Attached files

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EX-12.1 - RATIO OF EARNINGS TO FIXED ASSETS - PANTRY INCex12_1.htm
EX-31.1 - CERTIFICATION BY CHIEF EXECUTIVE OFFICER - PANTRY INCex31_1.htm
EX-31.2 - CERTIFICATION BY CHIEF FINANCIAL OFFICER - PANTRY INCex31_2.htm
EX-21.1 - SUBSIDIARIES - PANTRY INCex21_1.htm
EX-32.1 - SEC 1360 CERTIFICATION BY CHIEF EXECUTIVE OFFICER - PANTRY INCex32_1.htm
EX-32.2 - SEC 1360 CERTIFICATION BY CHIEF FINANCIAL OFFICER - PANTRY INCex32_2.htm
EX-10.21 - INDEPENDENT DIRECTOR COMPENSATION PROGRAM, FOURTH AMENDEMENT SEPTEMBER 2009 - PANTRY INCex10_21.htm
EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - PANTRY INCex23_1.htm


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 24, 2009

Commission File Number: 000-25813
 

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 No.)

P.O. Box 8019
305 Gregson Drive
Cary, North Carolina
27511
(Address of principal executive offices and zip code)
 

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

 



Securities registered pursuant to Section 12(b) of the Act:
 
   
Title of each class
Name of each exchange on which registered
Common Stock, $.01 par value
The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

NONE
 




Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes¨ No x

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 by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes ¨  No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “accelerated filer and large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
         
Large accelerated filer ¨
     
Accelerated filer   x
Non-accelerated filer      ¨
 
(Do not check if a smaller reporting company)
 
Smaller reporting company      ¨

 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes¨ No x

The aggregate market value of the voting common stock held by non-affiliates of the registrant as of March 26, 2009 was $402,427,780.
As of December 4, 2009, there were issued and outstanding 22,584,818 shares of the registrant’s common stock.

Documents Incorporated by Reference
 
     
Document
  
Where Incorporated
1.      Proxy Statement for the Annual Meeting of Stockholders to be held March 16, 2010
  
Part III
 
 






THE PANTRY, INC.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS
 
         
 
  
 
  
Page
Part I
  
 
  
 
Item 1:
  
  
1
Item 1A:
  
  
9
Item 1B:
  
  
18
Item 2:
  
  
19
Item 3:
  
  
19
Item 4:
  
  
20
     
Part II
  
 
  
 
Item 5:
  
  
21
Item 6:
  
  
21
Item 7:
  
  
26
Item 7A:
  
  
47
Item 8:
  
  
49
Item 9:
  
  
83
Item 9A:
  
  
83
Item 9B:
  
  
86
     
Part III
  
 
  
 
Item 10:
  
  
87
Item 11:
  
  
87
Item 12:
  
  
87
Item 13:
  
  
87
Item 14:
  
  
87
     
Part IV
  
 
  
 
Item 15:
  
  
88
 
  
  
84
 
  
  
95
 
i

 
 

 







PART I

Item 1.    Business.

General

We are the leading independently operated convenience store chain in the southeastern United States and the third largest independently operated convenience store chain in the country based on store count. As of September 24, 2009, we operated 1,673 stores in 11 states under a number of selected banners including Kangaroo Express ®, our primary operating banner. Our stores offer a broad selection of merchandise, gasoline and ancillary products and services designed to appeal to the convenience needs of our customers. Our strategy is to continue to improve upon our position as the leading independently operated convenience store chain in the southeastern United States by generating profitable growth through merchandising initiatives, sophisticated management of our gasoline business, leveraging our geographic economies of scale, and growing our store base through selective acquisitions and development of new stores.

Our principal executive offices are located at 305 Gregson Drive, Cary, North Carolina 27511. Our telephone number is 919-774-6700.

Our Internet address is www.thepantry.com. We make available through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission (“SEC”).

References in this annual report to “The Pantry,” “Pantry,” “we,” “us,” “our” and “our company” refer to The Pantry, Inc. and its subsidiaries, and references to “fiscal 2010” refer to our fiscal year which ends on September 23, 2010, references to “fiscal 2009” refer to our fiscal year which ended September 24, 2009, references to “fiscal 2008” refer to our fiscal year which ended September 25, 2008, references to “fiscal 2007” refer to our fiscal year which ended September 27, 2007, references to “fiscal 2006” refer to our fiscal year which ended September 28, 2006, and references to “fiscal 2005” refer to our fiscal year which ended September 29, 2005.  All fiscal years presented included 52 weeks, except fiscal 2010 which will include 53 weeks.

Operations

Merchandise Operations.    In fiscal 2009, our merchandise sales were 26.0% of our total revenues and gross profit on our merchandise sales was 65.2% of our total gross profit. The following table highlights certain information with respect to our merchandise sales for the last five fiscal years:
 
                               
   
Fiscal Year Ended
 
   
September 24,
2009
   
September 25,
 2008
   
September 27,
2007
   
September 28,
2006
   
September 29,
2005
 
Merchandise sales (in millions)
  $ 1,658.9     $ 1,636.7     $ 1,575.9     $ 1,385.7     $ 1,228.9  
 
Average merchandise sales per store (in thousands)
  $ 1,001.1     $ 991.3     $ 998.7     $ 954.3     $ 897.7  
Comparable store merchandise sales (decrease) increase (%)
    0.0 %     (1.7 %)     2.3 %     4.9 %     5.3 %
Comparable store merchandise sales (decrease) increase (in thousands)
  $ 327     $ (25,209 )   $ 29,443     $ 57,026     $ 53,218  
Merchandise gross margins (after purchase rebates, markdowns, inventory spoilage, inventory shrink and LIFO reserve)
    35.4 %     36.4 %     37.2 %     37.4 %     36.6 %
 

1

 
 

 







Based on merchandise purchase and sales information, we estimate category sales as a percentage of total merchandise sales for the last five fiscal years as follows:
 
                                 
 
  
Fiscal Year Ended
 
 
  
September 24,
 2009
   
September 25,
 2008
   
September 27,
 2007
   
September 28,
 2006
   
September 29,
 2005
   
Tobacco products
  
34.2
%
 
31.5
%
 
31.1
%
 
31.0
%
 
31.1
%
 
Packaged beverages )
  
16.4
   
17.7
   
17.5
   
16.9
   
16.3
   
Beer and wine
  
16.0
   
16.3
   
15.6
   
15.9
   
16.3
   
General merchandise, health and beauty care
  
5.5
   
5.0
   
5.9
   
6.0
   
6.3
   
Fast food service
  
4.7
   
4.4
   
4.3
   
4.2
   
4.2
   
Self-service fast foods and beverages
  
4.5
   
5.5
   
5.5
   
5.7
   
5.6
   
Salty snacks
  
4.4
   
4.4
   
4.4
   
4.5
   
4.2
   
Candy
  
4.0
   
4.1
   
4.0
   
3.9
   
3.9
   
Services
  
3.3
   
3.5
   
3.5
   
3.4
   
3.0
   
Dairy products
  
2.1
   
2.5
   
2.5
   
2.7
   
3.1
   
Bread and cakes
  
1.8
   
2.2
   
2.2
   
2.2
   
2.3
   
Grocery and other merchandise )
  
1.8
   
1.7
   
2.2
   
2.1
   
2.1
   
Newspapers and magazines
  
1.3
   
1.2
   
1.3
   
1.5
   
1.6
   
 
  
                             
Total
  
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
 
 
  
                             

As of September 24, 2009, we operated 229 quick service restaurants within 219 of our locations. In 164 of these quick service restaurants, we offer products from nationally branded food franchises including Subway ® , Quiznos ® , Hardee’s ® , Krystal ® , Church’s ® , Dairy Queen ® , Baskin-Robbins® and Bojangles ® . In addition, we offer a variety of proprietary food service programs in 83 quick service restaurants featuring breakfast biscuits, fried chicken, deli and other hot food offerings.

In fiscal 2009, we purchased over 55% of our merchandise, including most tobacco and grocery items, from a single wholesale grocer, McLane Company, Inc. (“McLane”), a wholly owned subsidiary of Berkshire Hathaway Inc. We have a distribution services agreement with McLane pursuant to which McLane is the primary distributor of traditional grocery products to our stores. We purchase the 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 receive per store service allowances from McLane that are amortized over the remaining term of the agreement, which expires in December 2014. We purchase the balance of our merchandise from a variety of other distributors. We do not have written contracts with a number of these vendors. All merchandise is delivered directly to our stores by McLane or other vendors. We do not maintain additional product inventories other than what is in our stores.

Our services revenue is derived from sales of lottery tickets, prepaid products, money orders, services such as public telephones, ATMs, amusement and video gaming and other ancillary product and service offerings. We also generate car wash revenue at 279 of our stores.

Gasoline Operations.    We purchase our gasoline from major oil companies and independent refiners. At our locations we offer a mix of branded and private branded gasoline based on an evaluation of local market conditions. Of our 1,655 stores that sold gasoline as of September 24, 2009, 1,141, or 68.9%, were branded under the BP ® , CITGO ® , Chevron ® , Shell® , Texaco® or ExxonMobil ®  brand names. We purchase our branded gasoline and diesel fuel from major oil companies under supply agreements. We purchase the fuel at the stated rack price, or market price, quoted at each terminal as adjusted per the terms of applicable contracts.  The initial terms of these supply agreements have expiration dates ranging from 2010 to 2013 and generally contain provisions for various payments to us based on volume of purchases and vendor allowances. We purchase the majority of our private branded gallons from CITGO Petroleum Corporation (“CITGO”). There are approximately 64 gasoline terminals in our operating areas, allowing us to choose from more than one distribution point for most of our stores. Our inventories of gasoline (both branded and private branded) turn approximately every four days.

 
2

 
 

 







Our gasoline supply agreements typically contain provisions relating to, among other things, minimum volumes, payment terms, use of the supplier’s brand names, compliance with the supplier’s requirements, acceptance of the supplier’s credit cards, insurance coverage and compliance with legal and environmental requirements. As is typical in the industry, gasoline suppliers generally can terminate the supply contracts if we do not comply with any reasonable and important requirement of the relationship, including if we were to fail to make payments when due, if the supplier withdraws from marketing activities in the area in which we operate, or if we are involved in fraud, criminal misconduct, bankruptcy or insolvency. In some cases, gasoline suppliers have the right of first refusal to acquire assets used by us to sell their branded gasoline.

In fiscal 2009, our gasoline revenues were 74.0% of our total revenues and gross profit on our gasoline revenues was 34.8% of our total gross profit. The following table highlights certain information regarding our gasoline operations for the last five fiscal years:
 
                               
   
Fiscal Year Ended
 
   
September 24,
2009
   
September 25,
2008
   
September 27,
2007
   
September 28,
2006
   
September 29,
2005
 
Retail
                             
Gasoline sales (in millions)
  $ 4,659.1     $ 7,150.4     $ 5,192.2     $ 4,533.4     $ 3,191.3  
Gasoline gallons sold (in millions)
    2,078.0       2,103.4       2,032.8       1,757.8       1,496.5  
 
Average gallons sold per store (in thousands)
    1,268.6       1,288.8       1,306.4       1,230.1       1,114.3  
 
Comparable store gallons (decrease) increase (%)
    (3.3 %)     (4.4 %)     1.0 %     3.1 %     4.7 %
Comparable store gallons (decrease) increase (in thousands)
    (68,480 )     (80,368 )     16,115       43,218       53,928  
Average price per gallon
  $ 2.24     $ 3.40     $ 2.55     $ 2.58     $ 2.13  
Average gross profit per gallon
  $ 0.150     $ 0.124     $ 0.109     $ 0.159     $ 0.143  
Locations selling gasoline
    1,655       1,635       1,623       1,470       1,377  
Branded locations
    1,141       1,119       1,093       971       878  
Private branded locations
    514       516       530       499       499  

The decrease in comparable store gasoline gallons sold was due primarily to continued economic deterioration and lower miles driven in our market areas.  Retail gasoline prices were impacted by the volatile wholesale gasoline markets, which resulted from significant fluctuations in the price of crude oil during fiscal 2009. Domestic crude oil prices decreased from a high of approximately $107 per barrel in September 2008 to a low of approximately $34 per barrel in December 2008, before steadily increasing the remainder of fiscal 2009. Crude oil ended fiscal 2009 at approximately $66 per barrel. We attempt to pass along wholesale gasoline cost changes to our customers through retail price changes; however, we are not always able to do so. The timing of any related increase or decrease in retail prices is affected by competitive conditions. As a result, we tend to experience lower gasoline margins in periods of rising wholesale costs and higher margins in periods of decreasing wholesale costs. We are unable to ensure that significant volatility in gasoline wholesale prices will not negatively affect gasoline gross margins or demand for gasoline within our markets in the future.

