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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended September 28, 2006

 

Commission File Number: 000-25813

 


 

THE PANTRY, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   56-1574463

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

P.O. Box 1410

1801 Douglas Drive

Sanford, North Carolina

27331-1410

(Zip Code)

(Address of principal executive offices)

 


 

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

 


 

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

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $.01 par value

  The NASDAQ Stock Market LLC

 

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

 

NONE

 


 

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

 

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

 

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

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x   Accelerated filer ¨   Non-accelerated filer ¨

 

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

 

The aggregate market value of the voting common stock held by non-affiliates of the registrant as of March 30, 2006 was $1,141,948,543.

 

As of December 8, 2006, there were issued and outstanding 22,687,240 shares of the registrant’s common stock.

 

Documents Incorporated by Reference

 

Document

   Where Incorporated

1.      Proxy Statement for the Annual Meeting of Stockholders to be held March 29, 2007

   Part III

 



Table of Contents

THE PANTRY, INC.

 

ANNUAL REPORT ON FORM 10-K

 

TABLE OF CONTENTS

 

         Page

Part I

    

Item 1:

 

Business

   1

Item 1A:

 

Risk Factors

   11

Item 1B:

 

Unresolved Staff Comments

   20

Item 2:

 

Properties

   20

Item 3:

 

Legal Proceedings

   20

Item 4:

 

Submission of Matters to a Vote of Security Holders

   21

Part II

    

Item 5:

 

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

   22

Item 6:

 

Selected Financial Data

   23

Item 7:

 

Management’s Discussion and Analysis of Financial Condition and Results of Operation

   26

Item 7A:

 

Quantitative and Qualitative Disclosures About Market Risk

   46

Item 8:

 

Consolidated Financial Statements and Supplementary Data

   48

Item 9:

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   91

Item 9A:

 

Controls and Procedures

   91

Item 9B:

 

Other Information

   94

Part III

    

Item 10:

 

Our Directors and Executive Officers

   95

Item 11:

 

Executive Compensation

   95

Item 12:

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   95

Item 13:

 

Certain Relationships and Related Transactions

   95

Item 14:

 

Principal Accounting Fees and Services

   95

Part IV

    

Item 15:

 

Exhibits and Financial Statement Schedule

   96
 

Signatures

   103
 

Schedule II—Valuation and Qualifying Accounts and Reserves

   104

 

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PART I

 

Item 1.    Business.

 

General

 

We are the leading independently operated convenience store chain in the southeastern United States and one of the largest independently operated convenience store chains in the country based on store count. As of September 28, 2006, we operated 1,493 stores in eleven states under a number of selected banners including Kangaroo Express SM , our primary operating banner. Our stores offer a broad selection of merchandise, gasoline and ancillary products and services designed to appeal to the convenience needs of our customers. Our strategy is to continue to improve upon our position as the leading independently operated convenience store chain in the southeastern United States by generating profitable growth through continuing to selectively pursue acquisitions, merchandising initiatives, sophisticated management of our gasoline business, upgrading our stores, new store development, leveraging our geographic economies of scale, and benefiting from the favorable demographics of our markets.

 

Our principal executive offices are located at 1801 Douglas Drive, Sanford, North Carolina 27331. Our telephone number is 919-774-6700.

 

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

 

References in this annual report to “The Pantry,” “Pantry,” “we,” “us,” and “our” refer to The Pantry, Inc., and its subsidiaries, and references to “fiscal 2006” refer to our fiscal year which ended September 28, 2006, references to “fiscal 2005” refer to our fiscal year which ended September 29, 2005, references to “fiscal 2004” refer to our fiscal year which ended September 30, 2004, references to “fiscal 2003” refer to our fiscal year which ended September 25, 2003, and references to “fiscal 2002” refer to our fiscal year which ended September 26, 2002. Our fiscal year ended September 30, 2004 included 53 weeks, all remaining periods presented included 52 weeks.

 

Operations

 

Merchandise Operations.    In fiscal 2006, our merchandise sales were 23.2% of our total revenues and gross profit on our merchandise sales was 64.8% of our total gross profit. The following table highlights certain information with respect to our merchandise sales for the last five fiscal years:

 

     Fiscal Year Ended  
     September 28,
2006
    September 29,
2005
    September 30,
2004
    September 25,
2003
    September 26,
2002
 

Merchandise sales (in millions)

   $ 1,385.7     $ 1,228.9     $ 1,172.8     $ 1,009.7     $ 1,012.8  
Average merchandise sales per store (in thousands)    $ 954.3     $ 897.7     $ 856.7     $ 791.9     $ 776.1  
Comparable store merchandise sales increase      4.9 %     5.3 %     3.4 %     0.9 %     2.8 %
Merchandise gross margins (after purchase rebates, markdowns, inventory spoilage, inventory shrink and LIFO reserve)      37.4 %     36.6 %     36.3 %     36.2 %     34.9 %

 

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The increase in average merchandise sales per store in fiscal 2006 is primarily due to the fiscal 2006 comparable store merchandise sales increase of 4.9%. We believe the comparable store gains were driven by our store conversion and re-branding program, as well as our ongoing focus on higher margin merchandise categories such as food service and private label products.

 

Based on merchandise purchase and sales information, we estimate category sales as a percentage of total merchandise sales for the last five fiscal years as follows:

 

     Fiscal Year Ended  
     September 28,
2006
    September 29,
2005
    September 30,
2004
    September 25,
2003
    September 26,
2002
 

Tobacco products

   31.0 %   31.1 %   30.8 %   32.7 %   34.3 %

Packaged beverages

   16.9     16.3     15.7     15.1     14.4  

Beer and wine

   15.9     16.3     16.8     16.1     16.1  

General merchandise, health and
beauty care

   6.0     6.3     6.0     6.3     6.3  

Self-service fast foods and beverages

   5.7     5.6     5.5     5.4     5.2  

Salty snacks

   4.5     4.2     4.2     4.2     3.8  

Fast food service

   4.2     4.2     3.9     4.2     4.1  

Candy

   3.9     3.9     3.8     4.1     3.5  

Services

   3.4     3.0     3.3     3.2     2.6  

Dairy products

   2.7     3.1     3.3     2.7     2.8  

Bread and cakes

   2.2     2.3     2.3     2.4     2.3  

Grocery and other merchandise

   2.1     2.1     2.7     1.8     2.6  

Newspapers and magazines

   1.5     1.6     1.7     1.8     2.0  
                              

Total

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %
                              

 

As of September 28, 2006, we operated 197 quick service restaurants within 190 of our locations. In 124 of these quick service restaurants, we offer products from nationally branded food franchises including Subway®, Quiznos®, Hardee’s®, Krystal®, Church’s®, Dairy Queen®, and Bojangles®. In addition, we offer a variety of proprietary food service programs in 73 quick service restaurants featuring breakfast biscuits, fried chicken, deli and other hot food offerings.

 

We purchase over 50% of our merchandise, including most tobacco and grocery items, from a single wholesale grocer, McLane Company, Inc., or McLane. We have a distribution services agreement with McLane pursuant to which McLane is the primary distributor of traditional grocery products to our stores. We purchase the products at McLane’s cost plus an agreed upon percentage, reduced by any promotional allowances and volume rebates offered by manufacturers and McLane. In addition, we receive per store service allowances from McLane that are amortized over the remaining term of the agreement, which expires in April 2010. We purchase the balance of our merchandise from a variety of other distributors. We do not have written contracts with a number of these vendors.

 

Our services revenue is derived from sales of lottery tickets, prepaid products, money orders and car washes, and services such as public telephones, ATMs, amusement and video gaming and other ancillary product and service offerings.

 

Gasoline Operations.    We purchase our gasoline from major oil companies and independent refiners. At our locations we offer a mix of branded and private brand gasoline based on an evaluation of local market conditions. Of our 1,470 stores that sold gasoline as of September 28, 2006, 971, or 66.1%, were branded under the BP®, Citgo®, Chevron®, or ExxonMobil®, brand names. We purchase our branded gasoline and diesel fuel from major oil companies under supply agreements. We purchase the fuel at the stated rack price, or market price, quoted at each terminal as adjusted per the terms of applicable contracts. The initial terms of these supply

 

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agreements have expiration dates ranging from 2010 to 2012 and generally contain provisions for various payments to us based on volume of purchases and vendor allowances. We purchase the majority of our private branded gallons from Citgo Petroleum Corporation, or Citgo®. There are approximately 55 gasoline terminals in our operating areas, allowing us to choose from more than one distribution point for most of our stores. Our inventories of gasoline (both branded and private branded) turn approximately every four days.

 

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

 

In fiscal 2006, our gasoline revenues were 76.8% of our total revenues and gross profit on our gasoline revenues was 35.2% of our total gross profit. The following table highlights certain information regarding our gasoline operations for the last five fiscal years:

 

    Fiscal Year Ended  
    September 28,
2006
    September 29,
2005
    September 30,
2004
    September 25,
2003
    September 26,
2002
 

Gasoline sales (in millions)

  $ 4,576.0     $ 3,200.3     $ 2,320.2     $ 1,740.7     $ 1,470.7  

Gasoline gallons sold (in millions)

    1,774.9       1,501.0       1,376.9       1,170.3       1,171.9  

Average gallons sold per store (in thousands)

    1,242.1       1,117.6       1,026.0       940.7       924.2  

Comparable store gallon growth

    3.1 %     4.7 %     2.0 %     0.7 %     1.5 %

Average retail price per gallon

  $ 2.58     $ 2.13     $ 1.69     $ 1.49     $ 1.25  

Average gross profit per gallon

  $ 0.158     $ 0.142     $ 0.120     $ 0.124     $ 0.104  

Locations selling gasoline

    1,470       1,377       1,335       1,232       1,253  

Branded locations

    971       878       890       872       959  

Private brand locations

    499       499       445       360       294  

 

The increase in average gallons sold per store in fiscal 2006 is primarily due to the comparable store gallon growth of 3.1%, our current year acquisitions which on average had higher per store gasoline volumes than our typical store, and our continued efforts to re-brand or re-image our gasoline facilities. In fiscal 2006, the gasoline markets were volatile, with domestic crude oil hitting a low in November 2005 of approximately $56 per barrel and a high in July 2006 of approximately $77 per barrel. We attempt to pass along wholesale gasoline cost changes to our customers through retail price changes; however, we are not always able to do so. The timing of any related increase or decrease in retail prices is affected by competitive conditions. As a result, we tend to experience lower gasoline margins in periods of rising wholesale costs and higher margins in periods of decreasing wholesale costs. We are unable to ensure that significant volatility in gasoline wholesale prices will not negatively affect gasoline gross margins or demand for gasoline within our markets.

 

Store Locations.    As of September 28, 2006, we operated 1,493 convenience stores located primarily in growing markets, coastal/resort areas and along major interstates and highways. Approximately 34% of our total stores are strategically located in coastal/resort areas such as Jacksonville, Orlando/Disney World, Myrtle Beach, Charleston, St. Augustine, Hilton Head and Gulfport/Biloxi that attract a large number of tourists who we believe value convenience shopping. Additionally, approximately 18% of our total stores are situated along major interstates and highways, which benefit from high traffic counts and customers seeking convenient fueling locations, including some stores in coastal or resort areas. Almost all of our stores are freestanding structures averaging approximately 2,600 square feet and provide ample customer parking.

 

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The following table shows the geographic distribution by state of our stores for each of the last five fiscal years:

 

           Number of Stores as of Fiscal Year Ended

State

   Percentage of
Total Stores at
September 28,
2006
   

September 28,

2006

   September 29,
2005
  

September 30,

2004

   September 25,
2003
   September 26,
2002

Florida

   29.5 %   441    442    461    477    494

North Carolina

   21.8     325    304    322    328    331

South Carolina

   15.8     236    235    239    240    248

Georgia

   8.4     125    126    98    56    56

Tennessee

   6.8     101    101    103    14    14

Alabama

   5.1     77    38    —      —      —  

Mississippi

   4.9     73    53    51    53    54

Virginia

   3.3     50    50    30    30    30

Kentucky

   2.1     31    33    37    38    39

Louisiana

   1.7     25    8    8    8    8

Indiana

   0.6     9    10    12    14    15
                              

Total

   100 %   1,493    1,400    1,361    1,258    1,289
                              

 

The following table summarizes our activities related to acquisitions, store openings and store closures during the last five fiscal years:

 

     Fiscal Year Ended  
     September 28,
2006
    September 29,
2005
    September 30,
2004
    September 25,
2003
    September 26,
2002
 
Number of stores at
beginning of period
   1,400     1,361     1,258     1,289     1,324  
Acquired or opened    117     97     140     4     3  
Closed or sold    (24 )   (58 )   (37 )   (35 )   (38 )
                              
Number of stores at end
of period
   1,493     1,400     1,361     1,258     1,289  
                              

 

Acquisitions.    We generally focus on selectively acquiring chains within and contiguous to our existing market areas. In evaluating potential acquisition candidates, we consider a number of factors, including strategic fit, desirability of location, price and our ability to improve the productivity and profitability of a location through the implementation of our operating strategy. Additionally, we would consider acquiring stores that are not within or contiguous to our current markets if the opportunity met certain criteria including, among others, a minimum number of stores, sales volumes and profitability.

 

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The tables below provide information concerning the acquisitions we completed in fiscal 2006 and in fiscal 2005:

 

Fiscal 2006

Date Acquired

 

Seller

 

Trade Name

 

Locations

 

Number of

Stores

February 9, 2006

  Lee-Moore Oil Company   TruBuy and On The Run®   North Carolina   19

February 16, 2006

  Waring Oil Company, LLC   Interstate Food Stops   Mississippi and Louisiana   39

May 11, 2006

  Shop-A-Snak Food Mart, Inc.   Shop-A-Snak Food MartSM   Alabama   38

August 10, 2006

  Fuel Mate, LLC   Fuel Mate   North Carolina   6

Others (fewer than 5 stores)

  Various   Various   Georgia, Florida, Mississippi, North Carolina, and South Carolina   11
         
Total         113
         

Fiscal 2005

Date Acquired

 

Seller

 

Trade Name

 

Locations

  Number of
Stores

April 21, 2005

  D&D Oil Co.   CowboysSM   Alabama, Georgia, Mississippi   53

August 18, 2005

  Angus I. Hines, Inc.   Sentry Food MartSM   Virginia   23

September 22, 2005

  Chatham Oil Company   SpeedmartSM Food Stores   Alabama   13

Others (fewer than 5 stores)

  Various   Various   Alabama, Mississippi, North Carolina, and South Carolina   7
         

Total

        96
         

 

New Stores.    In opening new stores in recent years, we have focused on selecting store sites on highly traveled roads in coastal/resort and suburban markets or near highway exit and entrance ramps that provide convenient access to the store location. In selecting sites for new stores, we use an evaluation process designed to enhance our return on investment that focuses on market area demographics, population density, traffic volume, visibility, ingress and egress and economic development in the market area. We also review the location of competitive stores and customer activity at those stores. During fiscal 2006, we opened four new locations. During fiscal 2007, we plan to expand our new store development and open approximately 20 new larger format stores. We feel the larger store layout in the correct location provides opportunity for higher merchandise and gasoline revenues and profit margins.

 

Improvement of Store Facilities and Equipment.    During fiscal 2006 and fiscal 2005, we upgraded the facilities and equipment at many of our existing and acquired store locations. The gross cost of these upgrades was approximately $70.6 million in fiscal 2006 and $57.9 million in fiscal 2005. Prior to making these expenditures, management assesses potential return on investment, sales volumes, and the lease term for leased locations. Following is a breakdown of these expenditures:

 

    we spent $19.6 million on rebuilds and remodeling in fiscal 2006 compared to $9.1 million in fiscal 2005; and

 

    we spent $7.5 million on gasoline and store branding in fiscal 2006 compared to $19.7 million in fiscal 2005; and

 

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    we spent $43.5 million on other capital improvements in fiscal 2006 compared to $29.1 million in fiscal 2005. These amounts included gasoline upgrades, building improvements, new store equipment, quick service restaurant installations and improvements, self-service food service installations and improvements, installation of scanning equipment and other store-related improvements.

 

Store Closures.    We continually evaluate the performance of each of our stores to determine whether any particular store should be closed or sold based on profitability trends and our market presence in the surrounding area. Although closing or selling underperforming stores reduces revenues, our operating results typically improve as these stores are generally unprofitable. During fiscal 2006, we closed or sold 24 stores compared to 58 stores in fiscal 2005.

 

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

 

Competition

 

The convenience store and retail gasoline industries are highly competitive. We compete with numerous other convenience stores, supermarkets, drug stores, discount clubs, gasoline service stations, out of channel retailers, mass merchants, fast food operations and other similar retail outlets. The performance of individual stores can be affected by changes in traffic patterns and the type, number and location of competing stores. Principal competitive factors include, among others, location, ease of access, gasoline brands, pricing, product and service selections, customer service, store appearance, cleanliness and safety. We believe that our modernized store base, strategic mix of locations, gasoline offerings and use of competitive market data, including our Gasoline Pricing System, which helps us optimize competitive gasoline pricing, combined with our management’s expertise, allow us to be an effective and significant competitor in our markets.

 

Technology and Store Automation

 

We continue to invest in and deploy technologies that make our business operations competitive. We recently developed a preliminary strategic roadmap to upgrade and replace systems that align with our business strategy and create synergies by effectively combining people, process and technology over the next few years. Starting in fiscal 2007, we expect to begin to combine existing IS projects with new initiatives which will ultimately touch most facets of our business. We will strategically involve subject matter experts and benchmarking to ensure we implement proven solutions.

 

Key objectives of this initiative include:

 

    Assessing our systems strategy and ensuring alignment with our overall business strategy;

 

    Responding to and planning for future growth;

 

    Continuing efforts to improve processes and apply systems (applications and technology) solutions; and

 

    Garnering expected efficiencies as we continue to grow.

 

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Our systems management plan and initiatives consider the following:

 

    Our strategy of growth through acquisition and organic growth through sales in our existing stores has required us to ensure that we have technology solutions that scale to our business growth. Additionally, we strive to ensure that performance of information systems are scalable to our store growth and geographical location of our stores.

 

    Recent business compliance requirements such as Sarbanes-Oxley and Payment Card Industry Standards (PCI) suggest that we replace manual controls with more reliable and consistent controls supported by robust software and network solutions.

 

In fiscal 2006 we continued to invest in complementary technology programs and system upgrades targeted to improve store level gasoline pricing and merchandise inventory management, along with new decision support and training tools. These initiatives included:

 

    Selection of a business partner for pilot sites that can assist us in the wide scale rollout of a communications network that will create a real-time connection between our Corporate Support Center and our stores. Pilot store locations have been used to test the new high performance network and have produced benefits in the form of reduced sales transaction times for customers and the ability to provide higher quality employee training programs delivered to the store from remote locations.

 

    The selection process and planning for a pilot program implementation of our go-forward Point-Of-Sale (POS) solution that will facilitate the testing and final selection of a new store based software and hardware package that, in addition to completing sales transactions, should facilitate improvements in store operations, merchandising opportunities and accounting processing.

 

As stated in previous years, we continue to develop, enhance and utilize proprietary and packaged applications to improve store level gasoline pricing, gasoline and merchandise inventory management, automate functions throughout our administrative departments and expand the use of decision support tools. We anticipate that we will continue to invest in information systems that make our business operations competitive.

 

Trade Names, Service Marks and Trademarks

 

We have registered, acquired the registration of, applied for the registration of and claim ownership of a variety of trade names, service marks and trademarks for use in our business, including The Pantry®, Worth®, Golden Gallon®, Bean Street Coffee Company®, Big Chill®, Celeste®, The Chill ZoneSM, Lil’ Champ Food Store®, Handy Way®, Quick StopSM, Kangaroo®, Kangaroo ExpressSM, Fast Lane®, Big K Food StoresSM, Mini MartSM, Depot SM, Food Chief®, Express StopSM, SprintSM, CowboysSM and Smokers ExpressSM. In the highly competitive business in which we operate, our trade names, service marks and trademarks are critical to distinguish our products and services from those of our competitors. We are not aware of any facts which would negatively impact our continuing use of any of the above trade names, service marks or trademarks.

 

Government Regulation and Environmental Matters

 

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

 

Storage and Sale of Gasoline.    We are subject to various federal, state and local environmental laws. We make financial expenditures in order to comply with regulations governing underground storage tanks adopted by

 

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federal, state and local regulatory agencies. In particular, at the federal level, the Resource Conservation and Recovery Act of 1976, as amended, requires the Environmental Protection Agency, or EPA, to establish a comprehensive regulatory program for the detection, prevention and cleanup of leaking underground storage tanks (e.g. overfills, spills and underground storage tank releases).

 

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 September 28, 2006, we maintain letters of credit in the aggregate amount of approximately $1.3 million in favor of state environmental agencies in North Carolina, South Carolina, Virginia, Georgia, Indiana, Tennessee, Kentucky and Louisiana.

 

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

 

Regulations enacted by the EPA in 1988 established requirements for:

 

    installing underground storage tank systems;

 

    upgrading underground storage tank systems;

 

    taking corrective action in response to releases;

 

    closing underground storage tank systems;

 

    keeping appropriate records; and

 

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

 

These regulations permit states to develop, administer and enforce their own regulatory programs, incorporating requirements that are at least as stringent as the federal standards. In 1998, Florida developed its own regulatory program, which incorporated requirements more stringent than the 1988 EPA regulations. We believe our facilities in Florida meet or exceed those regulations developed by the State of Florida in 1998. In addition, we believe all company-owned underground storage tank systems are in material compliance with these 1988 EPA regulations and all applicable state environmental regulations.

 

State Trust Funds.    All states in which we operate or have operated underground storage tank systems have established trust funds for the sharing, recovering and reimbursing of certain cleanup costs and liabilities incurred as a result of releases from underground storage tank systems. These trust funds, which essentially provide insurance coverage for the cleanup of environmental damages caused by the operation of underground storage tank systems, are funded by an underground storage tank registration fee and a tax on the wholesale purchase of motor fuels within each state. We have paid underground storage tank registration fees and gasoline taxes to each state where we operate to participate in these trust fund programs. We have filed claims and received reimbursements in North Carolina, South Carolina, Kentucky, Indiana, Georgia, Florida, Tennessee, Mississippi and Virginia. The coverage afforded by each state fund varies but generally provides up to $1.5 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;

 

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    removal and disposal of underground storage tank systems; and

 

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

 

The Florida trust fund will not cover releases first reported after December 31, 1998. We obtained private insurance coverage for remediation and third-party claims arising out of releases that occurred in Florida and were reported after December 31, 1998. We believe that this coverage exceeds federal and Florida financial responsibility regulations. In Georgia, we opted not to participate in the state trust fund effective December 30, 1999, except for certain sites, including sites where our lease requires us to participate in the Georgia trust fund. For all such sites where we have opted not to participate in the Georgia trust fund, we have obtained private insurance coverage for remediation and third party claims. We believe that this coverage exceeds federal and Georgia financial responsibility regulations.

 

Environmental reserves of $18.4 million and $16.3 million are included in other noncurrent liabilities in the accompanying consolidated balance sheets as of September 28, 2006 and September 29, 2005, respectively, and represent our estimates for future expenditures for remediation, tank removal and litigation associated with 269 known contaminated sites as of September 28, 2006 and September 29, 2005, as a result of releases (e.g., overfills, spills and underground storage tank releases) and are based on current regulations, historical results and certain other factors. We estimate that approximately $17.1 million of our environmental obligation will be funded by state trust funds and third party insurance; as a result we may spend up to $1.2 million for remediation, tank removal and litigation. Also, as of September 28, 2006 and September 29, 2005, there were an additional 534 and 510 sites, respectively, that are known to be contaminated sites that are being remediated by third parties, and therefore, the costs to remediate such sites are not included in our environmental reserve. Remediation costs for known sites are expected to be incurred over the next one to ten years. Environmental reserves have been established with remediation costs based on internal and external estimates for each site. Future remediation for which the timing of payments can be reasonably estimated is discounted using an appropriate rate to determine the reserve.

 

We anticipate that we will be reimbursed for expenditures from state trust funds and private insurance. As of September 28, 2006, anticipated reimbursements of $17.3 million are recorded as other noncurrent assets and $2.5 million are recorded as current receivables related to all sites. In Florida, remediation of such contamination reported before January 1, 1999 will be performed by the state (or state approved independent contractors) and substantially all of the remediation costs, less any applicable deductibles, will be paid by the state trust fund. We will perform remediation in other states through independent contractor firms engaged by us. For certain sites, the trust fund does not cover a deductible or has a co-pay which may be less than the cost of such remediation. Although we are not aware of releases or contamination at other locations where we currently operate or have operated stores, any such releases or contamination could require substantial remediation expenditures, some or all of which may not be eligible for reimbursement from state trust funds or private insurance.

 

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

 

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

 

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

 

Our operations are also subject to federal and state laws governing such matters as wage rates, overtime, working conditions and citizenship requirements. At the federal level, there are proposals under consideration from time to time to increase minimum wage rates and to introduce a system of mandated health insurance, each of which could affect our results of operations.

 

Employees

 

As of September 28, 2006, we employed 10,356 full-time and 1,649 part-time employees. Fewer part-time employees are employed during the winter months than during the peak spring and summer seasons. 11,312 of our employees are employed in our stores and 693 are corporate and field management personnel. None of our employees are represented by unions. We consider our employee relations to be good.

 

Executive Officers

 

The following table provides information on our executive officers. There are no family relationships between any of our executive officers:

 

Name

   Age   

Position with our Company

Peter J. Sodini

   65    President, Chief Executive Officer and Director

Steven J. Ferreira

   50    Senior Vice President, Administration

Daniel J. Kelly

   54    Vice President, Finance and Chief Financial Officer

David M. Zaborski

   51    Senior Vice President, Operations

Keith S. Bell

   42    Senior Vice President, Fuels

Melissa H. Anderson

   42    Senior Vice President, Human Resources

 

Peter J. Sodini has served as our President and Chief Executive Officer since June 1996 and became The Pantry’s Chairman of the Board in February 2006. He previously served as our Chief Operating Officer from February 1996 until June 1996. Mr. Sodini was Chief Executive Officer and a director of Purity Supreme, Inc. from December 1991 through February 1996. Prior to 1991, Mr. Sodini held executive positions at several supermarket chains including Boys Markets, Inc. and Piggly Wiggly Southern, Inc. Mr. Sodini has served as a director since November 1995.

 

Steven J. Ferreira has served as our Senior Vice President, Administration since February 2001 and prior to that served as Vice President, Strategic Planning since May 1997. Prior to joining The Pantry, he was with The Store 24 Companies, Inc. for nearly 20 years where he held various executive positions including Vice President Operations, Vice President Marketing and, finally, Chief Operating Officer.

 

Daniel J. Kelly has served as our Vice President, Finance and Chief Financial Officer since January 2003. Prior to joining The Pantry, Mr. Kelly was with Konover Property Trust, Inc., a public real estate investment trust, where he served as Chief Financial Officer and Executive Vice President from November 1999 to November 2002. Prior to joining Konover, Mr. Kelly was a partner in the audit division of Arthur Andersen LLP. Prior to being named partner in 1993, Mr. Kelly had various other positions during his sixteen-year tenure with that firm.

 

David M. Zaborski has served as Senior Vice President, Operations since January 2006. Mr. Zaborski served as Vice President, Marketing from November 2001 to January 2006. Mr. Zaborski also served as Vice

 

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President, Operations from June 2000 until November 2001. From March 1999 to June 2000, Mr. Zaborski served as Vice President, Strategic Planning. Mr. Zaborski served as Director of Marketing for Handy Way Food Stores from August 1990 to February 1999.

 

Keith S. Bell has served as our Senior Vice President, Fuels since July 2006. Mr. Bell is an 18-year veteran of BP p.l.c. and Amoco Company, which was acquired by BP p.l.c. in 1998. During his career at BP p.l.c. and Amoco, he progressed through a variety of sales and marketing positions, and most recently was Vice President in charge of BP’s U.S. branded jobber business.

 

Melissa H. Anderson has served as our Senior Vice President, Human Resources since November 2006. Prior to joining The Pantry, Ms. Anderson was with International Business Machines Corporation, or IBM, where for the last three years, she was the Vice President of Human Resources for IBM Global Financing. While at IBM, she led a worldwide team of human resource professionals responsible for creating and executing a worldwide workforce management strategy for an organization of approximately 3,500 employees. Previously, Ms. Anderson held numerous human resource positions in her 17-year tenure with IBM, including Human Resource Director for IBM’s Tivoli unit.

 

Item 1A.    Risk Factors.

 

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

 

Risks Related to Our Industry

 

The convenience store industry is highly competitive and impacted by new entrants.

 

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

 

Volatility of wholesale petroleum costs could impact our operating results.

 

Over the past three fiscal years, our gasoline revenue accounted for approximately 72.7% of total revenues and our gasoline gross profit accounted for approximately 32.2% of total gross profit. Crude oil and domestic wholesale petroleum markets are marked by significant volatility. General political conditions, acts of war or

 

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terrorism, and instability in oil producing regions, particularly in the Middle East and South America, could significantly impact crude oil supplies and wholesale petroleum costs. In addition, the supply of gasoline and our wholesale purchase costs could be adversely impacted in the event of a shortage, which could result from, among other things, lack of capacity at United States oil refineries or the fact that our gasoline contracts do not guarantee an uninterrupted, unlimited supply of gasoline. Significant increases and volatility in wholesale petroleum costs could result in significant increases in the retail price of petroleum products and in lower gasoline gross margin per gallon. Increases in the retail price of petroleum products could impact consumer demand for gasoline. This volatility makes it extremely difficult to predict the impact future wholesale cost fluctuations will have on our operating results and financial condition. These factors could materially impact our gasoline gallon volume, gasoline gross profit and overall customer traffic, which in turn would impact our merchandise sales.

 

Wholesale cost increases of tobacco products could impact our operating results.

 

Sales of tobacco products have averaged approximately 7.5% of our total revenue over the past three fiscal years, and our tobacco gross profit accounted for approximately 13.8% of total gross profit for the same period. Significant increases in wholesale cigarette costs and tax increases on tobacco products, as well as national and local campaigns to discourage smoking in the United States, may have an adverse effect on unit demand for cigarettes. In general, we attempt to pass price increases on to our customers. However, due to competitive pressures in our markets, we may not be able to do so. These factors could materially impact our retail price of cigarettes, cigarette unit volume and revenues, merchandise gross profit and overall customer traffic.

 

Changes in consumer behavior, travel and tourism could impact our business.

