PANTRY INC - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 27, 2003

Commission File Number 33-72574

THE PANTRY, INC.

(Exact name of registrant as specified in its charter)

Delaware

56-1574463

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

1801 Douglas Drive

Sanford, North Carolina

27330-1410

(Address of principal executive offices)

Registrant’s telephone number, including area code: (919) 774-6700

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

COMMON STOCK, $0.01 PAR VALUE		18,107,597 SHARES
(Class)		(Outstanding at May 1, 2003)

THE PANTRY, INC.

FORM 10-Q

MARCH 27, 2003

TABLE OF CONTENTS

		Page
Part I—Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets		3
Consolidated Statements of Operations		4
Consolidated Statements of Cash Flows		5
Notes to Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3. Quantitative and Qualitative Disclosures About Market Risk		30
Item 4. Controls and Procedures		32

Part II—Other Information
Item 4. Submission of Matters to a Vote of Security Holders		33
Item 6. Exhibits and Reports on Form 8-K		34
Certifications		S-1

PART I-FINANCIAL INFORMATION.

Item 1. Financial Statements.

THE PANTRY, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands)

	March 27, 2003			September 26, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	26,674		$	42,236
Receivables, net		33,509			34,316
Inventories (Note 2)		79,507			84,437
Prepaid expenses		5,488			3,499
Property held for sale		387			388
Deferred income taxes		292			1,414

Total current assets		145,857			166,290

Property and equipment, net (Note 8)		417,135			435,518

Other assets:
Goodwill (Note 5)		278,248			277,874
Deferred financing cost, net		8,015			8,965
Environmental receivables (Note 3)		12,531			11,696
Other assets		12,628			9,355

Total other assets		311,422			307,890

Total assets	$	874,414		$	909,698

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt (Note 4)	$	7,567		$	43,255
Current maturities of capital lease obligations		1,521			1,521
Short-term borrowings (Note 4)		10,000			—
Accounts payable		78,631			93,858
Accrued interest		11,463			13,175
Accrued compensation and related taxes		10,405			10,785
Income taxes payable		59			—
Other accrued taxes		12,709			17,463
Accrued insurance		10,944			9,687
Other accrued liabilities (Note 6)		9,062			19,969

Total current liabilities		152,361			209,713

Long-term debt (Note 4)		475,958			460,920

Other liabilities:
Environmental reserves (Note 3)		13,742			13,285
Deferred income taxes (Note 8)		37,790			38,360
Deferred revenue		49,679			51,772
Capital lease obligations		14,712			15,381
Other noncurrent liabilities (Notes 6 and 8)		13,839			5,063

Total other liabilities		129,762			123,861

Commitments and contingencies (Notes 3 and 4)
Shareholders’ equity (Notes 7, 8 and 10):
Common stock, $.01 par value, 50,000,000 shares authorized; 18,107,597 issued and outstanding at March 27, 2003 and September 26, 2002		182			182
Additional paid-in capital		128,002			128,002
Shareholder loans		(452	)		(708	)
Accumulated other comprehensive deficit, net		(324	)		(2,112	)
Accumulated deficit		(11,075	)		(10,160	)

Total shareholders’ equity		116,333			115,204

Total liabilities and shareholders’ equity	$	874,414		$	909,698

See Notes to Consolidated Financial Statements

THE PANTRY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended						Six Months Ended
	March 27, 2003			March 28, 2002			March 27, 2003			March 28, 2002
	(13 weeks)			(13 weeks)			(26 weeks)			(26 weeks)
Revenues:
Merchandise sales	$	234,900		$	232,477		$	477,240		$	469,715
Gasoline sales		431,719			322,015			833,652			656,328
Commissions		6,825			6,353			13,529			12,175

Total revenues		673,444			560,845			1,324,421			1,138,218

Cost of sales:
Merchandise		157,405			156,122			319,972			316,047
Gasoline		402,910			296,623			765,329			598,592

Total cost of sales		560,315			452,745			1,085,301			914,639

Gross profit		113,129			108,100			239,120			223,579

Operating expenses:
Operating, general and administrative expenses		92,323			89,962			185,464			178,938
Depreciation and amortization		13,683			13,512			26,775			26,904

Total operating expenses		106,006			103,474			212,239			205,842

Income from operations		7,123			4,626			26,881			17,737

Other income (expense):
Interest expense (Note 6 and 9)		(11,457	)		(11,823	)		(23,645	)		(24,166	)
Miscellaneous		507			302			941			327

Total other expense		(10,950	)		(11,521	)		(22,704	)		(23,839	)

Income (loss) before income taxes		(3,827	)		(6,895	)		4,177			(6,102	)
Income tax benefit (expense)		1,474			2,757			(1,610	)		2,439

Net income (loss) before cumulative effect adjustment		(2,353	)		(4,138	)		2,567			(3,663	)
Cumulative effect adjustment, net of tax (Note 8)		—			—			(3,482	)		—

Net loss	$	(2,353	)	$	(4,138	)	$	(915	)	$	(3,663	)

Net income (loss) per share (Note 11):
Basic:
Net income (loss) before cumulative effect adjustment	$	(0.13	)	$	(0.23	)	$	0.14		$	(0.20	)
Cumulative effect adjustment		—			—			(0.19	)		—

Net loss	$	(0.13	)	$	(0.23	)	$	(0.05	)	$	(0.20	)

Diluted:
Net income (loss) before cumulative effect adjustment	$	(0.13	)	$	(0.23	)	$	0.14		$	(0.20	)
Cumulative effect adjustment		—			—			(0.19	)		—

Net loss	$	(0.13	)	$	(0.23	)	$	(0.05	)	$	(0.20	)

See Notes to Consolidated Financial Statements

THE PANTRY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

	Six Months Ended
	March 27, 2003			March 26, 2002
	(26 weeks)			(26 weeks)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(915	)	$	(3,663	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		26,775			26,904
Provision for deferred income taxes		1,610			(2,439	)
(Gain) loss on sale of property and equipment		333			(163	)
Impairment of long-lived assets		300			40
Fair market value change in non-qualifying derivatives		(843	)		(1,157	)
Provision for closed stores		1,135			965
Cumulative effect of change in accounting principle		3,482			—
Changes in operating assets and liabilities (net of effects of acquisitions):
Receivables		55			(2,621	)
Inventories		4,930			451
Prepaid expenses		(1,987	)		(1,221	)
Other noncurrent assets		(3,642	)		(72	)
Accounts payable		(15,227	)		(579	)
Other current liabilities and accrued expenses		(12,672	)		(7,581	)
Reserves for environmental expenses		457			460
Other noncurrent liabilities		(2,226	)		(2,940	)

Net cash provided by operating activities		1,565			6,384

CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property held for sale		(1,074	)		(992	)
Additions to property and equipment		(6,810	)		(8,035	)
Proceeds from sale of property held for sale		1,521			2,066
Proceeds from sale of property and equipment		1,671			3,153
Acquisitions of related businesses, net of cash acquired		(1,169	)		(514	)

Net cash used in investing activities		(5,861	)		(4,322	)

CASH FLOWS FROM FINANCING ACTIVITIES
Principal repayments under capital leases		(669	)		(539	)
Principal repayments of long-term debt		(20,650	)		(23,852	)
Proceeds from short-term borrowings		10,000			—
Repayments of shareholder loans		256			10
Other financing costs		(203	)		(916	)

Net cash used in financing activities		(11,266	)		(25,297	)

NET DECREASE IN CASH AND CASH EQUIVALENTS		(15,562	)		(23,235	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		42,236			50,611

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	26,674		$	27,376

Cash paid (refunded) during the period:
Interest	$	26,200		$	25,567

Taxes	$	(59	)	$	(561	)

See Notes to Consolidated Financial Statements

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—BASIS OF PRESENTATION

Unaudited Consolidated Financial Statements

The accompanying consolidated financial statements include the accounts of The Pantry, Inc. and its wholly owned subsidiaries, the “Company”. All inter-company transactions and balances have been eliminated in consolidation. Transactions and balances of each of these wholly owned subsidiaries are immaterial to the consolidated financial statements.

The consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The interim consolidated financial statements have been prepared from the accounting records of The Pantry, Inc. and its subsidiaries and all amounts at March 27, 2003 and for the three and six months ended March 27, 2003 and March 28, 2002 are unaudited. References herein to “The Pantry” or “the Company” include all subsidiaries. Pursuant to Regulation S-X, certain information and note disclosures normally included in annual financial statements have been condensed or omitted. The information furnished reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented, and which are of a normal, recurring nature.

We suggest that these interim financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 26, 2002.

Our results of operations for the three and six months ended March 27, 2003 and March 28, 2002 are not necessarily indicative of results to be expected for the full fiscal year. The convenience store industry in our marketing areas generally experiences higher levels of revenues and profit margins during the summer months than during the winter months. Also, we have historically achieved higher revenues and earnings in our third and fourth quarters.

Accounting Period

We operate on a 52-53 week fiscal year ending on the last Thursday in September. Our 2003 fiscal year ends on September 25, 2003 and is a 52-week year. Fiscal 2002 was also a 52-week year.

The Pantry

As of March 27, 2003, we operated 1,274 convenience stores located in Florida (483), North Carolina (331), South Carolina (245), Georgia (56), Mississippi (54), Kentucky (39), Virginia (30), Indiana (14), Tennessee (14) and Louisiana (8). Our stores offer a broad selection of products and services designed to appeal to the convenience needs of our customers, including gasoline, car care products and services, tobacco products, beer, soft drinks, self-service fast food and beverages, publications, dairy products, groceries, health and beauty aids, money orders and other ancillary services. In our Florida, Georgia, Kentucky, Virginia, Louisiana, South Carolina and Indiana stores, we also sell lottery products. Self-service gasoline is sold at 1,243 locations, 946 of which sell gasoline under major oil company brand names including Amoco^®, BP^®, Chevron^®, Citgo^®, Mobil^®, Shell^® and Texaco^®.

Recently Adopted Accounting Standards

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

requires that certain cash consideration received by a customer from a vendor is presumed to be a reduction of the prices of the vendor’s products or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer’s income statement. However, that presumption is overcome if certain criteria are met. If the presumption is overcome, the consideration would be presented as revenue if it represents a payment for goods or services provided by the reseller to the vendor, or as an offset to an expense if it represents a reimbursement of a cost incurred by the reseller. The adoption of EITF 02-16 did not have a material impact on our results of operations or classification of expenses.

Effective December 27, 2002, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”), which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. The adoption of SFAS No. 146 did not have a material impact on our results of operations and financial condition.