In addition to the impact of volatile crude oil prices during fiscal 2009, wholesale gasoline supply was constrained during the first month of fiscal 2009 because of the residual impact of Hurricanes Ike and Gustav, which adversely affected refining in, and supply from, the Gulf Coast region.  At the height of the supply shortage, over 90% of the Gulf Coast refineries’ production was negatively impacted.  These shortages caused a ripple effect throughout our market areas as our suppliers were unable to ship sufficient amounts of fuel into most of our markets.

Store Locations.   Approximately 35% of our stores are strategically located in coastal/resort areas such as Jacksonville, Orlando/Disney World, Myrtle Beach, Charleston, St. Augustine, Hilton Head and Gulfport/Biloxi that attract a large number of tourists who we believe value convenience shopping. Additionally, approximately 25% of our total stores are situated along major interstates and highways, which benefit from high traffic counts and customers seeking convenient fueling locations, including some stores in coastal/resort areas. Almost all of our stores are freestanding structures averaging approximately 2,800 square feet and provide ample customer parking.


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The following table shows the geographic distribution by state of our stores for each of the last five fiscal years:
 
                           
 
  
     
Number of Stores as of Fiscal Year Ended
State
  
Percentage of Total Stores at
 September 24,
 2009
   
September 24,
2009
  
September 25,
2008
  
September 27,
2007
  
September 28,
2006
  
September 29,
2005
Florida
  
26.3
%
 
440
  
453
  
461
  
441
  
442
North Carolina
  
23.0
   
384
  
385
  
387
  
325
  
304
South Carolina
  
17.0
   
284
  
283
  
277
  
236
  
235
Georgia
  
7.9
   
132
  
133
  
136
  
125
  
126
Alabama
  
6.8
   
114
  
81
  
83
  
77
  
38
Tennessee
  
6.2
   
104
  
104
  
104
  
101
  
101
Mississippi
  
6.0
   
100
  
99
  
82
  
73
  
53
Virginia
  
3.0
   
50
  
50
  
50
  
50
  
50
Kentucky
  
1.7
   
29
  
30
  
30
  
31
  
33
Louisiana
  
1.6
   
27
  
26
  
25
  
25
  
8
Indiana
  
0.5
   
9
  
9
  
9
  
9
  
10
 
  
       
  
 
  
 
  
 
  
 
Total
  
100
%
 
1,673
  
1,653
  
1,644
  
1,493
  
1,400
 
  
       
  
 
  
 
  
 
  
 

The following table summarizes our activities related to acquisitions, store openings and store closures for each of the last five fiscal years:
 
                     
 
  
                   
   
Fiscal Year Ended
 
  
September 24,
 2009
 
September 25,
 2008
 
September 27,
 2007
 
September 28,
 2006
 
September 29,
 2005
Number of stores at
 beginning of period
  
1,653
 
1,644
 
1,493
 
1,400
 
1,361
Acquired or opened
  
44
 
32
 
162
 
117
 
97
Closed or sold
  
(24)
 
(23)
 
(11)
 
(24)
 
(58)
 
  
                 
Number of stores at end
 of period
  
1,673
 
1,653
 
1,644
 
1,493
 
1,400
 
  
                 


Acquisitions.    During fiscal 2009 we acquired 41 stores in three separate transactions, including 38 stores from Herndon Oil Corporation. During fiscal 2008 we acquired 20 stores in three separate transactions. We generally focus on selectively acquiring chains within and contiguous to our existing market areas. In evaluating potential acquisition candidates, we consider a number of factors, including strategic fit, desirability of location, price and our ability to improve the productivity and profitability of a location through the implementation of our operating strategy. Additionally, we would consider acquiring stores that are not within or contiguous to our current markets if the opportunity met certain criteria including, among others, a minimum number of stores, sales volumes and profitability. Our ability to create synergies due to our relative size and geographic concentration contributes to our willingness to establish a purchase price that is generally in excess of the fair value of assets acquired and liabilities assumed, which results in the recognition of goodwill. Finally, while we strive to ensure that our acquisitions will be accretive to our stockholders and provide a suitable return on our investment, we do not adhere to any strict requirements with respect to time to accretion or rate of return when identifying potential acquisitions.


4

 
 

 




New Stores.    In opening new stores in recent years, we have focused on selecting store sites on highly traveled roads in coastal/resort and suburban markets or near highway exit and entrance ramps that provide convenient access to the store location. In selecting sites for new stores, we use an evaluation process designed to enhance our return on investment that focuses on market area demographics, population density, traffic volume, visibility, ingress and egress and economic development in the market area. We also review the location of competitive stores and customer activity at those stores. As a result of the uncertainty that exists in the current economic environment we have reduced our pace of new store development. During fiscal 2009 we opened three new locations and anticipate minimal new store growth in fiscal 2010.

Improvement of Store Facilities and Equipment.    During fiscal 2009, we upgraded the facilities and equipment at many of our existing and acquired store locations. To determine locations for remodels and rebuilds, management assesses potential return on investment, sales volume, existing and potential competition and lease term. During fiscal 2009, we spent approximately $14.8 million on store remodels. The scope of remodel activity varied by location and included approximately 110 stores in fiscal 2009.

Store Closures.    We continually evaluate the performance of each of our stores to determine whether any particular store should be closed or sold based on profitability trends and our market presence in the surrounding area. Although closing or selling underperforming stores reduces revenues, our operating results typically improve as these stores are generally unprofitable. During fiscal 2009, we closed or sold 24 stores compared to 23 stores in fiscal 2008.

Store Operations.    Each convenience store is staffed with a manager, an assistant manager and sales associates who work various shifts to enable most stores to remain open 24 hours a day, seven days a week. Our field operations organization is comprised of a network of divisional vice presidents, regional directors and district managers who, with our corporate management, evaluate store operations. District managers typically oversee approximately 11 stores. We also monitor store conditions, maintenance and customer service through a regular store visitation program by district and region management.

Seasonality.    Due to the nature of our business and our reliance, in part, on consumer spending patterns in coastal, resort and tourist markets, we typically generate higher revenues during warm weather months in the southeastern United States, which fall within our third and fourth fiscal quarters.

Competition

The convenience store and retail gasoline industries are highly competitive and marked by ease of entry and constant change in the number and type of retailers offering the products and services found in our stores. We compete with numerous other convenience store chains, independent convenience stores, supermarkets, drugstores, discount clubs, gasoline service stations, mass merchants, fast food operations and other similar retail outlets.

The performance of individual stores can be affected by changes in traffic patterns and the type, number and location of competing stores. Principal competitive factors include, among others, location, ease of access, gasoline brands, pricing, product and service selections, customer service, store appearance, cleanliness and safety. We believe that our  store base, strategic mix of locations, gasoline offerings and use of competitive market data, combined with our management’s expertise, allow us to be an effective and significant competitor in our markets.

Technology and Store Automation

We continue to invest in our technology infrastructure to enable us to enhance the customer experience, improve operating efficiencies,  provide management with timely financial data.

During fiscal 2009, we continued our rollout of a wide area communications network that will create a real-time connection between our support center and our stores.  We are also in the process of upgrading our point of sale technology to facilitate improvements in customer service, store operations and merchandising opportunities.  As of the end of fiscal 2009 we had completed the rollout of this network to approximately 72% of our locations and 25% had been upgraded with new point of sale technology.  We anticipate that we will complete the network rollout in the third quarter of fiscal 2010 and upgrade an additional 900 stores with new point of sale technology in fiscal 2010.

5

 
 

 






 
All store level, back office and accounting functions, including our merchandise price book, are supported by a fully integrated management information and financial accounting system; several modules have been upgraded in the past year to a new platform providing enhanced functionality.  This improvement along with new systems in Human Resources and Facilities Management are driving efficiencies throughout our operation.  New analytical tools were also implemented this year which assist management further in decision making.  We also maintain a proprietary fuel pricing system that allows us to price fuel at individual stores taking into account competitor pricing and store volume trends.
 
In fiscal 2010 our technology focus will be on completing our point of sale upgrade and enhancing our ability to capture detailed merchandise movement data.  We also anticipate upgrading our merchandise pricing system in fiscal 2010 to enable us to execute a greater number of pricing zones.  In November, 2009 we established the position of Chief Information Officer and named Paul M. Lemerise to the role.  These investments in information systems infrastructure are a key component of our strategy to optimize store level performance.

Trade Names, Service Marks and Trademarks

We have registered, acquired the registration of, applied for the registration of and claim ownership of a variety of trade names, service marks and trademarks for use in our business, including The Pantry ®, Worth ®, Golden Gallon ®, Bean Street Coffee Company ®, Big Chill ®, Celeste ®, The Chill Zone ®, Lil’ Champ Food Store ®, Kangaroo ®, Kangaroo Express ®, Sprint SM (Florida only), Cowboys ®, Aunt M’s ®, Quickstop SM , and Petro Express ®. In the highly competitive business in which we operate, our trade names, service marks and trademarks are critical to distinguish our products and services from those of our competitors. We are not aware of any facts which would negatively impact our continuing use of any of the above trade names, service marks or trademarks.

Government Regulation and Environmental Matters

Many aspects of our operations are subject to regulation under federal, state and local laws and regulations. A violation or change of these laws or regulations could have a material adverse effect on our business, financial condition and results of operations. We describe below the most significant of the regulations that impact all aspects of our operations.

Storage and Sale of Gasoline.    We are subject to various federal, state and local environmental laws and regulations. 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 U.S. Environmental Protection Agency (“EPA”) to establish a comprehensive regulatory program for the detection, prevention and cleanup of leaking underground storage tanks (e.g. overfills, spills and underground storage tank releases). At the state level, we are sometimes required to upgrade or replace underground storage tanks.

 Federal and state laws and 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, as of September 24, 2009, we maintained letters of credit in the aggregate amount of approximately $1.4 million in favor of state environmental agencies in North Carolina, South Carolina, Virginia, Georgia, Indiana, Tennessee, Kentucky and Louisiana.

We also rely upon the reimbursement provisions of applicable state trust funds. In Florida, we meet our financial responsibility requirements by state trust fund coverage for releases occurring through December 31, 1998 and meet such requirements for releases thereafter through private commercial liability insurance. In Georgia, we meet our financial responsibility requirements by a combination of state trust fund coverage, private commercial liability insurance and a letter of credit.



6

 
 

 







Regulations enacted by the EPA in 1988 established requirements for:
 
 
 
installing underground storage tank systems;
 
 
 
upgrading underground storage tank systems;
 
 
 
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 that are at least as stringent as the federal standards. In 1998, Florida developed its own regulatory program, which incorporated requirements more stringent than the 1988 EPA regulations. For example, Florida 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, replace or remove underground storage tanks at approximately 27 locations by December 31, 2009. We anticipate that these capital expenditures will be approximately $2.9 million. At this time, we believe our facilities in Florida meet or exceed those regulations developed by the State of Florida in 1998. 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, Alabama, Mississippi and Virginia. The coverage afforded by each state trust 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 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 that occurred in Florida and were 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, except for certain sites, including sites where our lease requires us to participate in the Georgia trust fund. For all such sites where we have opted not to participate in the Georgia trust fund, we have obtained private insurance coverage for remediation and third-party claims. We believe that this coverage exceeds federal and Georgia financial responsibility regulations.

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As of September 24, 2009, environmental reserves of approximately $1.1 million and $21.6 million are included in other accrued liabilities and other noncurrent liabilities, respectively. As of September 25, 2008, environmental reserves of approximately $1.1 million and $18.8 million are included in other accrued liabilities and other noncurrent liabilities, respectively. These reserves represent our estimates for future expenditures for remediation, tank removal and litigation associated with
268 and 256 known contaminated sites as of September 24, 2009 and September 25, 2008, respectively, as a result of releases (e.g., overfills, spills and underground storage tank releases) and are based on current regulations, historical results and certain other factors. We estimate that approximately $20.1 million of our environmental obligations will be funded by state trust funds and third-party insurance; as a result we may spend up to $2.6 million for remediation, tank removal and litigation. Also, as of September 24, 2009 and September 25, 2008, there were an additional 513 and 518 sites, respectively, each year that are known to be contaminated sites that are being remediated by third parties, and therefore, the costs to remediate such sites are not included in our environmental reserve. Remediation costs for known sites are expected to be incurred over the next one to ten years. Environmental reserves have been established with remediation costs based on internal and external estimates for each site. Future remediation for which the timing of payments can be reasonably estimated is discounted at 8.8% to determine the reserve.