 

In the convenience store industry, customer traffic is generally driven by consumer preferences and spending trends, growth rates for automobile and truck traffic and trends in travel, tourism and weather. Changes in economic conditions generally or in the southeastern United States specifically could adversely impact consumer spending patterns and travel and tourism in our markets. Approximately 34.0% of our stores are located in coastal, resort or tourist destinations. Historically, travel and consumer behavior in such markets is more severely impacted by weak economic conditions. If visitors to resort or tourist locations decline due to economic conditions, changes in consumer preferences, changes in discretionary consumer spending or otherwise, our sales could decline.

 

Risks Related to Our Business

 

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

 

Substantially all of our stores are located in the southeast region of the United States. Although the southeast region is generally known for its mild weather, the region is susceptible to severe storms including hurricanes, thunderstorms, extended periods of rain, ice storms and heavy snow, all of which we have historically experienced. Inclement weather conditions as well as severe storms in the southeast region could damage our facilities or could have a significant impact on consumer behavior, travel and convenience store traffic patterns as well as our ability to operate our locations. In addition, we typically generate higher revenues and gross margins during warmer weather months in the Southeast, which fall within our third and fourth fiscal quarters. If weather conditions are not favorable during these periods, our operating results and cash flow from operations could be adversely affected. We would also be impacted by regional occurrences in the southeastern United States such as energy shortages or increases in energy prices, fires or other natural disasters.

 

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

 

An important part of our historical growth strategy has been to acquire other convenience stores that complement our existing stores or broaden our geographic presence. Since 1996, we have successfully completed

 

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and integrated more than 70 acquisitions, growing our store base from 379 to 1,493 stores. We expect to continue to selectively review acquisition opportunities as an element of our growth strategy. Acquisitions involve risks that could cause our actual growth or operating results to differ significantly from our expectations or the expectations of securities analysts. For example:

 

    We may not be able to identify suitable acquisition candidates or acquire additional convenience stores on favorable terms. We compete with others to acquire convenience stores. We believe that this competition may increase and could result in decreased availability or increased prices for suitable acquisition candidates. It may be difficult to anticipate the timing and availability of acquisition candidates.

 

    During the acquisition process we may fail or be unable to discover some of the liabilities of companies or businesses which we acquire. These liabilities may result from a prior owner’s noncompliance with applicable federal, state or local laws.

 

    We may not be able to obtain the necessary financing, on favorable terms or at all, to finance any of our potential acquisitions.

 

    We may fail to successfully integrate or manage acquired convenience stores.

 

    Acquired convenience stores may not perform as we expect or we may not be able to obtain the cost savings and financial improvements we anticipate.

 

    We face the risk that our existing systems, financial controls, information systems, management resources and human resources will need to grow to support significant growth.

 

Our substantial indebtedness could negatively impact our financial health.

 

We have a significant amount of indebtedness. As of September 28, 2006, we had consolidated debt, including lease finance obligations, of approximately $848.4 million. As of September 28, 2006, our availability under our senior credit facility for borrowing was approximately $104.2 million (approximately $44.2 million of which was available for issuance of letters of credit).

 

Our substantial indebtedness could have important consequences to you. For example, it could:

 

    make it more difficult for us to satisfy our obligations with respect to our debt and our leases;

 

    increase our vulnerability to general adverse economic and industry conditions;

 

    require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;

 

    limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

    place us at a competitive disadvantage compared to our competitors that have less indebtedness or better access to capital by, for example, limiting our ability to enter into new markets or renovate our stores; and

 

    limit our ability to borrow additional funds in the future.

 

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

 

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

 

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

 

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

 

We and our subsidiaries are able to incur additional indebtedness. The terms of the indenture that governs our senior subordinated notes permit us to incur additional indebtedness under certain circumstances. The indenture governing our convertible notes does not contain any limit on our ability to incur debt. In addition, our senior credit facility permits us to incur additional indebtedness (assuming certain financial conditions are met at the time) beyond the $150.0 million under our revolving credit facility. If we and our subsidiaries incur additional indebtedness, the related risks that we and they now face could increase.

 

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

 

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

 

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

 

Based on our current level of operations, we believe our cash flow from operations, available cash and available borrowings under our revolving credit facility will be adequate to meet our future liquidity needs for at least the next 12 months. We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our revolving credit facility in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness on or before maturity, sell assets, reduce or delay capital expenditures, seek additional equity financing or seek third-party financing to satisfy such obligations. We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all. Our failure to fund indebtedness obligations at any time could constitute an event of default under the instruments governing such indebtedness, which would likely trigger a cross-default under our other outstanding debt.

 

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

 

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

 

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

 

We are subject to state and federal environmental and other regulations.

 

Our business is subject to extensive governmental laws and regulations including, but not limited to, environmental regulations, employment laws and regulations, regulations governing the sale of alcohol and tobacco, minimum wage requirements, working condition requirements, public accessibility requirements, citizenship requirements and other laws and regulations. A violation or change of these laws could have a material adverse effect on our business, financial condition and results of operations.

 

Under various federal, state and local laws, ordinances and regulations, we may, as the owner or operator of our locations, be liable for the costs of removal or remediation of contamination at these or our former locations, whether or not we knew of, or were responsible for, the presence of such contamination. The failure to properly remediate such contamination may subject us to liability to third parties and may adversely affect our ability to sell or rent such property or to borrow money using such property as collateral. Additionally, persons who arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of such substances at sites where they are located, whether or not such site is owned or operated by such person. Although we do not typically arrange for the treatment or disposal of hazardous substances, we may be deemed to have arranged for the disposal or treatment of hazardous or toxic substances and, therefore, may be liable for removal or remediation costs, as well as other related costs, including governmental fines, and injuries to persons, property and natural resources.

 

Compliance with existing and future environmental laws regulating underground storage tanks may require significant capital expenditures and increased operating and maintenance costs. The remediation costs and other costs required to clean up or treat contaminated sites could be substantial. We pay tank registration fees and other taxes to state trust funds established in our operating areas and maintain private insurance coverage in Florida and Georgia in support of future remediation obligations.

 

These state trust funds or other responsible third parties including insurers are expected to pay or reimburse us for remediation expenses less a deductible. To the extent third parties do not pay for remediation as we anticipate, we will be obligated to make these payments. These payments could materially adversely affect our financial condition and results of operations. Reimbursements from state trust funds will be dependent on the maintenance and continued solvency of the various funds.

 

In the future, we may incur substantial expenditures for remediation of contamination that has not been discovered at existing or acquired locations. We cannot assure you that we have identified all environmental liabilities at all of our current and former locations; that material environmental conditions not known to us do

 

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not exist; that future laws, ordinances or regulations will not impose material environmental liability on us; or that a material environmental condition does not otherwise exist as to any one or more of our locations. In addition, failure to comply with any environmental laws, ordinances or regulations or an increase in regulations could adversely affect our operating results and financial condition.

 

State laws regulate the sale of alcohol and tobacco products. A violation or change of these laws could adversely affect our business, financial condition and results of operations because state and local regulatory agencies have the power to approve, revoke, suspend or deny applications for, and renewals of, permits and licenses relating to the sale of these products or to seek other remedies. In addition, certain states regulate relationships, including overlapping ownership, among alcohol manufacturers, wholesalers and retailers, and may deny or revoke licensure if relationships in violation of the state laws exist. We are not aware of any alcoholic beverage manufacturers or wholesalers having a prohibited relationship with our company.

 

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

 

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

 

We depend on one principal supplier for the majority of our merchandise.

 

We purchase over 50% of our general merchandise, including most tobacco products and grocery items, from a single wholesale grocer, McLane Company, Inc. We have a contract with McLane until April 2010, but we may not be able to renew the contract upon expiration. A change of suppliers, a disruption in supply or a significant change in our relationship with our principal suppliers could have a material adverse effect on our business, cost of goods sold, financial condition and results of operations.

 

We depend on two principal suppliers for the majority of our gasoline.

 

BP® and Citgo® supply approximately 82% of our gasoline purchases. We have contracts with Citgo® until 2010 and BP® until 2012, but we may not be able to renew either contract upon expiration. A change of suppliers, a disruption in supply or a significant change in our relationship with our principal suppliers could materially increase our cost of goods sold, which would negatively impact our financial condition and results of operations.

 

Because we depend on our senior management’s experience and knowledge of our industry, we would be adversely affected if senior management left The Pantry.

 

We are dependent on the continued efforts of our senior management team, including our President and Chief Executive Officer, Peter J. Sodini. Mr. Sodini’s employment contract terminates in September 2009. 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. We also rely on our ability to recruit store managers, regional managers and other store personnel. If we fail to continue to attract these individuals, our operating results may be adversely affected.

 

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

 

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

 

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

 

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

 

Pending SEC matters could adversely affect us.

 

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

 

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

 

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

 

We have in the past discovered, and may in the future discover, areas of our internal control over financial reporting that need improvement. For example, during management’s fiscal 2005 Sarbanes-Oxley Section 404

 

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assessment, two material weaknesses in internal control over financial reporting were identified. These material weaknesses resulted in a more than remote risk that a material misstatement of our annual or interim financial statements would not be prevented or detected.

 

We have devoted significant resources to remediate our deficiencies and improve our internal control over financial reporting. Although we believe that these efforts have strengthened our internal control over financial reporting and addressed the concerns that gave rise to the material weaknesses in fiscal 2005, we are continuing to work to improve our internal control over financial reporting. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Inferior internal control over financial reporting could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

 

Other Risks

 

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

 

If we or our existing stockholders sell shares of our common stock in the public market, including shares issued upon the exercise of outstanding options, or if the market perceives such sales or issuances could occur, the market price of our common stock could decline. As of December 8, 2006, there are 22,687,240 shares of our common stock outstanding. Of these shares, 22,432,241 shares are freely tradable (unless held by one of our affiliates). Pursuant to Rule 144 under the Securities Act of 1933, as amended, or the Securities Act, during any three-month period our affiliates can resell up to the greater of (a) 1% of our aggregate outstanding common stock or (b) the average weekly trading volume for the four weeks prior to the sale. Sales by our existing stockholders also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate or to use equity as consideration for future acquisitions.

 

In addition, we have filed registration statements with the SEC that cover up to 5,100,000 shares issuable pursuant to the exercise of stock options granted and to be granted under our stock option plans. Shares registered on a registration statement may be sold freely at any time after issuance.

 

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

 

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

 

We have also issued warrants to purchase up to 2,993,000 shares of our common stock to an affiliate of Merrill Lynch in connection with the note hedge and warrant transactions entered into at the time of our offering of convertible notes.

 

Raising funds by issuing securities dilutes the ownership of our existing stockholders. Additionally, certain types of equity securities that we may issue in the future could have rights, preferences or privileges senior to your rights as a holder of our common stock. We could choose to issue additional shares for a variety of reasons including for investment or acquisitive purposes. Such issuances may have a dilutive impact on your investment.

 

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

 

There currently is a public market for our common stock, but there is no assurance that there will always be such a market. Securities markets worldwide experience significant price and volume fluctuations. This market volatility could significantly affect the market price of our common stock without regard to our operating performance. In addition, the price of our common stock could be subject to wide fluctuations in response to the following factors among others:

 

    A deviation in our results from the expectations of public market analysts and investors;

 

    Statements by research analysts about our common stock, our company or our industry;

 

    Changes in market valuations of companies in our industry and market evaluations of our industry generally;

 

    Additions or departures of key personnel;

 

    Actions taken by our competitors;

 

    Sales or other issuances of common stock by the company, senior officers or other affiliates; or

 

    Other general economic, political or market conditions, many of which are beyond our control.

 

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

 

Our charter includes provisions that may have the effect of preventing or hindering a change in control and adversely affecting the market price of our common stock.

 

Our certificate of incorporation gives our board of directors the authority to issue up to five million shares of preferred stock and to determine the rights and preferences of the preferred stock, without obtaining stockholder approval. The existence of this preferred stock could make it more difficult or discourage an attempt to obtain control of The Pantry by means of a tender offer, merger, proxy contest or otherwise. Furthermore, this preferred stock could be issued with other rights, including economic rights, senior to our common stock, and, therefore, issuance of the preferred stock could have an adverse effect 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. For example, our certificate of incorporation makes us subject to the anti-takeover provisions of Section 203 of the General Corporation Law of the State of Delaware. In general, Section 203 prohibits publicly-held Delaware corporations to which it applies from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. This provision could discourage others from bidding for our shares and could, as a result, reduce the likelihood of an increase in our stock price that would otherwise occur if a bidder sought to buy our stock.

 

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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.

 

Item 1B.    Unresolved Staff Comments.

 

None.

 

Item 2.    Properties.

 

As of September 28, 2006, we own the real property at 368 of our stores and lease the real property at 1,125 stores. Management believes that none of these leases is individually material. Most of these leases are net leases requiring us to pay all costs related to the property, including taxes, insurance and maintenance costs. Certain of these leases are accounted for as lease finance obligations whereby the leased assets and related lease liabilities are included in our Consolidated Balance Sheets. The aggregate rent paid for fiscal 2006 for operating leases was $59.8 million and for leases accounted for as lease finance obligations was $24.7 million. The following table lists the expiration dates of our leases, including renewal options:

 

Lease Expiration

   Operating
Leases
  

Finance

Leases

   Total
Leased

2006-2010

   70    5    75

2011-2015

   66    1    67

2016-2020

   82    3    85

2021-2025

   117    11    128

2026-2030

   84    25    109

2031-2035

   245    10    255

2036-2040

   19    51    70

2041-2045

   115    14    129

2046-2050

   26    16    42

2051-2055

   13    152    165
              

Total

   837    288    1,125
              

 

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

 

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

 

We own our corporate headquarters, a three story, 51,000 square foot office building in Sanford, North Carolina and lease our corporate annex buildings in Jacksonville, Florida and Sanford, North Carolina. Although management believes that our headquarters are adequate for our present needs, we are currently reviewing alternatives to accommodate expected future growth.

 

Item 3.    Legal Proceedings.

 

As previously reported, on July 17, 2004 Constance Barton, Kimberly Clark, Wesley Clark, Tracie Hunt, Eleanor Walters, Karen Meredith, Gilbert Breeden, LaCentia Thompson, and Mathesia Peterson, on behalf of themselves and on behalf of classes of those similarly situated filed suit against The Pantry, Inc. seeking class

 

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action status and asserting claims on behalf of our North Carolina present and former employees for unpaid wages under North Carolina Wage and Hour laws. The suit also seeks an injunction against any unlawful practices, damages, liquidated damages, costs and attorneys’ fees. We filed an Answer denying any wrongdoing or liability to plaintiffs in any regard. The suit originally was filed in the Superior Court for Forsyth County, State of North Carolina. On August 17, 2004, the case was removed to the United States District Court for the Middle District of North Carolina and on July 18, 2005, plaintiffs filed an Amended Complaint asserting certain additional claims under the federal Fair Labor Standards Act on behalf of present and former store employees in the southeastern United States and adding one additional named plaintiff, Chester Charneski. We filed a motion to dismiss parts of the Amended Complaint and on May 17, 2006, the court granted in part and denied in part our motion, with the result that the court will now determine if the case may proceed as a class action under state law and/or a collective action under federal law and if so, who among our present or former employees will be members of the classes. Should the court decide that the case may proceed as a class action under state law or a collective action under federal law, we expect to defend any such claims on their merits. We believe our employment policies and procedures comply with applicable law and intend to vigorously defend this litigation.

 

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

 

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

 

None.

 

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PART II

 

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

 

Our common stock, $.01 par value, represents our only voting securities. There are 22,687,240 shares of common stock issued and outstanding as of September 28, 2006. Our common stock is traded on The Nasdaq Global Select Market under the symbol “PTRY.” The following table sets forth for each fiscal quarter the high and low sale prices per share of our common stock over the last two fiscal years as reported by Nasdaq, based on published financial sources.

 

     Fiscal 2006    Fiscal 2005

Quarter

   High    Low    High    Low

First

   $ 49.70    $ 32.34    $ 30.50    $ 21.45

Second

   $ 63.27    $ 46.20    $ 35.60    $ 27.80

Third

   $ 70.10    $ 49.31    $ 40.96    $ 27.33

Fourth

   $ 58.55    $ 43.20    $ 44.77    $ 33.62

 

As of December 8, 2006, there were 32 holders of record of our common stock. This number does not include beneficial owners of our common stock whose stock is held in nominee or “street” name accounts through brokers.

 

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

 

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Item 6.    Selected Financial Data.

 

The following table sets forth our historical consolidated financial data and store operating information for the periods indicated. The selected historical annual consolidated statement of operations and balance sheet data as of and for each of the five fiscal years presented are derived from, and are qualified in their entirety by, our consolidated financial statements. Historical results are not necessarily indicative of the results to be expected in the future. You should read the following data together with “Item 1. Business,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation,” and our consolidated financial statements and the related notes appearing in “Item 8. Consolidated Financial Statements and Supplementary Data.” In the following table, dollars are in millions, except per share, per store and per gallon data and as otherwise indicated. Our fiscal year ended September 30, 2004 included 53 weeks, all remaining periods presented included 52 weeks.

 

     Fiscal Year Ended  
     September 28,
2006
    September 29,
2005
    September 30,
2004
    September 25,
2003
    September 26,
2002
 

Statement of Operations Data:

          

Revenues:

          

Merchandise revenue

   $ 1,385.7     $ 1,228.9     $ 1,172.8     $ 1,009.7     $ 1,012.8  

Gasoline revenue

     4,576.0       3,200.3       2,320.2       1,740.7       1,470.7  
                                        

Total revenues

     5,961.7       4,429.2       3,493.1       2,750.4       2,483.5  

Gross profit:(a)

          

Merchandise gross profit

     517.9       449.2       425.4       365.5       353.9  

Gasoline gross profit

     281.2       213.9       165.4       145.3       121.5  
                                        

Total gross profit

     799.1       663.1       590.8       510.8       475.4  
                                        

Operating, general and administrative

     521.1       450.3       419.3       373.4       358.3  

Depreciation and amortization(b)

     76.0       64.3       60.9       55.8       55.6  

Income from operations

     202.0       148.5       110.6       81.7       61.5  

Loss on debt extinguishment(c)

     1.8       —         23.1       2.9       —    

Interest expense

     59.6       56.1       64.3       57.8       59.9  

Income before cumulative effect adjustment

     89.2       57.8       15.7       14.6       1.4  

Cumulative effect adjustment, net of tax

     —         —         —         (3.5 )(d)     —    
                                        

Net income

     89.2       57.8       15.7       11.1       1.4  

Earnings per share before cumulative effect adjustment:

          

Basic

   $ 3.95     $ 2.74     $ 0.80     $ 0.81     $ 0.08  

Diluted

   $ 3.88     $ 2.64     $ 0.76     $ 0.80     $ 0.08  

Earnings per share:

          

Basic

   $ 3.95     $ 2.74     $ 0.80     $ 0.61     $ 0.08  

Diluted

   $ 3.88     $ 2.64     $ 0.76     $ 0.61     $ 0.08  

Weighted-average shares outstanding:

          

Basic

     22,559       21,100       19,606       18,108       18,108  

Diluted

     22,987       21,930       20,669       18,370       18,109  

Other Financial Data:

          

Adjusted EBITDA(e)

   $ 283.8     $ 215.7     $ 173.2     $ 140.2     $ 117.8  

Cash provided by (used in):

          

Operating activities

   $ 154.3     $ 133.6     $ 117.0     $ 68.7     $ 54.4  

Investing activities(f)

     (219.3 )     (166.2 )     (227.1 )     (24.4 )     (23.1 )

Financing activities

     73.9       36.1       145.2       (13.7 )     (39.6 )

Gross capital expenditures

     96.8       73.4       49.4       25.5       26.5  

Net capital expenditures(g)

     87.0       58.7       32.8       18.9       18.8  

Store Operating Data:

          

Number of stores (end of period)

     1,493       1,400       1,361       1,258       1,289  

Average sales per store:

          

Merchandise revenue (in thousands)

   $ 954.3     $ 897.7     $ 856.7     $ 791.9     $ 776.1  

Gasoline gallons (in thousands)

     1,242.1       1,117.6       1,026.0       940.7       924.2  

Comparable store sales(h):

          

Merchandise

     4.9 %     5.3 %     3.4 %     0.9 %     2.8 %

Gasoline gallons

     3.1 %     4.7 %     2.0 %     0.7 %     1.5 %

Operating Data:

          

Merchandise gross margin

     37.4 %     36.6 %     36.3 %     36.2 %     34.9 %

Gasoline gallons sold (in millions)

     1,774.9       1,501.0       1,376.9       1,170.3       1,171.9  

Average retail gasoline price per gallon

   $ 2.58     $ 2.13     $ 1.69     $ 1.49     $ 1.25  

Average gasoline gross profit per gallon(i)

   $ 0.158     $ 0.142     $ 0.120     $ 0.124     $ 0.104  

Balance Sheet Data (end of period):

          

Cash and cash equivalents

   $ 120.4     $ 111.5     $ 108.0     $ 72.9     $ 42.2  

Working capital (deficiency)

     98.2       69.8       61.3       16.1       (43.4 )

Total assets

     1,587.9       1,388.2       1,232.9       992.4       987.3  

Total debt and lease finance obligations

     848.4       758.5       760.3       596.4       601.3  

Shareholders’ equity

     337.0       251.9       148.9       127.2       114.1  

 

(footnotes on following pages)

 

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(a) Gross profit does not include depreciation or allocation of operating, general and administrative expenses.

 

(b) Effective March 28, 2003, we accelerated the depreciation on certain assets related to our gasoline and store branding. These changes were the result of our gasoline brand consolidation project that resulted in either updating or changing the image of the majority of our stores. Accordingly, we reassessed the remaining useful lives of these assets based on our plans and recorded an increase in depreciation expense of $2.0 million and $3.4 million in fiscal 2004 and 2003, respectively.

 

(c) On December 29, 2005, we entered into a new senior secured credit facility, which consisted of a $205.0 million term loan and a $150.0 million revolving credit facility, each maturing January 2, 2012. As a result of the refinancing of our senior credit facility during the first quarter of fiscal 2006, we incurred $1.8 million in refinancing charges associated with the write-off of unamortized debt issue costs associated with the previous facility that was paid off. During fiscal 2004, we recorded $23.1 million in charges in connection with the refinancing of our senior credit facility and senior subordinated notes. These charges include the write-off of approximately $11.8 million in unamortized deferred financing costs, the write-off of approximately $3.5 million of original issue discount and call premiums of approximately $7.8 million. On April 14, 2003, we entered into a new senior secured credit facility. In connection with the refinancing, we recorded a non-cash charge of approximately $2.9 million related to the write-off of the unamortized deferred financing costs associated with the previous credit facility.

 

(d) Effective September 27, 2002, we adopted the provisions of SFAS No. 143, Accounting for Asset Retirement Obligations (“SFAS No. 143”), and, as a result, we recognize the future cost to remove an underground storage tank over the estimated useful life of the storage tank. Upon adoption, we recorded a discounted liability of $8.4 million, which is included in other noncurrent liabilities, increased net property and equipment by $2.7 million and recognized a one-time cumulative effect adjustment of $3.5 million (net of deferred income tax benefit of $2.2 million).

 

(e) Adjusted EBITDA is defined by us as net income before interest expense and loss on extinguishment of debt, income taxes, depreciation and amortization and cumulative effect of change in accounting principle. Adjusted EBITDA is not a measure of performance under accounting principles generally accepted in the United States of America, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data. We have included information concerning Adjusted EBITDA as one measure of our operating performance and historical ability to service debt and because we believe investors find this information useful as a reflection of the resources available for strategic opportunities including, among others, to invest in the business, make strategic acquisition decisions and to service debt. Management uses Adjusted EBITDA as an operating measure because it allows us to review the performance of our business directly resulting from our retail operations. Additionally, Adjusted EBITDA is used by management for budgeting and field operations compensation targets. Adjusted EBITDA as defined by us may not be comparable to similarly titled measures reported by other companies because such other companies may not calculate Adjusted EBITDA in the same manner as we do.

 

Any measure that excludes interest expense or loss on extinguishment of debt, depreciation and amortization or income taxes, has material limitations because we have borrowed money in order to finance our operations and our acquisitions, we use capital assets in our business and the payment of income taxes is a necessary element of our operations.

 

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The following table contains a reconciliation of Adjusted EBITDA to net income (amounts in thousands):

 

     Fiscal Year Ended  
     September 28,
2006
    September 29,
2005
    September 30,
2004
    September 25,
2003
    September 26,
2002
 

Adjusted EBITDA

   $ 283,811     $ 215,677     $ 173,182     $ 140,225     $ 117,834  

Interest expense and loss on extinguishment of debt

     (61,434 )     (56,130 )     (87,344 )     (60,693 )     (59,932 )

Depreciation and amortization

     (76,025 )     (64,341 )     (60,911 )     (55,767 )     (55,563 )

Provision for income taxes

     (57,154 )     (37,396 )     (9,201 )     (9,152 )     (901 )

Cumulative effect adjustment

     —         —         —         (3,482 )     —    
                                        

Net income

   $ 89,198     $ 57,810     $ 15,726     $ 11,131     $ 1,438  
                                        

 

(f) Investing activities include expenditures for acquisitions.

 

(g) Net capital expenditures include vendor reimbursements for capital improvements and proceeds from asset dispositions and lease finance transactions.

 

(h) The stores included in calculating comparable store sales growth are existing or replacement stores, which were in operation during the entire comparable period of both fiscal years. Remodeling, physical expansion or changes in store square footage are not considered when computing comparable store sales growth. Comparable store sales as defined by us may not be comparable to similarly titled measures reported by other companies.

 

(i) Gasoline gross profit per gallon represents gasoline revenue less costs of product and expenses associated with credit card processing fees and repairs and maintenance on gasoline equipment. Gasoline gross profit per gallon as presented may not be comparable to similarly titled measures reported by other companies.

 

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

 

This discussion and analysis of our financial condition and results of operation should be read in conjunction with “Item 6. Selected Financial Data” and our consolidated financial statements and the related notes appearing in “Item 8. Consolidated Financial Statements and Supplementary Data.”

 

Safe Harbor Discussion

 

This report, including without limitation statements under our discussion and analysis of financial condition and results of operations, contains statements that we believe are “forward-looking statements” under the meaning of the Private Securities Litigation Reform Act of 1995 and are intended to enjoy protection of the safe harbor for forward-looking statements provided by that Act. These forward-looking statements generally can be identified by use of phrases such as “believe”, “plan”, “expect”, “anticipate”, “intend”, “forecast” or other similar words or phrases. Descriptions of our objectives, goals, targets, plans, strategies, anticipated capital expenditures, including without limitation with regard to technology, costs and burdens of environmental remediation, expected cost savings and benefits and anticipated synergies from acquisitions, anticipated costs of re-branding our stores, anticipated sharing of costs of conversion with our gasoline suppliers, expectations regarding potential acquisitions and new store openings, and expectations regarding re-modeling, re-branding, re-imaging or otherwise converting our stores are also forward-looking statements. These forward-looking statements are based on our current plans and expectations and involve a number of risks and uncertainties that could cause actual results and events to vary materially from the results and events anticipated or implied by such forward-looking statements, including:

 

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

 

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

 

    Unfavorable weather conditions;

 

    Political conditions in crude oil producing regions and global demand;

 

    Volatility in crude oil and wholesale petroleum costs;

 

    Wholesale cost increases of tobacco products;

 

    Consumer behavior, travel and tourism trends;

 

    Changes in state and federal environmental and other laws and regulations;

 

    Dependence on one principal supplier for merchandise and two principal suppliers for gasoline;

 

    Financial leverage and debt covenants;

 

    Ability to generate cash to fund indebtedness and support liquidity needs;

 

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

 

    Inability to identify, acquire and integrate new stores;

 

    Dependence on senior management;

 

    Litigation risks, including with respect to food quality, health and other related issues;

 

    Ability to maintain an effective system of internal control over financial reporting;

 

    Acts of war and terrorism; and

 

    Other unforeseen factors.

 

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For a discussion of these and other risks and uncertainties, please refer to “Part 1. Item 1A Risk Factors”. The list of factors that could affect future performance and the accuracy of forward-looking statements is illustrative but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty. The forward-looking statements included in this report are based on, and include, our estimates as of December 12, 2006. We anticipate that subsequent events and market developments will cause our estimates to change. However, while we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if new information becomes available in the future.

 

Executive Summary

 

For the fiscal year ended September 28, 2006, we reported net income of $89.2 million and diluted earnings per share of $3.88 compared to net income of $57.8 million and diluted earnings per share of $2.64 in the fiscal year ended September 29, 2005. Our total revenues for fiscal 2006 increased 34.6% over fiscal 2005 to $6.0 billion. We believe this growth in our business was achieved through the continued execution of our strategy of enhancing same store volume and expanding our Southeast market presence through acquisitions and new store development. We enhanced our business by maintaining an aggressive regional store expansion, growing our store count from 1,400 at September 29, 2005 to 1,493 as of September 28, 2006.

 

The tables below provide information concerning the acquisitions we completed in fiscal 2006 and in fiscal 2005:

 

Fiscal 2006

Date Acquired

   Seller    Trade Name   Locations   

Number of

Stores

February 9, 2006    Lee-Moore Oil Company    TruBuy and On The
Run®
  North Carolina    19
February 16, 2006    Waring Oil Company,
LLC
   Interstate Food Stops   Mississippi and
Louisiana
   39
May 11, 2006    Shop-A-Snak Food
Mart, Inc.
   Shop-A-Snak Food
Mart
SM
  Alabama    38
August 10, 2006    Fuel Mate, LLC    Fuel Mate   North Carolina    6
Others (fewer than 5 stores)    Various    Various   Georgia, Florida,
Mississippi, North
Carolina, and
South Carolina
   11
            
Total            113
            

Fiscal 2005

Date Acquired

   Seller    Trade Name   Locations    Number of
Stores
April 21, 2005    D&D Oil Co.    CowboysSM   Alabama, Georgia,
Mississippi
   53
August 18, 2005    Angus I. Hines, Inc.    Sentry Food MartSM   Virginia    23
September 22, 2005    Chatham Oil Company    SpeedmartSM
Food Stores
  Alabama    13
Others (fewer than 5 stores)    Various    Various   Alabama,
Mississippi, North
Carolina
and South Carolina
   7
            
Total            96
            

 

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We believe investments in our core business are paying off as evidenced by certain key operating performance measurements. Merchandise revenue increased 12.8% to $1.4 billion in fiscal 2006 and merchandise margin increased for the fourth consecutive year. We experienced growth in comparable stores of 4.9%, driven by our store conversion and re-branding, as well as our focus on the food service and private label product categories and increases in services revenue of 26.0%. Comparable store gasoline gallon volume increased 3.1% in fiscal 2006 as we favorably benefited from a volatile wholesale gasoline market as gasoline gross profit per gallon increased 11.3% to $0.158 compared to $0.142 in fiscal 2005.

