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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 30, 2006
Commission File Number: 000-25813
THE PANTRY, INC.
(Exact name of registrant as specified in its charter)
Delaware | 56-1574463 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
1801 Douglas Drive
Sanford, North Carolina 27330-1410
(Address of principal executive offices)
Registrant’s telephone number, including area code: (919) 774-6700
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non- accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filerx | Accelerated filer¨ | Non-accelerated filer¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
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 | 22,675,749 SHARES | |
(Class) | (Outstanding at May 1, 2006) |
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THE PANTRY, INC.
FORM 10-Q
MARCH 30, 2006
Page | ||||
Part I—Financial Information | ||||
Item 1. | Financial Statements | |||
3 | ||||
4 | ||||
5 | ||||
6 | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 27 | ||
Item 3. | 36 | |||
Item 4. | 38 | |||
Part II—Other Information | ||||
Item 1. | 40 | |||
Item 1A. | 40 | |||
Item 4. | 48 | |||
Item 6. | 49 |
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Item 1. | Financial Statements |
THE PANTRY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands)
March 30, 2006 | September 29, 2005 | |||||
ASSETS | ||||||
Current assets: | ||||||
Cash and cash equivalents | $ | 130,524 | $ | 111,472 | ||
Receivables, net (Note 5) | 56,173 | 61,597 | ||||
Inventories (Note 2) | 125,538 | 125,348 | ||||
Prepaid expenses and other current assets (Notes 2 and 7) | 13,779 | 19,031 | ||||
Deferred income taxes | 6,115 | 5,837 | ||||
Total current assets | 332,129 | 323,285 | ||||
Property and equipment, net (Note 2) | 661,889 | 630,291 | ||||
Other assets: | ||||||
Goodwill (Notes 2 and 4) | 433,179 | 394,903 | ||||
Other noncurrent assets (Notes 2, 5, and 7) | 45,763 | 39,687 | ||||
Total other assets | 478,942 | 434,590 | ||||
Total assets | $ | 1,472,960 | $ | 1,388,166 | ||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||
Current liabilities: | ||||||
Current maturities of long-term debt (Note 6) | $ | 2,086 | $ | 16,045 | ||
Current maturities of lease finance obligations | 2,986 | 2,872 | ||||
Accounts payable | 139,450 | 131,618 | ||||
Accrued compensation and related taxes | 15,662 | 16,786 | ||||
Other accrued taxes | 18,523 | 34,346 | ||||
Accrued insurance | 24,333 | 22,544 | ||||
Other accrued liabilities (Note 2) | 23,430 | 29,322 | ||||
Total current liabilities | 226,470 | 253,533 | ||||
Other liabilities: | ||||||
Long-term debt (Note 6) | 603,259 | 539,328 | ||||
Lease finance obligations | 206,117 | 200,214 | ||||
Deferred income taxes | 65,164 | 64,848 | ||||
Deferred vendor rebates (Note 2) | 30,470 | 27,385 | ||||
Other noncurrent liabilities (Note 5) | 53,482 | 50,925 | ||||
Total other liabilities | 958,492 | 882,700 | ||||
Commitments and contingencies (Notes 5 and 6) | ||||||
Shareholders’ equity: | ||||||
Common stock, $.01 par value, 50,000,000 shares authorized; 22,675,749 and 22,316,439 issued and outstanding at March 30, 2006 and September 29, 2005, respectively (Notes 6 and 10) | 227 | 223 | ||||
Additional paid-in capital | 170,236 | 176,836 | ||||
Accumulated other comprehensive income, net (Note 8) | 1,920 | 1,426 | ||||
Retained earnings | 115,615 | 73,448 | ||||
Total shareholders’ equity | 287,998 | 251,933 | ||||
Total liabilities and shareholders’ equity | $ | 1,472,960 | $ | 1,388,166 | ||
See Notes to Condensed Consolidated Financial Statements
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share data)
Three Months Ended | Six Months Ended | |||||||||||||||
March 30, 2006 | March 31, 2005 | March 30, 2006 | March 31, 2005 | |||||||||||||
(13 weeks) | (13 weeks) | (26 weeks) | (26 weeks) | |||||||||||||
Revenues: | ||||||||||||||||
Merchandise | $ | 323,004 | $ | 284,289 | $ | 639,652 | $ | 571,356 | ||||||||
Gasoline | 992,742 | 661,471 | 1,991,417 | 1,315,947 | ||||||||||||
Total revenues | 1,315,746 | 945,760 | 2,631,069 | 1,887,303 | ||||||||||||
Cost of sales: | ||||||||||||||||
Merchandise | 201,457 | 178,557 | 399,369 | 361,532 | ||||||||||||
Gasoline | 945,396 | 627,351 | 1,857,486 | 1,231,940 | ||||||||||||
Total cost of sales | 1,146,853 | 805,908 | 2,256,855 | 1,593,472 | ||||||||||||
Gross profit | 168,893 | 139,852 | 374,214 | 293,831 | ||||||||||||
Operating expenses: | ||||||||||||||||
Operating, general and administrative expenses | 123,573 | 105,636 | 241,901 | 210,812 | ||||||||||||
Depreciation and amortization | 17,467 | 15,414 | 34,704 | 31,000 | ||||||||||||
Total operating expenses | 141,040 | 121,050 | 276,605 | 241,812 | ||||||||||||
Income from operations | 27,853 | 18,802 | 97,609 | 52,019 | ||||||||||||
Other income (expense): | ||||||||||||||||
Interest expense (Notes 7 and 9) | (14,413 | ) | (14,052 | ) | (28,846 | ) | (27,464 | ) | ||||||||
Loss on extinguishment of debt (Notes 6 and 9) | — | — | (1,832 | ) | — | |||||||||||
Interest income | 1,541 | 465 | 2,585 | 748 | ||||||||||||
Miscellaneous | 170 | 217 | 329 | 356 | ||||||||||||
Total other expense | (12,702 | ) | (13,370 | ) | (27,764 | ) | (26,360 | ) | ||||||||
Income before income taxes | 15,151 | 5,432 | 69,845 | 25,659 | ||||||||||||
Income tax expense | (5,955 | ) | (2,091 | ) | (27,678 | ) | (9,878 | ) | ||||||||
Net income | $ | 9,196 | $ | 3,341 | $ | 42,167 | $ | 15,781 | ||||||||
Earnings per share (Note 10): | ||||||||||||||||
Basic | $ | 0.41 | $ | 0.16 | $ | 1.88 | $ | 0.78 | ||||||||
Diluted | $ | 0.39 | $ | 0.16 | $ | 1.84 | $ | 0.74 |
See Notes to Condensed Consolidated Financial Statements
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Six Months Ended | ||||||||
March 30, 2006 | March 31, 2005 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net income | $ | 42,167 | $ | 15,781 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 34,704 | 31,000 | ||||||
Provision for deferred income taxes | 1 | 4,097 | ||||||
Loss on extinguishment of debt | 1,832 | — | ||||||
Income tax benefit related to exercise of stock options | — | 3,311 | ||||||
Stock-based compensation | 1,347 | — | ||||||
Excess income tax benefits from stock-based compensation arrangements | (5,748 | ) | — | |||||
Other | 1,054 | 737 | ||||||
Changes in operating assets and liabilities (net of effects of acquisitions): | ||||||||
Receivables | 5,133 | (1,433 | ) | |||||
Inventories | 5,129 | (1,572 | ) | |||||
Prepaid expenses and other current assets | (1,622 | ) | (2,907 | ) | ||||
Other noncurrent assets | 253 | (531 | ) | |||||
Accounts payable | 7,832 | (10,647 | ) | |||||
Other current liabilities and accrued expenses | (15,333 | ) | (9,568 | ) | ||||
Other noncurrent liabilities | (2,158 | ) | (618 | ) | ||||
Net cash provided by operating activities | 74,591 | 27,650 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Additions to property and equipment | (36,092 | ) | (27,900 | ) | ||||
Proceeds from sale of land, buildings and equipment | 3,008 | 4,338 | ||||||
Acquisitions of businesses, net of cash acquired | (63,252 | ) | (1,627 | ) | ||||
Net cash used in investing activities | (96,336 | ) | (25,189 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Principal repayments under lease finance obligations | (1,451 | ) | (1,384 | ) | ||||
Principal repayments of long-term debt | (305,028 | ) | (8,014 | ) | ||||
Proceeds from issuance of long-term debt | 355,000 | — | ||||||
Proceeds from lease finance obligations | 7,468 | 516 | ||||||
Proceeds from exercise of stock options | 4,160 | 3,150 | ||||||
Payment for purchase of note hedge | (43,720 | ) | — | |||||
Proceeds from issuance of warrant | 25,220 | — | ||||||
Excess income tax benefits from stock-based compensation arrangements | 5,748 | — | ||||||
Other financing costs | (6,600 | ) | — | |||||
Net cash provided (used in) by financing activities | 40,797 | (5,732 | ) | |||||
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 19,052 | (3,271 | ) | |||||
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD | 111,472 | 108,048 | ||||||
CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | 130,524 | $ | 104,777 | ||||
Cash paid during the period: | ||||||||
Interest | $ | 25,767 | $ | 27,364 | ||||
Income taxes | $ | 33,885 | $ | 6,806 | ||||
Non-cash transactions: | ||||||||
Accrued purchases of property and equipment | $ | 2,781 | $ | 5,897 | ||||
See Notes to Condensed Consolidated Financial Statements
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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 inter-company transactions and balances have been eliminated in consolidation. Transactions and balances of each of these 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 with the instructions to Form 10-Q and Article 10 of Regulation S-X. The interim condensed consolidated financial statements have been prepared from the accounting records of The Pantry, Inc. and its subsidiaries and all amounts at March 30, 2006 and for the three and six months ended March 30, 2006 and March 31, 2005 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 interim 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 29, 2005.
Our results of operations for the three and six months ended March 30, 2006 and March 31, 2005 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 2006” refer to our current fiscal year and references to “fiscal 2005” refer to our fiscal year ended September 29, 2005.
Certain amounts in our condensed consolidated financial statements for periods in fiscal 2005 have been reclassified to conform with fiscal 2006 presentation.
Accounting Period
We operate on a 52-53 week fiscal year ending on the last Thursday in September. Our 2006 fiscal year ends on September 28, 2006 and is a 52 week year. Fiscal 2005 was also a 52 week year.
The Pantry
As of March 30, 2006, we operated 1,458 convenience stores located in Florida (443), North Carolina (324), South Carolina (236), Georgia (128), Tennessee (101), Mississippi (72), Virginia (50), Alabama (38), Kentucky (32), Louisiana (24), and Indiana (10). Our stores offer a broad selection of merchandise, gasoline and ancillary products and services designed to appeal to the convenience needs of our customers, including gasoline, car care products and services, tobacco products, beer, soft drinks, self-service fast food and beverages, publications, dairy products, groceries, health and beauty aids, money orders and other ancillary services. In all states, except Alabama and Mississippi, we also sell lottery products. Self-service gasoline is sold at 1,435 locations, 934 of which sell gasoline under major oil company brand names including Amoco®, BP®, Chevron®, Citgo®, Mobil®, Exxon®, and Texaco®.
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
New Accounting Standards
In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. This statement clarifies that inventory costs that are “abnormal” are required to be charged to expense as incurred as opposed to being capitalized into inventory as a product cost. Examples of “abnormal” costs include costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage). The adoption of SFAS No. 151 during the first quarter of fiscal 2006 did not impact our financial position, results of operations or cash flows.
In December 2004, FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”). This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements and establishes fair value as the measurement objective in accounting for share-based payment arrangements. We adopted this standard as of the beginning of the first quarter of fiscal 2006 using the modified version of prospective application. See Note 3—Stock-Based Compensation for discussion regarding the impact of the adoption of SFAS No. 123R.
In March 2005, FASB issued Interpretation 47, Accounting for Conditional Asset Retirement Obligations—an interpretation of FASB Statement No. 143 (“FIN 47”). FIN 47 provides guidance relating to the identification of and financial reporting for legal obligations to perform an asset retirement activity. The interpretation requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of FIN 47 during the first quarter of fiscal 2006 did not impact our financial position, results of operations or cash flows.