We anticipate that we will be reimbursed for expenditures from state trust funds and private insurance. As of September 24, 2009, anticipated reimbursements of $20.5 million are recorded as other noncurrent assets and $4.5 million are recorded as current receivables related to all sites. In Florida, remediation of such contamination reported before January 1, 1999 will be performed by the state (or state approved independent contractors) and substantially all of the remediation costs, less any applicable deductibles, will be paid by the state trust fund. We will perform remediation in other states through independent contractor firms engaged by us. For certain sites, the trust fund does not cover a deductible or has a co-pay which may be less than the cost of such remediation. Although we are not aware of releases or contamination at other locations where we currently operate or have operated stores, any such releases or contamination could require substantial remediation expenditures, some or all of which may not be eligible for reimbursement from state trust funds or private insurance.

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.

Sale of Alcoholic Beverages.    In certain areas where stores are located, state or local laws limit the hours of operation for the sale of alcoholic beverages. State and local regulatory agencies have the authority to approve, revoke, suspend or deny applications for, and renewals of, permits and licenses relating to the sale of alcoholic beverages. These agencies may also impose various restrictions and sanctions. In many states, retailers of alcoholic beverages have been held responsible for damages caused by intoxicated individuals who purchased alcoholic beverages from them. While the potential exposure for damage claims as a seller of alcoholic beverages is substantial, we have adopted procedures intended to minimize such exposure. In addition, we maintain general liability insurance that may mitigate the effect of any liability.

Store Operations.    Our stores are subject to regulation by federal agencies and to licensing and regulations by state and local health, sanitation, safety, fire and other departments relating to the development and operation of convenience stores, including regulations relating to zoning and building requirements and the preparation and sale of food. Difficulties in obtaining or failures to obtain the required licenses or approvals could delay or prevent the development of a new store in a particular area.

Our operations are also subject to federal and state laws governing matters such as wage rates, overtime, working conditions and citizenship requirements. At the federal level, there are proposals under consideration from time to time to increase minimum wage rates and to introduce a system of mandated health insurance, each of which could adversely affect our results of operations.  For example, the federal minimum wage increased from $5.85 per hour to $6.55 per hour effective July 24, 2008, and increased to $7.25 per hour effective July 24, 2009.

Employees

As of September 24, 2009, we had 13,694 total employees (8,410 full-time and 5,284 part-time), with 12,938 employed in our stores and 756 in corporate and field management. Fewer part-time employees are employed during the winter months than during the peak spring and summer seasons. None of our employees are subject to collective bargaining agreements, and we consider our employee relations to be good.

 
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Executive Officers of the Registrant

The following table provides information on our executive officers. There are no family relationships between any of our executive officers:
 
         
Name
  
Age
  
Position with our Company
Terrance M. Marks
 
49
 
President and Chief Executive Officer
Frank G. Paci
  
52
  
Executive Vice President, Chief Financial Officer and Secretary
R. Brad Williams
  
39
  
Senior Vice President, Field Operations
Keith S. Bell
  
46
  
Senior Vice President, Fuels and Construction
Melissa H. Anderson
  
45
  
Senior Vice President, Human Resources
Paul  M. Lemerise
  
64
  
Chief Information Officer

Terrance M. Marks has served as our President and Chief Executive Officer since September 2009. Prior to joining The Pantry, Mr. Marks was President of Coca-Cola Enterprises, Inc. North American Group from 2005 to 2008.  Mr. Marks directed all sales, marketing, finance, operations, manufacturing, distribution, supply chain and human resources for a $15 billion enterprise with 55,000 employees in 400 facilities. From 1987 to 2004, Mr. Marks held various positions in sales, operations, finance and general management at Coca-Cola Enterprises, Inc.

Frank G. Paci joined The Pantry as our Senior Vice President, Chief Financial Officer and Secretary on July 2, 2007 and was promoted to Executive Vice President, Chief Financial Officer and Secretary in April 2009. Prior to joining The Pantry, Mr. Paci was with Blockbuster, Inc., where he served as Executive Vice President and had varying responsibilities in Finance and Accounting, Strategic Planning and Business Development. Prior to joining Blockbuster in 1999, he was with Yum! Brands where he served for three years as Vice President in charge of Pizza Hut’s “nontraditional location” business, and later in Strategic Planning.


Keith S. Bell has served as our Senior Vice President, Fuels since July 2006. Mr. Bell is an 18-year veteran of BP p.l.c. (“BP”) and Amoco Oil Company (“Amoco”), which was acquired by BP in 1998, where he most recently spent two years as Vice President of BP's US branded jobber business. During his career at BP and Amoco, Mr. Bell progressed through a variety of executive positions including two years as Vice President of Pricing and Supply for BP's US Fuels Northeast Region, two years as Eastern US Regional Vice President of BP’s branded jobber business, and three years as Performance Unit Leader – Southeast.

Melissa H. Anderson has served as our Senior Vice President, Human Resources since November 2006. Prior to joining The Pantry, Ms. Anderson was with International Business Machines Corporation (“IBM”) where for the last three years she was the Vice President of Human Resources for IBM Global Financing. Previously, Ms. Anderson held numerous human resource positions in her 17-year tenure with IBM, including Human Resource Director for IBM’s Tivoli unit.  On December 2, 2009 Ms. Anderson notified us of her intent to resign to pursue other opportunities.

Paul M. Lemerise began serving as a consultant to The Pantry in November 2009 in the role of our Chief Information Officer.  Mr. Lemerise has been an Executive Services Partner with Tatum LLC, a firm that provides management consulting services, since October 2001.  In that capacity, Mr. Lemerise has served as Chief Information Officer for numerous clients including Ventana Medical Systems, Pharmavite, LLC and Foster Farms.  Prior to joining Tatum, Mr. Lemerise also served as Executive Vice President, CIO for Tru-Serve Corporation, Senior Vice President and CIO for Merisel, Inc., and Vice President of Information Systems for Carter Hawley Hale Corporation.

Item 1A.    Risk Factors.

You should carefully consider the risks described below and under “Part II.Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” before making a decision to invest in our securities. The risks and uncertainties described below and elsewhere in this report are not the only ones facing us. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, could negatively impact our business, financial condition or results of operations in the future. If any such risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our securities could decline, and you may lose all or part of your investment.

 
Risks Related to Our Industry

The convenience store and retail gasoline industries are highly competitive and impacted by new entrants. Increased competition could result in lower margins.

The convenience store and retail gasoline industries in the geographic areas in which we operate are highly competitive and marked by ease of entry and constant change in the number and type of retailers offering the products and services found in our stores. We compete with numerous other convenience store chains,

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independent convenience stores, supermarkets, drugstores, discount clubs, gasoline service stations, mass merchants, fast food operations and other similar retail outlets.  In recent years, several non-traditional retailers, including supermarkets, club stores and mass merchants, have begun to compete directly with the convenience store industry.  These non-traditional gasoline retailers have obtained a significant share of the gasoline market and their market share is expected to grow, and these retailers may use promotional pricing or discounts, both at the gasoline pump and in the store, to encourage in-store merchandise sales. Additionally, 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 and competitors’ offerings and prices to ensure we offer a selection of convenience products and services at competitive prices to meet consumer demand. We must also maintain and upgrade our customer service levels, facilities and locations to remain competitive and drive customer traffic to our stores. Principal competitive factors include, among others, location, ease of access, gasoline brands, pricing, product and service selections, customer service, store appearance, cleanliness and safety. In a number of our markets, our competitors that sell ethanol-blended gasoline may have a competitive advantage over us because, in certain regions of the country, the wholesale cost of ethanol-blended gasoline may, at times, be less than pure gasoline. Competitive pressures could materially impact our gasoline and merchandise volume, sales and gross profit and overall customer traffic, which could in turn have a material adverse effect on our business, financial condition and results of operations.

Volatility in crude oil and wholesale petroleum costs could impact our operating results.

Over the past three fiscal years, our gasoline revenue accounted for approximately 78.2% of total revenues and our gasoline gross profit accounted for approximately 31.2% of total gross profit. Crude oil and domestic wholesale petroleum markets are volatile. General political conditions, acts of war or terrorism, instability in oil producing regions, particularly in the Middle East and South America, and the value of the U.S. dollar could significantly impact crude oil supplies and wholesale petroleum costs. In addition, the supply of gasoline and our wholesale purchase costs could be adversely impacted in the event of a shortage, which could result from, among other things, lack of capacity at United States oil refineries or the fact that our gasoline contracts do not guarantee an uninterrupted, unlimited supply of gasoline. Significant increases and volatility in wholesale petroleum costs have resulted, and could in the future result, in significant increases in the retail price of petroleum products and in lower gasoline gross margin per gallon. During fiscal 2009, increases in the retail price of petroleum products impacted consumer demand for gasoline, and we expect that future increases would have the same effect. This volatility makes it extremely difficult to predict the impact future wholesale cost fluctuations will have on our operating results and financial condition. Dramatic increases in crude oil prices squeeze retail fuel margin because fuel costs typically increase faster than retailers are able to pass them along to customers. Higher fuel prices also trigger higher credit card expenses, because credit card fees are calculated as a percentage of the transaction amount, not as a percentage of gasoline gallons sold. A significant change in any of these factors could materially impact our gasoline gallon volume, gasoline gross profit and overall customer traffic, which in turn could have a material adverse effect on our business, financial condition and results of operations.

Changes in economic conditions, 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 commercial truck traffic and trends in travel, tourism and weather. Changes in economic conditions generally, or in the southeastern United States specifically, could adversely impact consumer spending patterns and travel and tourism in our markets. In particular, weakening economic conditions may result in decreases in miles driven and discretionary consumer spending and travel, which impact spending on gasoline and convenience items. In addition, changes in the types of products and services demanded by consumers may adversely affect our merchandise sales and gross profit. Our success depends on our ability to anticipate and respond in a timely manner to changing consumer demands and preferences while continuing to sell products and services that will positively impact overall merchandise gross profit.

Approximately 35% 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, such as those currently impacting the United States. If visitors to coastal/resort or tourist locations decline due to economic conditions, changes in consumer preferences, changes in discretionary consumer spending or otherwise, our sales could decline, which in turn could have a material adverse effect on our business, financial condition and results of operations.

Recent market turmoil and uncertain economic conditions, including increases in food and fuel prices, changes in the credit and housing markets leading to the current financial and credit crisis, actual and potential job losses among many sectors of the economy, significant declines in the stock market resulting in large losses in consumer retirement and investment accounts and uncertainty regarding future federal tax and economic policies have resulted in reduced consumer confidence, curtailed retail spending and decreases in miles driven. There can be no assurances that government responses to the disruptions in the financial markets will restore consumer confidence.  During fiscal 2008 and fiscal 2009, we have experienced periodic per store sales declines in both gasoline and merchandise as a result of these economic conditions. If these economic conditions persist or deteriorate further, we may continue to experience sales declines in both gasoline and merchandise, which could have a material adverse effect on our business, financial condition and results of operations.

 

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Wholesale cost increases of, tax increases on, and campaigns to discourage tobacco products could adversely impact our operating results.

Sales of tobacco products accounted for approximately 6.2% of total revenues over the past three fiscal years, and our tobacco gross profit accounted for approximately 12.6% of total gross profit for the same period. Significant increases in wholesale cigarette costs and tax increases on tobacco products, as well as national and local campaigns to discourage the use of tobacco products, may have an adverse effect on demand for cigarettes and other tobacco products. Although the states in which we operate have historically imposed relatively low taxes on tobacco products, each year one or more of these states consider increasing the tax rate for tobacco products, either to raise revenues or deter the use of tobacco. In fiscal 2009, four states in which we operate (Florida, Kentucky, Mississippi and North Carolina) each increased the tax rate for certain tobacco products.  Additionally, a federal excise tax is imposed on the sale of cigarettes, and an increase of $0.62 per pack in the federal excise tax on cigarettes became effective on April 1, 2009.  Any increase in federal or state taxes on our tobacco products could materially impact our retail price of cigarettes, cigarette unit volume and revenues, merchandise gross profit and overall customer traffic, which could in turn have a material adverse effect on our business, financial condition and results of operations.

