with the traffic patterns. Now, as those restrictions have eased and we're starting to re-expand those operating hours and we're starting to see improved traffic, we're starting to add back those hours commensurate with that volume increase.

Really trying to strike that right balance of being appropriately staffed to meet the needs of the guests in the stores. The second thing from an OpEx standpoint in Q1 was we just had a significantly lower retail price for fuel versus prior year. Of course, there was a commensurate reduction in credit card fees as a result of that. Steve, I don't know if Cross talk] there's anything else you want to add.

Steve Bramlage (CFO)

I think I would just maybe, Ben, just add on as it relates to store expense, which is obviously the predominant piece of our operating expense line. The point I would make prospectively is we had been paying a recognition premium on an hourly basis to the vast majority of our workforce. We finished doing that midway through Q1. From a total dollar standpoint, the wage rate that we pay will actually be coming down sequentially in Q2, which gives us a little more flexibility around total hour utilization. The other point is operating expense. It's not exclusively store-related costs, right? Our G&A and distribution and logistics compose a portion of that, and there's some discretionary attributes of those spending.

We're trying to make sure we remain prudent around the discretionary spending on some of the above store categories that we have.

Ben Bienvenu (Research Analyst)

Perfect. Thanks for that. Shifting gears a little bit to prepared food and fountain, you've clearly added a lot of new capabilities. You aren't just standing still waiting for COVID to go away, though I know you're eager like all of us for it to go away. I'm wondering, though, how it might change your view on what your new stores would look like in the future, given that today, self-serve is a pretty central component of how the customer interacts with your prepared food business. Have you considered adding drive-through? Obviously, the customer adoption of digital and delivery, I'm sure, will continue to ramp up. Is it too early to start to think about how this might change the way the actual offer that you present to the customer looks like?

Darren Rebelez (President and CEO)

Yeah. Ben, this is Darren. I don't think it's too early to start having those conversations. I think what we've seen is that our guests prefer the self-service model. When we were under self-serve restrictions, we were still selling prepared foods, but in a full-service environment, and it just didn't resonate with our guests as much as when we were able to lift those restrictions and get back to self-service. I wouldn't say that I envision self-service going away. I think with the digital capabilities we've added with enhancing delivery, with our DoorDash relationship, with curbside pickup, I think we've addressed some other capabilities that the guest is clearly asking for. Whether we get all the way to drive-throughs or not, we'll have to have more discussions about that sort of thing in the future. We got 2,200 stores without them right now.

Our priority is to make sure that those are able to meet the guest needs as much as we can, and then we'll continue to innovate for the future.

Ben Bienvenu (Research Analyst)

Okay. Great. Thanks and best of luck.

Darren Rebelez (President and CEO)

Thank you.

Steve Bramlage (CFO)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Chris Mandeville from Jefferies. Your question, please.

Chris Mandeville (SVP)

Hey, good morning, guys. Darren, I could just start off with the quarter-to-date results that you provided. Can you just give us some clarity around what timeframe that runs through? I suppose I'm kind of curious here how clean they are as we're thinking about the self-service noise that was realized throughout Q1 relative to Q4, maybe where that stands today. You did reference also that the derecho had some impact in early August but did not necessarily quantify that. Obviously, also Murphy USA put out a deck this morning suggesting that the Labor Day shift had some influence on trends as well. Maybe you could provide just some greater color surrounding the quarter-to-date trend if you could.

Darren Rebelez (President and CEO)

Yeah, Chris. The results that I was referring to were through the Labor Day weekend. We did that deliberately because there was a mismatch on those dates, so we thought it'd probably be a little more informative to all of you to have that reconciled. What you see is as of Tuesday, essentially, yesterday. That should take out that noise. With respect to the derecho, we've kind of viewed that as really not much of an event from a sales perspective. On the one hand, we had some stores that were temporarily closed because of power outages. On the other hand, other stores got an increase in volume because the previous stores I mentioned were closed. When you wash it all out, we think we pretty much ended up about where we would have been anyway.

To make a long story short, like I said, we continue to see slow, steady improvement month by month as we continue to get further through the pandemic.

Chris Mandeville (SVP)

Okay. Just on the self-serve influence at this point in time, I mean, where are we relative to the 200 that you ended the quarter on?