Effective September 27, 2002, we adopted the provisions of SFAS No. 143, Accounting for Asset Retirement Obligations (“SFAS No. 143”), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 requires us to recognize an estimated liability associated with the removal of our underground storage tanks. See Note 8 for a discussion of our adoption of SFAS No. 143.

Effective September 27, 2002, we adopted the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). This statement supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of and Accounting Principles Board No. 30, Reporting the Results of Operation—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and how the results of a discontinued operation are to be measured and presented. The adoption of SFAS No. 144 did not have a material impact on our results of operations and financial condition.

Effective September 27, 2002, we adopted the provisions of SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure (“SFAS No. 148”), an amendment of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”). This statement was issued to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The amendments to SFAS No. 123 in paragraphs 2(a)-2(e) of this statement shall be effective for financial statements for fiscal years ending after December 15, 2002. The adoption of SFAS No. 148 did not impact our results of operations or financial condition. The interim disclosures required by SFAS No. 148 are discussed in Note 10.

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 2—INVENTORIES

Inventories are valued at the lower of cost or market. Cost is determined using the last-in, first-out method, except for gasoline inventories for which cost is determined using the weighted average cost method. Inventories consisted of the following (amounts in thousands):

	March 27, 2003			September 26, 2002
Inventories at FIFO cost:
Merchandise	$	76,545		$	79,535
Gasoline		20,378			21,669

		96,923			101,204
Less adjustment to LIFO cost:
Merchandise		(17,416	)		(16,767	)

Inventories at LIFO cost	$	79,507		$	84,437

NOTE 3—ENVIRONMENTAL LIABILITIES AND OTHER CONTINGENCIES

As of March 27, 2003, we were contingently liable for outstanding letters of credit in the amount of $30.2 million primarily related to several self-insured programs, vendor contract terms and regulatory requirements. The letters of credit are not to be drawn against unless we default on the timely payment of related liabilities.

We are involved in certain legal actions arising in the normal course of business. In the opinion of management, based on a review of such legal proceedings, we believe the ultimate outcome of these actions will not have a material effect on the consolidated financial statements.

Environmental Liabilities and Contingencies

We are subject to various federal, state and local environmental laws. We make financial expenditures in order to comply with regulations governing underground storage tanks adopted by federal, state and local regulatory agencies. In particular, at the federal level, the Resource Conservation and Recovery Act of 1976, as amended, requires the EPA to establish a comprehensive regulatory program for the detection, prevention and cleanup of leaking underground storage tanks.

Federal and state regulations require us to provide and maintain evidence that we are taking financial responsibility for corrective action and compensating third parties in the event of a release from our underground storage tank systems. In order to comply with these requirements, we maintain letters of credit in the aggregate amount of $1.1 million in favor of state environmental agencies in North Carolina, South Carolina, Virginia, Georgia, Kentucky, Tennessee, Louisiana and Indiana. We also rely on reimbursements from applicable state trust funds. In Florida, we meet our financial responsibility requirements by state trust fund coverage through December 31, 1998 and meet such requirements thereafter through private commercial liability insurance. In Georgia, we meet our financial responsibility requirements by state trust fund coverage through December 29, 1999 and meet such requirements thereafter through private commercial liability insurance and a letter of credit. In Mississippi, we meet our financial responsibility requirements through coverage under the state trust fund.

Regulations enacted by the EPA in 1988 established requirements for:

•

installing underground storage tank systems;

•

upgrading underground storage tank systems;

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

•

taking corrective action in response to releases;

•

closing underground storage tank systems;

•

keeping appropriate records and

•

maintaining evidence of financial responsibility for taking corrective action and compensating third parties for bodily injury and property damage resulting from releases.

These regulations permit states to develop, administer and enforce their own regulatory programs, incorporating requirements which are at least as stringent as the federal standards. The Florida rules for 1998 upgrades are more stringent than the 1988 EPA regulations. We believe our facilities in Florida meet or exceed such rules. We believe all company-owned underground storage tank systems are in material compliance with these 1988 EPA regulations and all applicable state environmental regulations.

State Trust Funds. All states in which we operate or have operated underground storage tank systems have established trust funds for the sharing, recovering and reimbursing of certain cleanup costs and liabilities incurred as a result of releases from underground storage tank systems. These trust funds, which essentially provide insurance coverage for the cleanup of environmental damages caused by the operation of underground storage tank systems, are funded by an underground storage tank registration fee and a tax on the wholesale purchase of motor fuels within each state. We have paid underground storage tank registration fees and gasoline taxes to each state where we operate to participate in these trust fund programs. We have filed claims and received reimbursements in North Carolina, South Carolina, Kentucky, Indiana, Georgia, Florida, Tennessee and Virginia. The coverage afforded by each state fund varies but generally provides up to $1.0 million per site or occurrence for the cleanup of environmental contamination, and most provide coverage for third-party liabilities. Costs for which we do not receive reimbursement include:

•

the per-site deductible;

•

costs incurred in connection with releases occurring or reported to trust funds prior to their inception;

•

removal and disposal of underground storage tank systems and

•

costs incurred in connection with sites otherwise ineligible for reimbursement from the trust funds.

The trust funds generally require us to pay deductibles ranging from $5 thousand to $150 thousand per occurrence depending on the upgrade status of our underground storage tank system, the date the release is discovered and/or reported and the type of cost for which reimbursement is sought. The Florida trust fund will not cover releases first reported after December 31, 1998. We obtained private insurance coverage for remediation and third party claims arising out of releases reported after December 31, 1998. We believe that this coverage exceeds federal and Florida financial responsibility regulations. In Georgia, we opted not to participate in the state trust fund effective December 30, 1999. We obtained private insurance coverage for remediation and third party claims arising out of releases reported after December 29, 1999. We believe that this coverage exceeds federal and Georgia financial responsibility regulations. During the next five years, we may spend up to $1.2 million for remediation. In addition, we estimate that state trust funds established in our operating areas or other responsible third parties (including insurers) may spend up to $12.5 million on our behalf. To the extent those third parties do not pay for remediation as we anticipate, we will be obligated to make such payments. This could materially adversely affect our financial condition, results of operations and cash flows. Reimbursements from state trust funds will be dependent upon the continued maintenance and continued solvency of the various funds.

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Several of the locations identified as contaminated are being remediated by third parties who have indemnified us as to responsibility for cleanup matters. Additionally, we are awaiting closure notices on several other locations that will release us from responsibility related to known contamination at those sites. These sites continue to be included in our environmental reserve until a final closure notice is received.

NOTE 4—LONG-TERM DEBT

Long-term debt consisted of the following (amounts in thousands):

	March 27, 2003		September 26, 2002
Senior subordinated notes payable; due October 15, 2007; interest payable semi-annually at 10.25%	$	200,000	$	200,000
Tranche A term loan; interest payable monthly at LIBOR plus 3.5%; principal due in quarterly installments through January 31, 2004		16,907		26,906
Tranche B term loan; interest payable monthly at LIBOR plus 4.0%; principal due in quarterly installments through January 31, 2006		175,238		176,185
Tranche C term loan; interest payable monthly at LIBOR plus 4.25%; principal due in quarterly installments through July 31, 2006		72,750		73,125
Acquisition term loan; interest payable monthly at LIBOR plus 3.5%; principal due in quarterly installments through January 31, 2004		18,500		27,500
Notes payable to McLane Company, Inc.; zero (0.0%) interest, with principal due in annual installments through February 26, 2003		—		297
Other notes payable; various interest rates and maturity dates		130		162

Total long-term debt		483,525		504,175
Less—current maturities		7,567		43,255

Long-term debt, net of current maturities	$	475,958	$	460,920

At March 27, 2003, our senior credit facility consists of a $45.0 million revolving credit facility, which expires January 31, 2004 and bears interest at a rate of LIBOR plus 3.5%, and $283.4 million in outstanding term loans. Our revolving credit facility is available for working capital financing, general corporate purposes and issuing commercial and standby letters of credit. As of March 27, 2003, there was $10.0 million outstanding under the revolving credit facility and we had approximately $27.3 million of standby letters of credit issued under the facility. Therefore, we had approximately $7.7 million in available borrowing capacity. Furthermore, the revolving credit facility limits our total outstanding letters of credit to $30.0 million. The LIBOR associated with our senior credit facility resets periodically and as of March 27, 2003, was 1.34%.

On April 14, 2003, we entered into a new senior secured credit facility, which consists of a $253.0 million first lien term loan, a $51.0 million second lien term loan and a $52.0 million revolving credit facility, each maturing March 31, 2007. Proceeds from the new senior secured credit facility were used to repay all amounts outstanding under the existing senior credit facility and loan origination costs. The term loans were issued with an original issue discount of $4.6 million, which will be amortized over the life of the agreement. The first lien term loan and revolving credit facility have a stated interest rate of LIBOR plus 4.25%. The second lien term loan has a stated interest rate of LIBOR plus 6.5%. The term loans have certain LIBOR floors. Certain scheduled principal payments on the first lien term loan are due quarterly and the second lien term loan and revolving credit facility are due in full at maturity.

The senior secured credit facility contains various restrictive covenants including a minimum EBITDA, maximum leverage ratio, minimum fixed charge coverage, maximum capital expenditures as well as other customary covenants, representations and warranties and events of default.

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

In connection with the refinancing, we will record a non-cash charge of approximately $2.9 million, or $1.8 million net of taxes, related to the write-off of deferred financing costs associated with the previous credit facility in the three month period ending June 26, 2003.

The remaining annual maturities of our long-term debt after completion of the new senior secured credit facility are as follows (amounts in thousands):

Year Ended September:
2003	$	2,533
2004		18,808
2005		24,779
2006		25,260
2007		232,750
Thereafter		200,000

Total long-term debt	$	504,130

As of March 27, 2003, we were in compliance with all covenants and restrictions relating to all outstanding borrowings and substantially all of our net assets are restricted as to payment of dividends and other distributions.

NOTE 5—GOODWILL

Effective September 28, 2001, we adopted the provisions of SFAS No. 142 and, as a result, our goodwill asset is no longer amortized but reviewed at least annually for impairment. We determined that we operate in one reporting unit based on the current reporting structure and have thus assigned goodwill at the enterprise level.

As of September 27, 2002, we completed our annual goodwill impairment test by comparing the enterprise fair value to its carrying or book value. This valuation indicated an aggregate fair value in excess of our book value; therefore, we had determined that no impairment existed. Fair value was measured using a valuation by an independent third party, which was based on market multiples, comparable transactions and discounted cash flow methodologies. We utilized an independent valuation to determine our fair value rather than our market capitalization, as we believe our market capitalization is not representative of the fair value of the Company because two institutions own approximately 83% of our outstanding common stock.