Currently, major cigarette manufacturers offer substantial rebates to retailers. We include these rebates as a component of our gross margin from sales of cigarettes. In the event these rebates are no longer offered, or decreased, our wholesale cigarette costs will increase accordingly. 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. In addition, reduced retail display allowances on cigarettes offered by cigarette manufacturers negatively impact gross margins. These factors could materially impact our retail price of cigarettes, cigarette unit volume and revenues, merchandise gross profit and overall customer traffic, which could in turn have a material adverse effect on our business, financial condition and results of operations.

 
Federal regulation of tobacco products could adversely impact our operating results.
 
 
In June 2009, Congress gave the Food and Drug Administration (FDA) broad authority to regulate tobacco products through passage of the Family Smoking Prevention and Tobacco Control Act (FSPTCA). Under the legislation, FDA regulation is expected to:
 
 
 
set national performance standards for tobacco products;
 
 
 
restrict the sale and marketing of tobacco products;
 
 
 
require manufacturers to obtain FDA clearance or approval for cigarette and smokeless tobacco products commercially launched, or to be launched, after February 15, 2007;
 
 
 
require new and bigger warning labels on tobacco products, including warnings that take up 50 percent of the front and back of every pack of cigarettes; and

 
 
prohibit the use of terms such as “light” or “low tar.”

Governmental actions and regulations, combined with the diminishing social acceptance of smoking, declines in the percentage of smokers in the general population and private actions to restrict smoking, have resulted in reduced industry volume, and we expect that such actions will continue to reduce consumption levels. These governmental actions could materially impact our retail price of cigarettes, cigarette unit volume and revenues, merchandise gross profit and overall customer traffic, which could in turn have a material adverse effect on our business, financial condition and results of operations.


Risks Related to Our Business

Unfavorable weather conditions or other trends or developments in the southeastern United States could adversely affect our business.

Substantially all of our stores are located in the southeastern United States. Although the southeast region 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, all of which we have historically experienced.

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Inclement weather conditions as well as severe storms in the southeast region could damage our facilities, our suppliers or could have a significant impact on consumer behavior, travel and convenience store traffic patterns, as well as our ability to operate our stores. In addition, we typically generate higher revenues and gross margins during warmer weather months in the Southeast, which fall within our third and fourth fiscal quarters. If weather conditions are not favorable during these periods, our operating results and cash flow from operations could be adversely affected. We could also be adversely impacted by regional occurrences in the southeastern United States such as energy shortages or increases in energy prices, fires or other natural disasters.

Inability to identify, acquire and integrate new stores could adversely affect our business.

An important part of our historical growth strategy has been to acquire other convenience stores that complement our existing stores or broaden our geographic presence.  Acquisitions involve risks that could cause our actual growth or operating results to differ significantly from our expectations or the expectations of securities analysts. For example:
 
 
 
We may not be able to identify suitable acquisition candidates or acquire additional convenience stores on favorable terms. We compete with others to acquire convenience stores. We believe that this competition may increase and could result in decreased availability or increased prices for suitable acquisition candidates. It may be difficult to anticipate the timing and availability of acquisition candidates.
 
 
 
During the acquisition process, we may fail or be unable to discover some of the liabilities of companies or businesses that we acquire. These liabilities may result from a prior owner’s noncompliance with applicable federal, state or local laws or regulations.
 
 
 
We may not be able to obtain the necessary financing, on favorable terms or at all, to finance any of our potential acquisitions.
 
 
 
We may fail to successfully integrate or manage acquired convenience stores.
 
 
 
Acquired convenience stores may not perform as we expect or we may not be able to obtain the cost savings and financial improvements we anticipate.
 
 
 
We face the risk that our existing financial controls, information systems, management resources and human resources will need to grow to support future growth.

Our indebtedness could negatively impact our financial health.

As of September 24, 2009, we had consolidated debt, including lease finance obligations, of approximately $1.3 billion. As of September 24, 2009, the availability under our revolving credit facility for borrowing was approximately $142.0 million (approximately $37.0 million of which was available for issuance of letters of credit).

Our substantial indebtedness could have important consequences. For example, it could:
 
 
 
make it more difficult for us to satisfy our obligations with respect to our debt and our leases;
 
 
 
increase our vulnerability to general adverse economic and industry conditions;
 
 
 
require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, including lease finance obligations, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;
 
 
 
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
 
 
 
place us at a competitive disadvantage compared to our competitors that have less indebtedness or better access to capital by, for example, limiting our ability to enter into new markets or renovate our stores; and
 
 
 
limit our ability to borrow additional funds in the future.

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We are vulnerable to increases in interest rates because the debt under our senior credit facility is subject to a variable interest rate. Although we have entered into certain hedging instruments in an effort to manage our interest rate risk, we may not be able to continue to do so, on favorable terms or at all, in the future.

If we are unable to meet our debt obligations, we could be forced to restructure or refinance our obligations, seek additional equity financing or sell assets, which we may not be able to do on satisfactory terms or at all. As a result, we could default on those obligations.

In addition, the credit agreement governing our senior credit facility and the indenture governing our senior subordinated notes contain financial and other restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with these covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our indebtedness, which would adversely affect our financial health and could prevent us from fulfilling our obligations.

Despite current indebtedness levels, we and our subsidiaries may still be able to incur additional debt. This could further increase the risks associated with our substantial leverage.

We are able to incur additional indebtedness. The terms of the indenture that governs our senior subordinated notes permit us to incur additional indebtedness under certain circumstances. The indenture governing our senior subordinated convertible notes (“convertible notes”), does not contain any limit on our ability to incur debt. In addition, the credit agreement governing our senior credit facility permits us to incur additional indebtedness (assuming certain financial conditions are met at the time) beyond the amounts available under our revolving credit facility. If we incur additional indebtedness, the related risks that we now face could increase.

To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.

Our ability to make payments on our indebtedness, including without limitation any payments required to be made to holders of our senior subordinated notes and our convertible notes, and to refinance our indebtedness and fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

For example, upon the occurrence of a “fundamental change” (as such term is defined in the indenture governing our convertible notes), holders of our convertible notes have the right to require us to purchase for cash all outstanding convertible notes at 100% of their principal amount plus accrued and unpaid interest, including additional interest (if any), up to but not including the date of purchase. We also may be required to make substantial cash payments upon other conversion events related to the convertible notes. We may not have enough available cash or be able to obtain third-party financing to satisfy these obligations at the time we are required to make purchases of tendered notes.

Based on our current level of operations, we believe our cash flow from operations, available cash and available borrowings under our revolving credit facility will be adequate to meet our future liquidity needs for at least the next 12 months.

We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our revolving credit facility in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness on or before maturity, sell assets, reduce or delay capital expenditures, seek additional equity financing or seek third-party financing to satisfy such obligations. We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all. Our failure to fund indebtedness obligations at any time could constitute an event of default under the instruments governing such indebtedness, which would likely trigger a cross-default under our other outstanding debt.

If we do not comply with the covenants in the credit agreement governing our senior credit facility and the indenture governing our senior subordinated notes or otherwise default under them or the indenture governing our convertible notes, we may not have the funds necessary to pay all of our indebtedness that could become due.

The credit agreement governing our senior credit facility and the indenture governing our senior subordinated notes require us to comply with certain covenants. In particular, our credit agreement prohibits us from incurring any additional indebtedness, except in specified circumstances, or materially amending the terms of any
agreement relating to existing indebtedness without lender approval. Further, our credit agreement restricts our ability to acquire and dispose of assets, engage in mergers or reorganizations, pay dividends or make investments or capital expenditures. Other restrictive covenants require that we meet a maximum total adjusted leverage ratio and a minimum interest coverage ratio, as defined in our credit agreement. A violation of any of these covenants could cause an event of default under our credit agreement.

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If we default on the credit agreement governing our senior credit facility, the indenture governing our senior subordinated notes or the indenture governing our convertible notes because of a covenant breach or otherwise, all outstanding amounts could become immediately due and payable. We cannot assure you that we would have sufficient funds to repay all the outstanding amounts, and any acceleration of amounts due under our credit agreement or either of the indentures governing our outstanding indebtedness likely would have a material adverse effect on us.

If future circumstances indicate that goodwill or indefinite lived intangible assets are impaired, there could be a requirement to write down amounts of goodwill and indefinite lived intangible assets and record impairment charges.

 Goodwill and indefinite lived intangible assets are initially recorded at fair value and are not amortized, but are reviewed for impairment at least annually or more frequently if impairment indicators are present. In assessing the recoverability of goodwill and indefinite lived intangible assets, we make estimates and assumptions about sales, operating margin, growth rates, consumer spending levels, general economic conditions and the market prices for our common stock. There are inherent uncertainties related to these factors and management's judgment in applying these factors. We could be required to evaluate the recoverability of goodwill and indefinite lived intangible assets prior to the annual assessment if we experience, among others, disruptions to the business, unexpected significant declines in our operating results, divestiture of a significant component of our business changes in operating strategy or sustained market capitalization declines. These types of events and the resulting analyses could result in goodwill and indefinite lived intangible asset impairment charges in the future. Impairment charges could substantially affect our financial results in the periods of such charges. In addition, impairment charges could negatively impact our financial ratios and could limit our ability to obtain financing on favorable terms, or at all, in the future.

We are subject to state and federal environmental laws and other regulations. Failure to comply with these laws and regulations may result in penalties or costs that could have a material adverse effect on our business.

We are 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, working condition requirements, public accessibility requirements, citizenship requirements and other laws and regulations. A violation or change of these laws or regulations could have a material adverse effect on our business, financial condition and results of operations.

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 and regulations regulating underground storage tanks may require significant capital expenditures and increased operating and maintenance costs. The remediation costs and other costs required to clean up or treat contaminated sites could be substantial. We pay tank registration fees and other taxes to state trust funds established in our operating areas and maintain private insurance coverage in Florida and Georgia 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. These payments could materially adversely affect our business, financial condition and results of operations. Reimbursements from state trust funds will be dependent on the maintenance and continued solvency of the various funds.

 In the future, we may incur substantial expenditures for remediation of contamination that has not been discovered at existing or acquired locations. 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 laws, ordinances or regulations or an increase in regulations could adversely affect our business, financial condition and results of operations.

Failure to comply with state laws regulating the sale of alcohol and tobacco products may result in the loss of necessary licenses and the imposition of fines and penalties on us, which could have a material adverse effect on our business.

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

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licenses relating to the sale of these products or to seek other remedies.  Such a loss or imposition could have a material adverse effect on our business. In addition, certain states regulate relationships, including overlapping ownership, among alcohol manufacturers, wholesalers and retailers, and may deny or revoke licensure if relationships in violation of the state laws exist. We are not aware of any alcoholic beverage manufacturers or wholesalers having a prohibited relationship with our company.

Failure to comply with the other state and federal regulations we are subject to may result in penalties or costs that could have a material adverse effect on our business.

Our business is subject to various other state and federal regulations, including, without limitation, employment laws and regulations, minimum wage requirements, overtime requirements, working condition requirements and other laws and regulations. Any appreciable increase in the statutory minimum wage rate, income or overtime pay, or adoption of mandated healthcare benefits would likely result in an increase in our labor costs and such cost increase, or the penalties for failing to comply with such statutory minimums or regulations, could have a material adverse effect on our business, financial condition and results of operations.  For example, the federal minimum wage increased from $6.55 per hour to $7.25 per hour effective July 24, 2009.  Further, the federal government has begun efforts to reform the health care system.  At this point, it is unclear what effect any reform may have on our business, but a reform that requires us to provide health care coverage to all employees could significantly increase our costs and adversely affect our business, financial condition and results of operations.

We depend on one principal supplier for the majority of our merchandise. A disruption in supply or a change in our relationship could have a material adverse effect on our business.

We purchase over 55% of our general merchandise, including most tobacco products and grocery items, from a single wholesale grocer, McLane. We have a contract with McLane through December 31, 2014, but we may not be able to renew the contract when it expires, or on similar terms. A change of merchandise suppliers, a disruption in supply or a significant change in our relationship with our principal merchandise suppliers could have a material adverse effect on our business, cost of goods sold, financial condition and results of operations.

We depend on two principal suppliers for the majority of our gasoline. A disruption in supply or a change in our relationship could have a material adverse effect on our business.