 

The results of our operations during fiscal 2006 include an exceptionally strong first quarter. Net income for our first quarter of fiscal 2006 of $33.0 million represented a 165.0% increase from $12.4 million in the first quarter of fiscal 2005. During the quarter, our comparable store merchandise revenue increased 5.0% while comparable store gasoline gallons increased 4.6%. These results were driven by an unusually strong performance in our gasoline operations, which we believe were made possible, in part, due to the benefits of our long-term gasoline supply contracts. These agreements gave us flexibility and greater certainty of supply in the wake of hurricanes Katrina and Rita. We do not expect our gasoline operations to be this strong in future quarters.

 

Fiscal 2007 will involve both challenges and opportunities in our gasoline operations. While our gasoline operations will continue to be faced with unknowns such as economic conditions, natural disasters, the war in the Middle East and an evolving political environment, we see unique opportunities going forward. For example, we have begun to evaluate the benefits of diversifying our existing supplier base in certain markets. We are accelerating our raze and re-build program at a number of sites, which we believe will continue to drive positive comparable store gasoline gallon growth.

 

Our management team has taken positive steps in fiscal 2006 toward strengthening our corporate infrastructure and enabling growth. We believe the additions of Keith S. Bell (Senior Vice President, Fuels) in July 2006, and Melissa H. Anderson (Senior Vice President, Human Resources) in November 2006, will provide additional executive talent to help us manage the significant growth we have experienced and plan to continue. Operationally, we have increased the number of store and administrative personnel to position ourselves for continued growth. We have implemented new training and development program initiatives in fiscal 2006. We have enhanced our college recruiting program and recently added a “Kan Doo University”, a comprehensive indoctrination into all aspects of management which all new District Managers are required to complete.

 

We generated $154.3 million of cash flow from operations in fiscal 2006, an increase of 15.5% from fiscal 2005, allowing us to make investments of $96.8 million in capital expenditures and $126.8 million in acquisitions. We believe our liquidity remains strong as evidenced by our $120.4 million in cash and cash equivalents at September 28, 2006. At the end of fiscal 2006, our working capital was $98.2 million and our leverage ratio (total debt and lease finance obligations divided by EBITDA) was 3.0 compared to 3.5 at the end of fiscal 2005. We believe the selected sales data and the percentage change in the dollar amounts of each of the items presented below are important in evaluating the performance of our business operations. We operate in one business segment and believe the information presented in our Management’s Discussion and Analysis of Financial Condition and Results of Operation provides an understanding of our business segment, our operations and our financial condition.

 

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Results of Operations

 

Fiscal 2006 and fiscal 2005 contained 52 weeks and fiscal 2004 contained 53 weeks. The table below provides a summary of our selected financial data for fiscal 2006, fiscal 2005 and fiscal 2004.

 

     Fiscal Year Ended  
     September 28,
2006
    September 29,
2005
    September 30,
2004
 

Selected financial data:

      

Merchandise margin[1]

     37.4 %     36.6 %     36.3 %

Gasoline gallons (millions)

     1,774.9       1,501.0       1,376.9  

Gasoline margin per gallon[1]

   $ 0.158     $ 0.142     $ 0.120  

Gasoline retail per gallon

   $ 2.58     $ 2.13     $ 1.69  

Operating, general and administrative expenses as a percentage of the sum of merchandise revenue and gasoline gallons[2]

     16.5 %     16.5 %     16.4 %

Comparable store data:

      

Merchandise sales %

     4.9 %     5.3 %     3.4 %

Gasoline gallons %

     3.1 %     4.7 %     2.0 %

Number of stores:

      

End of period

     1,493       1,400       1,361  

Weighted-average store count

     1,452       1,369       1,369  

 

[1] We compute gross profit exclusive of depreciation or allocation of operating, general and administrative expenses.

 

[2] We believe this presentation eliminates the impact of gasoline retail price changes and enhances year over year comparability.

 

Fiscal 2006 Compared to Fiscal 2005

 

Total Revenue.    Total revenue for fiscal 2006 was $6.0 billion compared to $4.4 billion for fiscal 2005, an increase of $1.5 billion, or 34.6%. The increase in total revenue is primarily due to a 21% increase in our average retail price of gasoline gallons sold, the revenue of stores acquired in fiscal 2006 and the effect of a full year of revenue from 2005 acquisitions of $776.1 million and comparable store increases in merchandise sales of $57.0 million and in gasoline gallons of 43.2 million. The impact of these factors was partially offset by lost revenue from closed stores.

 

Merchandise Revenue.    Total merchandise revenue for fiscal 2006 was $1.4 billion compared to $1.2 billion for fiscal 2005, an increase of $156.8 million, or 12.8%. This increase is primarily due to the merchandise revenue of stores acquired in fiscal 2006 and the effect of a full year of revenue from 2005 acquisitions of $119.1 million and a 4.9% increase in comparable store merchandise sales. These increases were partially offset by lost revenue from closed stores of approximately $23.6 million.

 

Gasoline Revenue and Gallons.    Total gasoline revenue for fiscal 2006 was $4.6 billion compared to $3.2 billion for fiscal 2005, an increase of $1.4 billion, or 43.0%. The increase in gasoline revenue is primarily due to $657.0 million in revenue from stores acquired in fiscal 2006 and the effect of a full year of revenue from 2005 acquisitions, an increase in comparable store gallons of 43.2 million and a 21.1% increase in our average retail price of gasoline. In fiscal 2006, our average retail price of gasoline was $2.58 per gallon, which represents a 45.0 cents per gallon increase in average retail price from fiscal 2005. The increase in our average retail price is the result of increasing wholesale prices from a volatile gasoline market for much of fiscal 2006. The resulting increases in gasoline revenue were partially offset by lost revenue from closed stores of approximately $34.8 million.

 

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In fiscal 2006, gasoline gallons sold were 1.8 billion, an increase of 273.9 million gallons, or 18.2%, from fiscal 2005. The increase is primarily attributable to 245.2 million gasoline gallons from stores acquired in fiscal 2006 and the effect of a full year of gallons from 2005 acquisitions, and the comparable store gasoline gallon increase discussed above, partially offset by lost gasoline volume from closed stores of approximately 18.2 million gallons.

 

Total Gross Profit.    Our fiscal 2006 gross profit was $799.1 million compared to $663.1 million for fiscal 2005, an increase of $136.0 million, or 20.5%. The increase is primarily attributable to the gross profit contribution of stores acquired in fiscal 2006 and the effect of a full year of gross profit contribution from 2005 acquisitions of $80.7 million, the increase in our gasoline gross profit per gallon and our comparable store volume increases discussed above. These increases were partially offset by lost gross profit from closed stores. We compute gross profit exclusive of depreciation or allocation of operating, general and administrative expenses.

 

Merchandise Gross Profit and Margin.    Merchandise gross profit was $517.9 million for fiscal 2006 compared to $449.3 million for fiscal 2005, an increase of $68.6 million, or 15.3%. This increase is primarily attributable to the increased merchandise revenue discussed above and an 80 basis point increase in our merchandise margin to 37.4% for fiscal 2006 compared to 36.6% for fiscal 2005. We compute gross profit exclusive of depreciation or allocation of operating, general and administrative expenses. The margin improvement is primarily attributable to increased service revenue and the continued growth in food service revenue and revenue from private label products, which on average represent higher margin categories. Service revenue increased 25.9% primarily due to higher lottery commission income driven by the introduction of the North Carolina Educational Lottery, and growth in the car wash, ATM and prepaid phone card categories.

 

Going forward, we expect to maintain our high merchandise yields with continued investment in our private label program and development of additional quick service restaurants.

 

Gasoline Gross Profit and Margin Per Gallon.    Gasoline gross profit was $281.2 million for fiscal 2006 compared to $213.9 million for fiscal 2005, an increase of $67.3 million, or 31.5%. The increase is primarily attributable to an increase in our gross profit per gallon to $0.158 for fiscal 2006 from $0.142 in fiscal 2005. The increase in gasoline gross profit was primarily due to our ability to pass along wholesale crude cost changes to retail prices during fiscal 2006. We compute gross profit exclusive of depreciation or allocation of operating, general and administrative expenses. We present gasoline gross profit per gallon inclusive of credit card processing fees and repairs and maintenance on gasoline equipment. These fees and costs totaled $0.041 per gallon and $0.036 per gallon for fiscal 2006 and fiscal 2005, respectively. The increase in these fees was primarily due to higher credit card fees as a result of a 21.1% increase in retail gasoline prices.

 

Operating, General and Administrative.    Operating, general and administrative expenses for fiscal 2006 were $521.1 million compared to $450.3 million for fiscal 2005, an increase of $70.8 million, or 15.7%. This increase is primarily due to increased store count from acquisitions and comparable store increases in labor and other variable expenses. As a percentage of the sum of merchandise revenue and gasoline gallons, operating, general and administrative expenses were 16.5% for fiscal 2006 and fiscal 2005.

 

Income from Operations.    Income from operations for fiscal 2006 was $202.0 million compared to $148.5 million for fiscal 2005, an increase of $53.5 million, or 36.0%. This increase is primarily due to the increases in gross profit discussed above, partially offset by the increases in operating, general and administrative expenses also discussed above.

 

EBITDA.    EBITDA is defined by us as net income before interest expense and loss on extinguishment of debt, income taxes, depreciation and amortization. EBITDA for fiscal 2006 was $283.8 million compared to $215.7 million for fiscal 2005, an increase of $68.1 million, or 31.6%. The increase is primarily due to the variances discussed above.

 

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EBITDA is not a measure of performance under accounting principles generally accepted in the United States of America, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data. We have included information concerning EBITDA as one measure of our operating performance and historical ability to service debt because we believe investors find this information useful as a reflection of the resources available for strategic opportunities including, among others, to invest in the business, make strategic acquisition decisions, and to service debt. Management uses EBITDA as an operating measure because it allows us to review the performance of our business directly resulting from our retail operations. Additionally, EBITDA is used by management for budgeting and field operations compensation targets. EBITDA as defined by us may not be comparable to similarly titled measures reported by other companies because such other companies may not calculate EBITDA in the same manner as we do.

 

Any measure that excludes interest expense or loss on extinguishment of debt, depreciation and amortization or income taxes, has material limitations because we have borrowed money in order to finance our operations and our acquisitions, we use capital assets in our business and the payment of income taxes is a necessary element of our operations.

 

The following table contains a reconciliation of EBITDA to net income (amounts in thousands):

 

     Fiscal Year Ended  
     September 28,
2006
    September 29,
2005
 

EBITDA

   $ 283,811     $ 215,677  

Interest expense and loss on extinguishment of debt

     (61,434 )     (56,130 )

Depreciation and amortization

     (76,025 )     (64,341 )

Provision for income taxes

     (57,154 )     (37,396 )
                

Net income

   $ 89,198     $ 57,810  
                

 

Loss on extinguishment of debt.    As a result of the refinancing of our senior secured credit facility during the first quarter of fiscal 2006, we incurred $1.8 million in refinancing charges associated with the write-off of unamortized debt issue costs.

 

Interest.    Interest expense is primarily comprised of interest on our long-term debt and lease finance obligations and the loss on extinguishment of debt referred to above. Interest expense, including loss on extinguishment of debt, for fiscal 2006 was $61.4 million compared to $56.1 million for fiscal 2005, an increase of $5.3 million, or 9.4%. The increase is primarily a result of an increase in our weighted-average borrowings as a result of the issuance of the convertible notes and additional lease financing

 

Income Tax Expense.    We recorded income tax expense of $57.2 million in fiscal 2006 as compared to $37.4 million in fiscal 2005. Our effective tax rate for fiscal 2006 was 39.1% compared to 39.3% for fiscal 2005. The decrease in the effective rate is primarily the result of the resolution of certain federal and state tax contingencies.

 

Net Income.    Net income for fiscal 2006 was $89.2 million compared to $57.8 million for fiscal 2005. The increase is primarily attributable to increased income from operations discussed above.

 

Fiscal 2005 Compared to Fiscal 2004

 

Total Revenue.    Total revenue for fiscal 2005 was $4.4 billion compared to $3.5 billion for fiscal 2004, an increase of $936.2 million, or 26.8%. The increase in total revenue is primarily due to the revenue of stores acquired in fiscal 2005 of $229.6 million, comparable store increases in merchandise sales of $53.2 million and in gasoline gallons of 53.9 million, and a 26.0% increase in our average retail price of gasoline gallons sold. The impact of these factors was partially offset by the impact of a 53rd week in fiscal 2004 of $66.0 million and lost volume from closed stores.

 

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Merchandise Revenue.    Total merchandise revenue for fiscal 2005 was $1.2 billion, an increase of $56.1 million, or 4.8%, from fiscal 2004. This increase is primarily due to the merchandise revenue of stores acquired in fiscal 2005 of $30.9 million and a comparable store merchandise sales increase of 5.3%. We believe the comparable store gains were driven by our store conversion and re-branding program, as well as our focus on merchandise categories such as food service and private label products. These increases were partially offset by the impact of a 53rd week in fiscal 2004 of $19.9 million and lost volume from closed stores of approximately $10.9 million.

 

Gasoline Revenue and Gallons.    Total gasoline revenue for fiscal 2005 was $3.2 billion compared to $2.3 billion for fiscal 2004, an increase of $880.1 million, or 37.9%. The increase in gasoline revenue is primarily due to the increase in our average retail price, gasoline revenue of stores acquired in fiscal 2005 of $198.7 million and comparable store gallon volume growth of 4.7%. We believe the comparable store gallon growth was driven by our efforts to re-brand or re-image our gasoline facilities. In fiscal 2005, our average retail price of gasoline was $2.13 per gallon, which represents a 44.0 cent per gallon, or 26.0%, increase in average retail price from fiscal 2004. The increase in our average retail price is the result of our passing along wholesale cost increases to our customers. These increases were partially offset by the impact of a 53 rd week in fiscal 2004 of $45.6 million and lost revenue from closed stores.

 

In fiscal 2005, gasoline gallon volume was 1.5 billion gallons, an increase of 124.2 million gallons, or 9.0%, from fiscal 2004. The increase in gasoline gallons was due to the gallon volume from stores acquired in fiscal 2005 of 86.5 million and the comparable store gallon volume increase of 4.7%. These increases were partially offset by the impact of a 53rd week in fiscal 2004 of 24.2 million gallons and lost volume from closed stores of 7.8 million gallons. We believe that the fiscal 2005 comparable store gallon increase was driven by a more consistent and competitive gasoline pricing philosophy as well as the positive impact that our upgrade and remodel activity has had on gasoline gallon volume.

 

Total Gross Profit.    Our fiscal 2005 gross profit was $663.1 million compared to $590.8 million for fiscal 2004, an increase of $72.3 million, or 12.2%. The increase in gross profit is primarily attributable to the gross profit contribution of stores acquired in fiscal 2005 of $21.4 million, the increase in our gasoline gross profit per gallon and our comparable store volume increases discussed above. These increases were partially offset by the impact of a 53rd week in fiscal 2004 of $9.2 million and lost gross profit from closed stores. We compute gross profit exclusive of depreciation or allocation of operating, general and administrative expenses.

 

Merchandise Gross Profit and Margin.    Merchandise gross profit was $449.3 million for fiscal 2005 compared to $425.4 million for fiscal 2004, an increase of $23.8 million, or 5.6%. This increase is primarily attributable to the merchandise gross profit of stores acquired in fiscal 2005 of $10.9 million, increases in merchandise revenue discussed above and a 30 basis point improvement in merchandise gross margin. These increases were partially offset by the impact of a 53rd week in fiscal 2004 of $7.2 million and lost merchandise gross profit from closed stores.

 

Gasoline Gross Profit and Margin Per Gallon.    Gasoline gross profit was $213.9 million for fiscal 2005 compared to $165.4 million for fiscal 2004, an increase of $48.5 million, or 29.3%. The increase is primarily attributable to the 2.2 cent increase in our gasoline margin per gallon, gasoline gross profit from stores acquired in fiscal 2005 and the comparable store sales gains discussed above. These increases were partially offset by the impact of a 53rd week in fiscal 2004 of $1.9 million and lost volume from closed stores. Gasoline gross profit per gallon was $0.142 in fiscal 2005 compared to $0.120 in fiscal 2004. The increase in gasoline gross profit was primarily due to our ability to pass along wholesale crude cost changes to retail prices during fiscal 2005. We present gasoline gross profit per gallon inclusive of credit card processing fees and repairs and maintenance on gasoline equipment. These expenses totaled 3.6 cents per gallon and 2.9 cents per gallon for fiscal 2005 and fiscal 2004, respectively. The increase in expenses was primarily related to an increase in credit card fees associated with an increase in the retail price of gasoline.

 

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Operating, General and Administrative.    Operating, general and administrative expenses for fiscal 2005 were $450.3 million compared to $419.3 million for fiscal 2004, an increase of $30.9 million, or 7.4%. The increase is primarily attributable to the operating expenses associated with stores acquired during fiscal 2005 and comparable store increases in labor and other variable expenses. In addition we recorded $6.8 million in charges related to stores closed in fiscal 2005 compared to $1.7 million in fiscal 2004. These increases were partially offset by the impact of a 53rd week in fiscal 2004 of $6.1 million.

 

Income from Operations.    Income from operations for fiscal 2005 was $148.5 million compared to $110.6 million for fiscal 2004, an increase of $37.9 million, or 34.3%. This increase is primarily due to the increase in gross profit discussed above partially offset by the increases in operating expenses and a $3.4 million increase in depreciation and amortization expenses.

 

EBITDA.    EBITDA is defined by us as net income before interest expense, loss on extinguishment of debt, income taxes, and depreciation and amortization. EBITDA for fiscal 2005 was $215.7 million compared to $173.2 million for fiscal 2004, an increase of $42.5 million, or 24.5%. The increase is primarily due to the variances discussed above.

 

The following table contains a reconciliation of EBITDA to net income (amounts in thousands):

 

     Fiscal Year Ended  
     September 29,
2005
    September 30,
2004
 

EBITDA

   $ 215,677     $ 173,182  

Interest expense and loss on extinguishment of debt

     (56,130 )     (87,344 )

Depreciation and amortization

     (64,341 )     (60,911 )

Provision for income taxes

     (37,396 )     (9,201 )
                

Net income

   $ 57,810     $ 15,726  
                

 

Loss on Extinguishment of Debt.    As a result of the retirement of our 10.25% subordinated notes and the refinancing of our senior credit facility during the second quarter of fiscal 2004, we incurred $23.1 million in debt extinguishment costs that have been included as a component of interest expense. These charges include the write-off of approximately $11.8 million in unamortized deferred financing costs, the write-off of approximately $3.5 million of unamortized original issue discount and call premiums of approximately $7.8 million. During the third quarter of fiscal 2003, we incurred $2.9 million in debt extinguishment costs related to the refinancing of our then outstanding senior credit facility, which represented the write-off of unamortized deferred financing costs.

 

Interest.    Interest expense is primarily interest on our long term debt and lease finance obligations and the loss on extinguishment of debt referred to above. Interest expense, excluding the loss on extinguishment of debt, for fiscal 2005 was $56.1 million compared to $64.3 million for fiscal 2004, a decrease of $8.1 million, or 12.6%. The decrease is primarily attributable to a reduction of approximately 250 basis points in our effective interest rate as a result of the refinancing of our senior credit facility and subordinated notes in February and March of fiscal 2004.

 

Income Tax Expense.    We recorded income tax expense of $37.4 million in fiscal 2005 as compared to $9.2 million in fiscal 2004. Our effective tax rate for fiscal 2005 was 39.3% compared to 36.9% for fiscal 2004. The increase in the effective rate is primarily the result of an increase in our statutory tax rate in fiscal 2005 coupled with the reversal in fiscal 2004 of approximately $400 thousand in tax reserves due to the expected utilization of various tax credits and net operating losses.

 

Net Income.    As a result of the items discussed above, net income for fiscal 2005 was $57.8 million compared to $15.7 million for fiscal 2004.

 

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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 revolving credit facility, lease finance transactions, and asset dispositions to finance our operations, pay interest and principal payments and fund capital expenditures. Cash provided by operations for fiscal 2006 totaled $154.3 million, for fiscal 2005 totaled $133.6 million and for fiscal 2004 totaled $117.0 million. Our increase in net cash provided by operating activities for fiscal 2006 over fiscal 2005 is primarily attributable to the increase in gasoline and merchandise gross profit and the impact of fiscal 2006 acquisitions on operating income.

 

Capital Expenditures.    Gross capital expenditures (excluding all acquisitions) for fiscal 2006 were $96.8 million. In fiscal 2006, we had proceeds of $4.3 million from asset dispositions and $5.5 million from lease finance obligations. As a result, our net capital expenditures, excluding all acquisitions, for fiscal 2006 were $87.0 million. Our capital expenditures are primarily expenditures for store improvements, store equipment, new store development, information systems and expenditures to comply with regulatory statutes, including those related to environmental matters. We finance substantially all capital expenditures and new store development through cash flow from operations, proceeds from lease finance transactions and asset dispositions and vendor reimbursements.

 

Our lease finance 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. We retain ownership of all personal property. Our leases are at market rates with initial lease terms between fifteen and twenty years plus several renewal option periods. The lease payment is based on market rates applied to the cost of each respective property. We received $42.9 million in proceeds from new lease finance transactions in fiscal 2006 and $14.1 million in fiscal 2005.

 

We anticipate that net capital expenditures for fiscal 2007 will be approximately $130 million. The increase in anticipated capital expenditures is due to expansion in our new store development and increased technology spending. We anticipate opening 20 new stores in fiscal 2007 compared to four newly-constructed stores in fiscal 2006. We expect capital expenditures for new stores to remain higher as compared to fiscal 2006 as we anticipate opening approximately 20-25 new stores annually over the next five years.

 

We expect our technology spending to increase during fiscal 2007 as we incur capital expenditures associated with upgrading, consolidating, and replacing our point-of-sale systems. We also expect to increase spending to automate functions throughout our administrative departments and expand the use of decision support tools. We anticipate that our capital expenditures related to technology will be in a range of $20 million to $30 million annually over the next three years.

 

Acquisitions.    During fiscal 2006, we purchased 113 stores and their related businesses in 13 separate transactions for approximately $126.8 million in aggregate purchase consideration. We anticipate that our acquisition activity in fiscal 2007 will meet or exceed the activity in fiscal 2006.

 

Cash Flows from Financing Activities.    For fiscal 2006, net cash provided by financing activities was $73.9 million. The net cash provided by financing activities is primarily the result of the issuance of the 3% senior subordinated convertible notes and warrants, less $43.7 million paid for the associated note hedge and the $100.0 million of principal paid on the then existing senior credit facility. In conjunction with the issuance of the convertible notes and the refinancing of our senior credit facility, we paid $6.6 million in loan origination costs. We also entered into new lease financing transactions with proceeds totaling $42.9 million, including $37.4 million related to acquisitions of businesses. At September 28, 2006, our debt consisted primarily of $204.0 million in loans under our senior credit facility, $250.0 million of outstanding 7.75% senior subordinated notes, $244.1 million of outstanding lease finance obligations and $150.0 million of outstanding convertible notes.

 

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Senior Credit Facility.    On December 29, 2005, we entered into a Second Amended and Restated Credit Agreement. The amended credit facility consists of (i) a $150.0 million revolving credit facility; and (ii) a $205.0 million term loan facility. The revolving credit facility is available for refinancing certain of our existing indebtedness, working capital financing, general corporate purposes and issuing commercial and standby letters of credit. Up to $90.0 million of the revolving credit facility is available as a letter of credit sub-facility. In addition, we may incur up to $100.0 million in incremental facilities. The amended credit facility matures in January 2012. The borrowings under the term loan facility were used to refinance our then existing credit facilities and pay related fees and expenses, and to the extent of any excess, for general corporate purposes. The revolving credit facility has been, and will continue to be, used for our working capital and general corporate requirements.

 

Our borrowings under each of the term loan facility and the revolving credit facility bear interest, at our option, at the base rate (generally the applicable prime lending rate of Wachovia Bank, as announced from time to time) plus 0.50% or LIBOR plus 1.75%. If our consolidated leverage ratio (as defined in the Amended and Restated Credit Agreement) is less than 3.00 to 1.00, the applicable margins on the borrowings under the revolving credit facility will each be decreased by 0.25%. In addition, we are required to pay quarterly a fee of 0.50% on the average daily unused portion of the revolving credit facility, and if our consolidated leverage ratio is less than 3.00 to 1.00, this fee will be decreased by 0.125%.

 

We are permitted to prepay principal amounts outstanding or reduce commitments under the amended credit facility at any time, in whole or in part, without premium or penalty, upon the giving of proper notice. We may elect how the optional prepayments are applied. In addition, subject to certain exceptions, we are required to prepay outstanding amounts under the amended credit facility with:

 

    the net proceeds of insurance not applied toward the repair of damaged properties within 360 days following receipt of the insurance proceeds;

 

    the net proceeds from asset sales other than in the ordinary course of business that are not reinvested within 270 days following the closing of the sale;

 

    50% of the net proceeds from the issuance of any unsecured subordinated debt, subject to certain exceptions;

 

    the net proceeds from the issuance of any other debt, subject to certain exceptions;

 

    50% of the net proceeds from the issuance of any equity, subject to certain exceptions; and

 

    50% of annual excess cash flow to the extent the total leverage ratio is greater than 3.5 to 1.0 at the end of our fiscal year.

 

All mandatory prepayments will be applied pro rata first to the term loan facility and second to the revolving credit facility and, after all amounts under the revolving credit facility have been repaid, to a collateral account with respect to outstanding letters of credit.

 

The amended credit facility contains customary affirmative and negative covenants for financings of its type (subject to customary exceptions). The financial covenants include:

 

    maximum total leverage ratio;

 

    maximum senior leverage ratio; and

 

    minimum fixed charge coverage ratio.

 

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Other covenants, among other things, limit our ability to:

 

    incur liens or other encumbrances;

 

    change our line of business;

 

    enter into mergers, consolidations and similar combinations;

 

    sell or dispose of assets other than in the ordinary course of business;

 

    enter into joint ventures, acquisitions and other investments;

 

    enter into transactions with affiliates;

 

    pay dividends;

 

    change fiscal year; and

 

    change organizational documents.

 

The amended credit facility contains customary events of default including, but not limited to:

 

    failure to make payments when due;

 

    breaches of representations and warranties;

 

    breaches of covenants;

 

    defaults under other indebtedness;

 

    bankruptcy or insolvency;

 

    judgments in excess of specified amounts;

 

    certain events related to the Employee Retirement Income Security Act of 1974, as amended;

 

    a change of control (as such term is defined in the Amended and Restated Credit Agreement); and

 

    invalidity of the guaranty or other documents governing the amended credit facility.

 

An event of default under the amended credit facility, if not cured or waived, could result in the acceleration of all our indebtedness under the amended credit facility (and other indebtedness containing cross default provisions).

 

As of September 28, 2006, we had no borrowings outstanding under the revolving credit facility and approximately $45.8 million of standby letters of credit had been issued. As of September 28, 2006, we have approximately $104.2 million in available borrowing capacity under the facility (approximately $44.2 million of which was available for issuances of letters of credit).

 

Senior Subordinated Notes.    In February 2004, we sold $250.0 million of 7.75% senior subordinated notes due February 15, 2014. Interest on the senior subordinated notes is due on February 15 and August 15 of each year. Proceeds from the sale of the senior subordinated notes were used to redeem $200.0 million in outstanding

 

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10.25% senior subordinated notes, including a $6.8 million call premium, pay principal of approximately $28.0 million on our senior credit facility and pay related financing costs. We incurred debt extinguishment charges of $10.7 million which consisted of the $6.8 million call premium and $3.9 million of unamortized deferred financing costs. We incurred approximately $6.6 million in costs associated with the new notes, which were deferred and will be amortized over the life of the new notes.

 

Our senior subordinated notes contain covenants that, among other things and subject to various exceptions, restrict our ability and any restricted subsidiary’s ability to:

 

    pay dividends, make distributions or repurchase stock;

 

    issue stock of subsidiaries;

 

    make investments in non-affiliated entities;

 

    incur liens to secure debt which is equal to or subordinate in right of payment to the senior subordinated notes, unless the notes are secured on an equal and ratable basis (or senior basis) with the obligations so secured;

 

    enter into transactions with affiliates; or

 

    engage in mergers, consolidations or sales of all or substantially all of our properties or assets.

 

We can incur debt under the senior subordinated notes if our fixed charge ratio, as defined, after giving effect to such incurrence, is at least 2.0 to 1.0. Even if we do not meet this ratio we can incur:

 

    debt under our senior credit facility;

 

    capital leases or purchase money debt in amounts not to exceed the greater of $35.0 million in the aggregate and 10% of our tangible assets at the time of incurrence;

 

    intercompany debt;

 

    debt existing on the date the senior subordinated notes were issued;

 

    up to $25.0 million in any type of debt;

 

    debt related to insurance and similar obligations arising in the ordinary course of business; or

 

    debt related to guarantees, earn-outs, or obligations in respect of purchase price adjustments in connection with the acquisition or disposition of property or assets.

 

The senior subordinated notes also place conditions on the terms of asset sales or transfers and require us either to reinvest the cash proceeds of an asset sale or transfer, or, if we do not reinvest those proceeds, to pay down our senior credit facility or other senior debt or to offer to redeem our senior subordinated notes with any asset sale proceeds not so used. In addition, upon the occurrence of a change of control, we will be required to offer to purchase all of the outstanding senior subordinated notes at a price equal to 101% of their principal amount plus accrued and unpaid interest to the date of redemption. Under the indenture governing the senior subordinated notes, a change of control is deemed to occur if (a) any person, other than certain “permitted holders” (defined as any member of the senior management of our company), becomes the beneficial owner of more than 50% of the voting power of our common stock, (b) any person, or group of persons acting together, other than a permitted holder, becomes the beneficial owner of more than 35% of the voting power of our

 

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common stock and the permitted holders own a lesser percentage than such other person, or (c) the first day on which a majority of the members of our board of directors are not “continuing directors” (as defined in the indenture). At any time prior to February 15, 2007, we may redeem on any one or more occasions up to 35% of the aggregate principal amount of the senior subordinated notes with the net cash proceeds of one or more public equity offerings at a redemption price that is currently 107.75% of the principal amount thereof, plus accrued and unpaid interest. Except in this circumstance, the senior subordinated notes are not redeemable at our option prior to February 15, 2009. On or after February 15, 2009, we may redeem the senior subordinated notes in whole or in part at a redemption price that is 103.875% and decreases to 102.583% after February 15, 2010, 101.292% after February 15, 2011 and 100.0% after February 15, 2012.

