-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ElAUWsAjhk9HKIsrruqzOcRUXSvlG7jl2oUVoQ+TW1aMC+umSf5WFLKBr5L+7y1F d7wIhU+3uNYwsoBxpHLZqg== 0000950168-02-001344.txt : 20020513 0000950168-02-001344.hdr.sgml : 20020513 ACCESSION NUMBER: 0000950168-02-001344 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020328 FILED AS OF DATE: 20020513 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PANTRY INC CENTRAL INDEX KEY: 0000915862 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-AUTO DEALERS & GASOLINE STATIONS [5500] IRS NUMBER: 561574463 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-25813 FILM NUMBER: 02643793 BUSINESS ADDRESS: STREET 1: 1801 DOUGLAS DR STREET 2: PO BOX 1410 CITY: SANFORD STATE: NC ZIP: 27330 BUSINESS PHONE: 9197746700 MAIL ADDRESS: STREET 1: 1801 DOUGLAS DR STREET 2: PO BOX 1410 CITY: SANFORD STATE: NC ZIP: 27330 10-Q 1 d10q.htm FORM 10-Q Prepared by R.R. Donnelley Financial -- FORM 10-Q
Table of Contents
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended March 28, 2002
 
Commission File Number 33-72574
 
 
THE PANTRY, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
  
56-1574463
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification Number)
 
1801 Douglas Drive
Sanford, North Carolina
27330-1410
(Address of principal executive offices)
 
 
Registrant’s telephone number, including area code: (919) 774-6700
 
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No ¨
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
COMMON STOCK, $0.01 PAR VALUE
  
18,107,597 SHARES
(Class)
  
(Outstanding at May 6, 2002)
 

Table of Contents
 
THE PANTRY, INC.
 
FORM 10-Q
 
MARCH 28, 2002
 
 

2

Table of Contents
 
PART I-FINANCIAL INFORMATION.
 
Item 1.    Financial Statements.
 
(Dollars in thousands)
 
    
March 28, 2002
     
September 27, 2001
  
    
(Unaudited)
     
(Audited)
  
ASSETS
                  
Current assets:
                  
Cash and cash equivalents
   
$
35,060
 
   
$
50,611
 
Receivables, net
   
 
32,461
 
   
 
30,424
 
Inventories (Note 2)
   
 
81,283
 
   
 
81,687
 
Prepaid expenses
   
 
4,677
 
   
 
3,521
 
Property held for sale
   
 
425
 
   
 
1,644
 
Deferred income taxes (Note 6)
   
 
1,811
 
   
 
2,591
 
    
  
Total current assets
   
 
155,717
 
   
 
170,478
 
    
  
Property and equipment, net
   
 
448,864
 
   
 
470,678
 
    
  
Other assets:
                  
Goodwill (Note 3)
   
 
277,924
 
   
 
277,665
 
Deferred financing cost, net
   
 
10,099
 
   
 
10,299
 
Environmental receivables (Note 4)
   
 
11,012
 
   
 
10,428
 
Other noncurrent assets
   
 
10,274
 
   
 
10,444
 
    
  
Total other assets
   
 
309,309
 
   
 
308,836
 
    
  
Total assets
   
$
913,890
 
   
$
949,992
 
    
  
LIABILITIES AND SHAREHOLDERS’ EQUITY
                  
Current liabilities:
                  
Current maturities of long-term debt (Note 5)
   
$
36,502
 
   
$
40,000
 
Current maturities of capital lease obligations
   
 
1,363
 
   
 
1,363
 
Accounts payable
   
 
101,274
 
   
 
94,169
 
Accrued interest
   
 
10,919
 
   
 
11,163
 
Accrued compensation and related taxes
   
 
12,402
 
   
 
12,514
 
Other accrued taxes
   
 
11,889
 
   
 
14,515
 
Accrued insurance
   
 
7,717
 
   
 
6,161
 
Other accrued liabilities (Notes 6 and 7)
   
 
10,030
 
   
 
20,423
 
    
  
Total current liabilities
   
 
192,096
 
   
 
200,308
 
    
  
Long-term debt (Note 5)
   
 
483,821
 
   
 
504,175
 
    
  
Other liabilities:
                  
Environmental reserves (Note 4)
   
 
12,667
 
   
 
12,207
 
Deferred income taxes
   
 
31,610
 
   
 
33,488
 
Deferred revenue
   
 
54,706
 
   
 
57,560
 
Capital lease obligations
   
 
13,481
 
   
 
14,020
 
Other noncurrent liabilities
   
 
16,497
 
   
 
17,093
 
    
  
Total other liabilities
   
 
128,961
 
   
 
134,368
 
    
  
Commitments and contingencies (Notes 4 and 5)
                  
Shareholders’ equity (Notes 6 and 9):
                  
Common stock, $.01 par value, 50,000,000 shares authorized; 18,114,737 issued and outstanding at September 27, 2001 and 18,107,597 at March 28, 2002
   
 
182
 
   
 
182
 
Additional paid-in capital
   
 
128,043
 
   
 
128,043
 
Shareholder loans
   
 
(827
)
   
 
(837
)
Accumulated other comprehensive deficit, net
   
 
(2,759
)
   
 
(4,283
)
Accumulated deficit
   
 
(15,627
)
   
 
(11,964
)
    
  
Total shareholders’ equity
   
 
109,012
 
   
 
111,141
 
    
  
Total liabilities and shareholders’ equity
   
$
913,890
 
   
$
949,992
 
    
  
 
See Notes to Consolidated Financial Statements.

3

Table of Contents
 
THE PANTRY, INC.
 
(Unaudited)
(Dollars in thousands, except per share data)
 
    
Three Months Ended
     
Six Months Ended
  
    
March 28, 2002
     
March 29, 2001
     
March 28, 2002
     
March 29, 2001
  
    
(13 weeks)
     
(13 weeks)
     
(26 weeks)
     
(26 weeks)
  
Revenues:
                                    
Merchandise sales
   
$
232,477
 
   
$
229,740
 
   
$
469,715
 
   
$
458,210
 
Gasoline sales
   
 
322,015
 
   
 
400,375
 
   
 
656,328
 
   
 
800,582
 
Commissions
   
 
6,353
 
   
 
5,588
 
   
 
12,175
 
   
 
11,154
 
    
  
  
  
Total revenues
   
 
560,845
 
   
 
635,703
 
   
 
1,138,218
 
   
 
1,269,946
 
    
  
  
  
Cost of sales:
                                    
Merchandise
   
 
156,122
 
   
 
150,883
 
   
 
316,047
 
   
 
301,791
 
Gasoline
   
 
296,623
 
   
 
368,560
 
   
 
598,592
 
   
 
732,950
 
    
  
  
  
Total cost of sales
   
 
452,745
 
   
 
519,443
 
   
 
914,639
 
   
 
1,034,741
 
    
  
  
  
Gross profit
   
 
108,100
 
   
 
116,260
 
   
 
223,579
 
   
 
235,205
 
    
  
  
  
Operating expenses:
                                    
Operating, general and administrative expenses
   
 
89,962
 
   
 
91,278
 
   
 
178,938
 
   
 
178,448
 
Restructuring and other charges (Note 7)
   
 
—  
 
   
 
3,470
 
   
 
—  
 
   
 
3,470
 
Depreciation and amortization
   
 
13,512
 
   
 
15,557
 
   
 
26,904
 
   
 
30,935
 
    
  
  
  
Total operating expenses
   
 
103,474
 
   
 
110,305
 
   
 
205,842
 
   
 
212,853
 
    
  
  
  
Income from operations
   
 
4,626
 
   
 
5,955
 
   
 
17,737
 
   
 
22,352
 
    
  
  
  
Other income (expense):
                                    
Interest expense (Note 8)
   
 
(11,823
)
   
 
(14,642
)
   
 
(24,166
)
   
 
(28,669
)
Miscellaneous
   
 
302
 
   
 
36
 
   
 
327
 
   
 
1,040
 
    
  
  
  
Total other expense
   
 
(11,521
)
   
 
(14,606
)
   
 
(23,839
)
   
 
(27,629
)
    
  
  
  
Loss before income taxes
   
 
(6,895
)
   
 
(8,651
)
   
 
(6,102
)
   
 
(5,277
)
Income tax benefit
   
 
2,757
 
   
 
3,762
 
   
 
2,439
 
   
 
2,295
 
    
  
  
  
Net loss
   
$
(4,138
)
   
$
(4,889
)
   
$
(3,663
)
   
$
(2,982
)
    
  
  
  
Loss per share (Note 9):
                                    
Basic
   
$
(0.23
)
   
$
(0.27
)
   
$
(0.20
)
   
$
(0.16
)
Diluted
   
$
(0.23
)
   
$
(0.27
)
   
$
(0.20
)
   
$
(0.16
)
 
See Notes to Consolidated Financial Statements.

4

Table of Contents
 
THE PANTRY, INC.
 
(Unaudited)
(Dollars in thousands)
 
      
Six Months Ended
  
      
March 28, 2002
     
March 29, 2001
  
      
(26 weeks)
     
(26 weeks)
  
CASH FLOWS FROM OPERATING ACTIVITIES
                    
Net loss
     
$
(3,663
)
   
$
(2,982
)
Adjustments to reconcile net loss to net cash provided by operating activities:
                    
Depreciation and amortization
     
 
26,904
 
   
 
30,935
 
Provision for deferred income taxes
     
 
(1,945
)
   
 
(1,727
)
(Gain) loss on sale of property and equipment
     
 
(163
)
   
 
19
 
Reserves for environmental expenses
     
 
460
 
   
 
(300
)
Impairment of long-lived assets
     
 
40
 
   
 
—  
 
Fair market value change in non-qualifying derivatives
     
 
(1,157
)
   
 
672
 
Provision for closed stores
     
 
965
 
   
 
600
 
Changes in operating assets and liabilities, net of effects of acquisitions:
                    
Receivables
     
 
(2,621
)
   
 
(820
)
Inventories
     
 
451
 
   
 
3,185
 
Prepaid expenses
     
 
(1,221
)
   
 
(2,055
)
Other noncurrent assets
     
 
(72
)
   
 
445
 
Accounts payable
     
 
7,105
 
   
 
(12,058
)
Other current liabilities and accrued expenses
     
 
(8,075
)
   
 
(6,353
)
Other noncurrent liabilities
     
 
(2,940
)
   
 
3,365
 
      
  
Net cash provided by operating activities
     
 
14,068
 
   
 
12,926
 
      
  
CASH FLOWS FROM INVESTING ACTIVITIES
                    
Additions to property held for sale
     
 
(992
)
   
 
(317
)
Additions to property and equipment
     
 
(8,035
)
   
 
(16,619
)
Proceeds from sale of property held for sale
     
 
2,066
 
   
 
3,504
 
Proceeds from sale of property and equipment
     
 
3,153
 
   
 
1,205
 
Acquisitions of related businesses, net of cash acquired
     
 
(514
)
   
 
(55,938
)
      
  
Net cash used in investing activities
     
 
(4,322
)
   
 
(68,165
)
      
  
CASH FLOWS FROM FINANCING ACTIVITIES
                    
Principal repayments under capital leases
     
 
(539
)
   
 
(479
)
Principal repayments of long-term debt
     
 
(23,852
)
   
 
(8,641
)
Proceeds from issuance of long-term debt
     
 
—  
 
   
 
40,000
 
Repayments of shareholder loans
     
 
10
 
   
 
50
 
Proceeds from exercise of stock options
     
 
—  
 
   
 
25
 
Other financing costs
     
 
(916
)
   
 
(41
)
      
  
Net cash provided by (used in) financing activities
     
 
(25,297
)
   
 
30,914
 
      
  
NET DECREASE IN CASH AND CASH EQUIVALENTS
     
 
(15,551
)
   
 
(24,325
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
     
 
50,611
 
   
 
53,354
 
      
  
CASH AND CASH EQUIVALENTS AT END OF PERIOD
     
$
35,060
 
   
$
29,029
 
      
  
Cash paid (refunded) during the period:
                    
Interest
     
$
25,567
 
   
$
28,783
 
      
  
Taxes
     
$
(561
)
   
$
1,164
 
      
  
 
See Notes to Consolidated Financial Statements.

