Pantry (PTRY) 10-Q 2010 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 24, 2009

Commission file number: 000-25813

THE PANTRY, INC.

(Exact name of registrant as specified in its charter)

Delaware	56-1574463
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

P.O. Box 8019

305 Gregson Drive

Cary, North Carolina 27511

(Address of principal executive offices and zip code)

(919) 774-6700

(Registrant’s telephone number, including area code)

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. Yesx            No¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer¨	Accelerated filerx
Non-accelerated filer¨ (Do not check if a smaller reporting company)	Smaller reporting company¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes¨        Nox

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

COMMON STOCK, $0.01 PAR VALUE	22,663,515 SHARES
(Class)	(Outstanding at January 29, 2010)

THE PANTRY, INC.

FORM 10-Q

December 24, 2009

TABLE OF CONTENTS

		Page
Part I—Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets (Unaudited)	3
	Condensed Consolidated Statements of Operations (Unaudited)	4
	Condensed Consolidated Statements of Cash Flows (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
Item 4.	Controls and Procedures	32
Item 4T.	Controls and Procedures	32
Part II—Other Information
Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 5.	Other Information	43
Item 6.	Exhibits	44

2

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

THE PANTRY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 (Dollars in thousands)

	December 24, 2009			September 24, 2009
				(As adjusted, see Note 1)
ASSETS
Current assets:
Cash and cash equivalents	$	179,517		$	169,880
Receivables, net		95,625			92,494
Inventories		125,177			124,524
Prepaid expenses and other current assets		11,863			18,142
Deferred income taxes		14,573			14,959
Total current assets		426,755			419,999
Property and equipment, net		1,014,035			1,028,982
Other assets:
Goodwill		633,993			634,703
Other intangible assets		8,038			29,887
Other noncurrent assets		30,234			40,584
Total other assets		672,265			705,174
Total assets	$	2,113,055		$	2,154,155
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	4,322		$	4,317
Current maturities of lease finance obligations		6,678			6,536
Accounts payable		145,704			140,730
Accrued compensation and related taxes		15,129			22,804
Other accrued taxes		18,156			25,164
Self-insurance reserves		30,056			30,904
Other accrued liabilities		35,113			31,386
Total current liabilities		255,158			261,841
Other liabilities:
Long-term debt		769,824			769,563
Lease finance obligations		456,813			458,509
Deferred income taxes		102,687			109,260
Deferred vendor rebates		15,344			17,392
Other noncurrent liabilities		70,710			70,415
Total other liabilities		1,415,378			1,425,139
Commitments and contingencies (Note 3)
Shareholders’ equity:
Common stock, $.01 par value, 50,000,000 shares authorized; 22,663,515 and 22,523,114 issued and outstanding at December 24, 2009 and September 24, 2009, respectively		227			225
Additional paid-in capital		205,507			204,798
Accumulated other comprehensive deficit, net of deferred income taxes of $2,109 at December 24, 2009 and $2,555 at September 24, 2009		(3,323	)		(4,025	)
Retained earnings		240,108			266,177
Total shareholders’ equity		442,519			467,175
Total liabilities and shareholders’ equity	$	2,113,055		$	2,154,155

See Notes to Condensed Consolidated Financial Statements

3

THE PANTRY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended
	December 24,  2009			December 25,  2008
	(13 weeks)			(13 weeks)
				(As adjusted, see Note 1)
Revenues:
Merchandise	$	417,572		$	390,116
Fuel		1,318,826			1,242,365
Total revenues		1,736,398			1,632,481
Costs and operating expenses:
Merchandise cost of goods sold (exclusive of items shown separately below)		281,284			251,435
Fuel cost of goods sold (exclusive of items shown separately below)		1,261,553			1,112,224
Store operating		131,134			130,607
General and administrative		22,104			26,015
Impairment charges		32,637			309
Depreciation and amortization		28,969			26,882
Total costs and operating expenses		1,757,681			1,547,472
Income (loss) from operations		(21,283	)		85,009
Interest expense, net		21,755			22,516
Income (loss) before income taxes		(43,038	)		62,493
Income tax benefit (expense)		16,969			(23,956	)
Net income (loss)	$	(26,069	)	$	38,537
Earnings (loss) per share:
Basic	$	(1.17	)	$	1.73
Diluted	$	(1.17	)	$	1.73

See Notes to Condensed Consolidated Financial Statements

4

THE PANTRY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

	Three Months Ended
	December 24,  2009			December 25,  2008
	(13 weeks)			(13 weeks)
				(As adjusted, see Note 1)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	(26,069	)	$	38,537
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		28,969			26,882
Impairment charges		32,637			309
Amortization of convertible note discount		1,345			1,335
Provision (benefit) for deferred income taxes		(6,633	)		916
Stock-based compensation expense		873			2,771
Other		1,328			1,041
Changes in operating assets and liabilities, net of effects of acquisitions:
Receivables		(3,131	)		24,693
Inventories		(653	)		20,696
Prepaid expenses and other current assets		6,101			2,811
Other noncurrent assets		(981	)		872
Accounts payable		4,974			(36,254	)
Other current liabilities and accrued expenses		(16,009	)		6,347
Other noncurrent liabilities		(1,221	)		(2,003	)
Net cash provided by operating activities		21,530			88,953
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property and equipment		(9,435	)		(25,969	)
Proceeds from sales of property and equipment		355			579
Acquisitions of businesses, net of cash acquired		10			(1	)
Net cash used in investing activities		(9,070	)		(25,391	)
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments of long-term debt, including redemption premiums		(1,079	)		(24,560	)
Repayments of lease finance obligations		(1,554	)		(1,418	)
Other		(190	)		6
Net cash used in financing activities		(2,823	)		(25,972	)
Net increase in cash		9,637			37,590
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR		169,880			217,188
CASH AND CASH EQUIVALENTS, END OF YEAR	$	179,517		$	254,778
Cash paid during the period:
Interest	$	16,257		$	17,845
Income taxes	$	—		$	5,828
Non-cash investing and financing activities:
Accrued purchases of property and equipment	$	5,040		$	2,936

See Notes to Condensed Consolidated Financial Statements

5

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1—BASIS OF PRESENTATION

Unaudited Condensed Consolidated Financial Statements

The accompanying condensed consolidated financial statements include the accounts of The Pantry, Inc. and its wholly owned subsidiaries (references to “the Company,” “Pantry,” “The Pantry,” “we,” “us” and “our” mean The Pantry, Inc. and its subsidiaries). All intercompany transactions and balances have been eliminated in consolidation. Transactions and balances of each of our wholly owned subsidiaries are immaterial to the condensed consolidated financial statements.

The condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. The condensed consolidated financial statements have been prepared from the accounting records of The Pantry, Inc. and its subsidiaries, and all amounts as of December 24, 2009 and for the three months ended December 24, 2009 and December 25, 2008 are unaudited. Pursuant to Regulation S-X, certain information and note disclosures normally included in annual financial statements have been condensed or omitted. The information furnished reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented, and which are of a normal, recurring nature. The condensed consolidated balance sheet at September 24, 2009 has been derived from our audited consolidated financial statements.

The condensed consolidated financial statements included herein should be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 24, 2009.

Our results of operations for the three months ended December 24, 2009 and December 25, 2008 are not necessarily indicative of results to be expected for the full fiscal year. The convenience store industry in our marketing areas generally experiences higher levels of revenues during the summer months than during the winter months.

References in this report to “fiscal 2010” refer to our current fiscal year, which ends on September 30, 2010, and references to “fiscal 2009” refer to our fiscal year which ended September 24, 2009.

Accounting Period

We operate on a 52-53 week fiscal year ending on the last Thursday in September. Fiscal 2010 is a 53 week year. Fiscal 2009 was a 52 week year.

Reclassifications

Certain prior period amounts have been reclassified to conform to current classifications.  A new caption for impairment charges is included in the condensed consolidated statement of operations.  These prior period amounts were reclassified from general and administrative expenses to impairment charges.  Amounts previously included in miscellaneous expense are now included in general and administrative expenses.  Amounts previously included in gain on extinguishment of debt in our condensed consolidated statement of cash flows have now been included in other adjustments to reconcile net income to net cash provided by operating activities.  Amounts previously included in excesss income tax benefits from stock-based compensation arrangements have now been included in other financing activities.

The Pantry

As of December 24, 2009, we operated 1,658 convenience stores located in Florida (427), North Carolina (383), South Carolina (283), Georgia (132), Tennessee (104), Mississippi (100), Alabama (114), Virginia (50), Kentucky (29), Louisiana (27), and Indiana (9). Our stores offer a broad selection of merchandise, fuel and ancillary products and services designed to appeal to the convenience needs of our customers, including fuel, car care products and services, tobacco products, beer, soft drinks, self-service fast food and beverages, publications, dairy products, groceries, health and beauty aids, money orders and other ancillary services. In all states, except Alabama and Mississippi, we also sell lottery products. As of December 24, 2009, we operated 234 quick service restaurants within 224 of our locations and 278 of our stores included car wash facilities. Self-service fuel is sold at 1,633 locations, 1,112 of which sell fuel under major oil company brand names including BP®, Chevron®, CITGO®, Texaco®, ExxonMobil® and Shell ®.

Excise Taxes

We collect and remit federal and state excise taxes on petroleum products. Fuel sales and cost of goods sold included excise and other taxes of approximately $228.6 million and $221.6 million for the three months ended December 24, 2009 and December 25, 2008, respectively.

6

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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 fuel inventories. The fuel we purchase from our vendors is temperature adjusted. The fuel we sell at retail is sold at ambient temperatures. The volume of fuel we maintain in inventory can expand or contract with changes in temperature. Depending on the actual temperature experience and other factors, we may realize a net increase or decrease in the volume of our fuel inventory during our fiscal year. At interim periods, we record any projected increases or decreases through cost of goods sold through the year based on gallon volume, which we believe more fairly reflects our results by better matching our costs to our retail sales. As of December 24, 2009 and December 25, 2008, we have increased inventory by capitalizing variances of approximately $2.4 million and $699 thousand, respectively. At the end of any fiscal year, the entire variance is absorbed during the year into cost of goods sold.

New Accounting Standards

In August 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2009-05, Fair Value Measurements and Disclosures (Topic 820): Measuring Liabilities at Fair Value, which provides guidance on measuring the fair value of liabilities under FASB Accounting Standards Codification™  (the "ASC") Topic 820 (formerly, Statement 157).  ASU 2009-05 was adopted in the first quarter of fiscal 2010 and did not have an impact on our financial statements.

In April 2008, the FASB issued FSP FAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”) which was primarily codified into Topic 350 “Intangibles – Goodwill and Other” in the ASC.  This guidance amends the factors that should be considered in developing renewal or extension assumptions used in determining the useful life of a recognized intangible asset under previous guidance of goodwill and other intangible assets.  The purpose of this standard is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 Goodwill and Other Intangible Assets which was primarily codified into Topic 350 in the ASC and the period of expected cash flows used to measure the fair value of an asset under SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141(R)”) which was primarily codified into Topic 805 “Business Combinations” in the ASC, and other GAAP.  This guidance was adopted in the first quarter of fiscal 2010 and did not have an impact on our financial statements.