During the quarter ended March 27, 2003, we changed the date of our annual goodwill impairment test to the last day of our monthly period ending in January. We selected our period ending in January to perform our annual goodwill impairment test because we believe such date represents the end of our annual seasonal business cycle. Typically, our business increases during warmer weather months in the southeastern United States and extends to the holiday season, which ends within our second fiscal quarter. We believe that the change will not delay, accelerate or avoid an impairment charge. Accordingly, we believe that the accounting change described above is to an alternative accounting principle that is preferable under the circumstances.

We completed our annual goodwill impairment test as of January 23, 2003 by comparing the enterprise fair value to its carrying or book value. This valuation indicated an aggregate fair value in excess of our book value; therefore, we have determined that no impairment existed. Fair value was measured using a valuation by an independent third party as of January 23, 2003, which was based on market multiples, comparable transactions and discounted cash flow methodologies.

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

On an ongoing basis, we will perform an annual goodwill impairment test. At least quarterly, we will analyze whether an event has occurred that would more likely than not reduce our enterprise fair value below its carrying amount and, if necessary, we will perform a goodwill impairment test between the annual dates. Impairment adjustments recognized after adoption, if any, will be recognized as operating expenses.

NOTE 6—DERIVATIVE FINANCIAL INSTRUMENTS

We enter into interest rate swap and collar agreements to modify the interest rate characteristics of our outstanding long-term debt and have designated each qualifying instrument as a cash flow hedge. We formally document our hedge relationships, including identifying the hedge instruments and hedged items, as well as our risk management objectives and strategies for entering into the hedge transaction. At hedge inception, and at least quarterly thereafter, we assess whether derivatives used to hedge transactions are highly effective in offsetting changes in the cash flow of the hedged item. We measure effectiveness by the ability of the interest rate swaps to offset cash flows associated with changes in the variable LIBOR rate associated with our term loan facilities using the hypothetical derivative method. To the extent the instruments are considered to be effective, changes in fair value are recorded as a component of other comprehensive income (loss). To the extent the instruments are considered ineffective, any changes in fair value relating to the ineffective portion are immediately recognized in earnings (interest expense). When it is determined that a derivative ceases to be a highly effective hedge, we discontinue hedge accounting, and any gains or losses on the derivative instrument are recognized in earnings. Interest income was $624 thousand and $922 thousand for the three months ended March 27, 2003 and March 28, 2002, respectively, and $843 thousand and $1.2 million for the six months ended March 27, 2003 and March 28, 2002, respectively, for the mark-to-market adjustment of those instruments that do not qualify for hedge accounting.

The fair values of our interest rate swaps and collars are obtained from dealer quotes. These values represent the estimated amount we would receive or pay to terminate the agreement taking into consideration the difference between the contract rate of interest and rates currently quoted for agreements of similar terms and maturities. At March 27, 2003, other accrued liabilities include derivative liabilities of $4.8 million. At September 26, 2002, other accrued liabilities and other noncurrent liabilities include derivative liabilities of $7.9 million and $699 thousand, respectively.

NOTE 7—COMPREHENSIVE INCOME

The components of comprehensive income (loss), net of related taxes, for the periods presented are as follows (amounts in thousands):

	Three Months Ended						Six Months Ended
	March 27, 2003			March 28, 2002			March 27, 2003			March 28, 2002
Net loss	$	(2,353	)	$	(4,138	)	$	(915	)	$	(3,663	)

Other comprehensive income:
Cumulative effect of adoption of SFAS No. 133 (net of deferred taxes of $34, $34, $68 and $67, respectively)		56			51			107			103
Net unrealized gains on qualifying cash flow hedges (net of deferred taxes of $536, $652, $1,053 and $929, respectively)		855			978			1,681			1,421

Other comprehensive income		911			1,029			1,788			1,524

Comprehensive income (loss)	$	(1,442	)	$	(3,109	)	$	873		$	(2,139	)

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The components of unrealized gains on qualifying cash flow hedges, net of related taxes, for the periods presented are as follows (amounts in thousands):

	Three Months Ended						Six Months Ended
	March 27, 2003			March 28, 2002			March 27, 2003			March 28, 2002
Unrealized gains on qualifying cash flow hedges	$	1,767		$	1,876		$	3,555		$	3,019
Less: Reclassification adjustment for expenses included in net loss		(912	)		(898	)		(1,874	)		(1,598	)

Net unrealized gains on qualifying cash flow hedges	$	855		$	978		$	1,681		$	1,421

The components of accumulated other comprehensive deficit, net of related taxes, are as follows (amounts in thousands):

	March 27, 2003			September 26, 2002
Cumulative effect of adoption of SFAS No. 133 (net of related taxes of $25 at March 27, 2003 and $93 at September 26, 2002)	$	(51	)	$	(158	)
Unrealized losses on qualifying cash flow hedges (net of related taxes of $208 at March 27, 2003 and $1,261 at September 26, 2002)		(273	)		(1,954	)

Accumulated other comprehensive deficit	$	(324	)	$	(2,112	)

NOTE 8—ASSET RETIREMENT OBLIGATION

Effective September 27, 2002, we adopted the provisions of SFAS No. 143 and, as a result, we recognize the future cost to remove an underground storage tank over the estimated useful life of the storage tank in accordance with SFAS No. 143. A liability for the fair value of an asset retirement obligation with a corresponding increase to the carrying value of the related long-lived asset is recorded at the time an underground storage tank is installed. We will amortize the amount added to property and equipment and recognize accretion expense in connection with the discounted liability over the remaining life of the respective underground storage tanks.

The estimated liability is based on historical experience in removing these tanks, estimated tank useful lives, external estimates as to the cost to remove the tanks in the future and federal and state regulatory requirements. The liability is a discounted liability using a credit-adjusted risk-free rate of approximately 9%. Revisions to the liability could occur due to changes in tank removal costs, tank useful lives or if federal and/or state regulators enact new guidance on the removal of such tanks.

Upon adoption, we recorded a discounted liability of $8.4 million, which is included in other noncurrent liabilities, increased net property and equipment by $2.7 million and recognized a one-time cumulative effect adjustment of $3.5 million (net of deferred tax benefit of $2.2 million). We will amortize the amount added to property and equipment and recognize accretion expense in connection with the discounted liability over the remaining lives of the respective underground storage tanks. Pro forma effects on earnings from continuing operations before cumulative effect of accounting change for the three months and six months ended March 28, 2002, assuming the adoption of SFAS No. 143 as of September 28, 2001, were not material to net income (loss) or income (loss) per share.

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

A reconciliation of the Company’s liability for the six months ended March 27, 2003, is as follows (amounts in thousands):

Upon adoption at September 27, 2002	$	8,443
Liabilities incurred		149
Liabilities settled		(38	)
Accretion expense		418

Total asset retirement obligation	$	8,972

NOTE 9—INTEREST EXPENSE

The components of interest expense are as follows (amounts in thousands):

	Three Months Ended						Six Months Ended
	March 27, 2003			March 28, 2002			March 27, 2003			March 28, 2002
Interest on long-term debt	$	9,097		$	9,916		$	18,476		$	20,171
Interest rate swap settlements		2,425			2,331			4,900			4,189
Interest on capital lease obligations		547			484			1,095			968
Fair market value change in non-qualifying derivatives		(624	)		(922	)		(843	)		(1,157	)
Miscellaneous		12			14			17			(5	)

Total interest expense	$	11,457		$	11,823		$	23,645		$	24,166

NOTE 10—STOCK OPTIONS AND OTHER EQUITY INSTRUMENTS

On January 1, 1998, we adopted an incentive and non-qualified stock option plan. Pursuant to the provisions of the plan, options may be granted to officers, key employees, consultants of our Company or any of our subsidiaries and certain members of the board of directors to purchase up to 1,275,000 shares of our Company’s common stock. On June 3, 1999, we adopted a new stock option plan (“1999 plan”) providing for the grant of incentive stock options and non-qualified stock options to officers, directors, employees and consultants, with provisions similar to the 1998 stock option plan and up to 3,825,000 shares of the Company’s common stock available for grant. The plans are administered by the board of directors or a committee of the board of directors. Options are granted at prices determined by the board of directors and may be exercisable in one or more installments. All options granted vest over a three-year period, with one-third of each grant vesting on the anniversary of the initial grant and have contractual lives of seven to ten years. Additionally, the terms and conditions of awards under the plans may differ from one grant to another. Under the plans, incentive stock options may only be granted to employees with an exercise price at least equal to the fair market value of the related common stock on the date the option is granted. Fair values are based on the most recent common stock sales.

On January 15, 2003, the board of directors amended the 1999 plan to increase the number of shares of common stock that may be issued under the plan by 882,505 shares. This number of shares corresponded to the number of shares that remained available at that time for issuance under the 1998 plan, which the board of directors terminated (except for the purpose of continuing to govern options outstanding under that plan) on January 15, 2003.

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Activity for stock options issued under the 1999 plan for the three and six months ended March 27, 2003 and March 28, 2002 is as follows:

	Three Months Ended		Six Months Ended
	March 27, 2003	March 28, 2002	March 27, 2003	March 28, 2002
Granted	35,000	40,000	390,000	240,000
Exercised	—	—	—	—
Forfeited	138,403	96,078	249,313	96,078
Expired	—	—	—	—

The following table summarizes information about stock options outstanding at March 27, 2003:

Exercise Prices	Date Granted	Number Outstanding at March 27, 2003	Weighted-Average Remaining Contractual Life	Number of Options Exercisable	Weighted-Average Exercise Price
$8.82	1/1/98	242,607	5 years	242,607	$	8.82
$11.27	8/25/98	78,285	6 years	78,285	$	11.27
$13.00	6/8/99, 9/30/99	129,000	4 years	129,000	$	13.00
$10.00	12/29/00	236,000	5 years	157,333	$	10.00
$5.12	11/26/01	150,000	6 years	50,000	$	5.12
$4.00	3/26/02	40,000	6 years	13,333	$	4.00
$1.66	10/22/02	20,000	7 years	—	$	1.66
$1.70	11/13/02	335,000	7 years	—	$	1.70
$3.97	1/6/03	35,000	7 years	—	$	3.97

Total		1,265,892		670,558

The Pantry’s stock option plans are accounted for in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Had compensation cost for the plan been determined consistent with SFAS No. 123, Accounting for Stock-Based Compensation, The Pantry’s pro-forma net loss would have been approximately $2.4 million and $4.2 million for the three months ending March 27, 2003 and March 28, 2002, respectively, and $3.8 million and $1.1 million for the six months ending March 27, 2003 and March 28, 2002, respectively. Pro forma basic and diluted loss per share would have been $0.13 and $0.23 for the three months ending March 27, 2003 and March 28, 2002, respectively, and $0.06 and $0.21 for the six months ending March 27, 2003 and March 28, 2002, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

	Three Months Ended
	March 27, 2003			March 28, 2002
Weighted-average grant date fair value	$	1.52		$	1.41
Weighted-average expected lives (years)		2			2
Weighted-average grant date fair value-exercise price equals market price	$	1.52		$	1.41
Weighted-average grant date fair value-exercise price greater than market price		—			—
Risk-free interest rate		1.84	%		3.72	%
Expected volatility		68.31	%		59.63	%
Dividend yield		0.00	%		0.00	%

THE PANTRY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 11—NET INCOME (LOSS) PER SHARE

We compute net income (loss) per share data in accordance with the requirements of SFAS No. 128, Earnings Per Share. Basic net income (loss) per share is computed on the basis of the weighted average number of common shares outstanding. Diluted net income (loss) per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding warrants and stock options using the “treasury stock” method.