5

Table of Contents
 
THE PANTRY, INC.
 
 
NOTE 1—THE COMPANY AND RECENT DEVELOPMENTS
 
Unaudited Consolidated Financial Statements
 
The accompanying consolidated financial statements include the accounts of The Pantry, Inc. and its wholly owned subsidiaries. All inter-company transactions and balances have been eliminated in consolidation. Transactions and balances of each of these wholly owned subsidiaries are immaterial to the consolidated financial statements.
 
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The interim consolidated financial statements have been prepared from the accounting records of The Pantry, Inc. and its subsidiaries and all amounts at March 28, 2002 and for the three and six months ended March 28, 2002 and March 29, 2001 are unaudited. References herein to “The Pantry” or “the Company” include all subsidiaries. Pursuant to Regulation S-X, certain information and note disclosures normally included in annual financial statements have been condensed or omitted. The information furnished reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented, and which are of a normal, recurring nature.
 
We suggest that these interim financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 27, 2001.
 
Our results of operations for the three and six months ended March 28, 2002 and March 29, 2001 are not necessarily indicative of results to be expected for the full fiscal year. Our results of operations and comparisons with prior and subsequent quarters are impacted by the results of operations of businesses acquired since September 28, 2000. These acquisitions have been accounted for under the purchase method. Furthermore, the convenience store industry in our marketing areas generally experiences higher levels of revenues and profit margins during the summer months than during the winter months. Also, we have historically achieved higher revenues and earnings in our third and fourth quarters.
 
We operate on a 52-53 week fiscal year ending on the last Thursday in September. Our 2002 fiscal year ends on September 26, 2002 and is a 52-week year. Fiscal 2001 was also a 52-week year.
 
The Pantry
 
As of March 28, 2002, we operated 1,305 convenience stores located in Florida (501), North Carolina (335), South Carolina (252), Georgia (56), Mississippi (55), Kentucky (39), Virginia (30), Indiana (15), Tennessee (14) and Louisiana (8). Our stores offer a broad selection of products and services designed to appeal to the convenience needs of our customers, including gasoline, car care products and services, tobacco products, beer, soft drinks, self-service fast food and beverages, publications, dairy products, groceries, health and beauty aids, money orders and other ancillary services. In our Florida, Georgia, Kentucky, Virginia, Louisiana and Indiana stores, we also sell lottery products. On January 9, 2002, South Carolina introduced a state-wide lottery; as of that date, we began selling lottery products in South Carolina. Self-service gasoline is sold at 1,268 locations, 975 of which sell gasoline under major oil company brand names including Amoco®, BP®, Chevron®, Citgo®, Mobil®, Shell®, and Texaco®.

6

Table of Contents

THE PANTRY, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
NOTE 2—INVENTORIES
 
Inventories are valued at the lower of cost or market. Cost is determined using the last-in, first-out method, except for gasoline inventories for which cost is determined using the weighted average cost method. Inventories consisted of the following (amounts in thousands):
 
    
March 28, 2002
     
September 27, 2001
  
Inventories at FIFO cost:
                  
Merchandise
   
$
77,620
 
   
$
73,861
 
Gasoline
   
 
18,969
 
   
 
21,765
 
    
  
    
 
96,589
 
   
 
95,626
 
Less adjustment to LIFO cost:
                  
Merchandise
   
 
(15,306
)
   
 
(13,939
)
    
  
Inventories at LIFO cost
   
$
81,283
 
   
$
81,687
 
    
  
 
NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS
 
Effective September 28, 2001, we adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). As a result, our goodwill asset is no longer amortized but reviewed at least annually for impairment. Other intangible assets will continue to be amortized over their useful lives. As permitted, we early adopted SFAS No. 142 effective September 28, 2001, which has resulted in the discontinuance of goodwill amortization. We determined that we operate in one reporting unit based on the current reporting structure and have thus assigned goodwill at the enterprise level.
 
We have completed the first step of the transitional goodwill impairment test by comparing the enterprise fair value to its carrying or book value. This valuation indicated an aggregate fair value significantly in excess of our market capitalization as of September 28, 2001, therefore, we have determined that no impairment exists at the effective date of the implementation of the new standard. We believe our market capitalization is not representative of the fair value of the Company because our common stock is not actively traded. Fair value was measured using a valuation by an independent third party as of September 28, 2001 which was based on market multiples, comparable transactions and discounted cash flow methodologies.
 
On an ongoing basis, we will perform an annual goodwill impairment test. At least quarterly, we will analyze whether an event has occurred that would more likely than not reduce our enterprise fair value below its carrying amount and, if necessary, we will perform a goodwill impairment test between the annual dates. Impairment adjustments recognized after adoption, if any, will be recognized as operating expenses.

7

Table of Contents

THE PANTRY, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
The following pro forma information presents a summary of consolidated results of operations as if we adopted the provisions of SFAS No. 142 at the beginning of the fiscal year for each of the periods presented (amounts in thousands, except per share data):
 
    
Three Months Ended
     
Six Months Ended
  
    
March 28, 2002
     
March 29, 2001
     
March 28, 2002
     
March 29, 2001
  
Net loss
   
$
(4,138
)
   
$
(4,889
)
   
$
(3,663
)
   
$
(2,982
)
Goodwill amortization, net
   
 
—  
 
   
 
1,534
 
   
 
—  
 
   
 
2,867
 
    
  
  
  
Pro forma net loss
   
$
(4,138
)
   
$
(3,355
)
   
$
(3,663
)
   
$
(115
)
    
  
  
  
Proforma loss per share—basic:
                                    
Net loss
   
$
(0.23
)
   
$
(0.27
)
   
$
(0.20
)
   
$
(0.16
)
Goodwill amortization, net
   
 
—  
 
   
 
0.08
 
   
 
—  
 
   
 
0.16
 
    
  
  
  
Proforma net loss per share—basic
   
$
(0.23
)
   
$
(0.19
)
   
$
(0.20
)
   
$
(0.01
)
    
  
  
  
Proforma loss per share—diluted:
                                    
Net loss
   
$
(0.23
)
   
$
(0.27
)
   
$
(0.20
)
   
$
(0.16
)
Goodwill amortization, net
   
 
—  
 
   
 
0.08
 
   
 
—  
 
   
 
0.16
 
    
  
  
  
Proforma net loss per share—diluted
   
$
(0.23
)
   
$
(0.19
)
   
$
(0.20
)
   
$
(0.01
)
    
  
  
  
 
NOTE 4—ENVIRONMENTAL LIABILITIES AND OTHER CONTINGENCIES
 
As of March 28, 2002, we were contingently liable for outstanding letters of credit in the amount of $18.9 million primarily related to several self-insured programs, regulatory requirements and vendor contract terms. The letters of credit are not to be drawn against unless we default on the timely payment of related liabilities.
 
We are involved in certain legal actions arising in the normal course of business. In the opinion of management, based on a review of such legal proceedings, we believe the ultimate outcome of these actions will not have a material effect on the consolidated financial statements.
 
Environmental Liabilities and Contingencies
 
We are subject to various federal, state and local environmental laws. We make financial expenditures in order to comply with regulations governing underground storage tanks adopted by federal, state and local regulatory agencies. In particular, at the federal level, the Resource Conservation and Recovery Act of 1976, as amended, requires the EPA to establish a comprehensive regulatory program for the detection, prevention and cleanup of leaking underground storage tanks.
 
Federal and state regulations require us to provide and maintain evidence that we are taking financial responsibility for corrective action and compensating third parties in the event of a release from our underground storage tank systems. In order to comply with these requirements, as of May 6, 2002, we maintain surety bonds in the aggregate amount of approximately $138 thousand in favor of state environmental agencies in the states of Georgia, Tennessee, Kentucky and Louisiana and letters of credit in the aggregate amount of $967 thousand in favor of state environmental agencies in North Carolina, South Carolina, Virginia and Indiana. We also rely on reimbursements from applicable state trust funds. Legislative and administrative rulemaking amendments in Indiana that became effective in November 2001 enable us to reduce our Indiana financial responsibility coverage from $1.0 million to $60 thousand. In Florida, we meet our financial responsibility requirements by

8

Table of Contents

THE PANTRY, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

state trust fund coverage through December 31, 1998 and meet such requirements thereafter through private commercial liability insurance. In Georgia, we meet our financial responsibility requirements by state trust fund coverage through December 29, 1999, and meet such requirements thereafter through private commercial liability insurance and a surety bond. In Mississippi, we meet our financial responsibility requirements through coverage under the state trust fund.
 
Regulations enacted by the EPA in 1988 established requirements for:
 
 
•
 
installing underground storage tank systems;
 
 
•
 
upgrading underground storage tank systems;
 
 
•
 
taking corrective action in response to releases;
 
 
•
 
closing underground storage tank systems;
 
 
•
 
keeping appropriate records; and
 
 
•
 
maintaining evidence of financial responsibility for taking corrective action and compensating third parties for bodily injury and property damage resulting from releases.
 
These regulations permit states to develop, administer and enforce their own regulatory programs, incorporating requirements which are at least as stringent as the federal standards. The Florida rules for 1998 upgrades are more stringent than the 1988 EPA regulations. We believe our facilities in Florida meet or exceed such rules. We believe all company-owned underground storage tank systems are in material compliance with these 1988 EPA regulations and all applicable state environmental regulations.
 
State Trust Funds.    All states in which we operate or have operated underground storage tank systems have established trust funds for the sharing, recovering and reimbursing of certain cleanup costs and liabilities incurred as a result of releases from underground storage tank systems. These trust funds, which essentially provide insurance coverage for the cleanup of environmental damages caused by the operation of underground storage tank systems, are funded by an underground storage tank registration fee and a tax on the wholesale purchase of motor fuels within each state. We have paid underground storage tank registration fees and gasoline taxes to each state where we operate to participate in these trust fund programs. We have filed claims and received reimbursement in North Carolina, South Carolina, Kentucky, Indiana, Georgia, Florida and Tennessee. We also have filed claims and received credit against our trust fund deductibles in Virginia. The coverage afforded by each state fund varies but generally provides up to $1.0 million per site or occurrence for the cleanup of environmental contamination, and most provide coverage for third-party liabilities. Costs for which we do not receive reimbursement include:
 
 
•
 
the per-site deductible;
 
 
•
 
costs incurred in connection with releases occurring or reported to trust funds prior to their inception;
 
 
•
 
removal and disposal of underground storage tank systems; and
 
 
•
 
costs incurred in connection with sites otherwise ineligible for reimbursement from the trust funds.
 
The trust funds generally require us to pay deductibles ranging from $5 thousand to $150 thousand per occurrence depending on the upgrade status of our underground storage tank system, the date the release is discovered/reported and the type of cost for which reimbursement is sought. The Florida trust fund will not cover releases first reported after December 31, 1998. We obtained private insurance coverage for remediation and third party claims arising out of releases reported after December 31, 1998. We believe that this coverage exceeds federal and Florida financial responsibility regulations. In Georgia, we opted not to participate in the

9

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THE PANTRY, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

state trust fund effective December 30, 1999. We obtained private insurance coverage for remediation and third party claims arising out of releases reported after December 29, 1999. We believe that this coverage exceeds federal and Georgia financial responsibility regulations. During the next five years, we may spend up to $1.7 million for remediation. In addition, we estimate that state trust funds established in our operating areas or other responsible third parties (including insurers) may spend up to $11.0 million on our behalf. To the extent those third parties do not pay for remediation as we anticipate, we will be obligated to make such payments. This could materially adversely affect our financial condition and results of operations. Reimbursements from state trust funds will be dependent upon the continued maintenance and continued solvency of the various funds.
 
Several of the locations identified as contaminated are being remediated by third parties who have indemnified us as to responsibility for cleanup matters. Additionally, we are awaiting closure notices on several other locations that will release us from responsibility related to known contamination at those sites. These sites continue to be included in our environmental reserve until a final closure notice is received.
 