Darren Rebelez (President and CEO)

Yeah. We're still in that same place. I kind of think of it as about 10% of the chain is under some sort of self-serve restriction. The way to think about that is if you compare those stores' comps to other stores that don't have those restrictions, they take a hit of kind of mid to high single digits versus what stores without the strict restrictions have.

Chris Mandeville (SVP)

Okay. That's great. I realize you guys always are focusing on gross profit dollars themselves. All things considered, the flat year-on-year growth in Q1 for in-store was impressive. Can you return to some level of in-store margin expansion going forward? I guess you've called out how you're thinking about cheese pricing and that maybe easing a little bit sequentially in the next quarter or two. How do we think about the tough grocery margin comparisons ahead and your desire to promote overall in-store?

Darren Rebelez (President and CEO)

Yeah. I think we do have some margin expansion opportunities inside the store for a couple of reasons. One, we mentioned our procurement efforts that we have ongoing. We're just getting started on that, but we've started with our goods for resale. We would expect to start to see some margin benefit as we work through those planning and negotiating efforts with our supplier partners. We also talked about in our Investor Day that we would be ramping up our private brands capability. That work is underway. We expect those products to have enhanced margin versus the national brand manufacturers. As we continue to develop the rewards program, we'll be more targeted in our promotional activity. We won't necessarily have to offer promotions to everybody that walks through the door.

We'll be able to target those more towards our most loyal and most frequent guests. I think all of those things will point towards higher margins moving forward.

Steve Bramlage (CFO)

Yeah. Chris, I might add just on the margin opportunity in the store, on the procurement point. The company historically really did not focus on trying to use the scale of the entire company to influence rates or purchasing price decisions, both in direct and indirect spend. As I think we bring in a team focused on that, there is a lot of opportunity for us to buy at scale across the footprint as opposed to buy or make purchasing decisions at the store level all by itself. I would also add the earlier conversation around vendors and asking partners to help support us in different ways. I think there is opportunity for us to more consistently do that across the entire footprint as well.

Chris Mandeville (SVP)

Okay. Great. Maybe one last one from me. Just in light of the fact that COVID delayed some of the new unit growth, I was curious if you had any type of update with respect to the non-fuel format and its launch sometime in the next fiscal year.

Darren Rebelez (President and CEO)

Yeah. We have a few sites identified in the pipeline. We're still working through the process. We have one that is moving along a little more quickly than the other. I think we'll probably get that one open in this fiscal year. We're still working through that process. Not much more to update on other than that.

Chris Mandeville (SVP)

Okay. Great. Thanks, guys. Best of luck for the rest of the year.

Darren Rebelez (President and CEO)

All right. Thanks, Chris.

Operator (participant)

Thank you. Our next question comes from the line, Bobby Griffin from Raymond James. Your question, please.

Bobby Griffin (Analyst)

Good morning, everybody. Thanks for taking my questions.

Steve Bramlage (CFO)

Morning, Bobby.

Bobby Griffin (Analyst)

I guess the first question I wanted to talk on was the M&A pipeline. We've talked before in the past how COVID could create some interesting opportunities from an M&A standpoint. Just curious, have those opportunities started to show up in the pipeline yet, or do you believe that's more of kind of like 2021 once we get past COVID at some point? Just any additional color around that?

Darren Rebelez (President and CEO)

Yeah, Bobby, this is Darren. We're having a lot of conversations with a lot of people right now. I think what has happened maybe a little bit in the short term is that other potential acquisition opportunities are experiencing some elevated fuel margins. They're making money right now at the moment, and they're feeling a little more comfortable. That being said, it's a very difficult operating environment to have to work in. Depending on who the conversation's with and what day you catch them on, some people are more interested in selling versus less. What we're doing is we're building up that pipeline. We're having those discussions and building those relationships so that when people are ready, we are as well. We still believe that in the intermediate to long term, the industry dynamics are going to be what they are.

Once we get back to more normal margins, we'll be a little bit tighter. Prepared foods will become a much bigger strategic capability that a lot of these people don't have. Scale is going to matter a lot more, and there'll be a lot of opportunities. We will continue to pursue what might be available today. We've got a great balance sheet, and we're in great position to act on those opportunities when they come up. We're real bullish about it. It's just maybe a bit of a timing issue is all.