In March 2008, the FASB concluded its re-deliberations on FSP APB No. 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) which was primarily codified into Topic 470 “Debt” in the ASC, deciding to retain its original proposal related to this matter. This guidance applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement, unless the embedded conversion option is required to be separately accounted for as a derivative under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities which was primarily codified into Topic 815 “Derivatives and Hedging” in the ASC. This guidance will require the issuer of a convertible debt instrument within its scope to separately account for the liability and equity components in a manner that will reflect the issuer’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods.  The excess of the principal amount of the liability component over its initial fair value must be amortized to interest cost using the interest method.  This guidance was effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods thereafter and was to be applied retrospectively to all periods presented.  Early adoption was not permitted.  The provisions of this guidance apply to our senior subordinated convertible notes (our “convertible notes”).  This guidance did not impact our actual past or future cash flows.  Although this guidance will not impact our actual past, current or future cash flows, the retrospective application resulted in a $1.5 million increase to interest expense, net for the first quarter of fiscal 2009.

The following tables set forth the effect of the retrospective application of FSP 14-1 on certain previously reported line items:

	September 24, 2009
	As previously reported		Adjustment			As adjusted
	(in thousands)
Condensed Consolidated Balance Sheet
Other noncurrent assets	$	41,080	$	(496	)	$	40,584
Long-term debt		787,940		(18,377	)		769,563
Deferred income taxes		102,311		6,949			109,260
Additional paid-in-capital		180,327		24,471			204,798
Retained earnings		279,716		(13,539	)		266,177

7

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

	Three Months Ended December 25, 2008
	As previously reported			Adjustment			As adjusted
	(in thousands)
Condensed Consolidated Statements of Operations
Interest expense, net	$	21,042		$	1,474		$	22,516
Income tax expense		(24,529	)		573			(23,956	)
Net income		39,438			(901	)		38,537
Earnings per share:
Basic	$	1.78		$	(0.05	)	$	1.73
Diluted	$	1.77		$	(0.04	)	$	1.73

	Three Months Ended December 25, 2008
	As previously reported		Adjustment			As adjusted
	(in thousands)
Condensed Consolidated Statements of Cash Flows
Net income	$	39,438	$	(901	)	$	38,537
Amortization of convertible debt discount		—		1,335			1,335
Provision for deferred income taxes		1,489		(573	)		916
Other		902		139			1,041

The debt and equity components recognized for the Company's convertible notes as of September 24, 2009 were as follows:

Principal amount of convertible notes	$	125,975
Unamortized discount (1)		18,377
Net carrying amount	$	107,598
Additional paid-in capital	$	24,471

(1) The remaining recognition period is 38 months as of September 24, 2009

The amount of interest expense recognized and the effective interest rate for the Company's convertible notes were as follows:

	Three Months Ended
	December 24, 2009			December 25, 2008
Contractual coupon interest	$	955		$	1,136
Amortization of discount on convertible notes		1,345			1,335
Interest expense	$	2,300		$	2,471
Effective interest rate		8.4	%		8.4	%

8

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

In February 2008, the FASB issued FSP FAS No. 157-2, Effective Date of FASB Statement No. 157 which was primarily codified into Topic 820 in the ASC, which delayed the effective date of previous fair value measurement and disclosure guidance to September 25, 2009 for us and for all nonfinancial assets and nonfinancial liabilities, except for items recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  We adopted this new fair value measurement and disclosure guidance in our first quarter of fiscal 2010 and the impact of adoption was to increase our disclosures regarding fair value measurements.  See Nore 10-Fair Value Measurements for the required disclosure.

In December 2007, the FASB issued SFAS No. 141(R), as amended and clarified by FSP 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies which was primarily codified into Topic 805 in the ASC. This guidance requires the acquiring entity in a business combination to recognize all assets acquired and liabilities assumed in the transaction, establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed and requires the acquirer to disclose the nature and financial effect of the business combination. This guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first fiscal year beginning on or after December 15, 2008.  Adoption of this guidance will affect acquisitions we make beginning in the first quarter of fiscal 2010, however there were no acquisitions made during our first quarter of fiscal 2010.

NOTE 2—GOODWILL AND OTHER INTANGIBLE ASSETS

We conduct our annual impairment assessment of goodwill in the second quarter of each fiscal year. We test goodwill for possible impairment on an annual basis and more frequently if impairment indicators arise. An impairment indicator represents an event or change in circumstances that would more likely than not reduce the fair value of the reporting unit below its carrying amount. We conduct our annual assessment of indefinite-lived intangibles in the fourth quarter of each fiscal year. Indefinite-lived intangibles are also reviewed for impairment more frequently if impairment indicators arise. On December 24, 2009, we performed interim impairment testing of our Petro Express® indefinite-lived tradename as a result of a strategic decision by management to discontinue the use of the tradename at existing and future store locations. See Note 11-Asset Impairments, for more information.

A significant amount of judgment is involved in determining if an indicator of goodwill impairment has occurred. Management monitors events and changes in circumstances in between annual testing dates to determine if these events or changes in circumstances are an impairment indicator. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements. We determined that there were no indicators of impairment related to goodwill in the first quarter of fiscal 2010. Market capitalization was below our book value during this period. However, the difference between our market capitalization and our book value was not significant and sustained and the variance can be explained by application of a reasonable control premium to our share price.

We are in the process of performing our annual goodwill impairment assessment in the second quarter of fiscal 2010. In accordance with our policy the annual assessment date in fiscal 2010 is January 21, 2010 and we will complete step 1 in the second quarter of fiscal 2010. If our book value exceeds our fair value we will proceed to step 2 of the goodwill impairment test to determine the amount of the impairment, if any. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill shall be determined in the same manner as the amount of goodwill recognized in a business combination is determined. That is, an entity shall allocate the fair value of a reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible assets such as the Kangaroo Express® brand) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The fair value of the assets and liabilities reflects market conditions, thus volatility in prices could have a material impact on the determination of the implied fair value of the reporting unit goodwill at the impairment test date.  If we are required to perform step 2 of the goodwill impairment test it may result in significant impairment of goodwill that could have a material adverse impact on our consolidated financial statements.

9

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following table reflects goodwill and other intangible asset balances as of September 24, 2009 and the activity thereafter through December 24, 2009 (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			2.0			11.2			24.3
Gross balance at September 24, 2009	$	634,703		$	21,250		$	5,650		$	1,928		$	12,728
Purchase accounting adjustments (1)		(710	)		—			—			—			—
Impairment charges		—			(21,250	)		—			—			—
Gross balance at December 24, 2009	$	633,993		$	—		$	5,650		$	1,928		$	12,728
Accumulated amortization at September 24, 2009							$	(3,988	)	$	(1,049	)	$	(6,632	)
Amortization								(237	)		(39	)		(322	)
Accumulated amortization at December 24, 2009							$	(4,225	)	$	(1,088	)	$	(6,954	)
Net book value	$	633,993		$	—		$	1,425		$	840		$	5,774

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

The estimated future amortization expense for trade names, customer agreements and non-compete agreements as of December 24, 2009 is as follows (amounts in thousands):

Fiscal Year Ending September:
2010	$	1,289
2011		1,203
2012		389
2013		345
2014		334
Thereafter		4,479
Total estimated amortization expense	$	8,039

NOTE 3—COMMITMENTS AND CONTINGENCIES

As of December 24, 2009, we were contingently liable for outstanding letters of credit in the amount of approximately $83.5 million primarily related to several self-insurance programs, vendor contracts and regulatory requirements. The letters of credit are not to be drawn against unless we default on the timely payment of related liabilities.

Since the beginning of fiscal 2007, over 45 class action lawsuits have been filed in federal courts across the country against numerous companies in the petroleum industry. Major petroleum companies and significant retailers in the industry have been named as defendants in these lawsuits. To date, we have been named as a defendant in seven cases: one in Florida (Cozza, et al. v. Murphy Oil USA, Inc. et al., S.D. Fla., No. 9:07-cv-80156-DMM, filed 2/16/07); one in Delaware (Becker, et al. v. Marathon Petroleum Company LLC, et al., D. Del., No. 1:07-cv-00136, filed 3/7/07); one in North Carolina (Neese, et al. v. Abercrombie Oil Company, Inc., et al., E.D.N.C., No. 5:07-cv-00091-FL, filed 3/7/07); one in Alabama (Snable, et al. v. Murphy Oil USA, Inc., et al., N.D. Ala., No. 7:07-cv-00535-LSC, filed 3/26/07); one in Georgia (Rutherford, et al. v. Murphy Oil USA, Inc., et al., No. 4:07-cv-00113-HLM, filed 6/5/07); one in Tennessee (Shields, et al. v. RaceTrac Petroleum, Inc., et al., No. 1:07-cv-00169, filed 7/13/07); and one in South Carolina (Korleski v. BP Corporation North America, Inc., et al., D.S.C., No 6:07-cv-03218-MDL, filed 9/24/07). Pursuant to an Order entered by the Joint Panel on Multi-District Litigation, all of the cases, including the seven in which we are named, have been  transferred to the United States District Court for the District of Kansas and consolidated for all pre-trial proceedings. The plaintiffs in the lawsuits generally allege that they are retail purchasers who received less motor fuel than the defendants agreed to deliver because the defendants measured the amount of motor fuel they delivered in non-temperature adjusted gallons which,

10

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

at higher temperatures, contain less energy. These cases seek, among other relief, an order requiring the defendants to install temperature adjusting equipment on their retail motor fuel dispensing devices. In certain of the cases, including some of the cases in which we are named, plaintiffs also have alleged that because defendants pay fuel taxes based on temperature adjusted 60 degree gallons, but allegedly collect taxes from consumers on non-temperature adjusted gallons, defendants receive a greater amount of tax from consumers than they paid on the same gallon of fuel. The plaintiffs in these cases seek, among other relief, recovery of excess taxes paid and punitive damages. Both types of cases seek compensatory damages, injunctive relief, attorneys’ fees and costs, and prejudgment interest. The defendants filed motions to dismiss all cases for failure to state a claim, which were denied by the court on February 21, 2008.  A number of the defendants, including the Company, subsequently moved to dismiss for lack of subject matter jurisdiction or, in the alternative, for summary judgment on the grounds that plaintiffs’ claims constitute non-justiciable “political questions.”  The Court denied the defendants’ motion to dismiss on political question grounds on December 3, 2009. Plaintiffs subsequently filed a motion with the court to certify an interlocutory appeal to the United States Court of Appeals for the Tenth Circuit. Plaintiffs’ motions for class certification, which defendants have opposed, remain pending.  We continue to believe that there are substantial factual and legal defenses to the theories alleged in these lawsuits, and intend to vigorously defend against the claims. As the cases are at an early stage, we cannot at this time estimate our ultimate exposure to loss or liability, if any, related to these lawsuits.