NOTE 5—LONG-TERM DEBT
 
Long-term debt consisted of the following (amounts in thousands):
 
    
March 28, 2002
     
September 27, 2001
  
Senior subordinated notes payable; due October 15, 2007; interest payable semi-annually at 10.25%
   
$
200,000
 
   
$
200,000
 
Tranche A term loan; interest payable monthly at LIBOR plus 3.5%; principal due in quarterly installments through January 31, 2004
   
 
36,906
 
   
 
45,906
 
Tranche B term loan; interest payable monthly at LIBOR plus 4.0%; principal due in quarterly installments through January 31, 2006
   
 
177,132
 
   
 
178,079
 
Tranche C term loan; interest payable monthly at LIBOR plus 4.25%; principal due in quarterly installments through July 31, 2006
   
 
73,500
 
   
 
73,875
 
Acquisition term loan; interest payable monthly at LIBOR plus 3.5%; principal due in quarterly installments through January 31, 2004
   
 
32,000
 
   
 
45,500
 
Notes payable to McLane Company, Inc.; zero (0.0%) interest, with principal due in annual installments through February 26, 2003
   
 
593
 
   
 
593
 
Other notes payable; various interest rates and maturity dates
   
 
192
 
   
 
222
 
    
  
Total long-term debt
   
 
520,323
 
   
 
544,175
 
    
  
Less—current maturities
   
 
(36,502
)
   
 
(40,000
)
    
  
Long-term debt, net of current maturities
   
$
483,821
 
   
$
504,175
 
    
  
 
At March 28, 2002, our senior credit facility consists of a $45.0 million revolving credit facility available for working capital financing, general corporate purposes and issuing commercial and standby letters of credit and $319.5 million in outstanding term loans. As of March 28, 2002, there were no outstanding balances issued under the revolving credit facility. However, we had outstanding letters of credit of $18.9 million issued under the revolving credit facility. The LIBOR associated with our senior credit facility resets periodically and as of March 28, 2002, was 1.89%.
 
On November 7, 2001, we entered into an amendment to our senior credit facility that, among other things, modified financial covenants and increased the floating interest rate spread by 50 basis points as long as our

10

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THE PANTRY, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

consolidated pro forma leverage ratio is greater than 4.5:1. The floating interest rate spread will be reduced 25 basis points when the consolidated pro forma leverage ratio is less than 4.5:1.
 
The remaining annual maturities of our long-term debt is as follows (amounts in thousands):
 
Year Ended September:
     
            2002
   
 
16,148
            2003
   
 
43,255
            2004
   
 
52,912
            2005
   
 
88,654
            2006
   
 
119,354
            Thereafter
   
 
200,000
    
    
$
520,323
    
 
As of March 28, 2002, we were in compliance with all covenants and restrictions relating to all outstanding borrowings and substantially all of our net assets are restricted as to payment of dividends and other distributions.
 
NOTE 6—DERIVATIVE FINANCIAL INSTRUMENTS AND OTHER COMPREHENSIVE INCOME
 
We enter into interest rate swap and collar agreements to modify the interest rate characteristics of its outstanding long-term debt and have designated each qualifying instrument as a cash flow hedge. We formally document our hedge relationships, including identifying the hedge instruments and hedged items, as well as its risk management objectives and strategies for entering into the hedge transaction. At hedge inception, and at least quarterly thereafter, the Company assesses whether derivatives used to hedge transactions are highly effective in offsetting changes in the cash flow of the hedged item. We measure effectiveness by the ability of the interest rate swaps to offset cash flows associated with changes in the variable LIBOR rate associated with its term loan facilities using the hypothetical derivative method. To the extent the instruments are considered to be effective, changes in fair value are recorded as a component of other comprehensive income (loss). To the extent the instruments are considered ineffective, any changes in fair value relating to the ineffective portion are immediately recognized in earnings (interest expense). When it is determined that a derivative ceases to be a highly effective hedge, we discontinue hedge accounting, and any gains or losses on the derivative instrument are recognized in earnings. A reduction in interest expense of $922 thousand was recorded in the second quarter of fiscal 2002 for the mark-to-market adjustment of those instruments that do not qualify for hedge accounting.
 
The fair values of our interest rate swaps and collars are obtained from dealer quotes. These values represent the estimated amount we would receive or pay to terminate the agreement taking into consideration the difference between the contract rate of interest and rates currently quoted for agreements of similar terms and maturities. At March 28, 2002, other accrued liabilities and other non-current liabilities include derivative liabilities of $1.1 million and $6.5 million, respectively.
 
The components of accumulated other comprehensive deficit, net of related taxes, are as follows (amounts in thousands):
 
Cumulative effect of adoption of SFAS No. 133, net of taxes of $289
   
$
(461
)
Amortization reclassified into other comprehensive deficit, net of taxes of $128
   
 
201
 
Unrealized losses on qualifying cash flow hedges, net of taxes of $1,623
   
 
(2,499
)
    
Accumulated other comprehensive deficit
   
$
(2,759
)
    

11

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THE PANTRY, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
The components of comprehensive loss, net of related taxes, are as follow (amounts in thousands):
 
    
Three Months Ended
     
Six Months Ended
  
    
March 28,
2002
     
March 29,
2001
     
March 28,
2002
     
March 29,
2001
  
Net loss
   
$
(4,138
)
   
$
(4,889
)
   
$
(3,663
)
   
$
(2,982
)
Amortization of cumulative effect
   
 
(51
)
   
 
23
 
   
 
(103
)
   
 
(6
)
Unrealized gains (losses) on qualifying cash flow hedges
   
 
978
 
   
 
(2,314
)
   
 
1,421
 
   
 
(2,314
)
    
  
  
  
Comprehensive loss
   
$
(3,211
)
   
$
(7,180
)
   
$
(2,345
)
   
$
(5,302
)
    
  
  
  
 
NOTE 7—RESTRUCTURING RESERVE
 
During fiscal 2001, we completed a plan designed to strengthen our organizational structure and reduce operating costs by centralizing corporate administrative functions. The plan included closing an administrative facility located in Jacksonville, Florida, and integrating key marketing, finance and administrative activities into our corporate headquarters located in Sanford, North Carolina.
 
As a result of these actions, the Company recorded pre-tax restructuring and other charges of $4.8 million during fiscal 2001. At the beginning of fiscal 2002, the restructuring reserve included amounts related to employee termination benefits, lease obligations and legal and other professional consultant fees. Employee termination benefits represent severance and outplacement benefits for 100 employees, 49 of which are in administrative positions and 51 of which are in managerial positions. Lease obligations represent remaining lease payments in excess of estimated sublease rental income for the Jacksonville facility. Fiscal 2002 activity related to the remaining restructuring reserve was as follows (amounts in thousands):
 
      
Restructuring reserve
      
September 27, 2001
   
Cash Outlays
   
Non-cash Write-offs
   
March 28, 2002
Employee termination benefits
     
$
793
   
$
183
   
$
 —  
   
$
610
Lease buyout costs
     
 
603
   
 
251
   
 
—  
   
 
352
Legal and other professional costs
     
 
149
   
 
109
   
 
—  
   
 
40
      
  
  
  
Total restructuring reserve
     
$
1,545
   
$
543
   
$
—  
   
$
1,002
      
  
  
  
 
NOTE 8—INTEREST EXPENSE
 
The components of interest expense are as follows (amounts in thousands):
 
    
Three Months Ended
   
Six Months Ended
  
    
March 28, 2002
     
March 29, 2001
   
March 28, 2002
     
March 29, 2001
  
Interest on long-term debt
   
$
9,916
 
   
$
13,518
   
$
20,171
 
   
$
26,988
 
Interest rate swap settlements
   
 
2,331
 
   
 
13
   
 
4,189
 
   
 
(30
)
Interest on capital lease obligations
   
 
484
 
   
 
432
   
 
968
 
   
 
863
 
Fair market value change in non-qualifying derivatives
   
 
(922
)
   
 
672
   
 
(1,157
)
   
 
833
 
Miscellaneous
   
 
14
 
   
 
7
   
 
(5
)
   
 
15
 
    
  
  
  
Total interest expense
   
$
11,823
 
   
$
14,642
   
$
24,166
 
   
$
28,669
 
    
  
  
  

12

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THE PANTRY, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
NOTE 9—EARNINGS PER SHARE
 
We compute earnings per share data in accordance with the requirements of SFAS No. 128, Earnings Per Share. Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding warrants and stock options using the “treasury stock” method.
 
The following table reflects the calculation of basic and diluted earnings per share (amounts in thousands, except per share data):
 
    
Three Months Ended
     
Six Months Ended
  
    
March 28, 2002
     
March 29, 2001
     
March 28, 2002
     
March 29, 2001
  
Net loss
   
$
(4,138
)
   
$
(4,889
)
   
$
(3,663
)
   
$
(2,982
)
    
  
  
  
Loss per share—basic:
                                    
Weighted average shares outstanding
   
 
18,108
 
   
 
18,112
 
   
 
18,108
 
   
 
18,112
 
    
  
  
  
Net loss per share—basic
   
$
(0.23
)
   
$
(0.27
)
   
$
(0.20
)
   
$
(0.16
)
    
  
  
  
Loss per share—diluted:
                                    
Weighted average shares outstanding
   
 
18,108
 
   
 
18,112
 
   
 
18,108
 
   
 
18,112
 
Dilutive impact of options and warrants outstanding
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
    
  
  
  
Weighted average shares and potential dilutive shares outstanding
   
 
18,108
 
   
 
18,112
 
   
 
18,108
 
   
 
18,112
 
    
  
  
  
Net loss per share—diluted
   
$
(0.23
)
   
$
(0.27
)
   
$
(0.20
)
   
$
(0.16
)
    
  
  
  
 
Options and warrants to purchase 3.5 million shares of common stock were not included in the computation of diluted earnings per share, because their inclusion would have been antidilutive, for the three and six month periods ending March 28, 2002 and March 29, 2001, respectively.

13

Table of Contents
 
 
The following discussion and analysis is provided to increase the understanding of, and should be read in conjunction with, the Consolidated Financial Statements and accompanying notes. Additional discussion and analysis related to the Company is contained in our Annual Report on Form 10-K for the fiscal year ended September 27, 2001.
 
Introduction
 
The Pantry is the leading convenience store operator in the southeastern United States and the second largest independently operated convenience store chain in the United States. As of March 28, 2002, we operated 1,305 stores in 10 southeastern states under approximately two dozen banners including The Pantry®, Handy Way®, Lil’ Champ Food Store®, Quick Stop, Zip Mart®, Kangaroo®, Fast Lane®, Depot and Big K. We currently operate in selected markets in Florida (501), North Carolina (335), South Carolina (252), Georgia (56), Mississippi (55), Kentucky (39), Virginia (30), Indiana (15), Tennessee (14) and Louisiana (8). Our network of retail locations offers a broad selection of merchandise, gasoline and ancillary services designed to appeal to the convenience needs of our customers.
 
Total revenues for the second quarter of fiscal 2002 were $560.8 million compared to $635.7 million in the second quarter of fiscal 2001, a decrease of 11.8%. The revenue decline is primarily attributable to a 19.6% decrease in our average gasoline retail price per gallon. Merchandise revenue, commission revenue and gasoline gallon volume actually increased 1.2%, 13.7% and 0.6%, respectively, compared to the second quarter of fiscal 2001.
 
Comparable store merchandise sales improved 1.9% and comparable store gasoline gallon volume improved 0.2%, respectively, compared to the second quarter of fiscal 2001. We believe the comparable store volume improvements are primarily attributable to our efforts to reposition our merchandise and gasoline offerings, remain competitively priced on key products, including gasoline, and enhance promotional activity to drive customer traffic. These improvements were realized despite continued volatility in crude markets and wholesale gasoline costs and generally weak economic conditions.
 
Our second quarter fiscal 2002 EBITDA was $18.1 million and our net loss was $4.1 million, or 23 cents per diluted share, compared to EBITDA of $25.0 million, a loss of $4.9 million, and a loss of 27 cents per diluted share in the second quarter of fiscal 2001. In the second quarter, our margins and gross profit continued to be influenced by several factors, including wholesale gasoline cost volatility, a general economic recession and competitive pressures in selected markets. Throughout the current economic downturn and volatility in crude markets, we have focused our attention on those aspects of our business we can influence in an effort to position our company for improved results as the business climate in the Southeast improves.
 