Bobby Griffin (Analyst)

Okay. That makes sense. When we look at the potential to have cheese costs trend maybe around $2 in Q2 and Q3, how does that compare to last year? Maybe put that in context versus the headwind that we experienced in Q1. Would that headwind be less on a year-over-year basis or anything there to help us think about that?

Steve Bramlage (CFO)

Yeah. This is Steve. Bobby, we should have a tailwind. At current prices in the market, I would expect a tailwind in Q2 and Q3. If you do the averaging right now, we're probably about 7% better in Q2 and Q3 in terms of cheese costs than we were last year if we land around that $2 number. And we had, it was about a 9% headwind in Q1 on a price, just looking at price. We should have a relatively favorable flip here in Q2 and Q3.

Bobby Griffin (Analyst)

Okay. That's helpful. Lastly for me, just kind of I understand it's hard to kind of bucket these, but your fuel margin outperformance versus kind of the regional OPIS data really accelerated this quarter. Just curious if you think that's a lot of the initiatives you've been working on that we've talked about, or is there any other dynamics happening in the market between the large and small players? It just seems that from the public results we've been witnessing over the last couple of weeks, the large players have really disconnected from the OPIS data in a favorable way.

Darren Rebelez (President and CEO)

Yeah, Bobby, this is Darren. I would attribute it more to sophistication of procurement and pricing activity. I mean, it's been a fairly volatile environment and an unusual time, to say the least. I think with larger players that have more centralized processes, have better access to data, and a little more sophistication in how they approach the market, I would imagine you'd start to see that separation. I can't really speak for everybody else, but I can tell you that's certainly the case with our team. Our fuel team has come a long way in the last year and has done a really nice job. I think this pandemic has really put them to the test, and I think they've passed it with flying colors as you've seen from the results.

I think the environment set itself up for favorable fuel margins, and our team was able to take full advantage of that.

Bobby Griffin (Analyst)

Okay. I appreciate the details. Congrats again on operating in a very challenging quarter. Best of luck going forward.

Darren Rebelez (President and CEO)

Thanks, Bobby.

Operator (participant)

Thank you. Our next question comes from the line of Anthony Lebiedzinski from Sidoti & Company. Your question, please.

Anthony Lebiedzinski (Analyst)

Yes. Good morning, everyone. Thank you for taking the question. Just wondering.

Darren Rebelez (President and CEO)

Hello.

Anthony Lebiedzinski (Analyst)

Hey, good morning. Within your 16-state operating area, have you seen any notable regional differences in terms of your same-store sales? If you could talk about the rural versus more of the suburban, I just wanted to get a better sense as to the same-store trends, whether there's a meaningful difference.

Darren Rebelez (President and CEO)

Yeah, Anthony, this is Darren. What we have seen is really some separation between the rural and more urban stores. Really across all parts of the business, fuel, prepared food, and grocery and other merchandise, our fuel is probably in the rural areas has probably performed the best versus the more urban areas. Prepared foods has performed pretty well. To a lesser extent, the grocery and other merchandise. Again, all of them have performed better. With respect to different geographies, that really kind of followed a cadence of where restrictions were and how shutdowns went. At any given time during that quarter, we might have had better or worse performance based on those restrictions.

Anthony Lebiedzinski (Analyst)

Got it. Okay. Thanks for that. In terms of the centralized fuel pricing, obviously a big change from historical philosophy of being price followers. Is it safe to say that now with this centralized fuel pricing that for the most part you're a price leader in markets or not? I mean, how should I think about that?

Darren Rebelez (President and CEO)

No, I wouldn't say we're a price leader in every market. I would say every market is approached differently. That's one of the differences between having this centralized pricing team is that they have good visibility to data and a broader perspective. We know how we want to show up in different markets, and we play that position. I think the other thing that really helps is that the team is really beginning to understand the knock-on effects of pricing one store and what that implies for another store and how our competitor might respond and how we need to respond back. I think being able to have that broader picture and in the context of what's going on in the commodity markets really helps them make better decisions. That's really what we're seeing.

Anthony Lebiedzinski (Analyst)

Got it. Okay. I also had a question in regards to the centralized procurement and private label products. When should we expect to see the benefits from those initiatives? Is there any way you can quantify perhaps what could be the potential benefit from these initiatives?