On September 29, 2009, Wimbreth Chism and Charlotte Minor, on behalf of themselves and on behalf of classes of those similarly situated, filed suit against The Pantry in the Circuit Court of Tuscaloosa County, Alabama (Wimbreth Chism et.al. v. The Pantry, Inc d/b/a Kangaroo Express, No. 63-CV-2009-900612.00) (“Chism matter”).  On November 19, 2009, Andrea Gee, on her own behalf and on behalf of those similarly situated, filed suit against The Pantry in the United States District Court for the Middle District of Florida (Gee, et. al. v. The Pantry, Inc. a/k/a Kangaroo Express No 3109-CV-1140) (“Gee matter”).  The plaintiffs in the Chism and Gee matters seek collective action status and assert claims on behalf of present and former employees for unpaid wages under the Fair Labor Standards Act of 1938, as amended (the “FLSA”).  The plaintiffs in these lawsuits generally allege that they are or were employed by The Pantry as store managers, but were misclassified as exempt, and as such are or were entitled to overtime compensation.  The suit seeks permission to give notice of this action to all current and former employees who were employed as store managers during the three years immediately preceding the filing of this suit.  The plaintiffs also seek damages, liquidated damages, costs, pre-judgment interest and attorneys’ fees, and any injunctive and/or declaratory relief to which they may be entitled.  On October 28, 2009, we removed the Chism matter to the United States District Court for the Northern District of Alabama, Western Division, and on November 18, 2009 filed an Answer to the Complaint.  On January 12, 2010, we filed a motion to transfer the Gee matter to the United States District Court, Northern District of Alabama, Western Division, and the motion is currently pending.  We believe that there are substantial factual and legal defenses to the theories alleged in these lawsuits, and intend to vigorously defend against the claims, including plaintiffs' efforts for collective action status.  As the cases are at a very early stage, we cannot at this time estimate our ultimate exposure to loss or liability, if any, related to these lawsuits.

On October 19, 2009, Patrick Amason, on behalf of himself and a putative class of similarly situated individuals, filed suit against The Pantry in the United States District Court for the Northern District of Alabama, Western Division (Patrick Amason v. Kangaroo Express and The Pantry, Inc. No. CV-09-P-2117-W).  The plaintiff seeks class action status and alleges that The Pantry included more information than is permitted on electronically printed credit and debit card receipts in willful violation of the Fair and Accurate Credit Transactions Act, codified at 15 U.S.C. § 1681c(g).  The plaintiff seeks an award of statutory damages for each alleged willful violation of the statute, as well as attorneys' fees, costs, punitive damages and a permanent injunction against the alleged unlawful practice.  We believe that there are substantial factual and legal defenses to the theories alleged in the lawsuit, and intend to vigorously defend against the claims, including plaintiffs' efforts for class action status.  As the case is at a very early stage, we cannot at this time estimate our ultimate exposure to loss or liability, if any, related to this lawsuit.

We are party to various other legal actions in the ordinary course of our business. We believe these other actions are routine in nature and incidental to the operation of our business. While the outcome of these actions cannot be predicted with certainty, management’s present judgment is that the ultimate resolution of these matters will not have a material adverse impact on our business, financial condition, results of operations, cash flows or prospects. If, however, our assessment of these actions is inaccurate, or there are any significant adverse developments in these actions, our business, financial condition, results of operations, cash flows and prospects 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 requests from the Securities and Exchange Commission (“SEC”) that we voluntarily provide certain information to the SEC Staff in connection with our sale-leaseback accounting, our decision to restate our financial statements with respect to sale-leaseback accounting and other lease accounting matters. In November 2006, the SEC informed us that in connection with the inquiry it had issued a formal order of private investigation. We are cooperating with the SEC in this ongoing investigation.

Our Board of Directors has adopted employment agreements for several of our executives, which create certain liabilities in the event of the termination of these executives following a change of control. These agreements have original terms of at least one year and specify the executive’s current compensation, benefits and perquisites, the executive’s entitlements upon termination of employment and other employment rights and responsibilities.

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(Unaudited)

Unamortized Liabilities Associated with Vendor Payments

Service and supply allowances are amortized over the life of each service or supply agreement, respectively, in accordance with the agreement’s specific terms. As of December 24, 2009, other accrued liabilities and deferred vendor rebates included the unamortized liabilities associated with these payments of $36 thousand and $15.3 million, respectively. As of September 24, 2009, other accrued liabilities and deferred vendor rebates included the unamortized liabilities associated with these payments of $16 thousand and $17.4 million, respectively.

 McLane Company, Inc.—we purchase over 55% of our general merchandise from a single wholesaler, McLane Company, Inc.  Our arrangement with McLane is governed by a distribution service agreement which expires in December 2014. We receive annual service allowances based on the number of stores operating on each contract anniversary date. The distribution service agreement requires us to reimburse McLane the unearned, unamortized portion, if any, of all service allowance payments received to date if the agreement is terminated under certain conditions. We amortize service allowances received as a reduction to merchandise cost of goods sold using the 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 fuel at market prices. The initial terms of these agreements have expiration dates ranging from 2010 to 2013. In connection with these agreements, we may receive upfront vendor allowances, volume incentive payments and other vendor assistance payments. If we default under the terms of any contract or terminate any 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. These payments are amortized and recognized as a reduction to fuel cost of goods sold using the specific amortization periods based on the terms of each agreement, either using the straight-line method or based on fuel volume purchased.

Environmental Liabilities and Contingencies

We are subject to various federal, state and local environmental laws and regulations. We make financial expenditures in order to comply with regulations governing underground storage tanks adopted by federal, state and local regulatory agencies. In particular, at the federal level, the Resource Conservation and Recovery Act of 1976, as amended, requires the U.S. Environmental Protection Agency 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 laws and regulations require us to provide and maintain evidence that we are taking financial responsibility for corrective action and compensating third parties in the event of a release from our underground storage tank systems. In order to comply with these requirements, as of December 24, 2009, we maintained letters of credit in the aggregate amount of approximately $1.4 million in favor of state environmental agencies in North Carolina, South Carolina, Virginia, Georgia, Indiana, Tennessee, Kentucky and Louisiana.

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

As of December 24, 2009, environmental reserves of approximately $1.1 million and $22.1 million are included in other accrued liabilities and other noncurrent liabilities, respectively. As of September 24, 2009, environmental reserves of approximately $1.1 million and $21.6 million are included in other accrued liabilities and other noncurrent liabilities, respectively. These environmental reserves represent our estimates for future expenditures for remediation, tank removal and litigation associated with 278 and 268 known contaminated sites as of December 24, 2009 and September 24, 2009, respectively, as a result of releases (e.g., overfills, spills and underground storage tank releases) and are based on current regulations, historical results and certain other factors. We estimate that approximately $20.5 million of our environmental obligations will be funded by state trust funds and third-party insurance; as a result, we estimate we will spend approximately $2.7 million for remediation, tank removal and litigation. Also, as of December 24, 2009 and September 24, 2009, there were an additional 510 and 513 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 at 8.75% to determine the reserve.

We anticipate that we will be reimbursed for expenditures from state trust funds and private insurance. As of December 24, 2009, anticipated reimbursements of $20.9 million are recorded as other noncurrent assets and $5.1 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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.

Fuel Contractual Contingencies

Our Branded Jobber Contract with BP® sets forth minimum volume requirements per year and a minimum volume guarantee if such minimum volume requirements are not met. Our obligation to purchase a minimum volume of BP® branded fuel is subject to increase each year during the remaining term of the agreement and is measured over a one-year period. Subject to certain adjustments, in any one-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. We did not meet the requirement for the one-year period ending September 30, 2009. While the amount owed to BP ® is still being negotiated, the final amount, if any, we will be required to reimburse BP ® is believed to be immaterial.  The minimum requirement for the one-year period ending September 30, 2010 is approximately 582 million gallons of BP ® branded product.  Based on current forecasts, we anticipate the shortfall, if any, to the minimum volume requirements to be immaterial for the one-year period ended September 30, 2010.

NOTE 4—LONG-TERM DEBT

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

	December 24, 2009			September 24, 2009
				(As adjusted, see Note 1)
Senior credit facility; interest payable monthly at LIBOR plus 1.50%; principal  due in quarterly installments through May 15, 2014	$	418,009		$	419,076
Senior subordinated notes payable; due February 15, 2014; interest payable  semi-annually at 7.75%		247,000			247,000
Senior subordinated convertible notes payable; due November 15, 2012; interest payable semi-annually at 3.0%		125,975			125,975
Other notes payable; various interest rates and maturity dates		194			206
Total long-term debt		791,178			792,257
Less—current maturities		(4,322	)		(4,317	)
Less—unamortized debt discount		(17,032	)		(18,377	)
Long-term debt, net of current maturities and unamortized debt discount	$	769,824		$	769,563

We are party to a Third Amended and Restated Credit Agreement (“credit agreement”), which defines the terms of our existing $675.0 million senior credit facility. Our senior credit facility includes: (i) a $225.0 million six-year revolving credit facility; (ii) a $350.0 million seven-year initial term loan facility; and (iii) a $100.0 million seven-year delayed draw term loan facility.  In addition, we may at any time incur up to $200.0 million in incremental facilities in the form of additional revolving or term loans so long as (i) such incremental facilities would not result in a default as defined in our credit agreement and (ii) we would be able to satisfy certain other conditions set forth in our credit agreement. The revolving credit facility matures in May 2013, and the term loan facility and delayed draw term loan facility mature in May 2014. We incurred approximately $2.5 million in costs associated with our current senior credit facility. We deferred these costs and are amortizing them over the life of the facility.

If our consolidated total leverage ratio (as defined in our credit agreement) is greater than 3.50 to 1.0 at the end of any fiscal year, the terms of our credit agreement require us to prepay our term loans using up to 50% of our excess cash flow (as defined in our credit agreement).  At the end of fiscal 2008, our consolidated total leverage ratio was in excess of 3.50 to 1.0, and we were required to make a principal payment of approximately $22.8 million during the first six months of fiscal 2009. We made this payment during the first quarter of fiscal 2009.  No excess cash flow payment was required for the fiscal year ended September 24, 2009.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Our borrowings under the term loans bear interest at our option, at either 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 total leverage ratio (as defined in our credit agreement) is less than 4.00 to 1.00, the applicable margins on the borrowings under the term loans are decreased by 0.25%. Changes, if any, to the applicable margins are effective five business days after we deliver to our lenders the financial information for the previous fiscal quarter that is required under the terms of our credit agreement.  Our consolidated total leverage ratio was less than 4.00 to 1.00 for the fourth quarter of fiscal 2009, so the applicable margins on our term loans during the first quarter of fiscal 2010 were 0.25% for base rate term loans and 1.50% for LIBOR rate term loans.

As of December 24, 2009, there were no outstanding borrowings under our revolving credit facility and we had approximately $83.5 million of standby letters of credit issued under the facility. As a result, we had approximately $141.5 million in available borrowing capacity under our revolving credit facility (approximately $36.5 million of which was available for issuance of letters of credit). The letters of credit primarily related to several self-insurance programs, vendor contracts and regulatory requirements. The LIBOR associated with our senior credit facility resets periodically, and was reset to 0.24% on November 30, 2009. As of December 24, 2009 we were in compliance with the covenants and restrictions contained in our senior credit facility.