In October 2005, FASB issued Staff Position 13-1, Accounting for Rental Costs Incurred During a Construction Period. This pronouncement states that rental costs associated with ground or building operating leases that are incurred during a construction period should be recognized as rental expense. The implementation will not impact our financial position, results of operations or cash flows.
Other accounting standards that have been issued or proposed by the FASB or other standard-setting bodies that do not require adoption until a future date are not expected to have a material impact on our financial condition, results of operations or cash flows upon adoption.
NOTE 2—ACQUISITIONS
On February 16, 2006, we completed the acquisition of 39 convenience stores in Mississippi and Louisiana from Waring Oil Company, LLC, which have been operating under the Interstate Food Stops banner. The purchase price was funded from available cash.
On February 9, 2006, we completed the acquisition of 19 convenience stores in North Carolina from Lee-Moore Oil Company, which have been operating under the TruBuy and On-The-Run® banners. The acquisition also included various dealer fuel supply arrangements for 20 additional stores. The purchase price was funded from available cash.
On March 1, 2006, we signed a definitive agreement to purchase 38 convenience stores in Alabama from Shop-A-Snak Food Mart, Inc. The acquisition also includes dealer and fuel supply arrangements for several
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
additional stores. The Company plans to finance the transaction with a combination of cash on hand and lease financing. The acquisition, which is subject to regulatory approvals and other customary closing conditions, is expected to close in the Company’s third fiscal quarter of 2006.
The following are the purchase price allocations for the stores acquired since the beginning of fiscal 2006. The allocations for stores acquired since the beginning of fiscal 2006 are preliminary estimates based on available information and certain assumptions management believes to be reasonable. These values are subject to change until certain third party valuations have been finalized and management completes its fair value assessments. Until the purchase price allocations are finalized, there may be material adjustments to the fair values of the assets and liabilities disclosed in this preliminary opening balance sheet. The allocations are based on the fair values on the date of the acquisitions (amounts in thousands):
Assets Acquired: | |||
Inventories | $ | 5,319 | |
Prepaid expenses and other current assets | 25 | ||
Property and equipment, net | 25,888 | ||
Total assets | 31,232 | ||
Liabilities Assumed: | |||
Other accrued liabilities | 2,176 | ||
Deferred vendor rebates | 5,944 | ||
Total liabilities | 8,120 | ||
Net tangible assets acquired, net of cash | 23,112 | ||
Non-compete agreements | 150 | ||
Goodwill, including direct acquisition costs | 40,050 | ||
Total consideration paid, including direct acquisition costs, net of cash acquired | $ | 63,312 | |
The following unaudited pro forma information presents a summary of our consolidated results of operations and the acquired assets as if the transactions occurred at the beginning of the fiscal year (amounts in thousands, except per share data):
Fiscal 2006 | Fiscal 2005 | |||||
Total revenues | $ | 2,734,675 | $ | 2,001,731 | ||
Net income | 44,280 | 18,147 | ||||
Earnings per share | ||||||
Basic | $ | 1.97 | $ | 0.89 | ||
Diluted | $ | 1.93 | $ | 0.85 |
NOTE 3—STOCK-BASED COMPENSATION
Prior to September 30, 2005, we accounted for our equity-based compensation plans under the recognition and measurement provision of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation. We did not recognize stock-based compensation cost in our Consolidated Statements of Operations prior to September 30, 2005, as all options granted under our equity-based compensation plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective September 30, 2005, we adopted the fair value recognition provisions of SFAS No. 123R, using the modified-prospective-transition method. Under this transition method,
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
compensation cost recognized includes compensation costs for all share-based payments granted prior to, but not yet vested as of September 29, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and compensation cost for all share-based payments granted subsequent to September 29, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. Results for prior periods have not been restated.
Stock options consist of options to purchase common stock at purchase prices equal to the fair market value of the related common stock on the date the option is granted. Options vest over a three-year period, with one-third of each grant vesting on the anniversary of the initial grant and have contractual lives of seven or ten years. Our stock option plans, which are shareholder approved, permits the grant of share options for up to 5.1 million shares of common stock. We recognize compensation expense on a straight line basis over the option vesting period. A summary of the status of stock options under our plans and changes during the three and six months ended March 30, 2006 is presented in the table below (amounts in thousands, except per share data):
Shares | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Term (Years) | Aggregate Instrinsic Value | ||||||||
Options Outstanding, September 29, 2005 | 787,071 | $ | 18.08 | ||||||||
Granted | 316,500 | 35.76 | |||||||||
Exercised | (50,596 | ) | 11.49 | ||||||||
Forfeited | (3,000 | ) | 26.77 | ||||||||
Options Outstanding, December 29, 2005 | 1,049,975 | $ | 23.70 | ||||||||
Granted | 50,000 | 60.64 | |||||||||
Exercised | (308,714 | ) | 11.59 | ||||||||
Options Outstanding, March 30, 2006 | 791,261 | $ | 30.76 | 5.9 | $ | 24,700 | |||||
Options Exercisable, March 30, 2006 | 80,179 | $ | 20.34 | 4.9 | $ | 3,300 |
The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model, which uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of our common stock price. We use historical data to estimate option exercises and employee terminations used in the model. The expected term of options granted is based on historical experience and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. As of March 30, 2006, remaining compensation expense to be recognized on these options through March 2009 is approximately $5.9 million.
The fair value of each option grant was determined using the Black-Scholes-Merton option pricing model with weighted-average assumptions used for options issued in the three and six months ended March 30, 2006 and March 31, 2005 as follows:
Three Months Ended | Six Months Ended | |||||||||||||||
March 30, 2006 | March 31, 2005 | March 30, 2006 | March 31, 2005 | |||||||||||||
Weighted-average grant date fair value | $ | 15.88 | $ | 10.58 | $ | 11.65 | $ | 9.50 | ||||||||
Weighted-average expected lives (years) | 2.0 | 2.0 | 2.0 | 2.0 | ||||||||||||
Risk-free interest rate | 4.7 | % | 3.9 | % | 4.4 | % | 3.0 | % | ||||||||
Expected volatility | 40 | % | 58 | % | 48 | % | 60 | % | ||||||||
Dividend yield | 0 | % | 0 | % | 0 | % | 0 | % |
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Prior to September 30, 2005 and the adoption of SFAS No. 123R, the expected volatility on shares of our common stock was based on the historical volatility of our stock price.
The weighted-average grant-date fair value of options granted during the three and six months ended March 30, 2006 was approximately $800 thousand and $4.3 million, respectively. The weighted-average grant-date fair value of options granted during the three and six months ended March 31, 2005 was approximately $317 thousand and $3.7 million, respectively. The total intrinsic value of options exercised during the three and six months ended March 30, 2006 was approximately $13.8 million and $15.1 million, respectively. The total intrinsic value of options exercised during the three and six months ended March 31, 2005 was approximately $9.9 million and $10.6 million, respectively. Cash received from options exercised totaled approximately $3.6 million and $4.2 million for the three and six months ended March 30, 2006, respectively. The total fair value of options vested during the six month periods ending March 30, 2006 and March 31, 2005 was approximately $1.8 million and $700 thousand, respectively.
As a result of adopting SFAS No. 123R, our income before income tax expense and net income for the three months ended March 30, 2006 are $719 thousand and $434 thousand lower, respectively, than if we had continued to account for stock-based compensation under APB No. 25. For the six months ended March 30, 2006, income before income tax expense and net income were reduced by $1.3 million and $813 thousand, respectively, by stock-based compensation expense. In addition, in connection with our adoption of SFAS No. 123R, net cash provided by operating activities decreased by $5.7 million for the six months ended March 30, 2006. Net cash provided by financing activities increased by $5.7 million related to excess income tax benefits from equity-based compensation plans.
The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to options granted under our stock option plans for the three and six months ended March 31, 2005. For purposes of this pro forma disclosure, the value of the options is estimated using the Black-Scholes-Merton option pricing model and amortized to expense over the options’ vesting periods.
Three Months Ended March 31, 2005 | Six Months Ended March 31, 2005 | |||||||
Net income (in thousands): | ||||||||
As reported | $ | 3,341 | $ | 15,781 | ||||
Deduct—Total stock-based compensation expense determined under fair value method for all awards, net of income tax | (280 | ) | (460 | ) | ||||
Pro forma | $ | 3,061 | $ | 15,321 | ||||
Basic earnings per share: | ||||||||
As reported | $ | 0.16 | $ | 0.78 | ||||
Pro forma | $ | 0.15 | $ | 0.75 | ||||
Diluted earnings per share: | ||||||||
As reported | $ | 0.16 | $ | 0.74 | ||||
Pro forma | $ | 0.14 | $ | 0.72 |
NOTE 4—GOODWILL AND OTHER INTANGIBLE ASSETS
We account for goodwill and other intangible assets acquired through business combinations in accordance with SFAS No. 141,Business Combinations, and SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 141 clarifies the criteria in recognizing other intangible assets separately from goodwill in a business combination. SFAS No. 142 states goodwill and other intangible assets deemed to have indefinite lives are no longer amortized but are reviewed for impairment annually (or more frequently if impairment indicators arise). Separable intangible assets that are not determined to have an indefinite life will continue to be amortized over
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
their useful lives and assessed for impairment under the provisions of SFAS No. 144,Accounting for theImpairment or Disposal of Long-Lived Assets. Other intangible assets are included in other noncurrent assets. We determined that we operate in one reporting unit based on our current reporting structure and have thus assigned goodwill at the enterprise level.
The following table reflects goodwill and intangible asset balances as of September 29, 2005 and the activity thereafter through March 30, 2006 (amounts in thousands):
Unamortized | Amortized | ||||||||||||||
Goodwill | Tradenames | Tradenames | Non-compete Agreements | ||||||||||||
Weighted-average useful life in years | N/A | N/A | 3.0 | 28.2 | |||||||||||
Gross balance at September 29, 2005 | $ | 394,903 | $ | 2,800 | $ | 2,850 | $ | 9,009 | |||||||
Dispositions | — | — | — | — | |||||||||||
Purchase accounting adjustments | (1,774 | ) | — | — | — | ||||||||||
Acquisitions | 40,050 | — | — | 150 | |||||||||||
Gross balance at March 30, 2006 | $ | 433,179 | $ | 2,800 | $ | 2,850 | $ | 9,159 | |||||||
Accumulated amortization at September 29, 2005 | $ | (402 | ) | $ | (1,887 | ) | |||||||||
Dispositions | — | — | |||||||||||||
Amortization | (475 | ) | (284 | ) | |||||||||||
Accumulated amortization at March 30, 2006 | $ | (877 | ) | $ | (2,171 | ) | |||||||||
The estimated future amortization expense for tradenames and non-compete agreements as of March 30, 2006 is as follows (amounts in thousands):
Fiscal year: | |||
2006 | $ | 795 | |
2007 | 1,463 | ||
2008 | 1,020 | ||
2009 | 342 | ||
2010 | 283 | ||
Thereafter | 5,058 | ||
Total estimated amortization expense | $ | 8,961 | |
In accordance with our policy, we conducted our annual impairment testing of goodwill and indefinite lived intangibles in the second quarter of fiscal 2006. In addition, goodwill and indefinite lived intangibles are reviewed for impairment more frequently if impairment indicators arise. No impairment charges related to goodwill and other intangible assets were recognized in the periods presented for fiscal 2006 and fiscal 2005.
NOTE 5—ENVIRONMENTAL LIABILITIES AND OTHER CONTINGENCIES
As of March 30, 2006, we were contingently liable for outstanding letters of credit in the amount of approximately $44.0 million primarily related to several self-insurance programs, vendor contract terms and regulatory requirements. The letters of credit are not to be drawn against unless we default on the timely payment of related liabilities.
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
We are party to various legal actions arising in the ordinary course of our business. We believe these other actions are routine and incidental to the operation of our business. While the outcome of these actions cannot be predicted with certainty, we believe that the ultimate resolution of these matters will not have a material adverse impact on our business, financial condition or prospects.
Environmental Liabilities and Contingencies
We are subject to various federal, state and local environmental laws. We make financial expenditures in order to comply with regulations governing underground storage tanks adopted by federal, state and local regulatory agencies. In particular, at the federal level, the Resource Conservation and Recovery Act of 1976, as amended, requires the United States Environmental Protection Agency to establish a comprehensive regulatory program for the detection, prevention and cleanup of leaking underground storage tanks.