The following table reflects the calculation of basic and diluted net income (loss) per share (dollars in thousands, except per share data):

	Three Months Ended						Six Months Ended
	March 27, 2003			March 28, 2002			March 27, 2003			March 28, 2002
Net income (loss) before cumulative effect adjustment	$	(2,353	)	$	(4,138	)	$	2,567		$	(3,663	)
Cumulative effect adjustment		—			—			(3,482	)		—

Net loss	$	(2,353	)	$	(4,138	)	$	(915	)	$	(3,663	)

Net loss per share—basic:
Weighted average shares outstanding		18,108			18,108			18,108			18,108

Net income (loss) per share before cumulative effect adjustment—basic	$	(0.13	)	$	(0.23	)	$	0.14		$	(0.20	)
Loss per share on cumulative effect adjustment—basic		—			—			(0.19	)		—

Net loss per share—basic	$	(0.13	)	$	(0.23	)	$	(0.05	)	$	(0.20	)

Net loss per share—diluted:
Weighted average shares outstanding		18,108			18,108			18,108			18,108
Dilutive impact of options and warrants outstanding		—			—			—			—
Weighted average shares and potential dilutive shares outstanding		18,108			18,108			18,108			18,108

Net income (loss) per share before cumulative effect adjustment—diluted	$	(0.13	)	$	(0.23	)	$	0.14		$	(0.20	)
Loss per share on cumulative effect adjustment—diluted		—			—			(0.19	)		—

Net loss per share—diluted	$	(0.13	)	$	(0.23	)	$	(0.05	)	$	(0.20	)

Options and warrants to purchase shares of common stock that were not included in the computation of diluted earnings per share, because their inclusion would have been antidilutive, were 3.6 million and 3.5 million for the three months ended March 27, 2003 and March 28, 2002, respectively, and 3.6 million and 3.5 million for the six months ended March 27, 2003 and March 28, 2002.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis is provided to increase the understanding of, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes. Additional discussion and analysis related to our Company is contained in our Annual Report on Form 10-K for the fiscal year ended September 26, 2002.

Introduction

The Pantry, Inc. is the leading convenience store operator in the southeastern United States and one of the largest independently operated convenience store chains in the country with 1,274 stores in 10 southeastern states. Our operating strategy is to provide value to our customers by maintaining high store standards and offering a wide selection of quality products at competitive prices. We sell general merchandise, petroleum products and other products and services targeted to appeal to consumers desire for convenience.

During the second quarter of fiscal 2003, we focused on several initiatives which we believe will maximize the performance of our existing store network and position the Company for improved results when the economic climate in the southeastern United States improves.

In the merchandise segment, we completed our reset program to reposition the assortment, presentation and price of the products offered in each of our locations. We believe this program contributed to our 2.5% increase in comparable store merchandise revenue for the second quarter of fiscal 2003.

In the gasoline segment, we entered into agreements with BP Products, NA (BP^®) and Citgo Petroleum Corporation (Citgo^®) to brand and supply most of our gasoline products over the next five years. We believe this brand consolidation will enable us to provide a more consistent operating identity while maximizing our gasoline gallon growth and margin per gallon. Additionally, we believe Citgo^®’s commitment to supply virtually all of our unbranded gallons will facilitate the growth of our Kangaroo^® brand gasoline.

During the second quarter of fiscal 2003, we also laid the groundwork for a $356 million refinancing, which we completed on April 14, 2003. The refinancing of our senior secured credit facility provides us greater liquidity and flexibility through a $7.0 million increase in the revolving credit facility to a total of $52.0 million and a $118 million reduction of scheduled principal payments through fiscal 2005. We continue to remain focused on reducing our outstanding debt while intelligently investing in capital projects, which result in the highest possible return on investment.

We remained focused on controlling store operating expenses. For the second quarter of fiscal 2003, store operating expenses as a percentage of merchandise revenue declined to 31.1% compared to 31.8% for the second quarter of fiscal 2002.

We anticipate closing approximately 35 stores during fiscal 2003 with 15 stores closed during the six months ending March 27, 2003. Historically, the stores we close are under performing in terms of volume and profitability, and, generally, we benefit from closing the locations by reducing direct overhead expenses and eliminating certain fixed costs.

Throughout the remainder of fiscal 2003, we remain focused on maximizing the benefits of our merchandise and gasoline initiatives as well as upgrading our network of 1,274 stores. We believe these initiatives will positively impact operating results in the future.

Results of Operations

Three Months Ended March 27, 2003 Compared to the Three Months Ended March 28, 2002

Total Revenue. Total revenue for the second quarter of fiscal 2003 was $673.4 million compared to $560.8 million for the second quarter of fiscal 2002, an increase of $112.6 million or 20.1%. The increase in total

revenue is primarily attributable to a 41 cents, or 35.7%, increase in our average gasoline retail price per gallon, a comparable store merchandise revenue increase of 2.5% and a $472 thousand increase in commission revenue. These increases were partially offset by a comparable store gasoline gallon volume decline of 0.2%.

Merchandise Revenue. Merchandise revenue for the second quarter of fiscal 2003 was $234.9 million compared to $232.5 million during the second quarter of fiscal 2002, an increase of $2.4 million or 1.0%. The increase is primarily attributable to a 2.5% increase in comparable store merchandise revenue compared to the second quarter of fiscal 2002, partially offset by lost revenue from closed stores of approximately $1.5 million. The increase in comparable store merchandise revenue is primarily attributable to our efforts to enhance and reposition our merchandise offerings, increased promotional activity and more aggressive pricing in key categories in an effort to drive customer traffic.

Gasoline Revenue and Gallons. Gasoline revenue for the second quarter of fiscal 2003 was $431.7 million compared to $322.0 million during the second quarter of fiscal 2002, an increase of $109.7 million or 34.1%. The increase in gasoline revenue is primarily attributable to the 41 cents, or 35.7%, increase in the average gasoline retail price per gallon, partially offset by a 0.2% decline in comparable store gasoline gallon volume. The increased average retail price per gallon of $1.56 for the second quarter of fiscal 2003 compared to $1.15 per gallon for the comparable prior year period coupled with unusually cold weather and a weak economic environment in the Southeast contributed to the comparable store gasoline gallon volume decline.

In the second quarter of fiscal 2003, gasoline gallons sold were 277.1 million compared to 281.0 million during the second quarter of fiscal 2002, a decrease of 3.9 million gallons or 1.4%. The decrease is primarily attributable to the comparable store gasoline gallon sales decline coupled with lost gallon volume from closed stores of approximately 1.0 million.

Commission Revenue. Commission revenue for the second quarter of fiscal 2003 was $6.8 million compared to $6.4 million during the second quarter of fiscal 2002, an increase of $472 thousand or 7.4%. The increase is primarily attributable to an increase in lottery revenue of approximately $200 thousand, prepaid credit card revenue of approximately $150 thousand and additional ATM income of approximately $100 thousand.

Total Gross Profit. Total gross profit for the second quarter of fiscal 2003 was $113.1 million compared to $108.1 million during the second quarter of fiscal 2002, an increase of $5.0 million or 4.7%. The increase in gross profit is primarily attributable to increases in gasoline margin per gallon, merchandise margin and commission revenue.

Merchandise Gross Profit and Margin. Merchandise gross profit was $77.5 million for the second quarter of fiscal 2003 compared to $76.4 million for the second quarter of fiscal 2002, an increase of $1.1 million or 1.5%. This increase is primarily attributable to the increased merchandise revenue discussed above and a 20 basis points increase in our merchandise margin. Merchandise margin increased to 33.0% for the second quarter of fiscal 2003 from the 32.8% reported for the second quarter of fiscal 2002.

Gasoline Gross Profit and Per Gallon Margin. Gasoline gross profit was $28.8 million for the second quarter of fiscal 2003 compared to $25.4 million for the second quarter of fiscal 2002, an increase of $3.4 million or 13.5%. The increase is primarily attributable to a 1.4 cents per gallon increase in gasoline margin, partially offset by the comparable store gallon decline of 0.2%. Gasoline gross profit per gallon was 10.4 cents in the second quarter of fiscal 2003 compared to 9.0 cents for the second quarter of fiscal 2002.

Operating, General and Administrative Expenses. Operating, general and administrative expenses for the second quarter of fiscal 2003 totaled $92.3 million compared to $90.0 million for the second quarter of fiscal 2002, an increase of $2.4 million or 2.6%. This increase is primarily due to higher insurance costs and professional and consulting fees.

Income from Operations. Income from operations totaled $7.1 million for the second quarter of fiscal 2003 compared to $4.6 million for the second quarter of fiscal 2002, an increase of $2.5 million or 54.0%. The increase is primarily attributable to the increases in gasoline and merchandise gross margins, an increase in commission revenue and positive comparable store merchandise revenue growth, partially offset by increases in certain general and administrative costs as discussed above.

EBITDA. EBITDA is defined by us as net income (loss) before interest expense, income taxes, depreciation and amortization and cumulative effect of a change in accounting principle. EBITDA for the second quarter of fiscal 2003 totaled $21.3 million compared to EBITDA of $18.4 million during the second quarter of fiscal 2002, an increase of $2.9 million or 15.6%. The increase is attributable to the increases in merchandise and gasoline gross profit as discussed above. EBITDA is not a measure of performance under accounting principles generally accepted in the United States of America, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data. We have included information concerning EBITDA as one measure of our cash flow and historical ability to service debt and we believe investors find this information useful. EBITDA, as defined by us, may not be comparable to similarly titled measures reported by other companies.