We have outstanding $247.0 million of our 7.75% senior subordinated notes due 2014. We incurred approximately $2.5 million in costs associated with the sale of these notes. We deferred these costs and are amortizing them over the life of the notes. During the second quarter of fiscal 2009 we repurchased $3.0 million in principal amount of the senior subordinated notes on the open market resulting in a gain on the extinguishment of debt, net of deferred loan costs, of approximately $600 thousand.

As of September 25, 2008, we had outstanding $150.0 million of convertible notes. During the second quarter of fiscal 2009, we repurchased approximately $24.0 million in principal amount of our convertible notes on the open market resulting in a gain on the extinguishment of debt, net of deferred loan costs, of approximately $6.5 million.  Our convertible notes bear interest at an annual rate of 3.0%, payable semi-annually on May 15th and November 15th of each year. 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 December 24, 2009, our closing stock price was $13.50. 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 of the outstanding convertible notes as a current liability. 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 additional 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 3,206,278.

The remaining annual maturities of our long-term debt as of December 24, 2009 are as follows (amounts in thousands):

Fiscal Year Ending September:
2010	$	3,238
2011		4,321
2012		4,325
2013		130,294
2014		649,000
Total principal payments	$	791,178

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The fair value of our indebtedness approximated $722.4 million at December 24, 2009. Substantially all of our net assets are restricted as to payment of dividends and other distributions.

NOTE 5—DERIVATIVE FINANCIAL INSTRUMENTS

We enter into interest rate swap agreements to modify the interest rate 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) and our risk-management objectives and strategies for entering into hedge transactions. 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 or loss. 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 the fair value of the hedge instrument are recognized in earnings.

The Company's derivative and hedging activities are presented in the following tables (in thousands):

	Location of Fair Value  in Balance Sheets	Fair Value December 24, 2009		Fair Value September 24, 2009
Derivatives designated as hedging instruments
Interest rate contracts	Other accrued liabilities	$	702	$	1,272
Interest rate contracts	Other noncurrent liabilities	$	4,731	$	5,308

	Location of Loss on Derivatives in Statements of Operations	Pre-tax Loss for Three Months Ended
		December 24, 2009			December 25, 2008
Derivatives accounted for as cash flow hedging relationships
Interest rate contracts	Interest expense, net	$	(1,636	)	$	(110	)

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Derivatives accounted for  as cash flow hedging relationships	Amount of Loss Recognized in OCI on Derivative (Effective Portion) Three Months Ended						Location of Loss Reclassified from Accumulated OCI into Income (Effective Portion)	Amount of Loss Reclassified from Accumulated OCI into Income (Effective Portion) Three Months Ended						Location of Loss Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)		Amount of Loss Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) Three Months Ended
	December 24, 2009			December 25, 2008				December 24, 2009			December 25, 2008					December 24, 2009		December 25, 2008
Interest rate contracts	$	(298	)	$	(5,265	)	Interest expense, net	$	(1,000	)	$	(67	)		N/A	$	—	$	—

Interest income (expense) was insignificant for all periods presented for the mark-to-market adjustments associated with hedge ineffectiveness.

The fair values for our interest rate swaps are obtained from dealer quotes. These values represent the estimated amounts that 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 December 24, 2009, other accrued liabilities and other noncurrent liabilities included derivative liabilities of approximately $702 thousand and $4.7 million, respectively. At September 24, 2009, other accrued liabilities and other noncurrent liabilities included derivative liabilities of approximately $1.3 million and $5.3 million, respectively.  Cash flow hedges at December 24, 2009 represent interest rate swaps with a notional amount of $200.0 million, a weighted-average pay rate of 3.11% and have various settlement dates, the latest of which is October 2011.

NOTE 6—STOCK COMPENSATION PLANS

During the first quarter of fiscal 2010, we granted options to purchase 81 thousand shares of our common stock at purchase prices equal to the fair market value of the related common stock on the date the options were granted. These options had an aggregate fair value of $479 thousand, which will be amortized to expense over the options’ requisite service periods. During the first quarter of fiscal 2010, we granted 118 thousand shares of restricted stock with an aggregate fair value of $1.7 million, which will be amortized over the requisite service period. We recognized $873 thousand (of which $481 thousand related to restricted stock) and $2.8 million (of which $965 thousand related to restricted stock) in stock-based compensation expense in general and administrative expenses during the first quarter of fiscal 2010 and fiscal 2009, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

NOTE 7—COMPREHENSIVE INCOME

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

	Three Months Ended
	December 24, 2009			December 25, 2008
Net (loss) income	$	(26,069	)	$	38,537
Other comprehensive income:
Net unrealized gains (losses) on qualifying cash flow hedges (net of deferred income taxes of $446 and $3,304, respectively)		702			(5,198	)
Comprehensive (loss) income	$	(25,367	)	$	33,339

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

	Three Months Ended
	December 24, 2009			December 25, 2008
Unrealized losses on qualifying cash flow hedges	$	(298	)	$	(5,265	)
Reclassification adjustment recorded as an increase in interest expense		1,000			67
Net unrealized gains (losses) on qualifying cash flow hedges	$	702		$	(5,198	)

NOTE 8—INTEREST EXPENSE, NET

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

	Three Months Ended
	December 24,  2009			December 25,  2008
Interest on long-term debt, including amortization of deferred financing costs	$	8,012		$	11,475
Interest on lease finance obligations		10,816			10,565
Interest rate swap settlements		1,636			110
Amortization of convertible note discount		1,345			1,335
Capitalized interest		(17	)		(85	)
Miscellaneous		11			(261	)
Subtotal: Interest expense		21,803			23,139
Interest income		(48	)		(623	)
Interest expense, net	$	21,755		$	22,516

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

NOTE 9—EARNINGS PER SHARE AND COMMON STOCK

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, restricted stock, stock options and convertible notes using the “treasury stock” method.

The following table reflects the calculation of basic and diluted earnings per share for the periods presented (amounts in thousands, except per share data):

	Three Months Ended
	December 24,  2009			December 25,  2008
Net (loss) income	$	(26,069	)	$	38,537
(Loss) earnings per share—basic:
Weighted-average shares outstanding		22,279			22,213
(Loss) earnings per share—basic	$	(1.17	)	$	1.73
(Loss) earnings per share—diluted:
Weighted-average shares outstanding		22,279			22,213
Dilutive impact of options		—			25
Weighted-average shares and potential dilutive shares outstanding		22,279			22,238
(Loss) earnings per share—diluted	$	(1.17	)	$	1.73

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 1.3 million for each of the first quarter of fiscal 2010 and fiscal 2009.

NOTE 10—FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance for accounting for fair value measurements established a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The three levels of inputs are defined as follows:

Tier	Description
Level 1	Defined as observable inputs such as quoted prices in active markets
Level 2	Defined as inputs other than quoted prices in active markets that are either directly or indirectly observable
Level 3	Defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions

Our assets and liabilities that are measured at fair value on a recurring basis are our derivative instruments. We are exposed to various market risks, including changes in interest rates.  We periodically enter into certain interest rate swap agreements to effectively convert floating rate debt to a fixed rate basis and to hedge anticipated future financings similar to those described in Note 5—Derivative Financial Instruments.

The valuation of our financial instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and while there are no quoted prices in active markets, it uses observable market-based inputs, including interest rate curves.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

For assets and liabilities measured at fair value on a recurring basis, quantitative disclosure of the fair value for each major category of assets and liabilities is presented below:

				Fair Value Measurements at Reporting Date Using (in thousands)
				Quoted prices
				in active markets		Significant other			Significant
				for identical assets		observable inputs			unobservable inputs
	December 24, 2009			Level 1		Level 2			Level 3
Liabilities:
Derivative financial instruments (1)	$	(5,433	)		—	$	(5,433	)		—
(1) Included in “Other accrued liabilities” and “Other noncurrent liabilities” in the accompanying condensed consolidated balance sheet.

				Fair Value Measurements at Reporting Date Using (in thousands)
				Quoted prices
				in active markets		Significant other			Significant
				for identical assets		observable inputs			unobservable inputs
	September 24, 2009			Level 1		Level 2			Level 3
Liabilities:
Derivative financial instruments (1)	$	(6,580	)		—	$	(6,580	)		—
(1) Included in “Other accrued liabilities” and “Other noncurrent liabilities” in the accompanying condensed consolidated balance sheet.

During the first quarter of fiscal 2010, we had no significant measurements of assets or liabilities at fair value on a nonrecurring basis subsequent to their initial recognition, except as it relates to impairment of intangible assets and long-lived tangible assets as described in Note 11—Asset Impairments.

In determining the impairment of  the Petro Express ® tradename, we determined fair value using a discounted cash flow model that incorporates the relief from royalty method.  Significant assumptions included, among other things, estimates of future cash flows, royalty rates and discount rates.  While some of these inputs are observable, significant judgment was required to select certain inputs from observed market data.  We classify these measurements as Level 3.

In determining the impairment of land parcels and operating stores, we determined the fair values by estimating selling prices of the assets.  We generally determine the estimated selling prices using information from comparable sales of similar assets and assumptions about demand in the market for these assets. While some of these inputs are observable, significant judgment was required to select certain inputs from observed market data.  We classify these measurements as Level 3.

For non-financial assets and liabilities measured at fair value on a non-recurring basis, quantitative disclosure of the fair value for each major category and any resulting realized losses included in earnings is presented below. Because these assets are not measured at fair value on a recurring basis, certain carrying amounts and fair value measurements presented in the table may reflect values at earlier measurement dates and may no longer represent their fair values at December 24, 2009.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

	Fair Value Measurements Non-recurring Basis (in thousands)
	Three Months Ended December 24, 2009		Quoted prices in active markets for identical assets Level 1		Significant other observable inputs Level 2		Significant unobservable inputs Level 3		Total gains/(losses) Level 3
Assets:
Tradenames (1)	$	—	$	—	$	—	$	—	$	(21,250	)
Land (2)		10,194		—		—		10,194		(7,769	)
Operating stores (2)		4,496		—		—		4,496		(3,618	)
Total assets	$	14,690	$	—	$	—	$	14,690	$	(32,637	)
(1) Included in "Other intangible assets" in the accompanying condensed consolidated balance sheet.
(2) Included in "Property and equipment, net" in the accompanying condensed consolidated balance sheet.

Our only financial instruments not measured at fair value on a recurring basis include cash and cash equivalents, receivables, accounts payable, accrued liabilities and long-term debt and are reflected in the financial statements at cost.  With the exception of long-term debt, cost approximates fair value for these items due to their short term nature. Estimated fair values for long-term debt have been determined using available market information, including reported trades and benchmark yields. The carrying amounts and the related estimated fair value of our long-term debt is disclosed in Note 4—Long-Term Debt.