Federal and state regulations require us to provide and maintain evidence that we are taking financial responsibility for corrective action and compensating third parties in the event of a release from our underground storage tank systems. In order to comply with these requirements, as of March 30, 2006, we maintain letters of credit in the aggregate amount of approximately $1.3 million in favor of state environmental agencies in North Carolina, South Carolina, Virginia, Georgia, Indiana, Tennessee, Kentucky and Louisiana.
We also rely upon the reimbursement provisions of applicable state trust funds. In Florida, we meet our financial responsibility requirements by state trust fund coverage for releases occurring through December 31, 1998 and meet such requirements for releases thereafter through private commercial liability insurance. In Georgia, we meet our financial responsibility requirements by a combination of state trust fund, private commercial liability insurance and a letter of credit.
Environmental reserves of $17.3 million and $16.3 million are included in other noncurrent liabilities in the accompanying consolidated balance sheets as of March 30, 2006 and September 29, 2005, respectively and represent our estimates for future expenditures for remediation, tank removal and litigation associated with 287 and 269 known contaminated sites, 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 $15.8 million of our environmental obligation will be funded by state trust funds and third party insurance; as a result we may spend up to $1.5 million for remediation, tank removal and litigation. Also, as of March 30, 2006 and September 29, 2005 there were an additional 519 and 510 sites, respectively, that are known to be contaminated sites that are being remediated by third parties and therefore the costs to remediate such sites are not included in our environmental reserve. Remediation costs for known sites are expected to be incurred over the next one to ten years. Environmental reserves have been established with remediation costs based on internal and external estimates for each site. Future remediation for which the timing of payments can be reasonably estimated is discounted using an appropriate rate to determine the reserve.
We anticipate that we will be reimbursed for expenditures from state trust funds and private insurance. As of March 30, 2006, anticipated reimbursements of $16.2 million are recorded as other noncurrent assets and $2.4 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.
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THE PANTRY, INC.
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 clean up matters. Additionally, we are awaiting closure notices on several other locations which will release us from responsibility related to known contamination at those sites. Our policy is that reserve estimates for these sites continue to be included in our environmental reserve until a final closure notice is received.
NOTE 6—LONG-TERM DEBT
Long-term debt consisted of the following (amounts in thousands):
March 30, 2006 | September 29, 2005 | |||||||
Senior subordinated notes payable; due February 19, 2014; interest payable semi-annually at 7.75% | $ | 250,000 | $ | 250,000 | ||||
Senior subordinated convertible notes payable; due November 15, 2012; interest payable semi-annually at 3.0% | 150,000 | — | ||||||
Senior credit facility; interest payable monthly at LIBOR plus 2.25%; repaid in December, 2005 | — | 305,000 | ||||||
Senior credit facility; interest payable monthly at LIBOR plus 1.75%; principal due in quarterly installments through January 2, 2012 | 205,000 | — | ||||||
Other notes payable; various interest rates and maturity dates | 345 | 373 | ||||||
Total long-term debt | 605,345 | 555,373 | ||||||
Less—current maturities | (2,086 | ) | (16,045 | ) | ||||
Long-term debt, net of current maturities | $ | 603,259 | $ | 539,328 | ||||
On November 22, 2005, we completed a private offering of $150.0 million of senior subordinated convertible notes due 2012 (“convertible notes”) to “qualified institutional buyers” pursuant to Rule 144A under the Securities Act of 1933, as amended. Subsequently, during the second quarter of fiscal 2006, we registered the convertible notes for resale by the holders thereof. The convertible notes bear interest at an annual rate of 3.0%, payable semi-annually on May 15th and November 15th of each year, with the first interest payment to be made on May 15, 2006. The convertible notes are convertible into our common stock at an initial conversion price of $50.09 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 120% of the conversion price per share for 20 of the last 30 trading days of any calendar quarter. If the price of our common stock exceeds 120% of the conversion price for 20 of the last 30 trading days of any calendar quarter then the possibility exists that the holders of the convertible notes could exercise the conversion provisions of the convertible notes which could result in the 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. This evaluation of the classification of amounts outstanding associated with the convertible notes will occur every calendar quarter. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the convertible note, or (ii) the conversion value, determined in the manner set forth in the indenture governing the convertible notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the convertible note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the convertible notes is 3,817,775.
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Concurrently with the sale of the convertible notes, we purchased a note hedge from an affiliate of Merrill Lynch (“the counterparty”), which is designed to mitigate potential dilution from the conversion of convertible notes. Under the note hedge, the counterparty is required to deliver to us the number of shares of our common stock that we are obligated to deliver to the holders of the convertible notes with respect to the conversion, calculated exclusive of shares deliverable by us by reason of any additional premium relating to the convertible notes or by reason of any election by us to unilaterally increase the conversion rate pursuant to the indenture governing the convertible notes. The note hedge expires at the close of trading on November 15, 2012, which is the maturity date of the convertible notes, although the counterparty will have ongoing obligations with respect to convertible notes properly converted on or prior to that date of which the counterparty has been timely notified.
In addition, we issued warrants to the counterparty that could require us to issue up to approximately 2,993,000 shares of our common stock on November 15, 2012 upon notice of exercise by the counterparty. The exercise price is $62.86 per share, which represented a 60.0% premium over the closing price of our shares of common stock on November 16, 2005. If the counterparty exercises the warrant, we will have the option to settle in cash or shares the excess of the price of our shares on that date over the initially established exercise price.
The note hedge and warrant are separate and legally distinct instruments that bind the Company and the counterparty and have no binding effect on the holders of the convertible notes.
Pursuant to Emerging Issues Task Force (“EITF”) 90-19, Convertible Bonds with Issuer Option to Settle for Cash upon Conversion, EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and EITF 01-6, The Meaning of Indexed to a Company’s Own Stock, the convertible notes are accounted for as convertible debt in the accompanying condensed consolidated balance sheet and the embedded conversion option in the convertible notes has not been accounted for as a separate derivative. Additionally, pursuant to EITF 00-19 and EITF 01-6, the note hedge and warrants are accounted for as equity transactions, and therefore, the payment associated with the issuance of the note hedge and the proceeds received from the issuance of the warrants were recorded as a charge and an increase, respectively, in additional paid-in capital in stockholders’ equity as separate equity transactions.
For income tax reporting purposes, we have elected to integrate the convertible notes and the note hedge transaction. Integration of the note hedge with the convertible notes creates an in-substance original issue debt discount for income tax reporting purposes and therefore the cost of the note hedge will be accounted for as interest expense over the term of the convertible notes for income tax reporting purposes. The associated income tax benefits will be recognized in the period that the deduction is taken for income tax reporting purposes as an increase in additional paid-in capital in stockholders’ equity.
Proceeds from the offering were used to pay down $100.0 million outstanding under our then existing senior credit facility, pay $43.7 million for the cost of the note hedge, pay approximately $4.7 million in issuance costs, including underwriting fees and for general corporate purposes, including acquisitions. Additionally, we received $25.2 million in proceeds from the issuance of the warrants.
On December 29, 2005, we entered into a new senior secured credit facility, which consisted of a $205.0 million term loan and a $150.0 million revolving credit facility, each maturing January 2, 2012. Proceeds from the new senior credit facility were used to repay all amounts outstanding under the previously existing credit facility and loan origination costs. In connection with the financing, we recorded a non-cash charge of approximately $1.8 million related to the write-off of deferred financing costs associated with the existing credit facility.
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
The new senior credit facility is secured by substantially all of our assets and is fully and unconditionally guaranteed by our existing and future, direct and indirect, domestic subsidiaries (other than D. & D. Oil Co., Inc.). In addition, our borrowings under each of the term loan facility and the revolving credit facility 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 leverage ratio (as defined in the credit agreement governing the senior credit facility) is less than 3.00 to 1.00, the applicable margins on the borrowings under the revolving credit facility will each be decreased by 0.25%. In addition, we are required to pay quarterly a fee of 0.50% on the average daily unused portion of the revolving credit facility, and if our consolidated leverage ratio is less than 3.00 to 1.00, this fee will be decreased by 0.125%. As of March 30, 2006, there were no outstanding borrowings under the revolving credit facility and we had approximately $44.0 million of standby letters of credit issued under the facility. As a result, we had approximately $106.0 million in available borrowing capacity (approximately $46.0 million of which was available for issuance of letters of credit). The LIBOR associated with our senior credit facility resets periodically, and was reset on March 31, 2006 at 4.64%.
The new credit facility contains customary affirmative and negative covenants, including the following: maximum total leverage ratio, maximum senior leverage ratio, and minimum fixed charge coverage ratio, as each is defined in the agreement. Additionally, the credit facility contains restrictive covenants regarding our ability to enter into mergers, acquisitions, and joint ventures, pay dividends, or change our line of business, among other things.
The remaining annual maturities of our long-term debt as of March 30, 2006 are as follows (amounts in thousands):
Year Ended September: | |||
2006 | $ | 1,043 | |
2007 | 2,087 | ||
2008 | 2,090 | ||
2009 | 2,094 | ||
2010 | 2,098 | ||
Thereafter | 595,933 | ||
Total long-term debt | $ | 605,345 | |
Substantially all of our net assets are restricted as to payment of dividends and other distributions. As of March 30, 2006, we were in compliance with our covenants and restrictions.
NOTE 7—DERIVATIVE FINANCIAL INSTRUMENTS
We enter into interest rate swap agreements to modify the interest rate characteristics of our outstanding long-term debt facilities and have designated each qualifying instrument as a cash flow hedge. We formally document our hedge relationships, including identifying the hedge instruments and hedged items, as well as our risk management objectives and strategies for entering into the hedge transaction. At hedge inception, and at least quarterly thereafter, we assess whether derivatives used to hedge transactions are highly effective in offsetting changes in the cash flow of the hedged item. We measure effectiveness by the ability of the interest rate swaps to offset cash flows associated with changes in the variable LIBOR rate associated with our term loan facilities using the hypothetical derivative method. To the extent the instruments are considered to be effective, changes in fair value are recorded as a component of other comprehensive income. To the extent there is any hedge
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
ineffectiveness, changes in fair value relating to the ineffective portion are immediately recognized in earnings (interest expense). When it is determined that a derivative ceases to be a highly effective hedge, we discontinue hedge accounting, and subsequent changes in fair value of the hedge instrument are recognized in earnings. Interest expense for the mark-to-market adjustment of those instruments that do not quality for hedge accounting was $0 and $63 thousand for the three months ended March 30, 2006 and March 31, 2005, respectively, and $(2) thousand and $(423) thousand for the six months ended March 30, 2006 and March 31, 2005, respectively.
The fair values of our interest rate swaps are obtained from dealer quotes. These values represent the estimated amount we would receive or pay to terminate the agreement taking into consideration the difference between the contract rate of interest and rates currently quoted for agreements of similar terms and maturities. At March 30, 2006, other current assets and other noncurrent assets include derivative assets of approximately $179 thousand and $3.0 million, respectively. At September 29, 2005 other current assets and other noncurrent assets included derivative assets of approximately $1.5 million and $800 thousand, respectively. Cash flow hedges at March 30, 2006 represent interest rate swaps with a notional amount of $177.0 million and a weighted-average pay rate of 2.83%. Additionally, we are party to cash flow hedges which will become effective April 2006 with a notional amount of $130.0 million, a weighted-average pay rate of 4.24%, and have various settlement dates, the latest of which is April 2009.