The following table contains a reconciliation of EBITDA to net cash provided by operating activities and cash flows from investing and financing activities (amounts in thousands):

	Three Months Ended
	March 27, 2003			March 28, 2002
EBITDA	$	21,313		$	18,440
Interest expense		(11,457	)		(11,823	)
Adjustments to reconcile net loss to net cash provided by operating activities (other than depreciation and amortization, provision for deferred income taxes and cumulative effect of change in accounting principle)		225			(212	)
Changes in operating assets and liabilities, net:
Assets		(4,766	)		(11,435	)
Liabilities		6,307			26,075

Net cash provided by operating activities	$	11,622		$	21,045
Net cash used in investing activities	$	(5,602	)	$	(2,019	)
Net cash used in financing activities	$	(942	)	$	(5,501	)

Interest Expense. Interest expense is primarily interest on borrowings under our senior credit facility and senior subordinated notes. Interest expense for the second quarter of fiscal 2003 was $11.5 million compared to $11.8 million for the second quarter of fiscal 2002, a decrease of $366 thousand or 3.1%. The decrease is primarily attributable to a general decline in interest rates and a decrease in our weighted average borrowings, partially offset by an increase in our interest rate swap settlement payments of $94 thousand for the second quarter of fiscal 2003 as compared to the same period of fiscal 2002.

Income Tax Benefit. We recorded an income tax benefit of $1.5 million for the second quarter of fiscal 2003 compared to $2.8 million for the second quarter of fiscal 2002. The decrease in income tax benefit was primarily attributable to the decrease in pre-tax loss partially offset by a decline in our effective tax rate to 38.5% compared to 40.0% in the second quarter of fiscal 2002.

Net Loss. Net loss for the second quarter of fiscal 2003 was $2.4 million compared to net loss of $4.1 million for the second quarter of fiscal 2002. The increase is attributable to the items discussed above.

Six Months Ended March 27, 2003 Compared to the Six Months Ended March 28, 2002

Total Revenue. Total revenue for the six months ended March 27, 2003 was $1.3 billion compared to $1.1 billion for the six months ended March 28, 2002, an increase of $186.2 million or 16.4%. The increase in total revenue is primarily attributable to a 34 cents, or 29.6%, increase in our average gasoline retail price per gallon, a comparable store merchandise revenue increase of 2.9% and a $1.4 million increase in commission revenue. These increases were partially offset by a comparable store gasoline gallon volume decline of 0.5%.

Merchandise Revenue. Merchandise revenue for the six months ended March 27, 2003 was $477.2 million compared to $469.7 million during the six months ended March 28, 2002, an increase of $7.5 million or 1.6%. The increase in merchandise revenue is primarily attributable to comparable store merchandise sales growth of 2.9%, partially offset by lost revenue from closed stores of approximately $3.0 million. The increase in comparable store merchandise revenue is primarily attributable to our efforts to enhance and reposition our merchandise offerings, increased promotional activity and more aggressive pricing in key categories in an effort to drive customer traffic.

Gasoline Revenue and Gallons. Gasoline revenue for the six months ended March 27, 2003 was $833.7 million compared to $656.3 million during the six months ended March 28, 2002, an increase of $177.3 million or 27.0%. The increase in gasoline revenue is primarily attributable to a 34 cents, or 29.6%, increase in average gasoline retail price per gallon, partially offset by a 0.5% decline in comparable store gasoline gallon volume. The sustained higher average retail price per gallon of $1.49 for the six months ended March 27, 2003 compared to $1.15 for the six months ended March 28, 2002 contributed to the comparable store gasoline gallon volume decline.

For the six months ended March 27, 2003, gasoline gallons sold were 561.0 million compared to 568.9 million during the six months ended March 28, 2002, a decrease of 7.9 million gallons or 1.4%. The decrease is primarily attributable to the comparable store gasoline gallon sales decline coupled with lost gallon volume from closed stores of approximately 2.1 million.

Commission Revenue. Commission revenue for the six months ended March 27, 2003 was $13.5 million compared to $12.2 million during the six months ended March 28, 2002, an increase of $1.4 million or 11.1%. The increase is primarily due to the January 2002 introduction of South Carolina’s Educational Lottery program that resulted in an increase of approximately $1.2 million in lottery commission.

Total Gross Profit. Total gross profit for the six months ended March 27, 2003 was $239.1 million compared to $223.6 million during the six months ended March 28, 2002, an increase of $15.5 million or 7.0%. The increase in gross profit is primarily attributable to increases in gasoline margin per gallon, merchandise margin and commission revenue.

Merchandise Gross Profit and Margin. Merchandise gross profit was $157.3 million for the six months ended March 27, 2003 compared to $153.7 million for the six months ended March 28, 2002, an increase of $3.6 million or 2.3%. This increase is primarily attributable to the increased merchandise revenue discussed above and a 30 basis points increase in our merchandise margin. Merchandise margin increased to 33.0% for the six months ended March 27, 2003 from the 32.7% reported for the six months ended March 28, 2002.

Gasoline Gross Profit and Per Gallon Margin. Gasoline gross profit was $68.3 million for the six months ended March 27, 2003 compared to $57.7 million for the six months ended March 28, 2002, an increase of $10.6 million or 18.3%. The increase is primarily attributable to a 2.0 cents, or 20.0%, per gallon increase in gasoline margin, partially offset by the comparable store gallon decline of 0.5%. Gasoline gross profit per gallon was 12.2 cents for the six months ended March 27, 2003 compared to 10.2 cents for the six months ended March 28, 2002.

Operating, General and Administrative Expenses. Operating, general and administrative expenses for the six months ended March 27, 2003 totaled $185.5 million compared to $178.9 million for the six months ended March 28, 2002, an increase of $6.5 million or 3.6%. The increase is primarily due to higher insurance costs, costs associated with asset disposals and professional and consulting fees.

Income from Operations. Income from operations totaled $26.9 million for the six months ended March 27, 2003 compared to $17.7 million for the six months ended March 28, 2002, an increase of $9.1 million or 51.6%. The increase is primarily attributable to the increases in gasoline and merchandise gross margins, higher commission revenue and positive comparable store merchandise revenue growth, partially offset by increases in certain general and administrative costs as discussed above.

EBITDA. EBITDA is defined by us as net income (loss) before interest expense, income taxes, depreciation and amortization and cumulative effect of a change in accounting principle. EBITDA for the six months ended March 27, 2003 totaled $54.6 million compared to EBITDA of $45.0 million for the six months ended March 28, 2002, an increase of $9.6 million or 21.4%. The increase is attributable to the items discussed above. EBITDA is not a measure of performance under accounting principles generally accepted in the United States of America, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data. We have included information concerning EBITDA as one measure of our cash flow and historical ability to service debt and because we believe investors find this information useful. EBITDA, as defined by us, may not be comparable to similarly titled measures reported by other companies.

The following table contains a reconciliation of EBITDA to net cash provided by operating activities and cash flows from investing and financing activities (amounts in thousands):

	Six Months Ended
	March 27, 2003			March 28, 2002
EBITDA	$	54,597		$	44,968
Interest expense		(23,645	)		(24,166	)
Adjustments to reconcile net loss to net cash provided by operating activities (other than depreciation and amortization, provision for deferred income taxes and cumulative effect of change in accounting principle)		925			(315	)
Changes in operating assets and liabilities, net:
Assets		(644	)		(3,463	)
Liabilities		(29,668	)		(10,640	)

Net cash provided by operating activities	$	1,565		$	6,384
Net cash used in investing activities	$	(5,861	)	$	(4,322	)
Net cash used in financing activities	$	(11,266	)	$	(25,297	)

Interest Expense. Interest expense is primarily interest on the borrowings under our senior credit facility and senior subordinated notes. Interest expense for the six months ended March 27, 2003 was $23.6 million compared to $24.2 million for the six months ended March 28, 2002, a decrease of $521 thousand or 2.2%. The decrease is primarily attributable to a general decline in interest rates and a decrease in our weighted average borrowings, partially offset by an increase in our interest rate swap settlement payments of $711 thousand.

Income Tax Expense. We recorded income tax expense of $1.6 million for the six months ended March 27, 2003 compared to an income tax benefit of $2.4 million for the six months ended March 28, 2002. The change in income tax expense was primarily attributable to a $10.3 million increase in pre-tax income. Our effective tax rate was 38.5% for the six months ended March 27, 2003 compared to 40.0% for the six months ended March 28, 2002.

Cumulative Effect Adjustment. We recorded a one-time cumulative effect charge of $3.5 million relating to the disposal of our underground storage tanks in accordance with the adoption of SFAS No. 143.

Net Loss. Net loss for the six months ended March 27, 2003 was $915.0 thousand compared to net loss of $3.7 million for the six months ended March 28, 2002. The increase is attributable to the items discussed above.

Liquidity and Capital Resources

Cash Flows from Operations. Due to the nature of our business, substantially all sales are for cash, and cash provided by operations is our primary source of liquidity. We rely primarily upon cash provided by operating activities, supplemented as necessary from time to time by borrowings under our senior credit facility, sale-leaseback transactions, asset dispositions and equity investments, to finance our operations, pay interest and principal payments and fund capital expenditures. Cash provided by operating activities declined from $6.4 million for the six months ended March 28, 2002 to $1.6 million for the six months ended March 27, 2003. Cash flows from operations for the six months ended March 27, 2003 decreased by $4.8 million compared to the six months ended March 28, 2002, even though net income before cumulative effect adjustment improved by $6.2 million. Cash flows from operations were impacted by a decrease in the payment days for certain trade vendors. In most cases, we received additional purchase discounts from such vendors in exchange for the decrease in payment terms. We had $26.7 million of cash and cash equivalents on hand at March 27, 2003.

Capital Expenditures. Capital expenditures (excluding all acquisitions) were approximately $7.9 million for the six months ended March 27, 2003. Capital expenditures are primarily expenditures for existing store improvements, store equipment, new store development, information systems and expenditures to comply with regulatory statutes, including those related to environmental matters.

We finance substantially all capital expenditures and new store development through cash flow from operations, a sale-leaseback program or similar lease activity, vendor reimbursements and asset dispositions. Our sale-leaseback program includes the packaging of our owned convenience store real estate, both land and buildings, for sale to investors in return for their agreement to lease the property back to us under long-term leases. Generally, the leases are operating leases at market rates with terms of twenty years with four five-year renewal options. The lease payments are based on market rates applied to the cost of each respective property. We retain ownership of all personal property and gasoline marketing equipment. Our senior credit facility limits or caps the proceeds of sale-leasebacks that we can use to fund our operations or capital expenditures. Under our sale-leaseback program, we received $1.5 million for the six months ended March 27, 2003. Vendor reimbursements primarily relate to oil-company payments to either enter into long-term supply agreements or to upgrade gasoline marketing equipment including canopies, gasoline dispensers and signs.