 

Senior Subordinated Convertible Notes.    On November 22, 2005, we completed a private offering of $150.0 million of our senior subordinated convertible notes due 2012 to “qualified institutional buyers” pursuant to Rule 144A under the Securities Act. Subsequently, during the second quarter of fiscal 2006, we registered the convertible notes for resale by the holders thereof. The convertible notes bear interest at an annual rate of 3.0%, payable semi-annually on May 15th and November 15th of each year, with the first interest payment paid on May 15, 2006. The convertible notes are convertible into our common stock at an initial conversion price of $50.09 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 120% of the conversion price per share for 20 of the last 30 trading days of any calendar quarter. If, upon the occurrence of certain events, the holders of the convertible notes exercise the conversion provisions of the convertible notes, we may need to remit the principal balance of the convertible notes to them in cash (see below). As such, we would be required to classify the entire amount outstanding of the convertible notes as a current liability in the following quarter. This evaluation of the classification of amounts outstanding associated with the convertible notes will occur every calendar quarter. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the convertible note, or (ii) the conversion value, determined in the manner set forth in the indenture governing the convertible notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the convertible note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the convertible notes is 3,817,775.

 

Proceeds from the sale of the convertible notes were used (a) to repay approximately $100.0 million of the $305.0 million outstanding under our then existing senior credit facility, (b) to pay a net cost of approximately $18.5 million associated with separate convertible bond hedge and warrant transactions entered into with one or more affiliates of Merrill Lynch, Pierce, Fenner & Smith Incorporated, which were designed to limit our exposure to potential dilution from conversion of the convertible notes and (c) to pay other expenses of approximately $4.4 million. We intend to use the remaining cash proceeds for general corporate purposes, including acquisitions.

 

Holders of the convertible notes may convert their notes prior to the close of business on the business day before the stated maturity date based on the applicable conversion rate only under the following circumstances:

 

    during any calendar quarter beginning after March 31, 2006 (and only during such calendar quarter), if the closing price of our common stock for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is more than 120% of the conversion price per share, which is $1,000 divided by the then applicable conversion rate;

 

    during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of senior subordinated convertible notes for each day of that period was less than 98% of the product of the closing price for our common stock for each day of that period and the number of shares of common stock issuable upon conversion of $1,000 principal amount of the convertible notes;

 

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    if specified distributions to holders of our common stock are made, or specified corporate transactions occur;

 

    if a fundamental change occurs;

 

    at any time on or after May 15, 2012 and through the business day preceding the maturity date.

 

The initial conversion rate is 19.9622 shares of common stock per $1,000 principal amount of the convertible notes. This is equivalent to an initial conversion price of approximately $50.09 per share of common stock.

 

Upon conversion, a holder will receive, in lieu of common stock, an amount in cash equal to the lesser of (i) the principal amount of the convertible note, or (ii) the conversion value, determined in the manner set forth in the convertible note, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the convertible note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the remaining common stock deliverable upon conversion.

 

The convertible notes are:

 

    junior in right of payment to all of our existing and future senior debt;

 

    equal in right of payment to all of our existing and future senior subordinated debt; and

 

    senior in right of payment to any of our future subordinated debt.

 

The terms of the indenture under which the convertible notes are issued do not limit our ability or the ability of our subsidiaries to incur additional debt, including secured debt.

 

We have filed with the SEC a shelf registration statement with respect to the resale of the convertible notes and the shares of our common stock issuable upon conversion of the convertible notes. We have agreed to keep such shelf registration statement effective until the earlier of (i) the sale pursuant to the shelf registration statement of all of the convertible notes and/or shares of common stock issuable upon conversion of the convertible notes, and (ii) the date when the holders, other than the holders that are our “affiliates”, of the convertible notes and the common stock issuable upon conversion or the convertible notes are able to sell all such securities immediately without restriction pursuant to the volume limit provisions of Rule 144 under the Securities Act or any successor rule thereto or otherwise. We will be required to pay additional interest, subject to some limitations, to the holders of the convertible notes if we fail to comply with our obligations to keep such shelf registration statement effective for the specified time period.

 

Shareholders’ Equity.    As of September 28, 2006, our shareholders’ equity totaled $337.0 million. The increase of $85.1 million in shareholders’ equity from September 29, 2005 is primarily attributable to fiscal 2006 net income of $89.2 million offset by a net decrease in additional paid-in capital of $3.9 million. The decrease in paid-in capital is related to the net cost of the note hedge and warrant transactions of $18.5 million associated with the issuance of the convertible notes offset by approximately $14.6 million related to stock option exercises and related tax benefits.

 

Long Term Liquidity.    We believe that anticipated cash flows from operations, funds available from our existing revolving credit facility, together with cash on hand and vendor reimbursements, will provide sufficient funds to finance our operations at least for the next 12 months. As of September 28, 2006, we had approximately $44.2 million available under our revolving credit facility. Changes in our operating plans, lower than anticipated sales, increased expenses, additional acquisitions or other events may cause us to need to seek additional debt or equity financing in future periods. There can be no guarantee that financing will be available on acceptable terms or at all. Additional equity financing could be dilutive to the holders of our common stock, and additional debt financing, if available, could impose greater cash payment obligations and more covenants and operating restrictions.

 

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Contractual Obligations and Commitments

 

Contractual Obligations.    The following table summarizes by fiscal year our expected long-term debt payment schedule, lease finance obligation commitments, future operating lease commitments and purchase obligations as of September 28, 2006:

 

Contractual Obligations

(Dollars in thousands)

 

    Fiscal
2007
  Fiscal
2008
  Fiscal
2009
  Fiscal
2010
  Fiscal
2011
  Thereafter   Total

Long-term debt (1)

  $ 2,088   $ 2,091   $ 2,094   $ 2,098   $ 2,102   $ 593,830   $ 604,303

Interest (2)

    36,893     36,932     37,365     37,790     37,645     54,498     241,123

Lease finance obligations (3)

    27,743     27,576     27,459     27,406     27,409     278,721     416,314

Operating leases (4)

    59,185     56,804     53,203     48,948     45,205     231,070     494,415

Purchase obligations (5)

    —       21,480     —       24,640     —       28,240     74,360
                                         

Total contractual obligations

  $ 125,909   $ 144,883   $ 120,121   $ 140,882   $ 112,361   $ 1,186,359   $ 1,830,515
                                         

 

(1) Included in long-term debt are amounts owed on our senior subordinated notes, convertible notes, and senior credit facility. These borrowings are further explained in “Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 6—Long-Term Debt.” The table assumes our long-term debt is held to maturity.

 

(2) Included in interest are expected payments on our senior subordinated notes, convertible notes, senior credit facility and interest rate swap agreements. Variable interest on the senior credit facility and swap agreements is based on the September 28, 2006 rate. See “Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 6—Long-Term Debt.”

 

(3) Included in lease finance obligations are both principal and interest.

 

(4) Some of our retail store leases require percentage rentals on sales and contain escalation clauses. The minimum future operating lease payments shown above do not include contingent rental expenses, which have historically been insignificant. Some lease agreements provide us with an option to renew. Our future operating lease obligations will change if we exercise these renewal options and if we enter into additional operating lease agreements.

 

(5) Our contract with BP requires us to purchase a minimum volume of gasoline gallons. In any period in which we fail to meet the minimum volume requirement as set forth in the agreement, we are required to pay an amount equal to two cents ($.02) per gallon times the difference between the actual gallon volume purchased and the minimum volume requirement. The amounts presented assume that we will not meet the minimal volume requirement, which, based on current forecasts, we anticipate meeting.

 

Letter of Credit Commitments.    The following table summarizes by fiscal year the expiration dates of our standby letters of credit issued under our senior credit facility as of September 28, 2006 (amounts in thousands):

 

     Fiscal
2007
   Total

Standby letters of credit

   $ 45,820    $ 45,820

 

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

 

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Environmental Considerations.    Environmental reserves of $18.4 million and $16.3 million as of September 28, 2006 and September 29, 2005, respectively, represent our estimates for future expenditures for remediation, tank removal and litigation associated with 269 known contaminated sites for both fiscal 2006 and fiscal 2005, as a result of releases (e.g., overfills, spills and underground storage tank releases) and are based on current regulations, historical results and certain other factors. We estimate that approximately $17.1 million of our environmental obligations will be funded by state trust funds and third party insurance; as a result, we may spend up to $1.2 million for remediation, tank removal and litigation. Also, as of September 28, 2006 and September 29, 2005 there were an additional 534 and 510 sites, respectively, that are known to be contaminated sites and that are being remediated by third parties, and therefore, the costs to remediate such sites are not included in our environmental reserve. Remediation costs for known sites are expected to be incurred over the next one to ten years. Environmental reserves have been established with remediation costs based on internal and external estimates for each site. Future remediation for which the timing of payments can be reasonably estimated is discounted using an appropriate rate to determine the reserve.

 

Florida environmental regulations require all single-walled underground storage tanks to be upgraded/replaced with secondary containment by December 31, 2009. In order to comply with these Florida regulations, we will be required to upgrade or replace underground storage tanks at approximately 140 locations. We anticipate that these capital expenditures will be approximately $29.0 million over the next three years. The ultimate number of locations and costs incurred will depend on several factors including future store closures, changes in the number of locations upgraded or replaced and changes in the costs to upgrade or replace the underground storage tanks.

 

Merchandise Supply Agreement.    We have a distribution service agreement with McLane pursuant to which McLane is the primary distributor of traditional grocery products to our stores. We also purchase a significant percentage of the cigarettes we sell from McLane. The agreement with McLane continues through April 10, 2010 and contains no minimum purchase requirements. We purchase products at McLane’s cost plus an agreed upon percentage, reduced by any promotional allowances and volume rebates offered by manufacturers and McLane. In addition, we received an initial service allowance, which is being amortized over the term of the agreement, and also receive additional per store service allowances, both of which are subject to adjustment based on the number of stores in operation. Total purchases from McLane exceeded 50% of total merchandise purchases in fiscal 2006.

 

Gasoline Supply Agreements.    We have historically purchased our branded gasoline and diesel fuel under supply agreements with major oil companies, including BP®, Citgo®, Chevron®, and ExxonMobil®. The fuel purchased has generally been based on the stated rack price, or market price, quoted at each terminal as adjusted per applicable contracts. These supply agreements have expiration dates ranging from 2010 to 2012 and contain provisions for various payments to us based on volume of purchases and vendor allowances. These agreements also, in certain instances, give the supplier a right of first refusal to purchase certain assets used by us to sell their gasoline.

 

On July 18, 2006, we entered into the Third Amendment (the “Third Amendment”) to the Branded Jobber Contract dated July 18, 2006 with BP. The Third Amendment extends the term of the Branded Jobber Contract between the Company and BP dated as of February 1, 2003 (the “Original Contract”) until September 30, 2012. In addition, the Third Amendment modified the following terms of the Original Contract:

 

    Minimum Volume—Our obligation to purchase a minimum volume of BP branded gasoline each year was amended and is now subject to increase at a rate of approximately 7% per year during the remaining term of the agreement and is measured over a two-year period. During fiscal 2006, we exceeded the requirement for the period ending September 30, 2006. The minimum requirement for the two-year period ending September 30, 2008 is approximately 1.074 billion gallons of BP branded product.

 

    Minimum Volume Guarantee—Subject to certain adjustments, in any two-year period in which we fail to meet our minimum volume purchase obligation, we have agreed to pay BP two cents per gallon times the difference between the actual volume of BP branded product purchased and the minimum volume requirement. Based on current forecasts, we do not anticipate paying any penalties under this contract.

 

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Except as expressly provided in the Third Amendment, all terms and conditions of the Original Contract remain in full force and effect.

 

In fiscal 2003, we signed a gasoline supply agreement with Citgo® and in October 2005, we extended the term of the Citgo agreement to 2010. We also have an agreement with ExxonMobil Corporation which provides us with another potential branded product supplier through 2010. We have re-branded and/or upgraded images for gasoline offerings at approximately 1,100 locations since initially entering into these agreements. Currently, BP® supplies approximately 28% of our total gasoline volume, which is sold under the BP®/Amoco® brand, and Citgo® supplies approximately 54% of our total gasoline volume. Citgo® supplies both our private brand gasoline, which is sold under our own Kangaroo® and other brands, and Citgo® branded gasoline. The remaining locations, primarily in Florida, remain branded by Chevron®. We entered into these branding and supply agreements to provide a more consistent operating identity while helping us to maximize our gasoline gallon growth and gasoline gross profit dollars. In order to receive certain benefits under these contracts, we must first meet certain purchase levels. To date, we have met these purchase levels and expect to continue to do so.

 

Other Commitments.    We make various other commitments and become subject to various other contractual obligations that we believe to be routine in nature and incidental to the operation of our business. Management believes that such routine commitments and contractual obligations do not have a material impact on our business, financial condition or results of operations. In addition, like all public companies, we have faced, and will continue to face increased costs in order to comply with new rules and standards relating to corporate governance and corporate disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq rules. We intend to devote all reasonably necessary resources to comply with evolving standards.

 

Off-Balance Sheet Arrangements

 

With the exception of our operating leases, we have no off-balance sheet arrangements that have had or are reasonably likely to have a material current or future effect on our financial position, results of operations or cash flows.

 

Quarterly Results of Operations and Seasonality

 

The following table sets forth certain unaudited financial and operating data for each fiscal quarter during fiscal 2006, fiscal 2005 and fiscal 2004. The unaudited quarterly information includes all normal recurring adjustments that we consider necessary for a fair presentation of the information shown. This information should be read in conjunction with our consolidated financial statements and the related notes appearing elsewhere in this report. Due to the nature of our business and our reliance, in part, on consumer spending patterns in coastal, resort and tourist markets, we typically generate higher revenues and gross margins during warm weather months in the southeastern United States, which fall within our third and fourth fiscal quarters. In the following table, gasoline gallons and dollars are in thousands, except per gallon data.

 

    Fiscal 2006     Fiscal 2005     Fiscal 2004  
    First
Quarter
    Second
Quarter
    Third
Quarter
    Fourth
Quarter
    First
Quarter
    Second
Quarter
    Third
Quarter
    Fourth
Quarter
    First
Quarter
    Second
Quarter
    Third
Quarter
    Fourth
Quarter
 

Total revenue

  $ 1,315,323     $ 1,315,746     $ 1,645,112     $ 1,685,521     $ 941,543     $ 945,760     $ 1,166,456     $ 1,375,480     $ 744,441     $ 786,353     $ 928,327     $ 1,033,964  

Merchandise revenue

    316,648       323,004       372,081       373,926       287,067       284,289       324,041       333,494       270,149       270,073       302,879       329,745  

Gasoline revenue

    998,675       992,742       1,273,031       1,311,595       654,476       661,471       842,415       1,041,986       474,292       516,280       625,448       704,219  

Merchandise gross profit (1)

    118,736       121,547       139,143       138,516       104,092       105,732       118,574       120,854       99,174       99,486       109,255       117,512  

Gasoline gross profit (1)

    86,585       47,346       64,778       82,495       49,887       34,120       48,447       81,441       40,936       33,741       44,455       46,284  

Income from operations

    69,756       27,853       47,323       57,113       33,217       18,802       40,444       56,080       24,200       17,817       34,475       34,103  

Net income (loss)

    32,971       9,196       20,291       26,740       12,440       3,341       16,601       25,428       4,527       (14,558 )     13,202       12,555  

Income from operations as a percentage of full year

    34.5 %     13.8 %     23.4 %     28.3 %     22.4 %     12.7 %     27.2 %     37.8 %     21.9 %     16.1 %     31.2 %     30.8 %

Comparable store merchandise sales increase

    5.0 %     5.4 %     5.8 %     3.0 %     5.2 %     6.6 %     4.1 %     4.7 %     2.4 %     3.4 %     3.9 %     3.8 %

Comparable store sales gasoline gallons increase

    4.6 %     4.0 %     2.3 %     0.3 %     3.4 %     7.7 %     5.6 %     3.1 %     3.4 %     1.2 %     0.2 %     3.2 %

Gasoline gross profit per gallon

    0.212       0.111       0.140       0.173       0.146       0.099       0.123       0.194       0.126       0.105       0.130       0.120  

Gasoline gallons

    409,093       428,230       461,524       476,079       340,644       346,151       395,022       419,215       325,580       321,805       342,818       386,657  

 

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(1) We compute gross profit exclusive of depreciation or allocation of operating, general and administrative expenses.

 

Inflation

 

Wholesale gasoline fuel prices were volatile during fiscal 2006, fiscal 2005, and fiscal 2004, and we expect that they will remain volatile into the foreseeable future. During fiscal 2006, wholesale crude oil prices hit a high of approximately $77 per barrel in July 2006 and a low of approximately $56 per barrel in November 2005. During fiscal 2005, wholesale crude oil prices hit a high of approximately $70 per barrel in August 2005 and a low of approximately $41 per barrel in December 2004. During fiscal 2004, wholesale crude oil prices hit a high of approximately $50 per barrel in September 2004 and a low of approximately $28 per barrel in September 2003.

 

We attempt to pass along wholesale gasoline cost changes to our customers through retail price changes; however, we are not always able to do so. The timing of any related increase or decrease in retail prices is affected by competitive conditions. As a result, we tend to experience lower gasoline margins in periods of rising wholesale costs and higher margins in periods of decreasing wholesale costs. We are unable to ensure that significant volatility in gasoline wholesale prices will not negatively affect gasoline gross margins or demand for gasoline within our markets.

 

General CPI, excluding energy, increased 4.0% during fiscal 2006 and 2.1% during fiscal 2005, while food at home CPI, which is most indicative of our merchandise inventory, increased 4.6% during fiscal 2006 and 2.1% during fiscal 2005. While we have generally been able to pass along these price increases to our customers, we can make no assurances that continued inflation will not have a material adverse effect on our sales and gross profit.

 

New Accounting Standards

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating SFAS No. 157 to determine the impact, if any, on our financial statements.

 

In September 2006, the SEC released Staff Accounting Bulletin 108 (“SAB 108”). SAB 108 provides interpretative guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 is not expected to have a material impact on our financial statements.

 

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the application of FASB Statement No. 109 by providing guidance on the recognition and measurement of an enterprise’s tax positions taken in a tax return. FIN 48 additionally clarifies how an enterprise should account for a tax position depending on whether the position is ‘more likely than not’ to pass a tax examination. The interpretation provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We will be required to adopt FIN 48 in fiscal 2008. We are currently evaluating FIN 48 to determine the impact, if any, on our financial statements.

 

In October 2005, the FASB issued Staff Position 13-1, Accounting for Rental Costs Incurred During a Construction Period. This pronouncement requires that rental costs associated with ground or building operating leases that are incurred during a construction period be recognized as rental expense. The implementation of this pronouncement did not impact our financial statements.

 

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In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations—an Interpretation of FASB Statement No. 143 (“FIN 47”). FIN 47 provides guidance relating to the identification of and financial reporting for legal obligations to perform an asset retirement activity. The interpretation requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. The adoption of FIN 47 during the first quarter of fiscal 2006 did not materially impact our financial statements.

 

In December 2004, the FASB issued SFAS No. 123R. This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements and establishes fair value as the measurement objective in accounting for share-based payment arrangements. We adopted this standard as of the beginning of the first quarter of fiscal 2006 using the modified version of prospective application. See “Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 16—Stock Compensation Plans” for a discussion of the impact of the adoption of SFAS No. 123R.

 

In November 2004, the FASB issued SFAS No. 151, Inventory Costs—an Amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies that inventory costs that are “abnormal” are required to be charged to expense as incurred as opposed to being capitalized into inventory as a product cost. Examples of “abnormal” costs include costs of idle facilities, excess freight and handling costs and wasted materials (spoilage). The adoption of SFAS No. 151 during the first quarter of fiscal 2006 did not materially impact our financial statements.

 

Critical Accounting Policies

 

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. 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.

 

Revenue Recognition.    Revenues from our two primary product categories, gasoline and merchandise, are recognized at the point of sale. We derive service revenue from lottery ticket sales, money orders, car washes, public telephones, amusement and video gaming and other ancillary product and service offerings, which are included in merchandise revenue. We evaluate the criteria of FASB Emerging Issues Task Force (“EITF”) 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in determining whether it is appropriate to record the gross amount of service revenue and related costs or the net amount earned as commissions. Generally, when we are the primary obligor, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, influence product or service specifications, or have several but not all of these indicators, revenue is recorded on a gross basis. If we are not the primary obligor and do not possess other indicators of gross reporting as noted above, we record the revenue at net amounts.

 

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Accounting for Leases.    We apply the criteria in SFAS No. 13, Accounting for Leases, relating to our leased facilities. Based upon this guidance leases are accounted for as either operating or capital. We also enter into sale and leaseback transactions for certain locations and apply the criteria of SFAS No. 98, Accounting for Leases. For all sale-leaseback transactions entered into through September 28, 2006, we retained ownership of the underground storage tanks, which represents a form of continuing involvement as defined in SFAS 98, and as such we account for these transactions as financing leases.

 

Insurance Liabilities.    We self-insure a significant portion of expected losses under our workers’ compensation, general liability 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. Although we have not experienced significant changes in actual expenditures compared to actuarial assumptions as a result of increased medical costs or incidence rates, such changes could occur in the future and could significantly impact our results of operations and financial position.

 

Long-Lived Assets and Closed Stores.    Long-lived assets at the individual store level are reviewed for impairment annually or 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 to be generated from 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. Cash flows vary for each store year to year and as a result, we have identified and recorded impairment charges for operating and closed stores for each of the past three years as changes in market demographics, traffic patterns, competition and other factors have impacted the overall operations of certain of our individual store locations. Similar changes may occur in the future that will require us to record impairment charges.

 

Property and equipment of stores we are closing are written down to their estimated net realizable value at the time we 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. Although we have not experienced significant changes in our estimate of net realizable value or sublease income, changes in real estate markets could significantly impact the net values realized from the sale of assets and rental or sublease income.

 

Derivative Financial Instruments.    We enter into interest rate swap agreements to modify the interest characteristics of our outstanding long-term debt and we have designated each qualifying instrument as a cash flow hedge. We formally document our hedge relationships, including identifying the hedge instruments and hedged items, as well as our risk management objectives and strategies for entering into the hedge transaction. At hedge inception, and at least quarterly thereafter, we assess whether derivatives used to hedge transactions are highly effective in offsetting changes in the cash flow of the hedged item. We measure effectiveness by the ability of the interest rate swaps to offset cash flows associated with changes in the variable LIBOR rate associated with our term loan facilities using the hypothetical derivative method. To the extent the instruments are considered to be effective, changes in fair value are recorded as a component of other comprehensive income. To the extent there is any hedge ineffectiveness, any changes in fair value relating to the ineffective portion are immediately recognized in earnings as interest expense. When it is determined that a derivative ceases to be a highly effective hedge, we discontinue hedge accounting, and subsequent changes in fair value of the hedge instrument are recognized in earnings.

 

The fair values of our interest rate swaps are obtained from dealer quotes. These values represent the estimated amount that we would receive or pay to terminate the agreement taking into account the difference between the contract rate of interest and rates currently quoted for agreements of similar terms and maturities.

 

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Asset Retirement Obligations.    We recognize the estimated future cost to remove an underground storage tank over the estimated useful life of the storage tank in accordance with the provisions of SFAS No. 143. We record a discounted liability for the fair value of an asset retirement obligation with a corresponding increase to the carrying value of the related long-lived asset at the time an underground storage tank is installed. We amortize the amount added to property and equipment and recognize accretion expense in connection with the discounted liability over the remaining life of the tank. We base our estimates of the anticipated future costs for removal of an underground storage tank on our prior experience with removal. We compare our cost estimates with our actual removal cost experience on an annual basis and as we did in fiscal 2004, when the actual costs we experience exceed our original estimates, we will recognize an additional liability for estimated future costs to remove the underground storage tanks. See also “Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 10—Asset Retirement Obligations.”

 

Vendor Allowances and Rebates.    We receive payments for vendor allowances, volume rebates and other supply arrangements in connection with various programs. Some of these vendor rebate, credit and promotional allowance arrangements require that we make assumptions and judgments regarding, for example, the likelihood of attaining specified levels of purchases or selling specified volumes of products, and the duration of carrying a specified product. Payments are recorded as a reduction to cost of goods sold or expenses to which the particular payment relates. Unearned payments are deferred and amortized as earned over the term of the respective agreement.

 

Environmental Liabilities and Related Receivables.    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. 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 an appropriate rate.

 

Reimbursements under state trust fund programs or third party insurers are recognized as receivables based on historical and expected collection rates. 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 is evaluated quarterly and adjustments are made based on updated experience at existing rates, 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 results of operations and financial position.

 

Item 7A.    Quantitative And Qualitative Disclosures About Market Risk.

 

Quantitative Disclosures.    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 convertible notes, and our variable rate debt relates to borrowings under our senior credit facility. 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 hold derivative instruments primarily to manage our exposure to these risks and all derivative instruments are matched against specific debt obligations. Our debt and interest rate swap instruments outstanding at September 28, 2006, including applicable interest rates, are discussed above in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources” and “Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 8—Derivative Financial Instruments.”

 

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The following table presents the future principal cash flows and weighted-average interest rates on our existing long-term debt instruments based on rates in effect at September 28, 2006. Fair values have been determined based on quoted market prices as of September 28, 2006.

 

Expected Maturity Date

as of September 28, 2006

(Dollars in thousands)

 

     Fiscal
2007
    Fiscal
2008
    Fiscal
2009
    Fiscal
2010
    Fiscal
2011
    Thereafter     Total     Fair Value

Long-term debt

   $ 2,088     $ 2,091     $ 2,094     $ 2,098     $ 2,102     $ 593,830     $ 604,303     $ 649,918

Weighted-average interest rate

     6.12 %     6.15 %     6.24 %     6.33 %     6.33 %     6.72 %     6.34 %  

 

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 September 28, 2006, the interest rate on 87.8% of our debt was fixed by either the nature of the obligation or through the interest rate swap arrangements compared to 81.5% at September 29, 2005. The annualized effect of a one percentage point change in floating interest rates on our interest rate swap agreements and other floating rate debt obligations at September 28, 2006, would be to change interest expense by approximately $740 thousand.

 

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)

 

     September 28,
2006
    September 29,
2005
 

Notional principal amount

   $ 130,000     $ 202,000  

Weighted average fixed pay rate

     4.24 %     2.72 %

Weighted average variable receive rate

     5.52 %     3.86 %

Weighted average years to maturity

     2.21       0.55  

 

As of September 28, 2006, the fair value of our swap agreements represented a net asset of $1.9 million.

 

Qualitative Disclosures.    Our primary exposure relates to:

 

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

 

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

 

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

 

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

 

We manage interest rate risk on our outstanding long-term and short-term debt through our use of fixed and variable rate debt. We expect the interest rate swaps mentioned above will reduce our exposure to short-term interest rate fluctuations. While we cannot predict or manage our ability to refinance existing debt or the impact interest rate movements will have on our existing debt, management evaluates our financial position on an ongoing basis.

 

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Item 8.    Consolidated Financial Statements and Supplementary Data.

 

     Page
The Pantry, Inc. Audited Consolidated Financial Statements:   
Report of Independent Registered Public Accounting Firm    49

Consolidated Balance Sheets as of September 28, 2006 and September 29, 2005

   50

Consolidated Statements of Operations for the years ended September 28, 2006, September 29, 2005 and September 30, 2004

   51

Consolidated Statements of Shareholders’ Equity for the years ended September 28, 2006, September 29, 2005 and September 30, 2004

   52

Consolidated Statements of Cash Flows for the years ended September 28, 2006, September 29, 2005 and September 30, 2004

   53

Notes to Consolidated Financial Statements

   55

Financial Statement Schedule:

  

Schedule II—Valuation and Qualifying Accounts and Reserves

   104

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of

The Pantry, Inc.

Sanford, North Carolina

 

We have audited the accompanying consolidated balance sheets of The Pantry, Inc. and subsidiaries (the “Company”) as of September 28, 2006 and September 29, 2005, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended September 28, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Pantry, Inc. and subsidiaries as of September 28, 2006 and September 29, 2005, and the results of their operations and their cash flows for each of the three years in the period ended September 28, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of September 28, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 12, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

/s/ Deloitte & Touche LLP

Charlotte, North Carolina

December 12, 2006

 

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THE PANTRY, INC.

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

     September 28,
2006
   September 29,
2005

ASSETS

     

Current assets:

     

Cash and cash equivalents

   $ 120,394    $ 111,472

Receivables (net of allowance for doubtful accounts of $262 at September 28, 2006 and $546 at September 29, 2005)

     68,064      61,597

Inventories

     140,135      125,348

Prepaid expenses and other current assets

     18,783      19,031

Deferred income taxes

     8,348      5,837
             

Total current assets

     355,724      323,285
             

Property and equipment, net

     745,721      630,291
             

Other assets:

     

Goodwill

     440,681      394,903

Other noncurrent assets

     45,781      39,687
             

Total other assets

     486,462      434,590
             

Total assets

   $ 1,587,907    $ 1,388,166
             

LIABILITIES AND SHAREHOLDERS’ EQUITY

     

Current liabilities:

     

Current maturities of long-term debt

     2,088      16,045

Current maturities of lease finance obligations

     3,511      2,872

Accounts payable

     139,939      131,618

Accrued compensation and related taxes

     19,676      16,786

Other accrued taxes

     27,440      34,346

Self-insurance reserves

     29,898      22,544

Other accrued liabilities

     34,978      29,322
             

Total current liabilities

     257,530      253,533
             

Other liabilities:

     

Long-term debt

     602,215      539,328

Lease finance obligations

     240,564      200,214

Deferred income taxes

     72,435      64,848

Deferred vendor rebates

     23,876      27,385

Other noncurrent liabilities

     54,280      50,925
             

Total other liabilities

     993,370      882,700
             

Commitments and contingencies (Note 13)

     

Shareholders’ equity:

     

Common stock, $.01 par value, 50,000,000 shares authorized; 22,687,240 and 22,316,439 issued and outstanding at September 28, 2006 and September 29, 2005, respectively

     227      223

Additional paid-in capital

     172,940      176,836

Accumulated other comprehensive income, net of deferred income taxes of $(762) at September 28, 2006 and $(909) at September 29, 2005

     1,194      1,426

Retained earnings

     162,646      73,448
             

Total shareholders’ equity

     337,007      251,933
             

Total liabilities and shareholders’ equity

   $ 1,587,907    $ 1,388,166
             

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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THE PANTRY, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

 

    September 28,
2006
    September 29,
2005
    September 30,
2004
 
    (52 weeks)     (52 weeks)     (53 weeks)  

Revenues:

     

Merchandise

  $ 1,385,659     $ 1,228,891     $ 1,172,846  

Gasoline

    4,576,043       3,200,348       2,320,239  
                       

Total revenues

    5,961,702       4,429,239       3,493,085  
                       

Costs and operating expenses:

     

Merchandise cost of goods sold (exclusive of items shown separately below)

    867,717       779,639       747,419  

Gasoline cost of goods sold (exclusive of items shown separately below)

    4,294,839       2,986,453       2,154,823  

Operating, general and administrative

    521,076       450,263       419,337  

Depreciation and amortization

    76,025       64,341       60,911  
                       

Total costs and operating expenses

    5,759,657       4,280,696       3,382,490  
                       

Income from operations

    202,045       148,543       110,595  
                       

Other income (expense):

     

Loss on extinguishment of debt

    (1,832 )     —         (23,087 )

Interest expense

    (59,602 )     (56,130 )     (64,257 )

Interest income

    4,941       1,816       725  

Miscellaneous

    800       977       951  
                       

Total other expense

    (55,693 )     (53,337 )     (85,668 )
                       

Income before income taxes

    146,352       95,206       24,927  

Income tax expense

    (57,154 )     (37,396 )     (9,201 )
                       

Net income

  $ 89,198     $ 57,810     $ 15,726  
                       

Earnings per share:

     

Basic

  $ 3.95     $ 2.74     $ 0.80  
                       

Diluted

  $ 3.88     $ 2.64     $ 0.76  
                       

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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THE PANTRY, INC.