NOTE 8—COMPREHENSIVE INCOME
The components of comprehensive income, net of related income taxes, for the periods presented are as follows (amounts in thousands):
Three Months Ended | Six Months Ended | |||||||||||
March 30, 2006 | March 31, 2005 | March 30, 2006 | March 31, 2005 | |||||||||
Net income | $ | 9,196 | $ | 3,341 | $ | 42,167 | $ | 15,781 | ||||
Other comprehensive income: | ||||||||||||
Net unrealized gains on qualifying cash flow hedges (net of deferred income taxes of $246, $923, $314 and $1,207, respectively) | 388 | 1,474 | 494 | 1,928 | ||||||||
Comprehensive income | $ | 9,584 | $ | 4,815 | $ | 42,661 | $ | 17,709 | ||||
The components of unrealized gains on qualifying cash flow hedges, net of related income taxes, for the periods presented are as follows (amounts in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
March 30, 2006 | March 30, 2005 | March 30, 2006 | March 30, 2005 | |||||||||||||
Unrealized gains (losses) on qualifying cash flow hedges | $ | (115 | ) | $ | 1,506 | $ | (350 | ) | $ | 2,207 | ||||||
Less: Reclassification adjustment recorded as interest expense | 503 | (32 | ) | 844 | (279 | ) | ||||||||||
Net unrealized gains on qualifying cash flow hedges | $ | 388 | $ | 1,474 | $ | 494 | $ | 1,928 | ||||||||
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
NOTE 9—INTEREST EXPENSE AND LOSS ON EXTINGUISHMENT OF DEBT
The components of interest expense are as follows (amounts in thousands):
Three Months Ended | Six Months Ended | ||||||||||||||
March 30, 2006 | March 31, 2005 | March 30, 2006 | March 31, 2005 | ||||||||||||
Interest on long-term debt, including amortization of deferred financing costs | $ | 9,706 | $ | 8,986 | $ | 19,556 | $ | 17,500 | |||||||
Interest on lease finance obligations | 5,487 | 4,950 | 10,834 | 9,893 | |||||||||||
Interest rate swap settlements | (829 | ) | 51 | (1,608 | ) | 453 | |||||||||
Fair market value change in non-qualifying derivatives | — | 63 | (2 | ) | (423 | ) | |||||||||
Miscellaneous | 49 | 2 | 66 | 41 | |||||||||||
Subtotal: Interest expense | $ | 14,413 | $ | 14,052 | $ | 28,846 | $ | 27,464 | |||||||
Loss on debt extinguishment | — | — | 1,832 | — | |||||||||||
Total interest expense and loss on extinguishment of debt | $ | 14,413 | $ | 14,052 | $ | 30,678 | $ | 27,464 | |||||||
NOTE 10—EARNINGS PER SHARE AND COMMON STOCK
We compute earnings per share data in accordance with the requirements of SFAS No. 128, Earnings Per Share. Basic earnings per share is computed on the basis of the weighted-average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted-average number of common shares outstanding, plus the effect of outstanding warrants and stock options using the “treasury stock” method. In addition, in accordance with EITF 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share, for each reporting period, when the average stock price for the period exceeds the conversion price of our convertible notes, diluted earnings per share will include incremental shares based on the net shares that would be delivered based on the average stock price for the period assuming all of the convertible notes would have been converted into our common stock regardless of whether the conversion option that allows the conversion has been met. The note hedge transaction will not be considered in diluted earnings per share as the transaction will always be antidilutive.
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
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 | Six Months Ended | |||||||||||
March 30, 2006 | March 31, 2005 | March 30, 2006 | March 31, 2005 | |||||||||
Net income | $ | 9,196 | $ | 3,341 | $ | 42,167 | $ | 15,781 | ||||
Earnings per share—basic: | ||||||||||||
Weighted-average shares outstanding | 22,539 | 20,418 | 22,433 | 20,354 | ||||||||
Earnings per share—basic | $ | 0.41 | $ | 0.16 | $ | 1.88 | $ | 0.78 | ||||
Earnings per share—diluted: | ||||||||||||
Weighed-average shares outstanding | 22,539 | 20,418 | 22,433 | 20,354 | ||||||||
Dilutive impact of options outstanding | 478 | 1,102 | 479 | 948 | ||||||||
Dilutive impact of senior subordinated convertible notes | 360 | — | — | — | ||||||||
Weighted-average shares and potential dilutive shares outstanding | 23,377 | 21,520 | 22,912 | 21,302 | ||||||||
Earnings per share—diluted | $ | 0.39 | $ | 0.16 | $ | 1.84 | $ | 0.74 | ||||
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 30 thousand and 50 thousand for the six months ended March 31, 2005 and March 30, 2006, respectively. The aggregate number of shares, totaling approximately 3.8 million, that we could be obligated to issue upon conversion of our convertible notes were excluded from the six months ended March 30, 2006 computation because their inclusion would have been antidilutive.
During the three month period ended December 29, 2005 and the six month period ended March 30, 2006, we issued 51 thousand and 359 thousand shares of common stock, respectively, related to the exercise of stock options for net proceeds of approximately $4.2 million.
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
NOTE 11—GUARANTOR SUBSIDIARIES
We have two wholly owned subsidiaries, R. & H. Maxxon, Inc. and Kangaroo, Inc., collectively referred to as the Guarantor Subsidiaries, which are guarantors of our senior credit facility, our subordinated notes, and our convertible notes. The guarantees are joint and several in addition to full and unconditional. The Guarantor Subsidiaries do not conduct any operations and do not have significant assets. The Guarantor Subsidiaries and D. & D. Oil Co., Inc., comprise all of our direct and indirect subsidiaries. Combined financial information for the Guarantor Subsidiaries is as follows:
THE PANTRY, INC. AND SUBSIDIARIES
SUPPLEMENTAL COMBINING BALANCE SHEETS
March 30, 2006
(Dollars in thousands)
The Pantry (Issuer) | Guarantor Subsidiaries | Eliminations | Total | ||||||||||||
ASSETS | |||||||||||||||
Current assets: | |||||||||||||||
Cash and cash equivalents | $ | 130,524 | $ | — | $ | — | $ | 130,524 | |||||||
Receivables, net | 56,173 | — | — | 56,173 | |||||||||||
Inventories | 125,538 | — | — | 125,538 | |||||||||||
Prepaid expenses and other current assets | 13,777 | 2 | — | 13,779 | |||||||||||
Deferred income taxes | 6,115 | — | — | 6,115 | |||||||||||
Total current assets | 332,127 | 2 | — | 332,129 | |||||||||||
Investment in subsidiaries | 40,723 | — | (40,723 | ) | — | ||||||||||
Property and equipment, net | 661,889 | — | — | 661,889 | |||||||||||
Other assets: | |||||||||||||||
Goodwill | 433,179 | — | — | 433,179 | |||||||||||
Intercompany notes receivable | (23,477 | ) | 43,872 | (20,395 | ) | — | |||||||||
Other noncurrent assets | 45,706 | 57 | — | 45,763 | |||||||||||
Total other assets | 455,408 | 43,929 | (20,395 | ) | 478,942 | ||||||||||
Total assets | $ | 1,490,147 | $ | 43,931 | $ | (61,118 | ) | $ | 1,472,960 | ||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||||||||||
Current liabilities: | |||||||||||||||
Current maturities of long-term debt | $ | 2,086 | $ | — | $ | — | $ | 2,086 | |||||||
Current maturities of lease financing obligations | 2,986 | — | — | 2,986 | |||||||||||
Accounts payable | 139,450 | — | — | 139,450 | |||||||||||
Accrued compensation and related taxes | 15,662 | — | — | 15,662 | |||||||||||
Other accrued taxes | 18,523 | — | — | 18,523 | |||||||||||
Accrued insurance | 24,333 | — | — | 24,333 | |||||||||||
Other accrued liabilities | 23,495 | — | (65 | ) | 23,430 | ||||||||||
Total current liabilities | 226,535 | — | (65 | ) | 226,470 | ||||||||||
Other liabilities: | |||||||||||||||
Long-term debt | 603,259 | — | — | 603,259 | |||||||||||
Lease finance obligations | 206,117 | — | — | 206,117 | |||||||||||
Deferred income taxes | 65,164 | — | — | 65,164 | |||||||||||
Deferred vendor rebates | 30,470 | — | — | 30,470 | |||||||||||
Intercompany notes payable | 17,124 | 3,208 | (20,332 | ) | — | ||||||||||
Other noncurrent liabilities | 53,480 | 2 | — | 53,482 | |||||||||||
Total other liabilities | 975,614 | 3,210 | (20,332 | ) | 958,492 | ||||||||||
Shareholders’ equity: | |||||||||||||||
Common stock | 227 | 523 | (523 | ) | 227 | ||||||||||
Additional paid-in capital | 170,236 | 40,551 | (40,551 | ) | 170,236 | ||||||||||
Accumulated other comprehensive income, net | 1,920 | — | — | 1,920 | |||||||||||
Retained earnings (deficit) | 115,615 | (353 | ) | 353 | 115,615 | ||||||||||
Total shareholders’ equity | 287,998 | 40,721 | (40,721 | ) | 287,998 | ||||||||||
Total liabilities and shareholders’ equity | $ | 1,490,147 | $ | 43,931 | $ | (61,118 | ) | $ | 1,472,960 | ||||||
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
THE PANTRY, INC. AND SUBSIDIARIES
SUPPLEMENTAL COMBINING BALANCE SHEETS
September 29, 2005
(Dollars in thousands)
The Pantry (Issuer) | Guarantor Subsidiaries | Eliminations | Total | ||||||||||||
ASSETS | |||||||||||||||
Current assets: | |||||||||||||||
Cash and cash equivalents | $ | 111,472 | $ | — | $ | — | $ | 111,472 | |||||||
Receivables, net | 61,597 | — | — | 61,597 | |||||||||||
Inventories | 125,348 | — | — | 125,348 | |||||||||||
Prepaid expenses and other current assets | 19,029 | 2 | — | 19,031 | |||||||||||
Deferred income taxes | 5,837 | — | — | 5,837 | |||||||||||
Total current assets | 323,283 | 2 | — | 323,285 | |||||||||||
Investment in subsidiaries | 40,723 | — | (40,723 | ) | — | ||||||||||
Property and equipment, net | 630,291 | — | — | 630,291 | |||||||||||
Other assets: | |||||||||||||||
Goodwill | 394,903 | — | — | 394,903 | |||||||||||
Intercompany notes receivable | (23,477 | ) | 43,872 | (20,395 | ) | — | |||||||||
Other noncurrent assets | 39,630 | 57 | — | 39,687 | |||||||||||
Total other assets | 411,056 | 43,929 | (20,395 | ) | 434,590 | ||||||||||
Total assets | $ | 1,405,353 | $ | 43,931 | $ | (61,118 | ) | $ | 1,388,166 | ||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||||||||||
Current liabilities: | |||||||||||||||
Current maturities of long-term debt | $ | 16,045 | $ | — | $ | — | $ | 16,045 | |||||||
Current maturities of lease finance obligations | 2,872 | — | — | 2,872 | |||||||||||
Accounts payable | 131,618 | — | — | 131,618 | |||||||||||
Accrued compensation and related taxes | 16,786 | — | — | 16,786 | |||||||||||
Other accrued taxes | 34,346 | — | — | 34,346 | |||||||||||
Accrued insurance | 22,544 | — | — | 22,544 | |||||||||||
Other accrued liabilities | 29,387 | — | (65 | ) | 29,322 | ||||||||||
Total current liabilities | 253,598 | — | (65 | ) | 253,533 | ||||||||||
Other liabilities: | |||||||||||||||
Long-term debt | 539,328 | — | — | 539,328 | |||||||||||
Lease finance obligations | 200,214 | — | — | 200,214 | |||||||||||
Deferred income taxes | 64,848 | — | — | 64,848 | |||||||||||
Deferred vendor rebates | 27,385 | — | — | 27,385 | |||||||||||
Intercompany notes payable | 17,124 | 3,208 | (20,332 | ) | — | ||||||||||
Other noncurrent liabilities | 50,923 | 2 | — | 50,925 | |||||||||||
Total other liabilities | 899,822 | 3,210 | (20,332 | ) | 882,700 | ||||||||||
Shareholders’ equity: | |||||||||||||||
Common stock | 223 | 523 | (523 | ) | 223 | ||||||||||
Additional paid-in capital | 176,836 | 40,551 | (40,551 | ) | 176,836 | ||||||||||
Accumulated other comprehensive income, net | 1,426 | — | — | 1,426 | |||||||||||
Retained earnings (deficit) | 73,448 | (353 | ) | 353 | 73,448 | ||||||||||
Total shareholders’ equity | 251,933 | 40,721 | (40,721 | ) | 251,933 | ||||||||||
Total liabilities and shareholders’ equity | $ | 1,405,353 | $ | 43,931 | $ | (61,118 | ) | $ | 1,388,166 | ||||||
20
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
THE PANTRY, INC. AND SUBSIDIARIES
SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS
Three Months Ended March 30, 2006
(Dollars in thousands)