NOTE 11— ASSET IMPAIRMENTS

In December 2009, management made a strategic decision to discontinue the use of the Petro Express® tradename at existing and future store locations. In reaching this conclusion, management considered, among other things, the impact of the December 2009 announcement by Chevron® that it was withdrawing its motor fuels operations in select areas of the East Coast. Our Petro Express® stores are located in the impacted regions and the vast majority of the stores will be required to de-brand the retail fuel operations by mid year 2010. Given the required de-branding, management made a decision to concurrently re-image both the retail fuel operations and the operating stores to capitalize on synergies in the re-branding process. As a result, we performed interim impairment testing of the Petro Express® tradename on December 24, 2009.  We determined fair value using a discounted cash flow model that incorporates the relief from royalty method and compared the fair value  to the carrying amount to test for impairment.  As a result of the impairment test we recorded an impairment charge of approximately $21.3 million during the three months ended December 24, 2009. There were no tradename impairments during the three months ended December 25, 2008.

In December 2009, management made a strategic decision not to develop stores on certain land parcels owned by the Company.  As a result, the carrying values of these land parcels were not recoverable through estimated undiscounted future cash flows.  We estimated the fair value of these land parcels and as a result, we recorded impairment charges related to land parcels of approximately $7.8 million during the three months ended December 24, 2009. There were no land parcels impaired during the three months ended December 25, 2008.

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THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

In the quarters ended December 24, 2009 and December 25, 2008 we tested operating stores for impairment.  For each operating store where events or changes in circumstances indicated that the carrying amount of the assets might not be recoverable we compared the carrying amount to its estimated future undiscounted cash flows to determine recoverability. If the sum of the estimated undiscounted cash flows did not exceed the carrying value we then estimated the fair value of these operating stores to measure the impairment, if any.  As a result of this testing, we recorded impairment charges related to operating stores of approximately $3.6 million and $309 thousand during the three months ended December 24, 2009 and December 25, 2008, respectively.

The impairment evaluation process requires management to make estimates and assumptions with regard to fair value.  Actual values may differ significantly from these estimates.  Such differences could result in future impairment that could have a material impact on our consolidated financial statements.  The impairment charges recorded during the three months ended December 24, 2009 and December 25, 2008 are presented in the table below (amounts in thousands):

	Three Months Ended
	December 24, 2009		December 25, 2008
Tradenames	$	21,250	$	—
Land		7,769		—
Operating stores		3,618		309
Impairment charges	$	32,637	$	309

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

This discussion and analysis of our financial condition and results of operations is provided to increase the understanding of, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying notes appearing elsewhere in this report. Additional discussion and analysis related to our business is contained in our Annual Report on Form 10-K for the fiscal year ended September 24, 2009. References to “the Company,” “The Pantry,” “Pantry,” “we,” “us” and “our” mean The Pantry, Inc. and its subsidiaries.

Safe Harbor Discussion

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

• competitive pressures from convenience stores, fuel stations and other non-traditional retailers located in our markets;

• volatility in crude oil and wholesale petroleum costs;

• political conditions in crude oil producing regions and global demand;

• changes in economic conditions generally and in the markets we serve;

• consumer behavior, travel and tourism trends;

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

• unfavorable weather conditions or other trends or developments in the southeastern United States;

• inability to identify, acquire and integrate new stores;

• financial leverage and debt covenants;

• federal and state environmental, tobacco and other laws and regulations;

• dependence on one principal supplier for merchandise and two principal suppliers for fuel;

• dependence on senior management;

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

• inability to maintain an effective system of internal control over financial reporting; and

• other unforeseen factors.

For a discussion of these and other risks and uncertainties, please refer to “Part II.—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 February 2, 2010. 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.

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Executive Overview

Our net loss for the first quarter of fiscal 2010 was $26.1 million, or $1.17 per share, which included the after-tax impact of impairment charges of $20.0 million or $0.90 per share, compared to net income of $38.5 million, or $1.73 per share for the first quarter of fiscal 2009.

Cigarette price inflation resulting from federal and state excise tax increases continued to positively impact merchandise comparable store sales and negatively impact merchandise gross margins.  Merchandise comparable store sales increased 5.2% versus a 3.0% decline in the prior year first quarter and a 1.6% increase in the fourth quarter of fiscal 2009.  Our merchandise gross margin for the first quarter of fiscal 2010 was 32.6%, compared with 35.5% in last year’s first quarter and 34.0% in the fourth quarter of fiscal 2009.

Fuel gross profits were impacted by rising fuel prices and were 11.0 cents per gallon compared to 25.8 cents per gallon in the corresponding period a year ago.  As part of our overall strategy to drive profitability we aggressively managed fuel margins in the latter part of the quarter which pressured gallon volume somewhat but drove higher fuel margins and overall profitability. In the first quarter of the prior year we experienced a favorable environment in the energy markets, as oil prices fell almost continuously throughout the quarter.

During the quarter we made two strategic decisions that impacted results.  We decided to phase out the Petro Express® brand and consolidate those locations under the Kangaroo Express® brand.  We also evaluated our pipeline of potential future store sites and identified certain land parcels we no longer intend to develop and as a result the carrying value of these sites was reduced.  We also conducted an evaluation of the expected performance of certain operating stores and determined the projected undiscounted cash flows were less than the carrying value and therefore a write down to fair value was required.  As a result, we recorded pre-tax impairment charges of approximately $32.6 million during the first fiscal quarter of 2010.

 For the remainder of fiscal 2010 we plan to focus on our key strategic initiatives of improving information systems, expanding on-the-go meals and maintaining a disciplined approach to capital allocation.  In regards to information systems our wide area network is now in 90% of our stores and we launched a new software project to replace our legacy fuel pricing system.  We believe that we are on track to pilot an expanded on-the-go meal offering in the second and third quarters of fiscal 2010.  Our primary capital focus in 2010 will be to improve the performance in our existing stores and to build a more robust operating model.  While we remain focused on our existing stores, we do believe that acquisitions will continue to play a meaningful role in our business growth.

Market and Industry Trends

While the U.S. and global economies have shown signs of recovery, unemployment remains above normal and the housing market remains unstable, which continues to reduce consumer discretionary income throughout our markets.  Lower disposable income resulted in decreased recreational travel and consumer spending, which resulted in lower demand for our fuel and merchandise.

During the first quarter of fiscal 2010, crude oil prices increased from $70 per barrel to a high of $81 per barrel, which increased our wholesale fuel costs. We attempt to pass along wholesale fuel 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 fuel margins in periods of rising wholesale costs and higher margins in periods of decreasing wholesale costs.

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Results of Operations

The table below provides a summary of our selected financial data for the three months ended December 24, 2009 and December 25, 2008 (dollars and gallons, except per gallon data, in thousands):

	Three Months Ended
	December 24, 2009			December 25, 2008
Selected financial data:
Merchandise gross profit[1]	$	136,288		$	138,681
Merchandise margin		32.6	%		35.5	%
Retail fuel data:
Gallons (in millions)		518.1			499.7
Margin per gallon	$	0.110		$	0.258
Retail price per gallon	$	2.52		$	2.43
Total fuel gross profit[1]	$	57,273		$	130,141
Comparable store data:
Merchandise sales increase (decrease) (%)		5.2	%		(3.0	%)
Merchandise sales increase (decrease)	$	20,155		$	(11,671	)
Fuel gallons (decrease) increase (%)		0.8	%		(7.2	%)
Fuel gallons (decrease) increase		4,140			(37,857	)
Number of stores:
End of period		1,658			1,648
Weighted-average store count		1,668			1,652

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

Three Months Ended December 24, 2009 Compared to the Three Months Ended December 25, 2008

Merchandise Revenue and Gross Profit. The increase in merchandise revenue is primarily attributable to an increase in comparable store merchandise revenue of 5.2%, or $20.1 million and merchandise revenue from newly constructed and acquired stores since the beginning of the first quarter of fiscal 2009 of $10.5 million, offset by lost revenue from closed stores of $2.9 million. The decrease in merchandise gross profit is primarily attributable to a 290 basis point decrease in merchandise gross margin to 32.6% for the first quarter of fiscal 2010 compared to 35.5% for the first quarter of fiscal 2009. The decrease in merchandise gross margin was primarily due to reduced margins on cigarettes and other tobacco products due to last year’s excise tax increases, a mix shift toward tobacco products and lower margins in the grocery category.

Fuel Revenue, Gallons and Gross Profit. The increase in fuel revenue is primarily attributable to the 3.7% increase in the average retail price per gallon to $2.52 and an increase in fuel gallons sold.  Retail fuel gallons sold for the first quarter of fiscal 2010 increased 18.5 million gallons, or 3.7%, from the first quarter of fiscal 2009.  The increase is primarily attributable to an increase in comparable store fuel gallons sold of 4.1 million gallons, or 0.8%. The increase in comparable store fuel gallons sold was primarily due to extreme fuel shortages in some of our markets during the first three weeks of the prior period’s quarter.

The decrease in fuel gross profit is primarily attributable to the 14.8 cent decrease in retail gross profit per gallon to 11.0 cents for the first quarter of fiscal 2010 from 25.8 cents in the first quarter of fiscal 2009. The decrease in retail gross profit per gallon is primarily due to increased oil prices during the first quarter of fiscal 2010, and the narrow range in which oil traded provided little opportunity for solid margins. We compute gross profit exclusive of depreciation and allocation of store operating and general and administrative expenses. We present fuel gross profit per gallon inclusive of credit card processing fees and cost of repairs and maintenance on fuel equipment. These fees totaled 4.6 cents per retail gallon for each of the three months ended December 24, 2009 and December 25, 2008.

Store Operating. Store operating expenses for the first quarter of fiscal 2010 increased $527 thousand, or 0.4%, from the first quarter of fiscal 2009. The increase in store operating costs is primarily a result of increased utilities and insurance expenses offset by lower store labor costs as we continue to manage labor to meet demand.

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General and Administrative. General and administrative expenses for the first quarter of fiscal 2010 decreased $3.9 million or 15.2%. The decrease was due to approximately $2.0 million in reduced stock-based compensation and approximately $2.0 million benefit in one-time personnel related charges.

Depreciation and Amortization. Depreciation and amortization expenses for the first quarter of fiscal 2010 increased $2.1million, or 7.8%, from the first quarter of fiscal 2009.

Impairment Charges.  During the quarter ended December 24, 2009, the Company performed interim impairment testing of its Petro Express® tradename due to events and changes in circumstances that resulted in a change to the estimate of the remaining useful life from indefinite to finite-lived. As a result of the impairment test we recorded an impairment charge to write-off the carrying value of the asset of approximately $21.3 million during the three months ended December 24, 2009. There were no tradename impairments during the three months ended December 25, 2008. See Part I, Item 1. Financial Statements—Notes to Condensed Consolidated Financial Statements—Note 11—Asset Impairments.

In December 2009, management made a strategic decision not to develop stores on certain land parcels owned by the Company.  As a result, we recorded impairment charges related to land parcels of approximately $7.8 million during the three months ended December 24, 2009. There were no land parcels impaired during the three months ended December 25, 2008.