BP® and CITGO® supply approximately 66% of our gasoline purchases. The initial term of our contract with CITGO® expires August 31, 2010 and our contract with BP® expires September 30, 2012.  At this time, we cannot ensure that our contract with CITGO® will automatically renew, or that we will be able to renew our BP® contract upon expiration. A change of suppliers, a disruption in supply or a significant change in our relationship with our principal suppliers could materially increase our cost of goods sold, which would negatively impact our business, financial condition and results of operations.

CITGO® obtains a significant portion of the crude oil it refines from its ultimate parent, Petroleos de Venezuela, SA (“PDVSA”), which is owned and controlled by the government of Venezuela. The political and economic environment in Venezuela can disrupt PDVSA’s operations and adversely affect CITGO ® ’s ability to obtain crude oil. In addition, the Venezuelan government can order, and in the past has ordered, PDVSA to curtail the production of oil in response to a decision by the Organization of Petroleum Exporting Countries to reduce production. The inability of CITGO ® to obtain crude oil in sufficient quantities would adversely affect its ability to provide gasoline to us and could have a material adverse effect on our business, financial condition and results of operations.

Because we depend on our senior management’s experience and knowledge of our industry, we would be adversely affected if we were to lose any members of our senior management team.

We are dependent on the continued efforts of our senior management team.  At the end of fiscal 2009, Peter J. Sodini resigned as our President and Chief Executive Officer.  Our Board of Directors hired Terrance M. Marks as our new President and Chief Executive Officer. If, for any reason, Mr. Marks or any other of our senior executives do not continue to be active in the management of our business, financial condition and results of operations could be adversely affected. We may not 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. We also rely on our ability to recruit qualified store and field managers. If we fail to continue to attract these individuals at reasonable compensation levels, our operating results may be adversely affected.

Pending litigation could adversely affect our financial condition, results of operations and cash flows.

We are party to various legal actions in the ordinary course of our business. We believe these actions are routine in nature and incidental to the operation of our business. While the outcome of these actions cannot be predicted with certainty, management’s present judgment is that the ultimate resolution of these matters will not have a material adverse impact on our business, financial condition, results of operations, cash flows or prospects. If, however, our assessment of these actions is inaccurate, or there are any significant adverse developments in these actions, our business, financial condition and results of operations could be adversely affected.

 
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Litigation and publicity concerning food quality, health and other related issues could result in significant liabilities or litigation costs and cause consumers to avoid our convenience stores.

Convenience store businesses and other food service operators can be adversely affected by litigation and complaints from customers or government agencies resulting from food quality, illness, or other health or environmental concerns or operating issues stemming from one or more locations. Adverse publicity about these allegations may negatively affect us, regardless of whether the allegations are true, by discouraging customers from purchasing gasoline, merchandise or food at one or more of our convenience stores. We could also incur significant liabilities if a lawsuit or claim results in a decision against us.  Even if we are successful in defending such litigation, our litigation costs could be significant, and the litigation may divert time and money away from our operations and adversely affect our performance.

Pending SEC matters could adversely affect us.

As previously disclosed, on July 28, 2005 we announced that we would restate earnings for the period from fiscal 2000 to fiscal 2005 arising from sale-leaseback accounting for certain transactions. In connection with our decision to restate, we filed a Form 8-K on July 28, 2005, as well as a Form 10-K/A on August 31, 2005 restating the transactions. The SEC issued a comment letter to us in connection with the Form 8-K, and we responded to the comments. Beginning in September 2005, we received requests from the SEC that we voluntarily provide certain information to the SEC Staff in connection with our sale-leaseback accounting, our decision to restate our financial statements with respect to sale-leaseback accounting and other lease accounting matters. In November 2006, the SEC informed us that in connection with the inquiry it had issued a formal order of private investigation. As previously disclosed, we are cooperating with the SEC in this ongoing investigation. We are unable to predict how long this investigation will continue or whether it will result in any adverse action.

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results. As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.

Effective internal control over financial reporting is necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed. The Sarbanes-Oxley Act of 2002, as well as related rules and regulations implemented by the SEC, NASDAQ and the Public Company Accounting Oversight Board, have required changes in the corporate governance practices and financial reporting standards for public companies. These laws, rules and regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002, have increased our legal and financial compliance costs and made many activities more time-consuming and more burdensome. These laws, rules and regulations are subject to varying interpretations in many cases. As a result, their application in practice may evolve over time as regulatory and governing bodies provide new guidance, which could result in continuing uncertainty regarding compliance matters. The costs of compliance with these laws, rules and regulations have adversely affected our financial results. Moreover, we run the risk of non-compliance, which could adversely affect our financial condition or results of operations or the trading price of our stock.

We have in the past discovered, and may in the future discover, areas of our internal control over financial reporting that need improvement. We have devoted significant resources to remediate our deficiencies and improve our internal control over financial reporting. Although we believe that these efforts have strengthened our internal control over financial reporting, we are continuing to work to improve our internal control over financial reporting. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Inferior internal control over financial reporting could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

The dangers inherent in the storage of gasoline could cause disruptions and could expose us to potentially significant losses, costs or liabilities.

We store gasoline in storage tanks at our retail locations.  Our operations are subject to significant hazards and risks inherent in storing gasoline.  These hazards and risks include, but are not limited to, fires, explosions, spills, discharges and other releases, any of which could result in distribution difficulties and disruptions, environmental pollution, governmentally-imposed fines or clean-up obligations, personal injury or wrongful death claims and other damage to our properties and the properties of others.  As a result, any such event could have a material adverse effect on our business, financial condition and results of operations.

We rely on information technology systems to manage numerous aspects of our business, and a disruption of these systems could adversely affect our business.

We depend on information technology (IT) systems to manage numerous aspects of our business transactions and provide information to management.  Our IT systems are an essential component of our business and growth strategies, and a serious disruption to our IT systems could significantly limit our ability to manage and operate our business efficiently.  These systems are vulnerable to, among other things, damage and interruption from power loss or natural disasters, computer system and network failures, loss of telecommunications services, physical and electronic loss of data, security breaches and computer viruses.  Any serious disruption could cause our business and competitive position to suffer and adversely affect our operating results.
 

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Other Risks

Future sales of additional shares into the market may depress the market price of our common stock.

If we or our existing stockholders sell shares of our common stock in the public market, including shares issued upon the exercise of outstanding options, or if the market perceives such sales or issuances could occur, the market price of our common stock could decline. As of December 4, 2009, there were 22,584,818 shares
of our common stock outstanding, most of which are freely tradable (unless held by one of our affiliates). Pursuant to Rule 144 under the Securities Act of 1933, as amended, during any three-month period our affiliates can resell up to the greater of (a) 1.0% of our aggregate outstanding common stock or (b) the average weekly trading volume for the four weeks prior to the sale. Sales by our existing stockholders 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.

In addition, we have filed with the SEC a registration statement that covers up to 839,385 shares issuable upon the exercise of stock options currently outstanding under our 1999 Stock Option Plan, as well as a registration statement that covers up to 2.4 million shares issuable pursuant to share-based awards under our Omnibus Plan, plus any options issued under our 1999 Stock Option Plan that are forfeited or cancelled after March 29, 2007. Generally, shares registered on a registration statement may be sold freely at any time after issuance.

Any issuance of shares of our common stock in the future could have a dilutive effect on your investment.

We may sell securities in the public or private equity markets if and when conditions are favorable, even if we do not have an immediate need for capital at that time. In other circumstances, we may issue shares of our common stock pursuant to existing agreements or arrangements. For example, upon conversion of our outstanding convertible notes, we may, at our option, issue shares of our common stock. In addition, if our convertible notes are converted in connection with a change of control, we may be required to deliver additional shares by increasing the conversion rate with respect to such notes. Notwithstanding the requirement to issue additional shares if convertible notes are converted on a change of control, the maximum conversion rate for our outstanding convertible notes is 25.4517 per $1,000 principal amount of convertible notes.

We have also issued warrants to purchase up to 2,993,000 shares of our common stock to an affiliate of Merrill Lynch in connection with the note hedge and warrant transactions entered into at the time of our offering of convertible notes. Raising funds by issuing securities dilutes the ownership of our existing stockholders. Additionally, certain types of equity securities that we may issue in the future could have rights, preferences or privileges senior to your rights as a holder of our common stock. We could choose to issue additional shares for a variety of reasons including for investment or acquisitive purposes. Such issuances may have a dilutive impact on your investment.

The market price for our common stock has been and may in the future be volatile, which could cause the value of your investment to decline.

There currently is a public market for our common stock, but there is no assurance that there will always be such a market. Securities markets worldwide experience significant price and volume fluctuations. This market volatility could significantly affect the market price of our common stock without regard to our operating performance. In addition, the price of our common stock could be subject to wide fluctuations in response to the following factors among others:
 
 
 
a deviation in our results from the expectations of public market analysts and investors;
 
 
 
statements by research analysts about our common stock, our company or our industry;
 
 
 
changes in market valuations of companies in our industry and market evaluations of our industry generally;
 
 
 
additions or departures of key personnel;
 
 
 
actions taken by our competitors;

 
 
sales or other issuances of common stock by us or our senior officers or other affiliates; or
 
 
 
other general economic, political or market conditions, many of which are beyond our control.

 
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The market price of our common stock will also be impacted by our quarterly operating results and quarterly comparable store sales growth, which may fluctuate from quarter to quarter. Factors that may impact our quarterly results and comparable store sales include, among others, general regional and national economic conditions, competition, unexpected costs and changes in pricing, consumer trends, the number of stores we open and/or close during any given period, costs of compliance with corporate governance and Sarbanes-Oxley requirements and other factors discussed in this Item 1A and throughout “Part II.—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” You may not be able to resell your shares of our common stock at or above the price you pay.

Provisions in our certificate of incorporation, our bylaws and Delaware law may have the effect of preventing or hindering a change in control and adversely affecting the market price of our common stock.

Provisions in our certificate of incorporation and our bylaws and applicable provisions of the Delaware General Corporation Law may make it more difficult and expensive for a third party to acquire control of us even if a change of control would be beneficial to the interests of our stockholders. These provisions could discourage potential takeover attempts and could adversely affect the market price of our common stock. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. Our certificate of incorporation and bylaws:

 
 
authorize the issuance of up to five million shares of “blank check” preferred stock that could be issued by our Board of Directors to thwart a takeover attempt without further stockholder approval;

 
 
prohibit cumulative voting in the election of directors, which would otherwise allow holders of less than a majority of stock to elect some directors;

 
 
limit who may call special meetings;
 
 
 
limit stockholder action by written consent, generally requiring all actions to be taken at a meeting of the stockholders; and
 
 
 
establish advance notice requirements for any stockholder that wants to propose a matter to be acted upon by stockholders at a stockholders’ meeting, including the nomination of candidates for election to our Board of Directors.

We are also subject to the provisions of Section 203 of the Delaware General Corporation Law, which limits business combination transactions with stockholders of 15% or more of our outstanding voting stock that our Board of Directors has not approved.

These provisions and other similar provisions make it more difficult for stockholders or potential acquirers to acquire us without negotiation and may apply even if some of our stockholders consider the proposed transaction beneficial to them. For example, these provisions might discourage a potential acquisition proposal or tender offer, even if the acquisition proposal or tender offer is at a premium over the then current market price for our common stock. These provisions could also limit the price that investors are willing to pay in the future for shares 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. Such measures may be adopted without vote or action by our stockholders.

 Item 1B.    Unresolved Staff Comments.

None.

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Item 2.    Properties.

As of September 24, 2009, we own the real property at 396 of our stores and lease the real property at 1,277 stores. Management believes that none of these leases is individually material. Most of these leases are net leases requiring us to pay all costs related to the property, including taxes, insurance and maintenance costs. Certain of these leases are accounted for as lease finance obligations whereby the leased assets and related lease liabilities are included in our Consolidated Balance Sheets. The aggregate rent paid in fiscal 2009 for operating leases and leases accounted for as lease finance obligations was $74.2 million and $47.2 million, respectively. The following table lists the expiration dates of our leases, including renewal options:
 
             
Lease Expiration
  
Operating
Leases
  
Finance
Leases
  
Total
Leased
2009-2010
  
21
  
—  
  
21
2011-2015
  
53
  
—  
  
53
2016-2020
  
86
  
4
  
90
2021-2025
  
135
  
11
  
146
2026-2030
  
109
  
28
  
137
2031-2035
  
248
  
10
  
258
2036-2040
  
23
  
53
  
76
2041-2045
  
174
  
27
  
201
2046-2050
  
31
  
20
  
51
2051-2055
  
17
  
227
  
244
 
  
 
  
 
  
 
Total
  
897
  
380
  
1,277
 
  
 
  
 
  
 

Management anticipates that it will be able to negotiate acceptable extensions of the leases that expire for those locations that we intend to continue operating. Beyond payment of our contractual lease obligations through the end of the term, early termination of these leases would result in minimal, if any, penalty to us.