Steve Bramlage (CFO)

Yeah. It's too soon for us to quantify something within a period of time. For some perspective, I mean, we're having conversations with manufacturing partners right now on some of the larger categories. We're literally hiring members for the team. I think we will start seeing results literally in the next several quarters depending on what the category is. As it relates to private label, we have a very low percentage of our store mix, very low single digits that's private label branded today, much lower than you would expect from an industry perspective. As we increase the percentage share on the shelves of private, before anything else on the procurement side, that clearly will be margin accretive for us.

We're aggressively looking to grow that percentage here over the next couple of quarters in the store by a couple hundred basis points in terms of the share of private label in the store. I think over the next four to six quarters, we will very consistently be attacking individual categories or segments that will help our cost of goods.

Anthony Lebiedzinski (Analyst)

Got it. All right. Thank you and best of luck.

Darren Rebelez (President and CEO)

Thanks, Anthony.

Operator (participant)

Thank you. Our next question comes from the line of Paul Trussell from Deutsche Bank. Your question, please.

Paul Trussell (Analyst)

Good morning and good quarter. I wanted to just circle back to the rewards program along with your DoorDash experience and the curbside pickup test. Let me just give us a little bit more color from what you have learned since the rollout of these programs and what you're seeing in terms of new customer engagement and kind of repeat shopping on these apps.

Darren Rebelez (President and CEO)

Yeah, this is Darren Rebelez. Yeah, we've learned quite a bit. I'll just give you a couple of stats that might help. When we look at our digital business, about 20% of our prepared food and fountain is done via digital. We think we have a pretty long runway to go in terms of growing that business. About 80% of the digital orders that we have are carryout right now. Although our delivery business is growing, it's still only about 20% of our entire digital business. One of the things that we've done more recently is expand that assortment that's available online to some of our top-selling grocery items. What we're finding is that we're getting really good adoption there. A lot of the prepared food orders are adding on a grocery item along with that. We are starting to see some bigger adoption there.

The last thing I'd say is that what's really been powerful is not just the rewards program or the online ordering, but it's really the entire offer. What we find is our most profitable and lucrative customers or guests are the ones that engage in all aspects of the business. They go into the store, they shop us online, and they buy fuel. All three of those, they're using our stores very heavily, and they're using it from all different avenues. Those tend to be the most profitable for us.

Paul Trussell (Analyst)

That's helpful. Just in terms of a follow-up, we've already spoken a bit to expenses obviously going back, coming rising as you open up store hours a bit more. I just want to better understand as we kind of look forward, to what extent have you found more permanent savings? To what extent should we think about the ability for this business to leverage operations on a lower comp threshold? I am just curious on anything more medium to longer term as we think about the cost structure.

Steve Bramlage (CFO)

Yeah. Paul, this is Steve. I'll answer that. You cut out a little bit on us. I think the question was related to longer term, our approach around managing operating expense generally and learnings that are applicable going forward. Listen, there's no doubt focus is the first thing, right? Focus goes a very long way in terms of just paying attention to the hours. We are definitely taking a more comprehensive and centralized point of view around what is the appropriate level of staffing for the type of store or the community that a store is sitting in. First and foremost, there's some technology and systems that we've put in place that we think will help us manage that more effectively going forward. There has been a significant amount of work done in our support infrastructure above the store level.

If you think of kind of regional and district management structure and spans of control there, we've recently, under Ena Williams' leadership, reorganized our store support management structure in the field to, we think, move us towards a more market-like structure in terms of giving people a little more responsibility and more opportunities. That also resulted in a net reduction in resources in the field. We feel that will help make it a little bit faster and more streamlined for us to make decisions and get information down to the stores as well.

Paul Trussell (Analyst)

Thank you and best of luck.

Steve Bramlage (CFO)

Thanks, Paul.

Operator (participant)

Thank you. Our next question comes from the line of Irene Nattel from RBC Capital Markets. Your question, please.

Irene Nattel (Managing Director)

Thanks and good morning, gentlemen.

Steve Bramlage (CFO)

Good morning, Irene Nattel.

Irene Nattel (Managing Director)

Good morning. A couple of questions. I'd like to drill down a little bit more on the loyalty side of things. As you think about the personalized offers, to what degree are you currently able to offer those? What types of offers are you providing to really help drive that sort of, if you will, your sort of the three legs of the stool, the prepared food, the grocery, and the fuel?