The Pantry (Issuer) | Guarantor Subsidiaries | Eliminations | Total | |||||||||||
Revenues: | ||||||||||||||
Merchandise | $ | 323,004 | $ | — | $ | — | $ | 323,004 | ||||||
Gasoline | 992,742 | — | — | 992,742 | ||||||||||
Total revenues | 1,315,746 | — | — | 1,315,746 | ||||||||||
Cost of sales: | ||||||||||||||
Merchandise | 201,457 | — | — | 201,457 | ||||||||||
Gasoline | 945,396 | — | — | 945,396 | ||||||||||
Total cost of sales | 1,146,853 | — | — | 1,146,853 | ||||||||||
�� | ||||||||||||||
Gross profit | 168,893 | — | — | 168,893 | ||||||||||
Operating expenses: | ||||||||||||||
Operating, general and administrative expenses | 123,573 | — | — | 123,573 | ||||||||||
Depreciation and amortization | 17,467 | — | — | 17,467 | ||||||||||
Total operating expenses | 141,040 | — | — | 141,040 | ||||||||||
Income from operations | 27,853 | — | — | 27,853 | ||||||||||
Other income (expense): | ||||||||||||||
Interest expense | (14,413 | ) | — | — | (14,413 | ) | ||||||||
Interest income | 1,541 | — | — | 1,541 | ||||||||||
Miscellaneous | 170 | — | — | 170 | ||||||||||
Total other expense | (12,702 | ) | — | — | (12,702 | ) | ||||||||
Income before income taxes | 15,151 | — | — | 15,151 | ||||||||||
Income tax expense | (5,955 | ) | — | — | (5,955 | ) | ||||||||
Net income | $ | 9,196 | $ | — | $ | — | $ | 9,196 | ||||||
21
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
THE PANTRY, INC. AND SUBSIDIARIES
SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2005
(Dollars in thousands)
The Pantry (Issuer) | Guarantor Subsidiaries | Eliminations | Total | |||||||||||
Revenues: | ||||||||||||||
Merchandise | $ | 284,289 | $ | — | $ | — | $ | 284,289 | ||||||
Gasoline | 661,471 | — | — | 661,471 | ||||||||||
Total revenues | 945,760 | — | — | 945,760 | ||||||||||
Cost of sales: | ||||||||||||||
Merchandise | 178,557 | — | — | 178,557 | ||||||||||
Gasoline | 627,351 | — | — | 627,351 | ||||||||||
Total cost of sales | 805,908 | — | — | 805,908 | ||||||||||
Gross profit | 139,852 | — | — | 139,852 | ||||||||||
Operating expenses: | ||||||||||||||
Operating, general and administrative expenses | 105,636 | — | — | 105,636 | ||||||||||
Depreciation and amortization | 15,414 | — | — | 15,414 | ||||||||||
Total operating expenses | 121,050 | — | — | 121,050 | ||||||||||
Income from operations | 18,802 | — | — | 18,802 | ||||||||||
Other income (expense): | ||||||||||||||
Interest expense | (14,052 | ) | — | — | (14,052 | ) | ||||||||
Interest income | 465 | — | — | 465 | ||||||||||
Miscellaneous | 217 | — | — | 217 | ||||||||||
Total other expense | (13,370 | ) | — | — | (13,370 | ) | ||||||||
Income before income taxes | 5,432 | — | — | 5,432 | ||||||||||
Income tax expense | (2,091 | ) | — | — | (2,091 | ) | ||||||||
Net income | $ | 3,341 | $ | — | $ | — | $ | 3,341 | ||||||
22
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
THE PANTRY, INC. AND SUBSIDIARIES
SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS
Six Months Ended March 30, 2006
(Dollars in thousands)
The Pantry (Issuer) | Guarantor Subsidiaries | Eliminations | Total | |||||||||||
Revenues: | ||||||||||||||
Merchandise | $ | 639,652 | $ | — | $ | — | $ | 639,652 | ||||||
Gasoline | 1,991,417 | — | — | 1,991,417 | ||||||||||
Total revenues | 2,631,069 | — | — | 2,631,069 | ||||||||||
Cost of sales: | ||||||||||||||
Merchandise | 399,369 | — | — | 399,369 | ||||||||||
Gasoline | 1,857,486 | — | — | 1,857,486 | ||||||||||
Total cost of sales | 2,256,855 | — | — | 2,256,855 | ||||||||||
Gross profit | 374,214 | — | — | 374,214 | ||||||||||
Operating expenses: | ||||||||||||||
Operating, general and administrative expenses | 241,901 | — | — | 241,901 | ||||||||||
Depreciation and amortization | 34,704 | — | — | 34,704 | ||||||||||
Total operating expenses | 276,605 | — | — | 276,605 | ||||||||||
Income from operations | 97,609 | — | — | 97,609 | ||||||||||
Other income (expense): | ||||||||||||||
Interest expense | (28,846 | ) | — | — | (28,846 | ) | ||||||||
Loss on extinguishment of debt | (1,832 | ) | — | — | (1,832 | ) | ||||||||
Interest income | 2,585 | — | — | 2,585 | ||||||||||
Miscellaneous | 329 | — | — | 329 | ||||||||||
Total other expense | (27,764 | ) | — | — | (27,764 | ) | ||||||||
Income before income taxes | 69,845 | — | — | 69,845 | ||||||||||
Income tax expense | (27,678 | ) | — | — | (27,678 | ) | ||||||||
Net income | $ | 42,167 | $ | — | $ | — | $ | 42,167 | ||||||
23
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
THE PANTRY, INC. AND SUBSIDIARIES
SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS
Six Months Ended March 31, 2005
(Dollars in thousands)
The Pantry (Issuer) | Guarantor Subsidiaries | Eliminations | Total | |||||||||||
Revenues: | ||||||||||||||
Merchandise | $ | 571,356 | $ | — | $ | — | $ | 571,356 | ||||||
Gasoline | 1,315,947 | — | — | 1,315,947 | ||||||||||
Total revenues | 1,887,303 | — | — | 1,887,303 | ||||||||||
Cost of sales: | ||||||||||||||
Merchandise | 361,532 | — | — | 361,532 | ||||||||||
Gasoline | 1,231,940 | — | — | 1,231,940 | ||||||||||
Total cost of sales | 1,593,472 | — | — | 1,593,472 | ||||||||||
Gross profit | 293,831 | — | — | 293,831 | ||||||||||
Operating expenses: | ||||||||||||||
Operating, general and administrative expenses | 210,812 | — | — | 210,812 | ||||||||||
Depreciation and amortization | 31,000 | — | — | 31,000 | ||||||||||
Total operating expenses | 241,812 | — | — | 241,812 | ||||||||||
Income from operations | 52,019 | — | — | 52,019 | ||||||||||
Other income (expense): | ||||||||||||||
Interest expense | (27,464 | ) | — | — | (27,464 | ) | ||||||||
Interest income | 748 | — | — | 748 | ||||||||||
Miscellaneous | 356 | — | — | 356 | ||||||||||
Total other expense | (26,360 | ) | — | — | (26,360 | ) | ||||||||
Income before income taxes | 25,659 | — | — | 25,659 | ||||||||||
Income tax expense | (9,878 | ) | — | — | (9,878 | ) | ||||||||
Net income | $ | 15,781 | $ | — | $ | — | $ | 15,781 | ||||||
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
THE PANTRY, INC. AND SUBSIDIARIES
SUPPLEMENTAL COMBINING STATEMENTS OF CASH FLOWS
Six Months Ended March 30, 2006
(Dollars in thousands)
The Pantry (Issuer) | Guarantor Subsidiaries | Eliminations | Total | |||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||||
Net income | $ | 42,167 | $ | — | $ | — | $ | 42,167 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||
Depreciation and amortization | 34,704 | — | — | 34,704 | ||||||||||
Provision for deferred income taxes | 1 | — | — | 1 | ||||||||||
Loss on extinguishment of debt | 1,832 | — | — | 1,832 | ||||||||||
Stock-based compensation | 1,347 | — | — | 1,347 | ||||||||||
Excess income tax benefits from stock-based compensation arrangements | (5,748 | ) | — | — | (5,748 | ) | ||||||||
Other | 1,054 | — | — | 1,054 | ||||||||||
Changes in operating assets and liabilities (net of effects of acquisitions): | ||||||||||||||
Receivables | 5,133 | — | — | 5,133 | ||||||||||
Inventories | 5,129 | — | — | 5,129 | ||||||||||
Prepaid expenses and other current assets | (1,622 | ) | — | — | (1,622 | ) | ||||||||
Other noncurrent assets | 253 | — | — | 253 | ||||||||||
Accounts payable | 7,832 | — | — | 7,832 | ||||||||||
Other current liabilities and accrued expenses | (15,333 | ) | — | — | (15,333 | ) | ||||||||
Other noncurrent liabilities | (2,158 | ) | — | — | (2,158 | ) | ||||||||
Net cash provided by operating activities | 74,591 | — | — | 74,591 | ||||||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||||
Additions to property and equipment | (36,092 | ) | — | — | (36,092 | ) | ||||||||
Proceeds from sale of land, buildings and equipment | 3,008 | — | — | 3,008 | ||||||||||
Acquisitions of businesses, net of cash acquired | (63,252 | ) | — | — | (63,252 | ) | ||||||||
Net cash used in investing activities | (96,336 | ) | — | — | (96,336 | ) | ||||||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||||
Principal repayments under lease finance obligations | (1,451 | ) | — | — | (1,451 | ) | ||||||||
Principal repayments of long-term debt | (305,028 | ) | — | — | (305,028 | ) | ||||||||
Proceeds from issuance of long-term debt | 355,000 | — | — | 355,000 | ||||||||||
Proceeds from lease finance obligations | 7,468 | — | — | 7,468 | ||||||||||
Proceeds from exercise of stock options | 4,160 | — | — | 4,160 | ||||||||||
Payment for purchase of note hedge | (43,720 | ) | — | — | (43,720 | ) | ||||||||
Proceeds from issuance of warrant | 25,220 | — | — | 25,220 | ||||||||||
Excess income tax benefits from stock-based compensation arrangements | 5,748 | — | — | 5,748 | ||||||||||
Other financing costs | (6,600 | ) | — | — | (6,600 | ) | ||||||||
Net cash provided by financing activities | 40,797 | — | — | 40,797 | ||||||||||
NET INCREASE IN CASH AND CASH EQUIVALENTS | 19,052 | — | — | 19,052 | ||||||||||
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | 111,472 | — | — | 111,472 | ||||||||||
CASH AND CASH EQUIVALENTS, END OF PERIOD | $ | 130,524 | $ | — | $ | — | $ | 130,524 | ||||||
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THE PANTRY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
THE PANTRY, INC. AND SUBSIDIARIES
SUPPLEMENTAL COMBINING STATEMENTS OF CASH FLOWS
Six Months Ended March 31, 2005
(Dollars in thousands)
The Pantry (Issuer) | Guarantor Subsidiaries | Eliminations | Total | |||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||||
Net income | $ | 15,781 | $ | — | $ | — | $ | 15,781 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||
Depreciation and amortization | 31,000 | — | — | 31,000 | ||||||||||
Provision for deferred income taxes | 4,097 | — | — | 4,097 | ||||||||||
Income tax benefit related to exercise of stock options | 3,311 | — | — | 3,311 | ||||||||||
Other | 737 | — | — | 737 | ||||||||||
Changes in operating assets and liabilities (net of effects of acquisitions): | ||||||||||||||
Receivables | (1,433 | ) | — | — | (1,433 | ) | ||||||||
Inventories | (1,572 | ) | — | — | (1,572 | ) | ||||||||
Prepaid expenses and other current assets | (2,907 | ) | — | — | (2,907 | ) | ||||||||
Other noncurrent assets | (531 | ) | — | — | (531 | ) | ||||||||
Accounts payable | (10,647 | ) | — | — | (10,647 | ) | ||||||||
Other current liabilities and accrued expenses | (9,568 | ) | — | — | (9,568 | ) | ||||||||
Other noncurrent liabilities | (618 | ) | — | — | (618 | ) | ||||||||
Net cash provided by operating activities | 27,650 | — | — | 27,650 | ||||||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||||
Additions to property and equipment | (27,900 | ) | — | — | (27,900 | ) | ||||||||
Proceeds from sale of land, buildings and equipment | 4,338 | — | — | 4,338 | ||||||||||
Acquisitions of businesses, net of cash acquired | (1,627 | ) | — | — | (1,627 | ) | ||||||||
Net cash used in investing activities | (25,189 | ) | — | — | (25,189 | ) | ||||||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||||
Principal repayments under lease finance obligations | (1,384 | ) | — | — | (1,384 | ) | ||||||||
Principal repayments of long-term debt | (8,014 | ) | — | — | (8,014 | ) | ||||||||
Proceeds from lease finance obligations | 516 | — | — | 516 | ||||||||||
Proceeds from exercise of stock options | 3,150 | — | — | 3,150 | ||||||||||
Net cash used in financing activities | (5,732 | ) | — | — | (5,732 | ) | ||||||||
NET DECREASE IN CASH AND CASH EQUIVALENTS | (3,271 | ) | — | — | (3,271 | ) | ||||||||
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | 108,048 | — | — | 108,048 | ||||||||||
CASH AND CASH EQUIVALENTS, END OF PERIOD | $ | 104,777 | $ | — | $ | — | $ | 104,777 | ||||||
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
The following 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 Company is contained in our Annual Report on Form 10-K for the fiscal year ended September 29, 2005.