We continue to focus our attention on the following key operating principles:
 
 
•
 
the consistent execution of our core strategies, including focused attention on leveraging the quality of our growing retail network in terms of revenues, product costs and operating expenses;
 
 
•
 
our research and investment in enhancing existing merchandise programs and introducing new ones;
 
 
•
 
our continuous effort to sensibly apply technology in all areas of our business; and
 
 
•
 
sensible store growth in existing and contiguous markets.
 
We believe our retail network, merchandise programs, purchasing leverage and in-store execution will allow us to improve comparable store sales and control store operating expenses as the economy improves. Regarding our fiscal year 2001 restructuring plan, the benefits we are realizing from those cost reduction initiatives are in line with and may possibly exceed our initial expectations of annualized savings of approximately $5.0 million.

14

Table of Contents
 
In the current environment, we continue to review our merchandise programs and are repositioning certain aspects to drive customer traffic. In the second quarter, we continued to promote key merchandise categories, placing downward pressure on merchandise margins compared to the second quarter of fiscal 2001. Over time, we believe these refinements coupled with our efforts to remain competitively priced on key product categories will positively impact comparable store merchandise sales and gross profit.
 
On the technology front, now that we have the core of our retail automation systems in place, we plan to roll out a checkout scanning system across much of our retail network in the later part of this fiscal year. We believe the benefits of scanning include a range of potential improvements from enhanced store merchandising and more effective in-store promotions to improved inventory controls. We will continue to evaluate and invest in strategic technology-based initiatives designed to improve operating efficiencies, strengthen internal controls and promote our long-term financial objectives.
 
Given current market conditions, we have substantially reduced the pace of our acquisitions and expect to acquire only a few stores in fiscal 2002. However, this does not represent a change in our long-term strategic direction. When the environment is once again favorable, we plan to continue to sensibly acquire premium chains located in our existing and contiguous markets.
 
During the second quarter of fiscal 2002, we closed 14 stores and acquired one. Historically, the stores we close are under performing in terms of volume and profitability and, generally, we benefit from closing the locations by reducing direct overhead expenses and eliminating certain fixed costs.
 
Over the next twelve months, we plan to focus primarily on the operations side of our business with a renewed effort to enhance in-store merchandising. In this twelve-month period, we anticipate reducing our average outstanding borrowings through scheduled principal payments and we plan to continue to seek ways to improve top-line growth and enhance long-term profitability.

15

Table of Contents
 
Results of Operations
 
Three Months Ended March 28, 2002 Compared to the Three Months Ended March 29, 2001
 
The table below provides a summary of our statements of operations and details our pro forma adjustments related to restructuring and other charges, fair market value changes in non-qualifying derivatives and the adoption of SFAS No. 142 (amounts in millions, except per share, margin and store data):
 
    
Three Months Ended
March 28, 2002 [a]
     
Three Months Ended
March 29, 2001 [a]
  
    
As reported
     
Pro forma adjustments
     
Pro forma
     
As reported
     
Pro forma adjustments
     
Pro forma
  
Total revenues
   
$
560.8
 
   
$
—  
 
   
$
560.8
 
   
$
635.7
 
   
$
—  
 
   
$
635.7
 
Cost of sales
   
 
452.7
 
   
 
—  
 
   
 
452.7
 
   
 
519.4
 
   
 
—  
 
   
 
519.4
 
    
  
  
  
  
  
Gross profit
   
 
108.1
 
            
 
108.1
 
   
 
116.3
 
   
 
—  
 
   
 
116.3
 
Operating, general and administrative
expenses
   
 
90.0
 
   
 
—  
 
   
 
90.0
 
   
 
91.3
 
   
 
—  
 
   
 
91.3
 
    
  
  
  
  
  
EBITDA
   
 
18.1
 
   
 
—  
 
   
 
18.1
 
   
 
25.0
 
   
 
—  
 
   
 
25.0
 
Restructuring and other non-recurring
charges [b]
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
3.4
 
   
 
(3.4
)
   
 
—  
 
Depreciation and amortization [c]
   
 
13.5
 
   
 
—  
 
   
 
13.5
 
   
 
15.6
 
   
 
(2.6
)
   
 
13.0
 
    
  
  
  
  
  
Income from operations
   
 
4.6
 
   
 
—  
 
   
 
4.6
 
   
 
6.0
 
   
 
6.0
 
   
 
12.0
 
Interest and miscellaneous expenses [d]
   
 
11.5
 
   
 
0.9
 
   
 
12.4
 
   
 
14.6
 
   
 
(0.7
)
   
 
14.0
 
    
  
  
  
  
  
Loss before taxes
   
 
(6.9
)
   
 
(0.9
)
   
 
(7.8
)
   
 
(8.7
)
   
 
6.7
 
   
 
(2.0
)
Tax benefit [e]
   
 
2.8
 
   
 
0.4
 
   
 
3.1
 
   
 
3.8
 
   
 
(3.0
)
   
 
0.8
 
    
  
  
  
  
  
Net loss
   
$
(4.1
)
   
$
(0.6
)
   
$
(4.7
)
   
$
(4.9
)
   
$
3.7
 
   
$
(1.2
)
Loss per diluted share
   
$
(0.23
)
   
$
(0.03
)
   
$
(0.26
)
   
$
(0.27
)
   
$
0.21
 
   
$
(0.06
)
Selected Financial Data:
                                                      
Merchandise margin
   
 
32.8
%
                     
 
34.3
%
                  
Gasoline gallons
   
 
281.0
 
                     
 
279.5
 
                  
Gasoline margin per gallon
   
$
0.0904
 
                     
$
0.1138
 
                  
Gasoline retail per gallon
   
$
1.15
 
                     
$
1.43
 
                  
Comparable store data:
                                                      
Merchandise sales %
   
 
1.9
%
                     
 
(1.6
)%
                  
Gasoline gallons %
   
 
0.2
%
                     
 
(4.7
)%
                  
Number of stores:
                                                      
End of Period
   
 
1,305
 
                     
 
1,332
 
                  
Weighted-average store count
   
 
1,312
 
                     
 
1,334
 
                  
[a]
 
These financial tables may not foot due to rounding.
[b]
 
Fiscal 2001 has been adjusted to exclude charges resulting from our fiscal year 2001 restructuring plan.
[c]
 
Fiscal 2001 has been adjusted as if SFAS No. 142 were adopted at the beginning of fiscal 2001, which would have eliminated goodwill amortization.
[d]
 
Fiscal 2001 and fiscal 2002 have been adjusted to eliminate the non-cash fair market value adjustments associated with non-qualifying derivative instruments.
[e]
 
The adjustment to income tax expense reflects the tax impact of the adjustments outlined above.
 
Total Revenue.    Total revenue for the second quarter of fiscal 2002 was $560.8 million compared to $635.7 million for the second quarter of fiscal 2001, a decrease of $74.9 million or 11.8%. The decrease in total revenue is primarily attributable to a 28 cents per gallon or 19.6% decrease in our average gasoline retail price per gallon. This decrease was partially offset by comparable store increases in merchandise revenue and gasoline gallons of 1.9% and 0.2%, respectively, as well as a $765 thousand increase in commission revenue.

16

Table of Contents
 
Merchandise Revenue.    Merchandise revenue for the second quarter of fiscal 2002 was $232.5 million compared to $229.7 million during the second quarter of fiscal 2001, an increase of $2.7 million or 1.2%. The increase is primarily attributable to a 1.9% increase in comparable store merchandise revenue compared to the second quarter of fiscal 2001. The increase in comparable store merchandise revenue is primarily attributable to our efforts to enhance and reposition our merchandise offerings, increased promotional activity and more aggressive pricing in key categories in an effort to drive customer traffic.
 
Gasoline Revenue and Gallons.    Gasoline revenue for the second quarter of fiscal 2002 was $322.0 million compared to $400.4 million during the second quarter of fiscal 2001, a decrease of $78.4 million or 19.6%. The decrease in gasoline revenue is primarily attributable to the 28 cents per gallon, or 19.6% decrease in the average gasoline retail price per gallon. This decrease was partially offset by a 0.2% increase in comparable store gasoline gallon sales.
 
In the second quarter of fiscal 2002, gasoline gallons sold were 281.0 million compared to 279.5 million during the second quarter of fiscal 2001, an increase of 1.5 million gallons or 0.6%. The increase is primarily attributable to the comparable store gasoline gallon sales increase of 0.2% during the period and the full quarter contribution of stores acquired in the second quarter of fiscal 2001.
 
Commission Revenue.    Commission revenue for the second quarter of fiscal 2002 was $6.4 million compared to $5.6 million during the second quarter of fiscal 2001, an increase of $765 thousand or 13.7%. The increase is primarily due to the January 2002 introduction of South Carolina’s Educational Lottery program.
 
Total Gross Profit.    Total gross profit for the second quarter of fiscal 2002 was $108.1 million compared to $116.3 million during the second quarter of fiscal 2001, a decrease of $8.2 million or 7.0%. The decrease in gross profit is primarily attributable to declines in gasoline gross profit per gallon and merchandise margin, partially offset by the increases in commission revenue, merchandise revenue and gasoline volume.
 
Merchandise Gross Profit and Margin.    Merchandise gross profit was $76.4 million for the second quarter of fiscal 2002 compared to $78.9 million for the second quarter of fiscal 2001, a decrease of $2.5 million or 3.2%. This decrease is primarily attributable to a 150 basis points decline in our merchandise margin to 32.8% for the second quarter of fiscal 2002 compared to 34.3% reported for the second quarter of fiscal 2001. The margin decrease is primarily due to heightened promotional activity and more aggressive retail pricing in key categories including cigarettes. Our second quarter merchandise margin of 32.8% was in line with the 32.6% margin we reported in the first quarter of fiscal 2002. The impact of the margin decline on merchandise gross profit was partially offset by the comparable store merchandise revenue increase.
 
Gasoline Gross Profit and Per Gallon Margin.    Gasoline gross profit was $25.4 million for the second quarter of fiscal 2002 compared to $31.8 million for the second quarter of fiscal 2001, a decrease of $6.4 million or 20.2%. This decrease is primarily attributable to a 2.4 cents per gallon decline in gasoline margin, partially offset by the comparable store gallon increase. Gasoline gross profit per gallon was 9.0 cents in the second quarter of fiscal 2002 compared to 11.4 cents for the second quarter of fiscal 2001.
 
Operating, General and Administrative Expenses.    Operating, general and administrative expenses for the second quarter of fiscal 2002 totaled $90.0 million compared to $91.3 million for the second quarter of fiscal 2001, a decrease of $1.3 million or 1.4%. The decrease in operating, general and administrative expenses is primarily attributable to the cost savings associated with our fiscal 2001 restructuring plan and other cost savings initiatives.
 
Restructuring and Other Charges.    As a result of our fiscal year 2001 restructuring plan, we recorded pre-tax restructuring and other charges of $3.5 million during the second quarter of fiscal 2001 and a total charge of $4.8 million during the full fiscal year of 2001. These charges consisted of employee termination benefits, lease obligations, professional fees and other costs.

17

Table of Contents
 
Income from Operations.    Income from operations totaled $4.6 million for the second quarter of fiscal 2002 compared to $6.0 million for the second quarter of fiscal 2001, a decrease of $1.3 million or 22.3%. The decrease is primarily attributable to the variances discussed above, partially offset by a $2.0 million decrease in depreciation and amortization primarily as a result of the adoption of SFAS No. 142. Pro forma income from operations for the second quarter of fiscal 2001, which is adjusted to exclude goodwill amortization and restructuring and other non-recurring charges, would have been $12.0 million compared to $4.6 million for the second quarter of fiscal 2002.
 
EBITDA.    EBITDA represents income from operations before depreciation and amortization and non-recurring charges. EBITDA for the second quarter of fiscal 2002 totaled $18.1 million compared to EBITDA of $25.0 million during the second quarter of fiscal 2001, a decrease of $6.8 million or 27.4%. The decrease is attributable to the gross profit decline offset partially by the improvements in operating expenses discussed above.
 
EBITDA is not a measure of performance under generally accepted accounting principles, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data, or as a measure of profitability or liquidity. We have included information concerning EBITDA as one measure of our cash flow and historical ability to service debt and we believe investors find this information useful. EBITDA as defined may not be comparable to similarly titled measures reported by other companies.
 