For the six months ended March 27, 2003, we received approximately $1.8 million in proceeds from asset dispositions and vendor reimbursements bringing total proceeds including sale-leaseback transactions to $3.3 million. As a result, our net capital expenditures, excluding all acquisitions, for the six months ended March 27, 2003 were $4.6 million. We anticipate that net capital expenditures for fiscal 2003 will be in the range of $24.0 million to $27.0 million. As a result of our new gasoline rebranding and supply alliance agreements signed in March, 2003, we anticipate capital expenditures totaling $10.0 million to $15.0 million over the next two years to convert and upgrade our existing stores that carry the BP^® and Citgo^® brands and/or our Kangaroo^® private label brand.

Long-Term Debt. Our long-term debt consisted of $200.0 million of senior subordinated notes, $283.4 million outstanding under our senior credit facility and $130 thousand in other notes payable with various interest rates and maturity dates.

We have outstanding $200.0 million of 10¹/4% senior subordinated notes due in 2007. Interest on the senior subordinated notes is due on October 15 and April 15 of each year.

As of March 27, 2003, our senior credit facility consisted of a $45.0 million revolving credit facility and $283.4 million in outstanding borrowings under term loans. Our revolving credit facility is available for working capital financing, general corporate purposes and issuing commercial and standby letters of credit. As of March 27, 2003, there was $10 million outstanding under the revolving credit facility and we had approximately $27.3 million of standby letters of credit issued under the facility. As a result, we had approximately $7.7 million in available borrowing capacity at March 27, 2003. The revolving credit facility limits our total outstanding letters

of credit to $30.0 million. During the second quarter of fiscal 2003, we secured additional letters of credit of $2.9 million collateralized by a money market account.

On April 14, 2003, we entered into a new senior secured credit facility, which consists of a $253.0 million first lien term loan, a $51.0 million second lien term loan and a $52.0 million revolving credit facility, each maturing March 31, 2007. Proceeds from the new senior secured credit facility were used to repay all amounts outstanding under the existing senior credit facility. The first lien term loan and revolving credit facility have a stated interest rate of LIBOR plus 4.25%. The second lien term loan has a stated interest rate of LIBOR plus 6.5%. The term loans have set LIBOR minimum rates. Principal payments on the first lien term loan are due quarterly over the life of the loan and the second lien term loan and revolving credit facility are due in full at maturity.

Cash Flows from Financing Activities. For the six months ended March 27, 2003, we used cash flows provided by operations and cash on hand to make principal repayments on long-term debt of $20.7 million.

Cash Requirements. We believe that cash on hand, together with cash flow anticipated to be generated from operations, short-term borrowings for seasonal working capital needs and permitted borrowings under our credit facilities will be sufficient to enable us to satisfy anticipated cash requirements for operating, investing and financing activities, including debt service, for the next twelve months.

Shareholders’ Equity. As of March 27, 2003, our shareholders’ equity totaled $116.3 million. The $1.1 million increase from September 26, 2002 is attributable to the decrease in our accumulated other comprehensive deficit related to our derivative instruments, partially offset by the net loss for the period.

Contractual Obligations and Commitments

Contractual Obligations. The following table shows our expected long-term debt repayment schedule, future capital lease commitments (including principal and interest) and future operating lease commitments by fiscal year as of March 27, 2003:

Contractual Obligations

(Dollars in thousands)

	2003		2004		2005		2006		2007		Thereafter		Total
Long-term debt	$	2,533	$	18,808	$	24,779	$	25,260	$	232,750	$	200,000	$	504,130
Capital lease obligations		1,724		3,275		2,949		2,728		2,648		20,975		34,299
Operating leases		25,333		49,186		47,028		44,583		43,259		337,910		547,299

Total contractual obligations	$	29,590	$	71,269	$	74,756	$	72,571	$	278,657	$	558,885	$	1,085,728

Contractual obligations for fiscal 2003 include only payments to be made for the remaining 26 weeks of fiscal 2003.

Letter of Credit Commitments. The following table shows the expiration dates of our standby letters of credit issued under our senior credit facility or supported by cash collateral as of March 27, 2003:

Other Commitments

(Dollars in thousands)

		2003			2004			2005			2006			2007			Thereafter			Total
Standby letters of credit		$	6,128		$	24,070		$	—		$	—		$	—		$	—		$	30,198

At maturity, we expect to renew a significant number of our standby letters of credit.

Environmental Considerations. Environmental reserves of $13.7 million as of March 27, 2003 represent estimates for future expenditures for remediation, tank removal and litigation associated with 238 known contaminated sites as a result of releases and are based on current regulations, historical results and certain other factors. There are 512 known contaminated sites that are being remediated by other third parties, and therefore, the costs to remediate such sites are not included in our environmental reserve. We estimate that approximately $12.5 million of our environmental obligation will be funded by state trust funds and third party insurance.

Florida environmental regulations require all single-walled underground storage tanks to be upgraded/replaced with secondary containment by December 31, 2009. In order to comply with these Florida regulations, we will be required to upgrade or replace underground storage tanks at approximately 160 locations. We anticipate that these capital expenditures will be approximately $16.0 million and will begin during our fiscal 2004. The ultimate costs incurred will depend on several factors including future store closures, changes in the number of locations upgraded or replaced and changes in the costs to upgrade or replace the underground storage tanks.

Merchandise Supply Agreements. We have a distribution service agreement with McLane Company, Inc. (“McLane”), a wholly owned subsidiary of Wal-Mart Stores, Inc., pursuant to which McLane is the primary distributor of traditional grocery products to our stores. We also purchase a significant percentage of the cigarettes we sell from McLane. The agreement with McLane continues through October 10, 2007 and contains no minimum purchase requirements. We purchase products at McLane’s cost plus an agreed upon percentage, reduced by any promotional allowances and volume rebates offered by manufacturers and McLane. In addition, we received an initial service allowance, which is being amortized over the term of the agreement and also receive additional per store service allowances, both of which are subject to adjustment based on the number of stores in operation. Total purchases from McLane exceeded 50% of total merchandise purchases in the six months of fiscal 2003.

Gasoline Supply Agreements. We purchase our branded gasoline and diesel fuel from major oil companies under supply agreements, including Amoco^®, BP^®, Chevron^®, Citgo^®, Shell^®, Mobil^® and Texaco^®. The fuel purchased is based on the stated rack price, or market price, quoted at each terminal. The initial terms of these supply agreements range from three to thirteen years and generally contain minimum annual purchase requirements as well as provisions for various payments to us based on volume of purchases and vendor allowances. We have met our purchase commitments under these contracts and expect to continue doing so in the future. We purchase the balance of our gasoline from a variety of independent fuel distributors.

During February of 2003, we signed new gasoline supply agreements with BP Products, NA (BP^®) and Citgo Petroleum Corporation (Citgo^®) to brand and supply most of our gasoline products for the next five years. After a twelve to eighteen month conversion involving approximately 1,000 locations, BP^® will supply approximately 35% of The Pantry’s total gasoline volume, which will be sold under the BP/Amoco^® brand. Citgo^® will supply both The Pantry’s private label gasoline, which will be sold under our own Kangaroo^® and other brands, and Citgo^® branded gasoline. In addition to supplying the Pantry’s private label gasoline, Citgo^® will supply approximately 50% of The Pantry’s total gasoline volume. The remaining locations, primarily in Florida, will remain branded and supplied by Chevron^®. We entered into these branding and supply agreements to provide a more consistent operating identity while maximizing our gasoline gallon growth and margin per gallon.

Other Commitments. We make various other commitments and become subject to various other contractual obligations that we believe to be routine in nature and incidental to the operation of the business. Management believes that such routine commitments and contractual obligations do not have a material impact on our business, financial condition or results of operations.

Recently Adopted Accounting Standards

Effective December 27, 2002, we adopted the provisions of Emerging Issues Task Force (“EITF”) No. 02-16, “Accounting by a Reseller for Cash Consideration Received from a Vendor” (“EITF 02-16”). EITF 02-16 requires that certain cash consideration received by a customer from a vendor is presumed to be a reduction of the prices of the vendor’s products or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer’s income statement. However, that presumption is overcome if certain criteria are met. If the presumption is overcome, the consideration would be presented as revenue if it represents a payment for goods or services provided by the reseller to the vendor, or as an offset to an expense if it represents a reimbursement of a cost incurred by the reseller. The adoption of EITF 02-16 did not have a material impact on our results of operations or classification of expenses.

Effective September 27, 2002, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations (“SFAS No. 143”), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 requires us to recognize an estimated liability associated with the removal of our underground storage tanks. See Note 8 for a discussion of our adoption of SFAS No. 143.

Effective September 27, 2002, we adopted the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). This statement supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of and Accounting Principles Board No. 30, Reporting the Results of Operation—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and how the results of a discontinued operation are to be measured and presented. The adoption of SFAS No. 144 did not have a material impact on our results of operations and financial condition.

Risk Factors

You should carefully consider the risks described below before making a decision to invest in our common stock, our senior subordinated notes and our senior credit facility. Any of these risk factors, or others not presently known to us or that we currently deem immaterial, could negatively impact our results of operations or

financial condition in the future. In that case, the trading price of our common stock, our senior subordinated notes and our senior credit facility could decline, and you may lose all or part of your investment.

Our Operating Results and Financial Condition are Subject to Fluctuations Caused by Many Factors. Our annual and quarterly results of operations are affected by a number of factors which can adversely effect our revenue, profitability or cash flow, including without limitation:

•

Competitive pressures from convenience store operators, gasoline stations and other non-traditional operators located in our markets;

•

Changes in economic conditions generally and in the markets we serve;

•

Unfavorable weather conditions;

•

Political conditions in crude oil producing regions, including South America and the Middle East;

•

Volatility in crude oil and wholesale petroleum costs;

•

Wholesale cost increases of tobacco products;

•

Consumer behavior, travel and tourism trends;

•

Changes in state and federal environmental and other regulations;

•

Financial leverage and debt covenants;

•

Changes in the credit ratings assigned to our debt securities, credit facilities and trade credit;

•

The interests of our controlling stockholder;

•

Acts of war and terrorism and

•

Other unforeseen factors.