When appropriate, we have chosen to sell and then lease back properties. Factors leading to this decision include alternative desires for use of cash, beneficial taxation, minimization of the risks associated with owning the property (especially changes in valuation due to population shifts, urbanization and/or proximity to high volume streets) and the economic terms of such lease finance transactions.

On December 3, 2008, we purchased a two story, 62,000 square foot office building in Cary, North Carolina.  This building, which houses approximately 200 employees, became our new corporate headquarters in July 2009. We also own a three story, 51,000 square foot corporate support building in Sanford, North Carolina and lease our corporate annex buildings in Jacksonville, Florida and Sanford, North Carolina.  We believe that with our new headquarters we will continue to have adequate office space for the foreseeable future.

Item 3.    Legal Proceedings.

As previously reported, on July 17, 2004 Constance Barton, Kimberly Clark, Wesley Clark, Tracie Hunt, Eleanor Walters, Karen Meredith, Gilbert Breeden, LaCentia Thompson and Mathesia Peterson, on behalf of themselves and on behalf of classes of those similarly situated, filed suit against The Pantry, Inc. seeking class action status and asserting claims on behalf of our North Carolina present and former employees for unpaid wages under North Carolina Wage and Hour laws. The suit also sought an injunction against any unlawful practices, damages, liquidated damages, costs and attorneys’ fees. The suit originally was filed in the Superior Court for Forsyth County, State of North Carolina. On August 17, 2004, the case was removed to the United States District Court for the Middle District of North Carolina, and on July 18, 2005, plaintiffs filed an Amended Complaint asserting certain additional claims under the federal Fair Labor Standards Act on behalf of all our present and former store employees. While we deny liability in this case, to avoid the burdens, expense and uncertainty of further litigation, on March 26, 2007, we reached a proposed settlement in principle with class counsel and the court granted final approval of the settlement on April 6, 2009. The deadline for appealing the court’s approval of the settlement expired on May 6, 2009, and no such appeal was filed. The settlement established a settlement fund of $1.0 million from which payments were made to settlement class members and class counsel. Additionally, the settlement provides for us to bear all costs of sending notices, processing and preparing payments and other administrative costs of the settlement. No other payments will be made to class members or class counsel. We incurred a one-time charge in the second quarter of fiscal 2007 of $1.25 million for the settlement and associated costs.

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Since the beginning of fiscal 2007, over 45 class action lawsuits have been filed in federal courts across the country against numerous companies in the petroleum industry. Major petroleum companies and significant retailers in the industry have been named as defendants in these lawsuits. To date, we have been named as a defendant in seven cases: one in Florida (Cozza, et al. v. Murphy Oil USA, Inc. et al., S.D. Fla., No. 9:07-cv-80156-DMM, filed 2/16/07); one in Delaware (Becker, et al. v. Marathon Petroleum Company LLC, et al., D. Del., No. 1:07-cv-00136, filed 3/7/07); one in North Carolina (Neese, et al. v. Abercrombie Oil Company, Inc., et al., E.D.N.C., No. 5:07-cv-00091-FL, filed 3/7/07); one in Alabama (Snable, et al. v. Murphy Oil USA, Inc., et al., N.D. Ala., No. 7:07-cv-00535-LSC, filed 3/26/07); one in Georgia (Rutherford, et al. v. Murphy Oil USA, Inc., et al., No. 4:07-cv-00113-HLM, filed 6/5/07); one in Tennessee (Shields, et al. v. RaceTrac Petroleum, Inc., et al., No. 1:07-cv-00169, filed 7/13/07); and one in South Carolina (Korleski v. BP Corporation North America, Inc., et al., D.S.C., No 6:07-cv-03218-MDL, filed 9/24/07). Pursuant to an Order entered by the Joint Panel on Multi-District Litigation, all of the cases, including the seven in which we are named, have been  transferred to the United States District Court for the District of Kansas and consolidated for all pre-trial proceedings. The plaintiffs in the lawsuits generally allege that they are retail purchasers who received less motor fuel than the defendants agreed to deliver because the defendants measured the amount of motor fuel they delivered in non-temperature adjusted gallons which, at higher temperatures, contain less energy. These cases seek, among other relief, an order requiring the defendants to install temperature adjusting equipment on their retail motor fuel dispensing devices. In certain of the cases, including some of the cases in which we are named, plaintiffs also have alleged that because defendants pay fuel taxes based on temperature adjusted 60 degree gallons, but allegedly collect taxes from consumers in non-temperature adjusted gallons, defendants receive a greater amount of tax from consumers than they paid on the same gallon of fuel. The plaintiffs in these cases seek, among other relief, recovery of excess taxes paid and punitive damages. Both types of cases seek compensatory damages, injunctive relief, attorneys’ fees and costs, and prejudgment interest. The defendants filed motions to dismiss all cases for failure to state a claim, which were denied by the court on February 21, 2008.  A number of the defendants, including the Company, subsequently moved to dismiss for lack of subject matter jurisdiction or, in the alternative, for summary judgment on the grounds that plaintiffs’ claims constitute non-justiciable “political questions.”  Those motions remain pending.  Also pending are plaintiffs’ motions for class certification, which defendants have opposed.  We continue to believe that there are substantial factual and legal defenses to the theories alleged in these lawsuits. As the cases are at an early stage, we cannot at this time estimate our ultimate exposure to loss or liability, if any, related to these lawsuits.

 We are party to various other legal actions in the ordinary course of our business. We believe these other actions are routine in nature and incidental to the operation of our business. While the outcome of these actions cannot be predicted with certainty, management’s present judgment is that the ultimate resolution of these matters will not have a material adverse impact on our business, financial condition, results of operations, cash flows or prospects. If, however, our assessment of these actions is inaccurate, or there are any significant adverse developments in these actions, our business, financial condition, results of operations and could be adversely affected.

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

None.

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PART II

Item 5.    Market for Our Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock, $.01 par value, represents our only voting securities. There were 22,523,114 shares of common stock issued and outstanding as of September 24, 2009. Our common stock is traded on The NASDAQ Global Select Market under the symbol “PTRY.” The following table sets forth for each fiscal quarter the high and low sale prices per share of our common stock over the last two fiscal years as reported by NASDAQ, based on published financial sources.

                         
 
Fiscal 2009
 
Fiscal 2008
 
Quarter
High
 
Low
 
High
 
Low
 
First
  $ 23.50     $ 13.31     $ 31.00     $ 23.99  
Second
  $ 22.00     $ 14.02     $ 31.05     $ 20.66  
Third
  $ 25.97     $ 16.01     $ 22.85     $ 8.81  
Fourth
  $ 18.43     $ 14.45     $ 22.61     $ 9.16  

As of December 4, 2009, there were 26 holders of record of our common stock. This number does not include beneficial owners of our common stock whose stock is held in nominee or “street” name accounts through brokers.

During the last three fiscal years, we have not paid any cash dividends on our common stock, and we do not expect to pay cash dividends on our common stock for the foreseeable future. We intend to retain earnings to support operations, reduce debt, repurchase our common stock, and finance expansion. The payment of cash dividends in the future will depend upon our ability to remove certain loan restrictions, and other factors such as our earnings, operations, capital requirements, financial condition and other factors deemed relevant by our Board of Directors. Currently, the payment of cash dividends is prohibited under restrictions contained in the indenture relating to our senior subordinated notes and our senior credit facility. See “Part II.—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and “Part II.—Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 6—Long-Term Debt.”

 Item 6.    Selected Financial Data.

The following table sets forth our historical consolidated financial data and store operating information for the periods indicated. The selected historical annual consolidated statement of operations and balance sheet data as of and for each of the five fiscal years presented are derived from, and are qualified in their entirety by, our consolidated financial statements. Historical results are not necessarily indicative of the results to be expected in the future. You should read the following data together with “Part I.—Item 1. Business,” “Part II.—Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing in “Part II.—Item 8. Consolidated Financial Statements and Supplementary Data.” In the following table, dollars are in millions, except per share, per store and per gallon data and as otherwise indicated. All fiscal years presented included 52 weeks.

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Fiscal Year Ended
 
   
September 24,
2009
     
September 25,
2008
   
September 27,
2007
     
September 28,
2006
     
September 29,
2005
 
Statement of Operations Data:
                                   
Revenues:
                                   
Merchandise revenue
  $ 1,658.9       $ 1,636.7     $ 1,575.9       $ 1,385.7       $ 1,228.9  
Gasoline revenue
    4,731.2         7,358.9       5,335.2         4,576.0         3,200.3  
                                               
Total revenues
    6,390.1         8,995.6       6,911.1         5,961.7         4,429.2  
Gross profit:(a)
                                             
Merchandise gross profit
    587.1         595.1       586.0         517.9         449.2  
Gasoline gross profit
    313.6         263.0       224.7         281.2         213.9  
                                               
Total gross profit
    900.7         858.1       810.7         799.1         663.1  
                                               
Store operating and general and administrative
    620.9         612.0       597.3         521.1         450.3  
Depreciation and amortization
    109.6         108.3       95.9         76.0         64.3  
Income from operations
    170.2         137.7       117.5         202.0         148.5  
Gain/(loss) on extinguishment of debt
    7.2  
(b)
          (2.2 )
(c)
    (1.8 )
(d)
     
Interest expense, net
    84.2         87.6       72.2         54.7         54.3  
                                               
Net income
    59.1         31.8       26.7         89.2         57.8  
Earnings per share:
                                             
Basic
  $ 2.66       $ 1.43     $ 1.17       $ 3.95       $ 2.74  
Diluted
  $ 2.65       $ 1.43     $ 1.17       $ 3.88       $ 2.64  
Weighted-average shares outstanding:
                                             
Basic
    22,233         22,205       22,776         22,559         21,100  
Diluted
    22,346         22,236       22,911         22,987         21,930  
Other Financial Data:
                                             
Adjusted EBITDA(e)
  $ 233.0       $ 201.1     $ 178.1       $ 254.2       $ 189.4  
EBITDA(e)
  $ 280.2       $ 247.2     $ 214.0       $ 278.9       $ 213.9  
Cash provided by (used in):
                                             
Operating activities
  $ 169.4       $ 157.5     $ 140.6       $ 154.3       $ 133.6  
Investing activities(f)
    (166.0 )       (115.5 )     (528.7 )       (219.3 )       (166.2 )
Financing activities
    (50.7 )       103.7       339.2         73.9         36.1  
Gross capital expenditures
    122.7         109.5       146.4         96.8         73.4  
Store Operating Data:
                                             
Number of stores (end of period)
    1,673         1,653       1,644         1,493         1,400  
Average sales per store:
                                             
Merchandise revenue (in thousands)
  $ 1,001.1       $ 991.3     $ 998.7       $ 954.3       $ 897.7  
Gasoline gallons (in thousands)—Retail
    1,268.6         1,288.8       1,306.4         1,230.1         1,114.3  
Comparable store sales(g):
                                             
Merchandise sales (decrease) increase (%)
    0.0 %       (1.7 %)     2.3 %       4.9 %       5.3 %
Merchandise sales (decrease) increase (in thousands)
  $ 327       $ (25,209 )   $ 29,443       $ 57,026       $ 53,218  
Gasoline gallons (decrease) increase (%)
    (3.3 %)       (4.4 %)     1.0 %       3.1 %       4.7 %
Gasoline gallons (decrease) increase (in thousands)
    (68,481 )       (80,368 )     16,115         43,218         53,928  
Operating Data:
                                             
Merchandise gross margin
    35.4 %       36.4 %     37.2 %       37.4 %       36.6 %
Retail gasoline gallons sold (in millions)
    2,078.0         2,103.4       2,032.8         1,757.8         1,496.5  
Average retail gasoline price per gallon
  $ 2.24       $ 3.40     $ 2.55       $ 2.58       $ 2.13  
Average retail gasoline gross profit per gallon(h)
  $ 0.150       $ 0.124     $ 0.109       $ 0.159       $ 0.143  
Balance Sheet Data (end of period):
                                             
Cash and cash equivalents
  $ 170.0       $ 217.2     $ 71.5       $ 120.4       $ 111.5  
Working capital
    158.2         183.8       33.9         98.2         69.8  
Total assets
    2,154.7         2,168.7       2,029.4         1,587.9         1,388.2  
Total debt and lease finance obligations
    1,257.3         1,311.5       1,208.2         848.4         758.5  
Shareholders’ equity
    456.2         389.9       353.8         337.0         251.9  

(footnotes on following pages)
22

 
 

 








(a)
Gross profit does not include depreciation or allocation of store operating and general and administrative expenses.
 