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Shares and dollars in thousands)

 

    Common Stock   Additional
Paid-in
Capital
    Shareholder
Loans
    Accumulated
Other
Comprehensive
Income/(Deficit)
   

Retained
Earnings

(Deficit)

    Total  
    Shares   Par
Value
                             

Balance, September 25, 2003

  18,108   $ 182   $ 128,002     $ (173 )   $ (690 )   $ (88 )   $ 127,233  

Comprehensive income, net of tax:

             

Net income

  —       —       —         —         —         15,726       15,726  

Unrealized gains on qualifying cash flow hedges

  —       —       —         —         896       —         896  
                                                 

Comprehensive income

  —       —       —         —         896       15,726       16,622  

Exercise of stock options and warrants

  2,164     22     4,877       —         —         —         4,899  

Repayment of shareholder loans

  —       —       —         173       —         —         173  
                                                 

Balance, September 30, 2004

  20,272   $ 204   $ 132,879     $ —       $ 206     $ 15,638     $ 148,927  

Comprehensive income, net of tax:

             

Net income

  —       —       —         —         —         57,810       57,810  

Unrealized gains on qualifying cash flow hedges

  —       —       —         —         1,220       —         1,220  
                                                 

Comprehensive income

  —       —       —         —         1,220       57,810       59,030  

Issuance of stock-public offering

  1,500     15     32,835       —         —         —         32,850  

Excess income tax benefits from stock-based compensation arrangements

  —       —       7,247       —         —         —         7,247  

Exercise of stock options and warrants

  544     4     3,875       —         —         —         3,879  
                                                 

Balance, September 29, 2005

  22,316   $ 223   $ 176,836     $ —       $ 1,426     $ 73,448     $ 251,933  

Comprehensive income, net of tax:

             

Net income

  —       —       —         —         —         89,198       89,198  

Unrealized losses on qualifying cash flow hedges

  —       —       —         —         (232 )     —         (232 )
                                                 

Comprehensive income (loss)

            (232 )     89,198       88,966  

Payment for purchase of note hedge

  —       —       (43,720 )     —         —         —         (43,720 )

Proceeds from issuance of warrant

        25,220             25,220  

Stock-based compensation expense

  —       —       2,812       —         —         —         2,812  

Exercise of stock options

  371     4     4,378       —         —         —         4,382  

Excess income tax benefits from stock-based compensation arrangements

  —       —       5,826       —         —         —         5,826  

Income tax benefit of note hedge

  —       —       1,588       —         —         —         1,588  
                                                 

Balance, September 28, 2006

  22,687   $ 227   $ 172,940     $ —       $ 1,194     $ 162,646     $ 337,007  
                                                 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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THE PANTRY, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

     Year Ended  
     September 28,
2006
    September 29,
2005
    September 30,
2004
 
     (52 weeks)     (52 weeks)     (53 weeks)  

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income

   $ 89,198     $ 57,810     $ 15,726  

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     76,025       64,341       60,911  

(Benefit)/provision for deferred income taxes

     (1,240 )     4,291       9,201  

Loss on extinguishment of debt

     1,832       —         23,087  

Stock compensation expense

     2,812       —         —    

Other

     (1,603 )     14,503       7,872  

Changes in operating assets and liabilities, net of effects of acquisitions:

      

Receivables

     (6,582 )     (18,539 )     (11,146 )

Inventories

     (5,121 )     (22,393 )     (977 )

Prepaid expenses and other current assets

     (4,811 )     1,565       (7,005 )

Other noncurrent assets

     (46 )     (2,015 )     242  

Accounts payable

     1,295       10,467       30,830  

Other current liabilities and accrued expenses

     13,687       30,551       (7,506 )

Other noncurrent liabilities

     (11,183 )     (7,000 )     (4,263 )
                        

Net cash provided by operating activities

     154,263       133,581       116,972  
                        

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Additions to property and equipment

     (96,826 )     (73,387 )     (51,916 )

Proceeds from sales of land, building and equipment

     4,332       10,215       10,454  

Acquisitions of businesses, net of cash acquired

     (126,791 )     (103,068 )     (185,607 )
                        

Net cash used in investing activities

     (219,285 )     (166,240 )     (227,069 )
                        

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Principal repayments under lease finance obligations

     (3,004 )     (2,719 )     (2,760 )

Principal repayments of long-term debt

     (306,070 )     (12,028 )     (617,412 )

Proceeds from issuance of long-term debt

     355,000       —         675,000  

Proceeds from lease finance obligations

     42,929       14,101       97,104  

Proceeds from issuance of common stock, net

     —         32,850       —    

Proceeds from exercise of stock options

     4,382       3,879       4,899  

Payment for purchase of note hedge

     (43,720 )     —         —    

Proceeds from issuance of warrant

     25,220       —         —    

Excess income tax benefits from stock-based compensation arrangements

     5,826       —         —    

Repayments of shareholder loans

     —         —         173  

Other financing costs

     (6,619 )     —         (11,760 )
                        

Net cash provided by financing activities

     73,944       36,083       145,244  
                        

Net increase in cash

     8,922       3,424       35,147  

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

     111,472       108,048       72,901  
                        

CASH AND CASH EQUIVALENTS, END OF YEAR

   $ 120,394     $ 111,472     $ 108,048  
                        

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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SUPPLEMENTAL DISCLOSURE OF CASH FLOW

(Dollars in thousands)

 

     Year Ended
     September 28,
2006
   September 29,
2005
   September 30,
2004

Cash paid during the year:

        

Interest

   $ 56,545    $ 54,085    $ 55,572
                    

Income taxes

   $ 60,812    $ 12,910    $ 62
                    

Non-cash investing and financing activities:

        

Capital expenditures financed through capital leases

   $ 164    $ —      $ —  
                    

Accrued purchases of property and equipment

   $ 3,807    $ 3,217    $ 6,211
                    

 

Other non-cash disclosure:

 

During fiscal 2006, we entered into a noncash nonmonetary exchange of land and building assets for an estimated value of $2.3 million.

 

During fiscal 2005, we issued a note payable of approximately $400,000 in exchange for the termination of a store lease.

 

During fiscal 2004, warrants to purchase 2,346,000 shares of common stock were exercised at a price of $7.45 per share. The exercise was cashless whereby shares of common stock received were reduced by the number of shares having an aggregate fair market value equal to the exercise price, or approximately $17.5 million. Consequently, upon exercise 1,607,855 shares of common stock were issued.

 

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THE PANTRY, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The Pantry

 

Our consolidated financial statements include the accounts of The Pantry, Inc. and its wholly-owned subsidiaries. Transactions and balances of each of our wholly-owned subsidiaries are immaterial to the consolidated financial statements. All intercompany transactions and balances have been eliminated in consolidation. As of September 28, 2006, we own and operate 1,493 convenience stores in Florida (441), North Carolina (325), South Carolina (236), Georgia (125), Tennessee (101), Alabama (77), Mississippi (73), Virginia (50), Kentucky (31), Louisiana (25), and Indiana (9).

 

Accounting Period

 

We operate on a 52 or 53 - week fiscal year ending on the last Thursday in September. Fiscal 2006 and fiscal 2005 included 52 weeks and fiscal 2004 included 53 weeks.

 

Acquisition Accounting

 

Our acquisitions are accounted for under the purchase method of accounting whereby purchase price is allocated to assets acquired and liabilities assumed based on fair value. Excess of purchase price over fair value of net assets acquired is recorded as goodwill. The Consolidated Statements of Operations for the fiscal years presented include the results of operations for each of the acquisitions from the date of acquisition.

 

Segment Reporting, Goodwill and Other Intangibles

 

We provide segment reporting in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, (“SFAS No. 131”) which establishes annual and interim reporting standards for an enterprise’s business segments and related disclosures about its products, services, geographic areas and major customers. Our chief operating decision maker regularly reviews our operating results on a consolidated basis, and therefore the company has concluded it has one operating and reporting segment under SFAS No. 131 and one reporting unit under SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”).

 

The provisions of SFAS No. 142 require allocating goodwill to reporting units and testing for impairment using a two-step approach. 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 valuations, 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 would be recorded as a component of operating expenses. See Note 5—Goodwill and Other Intangible Assets.

 

We account for goodwill and other intangible assets acquired through business combinations in accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”), and SFAS No. 142. SFAS No. 141 clarifies the criteria in recognizing other intangible assets separately from goodwill in a business combination. SFAS No. 142 states goodwill and other intangible assets deemed to have indefinite lives are no longer amortized but are reviewed for impairment annually (or more frequently if impairment indicators arise). Separable intangible assets that are not determined to have an indefinite life will continue to be amortized over their useful lives and assessed for impairment under the provisions of SFAS No. 144. Other intangible assets are included in other noncurrent assets.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Cash and Cash Equivalents

 

For purposes of the consolidated financial statements, cash and cash equivalents include cash on hand, demand deposits and short-term investments with original maturities of three months or less.

 

Inventories

 

Inventories are valued at the lower of cost or market. Cost is determined using the last-in, first-out method for merchandise inventories and using the weighted average method for gasoline inventories.

 

Property Held for Sale

 

Property is classified as a component of other current assets when management’s intent is to sell these assets in the ensuing fiscal year and the criteria under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), are met. The asset is then recorded at the lower of cost or fair value less cost to sell. These assets primarily consist of land and buildings.

 

Property and Equipment

 

Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization is provided primarily by the straight-line method over the estimated useful lives of the assets for financial statement purposes and by accelerated methods for income tax purposes.

 

Estimated useful lives for financial statement purposes are as follows:

 

Buildings

  

20 to 33 1/2 years

Equipment, furniture and fixtures

  

3 to 30 years

 

Upon sale or retirement of depreciable assets, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is recognized. Leased buildings capitalized in accordance with SFAS No. 13, Accounting for Leases, are recorded at the lesser of fair value or the discounted present value of future lease payments at the inception of the leases. Amounts capitalized are amortized over the estimated useful lives of the assets or terms of the leases (generally 5 to 20 years); whichever is less, using the straight-line method.

 

Long-Lived Assets

 

Long-lived assets are reviewed annually for impairment and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS No. 144. When an evaluation is required, the projected future undiscounted cash flows are compared to the carrying value of the long-lived assets to determine if a write-down to fair value is required. Fair values are internal estimates based on our experience in utilizing or disposing of similar assets. We recorded a provision of approximately $180 thousand, $3.0 million and $7.4 million for asset impairments for certain real estate, leasehold improvements and store and gasoline equipment at certain underperforming stores for fiscal 2006, 2005 and 2004, respectively. We record asset impairment as a component of operating, general and administrative expenses.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Lease Accounting

 

We apply the criteria in SFAS No. 13, Accounting for Leases (“SFAS No. 13”), relating to our leased facilities. Based upon this guidance leases are accounted for as either operating or capital. We also enter into sale and leaseback transactions for certain locations and apply the criteria of SFAS No. 98, Accounting for Leases (“SFAS No. 98”). For all sale-leaseback transactions entered into through September 28, 2006, we retained ownership of the underground storage tanks, which represents a form of continuing involvement as defined in SFAS 98, and as such we account for these transactions as financing leases.

 

Revenue Recognition

 

Revenues from our two primary product categories, gasoline and merchandise, are recognized at the point of sale. We derive service revenue, which is included in merchandise revenue, from sales of lottery tickets, money orders, and car washes and services such as public telephones, ATMs, amusement and video gaming and other ancillary product and service offerings. We evaluate the criteria of EITF 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in determining whether it is appropriate to record the gross amount of service revenue and related costs or the net amount earned as commissions. When we are the primary obligor, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, influence product or service specifications, or have several but not all of these indicators, revenue is recorded on a gross basis. If we are not the primary obligor and do not possess other indicators of gross reporting as noted above, we record revenue on a net basis.

 

Cost of Goods Sold

 

The primary components of cost of goods sold are gasoline, merchandise, repairs and maintenance of customer delivery equipment (e.g., gasoline dispensers) and franchise fees for branded fast food service less vendor allowances and rebates. Vendor allowances and rebates are recognized in cost of goods sold in accordance with vendor agreements and as the related inventories are sold.

 

Operating, General and Administrative Expenses

 

The primary components of operating, general and administrative expenses are store labor, store occupancy, operations management and administrative personnel, insurance, and other corporate costs necessary to operate the business.

 

Deferred Financing Costs

 

Deferred financing costs represent expenses related to issuing long-term debt, obtaining lines of credit and obtaining lease financing. See Note 6—Long-Term Debt and Note 7—Lease Finance Obligations. Such amounts are being amortized over the remaining term of the respective financing and are included in interest expense.

 

Vendor Allowances, Rebates and Other Vendor Payments

 

We receive payments for vendor allowances, volume rebates and other supply arrangements in connection with various programs. Our accounting practices with regard to some of our most significant arrangements are as follows:

 

    Vendor allowances for price markdowns are credited to cost of goods sold during the period in which the related markdown is taken.

 

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    Store imaging allowances are recognized as a reduction of cost of goods sold in the period earned in accordance with the vendor agreement. Store imaging includes signage, canopies, and other types of branding as defined in our gasoline contracts.

 

    Volume rebates by the vendor in the form of a reduction of the purchase price of the merchandise reduce cost of goods sold when the related merchandise is sold. Generally, volume rebates under a structured purchase program with allowances awarded based on the level of purchases are recognized when realization is probable and reasonably estimable, as a reduction in the cost of goods sold in the appropriate monthly period based on the actual level of purchases in the period relative to the total purchase commitment.

 

    Slotting and stocking allowances received from a vendor to ensure that its products are carried or to introduce a new product at our stores are recorded as a reduction of cost of goods sold over the period covered by the agreement.

 

Some of these typical vendor rebate, credit and promotional allowance arrangements require that we make assumptions and judgments regarding, for example, the likelihood of attaining specified levels of purchases or selling specified volumes of products, and the duration of carrying a specified product. We routinely review the relevant, significant factors and make adjustments where the facts and circumstances dictate.

 

The amounts recorded as a reduction of cost of goods sold were $124.9 million, $111.1 million and $107.0 million for fiscal 2006, 2005 and 2004, respectively.

 

Environmental Costs

 

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 the costs to remediate sites relating to the operation of underground storage tanks. Factors considered in the estimates of the reserve are the expected cost to remediate each contaminated site and the estimated length of time to remediate each site.

 

    Future remediation costs for amounts of deductibles under, or amounts 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 an appropriate rate. All other environmental costs are provided for on an undiscounted basis.

 

    Amounts that are probable of reimbursement under state trust fund programs or third party insurers, based on our experience, are recognized as receivables and are expected to be collected within a period of twelve to eighteen months after the reimbursement claim has been submitted. These receivables exclude all deductibles. The adequacy of the liability is evaluated quarterly and adjustments are made based on updated experience at existing sites, newly identified sites and changes in governmental policy.

 

    Annual fees for tank registration and environmental compliance testing are expensed as incurred.

 

    Expenditures for upgrading tank systems including corrosion protection, installation of leak detectors and overfill/spill devices are capitalized and depreciated over the remaining useful life of the asset or the respective lease term, whichever is less.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Income Taxes

 

All of our operations, including subsidiaries, are included in a consolidated Federal income tax return. Pursuant to SFAS No. 109, Accounting for Income Taxes, we recognize deferred income tax liabilities and assets for the expected future income tax consequences of temporary differences between financial statement carrying amounts and the related income tax basis.

 

Excise Taxes

 

We collect and remit various federal and state excise taxes on petroleum products. Gasoline sales and cost of goods sold included excise taxes of approximately $750.5 million, $622.5 million, and $550.6 million for fiscal 2006, 2005 and 2004, respectively.

 

Self-Insurance

 

The Company is self-insured for certain losses related to general liability, workers’ compensation and medical claims. The expected ultimate cost for claims incurred as of the balance sheet date is not discounted and is recognized as a liability. The expected ultimate cost of claims is estimated based upon analysis of historical data and actuarial estimates.

 

Advertising Costs

 

Advertising costs are expensed as incurred. Advertising expense was approximately $3.0 million, $2.7 million, and $2.0 million for fiscal 2006, 2005 and 2004, respectively.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

New Accounting Standards

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating SFAS No. 157 to determine the impact, if any, on our financial statements.

 

In September 2006, the SEC released Staff Accounting Bulletin 108 (“SAB 108”). SAB 108 provides interpretative guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 is not expected to have a material impact on our financial statements.

 

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In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the application of FASB Statement No. 109 by providing guidance on the recognition and measurement of an enterprise’s tax positions taken in a tax return. FIN 48 additionally clarifies how an enterprise should account for a tax position depending on whether the position is ‘more likely than not’ to pass a tax examination. The interpretation provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We will be required to adopt FIN 48 in fiscal 2008. We are currently evaluating FIN 48 to determine the impact, if any, on our financial statements.

 

In October 2005, the FASB issued Staff Position 13-1, Accounting for Rental Costs Incurred During a Construction Period. This pronouncement requires that rental costs associated with ground or building operating leases that are incurred during a construction period be recognized as rental expense. The implementation of this pronouncement did not impact our financial statements.

 

In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations—an Interpretation of FASB Statement No. 143 (“FIN 47”). FIN 47 provides guidance relating to the identification of and financial reporting for legal obligations to perform an asset retirement activity. The interpretation requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. The adoption of FIN 47 during the first quarter of fiscal 2006 did not materially impact our financial statements.

 

In December 2004, the FASB issued SFAS No. 123R. This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements and establishes fair value as the measurement objective in accounting for share-based payment arrangements. We adopted this standard as of the beginning of the first quarter of fiscal 2006 using the modified version of prospective application. See “Item 8. Consolidated Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 16—Stock Compensation Plans” for a discussion of the impact of the adoption of SFAS No. 123R.

 

In November 2004, the FASB issued SFAS No. 151, Inventory Costs—an Amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies that inventory costs that are “abnormal” are required to be charged to expense as incurred as opposed to being capitalized into inventory as a product cost. Examples of “abnormal” costs include costs of idle facilities, excess freight and handling costs and wasted materials (spoilage). The adoption of SFAS No. 151 during the first quarter of fiscal 2006 did not materially impact our financial statements.

 

NOTE 2—ACQUISITIONS

 

We generally focus on selectively acquiring convenience store chains within and contiguous to our existing market areas. Our ability to create synergies due to our relative size and geographic concentration contributes to a purchase price that is in excess of the fair value of assets acquired and liabilities assumed, which results in the recognition of goodwill.

 

Fiscal 2006 Acquisitions

 

During fiscal 2006, we purchased 113 stores and their related businesses in 13 separate transactions for approximately $126.8 million in aggregate purchase consideration. All of the fiscal 2006 acquisitions were funded from available cash.

 

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The table below provides information concerning the acquisitions we have completed in fiscal 2006:

 

Fiscal 2006

Date Acquired

 

Seller

 

Trade Name

 

Locations

  Number of
Stores

February 9, 2006

  Lee-Moore Oil Company   TruBuy and On The Run®   North Carolina   19

February 16, 2006

  Waring Oil Company, LLC   Interstate Food Stops   Mississippi and Louisiana   39

May 11, 2006

  Shop-A-Snak Food Mart, Inc.   Shop-A-Snak Food MartSM   Alabama   38

August 10, 2006

  Fuel Mate, LLC   Fuel Mate   North Carolina   6

Others (fewer than 5 stores)

  Various   Various   Georgia, Florida, Mississippi, North Carolina, and South Carolina   11
         

Total

        113
         

 

Following are the aggregate purchase price allocations for the 113 stores acquired during fiscal 2006. Certain allocations are preliminary estimates based on available information and certain assumptions management believes to be reasonable. These values are subject to change until certain third party valuations have been finalized and management completes its fair value assessments. We do not expect any adjustments to the fair values of the assets and liabilities disclosed in this preliminary opening balance sheet to be significant. The allocations were based on the fair values on the dates of the acquisitions (amounts in thousands):

 

Assets Acquired:

 

Receivables

  $ 556

Inventories

    9,667

Prepaid expenses and other current assets

    396

Other noncurrent assets

    1,347

Property and equipment, net

    91,771
     

Total assets

    103,737

Liabilities Assumed:

 

Accounts payable

    7,026

Other accrued liabilities

    888

Deferred income taxes

    6,223

Deferred vendor rebates

    8,255

Other noncurrent liabilities

    2,650
     

Total liabilities

    25,042
     

Net tangible assets acquired, net of cash

    78,695

Non-compete agreements

    605

Goodwill

    47,532
     

Total consideration paid, including direct acquisition costs, net of cash acquired

  $ 126,832
     

 

We expect that goodwill associated with these transactions totaling $39.8 million will be deductible for income tax purposes over 15 years and $7.7 million will not be deductible.

 

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Fiscal 2005 Acquisitions

 

During fiscal 2005, we purchased 96 stores and their related businesses in 8 separate transactions for approximately $103.1 million in aggregate purchase consideration. The fiscal 2005 acquisitions were funded from available cash and proceeds from the settlement of the forward equity sale agreement.

 

The table below provides information concerning the acquisitions we completed in fiscal 2005:

 

Fiscal 2005

Date Acquired

 

Seller

 

Trade Name

 

Locations

  Number of
Stores

April 21, 2005

  D&D Oil Co.   CowboysSM   Alabama, Georgia, Mississippi   53

August 18, 2005

  Angus I. Hines, Inc.   Sentry Food MartSM   Virginia   23

September 22, 2005

  Chatham Oil Company   SpeedmartSM Food Stores   Alabama   13

Others (fewer than 5 stores)

  Various   Various   Alabama, Mississippi, North Carolina, and South Carolina   7
         

Total

        96
         

 

Following are the aggregate purchase price allocations for the 96 stores acquired during fiscal 2005. These allocations were based on the fair values on the dates of the acquisitions (amounts in thousands):

 

Assets Acquired:

 

Inventories

  $ 8,515

Prepaid expenses and other current assets

    88

Property and equipment, net

    49,193

Deferred income taxes

    120
     

Total assets

    57,916

Liabilities Assumed:

 

Other accrued liabilities

    329

Deferred income taxes

    1,446

Deferred vendor rebates

    1,491

Other noncurrent liabilities

    9,033
     

Total liabilities

    12,299
     

Net tangible assets acquired, net of cash

    45,617

Trade names

    2,850

Non-compete agreements

    1,350

Goodwill

    53,251
     

Total consideration paid, including direct acquisition costs, net of cash acquired

  $ 103,068
     

 

We expect that goodwill associated with these transactions totaling $17.0 million will be deductible for income tax purposes over 15 years and $36.2 million will not be deducted.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The following unaudited pro forma information presents a summary of our consolidated results of operations and the acquired assets as if the transactions occurred at the beginning of the fiscal year for each of the periods presented (amounts in thousands, except per share data):

 

     2006    2005

Total revenues

   $ 6,148,623    $ 4,787,903

Net income

   $ 93,259    $ 64,898

Earnings per share:

     

Basic

   $ 4.13    $ 3.08

Diluted

   $ 4.06    $ 2.96

 

NOTE 3—INVENTORIES

 

At September 28, 2006 and September 29, 2005, inventories consisted of the following (amounts in thousands):

 

     2006     2005  

Inventories at FIFO cost:

    

Merchandise

   $ 92,378     $ 77,413  

Gasoline

     61,612       57,750  
                
     153,990       135,163  

Less adjustment to LIFO cost:

    

Merchandise

     (13,855 )     (9,815 )
                

Inventories at LIFO cost

   $ 140,135     $ 125,348  
                

 

The positive effect on cost of goods sold of LIFO inventory liquidations was $1.1 million, $184 thousand and $42 thousand for fiscal 2006, 2005 and 2004, respectively.

 

NOTE 4—PROPERTY AND EQUIPMENT

 

At September 28, 2006 and September 29, 2005, property and equipment consisted of the following (amounts in thousands):

 

     2006     2005  

Land

   $ 210,847     $ 174,601  

Buildings

     255,129       236,201  

Equipment, furniture and fixtures

     552,125       484,505  

Leasehold improvements

     122,217       93,776  

Construction in progress

     39,918       17,782  
                
     1,180,236       1,006,865  

Less—accumulated depreciation and amortization

     (434,515 )     (376,574 )
                

Property and equipment, net

   $ 745,721     $ 630,291  
                

 

Depreciation expense was $74.1 million, $63.4 million and $60.4 million for fiscal 2006, 2005 and 2004, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

NOTE 5—GOODWILL AND OTHER INTANGIBLE ASSETS

 

The following table reflects goodwill and other intangible asset balances as of September 30, 2004 and the activity thereafter through September 28, 2006 (amounts in thousands, except weighted average life data):

 

     Unamortized    Amortized  
     Goodwill     Trade names    Trade names     Customer
Agreements
    Non-compete
Agreements
 

Weighted average useful life in years

     N/A       N/A      3.0       7.4       27.0  

September 30, 2004 gross balance

   $ 341,652     $ 2,800    $ 45     $ —       $ 7,959  

Dispositions

     —         —        (47 )     —         (300 )

Acquisitions

     53,251       —        2,852       —         1,350  
                                       

September 29, 2005 gross balance

     394,903       2,800      2,850       —         9,009  

Purchase accounting adjustments (1)

     (1,754 )     —        —         —         —    

Acquisitions

     47,532       —        —         1,347       605  
                                       

September 28, 2006 gross balance

   $ 440,681     $ 2,800    $ 2,850     $ 1,347     $ 9,614  
                                       

September 30, 2004 accumulated amortization

        $ (37 )   $ —       $ (1,766 )

Dispositions

          47       —         300  

Amortization

          (412 )     —         (421 )
                             

September 29, 2005 accumulated amortization

          (402 )     —         (1,887 )

Amortization

          (950 )     (203 )     (673 )
                             

September 28, 2006 accumulated amortization

        $ (1,352 )   $ (203 )   $ (2,560 )
                             

 

(1) Amounts are purchase accounting adjustments related to the finalization of property valuations for prior period acquisitions.

 

The estimated future amortization expense for trade names, customer agreements and non-compete agreements is as follows (amounts in thousands):

 

Fiscal year:

  

2007

   $ 1,884

2008

     1,349

2009

     569

2010

     419

2011

     344

Thereafter

     5,131
      

Total estimated amortization expense

   $ 9,696
      

 

In accordance with our policy, we conducted our annual impairment testing of goodwill in the second quarter of 2006 and our annual testing of indefinite lived intangibles in the fourth quarter of 2006. Intangible assets that are subject to amortization are reviewed for impairment in accordance with the provisions of SFAS No. 144. No impairment charges related to goodwill and other intangible assets were recognized in fiscal 2006, 2005 or 2004.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

NOTE 6—LONG-TERM DEBT

 

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

 

     September 28,
2006
    September 29,
2005
 

Senior subordinated notes payable; due February 19, 2014; interest payable
semi-annually at 7.75%

   $ 250,000     $ 250,000  

Senior credit facility; interest payable monthly at LIBOR plus 1.75%; principal
due in quarterly installments through January 2, 2012

     203,975       —    

Senior subordinated convertible notes payable; due November 15, 2012; interest payable semi-annually at 3.0%

     150,000       —    

Senior credit facility; interest payable monthly at LIBOR plus 2.25%; principal due in quarterly installments through March 12, 2011

     —         305,000  

Other notes payable; various interest rates and maturity dates

     328       373  
                

Total long-term debt

     604,303       555,373  

Less—current maturities

     (2,088 )     (16,045 )
                

Long-term debt, net of current maturities

   $ 602,215     $ 539,328  
                

 

On February 19, 2004, we called for redemption of all the principal amount of our outstanding $200.0 million 10.25% senior subordinated notes due 2007 and completed the sale of $250.0 million of our 7.75% senior subordinated notes due 2014. The redemption of the 10.25% senior subordinated notes was completed on March 22, 2004. The 7.75% senior subordinated notes are guaranteed by our subsidiaries, except three subsidiaries with no indebtedness and de minimis assets (see Note 20—Guarantor Subsidiaries). We incurred approximately $6.6 million in costs associated with the sale of the new notes, which were deferred and will be amortized over the life of the new notes. We recorded a loss on the redemption of our 10.25% senior subordinated notes and refinancing of the senior credit facility of approximately $23.1 million (see Note 11—Interest Expense and Loss on Extinguishment of Debt).

 

On November 22, 2005, we completed a private offering of $150.0 million of senior subordinated convertible notes due 2012 (“convertible notes”) to “qualified institutional buyers” pursuant to Rule 144A under the Securities Act. Subsequently, during the second quarter of fiscal 2006, we registered the convertible notes for resale by the holders thereof. The convertible notes bear interest at an annual rate of 3.0%, payable semi-annually on May 15th and November 15th of each year, with the first interest payment paid on May 15, 2006. The convertible notes are convertible into our common stock at an initial conversion price of $50.09 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 120% of the conversion price per share for 20 of the last 30 trading days of any calendar quarter. The stock price at which the notes would be convertible is $60.11 and as of September 28, 2006, our closing stock price was $54.92. If, upon the occurrence of certain events, the holders of the convertible notes exercise the conversion provisions of the convertible notes, we may need to remit the principal balance of the convertible notes to them in cash (see below). As such, we would be required to classify the entire amount outstanding of the convertible notes as a current liability in the following quarter. This evaluation of the classification of amounts outstanding associated with the convertible notes will occur every calendar quarter. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the convertible note, or (ii) the conversion value, determined in the manner set forth in the indenture governing the convertible notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the convertible note on the conversion date, we will also deliver, at our election, cash or common stock or a

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the convertible notes is 3,817,775.