Darren Rebelez (President and CEO)

Yeah, Irene, this is Darren. We are still evolving into targeting offers to individual guests. We have not quite got there yet, but we are building that database and learning as we go. We are definitely targeting our rewards members more specifically than we would have in the past where we would just advertise an offer to everybody. Really central to that is our prepared food, obviously, and our whole pizza business. That is where we have seen the most growth. Building on that capability with the expanded assortment of grocery, we are able to bundle pizza offers with other grocery and other merchandise products. Most recently, as an example, over the Labor Day weekend, we were offering a whole pie deal with multi-packs of beer. Those are pretty complimentary items. We sell them both in our stores.

That positions us uniquely versus a lot of the other pizza players who really do not sell alcohol. It gives us a capability that differentiates us from our competitors, and we can activate that digitally through our rewards program.

Irene Nattel (Managing Director)

That's great. That's fascinating and such an obvious promotion, actually. Just kind of sticking on the whole subject of the loyalty, when you drill down initially, okay, into the data that you do have, you mentioned something about your highest value customers. Other than the fact that they're your most frequently shopped, are you able to, or is it too premature at this point, to really be able to sort of create kind of different categories of customers and tie them to lifestyle or whatever as you think about really using loyalty to drive behavior on a go-forward basis?

Darren Rebelez (President and CEO)

Yeah, that's the work that's underway as we speak. We recently hired a lady by the name of Carrie Stojak, who's our Vice President of Consumer Insights. She's got a wealth of knowledge in this space and has worked in multiple different industries. She and our consumer insights team will be primarily responsible for building out that view of the guest and those cohorts and helping our digital team to better target based on those guest insights. That is definitely part of the plan and is work in progress.

Irene Nattel (Managing Director)

When would you be targeting having that sort of being able to take those insights and turn them into actionable, make them actionable? Just give us an idea of how we should be thinking about it.

Darren Rebelez (President and CEO)

Yeah. Kerry's been on board for about a week now, so we're giving her a minute or two. I would say over the next few quarters, as we continue to onboard her and build out that database, we'll start to see the fruits of that labor.

Irene Nattel (Managing Director)

That's great. Just one final question, if I might. Coming back to the whole issue of procurement and improved procurement, as you sort of move down this path, you said you're starting obviously with some of the key categories. Have there been any areas that have been identified as, "Wow, we've really been leaving a lot of money on the table in this category or that category"?

Steve Bramlage (CFO)

Irene, I'll start with that. The commonplace people tend to start is on the P&L, right, in terms of cost of goods. We spend quite a bit of money on capital, right? You think of the amount of construction activity that the company does. I think the statement I made earlier around not necessarily using our scale in that category is just as relevant. We spend as much on capital as we do on many of the cost of sale categories. I think the opportunities for us on the capital spending side around how we build new stores and how we replace equipment in existing stores is quite significant. Eventually, that works its way to the P&L. From a cash standpoint, I think that's probably just as big of an opportunity as any cost of sale category that we have.

Irene Nattel (Managing Director)

That's fascinating. Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Kelly Bania from BMO Capital Markets. Your question, please.

Kelly Bania (Equity Research Analyst)

Hi, good morning. Thanks for taking our questions.

Steve Bramlage (CFO)

How are you doing?

Kelly Bania (Equity Research Analyst)

Good morning. Wondering if we could talk a little bit more about the prepared food and fountain category and just the performance of the day parts. You'd mentioned breakfast a little bit and some of the challenges I think are impacting the industry there. How do we think about breakfast as a percent of your mix versus what's happening in lunch and dinner just so we can maybe think about how to model that and the drivers going forward?

Darren Rebelez (President and CEO)

Yeah, Kelly, this is Darren. Certainly, I guess there's two areas where we're experiencing bigger declines versus others. Certainly, in our overnight business, where we were not operating 24 hours or we had reduced hours, that was probably the most significant decline that we saw. The morning day part with reduced commuting traffic was our other biggest part. I would say maybe for modeling purposes, the morning day part was down double versus what the lunch day part and the early evening day part was. Overnight was significantly more than that. I would say in both cases, we're starting to see some gradual recovery in that as we expand the hours back to more normal hours.

Really, until we see regular commuting traffic get back to normal, I would expect that the morning day part will be under some sort of pressure.