(b)
During fiscal 2009, we recorded a gain on extinguishment of debt of $7.2 million related to the buyback of approximately $24.0 million in principal amount of our senior subordinated convertible notes and $3.0 million in principal amount of our senior subordinated notes. The gain was net of the write-off of $438 thousand of unamortized deferred financing costs.

(c)
On May 15, 2007, we refinanced our then-existing senior credit facility and, in connection with the refinancing, recorded a non-cash charge of approximately $2.2 million related to the write-off of unamortized deferred financing costs associated with the then-existing senior credit facility.
 
(d)
On December 29, 2005, we refinanced our then-existing senior credit facility and, in connection with the refinancing, recorded a non-cash charge of approximately $1.8 million related to the write-off of unamortized deferred financing costs associated with the then-existing senior credit facility.
  
(e)
We define EBITDA as net income before interest expense, net, gain/loss on extinguishment of debt, income taxes, depreciation and amortization. Adjusted EBITDA includes the lease payments we make under our lease finance obligations as a reduction to EBITDA. EBITDA and Adjusted EBITDA are not measures of operating performance or liquidity under accounting principles generally accepted in the United States of America (“GAAP”) and should not be considered as substitutes for net income, cash flows from operating activities or other income or cash flow statement data. We have included information concerning EBITDA and Adjusted EBITDA because we believe investors find this information useful as a reflection of the resources available for strategic opportunities including, among others, to invest in our business, make strategic acquisitions and to service debt. Management also uses EBITDA and Adjusted EBITDA to review the performance of our business directly resulting from our retail operations and for budgeting and field operations compensation targets.

In accordance with GAAP, certain of our leases, including all of our sale-leaseback arrangements are accounted for as lease finance obligations. As a result, payments made under these lease arrangements are accounted for as interest expense and a reduction of the principal amounts outstanding on our lease finance obligations. By including in Adjusted EBITDA the amounts we pay under our lease finance obligations, we are able to present such payments as operating costs instead of financing costs. We believe that this presentation helps investors better understand our operating performance relative to other companies that have operating leases.
 
Any measure that excludes interest expense, gain/loss on extinguishment of debt, depreciation and amortization or income taxes has material limitations because we use debt and lease financing in order to finance our operations and acquisitions, we use capital and intangible assets in our business and the payment of income taxes is a necessary element of our operations. Due to these limitations, we use EBITDA and Adjusted EBITDA only in addition to and in conjunction with results and cash flows presented in accordance with GAAP. We strongly encourage investors to review our consolidated financial statements and publicly filed reports in their entirety and not to rely on any single financial measure.

Because non-GAAP financial measures are not standardized, EBITDA and Adjusted EBITDA, as defined by us, may not be comparable to similarly titled measures reported by other companies. It therefore may not be possible to compare our use of EBITDA and Adjusted EBITDA with non-GAAP financial measures having the same or similar names used by other companies.

23

 
 

 








The following table contains a reconciliation of EBITDA and Adjusted EBITDA to net income (amounts in thousands):
 
   
Fiscal Year Ended
 
   
September 24,
2009
   
September 25,
2008
   
September 27,
2007
   
September 28,
2006
   
September 29,
2005
 
Adjusted EBITDA
  $ 232,982     $ 201,093     $ 178,097     $ 254,151     $ 189,390  
Payments made for lease finance obligations
    47,175       46,137       35,889       24,719       24,471  
                                         
EBITDA
    280,157       247,230       213,986       278,870       213,861  
Gain/(loss) on extinguishment of debt
    7,163             (2,212 )     (1,832 )      
Interest expense, net
    (84,229 )     (87,593 )     (72,199 )     (54,661 )     (54,314 )
Depreciation and amortization
    (109,612 )     (108,326 )     (95,887 )     (76,025 )     (64,341 )
Income tax expense
    (34,368 )     (19,528 )     (16,956 )     (57,154 )     (37,396 )
                                         
Net income
  $ 59,111     $ 31,783     $ 26,732     $ 89,198     $ 57,810  
                                         
 

The following table contains a reconciliation of EBITDA and Adjusted EBITDA to net cash provided by operating activities (amounts in thousands):
 
   
Fiscal Year Ended
 
   
September 24,
2009
   
September 25,
2008
   
September 27,
2007
   
September 28,
2006
   
September 29,
2005
 
Adjusted EBITDA
  $ 232,982     $ 201,093     $ 178,097     $ 254,151     $ 189,390  
Payments made for lease finance obligations
    47,175       46,137       35,889       24,719       24,471  
EBITDA
    280,157       247,230       213,986       278,870       213,861  
Gain/(loss) on extinguishment of debt
    7,163             (2,212 )     (1,832 )      
Interest expense, net
    (84,229 )     (87,593 )     (72,199 )     (54,661 )     (54,314 )
Income tax expense
    (34,368 )     (19,528 )     (16,956 )     (57,154 )     (37,396 )
Stock-based compensation expense
    6,367       3,321       3,657       2,812        
Changes in operating assets and liabilities
    (18,050 )     (6,410 )     6,335       (18,587 )     (7,364 )
Other
    12,396       20,484       8,025       4,815       18,794  
Net cash provided by operating activities
  $ 169,436     $ 157,504     $ 140,636     $ 154,263     $ 133,581  
Net cash used in investing activities
  $ (166,012 )   $ (115,513 )   $ (528,723 )   $ (219,285 )   $ (166,240 )
 Net cash (used in) provided by financing activities
  $ (50,732 )   $ 103,694     $ 339,196     $ 73,944     $ 36,083  



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(f)
Investing activities include expenditures for acquisitions.
 
 
(g)
The stores included in calculating comparable store sales growth are existing or replacement stores, which were in operation during the entire comparable period of both fiscal years. Remodeling, physical expansion or changes in store square footage are not considered when computing comparable store sales growth. Comparable store sales as defined by us may not be comparable to similarly titled measures reported by other companies.
 
(h)
Gasoline gross profit per gallon represents gasoline revenue less costs of product and expenses associated with credit card processing fees and repairs and maintenance on gasoline equipment. Gasoline gross profit per gallon as presented may not be comparable to similarly titled measures reported by other companies.
 


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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand the results of operations and financial condition of The Pantry, Inc. MD&A is provided as a supplement to, and should be read in conjunction with “Part II.—Item 6. Selected Financial Data” and our consolidated financial statements and the related notes appearing in “Part II.—Item 8. Consolidated Financial Statements and Supplementary Data.”

Safe Harbor Discussion

This report, including, without limitation, our MD&A, contains statements that we believe are “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 and that are intended to enjoy the protection of the safe harbor for forward-looking statements provided by that Act. These forward-looking statements generally can be identified by the use of phrases such as “believe,” “plan,” “expect,” “anticipate,” “intend,” “forecast” or other similar words or phrases. Descriptions of our objectives, goals, targets, plans, strategies, costs and burdens of environmental remediation, anticipated capital expenditures, expected cost savings and benefits and anticipated synergies from acquisitions, and expectations regarding remodeling, rebranding, re-imaging or otherwise converting our stores are also forward-looking statements. These forward-looking statements are based on our current plans and expectations and involve a number of risks and uncertainties that could cause actual results and events to vary materially from the results and events anticipated or implied by such forward-looking statements, including:
 
 
 
competitive pressures from convenience stores, gasoline stations and other non-traditional retailers located in our markets;

 
 
volatility in crude oil and wholesale petroleum costs;

 
 
political conditions in crude oil producing regions and global demand;
 
 
 
changes in economic conditions generally and in the markets we serve;
 
 
 
consumer behavior, travel and tourism trends;

 
 
wholesale cost increases of, tax increases on and campaigns to discourage the use of tobacco products;

 
 
unfavorable weather conditions or other trends or developments in the southeastern United States;
 
 
 
inability to identify, acquire and integrate new stores;

 
 
financial leverage and debt covenants;

 
 
federal and state environmental, tobacco and other laws and regulations;
 
 
 
dependence on one principal supplier for merchandise and two principal suppliers for gasoline;
 
 
 
dependence on senior management;
 
 
 
litigation risks, including with respect to food quality, health and other related issues;
 
 
 
inability to maintain an effective system of internal control over financial reporting; and
 
 
 
other unforeseen factors.



26

 
 

 







For a discussion of these and other risks and uncertainties, please refer to “Part I.—Item 1A. Risk Factors.” The list of factors that could affect future performance and the accuracy of forward-looking statements is illustrative but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty. The forward-looking statements included in this report are based on, and include, our estimates as of December 8, 2009. We anticipate that subsequent events and market developments will cause our estimates to change. However, while we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if new information becomes available.

Our Business

We are the leading independently operated convenience store chain in the southeastern United States with 1,673 stores in 11 states as of September 24, 2009. Our stores operate under a number of select banners, with 1,569 of our stores operating under either the Kangaroo Express ® or Kangaroo ® banners, which are our primary operating banners. We derive our revenue from the sale of merchandise, gasoline and other ancillary products and services designed to appeal to the convenience needs of our customers. Our strategy is to continue to improve upon our position as the leading independently operated convenience store chain in the southeastern United States in the following ways:
 
 
 
generating profitable growth through merchandising initiatives;
 
 
 
sophisticated management of our gasoline business;
 
 
 
leveraging our geographic economies of scale;

 
 
strong cash flow generation to reinvest in our business and drive earnings growth ;
 
 
 
leveraging infrastructure to drive profitability and growth;
  
 
 
continuing to focus on in store growth; and

 
 
selectively pursuing acquisitions and developing new stores.

 
Executive Summary

Fiscal 2009 was a challenging year for our customers, as unemployment rates increased, energy prices rose and inflation outpaced wage growth. In addition, tumultuous financial markets led to decreasing consumer confidence in the economy. The unfavorable economic environment led consumers to reduce discretionary spending and miles driven.  In an effort to adjust to these challenging economic conditions, we aggressively managed per store operating expenses and utilized the cash flow from a favorable gasoline margin environment in the first half of fiscal 2009 to buy back debt.

Our total revenues for fiscal 2009 decreased 29.0% from fiscal 2008 to $6.4 billion. This decline in revenue was primarily driven by lower retail gasoline prices which fell from an average of $3.40 a gallon in fiscal 2008 to an average of $2.24 a gallon in fiscal 2009. We experienced an extremely favorable energy market environment in the first quarter of fiscal 2009, which saw oil prices plummet from $107 a barrel to $34 a barrel in the second quarter of fiscal 2009. Despite a positive gasoline market to begin fiscal 2009, the unfavorable economic environment continued to negatively impact comparable store gasoline gallon volume. Comparable store merchandise revenue trended higher in the second half of fiscal 2009 and we finished the fiscal year with two straight quarters of positive comparable store growth in merchandise sales primarily driven by cigarette inflation. For the year ended September 24, 2009, we recorded net income of $59.1 million and diluted earnings per share of $2.65 compared to net income of $31.8 million and diluted earnings per share of $1.43 in fiscal 2008.

 
We were able to make progress in several areas, including the following:
 
     
 
We enhanced our liquidity position by buying back $24.0 million in principal amount of our convertible bonds and $3.0 million in principal amount of our senior subordinated notes at a discount, which generated a pre-tax gain of approximately $7.2 million.

 
We grew our store base through the acquisition of 41 stores and the construction of three new stores in our existing markets.

 
We continued our focus on store level expense controls that enabled us to reduce per store operating costs year over year.

 
We delivered a gasoline margin of 15.0 cents per gallon, significantly above the 12.4 cents per gallon in fiscal 2008.  

27

 
 

 







On April 23, 2009 Peter J. Sodini, then Chairman and Chief Executive Officer, announced his retirement at the expiration of his contract on September 30, 2009.  On August 27, 2009 we announced that Terrance M. Marks would become President and Chief Executive Officer  effective September 25, 2009.  Mr. Marks previously served as Executive Vice President of Coca-Cola Enterprises, Inc. and President of Coca-Cola Enterprises, Inc. North America Corp.