We test our operating stores for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. For each operating store where events or changes in circumstances indicated that the carrying amount of the assets might not be recoverable we compared the carrying amount to its estimated future undiscounted cash flows to determine recoverability. As a result, we recorded impairment charges related to operating stores of approximately $3.6 million and $309 thousand during the three months ended December 24, 2009 and December 25, 2008, respectively.

EBITDA and Adjusted EBITDA. We define EBITDA as net income (loss) before interest expense, net gain/loss on extinguishment of debt, impairment charges, income taxes and depreciation and amortization. Adjusted EBITDA includes the lease payments we make under our lease finance obligations as a reduction to EBITDA. EBITDA for the first quarter of fiscal 2010 decreased $71.9 million, or 64.1%, from the first quarter of fiscal 2009.  Adjusted EBITDA for the first quarter of fiscal 2010 decreased $72.1 million, or 71.8%, from the first quarter of fiscal 2009. These decreases are primarily attributable to the variances discussed above.

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

In accordance with GAAP, certain of our leases, including all of our sale-leaseback arrangements, are accounted for as lease finance obligations. As a result, payments made under these lease arrangements are accounted for as interest expense and a reduction of the principal amounts outstanding under our lease finance obligations. By including in Adjusted EBITDA the amounts we pay under our lease finance obligations, we are able to present such payments as operating costs instead of financing costs. We believe that this presentation helps investors better understand our operating performance relative to other companies that do not account for their leases as lease finance obligations.

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

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

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

	Three Months Ended
	December 24, 2009			December 25, 2008
Adjusted EBITDA	$	28,371		$	100,489
Payments made for lease finance obligations		11,952			11,711
EBITDA		40,323			112,200
Interest expense, net		(21,755	)		(22,516	)
Depreciation and amortization		(28,969	)		(26,882	)
Impairment charges		(32,637	)		(309	)
Income tax benefit (expense)		16,969			(23,956	)
Net income (loss)	$	(26,069	)	$	38,537

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

	Three Months Ended
	December 24, 2009			December 25, 2008
Adjusted EBITDA	$	28,371		$	100,489
Payments made for lease finance obligations		11,952			11,711
EBITDA		40,323			112,200
Interest expense, net		(21,755	)		(22,516	)
Income tax benefit (expense)		16,969			(23,956	)
Stock-based compensation expense		873			2,771
Changes in operating assets and liabilities		(10,920	)		17,162
Other		(3,960	)		3,292
Net cash provided by operating activities	$	21,530		$	88,953
Net cash used in investing activities	$	(9,070	)	$	(25,391	)
Net cash used in  financing activities	$	(2,823	)	$	(25,972	)

Interest Expense, Net. Interest expense, net is primarily comprised of interest on our long-term debt and lease finance obligations, net of interest income. Interest expense, net for the first quarter of fiscal 2010 was $21.8 million compared to $22.5 million for the first quarter of fiscal 2009. This decrease is primarily due to lower average interest rates and reduced average outstanding borrowings.

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 on cash provided by operating activities, supplemented as necessary from time to time by borrowings under our revolving credit facility and lease finance transactions to finance our operations, pay principal and interest on our debt and fund capital expenditures. Our working capital as of December 24, 2009 was $176.1 million. Cash provided by operating activities decreased to $21.5 million for the first quarter of fiscal 2010 compared to $89.0 million for the first quarter of fiscal 2009. The decrease in cash flow from operations is primarily due to the net loss of $26.1 million and certain changes in working capital. We had $179.5 million of cash and cash equivalents on hand at December 24, 2009.

Capital Expenditures. Capital expenditures (excluding accrued purchases) for the first quarter of fiscal 2010 were $9.4 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 flows from operations, proceeds from lease financing transactions, asset dispositions and vendor reimbursements. We anticipate that net capital expenditures for fiscal 2010 will be approximately $80 million to $90 million.

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Cash Flows from Financing Activities. For the first quarter of fiscal 2010, net cash used in financing activities was $2.8 million, of which $1.1 million was used to repay long-term debt and $1.6 million was used to repay lease finance obligations.  As of December 24, 2009, our debt consisted primarily of $418.0 million in loans under our senior credit facility, $247.0 million of outstanding 7.75% senior subordinated notes and $126.0 million of outstanding 3.0% convertible notes. As of December 24, 2009, we also had outstanding $463.5 million of lease finance obligations.

Senior Credit Facility. We are party to a Third Amended and Restated Credit Agreement (“credit agreement”), which defines the terms of our senior credit facility, which includes (i) a $225.0 million revolving credit facility, (ii) a $350.0 million initial term loan facility and (iii) a $100.0 million delayed draw term loan facility.  In addition, we may at any time incur up to $200.0 million in incremental facilities in the form of additional revolving or term loans so long as (i) such incremental facilities would not result in a default as defined in our credit agreement and (ii) we would be able to satisfy certain other conditions set forth in our credit agreement. The revolving credit facility has been, and will continue to be, used for our working capital and general corporate requirements and is also available for refinancing or repurchasing certain of our existing indebtedness and issuing commercial and standby letters of credit. A maximum of $120.0 million of the revolving credit facility is available as a letter of credit sub-facility.

As of December 24, 2009, we had no outstanding borrowings under our revolving credit facility and approximately $83.5 million of standby letters of credit had been issued. As of December 24, 2009, we had approximately $141.5 million in available borrowing capacity under the revolving credit facility (approximately $36.5 million of which was available for issuances of letters of credit).

Senior Subordinated Notes. We have outstanding $247.0 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.

Senior Subordinated Convertible Notes. We have outstanding $126.0 million of our convertible notes which bear interest at an annual rate of 3.0%, payable semi-annually on May 15th and November 15th of each year. 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 upon occurrence of these events. 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 3,206,278.

Shareholders’ Equity. As of December 24, 2009, our shareholders’ equity totaled $442.5 million. The $24.7 million decrease from September 24, 2009 is primarily attributable to the net loss in the first quarter of fiscal 2010 of $26.1 million, partially offset by the $710 thousand increase in additional paid-in capital, and the $702 thousand in unrealized gains on cash flow hedges. The increase in additional paid-in capital is primarily due to stock compensation expense and related tax benefits.

Long Term Liquidity. We believe that anticipated cash flows from operations, funds available from our existing revolving credit facility, cash on hand and vendor reimbursements will provide sufficient funds to finance our operations at least for the next 12 months. As of December  24, 2009, we had approximately $141.5 million in available borrowing capacity under our revolving credit facility, approximately $36.5 million of which was available for issuances of letters of credit. 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.

We may from time to time seek to purchase or otherwise retire some or all of our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise.  Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.  The amounts involved may have a material effect on our liquidity, financial condition and results of operations. During the first quarter of fiscal 2009, we purchased approximately $1.0 million of our convertible notes on the open market. During the second quarter of fiscal 2009 we repurchased $24.0 million in principal amount of our convertible notes and $3.0 million in principal amount of our senior subordinated notes on the open market. These purchases did not have a material effect on our liquidity, financial condition or results of operations.

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New Accounting Standards

In August 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-05, Fair Value Measurements and Disclosures (Topic 820): Measuring Liabilities at Fair Value, which provides guidance on measuring the fair value of liabilities under FASB Accounting Standards Codification™  (the "ASC") Topic 820 (formerly, Statement 157).  ASU 2009-05 was adopted in the first quarter of fiscal 2010 and did not have an impact on our financial statements.

In April 2008, the FASB issued FSP FAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”) which was primarily codified into Topic 350 “Intangibles – Goodwill and Other” in the ASC.  This guidance amends the factors that should be considered in developing renewal or extension assumptions used in determining the useful life of a recognized intangible asset under previous guidance of goodwill and other intangible assets.  The purpose of this standard is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 Goodwill and Other Intangible Assets which was primarily codified into Topic 350 in the ASC and the period of expected cash flows used to measure the fair value of an asset under SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141(R)”) which was primarily codified into Topic 805 “Business Combinations” in the ASC, and other GAAP.  This guidance was adopted in the first quarter of fiscal 2010 and did not have an impact on our financial statements.

In March 2008, the FASB concluded its re-deliberations on FSP APB No. 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) which was primarily codified into Topic 470 “Debt” in the ASC, deciding to retain its original proposal related to this matter. This guidance applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement, unless the embedded conversion option is required to be separately accounted for as a derivative under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities which was primarily codified into Topic 815 “Derivatives and Hedging” in the ASC. This guidance will require the issuer of a convertible debt instrument within its scope to separately account for the liability and equity components in a manner that will reflect the issuer’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods.  The excess of the principal amount of the liability component over its initial fair value must be amortized to interest cost using the interest method.  This guidance was effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods thereafter and was to be applied retrospectively to all periods presented.  Early adoption was not permitted.  The provisions of this guidance apply to our senior subordinated convertible notes (our “convertible notes”).  This guidance did not impact our actual past or future cash flows.  Although this guidance will not impact our actual past, current or future cash flows, the retrospective application resulted in an increase of $1.5 million to interest expense, net for the first quarter of fiscal 2009.

The following tables set forth the effect of the retrospective application of FSP 14-1 on certain previously reported line items:

	September 24, 2009
	As previously reported		Adjustment			As adjusted
	(in thousands)
Condensed Consolidated Balance Sheet
Other noncurrent assets	$	41,080	$	(496	)	$	40,584
Long-term debt		787,940		(18,377	)		769,563
Deferred income taxes		102,311		6,949			109,260
Additional paid-in-capital		180,327		24,471			204,798
Retained earnings		279,716		(13,539	)		266,177

	Three Months Ended December 25, 2008
	As previously reported			Adjustment			As adjusted
	(in thousands)
Condensed Consolidated Statements of Operations
Interest expense, net	$	21,042		$	1,474		$	22,516
Income tax expense		(24,529	)		573			(23,956	)
Net income		39,438			(901	)		38,537
Earnings per share:
Basic	$	1.78		$	(0.05	)	$	1.73
Diluted	$	1.77		$	(0.04	)	$	1.73

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	Three Months Ended December 25, 2008
	As previously reported		Adjustment			As adjusted
	(in thousands)
Condensed Consolidated Statements of Cash Flows
Net income	$	39,438	$	(901	)	$	38,537
Amortization of convertible debt discount		—		1,335			1,335
Provision for deferred income taxes		1,489		(573	)		916
Other		902		(139	)		1,041

The debt and equity components recognized for our convertible notes as of September 24, 2009 were as follows:

Principal amount of convertible notes	$	125,975
Unamortized discount (1)		18,377
Net carrying amount	$	107,598
Additional paid-in capital	$	24,471

(1) The remaining recognition period is 38 months as of September 24, 2009

The amount of interest expense recognized and the effective interest rate for our convertible notes were as follows:

	Three Months Ended
	December 24, 2009			December 25, 2008
Contractual coupon interest	$	955		$	1,136
Amortization of discount on convertible notes		1,345			1,335
Interest expense	$	2,300		$	2,471
Effective interest rate		8.4	%		8.4	%

In February 2008, the FASB issued FSP FAS No. 157-2, Effective Date of FASB Statement No. 157 which was primarily codified into Topic 820 in the ASC, which delayed the effective date of previous fair value measurement and disclosure guidance to September 25, 2009 for us and for all nonfinancial assets and nonfinancial liabilities, except for items recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  We adopted this new fair value measurement and disclosure guidance in our first quarter of fiscal 2010 and the impact of adoption was to increase our disclosures regarding fair value measurements.  See Nore 10-Fair Value Measurements for the required disclosure.