Kelly Bania (Equity Research Analyst)

Okay. That's helpful. I guess just going to the curbside pickup, just curious, as you push that into the stores, are you able to leverage existing labor for that? Do you have to add any labor? Just thoughts on executing that from a labor perspective.

Darren Rebelez (President and CEO)

Yeah. At this point, we have not had to add incremental labor because we're already doing this carry-out business. We just get a few more transactions per day, and we're already preparing those orders. It's just a matter of somebody walking it out to the curb. We don't anticipate any sort of material impact to labor. It would be a great problem to have if we grow that business enough that we have to add a little bit. At this point, and particularly during our testing, we didn't see the need to do that.

Kelly Bania (Equity Research Analyst)

Okay. Perfect. Then one last one, if I can fit one in. Just wanted to check and see if there's any different or new thoughts on the multi-week delivery from a supply chain standpoint, especially in light of just some of the changes going on in the environment.

Darren Rebelez (President and CEO)

Yeah. We did suspend that. We were up to 400 stores doing twice-week delivery. We suspended that when we were in the height of COVID. We are starting to have those discussions about restarting that. I would anticipate somewhere either late Q2 or early third quarter that we would get back to those 400 stores and start that process again.

Kelly Bania (Equity Research Analyst)

Thank you.

Operator (participant)

Thank you. Our final question for today comes from the line of John Royall from J.P. Morgan. Your question, please.

John Royall (VP of Equity Research)

Hey, good morning, guys. Thanks for taking my question. CapEx was the lowest quarterly level I think you've had in about a decade despite really strong cash flows. I know you mentioned the permitting delays, but what can we expect going forward on the CapEx side? Have you gotten through these delay issues? Can we expect the rest of the year to be something closer to normal?

Steve Bramlage (CFO)

Yeah, I'll take that, John. Listen, we clearly expect CapEx to accelerate here in the last three quarters of the year. We will be able to finish the 40 stores that we mentioned that we'll build. We'll be able to finish those, I think, because those approvals are largely done. I do expect that CapEx will move at a much faster clip going forward. Not necessarily sure we're going to get to where we've been in the prior years because the same issue around new sites in certain geographies will still apply. If we had been building 50 or 60 stores in the past at a certain level of capital, we won't get to that same level realistically. I do think the other thing to keep in mind, right, we're building our third distribution center currently in Missouri.

Most of that spend, the entire project's a little over $63 million. Most of that spend should happen this fiscal year based on the current timeline. All in all, there probably will not be a significant difference from a total capital spending standpoint on a year-over-year basis. If we miss, we'll probably miss a little bit on the lighter side than heavier just because of the starting point.

John Royall (VP of Equity Research)

Great. Thank you. If this is too detailed, I'm happy to take it offline. There was a pretty sizable working capital draw this quarter. Looks like it was mostly driven by payables. Can you talk about the drivers there? Is there any risk of that reversing later in the fiscal year?

Steve Bramlage (CFO)

Yeah. I'll answer that now. I mean, it's a noticeable benefit for us in Q1. I think we will give some of that back a little bit later in the year. The two biggest pieces on the payable side really relate to fuel payable and grocery payable. You think of the way that math works. It's comparing where we ended Q1 to the end of the fiscal year. On the fuel side, right, the price of fuel was significantly higher at the end of Q1 than it was at the end of the fiscal year. That's going to give us a bigger payable number, which will show as a source of cash. On the grocery side, we're turning our inventory much faster at the end of Q1 than we did at the end of the fiscal year.

Most of the inventory at the end of the fiscal year had already been paid for. The payable number was lower as a result. Some of that will come back to us. On the other piece that was a source for us is on the accrued side. You have a couple of things there. There is a benefit for the deferral of the Social Security associated with some of the COVID relief and government that is helping us on that front. There is some timing of some of the payables. Working capital should be a source for us over the course of the year, but not to the magnitude that it was in Q1.

John Royall (VP of Equity Research)

Got it. Thanks very much.

Operator (participant)

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Darren Rebelez for any further remarks.

Darren Rebelez (President and CEO)

All right. Thank you for taking time today to join us on the call. I think our business has shown significant resilience during the pandemic, but we remain excited and optimistic about our company's future. I also want to thank all of our team members that continue to serve our guests during these remarkable times. Thank you, everybody, and enjoy the rest of your week.

Operator (participant)

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.