Interest Expense.    Interest expense is primarily interest on the borrowings under our senior credit facility and senior subordinated notes. Interest expense for the second quarter of fiscal 2002 totaled $11.8 million compared to $14.6 million for the second quarter of fiscal 2001, a decrease of $2.8 million or 19.3%. The decrease in interest expense is primarily attributable to a general decline in interest rates, the decrease in our weighted average borrowings and the change in fair market value of our non-qualifying interest rate derivatives. These declines were partially offset by an increase in our interest rate swap settlement payments of $2.3 million.
 
Income Tax Benefit.    We recorded income tax benefit totaling $2.8 million for the second quarter of fiscal 2002 compared to income tax benefit of $3.8 million for the second quarter of fiscal 2001. The decrease in income tax benefit was primarily attributable to the $1.8 million decrease in our pretax loss and a lower effective tax rate. Due to the adoption of SFAS No. 142 and the elimination of nondeductible goodwill amortization expense, our effective tax rate was 40.0% for the second quarter of fiscal 2002 compared to 43.5% for the second quarter of fiscal 2001.
 
Net Loss.    The net loss for the second quarter of fiscal 2002 was $4.1 million compared to a net loss of $4.9 million for the second quarter of fiscal 2001. The net loss decrease is attributable to the items discussed above. Pro forma net loss, which excludes the impact of our fiscal 2001 restructuring plan, the fair market value change in non-qualifying derivatives and the adoption of SFAS No. 142 for the second quarter of fiscal 2002 was $4.7 million compared to a pro forma net loss of $1.2 million for the second quarter of fiscal 2001.

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Six Months Ended March 28, 2002 Compared to the Six Months Ended March 29, 2001
 
The table below provides a summary of our statements of operations and details our pro forma adjustments related to restructuring and other charges, fair market value changes in non-qualifying derivatives and the adoption of SFAS No. 142 (amounts in millions, except per share, margin and store data):
 
    
Six Months Ended March 28, 2002 [a]
     
Six Months Ended March 29, 2001 [a]
  
    
As reported
     
Pro forma adjustments
     
Pro forma
     
As reported
     
Pro forma adjustments
     
Pro forma
  
Total revenues
   
$
1,138.2
 
   
$
—  
 
   
$
1,138.2
 
   
$
1,269.9
 
   
$
—  
 
   
$
1,269.9
 
Cost of sales
   
 
914.6
 
   
 
—  
 
   
 
914.6
 
   
 
1,034.7
 
   
 
—  
 
   
 
1,034.7
 
    
  
  
  
  
  
Gross profit
   
 
223.6
 
   
 
—  
 
   
 
223.6
 
   
 
235.2
 
   
 
—  
 
   
 
235.2
 
Operating, general and administrative expenses
   
 
178.9
 
   
 
—  
 
   
 
178.9
 
   
 
178.4
 
   
 
—  
 
   
 
178.4
 
    
  
  
  
  
  
EBITDA
   
 
44.6
 
   
 
—  
 
   
 
44.6
 
   
 
56.8
 
   
 
—  
 
   
 
56.8
 
Restructuring and other non-recurring
charges [b]
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
3.4
 
   
 
(3.4
)
   
 
—  
 
Depreciation and amortization [c]
   
 
26.9
 
   
 
—  
 
   
 
26.9
 
   
 
30.9
 
   
 
(4.8
)
   
 
26.2
 
    
  
  
  
  
  
Income from operations
   
 
17.7
 
            
 
17.7
 
   
 
22.4
 
   
 
8.2
 
   
 
30.6
 
Interest and miscellaneous expense [d]
   
 
23.8
 
   
 
1.2
 
   
 
25.0
 
   
 
27.6
 
   
 
(0.8
)
   
 
26.8
 
    
  
  
  
  
  
Income (loss) before taxes
   
 
(6.1
)
   
 
(1.2
)
   
 
(7.3
)
   
 
(5.3
)
   
 
9.1
 
   
 
3.8
 
Tax benefit (expense) [e]
   
 
2.4
 
   
 
0.5
 
   
 
2.9
 
   
 
2.3
 
   
 
(3.8
)
   
 
(1.5
)
    
  
  
  
  
  
Net income (loss)
   
$
(3.7
)
   
$
(0.7
)
   
$
(4.4
)
   
$
(3.0
)
   
$
5.3
 
   
$
2.3
 
Earnings (loss) per diluted share
   
$
(0.20
)
   
$
(0.04
)
   
$
(0.24
)
   
$
(0.16
)
   
$
0.29
 
   
$
0.13
 
Selected Financial Data:
                                                      
Merchandise margin
   
 
32.7
%
                     
 
34.1
%
                  
Gasoline gallons
   
 
568.9
 
                     
 
551.2
 
                  
Gasoline margin per gallon
   
$
0.1015
 
                     
$
0.1227
 
                  
Gasoline retail per gallon
   
$
1.15
 
                     
$
1.45
 
                  
Comparable store data:
                                                      
Merchandise sales %
   
 
1.8
%
                     
 
0.1
%
                  
Gasoline gallons %
   
 
0.4
%
                     
 
(5.3
)%
                  
Number of stores:
                                                      
End of period
   
 
1,305
 
                     
 
1,332
 
                  
Weighted-average store count
   
 
1,316
 
                     
 
1,324
 
                  
[a]
 
These financial tables may not foot due to rounding.
[b]
 
Fiscal 2001 has been adjusted to exclude charges resulting from our fiscal year 2001 restructuring plan.
[c]
 
Fiscal 2001 has been adjusted as if SFAS No. 142 were adopted at the beginning of fiscal 2001, which would have eliminated goodwill amortization.
[d]
 
Fiscal 2001 and fiscal 2002 have been adjusted to eliminate the non-cash fair market value adjustments associated with non-qualifying derivative instruments.
[e]
 
The adjustment to income tax expense reflects the tax impact of the adjustments outlined above.
 
Total Revenue.    Total revenue for the six months ended March 28, 2002 was $1.1 billion compared to $1.3 billion for the six months ended March 29, 2001, a decrease of $131.7 million or 10.4%. The decrease in total revenue is primarily attributable to a 30 cent per gallon, or 20.7%, decrease in average gasoline retail prices. This decline was partially offset by comparable store increases in merchandise revenue and gasoline gallons of 1.8% and 0.4%, respectively, as well as a $1.0 million increase in commission revenue.
 
Merchandise Revenue.    Merchandise revenue for the six months ended March 28, 2002 was $469.7 million compared to $458.2 million during the six months ended March 29, 2001, an increase of $11.5 million or 2.5%.

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The increase in merchandise revenue is primarily attributable to comparable store merchandise sales growth and the contribution of stores acquired or opened since September 28, 2000, partially offset by lost volume from closed stores. Comparable store merchandise revenue for the six months ended March 28, 2002 increased 1.8% over the six months ended March 29, 2001.
 
Gasoline Revenue and Gallons.    Gasoline revenue for the six months ended March 28, 2002 was $656.3 million compared to $800.6 million during the six months ended March 29, 2001, a decrease of $144.3 million or 18.0%. The decrease in gasoline revenue is primarily attributable to a 30 cent per gallon, or 20.7%, decrease in average gasoline gallon retail prices compared to the six months ended March 29, 2001.
 
For the six months ended March 28, 2002, gasoline gallons sold were 568.9 million compared to 551.2 million during the six months ended March 29, 2001, an increase of 17.7 million gallons or 3.2%. The increase is primarily attributable to a comparable store gasoline gallon sales increase of 0.4% during the period and the contribution of stores acquired or opened since September 28, 2000 partially offset by lost volume from closed stores.
 
Commission Revenue.    Commission revenue for the six months ended March 28, 2002 was $12.2 million compared to $11.2 million during the six months ended March 29, 2001, an increase of $1.0 million or 9.2%. The increase is primarily attributable to the January 2002 introduction of South Carolina’s Educational Lottery program.
 
Total Gross Profit.    Total gross profit for the six months ended March 28, 2002 was $223.6 million compared to $235.2 million during the six months ended March 29, 2001, a decrease of $11.6 million or 4.9%. The decrease in gross profit is primarily attributable to declines in gasoline gross profit per gallon and merchandise margin, partially offset by the increase in commission revenue, merchandise revenue and gasoline volume.
 
Merchandise Gross Profit and Margin.    Merchandise gross profit was $153.7 million for the six months ended March 28, 2002 compared to $156.4 million for the six months ended March 29, 2001, a decrease of $2.8 million or 1.8%. This decrease is primarily attributable to a 140 basis points decline in merchandise margin partially offset by the 1.8% increase in comparable store merchandise revenue.
 
Merchandise margin of 32.7% for the six months ended March 28, 2002 was 140 basis points below the merchandise margin of 34.1% reported for the six months ended March 29, 2001. The margin decrease is primarily due to more competitive pricing and increased promotional activity in key categories.
 
Gasoline Gross Profit and Per Gallon Margin.    Gasoline gross profit was $57.7 million for the six months ended March 28, 2002 compared to $67.6 million for the six months ended March 29, 2001, a decrease of $9.9 million or 14.6%. This decrease is primarily attributable to a 2.1 cent decline in gasoline margin per gallon, partially offset by the contribution from stores acquired or opened since September 28, 2000 and the comparable store gasoline gallon increase of 0.4%. Gasoline gross profit per gallon was $0.1015 for the six months ended March 28, 2002 compared to $0.1227 for the six months ended March 29, 2001.
 
Operating, General and Administrative Expenses.    Operating, general and administrative expenses for the six months ended March 28, 2002 totaled $178.9 million compared to $178.4 million for the six months ended March 29, 2001, an increase of $490 thousand or 0.3%. The increase in operating, general and administrative expenses is primarily attributable to increases in lease and insurance expenses of $3.1 million partially offset by savings associated with our restructuring initiatives.
 
Restructuring and Other Charges.    As a result of our fiscal year 2001 restructuring plan, we recorded pre-tax restructuring and other charges of $3.5 million during the six months ended March 29, 2001 and $4.8 million during the full fiscal year 2001. These charges consisted of employee termination benefits, lease obligations, professional fees and other costs.

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Income from Operations.    Income from operations totaled $17.7 million for the six months ended March 28, 2002 compared to $22.4 million for the six months ended March 29, 2001, a decrease of $4.6 million or 20.6%. The decrease is primarily attributable to the variances discussed above, partially offset by a $4.0 million decrease in depreciation and amortization primarily as a result of the adoption of SFAS No. 142. Pro forma income from operations for the six months ended March 29, 2001, which is adjusted to exclude goodwill amortization and restructuring and other non-recurring charges, would have been $30.6 million compared to $17.7 million for the second quarter of fiscal 2002 .
 
EBITDA.    EBITDA represents income from operations before depreciation and amortization and restructuring and other non-recurring charges. EBITDA for the six months ended March 28, 2002 totaled $44.6 million compared to EBITDA of $56.8 million for the six months ended March 29, 2001, a decrease of $12.1 million or 21.3%. The decrease is attributable to the items discussed above.
 
EBITDA is not a measure of performance under accounting principles, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with generally accepted accounting principles. EBITDA as defined may not be comparable to similarly titled measures reported by other companies. We have included information concerning EBITDA as one measure of our cash flow and historical ability to service debt and because we believe investors find this information useful.
 
Interest Expense.    Interest expense is primarily interest on our senior subordinated notes and borrowings under our senior credit facility as well as the mark-to-market adjustments associated with our non-qualifying derivative instruments. Interest expense for the six months ended March 28, 2002 totaled $24.2 million compared to $28.7 million for the six months ended March 29, 2001, a decrease of $4.5 million or 15.7%. The decrease in interest expense is primarily attributable to a general decline in interest rates, the decrease in our weighted average outstanding borrowings and the change in fair market value of our non-qualifying interest rate derivatives, partially offset by interest rate swap settlements of $4.2 million.
 
Income Tax Benefit.    We recorded an income tax benefit totaling $2.4 million for the six months ended March 28, 2002 compared to an income tax benefit of $2.3 million for the six months ended March 29, 2001. The change in income tax benefit was primarily attributable to the decrease in income before income taxes. Our effective tax rate was 40.0% for the six months ended March 28, 2002 compared to 43.5% for the six months ended March 29, 2001.
 