 

Concurrently with the sale of the convertible notes, we purchased a note hedge from an affiliate of Merrill Lynch (“the counterparty”), which is designed to mitigate potential dilution from the conversion of convertible notes. Under the note hedge, the counterparty is required to deliver to us the number of shares of our common stock that we are obligated to deliver to the holders of the convertible notes with respect to the conversion, calculated exclusive of shares deliverable by us by reason of any additional premium relating to the convertible notes or by reason of any election by us to unilaterally increase the conversion rate pursuant to the indenture governing the convertible notes. The note hedge expires at the close of trading on November 15, 2012, which is the maturity date of the convertible notes, although the counterparty will have ongoing obligations with respect to convertible notes properly converted on or prior to that date of which the counterparty has been timely notified.

 

In addition, we issued warrants to the counterparty that could require us to issue up to approximately 2,993,000 shares of our common stock on November 15, 2012 upon notice of exercise by the counterparty. The exercise price is $62.86 per share, which represented a 60.0% premium over the closing price of our shares of common stock on November 16, 2005. If the counterparty exercises the warrant, we will have the option to settle in cash or shares the excess of the price of our shares on that date over the initially established exercise price.

 

The note hedge and warrant are separate and legally distinct instruments that bind the Company and the counterparty and have no binding effect on the holders of the convertible notes.

 

Pursuant to EITF 90-19, Convertible Bonds with Issuer Option to Settle for Cash upon Conversion, (“EITF 90-19”), Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”), and EITF 01-6, The Meaning of Indexed to a Company’s Own Stock (“EITF 01-6”), the convertible notes are accounted for as convertible debt in the accompanying condensed consolidated balance sheet and the embedded conversion option in the convertible notes has not been accounted for as a separate derivative. Additionally, pursuant to EITF 00-19 and EITF 01-6, the note hedge and warrants are accounted for as equity transactions, and therefore, the payment associated with the issuance of the note hedge and the proceeds received from the issuance of the warrants were recorded as a charge and an increase, respectively, in additional paid-in capital in stockholders’ equity as separate equity transactions.

 

For income tax reporting purposes, we have elected to integrate the convertible notes and the note hedge transaction. Integration of the note hedge with the convertible notes creates an in-substance original issue debt discount for income tax reporting purposes and therefore the cost of the note hedge will be accounted for as interest expense over the term of the convertible notes for income tax reporting purposes. The associated income tax benefits will be recognized in the period that the deduction is taken for income tax reporting purposes as an increase in additional paid-in capital in stockholders’ equity.

 

Proceeds from the offering were used to pay down $100.0 million outstanding under our then existing senior credit facility, pay $43.7 million for the cost of the note hedge, pay approximately $4.7 million in issuance costs, including underwriting fees and for general corporate purposes, including acquisitions. Additionally, we received $25.2 million in proceeds from the issuance of the warrants.

 

On December 29, 2005, we entered into a new senior secured credit facility, which consisted of a $205.0 million term loan and a $150.0 million revolving credit facility, each maturing January 2, 2012. Proceeds from the new senior credit facility were used to repay all amounts outstanding under the previously existing

 

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credit facility and loan origination costs. In connection with the financing, we recorded a non-cash charge of approximately $1.8 million related to the write-off of deferred financing costs associated with the existing credit facility.

 

The new senior credit facility is secured by substantially all of our assets and is fully and unconditionally guaranteed by our existing and future, direct and indirect, domestic subsidiaries (other than D&D Oil Co., Inc., Shop-A-Snak Food Mart, Inc., and Marco Petroleum, Inc.). In addition, our borrowings under each of the term loan facility and the revolving credit facility bear interest, at our option, at the base rate (generally the applicable prime lending rate of Wachovia Bank, as announced from time to time) plus 0.50% or LIBOR plus 1.75%. If our consolidated leverage ratio (as defined in the credit agreement governing the senior credit facility) is less than 3.00 to 1.00, the applicable margins on the borrowings under the revolving credit facility will each be decreased by 0.25%. In addition, we are required to pay quarterly a fee of 0.50% on the average daily unused portion of the revolving credit facility, and if our consolidated leverage ratio is less than 3.00 to 1.00, this fee will be decreased by 0.125%. As of September 28, 2006, there were no outstanding borrowings under the revolving credit facility and we had approximately $45.8 million of standby letters of credit issued under the facility. As a result, we had approximately $104.2 million in available borrowing capacity (approximately $44.2 million of which was available for issuance of letters of credit). The LIBOR associated with our senior credit facility resets periodically, and was reset on September 28, 2006 to 5.33%.

 

The new credit facility contains customary affirmative and negative covenants, including the following: maximum total leverage ratio, maximum senior leverage ratio, and minimum fixed charge coverage ratio, as each is defined in the agreement. Additionally, the credit facility contains restrictive covenants regarding our ability to enter into mergers, acquisitions, and joint ventures, pay dividends, or change our line of business, among other things.

 

The remaining annual maturities of our long-term debt as of September 28, 2006 are as follows (amounts in thousands):

 

Fiscal year:

  

2007

   $ 2,088

2008

     2,091

2009

     2,094

2010

     2,098

2011

     2,102

Thereafter

     593,830
      

Total principal payments

   $ 604,303
      

 

The fair value of our indebtedness approximated $649.9 million at September 28, 2006.

 

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NOTE 7—LEASE FINANCE OBLIGATIONS

 

We lease certain facilities under capital leases and through sale-leaseback arrangements accounted for using the financing method. The net book values of assets under capital leases and lease finance obligations at September 28, 2006 and September 29, 2005 are summarized as follows (amounts in thousands):

 

     September 28,
2006
    September 29,
2005
 

Land

   $ 112,081     $ 88,053  

Buildings

     140,565       119,437  

Equipment

     5,530       5,403  

Accumulated depreciation

     (29,728 )     (23,611 )
                

Total

   $ 228,448     $ 189,282  
                

 

Following are the minimum lease payments that will have to be made in each of the years indicated based on non-cancelable leases in effect as of September 28, 2006 (amounts in thousands):

 

Fiscal year

   Lease
Finance
Obligations
    Operating
Leases

2007

   $ 27,743     $ 59,185

2008

     27,576       56,804

2009

     27,459       53,203

2010

     27,406       48,948

2011

     27,409       45,205

Later years

     278,721       231,070
              

Total minimum lease payments

   $ 416,314     $ 494,415
              

Amount representing interest

     172,239    
          

Present value of minimum lease payments

     244,075    

Less—current maturities

     (3,511 )  
          

Lease finance obligations, net of current maturities

   $ 240,564    
          

 

Rental expense for operating leases was approximately $65.4 million for fiscal 2006, $55.6 million for fiscal 2005, and $54.3 for fiscal 2004. We have facility leases with step rent provisions, capital improvement funding, and other forms of lease concessions. In accordance with generally accepted accounting principles, we record step rent provisions and lease concessions on a straight-line basis over the minimum lease term. Some of our leases require contingent rental payments; such amounts are not material for the fiscal years presented.

 

During fiscal 2006, 2005 and 2004, we entered into lease finance obligations with unrelated parties with net proceeds of $42.9 million, $14.1 million and $97.1 million, respectively. The assets sold in these transactions consisted of newly constructed or acquired convenience stores. Included in the fiscal 2006 lease finance obligations is $16.5 million associated with the acquisition of Shop-A-Snak Food Mart, Inc, included in the fiscal 2005 lease finance obligations is $12.1 million associated with the Sentry Food Mart acquisition, and included in the fiscal 2004 lease finance obligations is $94.5 million related to the Golden Gallon® acquisition. We retained ownership of all personal property at these locations.

 

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NOTE 8—DERIVATIVE FINANCIAL INSTRUMENTS

 

We enter into interest rate swap agreements to modify the interest rate characteristics of our outstanding long-term debt and have designated each qualifying instrument as a cash flow hedge. We formally document our hedge relationships, including identifying the hedge instruments and hedged items, as well as our risk management objectives and strategies for entering into the hedge transaction. At hedge inception, and at least quarterly thereafter, we assess whether derivatives used to hedge transactions are highly effective in offsetting changes in the cash flow of the hedged item. We measure effectiveness by the ability of the interest rate swaps to offset cash flows associated with changes in the variable LIBOR rate associated with our term loan facilities using the hypothetical derivative method. To the extent the instruments are considered to be effective, changes in fair value are recorded as a component of other comprehensive income (loss). To the extent there is any hedge ineffectiveness; 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 subsequent changes in fair value of the hedge instrument are recognized in earnings. Interest (expense) income was ($7) thousand, $423 thousand, and $1.3 million for fiscal 2006, 2005 and 2004, respectively, for the mark-to-market adjustment of those instruments that do not qualify for hedge accounting and adjustments for hedge ineffectiveness.

 

The fair values of our interest rate swaps 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 September 28, 2006, prepaid and other current assets and other noncurrent assets included derivative assets of approximately $107 thousand and approximately $1.8 million, respectively. Cash flow hedges at September 28, 2006 represent interest rate swaps with a notional amount of $130.0 million, a weighted-average pay rate of 4.24%, and have various settlement dates, the latest of which is April 2009.

 

NOTE 9—COMPREHENSIVE INCOME

 

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

 

         2006            2005    

Unrealized gains on qualifying cash flow hedges (net of related income taxes of $(762) and $(909), respectively)

     1,194      1,426
             

Accumulated other comprehensive income

   $ 1,194    $ 1,426
             

 

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

 

         2006             2005            2004    

Net unrealized gains (loss) on qualifying cash flow hedges (net of deferred income taxes of $(147), $781 and $561, respectively)

     (232 )     1,220      896
                     

Other comprehensive income (loss)

   $ (232 )   $ 1,220    $ 896
                     

 

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

 

         2006             2005            2004      

Unrealized (loss) gains on qualifying cash flow hedges

   $ (1,550 )   $ 1,142    $ 2,169  

Less: Reclassification adjustment recorded as interest income (expense)

     1,318       78      (1,273 )
                       

Net unrealized (loss) gains on qualifying cash flow hedges

   $ (232 )   $ 1,220    $ 896  
                       

 

NOTE 10—ASSET RETIREMENT OBLIGATIONS

 

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

 

The estimated liability is based on our historical experience in removing these tanks, estimated tank useful lives, external estimates as to the cost to remove the tanks in the future and federal and state regulatory requirements. The liability is a discounted liability using a credit-adjusted risk-free rate ranging from approximately 6.4% to 9.3%. Revisions to the liability could occur due to changes in tank removal costs, tank useful lives or if federal and/or state regulators enact new guidance on the removal of such tanks. This liability is included in other noncurrent liabilities.

 

We reviewed our estimate of this liability during the quarter ended September 30, 2004 due to changes in the estimate of future underground storage tank removal costs. The change in estimate resulted in an increase of $3.8 million to the carrying amount of the liability and the carrying amount of the related long-lived assets. Since this revision is a change in estimates, we will depreciate the asset and amortize the liability over the remaining useful life of the related underground storage tanks. There were no significant changes to the historical estimated removal costs during fiscal 2006 or 2005.

 

A reconciliation of the changes in our liability is as follows (amounts in thousands):

 

         2006             2005      

Beginning balance

   $ 16,822     $ 14,818  

Liabilities incurred

     1,470       199  

Liabilities assumed—acquisitions

     1,420       1,299  

Liabilities settled

     (1,507 )     (724 )

Accretion expense

     1,642       1,230  
                

Ending balance

   $ 19,847     $ 16,822  
                

 

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NOTE 11—INTEREST EXPENSE AND LOSS ON EXTINGUISHMENT OF DEBT

 

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

 

     2006     2005     2004  

Interest on long-term debt, including amortization of deferred financing costs

   $ 39,554     $ 36,246     $ 43,180  

Interest on lease finance obligations

     22,262       20,330       19,259  

Interest rate swap settlements

     (2,374 )     (128 )     3,427  

Fair market value change in non-qualifying derivatives

     7       (423 )     (1,312 )

Miscellaneous

     153       105       (297 )
                        

Subtotal: Interest expense

   $ 59,602     $ 56,130     $ 64,257  

Loss on extinguishment of debt

     1,832       —         23,087  
                        

Total interest expense and loss on extinguishment of debt

   $ 61,434     $ 56,130     $ 87,344  
                        

 

The loss on extinguishment of debt in fiscal year 2006 represents a write-off of approximately $1.8 million of unamortized loan origination costs associated with the refinancing of our senior credit facility in December 2005.

 

The loss on extinguishment of debt in fiscal year 2004 relates to the redemption of our $200 million 10.25% senior subordinated notes and the refinancing of the senior credit facility. The loss includes the write-off of the unamortized portion of deferred financing costs of $11.8 million, the call premium on the senior subordinated notes of $6.8 million, the call premium on the second lien term loan of $1.0 million, and the write-off of the unamortized original issue discount on the senior credit facility of $3.5 million.

 

NOTE 12—INCOME TAXES

 

The components of income tax expense are summarized below (amounts in thousands):

 

     2006     2005    2004

Current:

       

Federal

   $ 49,712     $ 27,733    $ 272

State

     8,682       5,372      4
                     

Current income tax expense

   $ 58,394     $ 33,105    $ 276
                     

Deferred:

       

Federal

   $ (1,288 )   $ 3,894    $ 7,882

State

     48       397      1,043
                     

Deferred income tax (benefit) expense

     (1,240 )     4,291      8,925
                     

Net income tax expense

   $ 57,154     $ 37,396    $ 9,201
                     

 

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As of September 28, 2006 and September 29, 2005, deferred income tax (liabilities) and assets are comprised of the following (amounts in thousands):

 

     2006     2005  

Property and equipment

   $ (68,193 )   $ (68,023 )

Inventories

     (3,580 )     (3,677 )

Goodwill and intangibles

     (35,315 )     (28,172 )

Environmental

     (560 )     (568 )

Prepaid expenses

     (2,173 )     (1,431 )

Other

     (872 )     (1,022 )
                

Gross deferred income tax liabilities

     (110,693 )     (102,893 )
                

Accrued insurance

     10,972       8,020  

Asset retirement obligations

     5,407       4,404  

Deferred vendor rebates

     11,099       12,430  

Reserve for closed stores

     3,697       4,243  

Impairment of long-lived assets

     741       771  

Lease finance obligations

     9,769       8,982  

Stock-based compensation expense—Nonqualified options

     613       —    

Other

     3,332       3,789  
                

Gross deferred income tax assets

     45,630       42,639  
                

Net operating loss carryforwards

     840       951  

State credits

     136       292  
                

Net deferred income tax liability

   $ (64,087 )   $ (59,011 )
                

 

As of September 28, 2006 and September 29, 2005, net current deferred income tax assets totaled $8.3 million and $5.8 million, respectively, and net noncurrent deferred income tax liabilities totaled $72.4 million and $64.8 million, respectively.

 

The change in net deferred income tax liability also included an increase to goodwill in the amount of $6.2 million which related to the current year stock acquisition.

 

Reconciliations of income taxes at the federal statutory rate (35% in fiscal 2006 and fiscal 2005, and 34% in fiscal 2004) to actual income tax expense for each of the periods presented are as follows (amounts in thousands):

 

     2006    2005    2004  

Tax expense at Federal statutory rate

   $ 51,224    $ 33,322    $ 8,475  

State tax expense, net of federal tax expense

     5,674      3,750      983  

Permanent differences:

        

Other permanent items, net

     256      324      (257 )
                      

Net income tax expense

   $ 57,154    $ 37,396    $ 9,201  
                      

 

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As of September 28, 2006, we had net operating loss carryforwards and state credits that can be used to offset future state income taxes. The benefit of these carryforwards is recognized as a deferred income tax asset. Loss carryforwards as of September 28, 2006 have the following expiration dates (amounts in thousands):

 

Year of Expiration    State

2016

   $ 3,010

2017

     2,788

2018

     3,515

2019

     2,470

2020

     2,751

2021

     678

2022

     321
      

Total loss carryforward

   $ 15,533
      

 

NOTE 13—COMMITMENTS AND CONTINGENCIES

 

As of September 28, 2006, we were contingently liable for outstanding letters of credit in the amount of $45.8 million related primarily to several areas in which we are self-insured. The letters of credit are not to be drawn against unless we default on the timely payment of related liabilities.

 

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

 

On July 28, 2005, we announced that we would restate earnings for the period from fiscal 2000 to fiscal 2005 arising from sale-leaseback accounting for certain transactions. Beginning in September 2005, we received from the SEC requests that we voluntarily provide certain information to the SEC Staff in connection with our sale-leaseback accounting, our decision to restate our financial statements with respect to sale-leaseback accounting and other lease accounting matters. In November 2006, the SEC informed us that in connection with the inquiry it had issued a formal order of private investigation. We are cooperating with the SEC in this ongoing investigation.

 

Unamortized Liabilities Associated with Vendor Payments

 

In accordance with the terms of each service or supply agreement and in accordance with accounting principles generally accepted in the United States of America, service and supply allowances are amortized over the life of each agreement in accordance with the specific terms. At September 28, 2006, other accrued liabilities and deferred vendor rebates include the unamortized liabilities associated with these payments of $5.0 million and $23.9 million, respectively. At September 29, 2005, other accrued liabilities and deferred vendor rebates include the unamortized liabilities associated with these payments of $5.4 million and $27.4 million, respectively.

 

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McLane Company, Inc.—we purchase over 50% of our general merchandise from a single wholesaler, McLane. Our arrangement with McLane is governed by a five-year distribution service agreement, which was amended in May 2006 and expires on April 2010. We receive annual service allowances based on the number of stores operating on each contract anniversary date. If we were to default under the contract or terminate the distribution service agreement prior to April 2010, we must reimburse McLane the unearned, unamortized portion of the service allowance payments received to date. In accordance with the terms of the distribution service agreement and in accordance with accounting principles generally accepted in the United States, the original service allowances received and all future service allowances are amortized and recognized as a reduction to cost of goods sold on a straight-line method over the life of the agreement.

 

Major Oil Companies—we have entered into product brand imaging agreements with numerous oil companies to buy gasoline at market prices. These contracts range in length from three to ten years. In connection with these agreements, we may receive upfront vendor allowances, volume incentive payments and other vendor assistance payments. If we were to default under the terms of any contract or terminate the supply agreement prior to the end of the initial term, we must reimburse the respective oil company for the unearned, unamortized portion of the payments received to date. In accordance with accounting principles generally accepted in the United States of America, these payments are amortized and recognized as a reduction to cost of goods sold using the specific amortization periods in accordance with the terms of each agreement, either using the straight-line method or based on gasoline volume purchased.

 

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 U.S. Environmental Protection Agency (“EPA”) to establish a comprehensive regulatory program for the detection, prevention and cleanup of leaking underground storage tanks (e.g. overfills, spills and underground storage tank releases).

 

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 September 28, 2006, we maintain letters of credit in the aggregate amount of approximately $1.3 million in favor of state environmental agencies in North Carolina, South Carolina, Virginia, Georgia, Indiana, Tennessee, Kentucky and Louisiana.

 

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

 

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;

 

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    closing underground storage tank systems;

 

    keeping appropriate records; and

 

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

 

These regulations permit states to develop, administer and enforce their own regulatory programs, incorporating requirements that are at least as stringent as the federal standards. In 1998, Florida developed their own regulatory program, which incorporated requirements more stringent than the 1988 EPA regulations. We

believe our facilities in Florida meet or exceed those regulations developed by the State of Florida in 1998. We believe all company-owned underground storage tank systems are in material compliance with these 1988 EPA regulations and all applicable state environmental regulations.

 

All states in which we operate or have operated underground storage tank systems have established trust funds for the sharing, recovering and reimbursing of certain cleanup costs and liabilities incurred as a result of releases from underground storage tank systems. These trust funds, which essentially provide insurance coverage for the cleanup of environmental damages caused by the operation of underground storage tank systems, are funded by an underground storage tank registration fee and a tax on the wholesale purchase of motor fuels within each state. We have paid underground storage tank registration fees and gasoline taxes to each state where we operate to participate in these trust fund programs. We have filed claims and received reimbursements in North Carolina, South Carolina, Kentucky, Indiana, Georgia, Florida, Tennessee, Mississippi and Virginia. The coverage afforded by each state fund varies but generally provides up to $1.5 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 zero dollars to $150 thousand per occurrence depending on the upgrade status of our underground storage tank system, the date the release is discovered and/or reported and the type of cost for which reimbursement is sought. The Florida trust fund will not cover releases first reported after December 31, 1998. We obtained private insurance coverage for remediation and third party claims arising out of releases that occurred in Florida and were reported after December 31, 1998. We believe that this coverage exceeds federal and Florida financial responsibility regulations. In Georgia, we opted not to participate in the state trust fund effective December 30, 1999, except for certain sites, including sites where our lease requires us to participate in the Georgia trust fund. For all such sites where we have opted not to participate in the Georgia trust fund, we have obtained private coverage for remediation and third party claims. We believe that this coverage exceeds federal and Georgia financial responsibility regulations.

 

In addition to immaterial amounts to be spent by us, a substantial amount will be expended for remediation on behalf of us by state trust funds established in our operating areas or other responsible third parties (including

 

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insurers). To the extent such third parties do not pay for remediation as anticipated by us, we will be obligated to make such payments, which could materially adversely affect our financial condition and results of operations. Reimbursement from state trust funds will be dependent upon the maintenance and continued solvency of the various funds.

 

Environmental reserves of $18.4 million and $16.3 million as of September 28, 2006 and September 29, 2005, respectively, represent our estimates for future expenditures for remediation, tank removal and litigation associated with 269 known contaminated sites in fiscal 2006 and fiscal 2005, as a result of releases (e.g., overfills, spills and underground storage tank releases) and are based on current regulations, historical results and certain other factors. We estimate that approximately $17.1 million of our environmental obligations will be funded by state trust funds and third party insurance; as a result, we may spend up to $1.2 million for remediation, tank removal and litigation. Also, as of September 28, 2006 and September 29, 2005, there were an additional 534 and 510 sites, respectively, that are known to be contaminated sites that are being remediated by third parties, and therefore, the costs to remediate such sites are not included in our environmental reserve. Remediation costs for known sites are expected to be incurred over the next one to ten years. Environmental reserves have been established with remediation costs based on internal and external estimates for each site. Future remediation for which the timing of payments can be reasonably estimated is discounted using an appropriate rate to determine the reserve. The undiscounted amount of future estimated payments for which we do not expect to be reimbursed for each of the five fiscal years and thereafter at September 28, 2006 and other cost amounts covered by responsible third parties are as follows (amounts in thousands):

 

Fiscal Year

     Expected Payments  

2007

     $ 490  

2008

       490  

2009

       415  

2010

       181  

2011

       77  

Thereafter

       101  
          

Total undiscounted amounts not covered by a third party

       1,754  

Other current cost amounts

       20,521  

Amount representing interest

       (3,917 )
          

Environmental reserves

     $ 18,358  
          

 

We anticipate that we will be reimbursed for expenditures from state trust funds and private insurance. As of September 28, 2006, anticipated reimbursements of $17.3 million are recorded in other noncurrent assets and $2.5 million are recorded as current receivables related to all sites. In Florida, remediation of such contamination reported before January 1, 1999 will be performed by the state (or state approved independent contractors) and substantially all of the remediation costs, less any applicable deductibles, will be paid by the state trust fund. We will perform remediation in other states through independent contractor firms engaged by us. For certain sites, the trust fund does not cover a deductible or has co-pay which may be less than the cost of such remediation. Although we are not aware of releases or contamination at other locations where we currently operate or have operated stores, any such releases or contamination could require substantial remediation expenditures, some or all of which may not be eligible for reimbursement from state trust funds or private insurance.

 

Several of the locations identified as contaminated are being remediated by third parties who have indemnified us as to responsibility for clean up 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.

 

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Gasoline Contractual Contingencies

 

On July 18, 2006, we entered into the Third Amendment (the “Third Amendment”) to the Branded Jobber Contract dated July 18, 2006 with BP Products North America Inc. (“BP”). The Third Amendment extends the term of the Branded Jobber Contract between the Company and BP dated as of February 1, 2003 (the “Original Contract”) until September 30, 2012. In addition, the Third Amendment modified the following terms of the Original Contract:

 

    Minimum Volume—Our obligation to purchase a minimum volume of BP branded gasoline each year was amended and is now subject to increase at a rate of approximately 7% per year during the remaining
 

term of the agreement and is measured over a two-year period. We exceeded the requirement for the period ending September 30, 2006. The minimum requirement for the two-year period ending September 30, 2008 is approximately 1.074 billion gallons of BP branded product.

 

    Minimum Volume Guarantee—Subject to certain adjustments, in any two-year period in which we fail to meet our minimum volume purchase obligation, we have agreed to pay BP two cents per gallon times the difference between the actual volume of BP branded product purchased and the minimum volume requirement. Based on current forecasts, we do not anticipate paying any penalties under this contract.

 

NOTE 14—BENEFIT PLANS

 

We sponsor a 401(k) Employee Retirement Savings Plan for eligible employees. Employees must be at least twenty-one years of age and have one year of service with at least 1,000 hours worked to be eligible to participate in the plan. Employees may contribute up to 100% of their annual compensation, and contributions are matched by us on the basis of 50% of the first 5% contributed. Matching contribution expense was $891 thousand, $837 thousand and $709 thousand for fiscal 2006, 2005 and 2004, respectively.

 

NOTE 15—COMMON STOCK

 

During December 2003, Freeman Spogli & Co. (“Freeman Spogli”) exercised warrants to purchase 2,346,000 shares of common stock at an exercise price of $7.45 per share. The exercise was cashless whereby shares of common stock received were reduced by the number of shares having an aggregate fair market value equal to the exercise price, or approximately $17.5 million. The aggregate fair market value was based on the average closing price of our common stock on each of the ten days prior to the date of exercise, or $23.68 per share. Consequently, upon exercise, Freeman Spogli received 1,607,855 shares of common stock. As there were no cash proceeds from the warrant exercise, we recorded the par value of the common stock issued with a corresponding reduction in additional paid-in capital.

 

During January 2004, we completed a secondary stock offering in which Freeman Spogli and other selling stockholders sold 5,750,000 shares of our common stock at a public offering price of $20.00 per share, reducing Freeman Spogli’s beneficial ownership at the time to approximately 38.2% of our outstanding common stock.

 

During October 2004, we completed a secondary stock offering in which Freeman Spogli sold 3,850,000 shares of our common stock at a public offering price of $22.96 per share. In connection with this secondary stock offering, we sold 1,500,000 shares of our common stock under a forward equity sale agreement with Merrill Lynch International, an affiliate of Merrill Lynch & Co., as forward purchaser, under which, at our request, Merrill Lynch International borrowed 1,500,000 shares of our common stock from stock lenders and

 

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sold such borrowed shares at a price of $21.8694 per share to certain underwriters pursuant to a purchase agreement. In accordance with EITF 00-19, we accounted for the forward equity sale agreement as equity with an initial fair value of zero. We applied the treasury stock method of accounting to the shares covered by the forward equity sale agreement in determining diluted shares outstanding.

 

In March 2005, Freeman Spogli sold the remaining 2,150,000 shares of our common stock it had registered under an existing shelf registration statement bringing their ownership at the time to approximately 1,700,000 shares, or 8.4% of our outstanding shares. Subsequent to this offering, Freeman Spogli distributed its remaining shares to its limited partners, and as of September 29, 2005, had no remaining ownership in the Company.

 

On April 20, 2005, we partially settled the forward equity sale agreement by issuing and delivering 1,078,697 shares of our common stock, par value $.01 per share. In connection with the partial settlement, we received $23.7 million in proceeds. On August 17, 2005, we settled the remaining shares subject to the forward equity sale agreement by issuing and delivering 421,303 shares of our common stock. In connection with the final settlement, we received $9.3 million in proceeds.

 

In November 2005 we issued warrants to purchase up to 2,993,000 shares of our common stock to an affiliate of Merrill Lynch in connection with the note hedge and warrant transactions entered into at the time of our offering of convertible notes. See Note 6—Long Term Debt for details.

 

NOTE 16—STOCK COMPENSATION PLANS

 

On January 1, 1998, we adopted an incentive and non-qualified stock option plan. Pursuant to the provisions of the plan, options may be granted to officers, key employees, consultants or any of our subsidiaries and certain members of the board of directors to purchase up to 1,275,000 shares of common stock. All options granted vest over a three-year period, with one-third of each grant vesting on the anniversary of the initial grant and have contractual lives of ten years.

 

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

 

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

 

Prior to September 30, 2005, we accounted for our equity-based compensation plans under the recognition and measurement provision of APB Opinion No. 25, and related interpretations, as permitted by SFAS No. 123. We did not recognize stock-based compensation cost in our Consolidated Statements of Operations prior to

 

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September 30, 2005, as all options granted under our equity-based compensation plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective September 30, 2005, we adopted the fair value recognition provisions of SFAS No. 123R, using the modified-prospective-transition method. Under this transition method, compensation cost recognized includes compensation costs for all share-based payments granted prior to, but not yet vested as of September 29, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and compensation cost for all share-based payments granted subsequent to September 29, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Results for prior periods have not been restated. Our stock option plans, which are shareholder approved, permit the grant of share options for up to 5.1 million shares of common stock. We recognize compensation expense on a straight-line basis over the requisite service period. A summary of the status of stock options under our plans and changes during fiscal 2004, 2005 and 2006 is presented in the table below:

 

    Shares     Weighted-
average exercise
price
  Weighted-
average contractual
term (years)
  Aggregate
intrinsic value
(in thousands)

Options outstanding, September 28, 2003

  1,305,892     $ 6.85    

Granted

  244,000       15.33    

Exercised

  (556,305 )     8.81    

Forfeited

  (56,834 )     6.74    
               

Options outstanding, September 30, 2004

  936,753     $ 7.90    

Granted

  395,000       27.11    

Exercised

  (544,682 )     7.12    

Forfeited

  —         —      
               

Options outstanding, September 29, 2005

  787,071     $ 18.08    

Granted

  411,500       40.40    

Exercised

  (370,801 )     11.82    

Forfeited

  (39,166 )     27.40    
               

Options outstanding, September 28, 2006

  788,604     $ 32.21   5.6   $ 17,900

Options exercisable, September 28, 2006

  70,771     $ 19.90   4.5   $ 2,500

 

The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model, which uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of our common stock price. We use historical data to estimate option exercises and employee terminations used in the model. The expected term of options granted is based on historical experience and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. As of September 28, 2006, remaining compensation expense to be recognized on these options through September 2009 is approximately $4.7 million.