In December 2007, the FASB issued SFAS No. 141(R), as amended and clarified by FSP 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies which was primarily codified into Topic 805 in the ASC. This guidance requires the acquiring entity in a business combination to recognize all assets acquired and liabilities assumed in the transaction, establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed and requires the acquirer to disclose the nature and financial effect of the business combination. This guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first fiscal year beginning on or after December 15, 2008.  Adoption of this guidance will affect acquisitions we make beginning in the first quarter of fiscal 2010, however there were no acquisitions made during our first quarter of fiscal 2010.

Critical Accounting Policies

As discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”  of the Company’s Annual Report on Form 10-K for the fiscal year ended September 24, 2009, we consider our policies on insurance liabilities, long-lived assets and closed stores, asset retirement obligations, vendor allowances and rebates, and environmental liabilities and related receivables to be the most critical in understanding the judgments that are involved in preparing our consolidated financial statements. There have been no changes in our critical accounting policies during the period ended December 24, 2009 except for the addition of accounting for goodwill as a critical accounting policy.

Goodwill. We conduct our annual impairment assessment of goodwill in the second quarter of each fiscal year. We test goodwill for possible impairment on an annual basis and more frequently if impairment indicators arise. An impairment indicator represents an event or change in circumstances that would more likely than not reduce the fair value of the reporting unit below its carrying amount.

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A significant amount of judgment is involved in determining if an indicator of goodwill impairment has occurred. Management monitors events and changes in circumstances in between annual testing dates to determine if these events or changes in circumstances are an impairment indicator. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on our consolidated financial statements.

The goodwill impairment assessment is a two-step impairment test. The first step compares the fair value of the reporting unit to its carrying value. We determine the fair value of the reporting unit using a combination of a discounted cash flow, market value and comparable transaction approach. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill shall be determined in the same manner as the amount of goodwill recognized in a business combination is determined. That is, an entity shall allocate the fair value of a reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible assets such as the Kangaroo Express® brand) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. The fair value of the assets and liabilities reflects market conditions, thus volatility in prices could have a material impact on the determination of the implied fair value of the reporting unit goodwill at the impairment test date. If we are required to perform step 2 of the goodwill impairment test it may result in significant impairment of the $634.0 million of recorded goodwill and could have a material adverse impact on our consolidated financial statements.

The impairment evaluation process requires management to make estimates and assumptions with regard to fair value.  Actual values may differ significantly from these estimates.  Such differences could result in future impairment that could have a material impact on our consolidated financial statements.

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Item 3. 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 such derivative instruments are matched against specific debt obligations. Our debt and interest rate swap instruments outstanding at December 24, 2009, including applicable interest rates, are discussed above in “Part I.—Item 1. Financial Statements—Notes to Condensed Consolidated Financial Statements—Note 5—Derivative Financial Instruments” and “Part I. —Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

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 December 24, 2009. Fair values have been determined based on quoted market prices as of December 24, 2009.

Expected Maturity Date
as of December 24, 2009
(Dollars in thousands)
	Fiscal 2010			Fiscal 2011			Fiscal 2012			Fiscal 2013			Fiscal 2014			Total			Fair Value
Long-term debt (fixed rate)	$	36		$	52		$	56		$	126,025		$	247,000		$	373,169		$	347,542
Weighted-average interest rate		6.15	%		6.15	%		6.15	%		7.47	%		7.75	%		6.50	%
Long-term debt (variable rate)	$	3,202		$	4,269		$	4,269		$	4,269		$	402,000		$	418,009		$	389,793
Weighted-average interest rate		2.93	%		2.53	%		1.80	%		1.74	%		1.74	%		2.15	%

In order to reduce our exposure to interest rate fluctuations on our variable-rate debt, 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 December 24, 2009, the interest rate on approximately 72.4% of our debt was fixed by either the nature of the obligation or through interest rate swap arrangements compared to 84.9% at September 24, 2009. The decrease in the fixed portion of our long-term debt for the first quarter of fiscal 2010 was due to the settlement of one of our interest rate swap arrangements with a fixed notional amount of $100.0 million. 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 December 24, 2009 would be to change interest expense by approximately $2.2 million.

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

Interest Rate Swap Contracts
(Dollars in thousands)
	December 24, 2009			September 24, 2009
Notional principal amount	$	200,000		$	300,000
Weighted-average fixed pay rate		3.11	%		3.65	%
Weighted-average variable receive rate		0.20	%		0.31	%
Weighted-average years to maturity		1.28			1.03

As of December 24, 2009, the fair value of our swap agreements represented a net liability of $5.4 million.

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Qualitative Disclosures. Our primary exposure relates to:

• interest rate risk on long-term and short-term borrowings resulting from changes in LIBOR;

• 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 that the interest rate swaps mentioned above will reduce our exposure to short-term interest rate fluctuations. While we cannot predict or manage our ability to refinance existing debt or the impact interest rate movements will have on our existing debt, management evaluates our financial position on an ongoing basis.

Item 4. Controls and Procedures.

As required by paragraph (b) of Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (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 in that they provide reasonable assurance that the information 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 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.

There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the first quarter of fiscal 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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.

Item 4T. Controls and Procedures.

Not Applicable

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THE PANTRY, INC.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

Since the beginning of fiscal 2007, over 45 class action lawsuits have been filed in federal courts across the country against numerous companies in the petroleum industry. Major petroleum companies and significant retailers in the industry have been named as defendants in these lawsuits. To date, we have been named as a defendant in seven cases: one in Florida (Cozza, et al. v. Murphy Oil USA, Inc. et al., S.D. Fla., No. 9:07-cv-80156-DMM, filed 2/16/07); one in Delaware (Becker, et al. v. Marathon Petroleum Company LLC, et al., D. Del., No. 1:07-cv-00136, filed 3/7/07); one in North Carolina (Neese, et al. v. Abercrombie Oil Company, Inc., et al., E.D.N.C., No. 5:07-cv-00091-FL, filed 3/7/07); one in Alabama (Snable, et al. v. Murphy Oil USA, Inc., et al., N.D. Ala., No. 7:07-cv-00535-LSC, filed 3/26/07); one in Georgia (Rutherford, et al. v. Murphy Oil USA, Inc., et al., No. 4:07-cv-00113-HLM, filed 6/5/07); one in Tennessee (Shields, et al. v. RaceTrac Petroleum, Inc., et al., No. 1:07-cv-00169, filed 7/13/07); and one in South Carolina (Korleski v. BP Corporation North America, Inc., et al., D.S.C., No 6:07-cv-03218-MDL, filed 9/24/07). Pursuant to an Order entered by the Joint Panel on Multi-District Litigation, all of the cases, including the seven in which we are named, have been  transferred to the United States District Court for the District of Kansas and consolidated for all pre-trial proceedings. The plaintiffs in the lawsuits generally allege that they are retail purchasers who received less motor fuel than the defendants agreed to deliver because the defendants measured the amount of motor fuel they delivered in non-temperature adjusted gallons which, at higher temperatures, contain less energy. These cases seek, among other relief, an order requiring the defendants to install temperature adjusting equipment on their retail motor fuel dispensing devices. In certain of the cases, including some of the cases in which we are named, plaintiffs also have alleged that because defendants pay fuel taxes based on temperature adjusted 60 degree gallons, but allegedly collect taxes from consumers on non-temperature adjusted gallons, defendants receive a greater amount of tax from consumers than they paid on the same gallon of fuel. The plaintiffs in these cases seek, among other relief, recovery of excess taxes paid and punitive damages. Both types of cases seek compensatory damages, injunctive relief, attorneys’ fees and costs, and prejudgment interest. The defendants filed motions to dismiss all cases for failure to state a claim, which were denied by the court on February 21, 2008.  A number of the defendants, including the Company, subsequently moved to dismiss for lack of subject matter jurisdiction or, in the alternative, for summary judgment on the grounds that plaintiffs’ claims constitute non-justiciable “political questions.”  The Court denied the defendants’ motion to dismiss on political question grounds on December 3, 2009. Plaintiffs subsequently filed a motion with the court to certify an interlocutory appeal to the United States Court of Appeals for the Tenth Circuit. Plaintiffs’ motions for class certification, which defendants have opposed, remain pending.  We continue to believe that there are substantial factual and legal defenses to the theories alleged in these lawsuits, and intend to vigorously defend against the claims. As the cases are at an early stage, we cannot at this time estimate our ultimate exposure to loss or liability, if any, related to these lawsuits.

 On September 29, 2009, Wimbreth Chism and Charlotte Minor, on behalf of themselves and on behalf of classes of those similarly situated, filed suit against The Pantry in the Circuit Court of Tuscaloosa County, Alabama (Wimbreth Chism et.al. v. The Pantry, Inc d/b/a Kangaroo Express, No. 63-CV-2009-900612.00) (“Chism matter”).  On November 19, 2009, Andrea Gee, on her own behalf and on behalf of those similarly situated, filed suit against The Pantry in the United States District Court for the Middle District of Florida (Gee, et. al. v. The Pantry, Inc. a/k/a Kangaroo Express No 3109-CV-1140) (“Gee matter”).  The plaintiffs in the Chism and Gee matters seek collective action status and assert claims on behalf of present and former employees for unpaid wages under the Fair Labor Standards Act of 1938, as amended (the “FLSA”).  The plaintiffs in these lawsuits generally allege that they are or were employed by The Pantry as store managers, but were misclassified as exempt, and as such are or were entitled to overtime compensation.  The suit seeks permission to give notice of this action to all current and former employees who were employed as store managers during the three years immediately preceding the filing of this suit.  The plaintiffs also seek damages, liquidated damages, costs, pre-judgment interest and attorneys’ fees, and any injunctive and/or declaratory relief to which they may be entitled.  On October 28, 2009, we removed the Chism matter to the United States District Court for the Northern District of Alabama, Western Division, and on November 18, 2009 filed an Answer to the Complaint.  On January 12, 2010, we filed a motion to transfer the Gee matter to the United States District Court, Northern District of Alabama, Western Division, and the motion is currently pending.  We believe that there are substantial factual and legal defenses to the theories alleged in these lawsuits, and intend to vigorously defend against the claims, including plaintiffs' efforts for collective action status.  As the cases are at a very early stage, we cannot at this time estimate our ultimate exposure to loss or liability, if any, related to these lawsuits.