Net Loss.    The net loss for the six months ended March 28, 2002 was $3.7 million compared to a net loss of $3.0 million for the six months ended March 29, 2001. The increase is attributable to the items discussed above. Pro forma net loss for the six months ended March 28, 2002, which excludes the impact of our fiscal 2001 restructuring plan, the fair market value change in non-qualifying derivatives and the adoption of SFAS No. 142, was $4.4 million compared to pro forma net income of $2.3 million for the six months ended March 29, 2001.
 
Liquidity and Capital Resources
 
Cash Flows from Operations.    Due to the nature of our business, substantially all sales are for cash, and cash provided by operations is our primary source of liquidity. We rely primarily upon cash provided by operating activities, supplemented as necessary from time to time by borrowings under our senior credit facility, sale-leaseback transactions, asset dispositions and equity investments, to finance our operations, pay interest and debt amortization and fund capital expenditures. Cash provided by operating activities increased from $12.9 million for the six months ended March 29, 2001 to $14.1 million for the six months ended March 28, 2002. We had $35.1 million of cash and cash equivalents on hand at March 28, 2002.
 
Capital Expenditures.    Capital expenditures (excluding all acquisitions) were approximately $9.0 million for the six months ended March 28, 2002. Capital expenditures are primarily expenditures for existing store

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improvements, store equipment, new store development, information systems and expenditures to comply with regulatory statutes, including those related to environmental matters.
 
We finance substantially all capital expenditures and new store development through cash flow from operations, a sale-leaseback program or similar lease activity, vendor reimbursements and asset dispositions. Our sale-leaseback program includes the packaging of our owned convenience store real estate, both land and buildings, for sale to investors in return for their agreement to lease the property back to us under long-term leases. Generally, the leases are operating leases at market rates with terms of twenty years with four five-year renewal options. The lease payments are based on market rates applied to the cost of each respective property. We retain ownership of all personal property and gasoline marketing equipment. Our senior credit facility limits or caps the proceeds of sale-leasebacks that we can use to fund our operations or capital expenditures. Under our sale-leaseback program, we received $2.1 million for the six months ended March 28, 2002. Vendor reimbursements primarily relate to oil-company payments to either enter into long-term supply agreements or to upgrade gasoline marketing equipment including canopies, gasoline dispensers and signs.
 
For the six months ended March 28, 2002, we received approximately $5.3 million from asset dispositions, sale-leaseback proceeds and other reimbursements for capital improvements. Net capital expenditures, excluding acquisitions, for the six months ended March 28, 2002 were $3.7 million. We anticipate that net capital expenditures for fiscal 2002 will be in the range of $25.0 to $27.5 million.
 
Long-Term Debt.    Our long-term debt consisted of $200.0 million of senior subordinated notes, $319.5 million outstanding under our senior credit facility and $785 thousand in other notes payable with various interest rates and maturity dates.
 
We have outstanding $200.0 million of 10 1/4% senior subordinated notes due 2007. Interest on the senior subordinated notes is due on October 15 and April 15 of each year.
 
As of March 28, 2002, our senior credit facility consisted of a $45.0 million revolving credit facility for working capital financing, general corporate purposes and issuing commercial and standby letters of credit and $319.5 million in outstanding borrowings under term loans. As of May 8, 2002, we had $23.3 million available for borrowing or additional letters of credit under the credit facility.
 
During the first quarter of fiscal 2002, we executed an amendment to our senior credit facility that, among other things, modified financial covenants and increased the floating interest rate spread by 50 basis points as long as our consolidated pro forma leverage ratio is greater than 4.5:1. The floating interest rate spread will be reduced 25 basis points when the consolidated pro forma leverage ratio is less than 4.5:1. The changes to financial covenants, among other things, relaxed our coverage and consolidated pro forma leverage ratios but imposed tighter limits on capital expenditures and expenditures to acquire related businesses. Our net capital expenditures are limited to $27.5 million in fiscal 2002, $30.0 million in fiscal 2003, $32.5 million in fiscal 2004 and $35.0 million annually thereafter. In addition, the amendment limits acquisition expenditures to $3.0 million in fiscal 2002 and $15.0 million in fiscal 2003.
 
Cash Flows from Financing Activities.    For the six months ended March 28, 2002, we used cash on hand to make principal repayments of $23.9 million and pay fees and expenses of $916 thousand related to our senior credit facility amendment.
 
Cash Requirements.    We believe that cash on hand, together with cash flow anticipated to be generated from operations, short-term borrowings for seasonal working capital needs and permitted borrowings under our credit facilities will be sufficient to enable us to satisfy anticipated cash requirements for operating, investing and financing activities, including debt service, for the next twelve months.
 
Shareholders’ Equity.    As of March 28, 2002, our shareholders’ equity totaled $109.0 million. The $2.1 million decrease from September 27, 2001 is attributable to the net loss for the period partially offset by a decrease in our accumulated other comprehensive deficit related to our derivative instruments.

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Contractual Obligations.    The following table shows our long-term debt amortization schedule, our future capital lease commitments (including principal and interest) and our future operating lease commitments as of March 28, 2002:
 
Contractual Obligations
(Dollars in thousands)
 
    
2002
   
2003
   
2004
   
2005
   
2006
   
Thereafter
   
Total
Long-term debt
   
$
16,148
   
$
43,255
   
$
52,912
   
$
88,654
   
$
119,354
   
$
200,000
   
$
520,323
Capital lease obligations
   
 
1,672
   
 
3,278
   
 
3,093
   
 
2,745
   
 
2,514
   
 
20,796
   
 
34,098
Operating leases
   
 
25,181
   
 
49,310
   
 
47,765
   
 
45,501
   
 
42,953
   
 
370,809
   
 
581,519
 
Contractual obligations for fiscal 2002 include only payments to be made for the remaining 26 weeks of fiscal 2002.
 
Other Commitments.    The following table shows the expiration dates of our standby letters of credit issued under our senior credit facility as of March 28, 2002:
 
Other Commitments
(Dollars in thousands)
 
    
2002
   
2003
   
2004
   
2005
   
2006
   
Thereafter
   
Total
Standby letters of credit
   
$
1,500
   
$
17,416
   
$
  —  
   
$
  —    
   
$
  —  
   
$
  —  
   
$
18,916
 
Other commitments for fiscal 2002 include only standby letters of credit which expire during the remaining 26 weeks of fiscal 2002. At maturity, we expect to renew a significant number of our standby letters of credit.
 
Critical Accounting Policies
 
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Critical accounting policies are those we believe are both most important to the portrayal of our financial condition and results, and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those polices may result in materially different amounts being reported under different conditions or using different assumptions. We believe the following policies to be the most critical in understanding the judgments that are involved in preparing our consolidated financial statements.
 
Environmental Liabilities and Related Receivables.    We account for the cost incurred to comply with federal and state environmental regulations as follows:
 
 
•
 
Environmental reserves reflected in the financial statements are based on internal and external estimates of costs to remediate sites relating to the operation of underground storage tanks. Factors considered in the estimates of the reserve are the expected cost and the estimated length of time to remediate each contaminated site.

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•
 
Deductibles and remediation costs not covered by state trust fund programs and third party insurance arrangements, and for which the timing of payments can be reasonably estimated, are discounted using a ten-percent discount rate.
 
 
•
 
Reimbursement under state trust fund programs or third party insurers are recognized as receivables and a provision for uncollectible reimbursements is recorded based on historical and expected collection rates. Our historical collection experience exceeds 95%. All recorded reimbursements are expected to be collected within a period of twelve to eighteen months after submission of the reimbursement claim. The adequacy of the liability and uncollectible receivable reserve is evaluated quarterly and adjustments are made based on updated experience at existing sites, newly identified sites and changes in governmental policy.
 
Changes in laws and government regulation, the financial condition of the state trust funds and third party insurers and actual remediation expenses compared to historical experience could significantly impact our statement of operations and financial position.
 
Vendor Allowances and Rebates.    We receive payments for vendor allowances, volume rebates and other supply arrangements in connection with various programs. Payments are recorded as a reduction to cost of sales or expenses to which the particular payment relates. Unearned payments are deferred and amortized as earned over the term of the respective agreement.
 
Long-Lived Assets and Closed Stores.    Long-lived assets are reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. When an evaluation is required, the projected future undiscounted cash flows due to each store are compared to the carrying value of the long-lived assets of that store to determine if a write-down to fair value is required.
 
Property and equipment of stores we are closing are written down to their estimated net realizable value at the time we commit to a plan to close such stores. If applicable, we provide for future estimated rent and other exit costs associated with the store closure, net of sublease income, using a discount rate to calculate the present value of the remaining rent payments on closed stores. We estimate the net realizable value based on our experience in utilizing or disposing of similar assets and on estimates provided by our own and third-party real estate experts. Changes in real estate markets could significantly impact the net realizable value from the sale of assets and rental or sublease income.
 
Insurance Liabilities.    We self-insure a significant portion of expected losses under our workers’ compensation and employee medical programs. Accrued liabilities have been recorded based on our estimates of the ultimate costs to settle incurred and incurred but not reported claims. Our accounting policies regarding self-insurance programs include judgments and actuarial assumptions regarding economic conditions, the frequency and severity of claims, claim development patterns and claim management and settlement practices. Significant changes in actual expenditures compared to historical experience rates as a result of increased medical costs or incidence rates could significantly impact our statement of operations and financial position.
 
Goodwill Impairment.    We have adopted the provisions of SFAS No. 142 which requires allocating goodwill to each reporting unit and testing for impairment using a two-step approach. Based on our current reporting structure, we have determined that we operate as one reporting unit and therefore have assigned goodwill at the enterprise level. Fair value is measured using a valuation based on market multiples, comparable transactions and discounted cash flow methodologies. The valuation required at adoption of SFAS No. 142 indicated an aggregate fair value significantly in excess of our carrying or book value as of September 28, 2001 therefore; we have determined that no impairment existed as of September 28, 2001. The goodwill impairment test is performed annually or whenever an event has occurred that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For future valuation, should the enterprise carrying value exceed the estimated fair market value we would have to perform additional valuations to determine if any goodwill impairment exists. Any impairment recognized will be recorded as a component of operating expenses.

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Changes in the long-term economics of the gasoline and convenience store markets, fluctuations in capital markets and competition could impact our fair value measurements which could significantly impact our statement of operations and financial position.
 
Recently Adopted Accounting Standards
 
In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141, Business Combinations (“SFAS No. 141”) which establishes accounting and reporting standards for all business combinations initiated after June 30, 2001 and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS No. 141 eliminates the pooling-of-interest method of accounting and requires all acquisitions consummated subsequent to June 30, 2001 to be accounted for under the purchase method. The adoption of SFAS No. 141 did not have a material impact on our results of operations and financial condition.
 
In June 2001, the FASB issued SFAS No. 142 which addresses financial accounting and reporting for acquired goodwill and other intangible assets. SFAS No. 142 eliminates amortization of goodwill and other intangible assets that are determined to have an indefinite useful life and instead requires an impairment only approach. At adoption, any goodwill impairment loss will be recognized as the cumulative effect of a change in accounting principle. Subsequently, any impairment losses will be recognized as a component of income from operations. As of September 27, 2001, we had net goodwill of $277.7 million and incurred $9.7 million in goodwill amortization in the statement of operations for the year then ended.
 
As permitted, we early adopted SFAS No. 142 effective September 28, 2001, which has resulted in the discontinuance of goodwill amortization. We determined that we operate in one reporting unit based on the current reporting structure and have thus assigned goodwill at the enterprise level. We have completed the first step of the transitional goodwill impairment test by comparing the enterprise fair value to its carrying value and have determined that no impairment exists at the effective date of the implementation of the new standard. Fair value was measured using a valuation by an independent third party as of September 28, 2001 which was based on market multiples, comparable transactions and discounted cash flow methodologies.
 
This valuation indicated an aggregate fair value significantly in excess of our market capitalization as of September 28, 2001. We believe the market capitalization is not representative of the fair value of the Company because our common stock is not actively traded. On an ongoing basis, we will perform an annual goodwill impairment test.
 