This report, including without limitation, statements under our discussion and analysis of financial condition and results of operations, contains statements that we believe are “forward-looking statements” under the meaning of the Private Securities Litigation Reform Act of 1995 and are intended to enjoy protection of the safe harbor for forward-looking statements provided by that Act. These forward-looking statements generally can be identified by use of phrases such as “believe,” “plan,” “expect,” “anticipate,” “intend,” “forecast” or other similar words or phrases. Descriptions of our objectives, goals, targets, plans, strategies, anticipated capital expenditures, costs and burdens of environmental remediation, expected cost savings and benefits and anticipated synergies from acquisitions, anticipated costs of re-branding our stores, anticipated sharing of costs of conversion with our gasoline suppliers, and expectations regarding re-modeling, re-branding, re-imaging or otherwise converting our stores are also forward-looking statements. These forward-looking statements are based on our current plans and expectations and involve a number of risks and uncertainties that could cause actual results and events to vary materially from the results and events anticipated or implied by such forward-looking statements, including:
• | Competitive pressures from convenience stores, gasoline stations and other non-traditional retailers located in our markets; |
• | Changes in economic conditions generally and in the markets we serve; |
• | Unfavorable weather conditions; |
• | Political conditions in crude oil producing regions and global demand; |
• | Volatility in crude oil and wholesale petroleum costs; |
• | Wholesale cost increases of tobacco products; |
• | Consumer behavior, travel and tourism trends; |
• | Changes in state and federal environmental and other laws and regulations; |
• | Dependence on one principal supplier for merchandise and two principal suppliers for gasoline; |
• | Financial leverage and debt covenants; |
• | Changes in the credit ratings assigned to our debt securities, credit facilities and trade credit; |
• | Inability to identify, acquire and integrate new stores; |
• | Dependence on senior management; |
• | Acts of war and terrorism; and |
• | Other unforeseen factors. |
For a discussion of these and other risks and uncertainties, please refer to Part II. Other Information-Item 1A. Risk Factors below. 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 May 9, 2006. We anticipate that subsequent events and market developments will cause our estimates to change. However, while we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if new information becomes available in the future.
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Executive Overview
We are the leading independently operated convenience store chain in the southeastern United States and the third largest independently operated convenience store chain in the country based on store count with 1,458 stores in eleven states as of March 30, 2006. Our stores offer a broad selection of merchandise, gasoline and ancillary products and services designed to appeal to the convenience needs of our customers. Our strategy is to continue to improve upon our position as the leading independently operated convenience store chain in the southeastern United States by generating profitable growth through merchandising initiatives, sophisticated management of our gasoline business, upgrading our stores, leveraging our geographic economies of scale, benefiting from the favorable demographics of our markets and continuing to selectively pursue acquisitions.
Net income for our second quarter of fiscal 2006 of $9.2 million represented a 175.3% increase from $3.3 million in the second quarter of fiscal 2005. During the quarter, our comparable store merchandise revenue increased 5.4% while comparable store gasoline gallons increased 4.0%. These results were driven by an unusually strong performance in our gasoline operations which we believe were made possible, in part, due to the benefits of our long-term gasoline supply contracts. In our merchandise business, we believe that we continued to benefit from our ongoing focus on higher-margin merchandise such as food service and private label products. Our recent acquisitions also contributed to increased gasoline and merchandise volumes adding to overall profitability.
On March 1, 2006, we signed a definitive agreement to purchase 38 convenience stores in Alabama from Shop-A-Snak Food Mart, Inc. The acquisition also includes dealer and fuel supply arrangements for several additional stores. We plan to finance the transaction with a combination of cash on hand and lease financing. The acquisition, which is subject to regulatory approvals and other customary closing conditions, is expected to close in our third fiscal quarter of 2006.
On March 30, 2006, we began selling lottery tickets in North Carolina. We believe that North Carolina’s decision to sell lottery products will help generate additional revenue for our company.
Market and Industry Trends
During the second quarter of fiscal 2006, we experienced a volatile wholesale gasoline cost environment as domestic crude oil prices peaked at a high of approximately $68 per barrel in January 2006 before hitting a low of approximately $58 per barrel in February 2006. We attempt to pass along wholesale gasoline cost changes to our customers through retail price changes; however, we are not always able to do so. The timing of any related increase or decrease in retail prices is affected by competitive conditions. As a result, we tend to experience lower gasoline margins in periods of rising wholesale costs and higher margins in periods of decreasing wholesale costs. Since 1995, our gasoline margin per gallon has remained relatively stable and averaged approximately 12 cents per gallon on an annual basis.
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Results of Operations
The following table presents, for the periods indicated, selected items in the condensed consolidated statements of operations as a percentage of our total revenue:
Three Months Ended | Six Months Ended | |||||||||||
March 30, 2006 | March 31, 2005 | March 30, 2006 | March 31, 2005 | |||||||||
Total revenue | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||
Gasoline revenue | 75.4 | 69.9 | 75.7 | 69.7 | ||||||||
Merchandise revenue | 24.6 | 30.1 | 24.3 | 30.3 | ||||||||
Cost of sales | 87.2 | 85.2 | 85.8 | 84.4 | ||||||||
Gross profit | 12.8 | 14.8 | 14.2 | 15.6 | ||||||||
Gasoline gross profit | 3.6 | 3.6 | 5.1 | 4.5 | ||||||||
Merchandise gross profit | 9.2 | 11.2 | 9.1 | 11.1 | ||||||||
Operating, general and administrative expenses | 9.4 | 11.2 | 9.2 | 11.2 | ||||||||
Depreciation and amortization | 1.3 | 1.6 | 1.3 | 1.6 | ||||||||
Income from operations | 2.1 | 2.0 | 3.7 | 2.8 | ||||||||
Total other expense | (1.0 | ) | (1.4 | ) | (1.1 | ) | (1.4 | ) | ||||
Income before income taxes | 1.1 | 0.6 | 2.6 | 1.4 | ||||||||
Income tax expense | (0.4 | ) | (0.2 | ) | (1.0 | ) | (0.6 | ) | ||||
Net income | 0.7 | % | 0.4 | % | 1.6 | % | 0.8 | % | ||||
The table below provides a summary of our selected financial data for our three and six months ended March 30, 2006 and March 31, 2005.
Three Months Ended | Six Months Ended | |||||||||||||||
March 30, 2006 | March 31, 2005 | March 30, 2006 | March 31, 2005 | |||||||||||||
Selected financial data: | ||||||||||||||||
Merchandise margin | 37.6 | % | 37.2 | % | 37.6 | % | 36.7 | % | ||||||||
Gasoline gallons (millions) | 428.2 | 346.2 | 837.3 | 686.8 | ||||||||||||
Gasoline margin per gallon | $ | 0.1106 | $ | 0.0986 | $ | 0.1600 | $ | 0.1223 | ||||||||
Gasoline retail per gallon | $ | 2.32 | $ | 1.91 | $ | 2.38 | $ | 1.92 | ||||||||
Operating, general and administrative expenses as a percentage of the sum of merchandise revenue and gasoline gallons [1] | 16.4 | % | 16.8 | % | 16.4 | % | 16.8 | % | ||||||||
Comparable store data: | ||||||||||||||||
Merchandise sales % | 5.4 | % | 6.6 | % | 5.2 | % | 6.2 | % | ||||||||
Gasoline gallons % | 4.0 | % | 7.7 | % | 4.3 | % | 5.9 | % | ||||||||
Number of stores: | ||||||||||||||||
End of period | 1,458 | 1,345 | 1,458 | 1,345 | ||||||||||||
Weighted-average store count | 1,429 | 1,348 | 1,414 | 1,351 |
[1] | We believe this presentation eliminates the impact of gasoline retail changes and enhances year over year comparisons. |
Three Months Ended March 30, 2006 Compared to the Three Months Ended March 31, 2005
Merchandise Revenue. Merchandise revenue for the second quarter of fiscal 2006 was $323.0 million compared to $284.3 million during the second quarter of fiscal 2005, an increase of $38.7 million, or 13.6%. The increase is primarily attributable to $29.3 million in revenue from stores acquired since March 31, 2005 and a 5.4%, or $14.9 million, increase in comparable store merchandise revenue compared to the second quarter of fiscal 2005. These increases were partially offset by lost revenue from closed stores of approximately $6.9 million.
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Gasoline Revenue and Gallons. Gasoline revenue for the second quarter of fiscal 2006 was $992.7 million compared to $661.5 million during the second quarter of fiscal 2005, an increase of $331.2 million, or 50.1%. The increase in gasoline revenue is primarily attributable to $166.3 million in revenue from stores acquired since March 31, 2005, an increase in comparable store gallons of 13.4 million, or 4.0%, and the 41 cent per gallon increase in the average gasoline retail price per gallon. The increase in the average gasoline retail price per gallon is a result of our passing along to customers the increases in wholesale fuel costs experienced in the second quarter of fiscal 2006. These increases were partially offset by lost revenue from closed stores of approximately $10.2 million.
In the second quarter of fiscal 2006, gasoline gallons sold were 428.2 million compared to 346.2 million during the second quarter of fiscal 2005, an increase of 82.1 million gallons, or 23.7%. The increase is primarily attributable to 72.6 million gasoline gallons from stores acquired since March 31, 2005 and the comparable store gasoline gallon increase discussed above, partially offset by lost gallon volume from closed stores of approximately 5.4 million gallons.
Merchandise Gross Profit and Margin. Merchandise gross profit was $121.5 million for the second quarter of fiscal 2006 compared to $105.7 million for the second quarter of fiscal 2005, an increase of $15.8 million, or 15.0%. This increase is primarily attributable to the increased merchandise revenue discussed above and a 40 basis point increase in merchandise margin to 37.6% for the second quarter of fiscal 2006 compared to 37.2% for the second quarter of fiscal 2005. The margin improvement is primarily due to the continued growth in food service revenue and private label products, which on average represent higher margin categories. Additionally, service revenue increased 21.3% primarily due to higher lottery commission income.
Gasoline Gross Profit and Per Gallon Margin. Gasoline gross profit was $47.3 million for the second quarter of fiscal 2006 compared to $34.1 million for the second quarter of fiscal 2005, an increase of $13.2 million, or 38.8%. The increase is primarily attributable to an increase in our gross profit per gallon to 11.1 cents for the second quarter of fiscal 2006 from 9.9 cents in the second quarter of fiscal 2005. During the second quarter of fiscal 2006, our gasoline gross profit per gallon benefited from declining wholesale crude costs. We present gasoline gross profit per gallon inclusive of credit card processing fees and cost of repairs and maintenance on gasoline equipment. These fees and costs totaled 3.9 cents per gallon and 3.3 cents per gallon for the three months ended March 30, 2006 and March 31, 2005, respectively. The increase in these fees and costs was primarily due to higher credit card fees as a result of a 21.3% increase in retail gasoline prices.