On October 19, 2009, Patrick Amason, on behalf of himself and a putative class of similarly situated individuals, filed suit against The Pantry in the United States District Court for the Northern District of Alabama, Western Division (Patrick Amason v. Kangaroo Express and The Pantry, Inc. No. CV-09-P-2117-W).  The plaintiff seeks class action status and alleges that The Pantry included more information than is permitted on electronically printed credit and debit card receipts in willful violation of the Fair and Accurate Credit Transactions Act, codified at 15 U.S.C. § 1681c(g).  The plaintiff seeks an award of statutory damages for each alleged willful violation of the statute, as well as attorneys' fees, costs, punitive damages and a permanent injunction against the alleged unlawful practice.  We believe that there are substantial factual and legal defenses to the theories alleged in the lawsuit, and intend to vigorously defend against the claims, including plaintiffs' efforts for class action status.  As the case is at a very early stage, we cannot at this time estimate our ultimate exposure to loss or liability, if any, related to this lawsuit.

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

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Item 1A. Risk Factors.

You should carefully consider the risks described below and under “Part I.—Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” before making a decision to invest in our securities. The risks and uncertainties described below and elsewhere in this report are not the only ones facing us. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, could negatively impact our 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 and retail fuel industries are highly competitive and impacted by new entrants. Increased competition could result in lower margins.

The convenience store and retail fuel industries in the geographic areas in which we operate are highly competitive and marked by ease of entry and constant change in the number and type of retailers offering the products and services found in our stores. We compete with numerous other convenience store chains, independent convenience stores, supermarkets, drugstores, discount clubs, fuel service stations, mass merchants, fast food operations and other similar retail outlets.  In recent years, several non-traditional retailers, including supermarkets, club stores and mass merchants, have begun to compete directly with the convenience store industry.  These non-traditional fuel retailers have obtained a significant share of the fuel market and their market share is expected to grow, and these retailers may use promotional pricing or discounts, both at the fuel pump and in the store, to encourage in-store merchandise sales. Additionally,in some of our markets, our competitors have been in existence longer and have greater financial, marketing and other resources than we do. As a result, our competitors may be able to respond better to changes in the economy and new opportunities within the industry.

To remain competitive, we must constantly analyze consumer preferences and competitors’ offerings and prices to ensure we offer a selection of convenience products and services at competitive prices to meet consumer demand. We must also maintain and upgrade our customer service levels, facilities and locations to remain competitive and drive customer traffic to our stores. Principal competitive factors include, among others, location, ease of access, fuel brands, pricing, product and service selections, customer service, store appearance, cleanliness and safety. In a number of our markets, our competitors that sell ethanol-blended fuel may have a competitive advantage over us because, in certain regions of the country, the wholesale cost of ethanol-blended fuel may, at times, be less than pure fuel. Competitive pressures could materially impact our fuel and merchandise volume, sales and gross profit and overall customer traffic, which could in turn have a material adverse effect on our business, financial condition and results of operations.

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

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

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

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

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Approximately 35% of our stores are located in coastal/resort or tourist destinations.  Historically, travel and consumer behavior in such markets is more severely impacted by weak economic conditions, such as those currently impacting the United States. If visitors to coastal/resort or tourist locations decline due to economic conditions, changes in consumer preferences, changes in discretionary consumer spending or otherwise, our sales could decline, which in turn could have a material adverse effect on our business, financial condition and results of operations.

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

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

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

Currently, major cigarette manufacturers offer substantial rebates to retailers. We include these rebates as a component of our gross margin from sales of cigarettes. In the event these rebates are no longer offered, or decreased, our wholesale cigarette costs will increase accordingly. In general, we attempt to pass price increases on to our customers. However, due to competitive pressures in our markets, we may not be able to do so. In addition, reduced retail display allowances on cigarettes offered by cigarette manufacturers negatively impact gross margins. These factors could materially impact our retail price of cigarettes, cigarette unit volume and revenues, merchandise gross profit and overall customer traffic, which could in turn have a material adverse effect on our business, financial condition and results of operations.

Federal regulation of tobacco products could adversely impact our operating results.

In June 2009, Congress gave the Food and Drug Administration (FDA) broad authority to regulate tobacco products through passage of the Family Smoking Prevention and Tobacco Control Act (FSPTCA). Under the legislation, FDA regulation is expected to:

• set national performance standards for tobacco products;

• restrict the sale and marketing of tobacco products;

• require manufacturers to obtain FDA clearance or approval for cigarette and smokeless tobacco products commercially launched, or to be launched, after February 15, 2007;

• require new and bigger warning labels on tobacco products, including warnings that take up 50 percent of the front and back of every pack of cigarettes; and

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

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

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Risks Related to Our Business

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

Substantially all of our stores are located in the southeastern United States. Although the southeast region is generally known for its mild weather, the region is susceptible to severe storms, including hurricanes, thunderstorms, extended periods of rain, ice storms and heavy snow, all of which we have historically experienced.

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

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

An important part of our historical growth strategy has been to acquire other convenience stores that complement our existing stores or broaden our geographic presence.  Acquisitions involve risks that could cause our actual growth or operating results to differ significantly from our expectations or the expectations of securities analysts. For example:

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

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

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

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

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

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

Our indebtedness could negatively impact our financial health.

As of December 24, 2009, we had consolidated debt, including lease finance obligations, of approximately $1.2 billion. As of December 24, 2009, the availability under our revolving credit facility for borrowing was approximately $141.5 million (approximately $36.5 million of which was available for issuance of letters of credit).

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

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

• increase our vulnerability to general adverse economic and industry conditions;

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

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• 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.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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 fuel, merchandise or food at one or more of our convenience stores. We could also incur significant liabilities if a lawsuit or claim results in a decision against us.  Even if we are successful in defending such litigation, our litigation costs could be significant, and the litigation may divert time and money away from our operations and adversely affect our performance.

Pending SEC matters could adversely affect us.

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

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

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

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

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

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

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

We depend on information technology (IT) systems to manage numerous aspects of our business transactions and provide information to management.  Our IT systems are an essential component of our business and growth strategies, and a serious disruption to our IT systems could significantly limit our ability to manage and operate our business efficiently.  These systems are vulnerable to, among other things, damage and interruption from power loss or natural disasters, computer system and network failures, loss of telecommunications services, physical and electronic loss of data, security breaches, computer viruses and laws and regulations necessitating mandatory upgrades and timelines with which we may not be able to comply.  Any serious disruption could cause our business and competitive position to suffer and adversely affect our operating results.

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 January 29, 2010, there were 22,663,515 shares of our common stock outstanding, most of which are freely tradable (unless held by one of our affiliates). Pursuant to Rule 144 under the Securities Act of 1933, as amended, during any three-month period our affiliates can resell up to the greater of (a) 1.0% of our aggregate outstanding common stock or (b) the average weekly trading volume for the four weeks prior to the sale. Sales by our existing stockholders also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate or to use equity as consideration for future acquisitions.

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

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

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

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

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

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

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

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

• changes in market valuations of companies in our industry and market evaluations of our industry generally;

• additions or departures of key personnel;

• actions taken by our competitors;

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• sales or other issuances of common stock by us or our senior officers or other affiliates; or

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

The market price of our common stock will also be impacted by our quarterly operating results and quarterly comparable store sales growth, which may fluctuate from quarter to quarter. Factors that may impact our quarterly results and comparable store sales include, among others, general regional and national economic conditions, competition, unexpected costs and changes in pricing, consumer trends, the number of stores we open and/or close during any given period, costs of compliance with corporate governance and Sarbanes-Oxley requirements and other factors discussed in this Item 1A and throughout “Part I.—Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” You may not be able to resell your shares of our common stock at or above the price you pay.

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

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

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

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

• limit who may call special meetings;

• limit stockholder action by written consent, generally requiring all actions to be taken at a meeting of the stockholders; and

• establish advance notice requirements for any stockholder that wants to propose a matter to be acted upon by stockholders at a stockholders’ meeting, including the nomination of candidates for election to our Board of Directors.

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

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

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

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

There were no sales of unregistered securities during the first quarter of fiscal 2010.

The following table lists all repurchases during the first quarter of fiscal 2010 of any of our securities registered under Section 12 of the Exchange Act by or on behalf of us or any affiliated purchaser.

Issuer Purchases of Equity Securities
Period	Total Number of Shares Purchased(1)		Average Price Paid per Share(2)		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
September 25, 2009 - October 22, 2009		-	$	-		-	$	-
October 23, 2009 - November 26, 2009		35,951	$	15.24		-	$	-
November 27, 2009 - December 24, 2009		-	$	-		-	$	-
Total		35,951	$	15.24		-	$	-

(1)	Represents shares repurchased in connection with tax withholding obligations under the Omnibus Plan.
(2)	Represents the average price paid per share for the shares repurchased in connection with tax withholding obligations under the Omnibus Plan.

Item 5.                        Other Information.

In December 2009, management concluded that we were required under generally accepted accounting principles to record in the first quarter of fiscal 2010 a pre-tax, non-cash charge of $21.3 million for impairment of the Petro Express® tradename.

We do not expect to be required to make any current or future cash expenditures as a result of the impairment.

The conclusion to record an impairment charge to the Petro Express® tradename was primarily the result of a strategic decision by management to discontinue use of the Petro Express® tradename and to re-brand existing stores currently operating under the Petro Express® tradename.  The decision to re-brand stores operating under the Petro Express® tradename was driven, in part, by a major fuel supplier informing us that it is withdrawing its motor fuels operations in select areas of the East Coast, including all areas where Petro Express® stores are currently located.  The majority of our Petro Express® stores located in the impacted regions will be required to de-brand the retail fuel operations by mid year 2010. As a result, management made a strategic decision to re-brand the retail fuel operations and re-image the operating stores in order to capitalize on synergies in the re-branding process.

See “Part I, Item 1 Financial Statements—Notes to Condensed Consolidated Financial Statements—Note 11—Asset Impairments,” which is incorporated herein by reference.

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Item 6. Exhibits.

Exhibit Number	Description of Document
10.1	Independent Director Compensation Program, Fifth Amendment January 2010
10.2	Form of Performance-Based Restricted Stock Award Agreement (Awarding Performance-Based Restricted Stock to Employee) (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 9, 2009)
10.3	Amended and Restated Employment Agreement dated December 17, 2007 by and between Robert B. Williams and The Pantry (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 December 23, 2009)
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification by Chief Executive Officer 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 by Chief Financial Officer 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.]

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SIGNATURE

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

THE PANTRY, INC.
By:	/s/ Frank G. Paci
	Frank G. Paci
	Executive Vice President, Chief Financial Officer and Secretary (Authorized Officer and Principal Financial Officer)
Date:	February 2, 2010

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EXHIBIT INDEX

Exhibit Number	Description of Document
10.1	Independent Director Compensation Program, Fifth Amendment January 2010
10.2	Form of Performance-Based Restricted Stock Award Agreement (Awarding Performance-Based Restricted Stock to Employee) (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 9, 2009)
10.3	Amended and Restated Employment Agreement dated December 17, 2007 by and between Robert B. Williams and The Pantry (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 December 23, 2009)
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification by Chief Executive Officer 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 by Chief Financial Officer 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.]

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