The Convenience Store Industry Is Highly Competitive and Impacted by New Entrants. The industry and geographic areas in which we operate are highly competitive and marked by ease of entry and constant change in terms of the number and type of retailers offering the products and services found in our stores. We compete with other convenience store chains, gasoline stations, supermarkets, drugstores, discount stores, club stores and mass merchants. In recent years, several non-traditional retail segments entering the gasoline retail business including supermarkets, club stores and mass merchants have impacted the convenience store industry. These non-traditional gasoline retailers have obtained a share of the motor fuels market and their market share is expected to grow. In some of our markets, our competitors have been in existence longer and have greater financial, marketing and other resources than we do. As a result, our competitors may be able to respond better to changes in the economy and new opportunities within the industry. To remain competitive, we must constantly analyze consumer preferences, competitive offerings and competitive prices to ensure we offer a selection of products and services consumers demand at competitive prices. We must also maintain and upgrade our customer service levels, facilities and locations to remain competitive and drive customer traffic to our stores. Major competitive factors include, among others, location, ease of access, gasoline brands, pricing, product and service selections, customer service, store appearance, cleanliness and safety.

Changes in Economic Conditions may Influence Consumer Preferences and Spending Patterns. Changes in economic conditions generally or in the Southeast could adversely impact consumer spending patterns and travel and tourism in our market areas. Approximately 47% of our stores are located in coastal, resort or tourist destinations. Historically, travel and consumer behavior in such markets is more severely impacted by weak economic conditions.

Unfavorable Weather Conditions Could Adversely Affect Our Business. Substantially all of our stores are located in the Southeast region of the United States. Though the Southeast is generally known for its mild

weather, the region is susceptible to severe storms including hurricanes, thunderstorms, extended periods of rain, ice storms and heavy snow. Approximately 51% of our stores are located in coastal areas and Florida. Inclement weather conditions as well as severe storms in the Southeast could damage our facilities or could have a significant impact on consumer behavior, travel and convenience store traffic patterns as well as our ability to operate our locations. In addition, we typically generate higher revenues and gross margins during warmer weather months in the Southeast, which fall within our third and fourth quarters. If weather conditions are not favorable during these periods, our operating results and cash flow from operations could be adversely affected.

Political Conditions in Oil Producing Regions Could Impact the Price of Wholesale Petroleum Costs and Our Operating Results. General political conditions and instability in oil producing regions particularly in the Middle East and Venezuela could significantly impact crude oil supplies and wholesale petroleum costs. In addition, the supply of gasoline for our unbranded locations and our wholesale purchase costs could be adversely impacted in the event of a shortage as our gasoline contracts do not guarantee an uninterrupted, unlimited supply of gasoline. Significant increases and volatility in wholesale petroleum costs could result in significant increases in the retail price of petroleum products and in lower gasoline gross margin per gallon. Increases in the retail price of petroleum products could impact consumer demand for gasoline. These factors could materially impact our gasoline gallon volume, gasoline gross profit and overall customer traffic.

Volatility in Crude Oil and Wholesale Petroleum Costs Could Impact Our Operating Results. In the past three fiscal years, our gasoline revenue accounted for approximately 61.0% of total revenues and our gasoline gross profit accounted for approximately 28.2% of total gross profit. Crude oil and domestic wholesale petroleum markets are marked by significant volatility. This volatility makes it is extremely difficult to predict the impact future wholesale cost fluctuations will have on our operating results and financial condition. These factors could materially impact our gasoline gallon volume, gasoline gross profit and overall customer traffic.

Wholesale Cost Increases of Tobacco Products Could Impact our Merchandise Gross Profit. Sales of tobacco products have averaged approximately 13.9% of our total revenue over the past three fiscal years. Significant increases in wholesale cigarettes costs and tax increase on tobacco products, as well as national and local campaigns to discourage smoking in the United States, may have an adverse effect on unit demand for cigarettes domestically. In general, we attempt to pass price increases on to our customers, however due to competitive pressures in our markets, we may not be able to do so. These factors could materially impact our retail price of cigarettes; cigarette unit volume and revenues; merchandise gross profit and overall customer traffic.

Changes in Consumer Behavior, Travel and Tourism Could Impact Our Business. In the convenience store industry, customer traffic is generally driven by consumer preferences and spending trends, growth rates for automobile and truck traffic and trends in travel, tourism and weather. To meet consumer demands and remain competitive, we must stock our locations with the right mix of products consumers prefer and constantly compare our assortment of products to market research data. If we are unable to obtain and offer an appropriate mix of products, our operating results may be impacted and we may lose customers to other convenience store chains or other channels.

We are Subject to State and Federal Environmental and Other Regulations. Our business is subject to extensive governmental laws and regulations including, but not limited to, environmental regulations, employment laws and regulations, regulations governing the sale of alcohol and tobacco, minimum wage requirements and other laws and regulations.

Under various federal, state and local laws, ordinances and regulations, we may, as the owner or operator of our locations, be liable for the costs of removal or remediation of contamination at these or our former locations, whether or not we knew of, or were responsible for, the presence of such contamination. The failure to properly remediate such contamination may subject us to liability to third parties and may adversely affect our ability to sell or rent such property or to borrow money using such property as collateral. Additionally, persons who

arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of such substances at sites where they are located, whether or not such site is owned or operated by such person. Although we do not typically arrange for the treatment or disposal of hazardous substances, we may be deemed to have arranged for the disposal or treatment of hazardous or toxic substances and, therefore, may be liable for removal or remediation costs, as well as other related costs, including governmental fines, and injuries to persons, property and natural resources.

Compliance with existing and future environmental laws regulating underground storage tanks may require significant capital expenditures and the remediation costs and other costs required to clean up or treat contaminated sites could be substantial. We pay tank fees and other taxes to state trust funds in support of future remediation obligations. These state trust funds or other responsible third parties including insurers are expected to pay or reimburse us for remediation expenses less a deductible. To the extent third parties do not pay for remediation as we anticipate, we will be obligated to make these payments, which could materially adversely affect our financial condition and results of operations. Reimbursements from state trust funds will be dependent on the continued viability of these funds.

In the future, we may incur substantial expenditures for remediation of contamination that has not been discovered at existing locations or locations, which we may acquire. We cannot assure you that we have identified all environmental liabilities at all of our current and former locations; that material environmental conditions not known to us do not exist; that future laws, ordinances or regulations will not impose material environmental liability on us; or that a material environmental condition does not otherwise exist as to any one or more of our locations. In addition, failure to comply with any environmental regulations or an increase in regulations could affect operating results and financial condition.

State laws regulate the sale of alcohol and tobacco products. A violation or change of these laws could adversely affect our business, financial condition and results of operations because state and local regulatory agencies have the power to approve, revoke, suspend or deny applications for, and renewals of, permits and licenses relating to the sale of these products or to seek other remedies.

Any appreciable increase in the statutory minimum wage rate would result in an increase in our labor costs and such cost increase, or the penalties for failing to comply with such statutory minimums, could adversely affect our business, financial condition and results of operations.

From time to time, regulations are proposed which, if adopted, could have an adverse effect on our business, financial condition or results of operations.

We Depend on One Principal Supplier for The Majority of Our Merchandise. We purchase over 50% of our general merchandise, including most tobacco products and grocery items, from a single wholesale grocer, McLane Company, Inc. We have a contract with McLane until 2007, but we may not be able to renew the contract upon expiration. A change of suppliers could have a material adverse effect on our business, cost of goods, financial condition and results of operations.

We Depend on Two Principal Suppliers for The Majority of Our Gasoline. During February of 2003, we signed new gasoline supply agreements with BP Products, NA (BP^®) and Citgo Petroleum Corporation (Citgo^®) to brand and supply approximately 85% of our future gasoline purchases after an approximate eighteen-month conversion process. We have contracts with BP^® and Citgo^® until 2008, but we may not be able to renew the contract upon expiration. A change of suppliers could have a material adverse effect on our business, cost of goods, financial condition and results of operations.

Our Financial Leverage and Debt Covenants Impact Our Fiscal and Financial Flexibility. We are highly leveraged, which means that the amount of our outstanding debt is large compared to the net book value of our assets, and we have substantial repayment obligations under our outstanding debt. We will have to use a portion

of our cash flow from operations for debt service, rather than for our operations or to implement our growth strategy. As of March 27, 2003, we had consolidated debt including capital lease obligations of approximately $509.8 million and shareholders’ equity of approximately $116.3 million. Under our new senior secured credit facility, our $52.0 million revolving facility allows a maximum availability for issuing letters of credit of $45.0 million. At March 27, 2003, we had $27.3 million outstanding standby letters of credit. As a result, at March 27, 2003, we would have had $24.7 million available in borrowings, with up to $17.7 million of this amount available for issuing standby letters of credit.

We are vulnerable to increases in interest rates because the debt under our senior credit facility is at a variable interest rate and although in the past we have on occasion entered into certain hedging instruments in an effort to manage our interest rate risk, we cannot assure you that we will continue to do so, on favorable terms or at all, in the future.

Our senior credit facility contains numerous financial and operating covenants that limit our ability to engage in activities such as acquiring or disposing of assets, engaging in mergers or reorganizations, making investments or capital expenditures and paying dividends. These covenants require that we meet fixed charge coverage, minimum EBITDA and leverage tests. The indenture governing our senior subordinated notes and our senior credit facility permit us and our subsidiaries to incur or guarantee additional debt, subject to limitations.

Any breach of these covenants could cause a default under our debt obligations and result in our debt becoming immediately due and payable which would adversely affect our business, financial condition and results of operations. For the twelve-month period ending September 27, 2001, we failed to satisfy two financial covenants required by our previous senior credit facility. During the first quarter of fiscal 2002, we received a waiver from our previous senior credit group and executed an amendment to that facility that included, among other things, a modification to financial covenants and certain increases in the floating interest rate. Our ability to respond to changing business conditions and to secure additional financing may be restricted by these covenants, which may become more restrictive in the future. We also may be prevented from engaging in transactions, including acquisitions that may be important to our long-term growth strategy.

Changes in Our Credit Ratings or Trade Credit Terms Could Adversely Impact our Financial Condition and Operating Flexibility. If our credit ratings are downgraded, our financial flexibility, borrowing costs, product supply costs and ability to obtain future financing on acceptable terms may be affected. Furthermore, we rely on credit terms provided by our major suppliers including our major wholesaler, gasoline suppliers and other suppliers. Material changes in these credit terms could impact our operating results and financial condition.

The Interests of The Pantry’s Controlling Stockholder May Conflict With Our Interests and The Interests of Our Other Stockholders. As a result of its stock ownership and board representation, Freeman Spogli & Co. is in a position to affect our corporate actions such as mergers or takeover attempts in a manner that could conflict with the interests of our other stockholders. As of May 2, 2003, Freeman Spogli owned 11,815,538 shares of common stock and warrants to purchase 2,346,000 shares of common stock. Freeman Spogli’s beneficial ownership of The Pantry, including shares underlying warrants, at May 2, 2003 was approximately 69.2%. In addition, four of the nine members of our board of directors are representatives of, or have consulting arrangements with, Freeman Spogli.