Market and Industry Outlook

Our financial results are significantly affected by the cost of petroleum and the commodities market; however we believe our fiscal 2010 performance may be influenced by a number of additional trends. These market and industry trends include:

 
The convenience store industry continues to consolidate. Some convenience store companies have already affirmed that they will be active participants in the acquisition arena. Fifty percent or more of the convenience stores in our primary markets are single store operators providing opportunities for consolidation.
 
 
Many convenience store companies are concentrating on providing more offerings in base store food service. This trend includes providing fresh foods, quick service restaurants or some type of proprietary offering.
 

 
The wholesale cost of cigarettes is trending higher. Several tobacco companies have already raised their prices on most brands or are in the process of doing so. We also continue to be impacted by state cigarette excise tax increases instituted during fiscal 2009 and expect to continue to see increases in state cigarette excise taxes.

 
Oil and gasoline prices will in all probability remain volatile and unpredictable.


28

 
 

 







Results of Operations

We believe the selected sales data and the percentage change in the dollar amounts of each of the items presented below are important in evaluating the performance of our business operations. We operate in one business segment and believe the information presented in MD&A provides an understanding of our business segment, our operations and our financial condition. The table below provides a summary of our selected financial data for fiscal 2009, fiscal 2008 and fiscal 2007, each of which contained 52 weeks (dollars in thousands, except per gallon data):
 
   
Fiscal Year Ended
 
   
September 24,
2009
   
September 25,
2008
   
September 27,
2007
 
Selected financial data:
                 
Merchandise gross profit[1]
  $ 587,084     $ 595,137     $ 586,028  
Merchandise margin
    35.4 %     36.4 %     37.2 %
Retail gasoline data:
                       
Gallons (in millions)
    2,078.0       2,103.4       2,032.8  
Margin per gallon
  $ 0.150     $ 0.124     $ 0.109  
Retail price per gallon
  $ 2.24     $ 3.40     $ 2.55  
Total gasoline gross profit[1]
  $ 313,658     $ 262,964     $ 224,696  
Comparable store data:
                       
Merchandise sales increase (decrease) (%)
    0.0 %     (1.7 %)     2.3 %
Merchandise sales increase (decrease)
  $ 327     $ (25,209 )   $ 29,443  
Gasoline gallons (decrease) increase (%)
    (3.3 %)     (4.4 %)     1.0 %
Gasoline gallons (decrease) increase  (in thousands)
    (68,481 )     (80,368 )     16,115  
Number of stores:
                       
End of period
    1,673       1,653       1,644  
Weighted-average store count
    1,657       1,651       1,578  
 
[1]
We compute gross profit exclusive of depreciation and allocation of store operating and general and administrative expenses.
 

Fiscal 2009 Compared to Fiscal 2008

Merchandise Revenue and Gross Profit.    Merchandise revenue for fiscal 2009 increased $22.2 million, or 1.4%, from fiscal 2008. This increase is primarily due to the merchandise revenue from stores acquired in fiscal 2009 and the effect of a full year of revenue from 2008 acquisitions of $19.5 million. Revenue from stores constructed in fiscal 2009 and the effect of a full year of revenue from stores constructed in 2008 of $12.5 million also added to the increase in merchandise revenue.  Revenue from newly acquired and newly constructed stores and an increase in comparable store merchandise revenue of $327 thousand was partially offset by lost revenue from closed stores of approximately $10.4 million. Although the sluggish economy has decreased merchandise unit sales, the increase in comparable store merchandise revenue was primarily attributed to increased retail prices resulting from the recent increase in federal excise cigarette taxes and growth in food service sales. Merchandise revenue included service revenue of $55.6 million for fiscal 2009 compared to $56.9 million for fiscal 2008, a decrease of $1.3 million, or 2.2%.  This decline was primarily the result of decreased consumer discretionary spending which impacted carwash revenue and other service categories.

Merchandise gross profit for fiscal 2009 decreased $8.1 million, or 1.4%, from fiscal 2008. This decrease is primarily attributable to a 100 basis point decrease in merchandise gross margin to 35.4% for fiscal 2009 compared to 36.4% for fiscal 2008, partially offset by the increased merchandise revenue discussed above. The decrease in merchandise gross margin was primarily due to the impact of increased state and federal excise taxes in the cigarette category. We saw large increases in federal excise taxes to support the State Children’s Health Insurance Program (SCHIP) during the fiscal year. The federal excise tax on cigarettes increased $0.62 per pack on April 1, 2009. Additionally, Florida increased state excise taxes $1.00 per pack effective July 1, 2009 which impacted approximately 26% of our stores. While we attempted to pass on the increased cost to our customers, the tax increase resulted in lower unit volumes and reduced merchandise margins. We also began to experience, and expect to continue to see, increases in state cigarette excise taxes, as states look for additional revenue sources to cover their revenue shortfalls caused by the soft economy. Additionally, the weak economic conditions led to a continued sales mix shift away from some of our higher margin categories like grocery, packaged beverages and services toward lower margin categories like cigarettes and beer.  Our overall merchandise gross margin has recently been trending lower and we anticipate continued pressure on merchandise margins in fiscal 2010. We compute gross profit exclusive of depreciation and allocation of store operating and general and administrative expenses.

29

 
 

 








Gasoline Revenue, Gallons, and Gross Profit.    Gasoline revenue for fiscal 2009 decreased $2.6 billion, or 35.7%, from fiscal 2008. This decrease is primarily due to a decrease in gallons sold and a drop in the average retail gasoline price per gallon from $3.40 in fiscal 2008 to $2.24 for fiscal 2009. The decrease in our average retail price per gallon was primarily the result of falling oil prices, which went from a high of $107 a barrel to a low of $34 a barrel, in the second quarter of fiscal 2009. While oil prices trended higher the rest of our fiscal year, the average retail price per gasoline gallon in fiscal 2009 remained significantly lower than fiscal 2008. Retail gasoline gallons sold for fiscal 2009 decreased 25.4 million gallons, or 1.2%, from fiscal 2008. This decrease is primarily attributable to a 68.5 million gallon decrease in comparable store gasoline gallons sold and lost gasoline volume from closed stores of approximately 8.3 million gallons.  These declines were partially offset by 28.5 million gasoline gallons sold at stores acquired since the beginning of fiscal 2008 and 23.1 million gasoline gallons sold at newly-constructed stores since the beginning of fiscal 2008.  The decrease in comparable store gasoline gallons sold was primarily attributed to continued economic difficulty and decreased diesel demand. While comparable store non-diesel gallon volume trended higher throughout fiscal 2009, diesel gallon volume remained extremely soft as the faltering economy led to decreased truck traffic.

Gasoline gross profit for fiscal 2009 increased $50.7 million, or 19.3%, from fiscal 2008. This increase was primarily due to our retail gross profit per gallon rising from $0.124 in fiscal 2008 to $0.150 for fiscal 2009, partially offset by the decline in gallon volume discussed above. As a result of a continued global economic recession which impacted oil demand, we experienced a sharp decline in oil and gasoline prices in our first quarter of fiscal 2009, which favorably impacted our gasoline margins. We compute gross profit exclusive of depreciation and allocation of store operating and general and administrative expenses. We present gasoline gross profit per gallon inclusive of credit card processing fees and repairs and maintenance on gasoline equipment. These fees and costs totaled $0.045 per gallon and $0.057 per gallon for fiscal 2009 and fiscal 2008, respectively. The decrease in these fees was primarily due to lower average retail gasoline prices.
 
Store Operating and General and Administrative.    Store operating and general and administrative expenses for fiscal 2009 increased $8.9 million, or 1.5%, from fiscal 2008. The increase in store operating expenses is primarily due to increased store count from acquisitions and new builds as well as increased store facilities expense associated with refurbishing many of our stores. Rent expenses increased due to a higher store count and we experienced higher utilities expenses as a result of rate increases. These expense increases were offset by increased focus on reducing store controllable expenses and our concentrated efforts on adjusting our labor needs to match decreases in store traffic and volumes. This focus led to favorable year over year variances in store salary and wage expense. The increase in general and administrative expenses is primarily due to increased bonus accruals, accelerated vesting of stock-based compensation and CEO transition costs.

Depreciation and Amortization.    Depreciation and amortization expenses for fiscal 2009 were generally consistent with fiscal 2008.  Depreciation and amortization expenses increased $1.3 million, or 1.2%, to $109.6 million in fiscal 2009 compared to $108.3 million in fiscal 2008.

Income from Operations.    Income from operations for fiscal 2009 increased $32.5 million, or 23.6%, from fiscal 2008. This increase is primarily due to the increase in gasoline gross profit of $50.7 million, offset by the decrease in merchandise gross profit of $8.1 million, the increase in store operating expenses and general and administrative of $8.9 million and the increase in depreciation of $1.3 million.

EBITDA and Adjusted EBITDA.    We define EBITDA as net income before interest expense, net, gain/loss on extinguishment of debt, income taxes, depreciation and amortization. Adjusted EBITDA includes the lease payments we make under our lease finance obligations as a reduction to EBITDA. EBITDA for fiscal 2009 increased $32.9 million, or 13.3%, from fiscal 2008. Adjusted EBITDA for fiscal 2009 increased $31.9 million, or 15.9%, from 2008. These increases are primarily due to the variances discussed above.

EBITDA and Adjusted EBITDA are not measures of operating performance or liquidity under GAAP and should not be considered as substitutes for net income, cash flows from operating activities or other income or cash flow statement data. We have included information concerning EBITDA and Adjusted EBITDA because we believe investors find this information useful as a reflection of the resources available for strategic opportunities including, among others, to invest in our business, make strategic acquisitions and to service debt. Management also uses EBITDA and Adjusted EBITDA to review the performance of our business directly resulting from our retail operations and for budgeting and field operations compensation targets.

In accordance with GAAP, certain of our leases, including all our sale-leaseback arrangements are accounted for as lease finance obligations. As a result, payments made under these lease arrangements are accounted for as interest expense and a reduction of the principal amounts outstanding on our lease finance obligations. By including in Adjusted EBITDA the amounts we pay under our lease finance obligations, we are able to present such payments as operating costs instead of financing costs. We believe that this presentation helps investors better understand our operating performance relative to other companies that have operating leases.

30

 
 

 






Any measure that excludes interest expense, loss on extinguishment of debt, depreciation and amortization or income taxes has material limitations because we use debt and lease financing in order to finance our operations and acquisitions, we use capital and intangible assets in our business and the payment of income taxes is a necessary element of our operations. Due to these limitations, we use EBITDA and Adjusted EBITDA only in addition to and in conjunction with results and cash flows presented in accordance with GAAP. We strongly encourage investors to review our consolidated financial statements and publicly filed reports in their entirety and not to rely on any single financial measure.

Because non-GAAP financial measures are not standardized, EBITDA and Adjusted EBITDA, as defined by us, may not be comparable to similarly titled measures reported by other companies. It therefore may not be possible to compare our use of EBITDA and Adjusted EBITDA with non-GAAP financial measures having the same or similar names used by other companies.

 
The following table contains a reconciliation of EBITDA and Adjusted EBITDA to net income (amounts in thousands):
 
             
   
Fiscal Year Ended
 
   
September 24,
2009
   
September 25,
2008
 
Adjusted EBITDA
  $ 232,982     $ 201,093  
Payments made for lease finance obligations
    47,175       46,137  
                 
EBITDA
    280,157       247,230  
Gain on extinguishment of debt
    7,163        
Interest expense, net
    (84,229 )     (87,593 )
Depreciation and amortization
    (109,612 )     (108,326 )
Income tax expense
    (34,368 )     (19,528 )
                 
Net income
  $ 59,111     $ 31,783 )
                 

The following table contains a reconciliation of EBITDA and Adjusted EBITDA to net cash provided by operating activities (amounts in thousands):
 
   
Fiscal Year Ended
 
   
September 24,
2009
   
September 25,
2008
 
Adjusted EBITDA
  $ 232,982     $ 201,093  
Payments made for lease finance obligations
    47,175       46,137  
                 
EBITDA
    280,157       247,230  
Gain on extinguishment of debt
    7,163        
Interest expense, net
    (84,229 )     (87,593 )
Income tax expense
    (34,368 )     (19,528 )
Stock-based compensation expense
    6,367       3,321  
Changes in operating assets and liabilities
    (18,050 )     (6,410 )
Other
    12,396       20,484  
                 
Net cash provided by operating activities
  $ 169,436     $ 157,504