At least quarterly, we will evaluate to determine if an event has occurred that would more likely than not reduce our enterprise fair value below its carrying amount and if necessary we will perform a goodwill impairment test between the annual dates. Impairment adjustments recognized after adoption, if any, will be recognized as operating expenses.
 
Recently Issued Accounting Standards
 
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, (“SFAS No. 143”) which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. Adoption of SFAS No. 143 is required for fiscal years beginning after June 15, 2002, which would be our fiscal 2003. We have not yet determined the impact, if any, on our results of operations and financial condition.
 
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. (“SFAS No. 144”) This statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. SFAS No. 144 addresses financial accounting and

25

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reporting for the impairment or disposal of long-lived assets. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001, with earlier adoption encouraged. We do not anticipate that the adoption of SFAS No. 144 will have a material impact on our results of operations and financial condition.
 
 
Quantitative Disclosures.    We are exposed to market risks inherent in our financial instruments. These instruments arise from transactions entered into in the normal course of business and, in some cases, relate to our acquisitions of related businesses. We are subject to interest rate risk on our existing long-term debt and any future financing requirements. Our fixed rate debt consists primarily of outstanding balances on our senior subordinated notes and our variable rate debt relates to borrowings under our senior credit facility.
 
The following table presents the future principal cash flows and weighted average interest rates based on rates in effect at March 28, 2002, on our existing long-term debt instruments. Fair values have been determined based on quoted market prices as of May 6, 2002.
 
Expected Maturity Date
as of March 28, 2002
(Dollars in thousands)
 
    
Fiscal 2002
     
Fiscal 2003
     
Fiscal 2004
     
Fiscal 2005
     
Fiscal 2006
     
Thereafter
     
Total
     
Fair Value
Long-term debt
   
$
16,148
 
   
$
43,255
 
   
$
52,912
 
   
$
88,654
 
   
$
119,354
 
   
$
200,000
 
   
$
520,323
 
   
$
494,245
Weighted average interest rate
   
 
9.06
%
   
 
8.76
%
   
 
8.05
%
   
 
8.34
%
   
 
9.29
%
   
 
10.25
%
   
 
8.79
%
       
 
In order to reduce our exposure to interest rate fluctuations, we have entered into interest rate swap arrangements in which we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed upon notional amount. The interest rate differential is reflected as an adjustment to interest expense over the life of the swaps. Fixed rate swaps are used to reduce our risk of increased interest costs during periods of rising interest rates. At March 28, 2002, the interest rate on 73.2% of our debt was fixed by either the nature of the obligation or through the interest rate swap arrangements compared to 68.2% at March 29, 2001.
 
The following table presents the notional principal amount, weighted average pay rate, weighted average receive rate and weighted average years to maturity on our interest rate swap contracts:
 
Interest Rate Swap Contracts
(Dollars in thousands)
 
 
    
March 28, 2002
     
March 29, 2001
  
Notional principal amount
   
$
180,000
 
   
$
180,000
 
Weighted average pay rate
   
 
6.12
%
   
 
6.12
%
Weighted average receive rate
   
 
1.90
%
   
 
5.13
%
Weighted average years to maturity
   
 
1.37
 
   
 
2.36
 
 
Effective February 1, 2001, the Company entered into an interest rate collar arrangement covering a notional amount of $55.0 million. The interest rate collar agreement expires in February 2003, and has a cap rate of 5.70% and a floor rate of 5.03%. As of March 28, 2002, the fair value of our swap and collar agreements represented a liability of $7.6 million.
 
Qualitative Disclosures.    Our primary exposure relates to:
 
 
•
 
interest rate risk on long-term and short-term borrowings;

26

Table of Contents
 
 
•
 
our ability to pay or refinance long-term borrowings at maturity at market rates;
 
 
•
 
the impact of interest rate movements on our ability to meet interest expense requirements and exceed financial covenants; and
 
 
•
 
the impact of interest rate movements on our ability to obtain adequate financing to fund future acquisitions.
 
We manage interest rate risk on our outstanding long-term and short-term debt through our use of fixed and variable rate debt. We expect the interest rate swaps mentioned above will reduce our exposure to short-term interest rate fluctuations. While we cannot predict or manage our ability to refinance existing debt or the impact interest rate movements will have on our existing debt, management evaluates our financial position on an ongoing basis.
 
 
On March 26, 2002, we held our Annual Meeting of Stockholders during which our stockholders:
 
 
(1)
 
Elected seven nominees to serve as directors each for a term of one year or until his successor is duly elected and qualified. The votes were cast as follows:
 
Name
   
Votes For
   
Votes Withheld
Peter J. Sodini
   
17,796,723
   
153,041
Todd W. Halloran
   
17,795,323
   
154,441
Jon D. Ralph
   
17,794,823
   
154,941
Charles P. Rullman
   
17,795,523
   
154,241
William M. Webster, III
   
17,872,446
   
77,318
Peter M. Starrett
   
17,872,646
   
77,118
Hubert E. Yarborough, III
   
17,872,846
   
76,918
 
 
(2)
 
Ratified the appointment of Deloitte & Touche LLP as independent public accountants for the Company and its subsidiaries for the fiscal year ending September 26, 2002. The votes were cast as follows:
    
Votes For
   
Votes Against
   
Votes Withheld
Ratification of Deloitte & Touche, LLP
   
17,934,339
   
225
   
15,200

27

Table of Contents
 
THE PANTRY, INC.
 
PART II-OTHER INFORMATION.
 
 
On March 26, 2002, our board of directors elected Byron E. Allumbaugh to serve as a director. Mr. Allumbaugh fills the seat vacated by the retirement of Edfred L. Shannon.
 
 
 
(a)
 
Exhibits
 
99.1 Risk Factors
 
 
(b)
 
Reports on Form 8-K
 
None

28

Table of Contents
 
SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
THE PANTRY, INC.
By:
  
/s/    WILLIAM T. FLYG        
   
William T. Flyg
Senior Vice President Finance and Secretary
(Authorized Officer and
Principal Financial Officer)
   
Date: May 13, 2002

29

Table of Contents
 
EXHIBIT INDEX
 
Exhibit No.
   
Description of Document
99.1
   
Risk Factors.

30
EX-99.1 3 dex991.htm RISK FACTORS Prepared by R.R. Donnelley Financial -- RISK FACTORS
 
EXHIBIT 99.1
 
RISK FACTORS
 
You should carefully consider the risks described below before making a decision to invest in our common stock, our senior subordinated notes and our senior credit facility. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, may also impair our business operations. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our common stock, our senior subordinated notes and our senior credit facility could decline, and you may lose all or part of your investment.
 
Because Gasoline Sales Comprise A Substantial Portion of Our Revenues, Interruptions in The Supply of Gasoline or Increases in The Cost of Gasoline Could Adversely Affect Our Business
 
Gasoline profit margins have a significant impact on our earnings because gasoline revenue has averaged 60.3% of our total revenue over the past three fiscal years. Several factors beyond our control affect the volume of gasoline we sell and the gasoline profit margins we achieve:
 
 
•
 
the supply and demand for gasoline
 
 
•
 
geo-political factors that may disrupt supply or impact demand in world crude oil markets
 
 
•
 
any volatility in the wholesale gasoline market
 
 
•
 
the pricing policies of competitors in local markets
 
In addition, volatility in the cost of gasoline could adversely affect the demand for gasoline and our business, financial condition or results of operations if gasoline sales volume is reduced as a result. We face this particular risk because:
 
 
•
 
higher gasoline retail prices may impact customer demand and gasoline gallon volume
 
 
•
 
we typically have no more than a seven-day supply of gasoline
 
 
•
 
our gasoline contracts do not guarantee an uninterrupted, unlimited supply of gasoline in the event of a shortage
 
 
•
 
the supply of gasoline for our unbranded locations could be adversely impacted in the event of a shortage
 
Reductions in volume of gasoline sold or our gasoline profit margins could have a material adverse effect on our results of operations. In addition, because gasoline sales generate customer traffic to our stores, decreases in gasoline sales could impact merchandise sales.
 
Our Growth and Operating Results Could Suffer If We are Unable to Identify and Acquire Suitable Companies, Obtain Financing or Integrate Acquired Stores or If We Discover Previously Undisclosed Liabilities Associated With Our Acquired Stores
 
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. From April 1997 through March 2002, we acquired approximately 1,160 convenience stores in more than 40 transactions. Given overall market conditions, currently we have substantially reduced the pace of our acquisitions and expect to acquire only a few stores in fiscal 2002. However, this does not represent a change in our long-term strategic direction. When the environment is once again favorable, we plan to continue to sensibly acquire premium chains located in our existing and contiguous markets.

1

 
While our acquisition pace may have slowed, we expect to continue our growth strategy through acquisitions which, by their nature, involve risks that could cause our actual growth or operating results to differ compared to our expectations or the expectations of security analysts. For example:
 
 
•
 
Our senior credit facility limits our expenditures to acquire stores to $3.0 million in fiscal 2002 and $15.0 million in 2003.
 
 
•
 
We may not be able to identify suitable acquisition candidates or acquire additional convenience stores on favorable terms.
 
 
•
 
Competition for suitable acquisition candidates may increase and could result in decreased availability or increased price for suitable acquisition candidates. In addition, it is 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 which we acquire.
 
 
•
 
We may not be able to obtain the capital necessary, on favorable terms or at all, to finance 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.
 
The Large Amount of Our Total Outstanding Debt and Our Obligation to Service That Debt and Meet The Related Financial Covenants Could Divert Necessary Funds from Operations, Limit Our Ability to Obtain Financing For Future Needs, Expose Us to Interest Rate Risks and Expose Us to Liquidity Risks With The Potential of Accelerated Principal Amortization
 
We are highly leveraged, which means that the amount of our outstanding debt is large compared to the net book value of our assets, and have substantial repayment obligations under our outstanding debt. As of March 28, 2002, we had:
 
 
•
 
Total consolidated debt including capital lease obligations of approximately $535.2 million
 
 
•
 
Shareholders’ equity of approximately $109.0 million
 
As of March 28, 2002, our availability under our senior credit facility for borrowing or issuing additional letters of credit was approximately $26.1 million.
 
Our senior credit facility contains numerous financial and operating covenants that limit our ability, and the ability of most of our subsidiaries, to engage in activities such as acquiring or disposing of assets, engaging in mergers or reorganizations, making investments or capital expenditures and paying dividends. These covenants require that we meet interest coverage, net worth and leverage tests. The indenture governing our senior subordinated notes and our senior credit facility permit us and our subsidiaries to incur or guarantee additional debt, subject to limitations.
 
Our level of debt and the limitations imposed on us by our debt agreements could have other important consequences to our stockholders, including the following:
 
 
•
 
We will have to use a portion of our cash flow from operations for debt service, rather than for our operations or to implement our growth strategy
 
 
•
 
We may not be able to obtain additional debt financing for future working capital, capital expenditures, acquisitions or other corporate purposes

2

 
 
•
 
We are vulnerable to increases in interest rates because the debt under our senior credit facility is at a variable interest rate and although in the past we have on occasion entered into certain hedging instruments in an effort to manage our interest rate risk, we cannot assure you that we will continue to do so, on favorable terms or at all, in the future
 
Restrictive Covenants in Our Debt Agreements May Restrict Our Ability to Implement Our Growth Strategy, Respond to Changes in Industry Conditions, Secure Additional Financing or Engage in Acquisitions
 
Restrictive covenants contained in our existing senior credit facility and indenture could limit our ability to finance future acquisitions, new locations and other expansion of our operations. Credit facilities entered into in the future likely will contain similar restrictive covenants. These covenants may require us to achieve specific financial ratios and to obtain lender consent prior to completing acquisitions. Any of these covenants could become more restrictive in the future. Our ability to respond to changing business conditions and to secure additional financing may be restricted by these covenants. We also may be prevented from engaging in transactions, including acquisitions which are important to our growth strategy. Any breach of these covenants could cause a default under our debt obligations and result in our debt becoming immediately due and payable which would adversely affect our business, financial condition and results of operations. For the twelve-month period ending September 27, 2001, we did not satisfy two financial covenants required by our senior credit facility. During the first quarter of fiscal 2002, we received a waiver from our senior credit group and executed an amendment to the senior credit facility that includes, among other things, a modification to financial covenants and certain increases in the floating interest rate.
 