Because We Depend on Our Senior Management’s Experience and Knowledge of Our Industry, We Would be Adversely Affected if Senior Management Left The Pantry. We are dependent on the continued efforts of our senior management team, including our President and Chief Executive Officer, Peter J. Sodini. Mr. Sodini’s employment contract terminates in September 2004. If, for any reason, our senior executives do not continue to be active in management, our business, financial condition or results of operations could be adversely affected. We cannot assure you that we will be able to attract and retain additional qualified senior personnel as needed in the future. In addition, we do not maintain key personnel life insurance on our senior executives and other key employees.

Future Sales of Additional Shares into The Market May Depress The Market Price of The Common Stock. If our existing stockholders sell shares of common stock in the public market, including shares issued upon the exercise of outstanding options and warrants, or if the market perceives such sales could occur, the market price of our common stock could decline. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate or to use equity as consideration for future acquisitions.

As of March 27, 2003, there are 18,107,597 shares of our common stock outstanding. Of these shares, 6,250,000 shares are freely tradable. 11,815,538 shares are held by affiliate investment funds of Freeman Spogli. Pursuant to Rule 144 under the Securities Act of 1933, as amended, affiliates of The Pantry can resell up to 1% of the aggregate outstanding common stock during any three month period. In addition, Freeman Spogli has registration rights allowing them to require us to register the resale of their shares. If Freeman Spogli exercises its registration rights and sell shares of common stock in the public market, the market price of our common stock could decline.

Our Charter Includes Provisions Which May Have The Effect of Preventing or Hindering A Change in Control and Adversely Affecting The Market Price of Our Common Stock. Our certificate of incorporation gives our board of directors the authority to issue up to five million shares of preferred stock and to determine the rights and preferences of the preferred stock, without obtaining stockholder approval. The existence of this preferred stock could make it more difficult or discourage an attempt to obtain control of The Pantry by means of a tender offer, merger, proxy contest or otherwise. Furthermore, this preferred stock could be issued with other rights, including economic rights, senior to our common stock, and, therefore, issuance of the preferred stock could have an adverse affect on the market price of our common stock. We have no present plans to issue any shares of our preferred stock.

Other provisions of our certificate of incorporation and bylaws and of Delaware law could make it more difficult for a third party to acquire us or hinder a change in management even if doing so would be beneficial to our stockholders. These governance provisions could affect the market price of our common stock.

We may, in the future, adopt other measures that may have the effect of delaying, deferring or preventing an unsolicited takeover, even if such a change in control were at a premium price or favored by a majority of unaffiliated stockholders. These measures may be adopted without any further vote or action by our stockholders.

Acts of War and Terrorism Could Impact Our Business. Acts of war and terrorism could impact general economic conditions and the supply and price of crude oil. In addition, these events may cause damage to our retail facilities and disrupt the supply of the products and services we offer in our locations. These factors could impact our revenues, operating results and financial condition.

Any of the above factors may cause actual results to vary materially from anticipated results, historical results or recent trends in operating results and financial condition.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Quantitative Disclosures. We are exposed to market risks inherent in our financial instruments. These instruments arise from transactions entered into in the normal course of business and, in some cases, relate to our acquisitions of related businesses. We are subject to interest rate risk on our existing long-term debt and any future financing requirements. Our fixed rate debt consists primarily of outstanding balances on our senior subordinated notes and our variable rate debt relates to borrowings under our senior credit facility.

The following table presents the future principal cash flows and weighted average interest rates based on rates in effect at March 27, 2003, on our refinanced senior secured credit facility and other remaining long-term debt instruments. Fair values have been determined based on quoted market prices as of May 8, 2003.

Expected Maturity Date

as of March 27, 2003

(Dollars in thousands)

Fiscal 2003

Fiscal 2004

Fiscal 2005

Fiscal 2006

Fiscal 2007

Thereafter

Total

Fair

Value

Long-term debt

2,533

18,808

24,779

25,260

232,750

200,000

504,130

508,662

Weighted average interest rate

9.38

8.43

8.28

8.42

9.08

10.25

8.62

In order to reduce our exposure to interest rate fluctuations, we have entered into interest rate swap arrangements in which we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed upon notional amount. The interest rate differential is reflected as an adjustment to interest expense over the life of the swaps. Fixed rate swaps are used to reduce our risk of increased interest costs during periods of rising interest rates. At March 27, 2003, the interest rate on 78.0% of our debt was fixed by either the nature of the obligation or through the interest rate swap arrangements compared to 73.2% at March 28, 2002.

The following table presents the notional principal amount, weighted average pay rate, weighted average receive rate and weighted average years to maturity on our interest rate swap contracts:

Interest Rate Swap Contracts

(Dollars in thousands)

	March 27, 2003			March 28, 2002
Notional principal amount	$	185,000		$	180,000
Weighted average pay rate		5.75	%		6.12	%
Weighted average receive rate		1.39	%		1.90	%
Weighted average years to maturity		0.60			1.37

Our interest rate collar arrangement entered into on February 1, 2001 and covering a notional amount of $55.0 million was converted to an interest rate swap arrangement effective February 3, 2003. As of March 27, 2003, the fair value of our swap agreements represented a liability of $4.8 million.

Qualitative Disclosures. Our primary exposure relates to:

•

interest rate risk on long-term and short-term borrowings;

•

our ability to pay or refinance long-term borrowings at maturity at market rates;

•

the impact of interest rate movements on our ability to meet interest expense requirements and exceed financial covenants and

•

the impact of interest rate movements on our ability to obtain adequate financing to fund future acquisitions.

We manage interest rate risk on our outstanding long-term and short-term debt through our use of fixed and variable rate debt. We expect the interest rate swaps mentioned above will reduce our exposure to short-term

interest rate fluctuations. While we cannot predict or manage our ability to refinance existing debt or the impact interest rate movements will have on our existing debt, management evaluates our financial position on an ongoing basis.

Item 4. Controls and Procedures

Based on the Company’s most recent evaluation, which was completed within 90 days of the filing of this Quarterly Report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer believe the Company’s disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as amended) (the “Exchange Act”) provide reasonable assurances that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time period required by the United States Securities and Exchange Commission’s rules and forms. There have been no significant changes in internal control or in other factors that could significantly affect these controls subsequent to the date of the most recent evaluation of the Company’s internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

THE PANTRY, INC.

PART II-OTHER INFORMATION.

Item 4. Submission of Matters to a Vote of Security Holders.

On March 25, 2003, we held our Annual Meeting of Stockholders during which our stockholders:

(1)

Elected nine nominees to serve as directors each for a term of one year or until his successor is duly elected and qualified. The votes were cast as follows:

Name	Votes For	Votes Withheld
Peter J. Sodini	17,373,059	302,705
Todd W. Halloran	17,373,059	302,705
Jon D. Ralph	17,317,750	358,014
Charles P. Rullman	17,317,750	358,014
William M. Webster, III	17,388,677	287,087
Peter M. Starrett	17,387,333	288,431
Hubert E. Yarborough, III	17,389,277	286,487
Byron E. Allumbaugh	17,389,077	286,687
Thomas M. Murnane	17,389,477	286,287

(2)

Approved the Company’s 1999 Stock Option Plan, which included an amendment to increase the number of shares available for grant under the plan by 882,505 shares. The votes were cast as follows:

		Votes For		Votes Against		Votes Withheld
Approval of 1999 Stock Option Plan		17,091,749		546,165		37,850

(3)

Ratified the appointment of Deloitte & Touche LLP as independent public accountants for the Company and its subsidiaries for the fiscal year ending September 25, 2003. The votes were cast as follows:

		Votes For		Votes Against		Votes Withheld
Ratification of Deloitte & Touche LLP		17,556,670		94,194		24,900

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits

10.1		Branded Jobber Contract between The Pantry, Inc. and BP Products North America Inc. dated as of February 1, 2003, as amended (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission).

10.2		Distributor Franchise Agreement between The Pantry, Inc. and CITGO Petroleum Corporation dated as of August 2000, including Amended and Restated Addendum dated February 11, 2003 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission).

10.3		Letter of Preferability regarding change in Goodwill Impairment test date change from Deloitte & Touche LLP

99.1		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [Furnished in accordance with the Securities and Exchange Commission’s guidance published in SEC Rel. No. 34-47551. This exhibit shall not be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended.]

99.2		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuance to Section 906 of The Sarbanes-Oxley Act of 2002. [Furnished in accordance with the Securities and Exchange Commission’s guidance published in SEC Rel. No. 34-47551. This exhibit shall not be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended.]

(b) Reports on Form 8-K

On February 4, 2003, the Company filed a Current Report on Form 8-K attaching the certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

On March 6, 2003, the Company filed a Current Report on Form 8-K attaching a press release describing its new gasoline supply agreements.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

THE PANTRY, INC.

By:		/s/ DANIEL J. KELLY
		Daniel J. Kelly Vice President, Finance, Chief Financial Officer and Assistant Secretary (Authorized Officer and Principal Financial Officer)

Date: May 9, 2003

THE PANTRY, INC.

I, Peter J. Sodini, certify that:

I have reviewed this quarterly report on Form 10-Q of The Pantry, Inc.;

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 9, 2003

/s/ PETER J. SODINI

Peter J. Sodini

Chief Executive Officer

S-1

THE PANTRY, INC.

I, Daniel J. Kelly, certify that:

I have reviewed this quarterly report on Form 10-Q of The Pantry, Inc.;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date: May 9, 2003

/s/ DANIEL J. KELLY

Daniel J. Kelly

Chief Financial Officer

S-2

EXHIBIT INDEX

Exhibit No.		Description of Document
10.1		Branded Jobber Contract between The Pantry, Inc. and BP Products North America Inc. dated as of February 1, 2003, as amended (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission).
10.2		Distributor Franchise Agreement between The Pantry, Inc. and CITGO Petroleum Corporation dated as of August 2000, including Amended and Restated Addendum dated February 11, 2003 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission).
10.3		Letter of Preferability regarding change in Goodwill Impairment test date change from Deloitte & Touche LLP
99.1		Certification Pursuance to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [Furnished in accordance with the Securities and Exchange Commission’s guidance published in SEC Rel. No. 34-47551. This exhibit shall not be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended.]
99.2		Certification Pursuance to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [Furnished in accordance with the Securities and Exchange Commission’s guidance published in SEC Rel. No. 34-47551. This exhibit shall not be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended.]

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