 

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The fair value of each option grant was determined using the Black-Scholes-Merton option pricing model with weighted-average assumptions used for options issued in fiscal 2006, 2005 and 2004 as follows:

 

     Year Ended  
     September 28,
2006
    September 29,
2005
    September 30,
2004
 

Weighted-average grant fair value

   $ 11.74     $ 9.50     $ 6.48  

Weighted-average expected lives (years)

     2.00       2.00       2.00  

Risk-free interest rate

     4.5 %     3.0 %     1.8 %

Expected volatility

     47.0 %     60.0 %     77.0 %

Dividend yield

     0.0 %     0.0 %     0.0 %

 

The aggregate grant-date fair value of options granted during fiscal 2006, 2005 and 2004 was approximately $4.8 million, $3.8 million, and $1.6 million, respectively. The total intrinsic value of options exercised during fiscal 2006, 2005 and 2004 was approximately $15.9 million, $14.1 million, and $6.4 million, respectively. Cash received from options exercised totaled approximately $4.4 million, $3.9 million, and $4.9 million, during fiscal 2006, 2005 and 2004 respectively. The total fair value of options vested during fiscal 2006, 2005 and 2004 was approximately $1.8 million, $700 thousand and $500 thousand, respectively.

 

As a result of adopting SFAS No. 123R, we recorded $2.8 million in stock compensation expense and a related tax benefit of $1.1 million in fiscal 2006.

 

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to options granted under our stock option plans for fiscal 2005 and 2004. For purposes of this pro forma disclosure, the value of the options is estimated using the Black-Scholes-Merton option pricing model and amortized to expense over the options’ vesting periods.

 

     September 29,
2005
    September 30,
2004
 

Net income (amounts in thousands, except per share data):

    

As reported

   $ 57,810     $ 15,726  

Deduct—Total stock-based compensation expense determined under fair value method for all awards, net of income tax

     (992 )     (486 )
                

Pro forma

   $ 56,818     $ 15,240  
                

Basic earnings per share:

    

As reported

   $ 2.74     $ 0.80  

Pro forma

   $ 2.69     $ 0.78  

Diluted earnings per share:

    

As reported

   $ 2.64     $ 0.76  

Pro forma

   $ 2.59     $ 0.74  

 

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The following table summarizes information about stock options outstanding at September 28, 2006:

 

Date Granted

   Exercise Prices   

Number Outstanding

September 28, 2006

   Remaining
Contractual Life
  

Number of

Options

Exercisable

8/31/98

   $  11.27    57    2 years    57

11/26/01

       5.12    1,334    2 years    1,334

3/25/03

       4.50    5,000    3 years    5,000

7/23/03

       8.09    3,334    4 years    3,334

10/22/03

   14.80    87,397    4 years    21,397

3/31/04

   19.95    10,000    5 years    6,667

11/19/04

   26.77    255,315    5 years    27,982

12/15/04

   27.89    6,667    5 years    —  

3/29/05

   30.48    15,000    6 years    5,000

10/26/05

   35.76    309,500    6 years    —  

01/24/06

   58.31    10,000    6 years    —  

03/01/06

   58.79    10,000    6 years    —  

03/30/06

   62.03    30,000    7 years    —  

07/05/06

   56.61    20,000    7 years    —  

08/02/06

   45.74    25,000    7 years    —  
               
                 Total    788,604       70,771
               

 

As of September 28, 2006 we have approximately 2.8 million shares available for stock option grants.

 

NOTE 17—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):

 

     2006    2005    2004

Net income

   $ 89,198    $ 57,810    $ 15,726
                    

Earnings per share—basic:

        

Weighted-average shares outstanding

     22,559      21,100      19,606
                    

Earnings per share—basic

   $ 3.95    $ 2.74    $ 0.80
                    

Earnings per share—diluted:

        

Weighted-average shares outstanding

     22,559      21,100      19,606

Dilutive impact of options and convertible notes outstanding

     428      830      1,063
                    

Weighted-average shares and potential dilutive shares outstanding

     22,987      21,930      20,669
                    

Earnings per share—diluted

   $ 3.88    $ 2.64    $ 0.76
                    

 

Options to purchase shares of common stock that were not included in the computation of diluted earnings per share, because their inclusion would have been antidilutive, were 95 thousand for fiscal 2006. There were no options to purchase shares of common stock that were not included in the computation of diluted earnings per share for fiscal 2004 and fiscal 2005.

 

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NOTE 18—SUBSEQUENT EVENTS

 

On November 22, 2006, we signed a definitive agreement to acquire 16 stores in South Carolina from Anglers Mini Mart, Inc. which have been operating under the Anglers banner. The acquisition, which is subject to regulatory and other customary closing conditions, is expected to close in the second quarter of fiscal 2007. We plan to finance the transaction with cash on hand.

 

On December 11, 2006, we signed a definitive agreement to acquire 24 stores in Alabama, Florida and Georgia from Southwest Georgia Oil Company, Inc. which have been operating under the Sun Stop banner. The acquisition, which is subject to regulatory and other customary closing conditions, is expected to close in the second quarter of fiscal 2007. We plan to finance the transaction with cash on hand.

 

Separately, the Company recently signed definitive agreements to acquire seventeen additional stores in 8 separate transactions.

 

NOTE 19—GUARANTOR SUBSIDIARIES

 

We have two wholly owned subsidiaries, R. & H. Maxxon, Inc. and Kangaroo, Inc. (the “Guarantor Subsidiaries”) that are guarantors of our senior credit facility, our subordinated notes, and our convertible notes. The guarantees are joint and several in addition to full and unconditional. The Guarantor Subsidiaries do not conduct any operations and do not have significant assets. The Non-Guarantor Subsidiaries are D&D Oil Co., Inc., Shop-A-Snak Food Mart, Inc., and Marco Petroleum, Inc. Combined financial information is as follows:

 

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THE PANTRY, INC. AND SUBSIDIARIES

 

SUPPLEMENTAL COMBINING BALANCE SHEETS

 

September 28, 2006

(Dollars in thousands)

 

    The Pantry
(Issuer)
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
  Eliminations     Total

ASSETS

         

Current assets:

         

Cash and cash equivalents

  $ 120,394     $ —       $ —     $ —       $ 120,394

Receivables, net

    68,064       —         —       —         68,064

Inventories

    140,135       —         —       —         140,135

Prepaid expenses and other current assets

    18,781       2       —       —         18,783

Deferred income taxes

    8,348       —         —       —         8,348
                                   

Total current assets

    355,722       2       —       —         355,724
                                   

Investment in subsidiaries

    71,773       —         —       (71,773 )     —  
                                   

Property and equipment, net

    745,721       —         —       —         745,721
                                   

Other assets:

         

Goodwill

    440,681       —         —       —         440,681

Intercompany note receivable

    (23,477 )     43,872       31,050     (51,445 )     —  

Other noncurrent assets

    45,724       57       —       —         45,781
                                   

Total other assets

    462,928       43,929       31,050     (51,445 )     486,462
                                   

Total assets

  $ 1,636,144     $ 43,931     $ 31,050   $ (123,218 )   $ 1,587,907
                                   

LIABILITIES AND SHAREHOLDERS’ EQUITY

         

Current liabilities:

         

Current maturities of long-term debt

  $ 2,088     $ —       $ —     $ —       $ 2,088

Current maturities of lease finance obligations

    3,511       —         —       —         3,511

Accounts payable

    139,939       —         —       —         139,939

Accrued compensation and related taxes

    19,676       —         —       —         19,676

Other accrued taxes

    27,440       —         —       —         27,440

Self-insurance reserves

    29,898       —         —       —         29,898

Other accrued liabilities

    35,043       —         —       (65 )     34,978
                                   

Total current liabilities

    257,595       —         —       (65 )     257,530
                                   

Other liabilities:

         

Long-term debt

    602,215       —         —       —         602,215

Lease finance obligations

    240,564       —         —       —         240,564

Deferred income taxes

    72,435       —         —       —         72,435

Deferred vendor rebates

    23,876       —         —       —         23,876

Intercompany note payable

    48,174       3,208       —       (51,382 )     —  

Other noncurrent liabilities

    54,278       2       —       —         54,280
                                   

Total other liabilities

    1,041,542       3,210       —       (51,382 )     993,370
                                   

SHAREHOLDERS’ EQUITY:

         

Common stock

    227       523       4     (527 )     227

Additional paid-in-capital

    172,940       40,551       26,702     (67,253 )     172,940

Accumulated other comprehensive income, net

    1,194       —         —       —         1,194

Retained earnings (deficit)

    162,646       (353 )     4,344     (3,991 )     162,646
                                   

Total shareholders’ equity

    337,007       40,721       31,050     (71,771 )     337,007
                                   

Total liabilities and shareholders’ equity

  $ 1,636,144     $ 43,931     $ 31,050   $ (123,218 )   $ 1,587,907
                                   

 

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THE PANTRY, INC. AND SUBSIDIARIES

 

SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS

 

Year Ended September 28, 2006

(Dollars in thousands)

 

    The Pantry
(Issuer)
    Guarantor
Subsidiaries
  Non-Guarantor
Subsidiaries
  Eliminations   Total  

Revenues:

         

Merchandise

  $ 1,385,659     $ —     $ —     $ —     $ 1,385,659  

Gasoline

    4,576,043       —       —       —       4,576,043  
                                 

Total revenues

    5,961,702       —       —       —       5,961,702  
                                 

Costs and operating expenses:

         

Merchandise cost of goods sold

    867,717       —       —       —       867,717  

Gasoline cost of good sold

    4,294,839       —       —       —       4,294,839  

Operating, general and administrative

    521,076       —       —       —       521,076  

Depreciation and amortization

    76,025       —       —       —       76,025  
                                 

Total costs and operating expenses

    5,759,657       —       —       —       5,759,657  
                                 

Income from operations

    202,045       —       —       —       202,045  
                                 

Other income (expense):

      —       —       —    

Loss on extinguishment of debt

    (1,832 )     —       —       —       (1,832 )

Interest expense

    (59,602 )     —       —       —       (59,602 )

Interest income

    4,941       —       —       —       4,941  

Miscellaneous

    800       —       —       —       800  
                                 

Total other expense

    (55,693 )     —       —       —       (55,693 )
                                 

Income before income taxes

    146,352       —       —       —       146,352  

Income tax expense

    (57,154 )     —       —       —       (57,154 )
                                 

Net income

  $ 89,198     $ —     $ —     $ —     $ 89,198  
                                 

 

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THE PANTRY, INC.

 

SUPPLEMENTAL COMBINING STATEMENTS OF CASH FLOWS

 

Year Ended September 28, 2006

(Dollars in thousands)

 

    The Pantry
(Issuer)
    Guarantor
Subsidiaries
  Non-Guarantor
Subsidiaries
    Eliminations   Total  

CASH FLOWS FROM OPERATING ACTIVITIES:

         

Net income

  $ 89,198     $ —     $ —       $ —     $ 89,198  

Adjustments to reconcile net income to net cash provided by operating activities:

         

Depreciation and amortization

    76,025       —       —         —       76,025  

Provision for deferred income taxes

    (1,240 )     —       —         —       (1,240 )

Loss on extinguishment of debt

    1,832       —       —         —       1,832  

Stock compensation expense

    2,812       —       —         —       2,812  

Other

    (1,603 )     —       —         —       (1,603 )

Changes in operating assets and liabilities, net of effects of acquisitions:

         

Receivables

    (7,138 )     —       556       —       (6,582 )

Inventories

    (5,125 )     —       4       —       (5,121 )

Prepaid expenses and other current assets

    (9,396 )     —       4,585       —       (4,811 )

Other noncurrent assets

    (46 )     —       —         —       (46 )

Accounts payable

    7,999       —       (6,704 )     —       1,295  

Other current liabilities and accrued expenses

    14,652       —       (965 )     —       13,687  

Other noncurrent liabilities

    (8,320 )     —       (2,863 )     —       (11,183 )
                                   

Net cash provided by operating activities

    159,650       —       (5,387 )     —       154,263  
                                   

CASH FLOWS FROM INVESTING ACTIVITIES:

         

Additions to property and equipment

    (96,826 )     —       —         —       (96,826 )

Proceeds from sales of land, building and equipment

    4,332       —       —         —       4,332  

Acquisitions of businesses, net of cash acquired

    (132,178 )     —       5,387       —       (126,791 )
                                   

Net cash used in investing activities

    (224,672 )     —       5,387       —       (219,285 )
                                   

CASH FLOWS FROM FINANCING ACTIVITIES:

         

Principle repayments under lease finance obligations

    (3,004 )     —       —         —       (3,004 )

Principle repayments of long-term debt

    (306,070 )     —       —         —       (306,070 )

Proceeds from issuance of long-term debt

    355,000       —       —         —       355,000  

Proceeds from lease finance obligations

    42,929       —       —         —       42,929  

Proceeds from exercise of stock options

    4,382       —       —         —       4,382  

Payment for purchase of note hedge

    (43,720 )     —       —         —       (43,720 )

Proceeds from issuance of warrant

    25,220       —       —         —       25,220  

Excess income tax benefits from stock-based compensation arrangements

    5,826       —       —         —       5,826  

Other financing costs

    (6,619 )     —       —         —       (6,619 )
                                   

Net cash provided by financing activities

    73,944       —       —         —       73,944  
                                   

Net increase in cash

    8,922       —       —         —       8,922  

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

    111,472       —       —         —       111,472  
                                   

CASH AND CASH EQUIVALENTS, END OF YEAR

  $ 120,394     $ —     $ —       $ —     $ 120,394  
                                   

 

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THE PANTRY, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

THE PANTRY, INC. AND SUBSIDIARIES

 

SUPPLEMENTAL COMBINING BALANCE SHEETS

 

September 29, 2005

(Dollars in thousands)

 

    The Pantry
(Issuer)
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
  Eliminations     Total

ASSETS

         

Current assets:

         

Cash and cash equivalents

  $ 111,472     $ —       $ —     $ —       $ 111,472

Receivables, net

    61,597       —         —       —         61,597

Inventories

    125,348       —         —       —         125,348

Prepaid expenses and other current assets

    19,029       2       —       —         19,031

Deferred income taxes

    5,837       —         —       —         5,837
                                   

Total current assets

    323,283       2       —       —         323,285
                                   

Investment in subsidiaries

    40,723       —         —       (40,723 )     —  
                                   

Property and equipment, net

    630,291       —         —       —         630,291
                                   

Other assets:

         

Goodwill

    394,903       —         —       —         394,903

Intercompany note receivable

    (23,477 )     43,872       —       (20,395 )     —  

Other noncurrent assets

    39,630       57       —       —         39,687
                                   

Total other assets

    411,056       43,929       —       (20,395 )     434,590
                                   

Total assets

  $ 1,405,353     $ 43,931     $ —     $ (61,118 )   $ 1,388,166
                                   

LIABILITIES AND SHAREHOLDERS’ EQUITY

         

Current liabilities:

         

Current maturities of long-term debt

  $ 16,045     $ —       $ —     $ —       $ 16,045

Current maturities of lease finance obligations

    2,872       —         —       —         2,872

Accounts payable

    131,618       —         —       —         131,618

Accrued compensation and related taxes

    16,786       —         —       —         16,786

Other accrued taxes

    34,346       —         —       —         34,346

Self-insurance reserve

    22,544       —         —       —         22,544

Other accrued liabilities

    29,387       —         —       (65 )     29,322
                                   

Total current liabilities

    253,598       —         —       (65 )     253,533
                                   

Other liabilities:

         

Long-term debt

    539,328       —         —       —         539,328

Lease finance obligations

    200,214       —         —       —         200,214

Deferred income taxes

    64,848       —         —       —         64,848

Deferred vendor rebates

    27,385       —         —       —         27,385

Intercompany note payable

    17,124       3,208       —       (20,332 )     —  

Other noncurrent liabilities

    50,923       2       —       —         50,925
                                   

Total other liabilities

    899,822       3,210       —       (20,332 )     882,700
                                   

SHAREHOLDERS’ EQUITY:

         

Common stock

    223       523       —       (523 )     223

Additional paid-in-capital

    176,836       40,551       —       (40,551 )     176,836

Accumulated other comprehensive income, net

    1,426       —         —       —         1,426

Retained earnings (deficit)

    73,448       (353 )     —       353       73,448
                                   

Total shareholders’ equity

    251,933       40,721       —       (40,721 )     251,933
                                   

Total liabilities and shareholders’ equity

  $ 1,405,353     $ 43,931     $ —     $ (61,118 )   $ 1,388,166
                                   

 

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THE PANTRY, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

THE PANTRY, INC. AND SUBSIDIARIES

 

SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS

 

Year Ended September 29, 2005

(Dollars in thousands)

 

    The Pantry
(Issuer)
    Guarantor
Subsidiaries
  Non-Guarantor
Subsidiaries
  Eliminations   Total  

Revenues:

         

Merchandise

  $ 1,228,891     $ —     $ —     $ —     $ 1,228,891  

Gasoline

    3,200,348       —       —       —       3,200,348  
                                 

Total revenues

    4,429,239       —       —       —       4,429,239  
                                 

Costs and operating expenses:

         

Merchandise cost of goods sold

    779,639       —       —       —       779,639  

Gasoline cost of good sold

    2,986,453       —       —       —       2,986,453  

Operating, general and administrative

    450,263       —       —       —       450,263  

Depreciation and amortization

    64,341       —       —       —       64,341  
                                 

Total costs and operating expenses

    4,280,696       —       —       —       4,280,696  
                                 

Income from operations

    148,543       —       —       —       148,543  
                                 

Other income (expense):

         

Interest expense

    (56,130 )     —       —       —       (56,130 )

Interest income

    1,816       —       —       —       1,816  

Miscellaneous

    977       —       —       —       977  
                                 

Total other expense

    (53,337 )     —       —       —       (53,337 )
                                 

Income before income taxes

    95,206       —       —       —       95,206  

Income tax expense

    (37,396 )     —       —       —       (37,396 )
                                 

Net income

  $ 57,810     $ —     $ —     $ —     $ 57,810  
                                 

 

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THE PANTRY, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

THE PANTRY, INC.

 

SUPPLEMENTAL COMBINING STATEMENTS OF CASH FLOWS

 

Year Ended September 29, 2005

(Dollars in thousands)

 

    The Pantry
(Issuer)
    Guarantor
Subsidiaries
  Non-Guarantor
Subsidiaries
  Eliminations   Total  

CASH FLOWS FROM OPERATING ACTIVITIES:

         

Net income

  $ 57,810     $ —     $ —     $ —     $ 57,810  

Adjustments to reconcile net income to net cash provided by operating activities:

         

Depreciation and amortization

    64,341       —       —       —       64,341  

Provision for deferred income taxes

    4,291       —       —       —       4,291  

Other

    14,503       —       —       —       14,503  

Changes in operating assets and liabilities, net of effects of acquisitions:

         

Receivables

    (18,539 )     —       —       —       (18,539 )

Inventories

    (22,393 )     —       —       —       (22,393 )

Prepaid expenses and other current assets

    1,565       —       —       —       1,565  

Other noncurrent assets

    (2,015 )     —       —       —       (2,015 )

Accounts payable

    10,467       —       —       —       10,467  

Other current liabilities and accrued expenses

    30,551       —       —       —       30,551  

Other noncurrent liabilities

    (7,000 )     —       —       —       (7,000 )
                                 

Net cash provided by operating activities

    133,581       —       —       —       133,581  
                                 

CASH FLOWS FROM INVESTING ACTIVITIES:

         

Additions to property and equipment

    (73,387 )     —       —       —       (73,387 )

Proceeds from sales of land, building and equipment

    10,215       —       —       —       10,215  

Acquisitions of businesses, net of cash acquired

    (103,068 )     —       —       —       (103,068 )
                                 

Net cash used in investing activities

    (166,240 )     —       —       —       (166,240 )
                                 

CASH FLOWS FROM FINANCING ACTIVITIES:

         

Principle repayments under lease finance obligations

    (2,719 )     —       —       —       (2,719 )

Principle repayments of long-term debt

    (12,028 )     —       —       —       (12,028 )

Proceeds from lease finance obligations

    14,101       —       —       —       14,101  

Proceeds from issuance of common stock, net

    32,850       —       —       —       32,850  

Proceeds from exercise of stock options

    3,879       —       —       —       3,879  
                                 

Net cash provided by financing activities

    36,083       —       —       —       36,083  
                                 

Net increase in cash

    3,424       —       —       —       3,424  

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

    108,048       —       —       —       108,048  
                                 

CASH AND CASH EQUIVALENTS, END OF YEAR

  $ 111,472     $ —     $ —     $ —     $ 111,472  
                                 

 

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THE PANTRY, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

THE PANTRY, INC. AND SUBSIDIARIES

 

SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS

 

Year Ended September 30, 2004

(Dollars in thousands)

 

     The Pantry
(Issuer)
    Guarantor
Subsidiaries
   Non-Guarantor
Subsidiaries
   Eliminations    Total  

Revenues:

             

Merchandise

   $ 1,172,846     $ —      $ —      $ —      $ 1,172,846  

Gasoline

     2,320,239       —        —        —        2,320,239  
                                     

Total revenues

     3,493,085       —        —        —        3,493,085  
                                     

Costs and operating expenses:

             

Merchandise cost of goods sold

     747,419       —        —        —        747,419  

Gasoline cost of good sold

     2,154,823       —        —        —        2,154,823  

Operating, general and administrative

     419,337       —        —        —        419,337  

Depreciation and amortization

     60,911       —        —        —        60,911  
                                     

Total costs and operating expenses

     3,382,490       —        —        —        3,382,490  
                                     

Income from operations

     110,595       —        —        —        110,595  
                                     

Other income (expense):

             

Loss on extinguishment of debt

     (23,087 )     —        —        —        (23,087 )

Interest expense

     (64,257 )     —        —        —        (64,257 )

Interest income

     725       —        —        —        725  

Miscellaneous

     951       —        —        —        951  
                                     

Total other expense

     (85,668 )     —        —        —        (85,668 )
                                     

Income before income taxes

     24,927       —        —        —        24,927  

Income tax expense

     (9,201 )     —        —        —        (9,201 )
                                     

Net income

   $ 15,726     $ —      $ —      $ —      $ 15,726  
                                     

 

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THE PANTRY, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

THE PANTRY, INC. AND SUBSIDIARIES

 

SUPPLEMENTAL COMBINING STATEMENTS OF CASH FLOWS

 

Year Ended September 30, 2004

(Dollars in thousands)

 

    The Pantry
(Issuer)
    Guarantor
Subsidiaries
  Non-Guarantor
Subsidiaries
  Eliminations   Total  

CASH FLOWS FROM OPERATING ACTIVITIES:

         

Net income

  $ 15,726     $ —     $ —     $ —     $ 15,726  

Adjustments to reconcile net income to net cash provided by operating activities:

         

Depreciation and amortization

    60,911       —       —       —       60,911  

Provision for deferred income taxes

    9,201       —       —       —       9,201  

Loss on extinguishment of debt

    23,087       —       —       —       23,087  

Other

    7,872       —       —       —       7,872  

Changes in operating assets and liabilities, net of effects of acquisitions:

         

Receivables

    (11,146 )     —       —       —       (11,146 )

Inventories

    (977 )     —       —       —       (977 )

Prepaid expenses and other current assets

    (7,005 )     —       —       —       (7,005 )

Other noncurrent assets

    242       —       —       —       242  

Accounts payable

    30,830       —       —       —       30,830  

Other current liabilities and accrued expenses

    (7,506 )     —       —       —       (7,506 )

Other noncurrent liabilities

    (4,263 )     —       —       —       (4,263 )
                                 

Net cash provided by operating activities

    116,972       —       —       —       116,972  
                                 

CASH FLOWS FROM INVESTING ACTIVITIES:

         

Additions to property and equipment

    (51,916 )     —       —       —       (51,916 )

Proceeds from sales of land, building and equipment

    10,454       —       —       —       10,454  

Acquisitions of businesses, net of cash acquired

    (185,607 )     —       —       —       (185,607 )
                                 

Net cash used in investing activities

    (227,069 )     —       —       —       (227,069 )
                                 

CASH FLOWS FROM FINANCING ACTIVITIES:

         

Principle repayments under lease finance obligations

    (2,760 )     —       —       —       (2,760 )

Principle repayments of long-term debt

    (617,412 )     —       —       —       (617,412 )

Proceeds from issuance of long-term debt

    675,000       —       —       —       675,000  

Proceeds from lease finance obligations

    97,104       —       —       —       97,104  

Proceeds from exercise of stock options

    4,899       —       —       —       4,899  

Repayments of shareholder loans

    173       —       —       —       173  

Other financing costs

    (11,760 )     —       —       —       (11,760 )
                                 

Net cash provided by financing activities

    145,244       —       —       —       145,244  
                                 

Net increase in cash

    35,147       —       —       —       35,147  

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

    72,901       —       —       —       72,901  
                                 

CASH AND CASH EQUIVALENTS, END OF YEAR

  $ 108,048     $ —     $ —     $ —     $ 108,048  
                                 

 

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Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.    Controls and Procedures

 

DISCLOSURE CONTROLS AND PROCEDURES

 

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to provide reasonable assurance that the information that we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that, because of inherent limitations, our disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the disclosure controls and procedures are met.

 

As required by paragraph (b) of Rule 13a-15 under the Exchange Act, our Chief Executive Officer and our Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded, as of the end of the period covered by this report, that our disclosure controls and procedures were effective to ensure that the information required to be disclosed by the Company in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is a process that is designed under the supervision of our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Our internal control over financial reporting includes those policies and procedures that:

 

i. Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

 

ii. Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures recorded by us are being made only in accordance with authorizations of our management and board of directors; and

 

iii. Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that

 

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controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

 

Management has conducted its evaluation of the effectiveness of internal control over financial reporting as of September 28, 2006 based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing the operational effectiveness of our internal control over financial reporting. Management reviewed the results of the assessment with the Audit Committee of the board of directors. Based on our assessment, management determined that, at September 28, 2006, we maintained effective internal control over financial reporting.

 

Our independent registered public accounting firm, Deloitte & Touche LLP, has audited our management’s assessment of the effectiveness of our internal control over financial reporting as of September 28, 2006, as stated in their report, which is included herein.

 

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

 

There have been no changes in our internal control over financial reporting during the fourth quarter of fiscal 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting other than the remediation steps described above.

 

From time to time, we make changes to our internal control over financial reporting that are intended to enhance its effectiveness and which do not have a material effect on our overall internal control over financial reporting. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an ongoing basis and will take action as appropriate.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of

The Pantry, Inc.

Sanford, North Carolina

 

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that The Pantry, Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of September 28, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of September 28, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 28, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended September 28, 2006 of the Company and our report dated December 12, 2006 expressed an unqualified opinion on those financial statements and financial statement schedule.

 

/s/    Deloitte & Touche LLP

Charlotte, North Carolina

December 12, 2006

 

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Item 9B.    Other Information.

 

None.

 

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PART III

 

Item 10.    Our Directors and Executive Officers.

 

Information concerning our executive officers is included in the section entitled “Executive Officers” on page 10 of this report. Information concerning our directors and the filing of certain reports of beneficial ownership is incorporated by reference from the sections entitled “Proposal 1: Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement to be filed with respect to the Annual Meeting of Stockholders to be held March 29, 2007. Information concerning the audit committee of our board of directors is incorporated by reference from the section entitled “Information About Our Board of Directors—Board Committees—Audit Committee” in our definitive proxy statement to be filed with respect to the Annual Meeting of Stockholders to be held March 29, 2007. There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors since the date of our proxy statement for the Annual Meeting of Stockholders held in March 2006.

 

Item 11.    Executive Compensation.

 

This information is incorporated by reference from the section entitled “Executive Compensation” in our definitive proxy statement to be filed with respect to the Annual Meeting of Stockholders to be held March 29, 2007.

 

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters.

 

This information is incorporated by reference from the sections entitled “Principal Stockholders” and “Equity Compensation Plan Information” in our definitive proxy statement to be filed with respect to the Annual Meeting of Stockholders to be held March 29, 2007.

 

Item 13.    Certain Relationships and Related Transactions.

 

This information is incorporated by reference from the sections entitled “Principal Stockholders” and “Transactions with Affiliates” in our definitive proxy statement to be filed with respect to the Annual Meeting of Stockholders to be held March 29, 2007.

 

Item 14.    Principal Accounting Fees and Services.

 

This information is incorporated by reference from the section entitled “Principal Accountant Fees and Services” in our definitive proxy statement to be filed with respect to the Annual Meeting of Stockholders to be held March 29, 2007.

 

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PART IV

 

Item 15. Exhibits and Financial Statement Schedule.

 

(a) Financial Statements, Financial Statement Schedule and Exhibits—The following documents are filed as part of this Annual Report on Form 10-K for the year ended September 28, 2006:

 

  (i) Consolidated Financial Statements—See index on page 48 of this Annual Report on Form 10-K for the year ended September 28, 2006.

 

  (ii) Financial Statement Schedule—See index on page 48 of this Annual Report on Form 10-K for the year ended September 28, 2006.

 

  (iii) Exhibits:

 

Exhibit No.   

Description of Document

3.1    Amended and Restated Certificate of Incorporation of The Pantry (incorporated by reference to Exhibit 3.1 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221))
3.2    Amended and Restated Bylaws of The Pantry (incorporated by reference to Exhibit 3.2 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221))
4.1    Indenture dated November 22, 2005 by and among The Pantry, Kangaroo, Inc. and R. & H. Maxxon, Inc., subsidiaries of The Pantry, as guarantors, and Wachovia Bank, National Association (“Wachovia”), as Trustee, with respect to the 3% Senior Subordinated Convertible Notes Due 2012 (incorporated by reference to Exhibit 10.8 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
4.2    Form of 3% Senior Subordinated Convertible Notes Due 2012 (included in Exhibit 4.6) (incorporated by reference to Exhibit 10.8 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
4.3    Indenture dated February 19, 2004 among The Pantry, R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as Guarantors, and Wachovia, as Trustee, with respect to the 7.75% Senior Subordinated Notes due 2014 (incorporated by reference to Exhibit 4.5 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-115060))
4.4    Form of 7.75% Senior Subordinated Note due 2014 (included in Exhibit 4.8) (incorporated by reference to Exhibit 4.5 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-115060))
10.1    Amended and Restated Credit Agreement dated March 12, 2004 among The Pantry, as borrower, R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and lender, Credit Suisse First Boston, as syndication agent and lender, Wells Fargo Bank (“Wells Fargo”), as documentation agent and lender, and Credit Industrial et Commercial, Guaranty Bank, IKB Capital Corporation and Raymond James Bank, FSB, as lenders (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2004)
10.2    Amended and Restated Pledge Agreement dated March 12, 2004 by and among The Pantry and R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as pledgors and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2004)
10.3    Amended and Restated Security Agreement dated March 12, 2004 among The Pantry and R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as obligors and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.3 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2004)

 

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Exhibit No.   