Operating, General and Administrative Expenses. Operating, general and administrative expenses for the second quarter of fiscal 2006 totaled $123.6 million compared to $105.6 million for the second quarter of fiscal 2005, an increase of $17.9 million, or 17.0%. This increase is primarily due to increased store count from acquisitions and comparable store increases in labor and other variable expenses.
Income from Operations. Income from operations totaled $27.9 million for the second quarter of fiscal 2006 compared to $18.8 million for the second quarter of fiscal 2005, an increase of $9.1 million, or 48.1%. The increase is primarily attributable to the increases in gasoline and merchandise gross profit discussed above, partially offset by the increase in operating, general and administrative expenses also discussed above.
EBITDA. EBITDA is defined by us as net income before interest expense and loss on extinguishment of debt, income taxes, depreciation and amortization. EBITDA for the second quarter of fiscal 2006 totaled $47.0 million compared to EBITDA of $34.9 million during the second quarter of fiscal 2005, an increase of $12.1 million, or 34.8%. The increase is primarily attributable to the increase in income from operations discussed above and a $1.1 million increase in interest income.
EBITDA is not a measure of performance under accounting principles generally accepted in the United States of America, and should not be considered as a substitute for net income, cash flows from operating activities and other income or cash flow statement data. We have included information concerning EBITDA as one measure of our operating performance and historical ability to service debt and because we believe investors
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find this information useful because it reflects the resources available for strategic opportunities including, among others, to invest in the business, make strategic acquisitions and to service debt. EBITDA as defined by us may not be comparable to similarly titled measures reported by other companies.
The following table contains a reconciliation of EBITDA to net income (amounts in thousands):
Three Months Ended | ||||||||
March 30, 2006 | March 31, 2005 | |||||||
EBITDA | $ | 47,031 | $ | 34,898 | ||||
Interest expense | (14,413 | ) | (14,052 | ) | ||||
Depreciation and amortization | (17,467 | ) | (15,414 | ) | ||||
Provision for income taxes | (5,955 | ) | (2,091 | ) | ||||
Net income | $ | 9,196 | $ | 3,341 | ||||
Interest Expense. Interest expense is primarily comprised of interest on our long-term debt and lease finance obligations. Interest expense for the second quarter of fiscal 2006 was $14.4 million compared to $14.1 million for the second quarter of fiscal 2005. The increase is primarily the result of an increase in our weighted-average borrowings as a result of the issuance of the convertible notes partially offset by decreases in the credit facility.
Net income. Net income for the second quarter of fiscal 2006 was $9.2 million compared to net income of $3.3 million for the second quarter of fiscal 2005. The increase is primarily attributable to increased income from operations discussed above.
Six Months Ended March 30, 2006 Compared to the Six Months Ended March 31, 2005
Merchandise Revenue. Merchandise revenue for the first six months of fiscal 2006 was $639.7 million compared to $571.4 million for the first six months of fiscal 2005, an increase of $68.3 million, or 12.0%. The increase is primarily attributable to $51.7 million in revenue from stores acquired since March 31, 2005 and a 5.2%, or $28.8 million, increase in comparable store merchandise revenue compared to the first six months of fiscal 2005. These increases were partially offset by lost revenue from closed stores of approximately $14.3 million.
Gasoline Revenue and Gallons. Gasoline revenue for the first six months of fiscal 2006 was $1,991.4 million compared to $1,315.9 million during the first six months of fiscal 2005, an increase of $675.5 million, or 51.3%. The increase in gasoline revenue is primarily attributable to $307.5 million in revenue from stores acquired since March 31, 2005, an increase in comparable store gallons of 28.7 million, or 4.3%, and the 46 cent per gallon increase in the average gasoline retail price per gallon. The increase in the average gasoline retail price per gallon is a result of our passing along to customers the increases in wholesale fuel costs experienced in fiscal 2006. These increases were partially offset by lost revenue from closed stores of approximately $20.6 million.
For the first six months of fiscal 2006, gasoline gallons sold were 837.3 million compared to 686.8 million during the first six months of fiscal 2005, an increase of 150.5 million gallons, or 21.9%. The increase is primarily attributable to 131.1 million gasoline gallons from stores acquired since March 31, 2005 and the comparable store gasoline gallon increase discussed above, partially offset by lost gallon volume from closed stores of approximately 10.9 million.
Merchandise Gross Profit and Margin. Merchandise gross profit was $240.3 million for the first six months of fiscal 2006 compared to $209.8 million for the first six months of fiscal 2005, an increase of $30.5 million, or 14.5%. This increase is primarily attributable to the increased merchandise revenue discussed above and a 90 basis point increase in merchandise margin to 37.6% for the first six months of fiscal 2006 compared to 36.7% for the first six months of fiscal 2005.
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Gasoline Gross Profit and Per Gallon Margin. Gasoline gross profit was $133.9 million for the first six months of fiscal 2006 compared to $84.0 million for the first six months of fiscal 2005, an increase of $49.9 million, or 59.4%. The increase is primarily attributable to an increase in our gross profit per gallon to 16.0 cents for the first six months of fiscal 2006 from 12.2 cents in the first six months of fiscal 2005. During the first six months of fiscal 2006, our gasoline gross profit per gallon benefited from decreasing wholesale crude costs. Additionally, we believe our first quarter results benefited from our long-term gasoline supply contracts which gave us flexibility and greater certainty of supply in the wake of hurricanes Katrina and Rita. We present gasoline gross profit per gallon inclusive of credit card processing fees and cost of repairs and maintenance on gasoline equipment. These fees and costs totaled 3.9 cents per gallon and 3.4 cents per gallon for the six months ended March 30, 2006 and March 31, 2005, respectively. The increase in these fees and costs was primarily due to higher credit card fees as a result of a 24% increase in retail gasoline prices.
Operating, General and Administrative Expenses. Operating, general and administrative expenses for the first six months of fiscal 2006 totaled $241.9 million compared to $210.8 million for the first six months of fiscal 2005, an increase of $31.1 million, or 14.8%. This increase is primarily due to increased store count from acquisitions and comparable store increases in labor and other variable expenses.
Income from Operations. Income from operations totaled $97.6 million for the first six months of fiscal 2006 compared to $52.0 million for the first six months of fiscal 2005, an increase of $45.6 million, or 87.6%. The increase is primarily attributable to the increases in gasoline and merchandise gross profit discussed above, partially offset by the increase in operating, general and administrative expenses also discussed above.
EBITDA. EBITDA for the first six months of fiscal 2006 totaled $135.2 million compared to EBITDA of $84.1 million for the first six months of fiscal 2005, an increase of $51.1 million, or 60.8%. The increase is primarily attributable to the increase in income from operations discussed above and a $1.8 million increase in interest income.
The following table contains a reconciliation of EBITDA to net income (amounts in thousands):
Six Months Ended | ||||||||
March 30, 2006 | March 31, 2005 | |||||||
EBITDA | $ | 135,227 | $ | 84,123 | ||||
Interest expense and loss on extinguishment of debt | (30,678 | ) | (27,464 | ) | ||||
Depreciation and amortization | (34,704 | ) | (31,000 | ) | ||||
Provision for income taxes | (27,678 | ) | (9,878 | ) | ||||
Net income | $ | 42,167 | $ | 15,781 | ||||
Loss on Extinguishment of Debt. As a result of the refinancing of our senior secured credit facility during the first quarter of fiscal 2006, we incurred $1.8 million in refinancing charges associated with the write-off of unamortized debt issue costs associated with the facility that was paid off.
Interest Expense. Interest expense is primarily comprised of interest on our long-term debt, lease finance obligations, and the loss on extinguishment of debt referred to above. Interest expense, excluding the loss on extinguishment of debt, for the first six months of fiscal 2006 was $28.8 million compared to $27.5 million for the first six months of fiscal 2005. The increase is primarily the result of an increase in our weighted-average borrowings as a result of the issuance of the convertible notes.
Net Income. Net income for the first six months of fiscal 2006 was $42.2 million compared to a net income of $15.8 million for the first six months of fiscal 2005. The increase is primarily attributable to increased income from operations discussed above.
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Liquidity and Capital Resources
Cash Flows from Operations. Due to the nature of our business, substantially all sales are for cash and cash provided by operations is our primary source of liquidity. We rely primarily upon cash provided by operating activities, supplemented as necessary from time to time by borrowings under our revolving credit facility, lease finance transactions, and asset dispositions to finance our operations, pay interest and principal payments and fund capital expenditures. Cash provided by operating activities increased to $74.6 million for the first six months of fiscal 2006 compared to $27.7 million for the first six months of fiscal 2005. The increase in cash flow from operations is primarily attributable to the $45.6 million increase in income from operations and changes in working capital. We had $130.5 million of cash and cash equivalents on hand at March 30, 2006.
Capital Expenditures. Gross capital expenditures (excluding all acquisitions) for the first six months of fiscal 2006 were $36.1 million. In the first six months of fiscal 2006, we had proceeds of $3.1 million from asset dispositions and $2.7 million from lease finance obligations. As a result, our net capital expenditures, excluding all acquisitions, for the first six months of fiscal 2006 were $30.3 million. We anticipate that net capital expenditures for fiscal 2006 will be approximately $90 million.
Our capital expenditures are primarily expenditures for store improvements, store equipment, new store development, information systems and expenditures to comply with regulatory statues, including those related to environmental matters. We finance substantially all capital expenditures and new store development through cash flow from operations, proceeds from lease financing transactions, asset dispositions and vendor reimbursements.
Acquisitions. During the first six months of fiscal 2006, we purchased 62 stores and their related businesses in seven separate transactions for approximately $63.3 million in purchase consideration.
Cash Flows from Financing Activities. For the first six months of fiscal 2006, net cash provided by financing activities was $40.8 million. The net cash provided by financing activities is primarily the result of the issuance of the $150.0 million senior subordinated convertible notes, less $18.5 million paid for the associated note hedge and warrant transactions, and the $100.0 million of principal paid on the then existing senior credit facility. In conjunction with the issuance of the $150.0 million senior subordinated convertible notes and the refinancing of our senior credit facility, we paid $6.4 million in loan origination costs. We also entered into new lease financing transactions with proceeds totaling $5.6 million, including $4.7 million related to acquisitions of related businesses. At March 30, 2006, our debt consisted primarily of $205.0 million in loans under our senior credit facility, $250.0 million of outstanding 7.75% senior subordinated notes, $209.0 million of outstanding lease finance obligations and $150.0 million of outstanding 3.0% senior subordinated convertible notes.
Senior Credit Facility. On December 29, 2005, we entered into a Second Amended and Restated Credit Agreement. The amended credit facility consists of (i) a $150.0 million revolving credit facility; and (ii) a $205.0 million term loan facility. The revolving credit facility is available for refinancing certain of our existing indebtedness, working capital financing, general corporate purposes and issuing commercial and standby letters of credit. Up to $90.0 million of the revolving credit facility is available as a letter of credit sub-facility. In addition, we may incur up to $100.0 million in incremental facilities. The amended credit facility expires in January 2012. The borrowings under the term loan facility were used to refinance our then existing credit facilities and pay related fees and expenses and to the extent of any excess, for general corporate purposes. The revolving credit facility has been, and will continue to be, used for our working capital and general corporate requirements.
Our borrowings under each of the term loan facility and the revolving credit facility bear interest, at our option, at 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 leverage ratio (as defined in the Amended and Restated Credit Agreement) is less than 3.00 to 1.00, the applicable margins on the borrowings under the revolving credit facility will each be decreased by 0.25%. In addition, we are required to pay quarterly a fee of 0.50% on the average daily unused portion of the revolving credit facility, and if our consolidated leverage ratio is less than 3.00 to 1.00, this fee will be decreased by 0.125%.