If Our History of Losses Continues, We May be Unable to Complete Our Growth Strategy and Financing Plans
 
We have experienced losses during two out of our most recent four fiscal years. Our net losses were $3.3 million in fiscal 1998 and $2.7 million in fiscal 2001. In fiscal 1999, we had net income of $10.4 million and in fiscal 2000 we had net income of $14.0 million. We incurred interest expense of $41.3 million in fiscal 1999, $52.3 million in fiscal 2000 and $58.7 million in fiscal 2001. In fiscal 2001, we incurred unusual charges $9.0 million related to our fiscal 2001 restructuring plan ($4.8 million) and non-cash charges related to the change in fair value ($4.2 million) of certain interest rate derivative instruments. We also incurred an extraordinary loss of $3.6 million (net of taxes) in fiscal 1999, related to the early extinguishment of debt.
 
If we incur net losses in future periods, we may not be able to implement our growth strategy in accordance with our present plans. Continuation of our net losses may also require us to secure additional financing sooner than anticipated. Such financing may not be available in sufficient amounts, or on terms acceptable to us, and may dilute existing stockholders. If we do achieve profitability, we may not sustain or increase profitability in the future. This may, in turn, cause the trading price of our common stock, our senior subordinated notes and our senior credit facility to decline.
 
We Have Grown Rapidly and Our Failure to Effectively Manage Our Growth and Realize Anticipated Efficiencies as A Result of Our Restructuring Plans and Acquisition Plans May Adversely Affect Our Business
 
We have grown from total revenue of $384.8 million in fiscal 1996 to $2.6 billion in fiscal 2001. Our ability to manage the growth of our operations will require us to continue to improve our operational, financial and human resource management information systems and our other internal systems and controls. We have recently completed our plan designed to strengthen our organizational structure and reduce our operating costs by centralizing corporate administrative functions. As part of this plan we closed an administrative facility located in Jacksonville, Florida, and integrated key marketing, finance and administrative activities into our corporate headquarters located in Sanford, North Carolina. In addition, during fiscal 2001 we achieved more efficient and streamlined operations through the merger of Lil’ Champ Food Stores, Inc. into The Pantry.

3

 
Failure to make adequate improvements to our systems and controls or to achieve the expected efficiencies of our recently completed plan may adversely affect our business, financial condition and results of operations.
 
In addition, our growth will increase our need to attract, develop, motivate and retain both our management and professional employees. The inability of our management to manage our growth effectively, or the inability of our employees to achieve anticipated performance or utilization levels, could have an adverse effect on our business, financial condition and results of operations.
 
If We Are Unable to Pass Along Price Increases of Tobacco Products to Our Customers, Our Business Could Be Adversely Affected Because Tobacco Sales Comprise A Substantial Portion of Our Revenues
 
Sales of tobacco products have averaged approximately 13.9% of our total revenue over the past three fiscal years. National and local campaigns to discourage smoking in the United States, as well as increases in taxes on cigarettes and other tobacco products, may have an adverse effect on our sales of, and margins for, tobacco products. The consumer price index on tobacco products increased approximately 9% in fiscal 2001. In general, we have passed price increases on to our customers. However due to competitive pricing in our markets, we were unable to pass along all the cost increases we encountered in fiscal 2001.
 
Major cigarette manufacturers periodically offer monthly rebates to retailers and historically we have passed along these rebates to our customers. We cannot assure you that major cigarette manufacturers will continue to offer these rebates or that any resulting increase in prices to our customers will not have a material adverse effect on our cigarette sales and gross profit dollars. A reduction in the amount of cigarettes we are able to sell could adversely affect our business, financial condition and results of operations.
 
Violations of, or Changes to, Regulations Governing The Sale of Tobacco and Alcohol Could Adversely Affect 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 licenses relating to the sale of these products or to seek other remedies.
 
We Are Subject to Extensive Environmental Regulation, and Increased Regulation or Our Failure to Comply With Existing Regulations Could Require Substantial Capital Expenditures or Adversely Affect Our Business
 
Our business is subject to extensive environmental requirements, particularly environmental laws regulating underground storage tanks. Compliance with these regulations may require significant capital expenditures.
 
Federal, state and local regulations governing underground storage tanks were phased in over a period ending in December 1998. These regulations required us to make expenditures for compliance with corrosion protection and leak detection requirements and required spill/overfill equipment by December 1998. We believe we are in compliance with the December 1998 upgrade requirements. Failure to comply with any environmental regulations or an increase in regulations could affect our business, financial condition and results of operations.
 
We May Incur Substantial Liabilities For Remediation of Environmental Contamination at Our Locations
 
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

4

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.
 
We estimate that our future expenditures for remediation of current locations net of reimbursements will be approximately $1.7 million for which reserves have been established on our financial statements. In addition, The Pantry estimates that up to $11.0 million may be expended for remediation on our behalf by state trust funds established in our operating areas or other responsible third parties including insurers. To the extent third parties do not pay for remediation as we anticipate, we will be obligated to make these payments, which could materially adversely affect our financial condition and results of operations. Reimbursements from state trust funds will be dependent on the continued viability of these funds.
 
We may incur additional substantial expenditures for remediation of contamination that has not been discovered at existing locations or locations which we may acquire in the future. 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.
 
Changes in Traffic Patterns and The Type, Number and Location of Competing Stores Could Result in The Loss of Customers and A Corresponding Decrease in Revenues for Affected Stores
 
The convenience store and retail gasoline industries are highly competitive and we may not be able to compete successfully. Changes in traffic patterns and the type, number and location of competing stores could result in the loss of customers and a corresponding decrease in revenues for affected stores. Major competitive factors include, among others, location, ease of access, gasoline brands, pricing, product and service selections, customer service, store appearance, cleanliness and safety. In addition, inflation, increased labor and benefit costs and the lack of availability of experienced management and hourly employees may adversely affect the profitability of the convenience store industry. Any or all of these factors could create heavy competitive pressures and have an adverse affect on our business, financial condition and results of operations.
 
We compete with numerous retail formats including other convenience stores, gasoline service stations, supermarket chains, super stores and warehouse stores, drug stores, fast food operations and other similar retail outlets. In some of our markets our competitors have been in existence longer and have greater financial, marketing and other resources than us. As a result, our competitors may be able to respond better to changes in the economy and new opportunities in our industry.
 
We Depend on One Principal Supplier for The Majority of Our Merchandise and Loss of This Supplier Could Have an Adverse Impact on Our Cost of Goods and Our Business
 
We purchase over 50% of our general merchandise, including most tobacco products and grocery items, from a single wholesale grocer, McLane Company, Inc., a wholly owned subsidiary of Wal-Mart. In addition, McLane supplies health and beauty aids, toys and seasonal items to all of our stores. We have a contract with McLane until 2003, but we may not be able to renew the contract upon expiration. We believe that our arrangements with vendors, including McLane, have enabled us to decrease the operating expenses of acquired companies after we complete an acquisition. Therefore, a change of suppliers could have a material adverse effect on our business, cost of goods, financial condition and results of operations.
 
Increases in Federal Minimum Wage Rates Could Adversely Affect Our Business
 
Any appreciable increase in the statutory minimum wage rate would result in an increase in our labor costs and such cost increase, or the penalties for failing to comply with such statutory minimums, could adversely affect our business, financial condition and results of operations.

5

 
Proposed Regulations, if Adopted, Could Adversely Affect Our Business
 
From time to time, regulations are proposed which, if adopted, could have an adverse effect on our business, financial condition or results of operations. One example is the possibility of the introduction of a mandated system of health insurance. If such a system were adopted and applied to us, our labor costs could increase significantly and any violations of such regulation could result in fines or other penalties, which could also adversely affect our business, financial condition and results of operations.
 
Because Substantially all of Our Stores are Located in the Southeastern United States, Our Revenues Could Suffer if The Economy of that Region Deteriorates
 
Substantially all of our stores are located in the Southeast region of the United States. As a result, our results of operations are subject to general economic conditions in that region. In the event of an economic downturn in the Southeast, our business, financial condition and results of operations could be adversely impacted.
 
Unfavorable Weather Conditions Could Adversely Affect Our Business
 
Weather conditions in our operating area impact our business, financial condition and results of operations. During the spring and summer vacation season, customers are more likely to purchase higher profit margin items at our stores, such as fast foods, fountain drinks and other beverages, and more gasoline at our gasoline locations. As a result, we typically generate higher revenues and gross margins during warmer weather months in the Southeast, which fall within our third and fourth quarters. If weather conditions are not favorable during these periods, our operating results and cash flow from operations could be adversely affected.
 
In addition, approximately 37% of our stores are concentrated in coastal areas in the southeastern United States, and are therefore exposed to damage associated with hurricanes, tropical storms and other weather conditions in these areas.
 
The Interests of Freeman Spogli & Co., Our Controlling Stockholder, May Conflict With Our Interests and The Interests of Our Other Stockholders
 
As a result of its stock ownership and board representation, Freeman Spogli will be in a position to affect our corporate actions such as mergers or takeover attempts in a manner that could conflict with the interests of our other stockholders. As of May 6, 2002, Freeman Spogli owned 10,329,524 shares of common stock and warrants to purchase 2,346,000 shares of common stock, or approximately 62.0% of our common stock on a fully diluted basis. In addition, four of the eight members of our board of directors are representatives of Freeman Spogli.
 
Because We Depend on Our Senior Management’s Experience and Knowledge of Our Industry, We Would be Adversely Affected if Senior Management Left the Pantry
 
We are dependent on the continued efforts of our senior management team, including our President and Chief Executive Officer, Peter Sodini. Mr. Sodini’s employment contract terminates in September 2004. If, for any reason, our senior executives do not continue to be active in management, our business, financial condition or results of operations could be adversely affected. We cannot assure you that we will be able to attract and retain additional qualified senior personnel as needed in the future. In addition, we do not maintain key personnel life insurance on our senior executives and other key employees.
 
Future Sales of Additional Shares into The Market May Depress The Market Price of The Common Stock
 
If our existing stockholders sell shares of common stock in the public market, including shares issued upon the exercise of outstanding options and warrants, or if the market perceives such sales could occur, the market price of our common stock could decline. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate or to use equity as consideration for future acquisitions.

6

 
As of May 6, 2002, there are 18,107,597 outstanding shares of our common stock outstanding. Of these shares, 6,250,000 shares are freely tradable. 12,538,951 shares are held by affiliate investment funds of Freeman Spogli and affiliates of J.P. Morgan Partners L.L.C. (‘‘J.P. Morgan’’), who may be deemed to be affiliates of The Pantry. Pursuant to Rule 144 under the Securities Act of 1933, as amended, affiliates of The Pantry can resell up to 1% of the aggregate outstanding common stock during any three month period. In addition, Freeman Spogli and J.P. Morgan have registration rights allowing them to require us to register the resale of their shares. If Freeman Spogli and J.P. Morgan exercise their registration rights and sell shares of common stock in the public market, the market price of our common stock could decline.
 
Our Charter Includes Provisions Which May Have The Effect of Preventing or Hindering A Change in Control and Adversely Affecting The Market Price of Our Common Stock
 
Our certificate of incorporation gives our board of directors the authority to issue up to five million shares of preferred stock and to determine the rights and preferences of the preferred stock, without obtaining shareholder approval. The existence of this preferred stock could make more difficult or discourage an attempt to obtain control of The Pantry by means of a tender offer, merger, proxy contest or otherwise. Furthermore, this preferred stock could be issued with other rights, including economic rights, senior to our common stock, and, therefore, issuance of the preferred stock could have an adverse affect on the market price of our common stock. We have no present plans to issue any shares of our preferred stock.
 
Other provisions of our certificate of incorporation and bylaws and of Delaware law could make it more difficult for a third party to acquire us or hinder a change in management even if doing so would be beneficial to our stockholders. These governance provisions could affect the market price of our common stock.
 
We may, in the future, adopt other measures that may have the effect of delaying, deferring or preventing an unsolicited takeover, even if such a change in control were at a premium price or favored by a majority of unaffiliated stockholders. These measures may be adopted without any further vote or action by our stockholders.

7
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