Description of Document

10.4    First Amendment to Amended and Restated Credit Agreement dated September 30, 2004 by and among The Pantry, as borrower, R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and lender, Credit Suisse First Boston, as syndication agent and lender, Wells Fargo, as documentation agent and lender, and certain other lenders, as identified in the signature pages thereto (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 4, 2004)
10.5    Second Amendment to Amended and Restated Credit Agreement and Waiver dated August 5, 2005 by and among The Pantry, as borrower, R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and certain lenders identified in the signature pages thereto (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 9, 2005)
10.6    Third Amendment to Amended and Restated Credit Agreement dated November 11, 2005 by and among The Pantry, as borrower, R&H Maxxon, Inc., Kangaroo, Inc. and D& D Oil Co., Inc, subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent, and the lenders party thereto (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2005)
10.7    Purchase Agreement dated November 16, 2005 by and among The Pantry, Kangaroo, Inc. and R. & H. Maxxon, Inc., subsidiaries of The Pantry, as guarantors, and Merrill Lynch, Pierce, Fenner & Smith Incorporated, relating to the 3% Senior Subordinated Convertible Notes due 2012 (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.8    Registration Rights Agreement dated November 22, 2005 by and among The Pantry, Kangaroo, Inc. and R.&H. Maxxon, Inc., subsidiaries of The Pantry, as Guarantors, and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Wachovia Capital Markets, LLC as the initial purchasers, relating to the 3% Senior Subordinated Convertible Notes due 2012 (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.9    Confirmation of OTC Warrant Transaction dated November 16, 2005 between The Pantry and Merrill Lynch International (incorporated by reference to Exhibit 10.5 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.10    Confirmation of OTC Convertible Note Hedge dated November 16, 2005 between The Pantry and Merrill Lynch International (incorporated by reference to Exhibit 10.3 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.11    Confirmation of OTC Warrant Transaction dated November 21, 2005 between The Pantry and Merrill Lynch International (incorporated by reference to Exhibit 10.6 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.12    Confirmation of OTC Convertible Note Hedge dated November 21, 2005 between The Pantry and Merrill Lynch International (incorporated by reference to Exhibit 10.4 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.13    Registration Rights Agreement dated February 13, 2004 by and among The Pantry, Credit Suisse First Boston LLC and Wachovia Capital Markets, LLC, as the Initial Purchasers (incorporated by reference to Exhibit 4.8 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-115060))
10.14    Amended and Restated Registration Rights Agreement dated July 2, 1998 by and among The Pantry, FS Equity Partners III, L.P. (“FSEP III”), FS Equity Partners IV, L.P. (“FSEP IV”), FS Equity Partners International, L.P. (“FSEP International”), Chase Manhattan Capital, L.P., CB Capital Investors, L.P., Baseball Partners, and Peter J. Sodini (incorporated by reference to Exhibit 4.2 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221))

 

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Exhibit No.   

Description of Document

10.15    Amendment No. 1 to Amended and Restated Registration Rights Agreement dated June 1, 1999 by and among The Pantry, FSEP III, FSEP IV, FSEP International, Chase Manhattan Capital, L.P., CB Capital Investors, L.P., Baseball Partners and Peter J. Sodini (incorporated by reference to Exhibit 10.36 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended June 24, 1999)
10.16    Second Amended and Restated Credit Agreement dated December 29, 2005 among The Pantry, as borrower, R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and lender, Regions Bank and Wells Fargo, as co-syndication agents and lenders, Harris N.A. and Rabobank International as co-documentation agents and lenders, and the other financial institutions signatory thereto, as lenders (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006)
10.17    Second Amended and Restated Pledge Agreement dated December 29, 2005 between The Pantry and R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as pledgors, and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006)
10.18    Second Amended and Restated Security Agreement dated December 29, 2005 between The Pantry and R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as obligors, and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.3 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006)
10.19    Form of Amended and Restated Deed of Trust, Security Agreement, Assignment of Rents and Leases and Fixture Filing (North Carolina) dated October 23, 1997 by and from The Pantry to David R. Cannon, as Trustee, and First Union, as Agent (incorporated by reference to Exhibit 10.18 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.20    Form of Amended and Restated Mortgage, Security Agreement, Assignment of Rents and Leases And Fixture Filing (South Carolina) dated October 23, 1997 by and from The Pantry to First Union, as Agent (incorporated by reference to Exhibit 10.19 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.21    Form of Amended and Restated Deed of Trust, Security Agreement, Assignment of Rents and Leases and Fixture Filing (Tennessee) dated October 23, 1997 by and from The Pantry to David R. Cannon, as Trustee, and First Union, as Agent (incorporated by reference to Exhibit 10.20 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.22    Form of Amended and Restated Mortgage, Security Agreement, Assignment of Rents and Leases (Kentucky) dated October 23, 1997 by and from The Pantry to First Union, as Agent (incorporated by reference to Exhibit 10.21 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.23    Form of Amended and Restated Mortgage, Security Agreement, Assignment of Rents and Leases and Fixture Filing (Indiana) dated October 23, 1997 by and from The Pantry to First Union, as Agent (incorporated by reference to Exhibit 10.22 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.24    Form of Mortgage, Security Agreement, Assignment of Rents and Leases and Fixture Filing (Florida) dated October 23, 1997 by and from Lil’ Champ Food Stores, Inc. (“Lil’ Champ”) to First Union, as Agent (incorporated by reference to Exhibit 10.23 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.25    Form of Deed to Secure Debt, Security Agreement, and Assignment of Rents (Georgia) dated October 23, 1997 by and from Lil’ Champ to First Union, as Agent (incorporated by reference to Exhibit 10.24 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))

 

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Exhibit No.   

Description of Document

10.26    Form of Lease Agreement between The Pantry and certain parties to the Purchase and Sale Agreement referenced in Exhibit 2.3 above (incorporated by reference to Exhibit 2.5 to The Pantry’s Current Report on Form 8-K with the Securities and Exchange Commission on October 31, 2003))
10.27    Independent Director Compensation Program, Second Amendment February 2006 (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 21, 2006) (represents a management contract or compensatory plan or arrangement)
10.28    Summary of Material Terms of The Pantry Annual Incentive Plan (incorporated by reference to Exhibit 10.2 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended March 31, 2005) (represents a management contract or compensatory plan or arrangement)
10.29    Management and Administrative Incentive Plan (incorporated by reference to Exhibit 10.44 to The Pantry’s Annual Report on Form 10-K for the year ended September 26, 2002) (represents a management contract or compensatory plan or arrangement)
10.30    Form of Indemnification Agreement (incorporated by reference to Exhibit 10.29 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221)) (represents a management contract or compensatory plan or arrangement)
10.31    1999 Stock Option Plan, as amended and restated as of August 2, 2006 (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 7, 2006) (represents a management contract or compensatory plan or arrangement)
10.32    Form of Incentive Stock Option Agreement to the 1999 Stock Option Plan (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 28, 2004) (represents a management contract or compensatory plan or arrangement)
10.33    The Pantry 1998 Stock Option Plan (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended December 25, 1997) (represents a management contract or compensatory plan or arrangement)
10.34    Form of Incentive Stock Option Agreement to the 1998 Stock Option Plan (incorporated by reference to Exhibit 10.2 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221)) (represents a management contract or compensatory plan or arrangement)
10.35    The Pantry Inc. 1998 Stock Subscription Plan (incorporated by reference to Exhibit 10.25 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 24, 1998) (represents a management contract or compensatory plan or arrangement)
10.36    Form of Stock Subscription Agreement (incorporated by reference to Exhibit 10.26 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221)) (represents a management contract or compensatory plan or arrangement)
10.37    Employment Agreement dated October 1, 1997 between Peter J. Sodini and The Pantry (incorporated by reference to Exhibit 10.11 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811)) (represents a management contract or compensatory plan or arrangement)
10.38    Amendment No. 1 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.34 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended June 24, 1999) (represents a management contract or compensatory plan or arrangement)
10.39    Amendment No. 2 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.19 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 27, 2001) (represents a management contract or compensatory plan or arrangement)

 

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Exhibit No.   

Description of Document

10.40    Amendment No. 3 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended December 26, 2002) (represents a management contract or compensatory plan or arrangement)
10.41    Amendment No. 4 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.45 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 25, 2003) (represents a management contract or compensatory plan or arrangement)
10.42    Amendment No. 5 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.7 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005) (represents a management contract or compensatory plan or arrangement)
10.43    Employment Agreement dated May 2, 2003 by and between Daniel J. Kelly and The Pantry (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 26, 2003) (represents a management contract or compensatory plan or arrangement)
10.44    Employment Agreement dated May 1, 2003 by and between Steven J. Ferreira and The Pantry (incorporated by reference to Exhibit 10.2 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 26, 2003) (represents a management contract or compensatory plan or arrangement)
10.45    Employment Agreement dated May 3, 2003 by and between Joseph A. Krol and The Pantry (incorporated by reference to Exhibit 10.3 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 26, 2003) (represents a management contract or compensatory plan or arrangement)
10.46    Employment Agreement dated May 6, 2003 by and between David M. Zaborski and The Pantry (incorporated by reference to Exhibit 10.4 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 26, 2003) (represents a management contract or compensatory plan or arrangement)
10.47    Employment Agreement dated July 21, 2006 by and between Keith S. Bell and The Pantry (represents a management contract or compensatory plan or arrangement)
10.48    Employment Agreement dated October 11, 2006 by and between Melissa H. Anderson and The Pantry (represents a management contract or compensatory plan or arrangement)
10.49    Summary of Amendment to Halloran Option Agreement (incorporated by reference to Exhibit 10.5 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2006) (represents a management contract or compensatory plan or arrangement)
10.50    Summary of Amendments to Allumbaugh, Yarborough, III, and Starrett Option Agreements (incorporated by reference to Exhibit 10.6 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2006) (represents a management contract or compensatory plan or arrangement)
10.51    Distribution Service Agreement dated October 10, 1999 by and between The Pantry, Lil’ Champ and McLane Company, Inc. (“McLane”), as amended by the First Amendment to Distribution Service Agreement dated June 28, 2001 and the Second Amendment to Distribution Service Agreement dated September 8, 2001 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.39 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 27, 2001)
10.52    Third Amendment to Distribution Service Agreement by and between The Pantry, Lil’ Champ and McLane dated October 5, 2002 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.39 to The Pantry’s Annual Report on Form 10-K for the year ended September 26, 2002)

 

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Exhibit No.   

Description of Document

10.54    Fourth Amendment to Distribution Service Agreement dated October 16, 2003 by and between The Pantry and McLane (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.35 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 25, 2003)
10.55    Fifth Amendment to Distribution Service Agreement dated April 1, 2004 by and between The Pantry and McLane (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended March 31, 2005)
10.56    Sixth Amendment to Distribution Service Agreement dated April 21, 2005 by and between The Pantry and McLane Company, Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005)
10.57    Seventh Amendment to Distribution Service Agreement dated May 11, 2006 between The Pantry and McLane Company Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 29, 2006)
10.58    Distributor Franchise Agreement between The Pantry and CITGO Petroleum Corporation dated August 2000, including Amended and Restated Addendum dated February 11, 2003 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.2 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended March 27, 2003)
10.59    Letter Amendment to the Amended and Restated Addendum dated July 7, 2004 to the Distributor Franchise Agreement between The Pantry and CITGO Petroleum Corporation, dated August 2000, as amended by Amended and Restated Addendum to Distributor Franchise Agreement dated February 11, 2003 (incorporated by reference to Exhibit 10.2 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended June 24, 2004)
10.60    First Amendment to Amended and Restated Addendum to Distributor Franchise Agreement by and between CITGO Petroleum Corporation and The Pantry dated March 31, 2005 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.3 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended March 31, 2005)
10.61    Second Amendment to Amended and Restated Addendum to Distributor Franchise Agreement dated October 17, 2005 between CITGO Petroleum Corporation and The Pantry (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended December 29, 2005)
10.62    Branded Jobber Contract by and between The Pantry and BP Products North America Inc. dated February 1, 2003, as amended by the Amendment to the Branded Jobber Contract dated February 14, 2003 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended March 27, 2003)

 

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Exhibit No.   

Description of Document

10.63    Second Amendment to the Branded Jobber Contract between The Pantry and BP Products North America Inc. dated June 11, 2004 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 29, 2004)
10.64    Third Amendment to the Branded Jobber Contract by and between The Pantry and BP Products North America Inc. dated July 18, 2006 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission)
12.1    Statement regarding Computation of Earnings to Fixed Charges Ratio
21.1    Subsidiaries of The Pantry
23.1    Consent of Deloitte & Touche LLP
31.1    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.]
32.2    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.]

 

(b) See (a)(iii) above.

 

(c) See (a)(ii) above.

 

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SIGNATURE

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

 

THE PANTRY, INC.

By:

  

/s/    PETER J. SODINI        

  

Peter J. Sodini

President and Chief Executive Officer

  Date: December 12, 2006

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

Signature

  

Title

   Date

/s/    PETER J. SODINI        

Peter J. Sodini

   President, Chief Executive Officer and Director (Principal Executive Officer)    December 12, 2006

/s/    DANIEL J. KELLY        

Daniel J. Kelly

   Vice President and Chief Financial Officer (Principal Financial Officer)    December 12, 2006

/s/    BERRY L. EPLEY        

Berry L. Epley

   Corporate Controller, Assistant Secretary (Principal Accounting Officer)    December 12, 2006

/s/    ROBERT F. BERNSTOCK        

Robert F. Bernstock

   Director    December 12, 2006

/s/    WILFRED A. FINNEGAN        

Wilfred A. Finnegan

   Director    December 12, 2006

/s/    EDWIN J. HOLMAN        

Edwin J. Holman

   Director    December 12, 2006

/s/    TERRY L. MCELROY        

Terry L. McElroy

   Director    December 12, 2006

/s/    MARK D. MILES        

Mark D. Miles

   Director    December 12, 2006

/s/    BRYAN E. MONKHOUSE        

Bryan E. Monkhouse

   Director    December 12, 2006

/s/    THOMAS M. MURNANE        

Thomas M. Murnane

   Director    December 12, 2006

/s/    MARIA DEL CARMEN RICHTER        

Maria Del Carmen Richter

   Director    December 12, 2006

/s/    PAUL L. BRUNSWICK        

Paul L. Brunswick

   Director    December 12, 2006

 

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SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

(Dollars in thousands)

 

     Balance at
beginning
of period
   Additions
charged to
costs and
expenses
   Additions
related to
acquisitions
   Deductions
for
payments or
write-offs
   

Balance
at

end of
period

Year ended September 28, 2006

             

Allowance for doubtful accounts

   $ 546    $ —      $ —      $ (284 )   $ 262

Reserve for environmental issues

     16,320      3,097      —        (1,059 )     18,358

Reserve for closed stores

     7,946      498      —        (1,355 )     7,089
                                   
   $ 24,812    $ 3,595    $ —      $ (2,698 )   $ 25,709
                                   

Year ended September 29, 2005

             

Allowance for doubtful accounts

   $ 417    $ 219    $ —      $ (90 )   $ 546

Reserve for environmental issues

     14,051      3,259      —        (990 )     16,320

Reserve for closed stores

     3,029      5,558      —        (641 )     7,946
                                   
   $ 17,497    $ 9,036    $ —      $ (1,721 )   $ 24,812
                                   

Year ended September 30, 2004

             

Allowance for doubtful accounts

   $ 665    $ 700    $ —      $ (948 )   $ 417

Reserve for environmental issues

     13,823      437      675      (884 )     14,051

Reserve for closed stores

     3,201      1,736      —        (1,908 )     3,029
                                   
   $ 17,689    $ 2,873    $ 675    $ (3,740 )   $ 17,497
                                   

 

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Exhibit Index

 

Exhibit No.   

Description of Document

3.1    Amended and Restated Certificate of Incorporation of The Pantry (incorporated by reference to Exhibit 3.1 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221))
3.2    Amended and Restated Bylaws of The Pantry (incorporated by reference to Exhibit 3.2 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221))
4.1    Indenture dated November 22, 2005 by and among The Pantry, Kangaroo, Inc. and R. & H. Maxxon, Inc., subsidiaries of The Pantry, as guarantors, and Wachovia Bank, National Association (“Wachovia”), as Trustee, with respect to the 3% Senior Subordinated Convertible Notes Due 2012 (incorporated by reference to Exhibit 10.8 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
4.2    Form of 3% Senior Subordinated Convertible Notes Due 2012 (included in Exhibit 4.6) (incorporated by reference to Exhibit 10.8 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
4.3    Indenture dated February 19, 2004 among The Pantry, R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as Guarantors, and Wachovia, as Trustee, with respect to the 7.75% Senior Subordinated Notes due 2014 (incorporated by reference to Exhibit 4.5 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-115060))
4.4    Form of 7.75% Senior Subordinated Note due 2014 (included in Exhibit 4.8) (incorporated by reference to Exhibit 4.5 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-115060))
10.1    Amended and Restated Credit Agreement dated March 12, 2004 among The Pantry, as borrower, R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and lender, Credit Suisse First Boston, as syndication agent and lender, Wells Fargo Bank (“Wells Fargo”), as documentation agent and lender, and Credit Industrial et Commercial, Guaranty Bank, IKB Capital Corporation and Raymond James Bank, FSB, as lenders (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2004)
10.2    Amended and Restated Pledge Agreement dated March 12, 2004 by and among The Pantry and R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as pledgors and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2004)
10.3    Amended and Restated Security Agreement dated March 12, 2004 among The Pantry and R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as obligors and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.3 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2004)
10.4    First Amendment to Amended and Restated Credit Agreement dated September 30, 2004 by and among The Pantry, as borrower, R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and lender, Credit Suisse First Boston, as syndication agent and lender, Wells Fargo, as documentation agent and lender, and certain other lenders, as identified in the signature pages thereto (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 4, 2004)
10.5    Second Amendment to Amended and Restated Credit Agreement and Waiver dated August 5, 2005 by and among The Pantry, as borrower, R&H Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and certain lenders identified in the signature pages thereto (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 9, 2005)
10.6    Third Amendment to Amended and Restated Credit Agreement dated November 11, 2005 by and among The Pantry, as borrower, R&H Maxxon, Inc., Kangaroo, Inc. and D& D Oil Co., Inc, subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent, and the lenders party thereto (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2005)


Table of Contents
Exhibit No.   

Description of Document

10.7    Purchase Agreement dated November 16, 2005 by and among The Pantry, Kangaroo, Inc. and R. & H. Maxxon, Inc., subsidiaries of The Pantry, as guarantors, and Merrill Lynch, Pierce, Fenner & Smith Incorporated, relating to the 3% Senior Subordinated Convertible Notes due 2012 (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.8    Registration Rights Agreement dated November 22, 2005 by and among The Pantry, Kangaroo, Inc. and R.&H. Maxxon, Inc., subsidiaries of The Pantry, as Guarantors, and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Wachovia Capital Markets, LLC as the initial purchasers, relating to the 3% Senior Subordinated Convertible Notes due 2012 (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.9    Confirmation of OTC Warrant Transaction dated November 16, 2005 between The Pantry and Merrill Lynch International (incorporated by reference to Exhibit 10.5 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.10    Confirmation of OTC Convertible Note Hedge dated November 16, 2005 between The Pantry and Merrill Lynch International (incorporated by reference to Exhibit 10.3 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.11    Confirmation of OTC Warrant Transaction dated November 21, 2005 between The Pantry and Merrill Lynch International (incorporated by reference to Exhibit 10.6 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.12    Confirmation of OTC Convertible Note Hedge dated November 21, 2005 between The Pantry and Merrill Lynch International (incorporated by reference to Exhibit 10.4 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005)
10.13    Registration Rights Agreement dated February 13, 2004 by and among The Pantry, Credit Suisse First Boston LLC and Wachovia Capital Markets, LLC, as the Initial Purchasers (incorporated by reference to Exhibit 4.8 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-115060))
10.14    Amended and Restated Registration Rights Agreement dated July 2, 1998 by and among The Pantry, FS Equity Partners III, L.P. (“FSEP III”), FS Equity Partners IV, L.P. (“FSEP IV”), FS Equity Partners International, L.P. (“FSEP International”), Chase Manhattan Capital, L.P., CB Capital Investors, L.P., Baseball Partners, and Peter J. Sodini (incorporated by reference to Exhibit 4.2 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221))
10.15    Amendment No. 1 to Amended and Restated Registration Rights Agreement dated June 1, 1999 by and among The Pantry, FSEP III, FSEP IV, FSEP International, Chase Manhattan Capital, L.P., CB Capital Investors, L.P., Baseball Partners and Peter J. Sodini (incorporated by reference to Exhibit 10.36 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended June 24, 1999)
10.16    Second Amended and Restated Credit Agreement dated December 29, 2005 among The Pantry, as borrower, R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and lender, Regions Bank and Wells Fargo, as co-syndication agents and lenders, Harris N.A. and Rabobank International as co-documentation agents and lenders, and the other financial institutions signatory thereto, as lenders (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006)
10.17    Second Amended and Restated Pledge Agreement dated December 29, 2005 between The Pantry and R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as pledgors, and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006)


Table of Contents
Exhibit No.   

Description of Document

10.18    Second Amended and Restated Security Agreement dated December 29, 2005 between The Pantry and R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as obligors, and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.3 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006)
10.19    Form of Amended and Restated Deed of Trust, Security Agreement, Assignment of Rents and Leases and Fixture Filing (North Carolina) dated October 23, 1997 by and from The Pantry to David R. Cannon, as Trustee, and First Union, as Agent (incorporated by reference to Exhibit 10.18 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.20    Form of Amended and Restated Mortgage, Security Agreement, Assignment of Rents and Leases And Fixture Filing (South Carolina) dated October 23, 1997 by and from The Pantry to First Union, as Agent (incorporated by reference to Exhibit 10.19 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.21    Form of Amended and Restated Deed of Trust, Security Agreement, Assignment of Rents and Leases and Fixture Filing (Tennessee) dated October 23, 1997 by and from The Pantry to David R. Cannon, as Trustee, and First Union, as Agent (incorporated by reference to Exhibit 10.20 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.22    Form of Amended and Restated Mortgage, Security Agreement, Assignment of Rents and Leases (Kentucky) dated October 23, 1997 by and from The Pantry to First Union, as Agent (incorporated by reference to Exhibit 10.21 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.23    Form of Amended and Restated Mortgage, Security Agreement, Assignment of Rents and Leases and Fixture Filing (Indiana) dated October 23, 1997 by and from The Pantry to First Union, as Agent (incorporated by reference to Exhibit 10.22 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.24    Form of Mortgage, Security Agreement, Assignment of Rents and Leases and Fixture Filing (Florida) dated October 23, 1997 by and from Lil’ Champ Food Stores, Inc. (“Lil’ Champ”) to First Union, as Agent (incorporated by reference to Exhibit 10.23 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.25    Form of Deed to Secure Debt, Security Agreement, and Assignment of Rents (Georgia) dated October 23, 1997 by and from Lil’ Champ to First Union, as Agent (incorporated by reference to Exhibit 10.24 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811))
10.26    Form of Lease Agreement between The Pantry and certain parties to the Purchase and Sale Agreement referenced in Exhibit 2.3 above (incorporated by reference to Exhibit 2.5 to The Pantry’s Current Report on Form 8-K with the Securities and Exchange Commission on October 31, 2003))
10.27    Independent Director Compensation Program, Second Amendment February 2006 (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 21, 2006) (represents a management contract or compensatory plan or arrangement)
10.28    Summary of Material Terms of The Pantry Annual Incentive Plan (incorporated by reference to Exhibit 10.2 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended March 31, 2005) (represents a management contract or compensatory plan or arrangement)
10.29    Management and Administrative Incentive Plan (incorporated by reference to Exhibit 10.44 to The Pantry’s Annual Report on Form 10-K for the year ended September 26, 2002) (represents a management contract or compensatory plan or arrangement)
10.30    Form of Indemnification Agreement (incorporated by reference to Exhibit 10.29 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221)) (represents a management contract or compensatory plan or arrangement)


Table of Contents
Exhibit No.   

Description of Document

10.31    1999 Stock Option Plan, as amended and restated as of August 2, 2006 (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 7, 2006) (represents a management contract or compensatory plan or arrangement)
10.32    Form of Incentive Stock Option Agreement to the 1999 Stock Option Plan (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 28, 2004) (represents a management contract or compensatory plan or arrangement)
10.33    The Pantry 1998 Stock Option Plan (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended December 25, 1997) (represents a management contract or compensatory plan or arrangement)
10.34    Form of Incentive Stock Option Agreement to the 1998 Stock Option Plan (incorporated by reference to Exhibit 10.2 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221)) (represents a management contract or compensatory plan or arrangement)
10.35    The Pantry Inc. 1998 Stock Subscription Plan (incorporated by reference to Exhibit 10.25 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 24, 1998) (represents a management contract or compensatory plan or arrangement)
10.36    Form of Stock Subscription Agreement (incorporated by reference to Exhibit 10.26 to The Pantry’s Registration Statement on Form S-1, as amended (Registration No. 333-74221)) (represents a management contract or compensatory plan or arrangement)
10.37    Employment Agreement dated October 1, 1997 between Peter J. Sodini and The Pantry (incorporated by reference to Exhibit 10.11 to The Pantry’s Registration Statement on Form S-4, as amended (Registration No. 333-42811)) (represents a management contract or compensatory plan or arrangement)
10.38    Amendment No. 1 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.34 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended June 24, 1999) (represents a management contract or compensatory plan or arrangement)
10.39    Amendment No. 2 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.19 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 27, 2001) (represents a management contract or compensatory plan or arrangement)
10.40    Amendment No. 3 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended December 26, 2002) (represents a management contract or compensatory plan or arrangement)
10.41    Amendment No. 4 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.45 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 25, 2003) (represents a management contract or compensatory plan or arrangement)
10.42    Amendment No. 5 to Employment Agreement by and between The Pantry and Peter J. Sodini (incorporated by reference to Exhibit 10.7 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 22, 2005) (represents a management contract or compensatory plan or arrangement)
10.43    Employment Agreement dated May 2, 2003 by and between Daniel J. Kelly and The Pantry (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 26, 2003) (represents a management contract or compensatory plan or arrangement)
10.44    Employment Agreement dated May 1, 2003 by and between Steven J. Ferreira and The Pantry (incorporated by reference to Exhibit 10.2 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 26, 2003) (represents a management contract or compensatory plan or arrangement)


Table of Contents
Exhibit No.   

Description of Document

10.45    Employment Agreement dated May 3, 2003 by and between Joseph A. Krol and The Pantry (incorporated by reference to Exhibit 10.3 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 26, 2003) (represents a management contract or compensatory plan or arrangement)
10.46    Employment Agreement dated May 6, 2003 by and between David M. Zaborski and The Pantry (incorporated by reference to Exhibit 10.4 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 26, 2003) (represents a management contract or compensatory plan or arrangement)
10.47    Employment Agreement dated July 21, 2006 by and between Keith S. Bell and The Pantry (represents a management contract or compensatory plan or arrangement)
10.48    Employment Agreement dated October 11, 2006 by and between Melissa H. Anderson and The Pantry (represents a management contract or compensatory plan or arrangement)
10.49    Summary of Amendment to Halloran Option Agreement (incorporated by reference to Exhibit 10.5 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2006) (represents a management contract or compensatory plan or arrangement)
10.50    Summary of Amendments to Allumbaugh, Yarborough, III, and Starrett Option Agreements (incorporated by reference to Exhibit 10.6 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2006) (represents a management contract or compensatory plan or arrangement)
10.51    Distribution Service Agreement dated October 10, 1999 by and between The Pantry, Lil’ Champ and McLane Company, Inc. (“McLane”), as amended by the First Amendment to Distribution Service Agreement dated June 28, 2001 and the Second Amendment to Distribution Service Agreement dated September 8, 2001 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.39 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 27, 2001)
10.52    Third Amendment to Distribution Service Agreement by and between The Pantry, Lil’ Champ and McLane dated October 5, 2002 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.39 to The Pantry’s Annual Report on Form 10-K for the year ended September 26, 2002)
10.54    Fourth Amendment to Distribution Service Agreement dated October 16, 2003 by and between The Pantry and McLane (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.35 to The Pantry’s Annual Report on Form 10-K, as amended, for the year ended September 25, 2003)
10.55    Fifth Amendment to Distribution Service Agreement dated April 1, 2004 by and between The Pantry and McLane (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended March 31, 2005)
10.56    Sixth Amendment to Distribution Service Agreement dated April 21, 2005 by and between The Pantry and McLane Company, Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005)
10.57    Seventh Amendment to Distribution Service Agreement dated May 11, 2006 between The Pantry and McLane Company Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended June 29, 2006)


Table of Contents
Exhibit No.   

Description of Document

10.58    Distributor Franchise Agreement between The Pantry and CITGO Petroleum Corporation dated August 2000, including Amended and Restated Addendum dated February 11, 2003 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.2 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended March 27, 2003)
10.59    Letter Amendment to the Amended and Restated Addendum dated July 7, 2004 to the Distributor Franchise Agreement between The Pantry and CITGO Petroleum Corporation, dated August 2000, as amended by Amended and Restated Addendum to Distributor Franchise Agreement dated February 11, 2003 (incorporated by reference to Exhibit 10.2 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended June 24, 2004)
10.60    First Amendment to Amended and Restated Addendum to Distributor Franchise Agreement by and between CITGO Petroleum Corporation and The Pantry dated March 31, 2005 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.3 to The Pantry’s Quarterly Report on Form 10-Q, as amended, for the quarterly period ended March 31, 2005)
10.61    Second Amendment to Amended and Restated Addendum to Distributor Franchise Agreement dated October 17, 2005 between CITGO Petroleum Corporation and The Pantry (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended December 29, 2005)
10.62    Branded Jobber Contract by and between The Pantry and BP Products North America Inc. dated February 1, 2003, as amended by the Amendment to the Branded Jobber Contract dated February 14, 2003 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Quarterly Report on Form 10-Q for the quarterly period ended March 27, 2003)
10.63    Second Amendment to the Branded Jobber Contract between The Pantry and BP Products North America Inc. dated June 11, 2004 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission) (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 29, 2004)
10.64    Third Amendment to the Branded Jobber Contract by and between The Pantry and BP Products North America Inc. dated July 18, 2006 (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission)
12.1    Statement regarding Computation of Earnings to Fixed Charges Ratio
21.1    Subsidiaries of The Pantry
23.1    Consent of Deloitte & Touche LLP
31.1    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.]
32.2    Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.]