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We are permitted to voluntarily prepay principal amounts outstanding or reduce commitments under the amended credit facility at any time, in whole or in part, without premium or penalty, upon the giving of proper notice. We may elect how the optional prepayments are applied. In addition, subject to certain exceptions, we are required to prepay outstanding amounts under the amended credit facility with:
• | the net proceeds of insurance not applied toward the repair of damaged properties within 360 days following receipt of the insurance proceeds; |
• | the net proceeds from asset sales other than in the ordinary course of business that are not reinvested within 270 days following the closing of the sale; |
• | 50% of the net proceeds from the issuance of any unsecured subordinated debt, subject to certain exceptions; |
• | the net proceeds from the issuance of any other debt, subject to certain exceptions; |
• | 50% of the net proceeds from the issuance of any equity, subject to certain exceptions; and |
• | 50% of annual excess cash flow to the extent the total leverage ratio is greater than 3.5 to 1.0 at the end of our fiscal year. |
All mandatory prepayments will be applied pro rata first to the term loan facility and second to the revolving credit facility and, after all amounts under the revolving credit facility have been repaid, to a collateral account with respect to outstanding letters of credit.
The amended credit facility contains customary affirmative and negative covenants for financings of its type (subject to customary exceptions). The financial covenants include:
• | maximum total leverage ratio; |
• | maximum senior leverage ratio; and |
• | minimum fixed charge coverage ratio. |
Other covenants, among other things, limit our ability to:
• | incur liens or other encumbrances; |
• | change our line of business; |
• | enter into mergers, consolidations and similar combinations; |
• | sell or dispose of assets other than in the ordinary course of business; |
• | enter into joint ventures, acquisitions and other investments; |
• | enter into transactions with affiliates; |
• | pay dividends; |
• | change fiscal year; and |
• | change organizational documents. |
The amended credit facility contains customary events of default including, but not limited to:
• | failure to make payments when due; |
• | breaches of representations and warranties; |
• | breaches of covenants; |
• | defaults under other indebtedness; |
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• | bankruptcy or insolvency; |
• | judgments in excess of specified amounts; |
• | ERISA events; |
• | a change of control (as such term is defined in the Amended and Restated Credit Agreement); and |
• | invalidity of the guaranty or other documents governing the amended credit facility. |
An event of default under the amended credit facility, if not cured or waived, could result in the acceleration of all our indebtedness under the amended credit facility (and other indebtedness containing cross default provisions).
As of March 30, 2006, we had no borrowings outstanding under the revolving credit facility and approximately $44.0 million of standby letters of credit had been issued. As of March 30, 2006, we have approximately $106.0 million in available borrowing capacity under the facility (approximately $46.0 million of which was available for issuances of letters of credit).
Senior Subordinated Notes. We have outstanding $250.0 million of 7.75% senior subordinated notes due February 19, 2014. Interest on the senior subordinated notes is due on February 19 and August 19 of each year.
Senior Subordinated Convertible Notes. On November 22, 2005, we completed a private offering of $150.0 million of our convertible notes to “qualified institutional buyers” pursuant to Rule 144A under the Securities Act of 1933, as amended. Subsequently, during the second quarter of fiscal 2006, we registered the convertible notes for resale by the holders thereof. The convertible notes bear interest at an annual rate of 3.0%, payable semi-annually on May 15th and November 15th of each year, with the first interest payment to be made on May 15, 2006. The convertible notes are convertible into our common stock at an initial conversion price of $50.09 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 120% of the conversion price per share for 20 of the last 30 trading days of any calendar quarter. If the price of our common stock exceeds 120% of the conversion price for 20 of the last 30 trading days of any calendar quarter then the possibility exists that the holders of the convertible notes could exercise the conversion provisions of the convertible notes which could result in the need to remit the principal balance of the convertible notes to them in cash (see below). As such, the Company we would be required to classify the entire amount outstanding of the 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 conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the convertible notes is 3,817,775.
Stockholders’ Equity. As of March 30, 2006, our shareholders’ equity totaled $288.0 million. The $36.1 million increase from September 29, 2005 is primarily attributable to the net income for the period of $42.2 million offset by a net decrease in additional paid-in capital of $6.6 million. The decrease in paid-in capital is related to the net cost of the note hedge and warrant transactions of $18.5 million associated with the issuance of the 3.0% senior subordinated convertible notes offset by approximately $9.9 million related to stock option exercises and related tax benefits.
Long Term Liquidity. We believe that anticipated cash flows from operations and funds available from our senior credit facility, together with cash on hand and vendor reimbursements, will provide sufficient funds to finance our operations and fund our contractual commitments at least for the next 12 months. As a normal part of our business, depending on market conditions, we from time to time consider opportunities to refinance our
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existing indebtedness, and although we may refinance all or part of our existing indebtedness in the future, there can be no assurances that we will do so. 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.
New Accounting Standards
In November 2004, FASB issued SFAS No. 151. This statement clarifies that inventory costs that are “abnormal” are required to be charged to expense as incurred as opposed to being capitalized into inventory as a product cost. Examples of “abnormal” costs include costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage). We are already in compliance with this new pronouncement, and therefore, the adoption of SFAS No. 151 during the first quarter of fiscal 2006 did not impact our financial position, results of operations or cash flows.
In December 2004, FASB issued SFAS No. 123R. This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements and establishes fair value as the measurement objective in accounting for share-based payment arrangements. We adopted this standard as of the beginning of the first quarter of fiscal 2006 using the modified version of prospective application. See Item 1. Financial Statements—Notes to Condensed Consolidated Financial Statements—Note 3—Stock-Based Compensation for discussion regarding the impact of the adoption of SFAS No. 123R.
In March 2005, FASB issued FIN 47. FIN 47 provides guidance relating to the identification of and financial reporting for legal obligations to perform an asset retirement activity. The interpretation requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of FIN 47 during the first quarter of fiscal 2006 did not impact our financial position, results of operations or cash flows.
In October 2005, FASB issued Staff Position 13-1, Accounting for Rental Costs Incurred During a Construction Period. This pronouncement states that rental costs associated with ground or building operating leases that are incurred during a construction period should be recognized as rental expense. We are already in compliance with this new pronouncement; therefore, the implementation will not impact our financial position, results of operations or cash flows.
Other accounting standards that have been issued or proposed by the FASB or other standard-setting bodies that do not require adoption until a future date are not expected to have a material impact on our financial condition, results of operations, or cash flows upon adoption.
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 senior subordinated convertible notes and our variable rate debt relates to borrowings under our senior credit facility. We are exposed to market risks inherent in our financial instruments. These instruments arise from transactions entered into in the normal course of business and, in some cases, relate to our acquisitions of related businesses. We hold derivative instruments primarily to manage our exposure to these risks and all derivative instruments are matched against specific debt obligations. Our debt and interest rate swap instruments outstanding at March 30, 2006, including applicable interest rates, are discussed above, in Item 1. Financial Statements—Notes to Condensed Consolidated Financial Statements—Note 7—Derivative Financial Instruments.
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The following table presents the future principal cash flows and weighted-average interest rates, based on rates in effect at March 30, 2006, on our existing long-term debt instruments. Fair values have been determined based on quoted market prices as of March 30, 2006.
Expected Maturity Date
as of March 30, 2006
(Dollars in thousands)
Fiscal 2006 | Fiscal 2007 | Fiscal 2008 | Fiscal 2009 | Fiscal 2010 | Thereafter | Total | Fair Value | ||||||||||||||||||||||||
Long-term debt | $ | 1,043 | $ | 2,087 | $ | 2,090 | $ | 2,094 | $ | 2,098 | $ | 595,933 | $ | 605,345 | $ | 679,933 | |||||||||||||||
Weighted-average interest rate | 6.19 | % | 6.26 | % | 6.31 | % | 6.50 | % | 6.68 | % | 6.74 | % | 6.52 | % |
In order to reduce our exposure to interest rate fluctuations, we have entered into interest rate swap arrangements in which we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed upon notional amount. The interest rate differential is reflected as an adjustment to interest expense over the life of the swaps. Fixed rate swaps are used to reduce our risk of increased interest costs during periods of rising interest rates. At March 30, 2006, the interest rate on approximately 95.4% of our debt was fixed by either the nature of the obligation or through the interest rate swap arrangements compared to 81.5% at September 29, 2005. The annualized effect of a one percentage point change in floating interest rates on our interest rate swap agreements and other floating rate debt obligations at March 30, 2006, would be to change interest expense by approximately $300 thousand.
The following table presents the notional principal amount, weighted-average pay rate, weighted-average receive rate and weighted-average years to maturity on our interest rate swap contracts:
Interest Rate Swap Contracts
(Dollars in thousands)
March 30, 2006 | September 29, 2005 | |||||||
Notional principal amount | $ | 177,000 | $ | 202,000 | ||||
Weighted-average pay rate | 2.83 | % | 2.72 | % | ||||
Weighted-average receive rate | 4.88 | % | 3.86 | % | ||||
Weighted-average years to maturity | .05 | 0.55 |
We have also entered into swap agreements having a notional amount of $130.0 million which will become effective April 2006. These swap agreements have a weighted-average pay rate of 4.24% with various settlement dates, the latest of which is April 2009.
As of March 30, 2006, the fair value of our swap agreements represented a net benefit of $3.1 million.
Qualitative Disclosures. Our primary exposure relates to:
• | interest rate risk on long-term and short-term borrowings; |
• | our ability to pay or refinance long-term borrowings at maturity at market rates; |
• | the impact of interest rate movements on our ability to meet interest expense requirements and exceed financial covenants; and |
• | the impact of interest rate movements on our ability to obtain adequate financing to fund future acquisitions. |
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We manage interest rate risk on our outstanding long-term and short-term debt through our use of fixed and variable rate debt. We expect the interest rate swaps mentioned above will reduce our exposure to short-term interest rate fluctuations. While we cannot predict or manage our ability to refinance existing debt or the impact interest rate movements will have on our existing debt, management evaluates our financial position on an ongoing basis.
Item 4. | Controls and Procedures. |
As required by paragraph (b) of Rule 13a-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 conclude that, as of the end of the period covered by this report, our disclosure controls and procedures are effective, in that they provide reasonable assurance that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission, or the SEC’s rules and forms.
From time to time, we make changes to our internal controls over financial reporting that are intended to enhance their effectiveness and which do not have a material effect on our overall internal control over financial reporting. In our Annual Report on Form 10-K for the fiscal year ended September 29, 2005, management conducted an evaluation of the effectiveness of internal control over financial reporting as of September 29, 2005 based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. During this evaluation, management identified the following two material weaknesses (a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected) in our internal control over financial reporting:
• | Inadequate controls within certain aspects of our accounting system over user access, segregation of duties and monitoring of changes to our vendor database. Management identified instances whereby users had access to and authority to initiate transactions within the accounts payable module of our accounting system, as well as the ability to add or modify information to our vendor database. These inappropriate access rights and inappropriate segregation of duties give rise to the potential for unauthorized and undetected activity within our accounting system and results in more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected on a timely basis by employees during the normal course of performing their assigned functions. |
• | Inadequate controls over the posting of journal entries to our accounting system resulting in potential differences between the journal entries reviewed by management and those recorded in our accounting system. Specifically, our accounting software, which is standard software in our industry, does not enable our accounting personnel to perform a system review of journal entries entered prior to postings. As a result of these deficiencies, more than a remote likelihood exists that a material misstatement of our annual or interim financial statements would not be prevented or detected on a timely basis by employees during the normal course of performing their assigned functions. |
During the first six months of fiscal 2006, we have taken the following actions to remediate the material weaknesses identified in our Annual Report on Form 10-K for the fiscal year ended September 29, 2005:
• | With the assistance of our Information Services personnel, we have restricted user access for the identified individuals within our accounting system to more appropriately segregate the identified individuals’ authority in a manner consistent with their respective roles and responsibilities. In addition, we have assigned responsibilities for maintenance to the vendor database to individuals independent of the payables and disbursements functions. Finally, we have restricted the usage of inactive vendors |
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within our vendor database in order to maintain pertinence. Management believes these changes effectively remediate this material weakness in our internal control over financial reporting that existed as of September 29, 2005. |
• | We have customized our accounting system to generate a report of all posted journal entries that are then compared to the approved journal entries and related supporting documentation. Discrepancies identified through this monitoring process are investigated and corrected prior to completion of the financial closing process. Management believes these changes effectively remediate this material weakness in our internal control over financial reporting that existed as of September 29, 2005. |
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. Except for the changes referenced above, 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 period covered by this report that we believe have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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THE PANTRY, INC.
PART II—OTHER INFORMATION
Item 1. | Legal Proceedings. |
As previously reported, there is pending (instituted on July 17, 2004) a suit (Constance Barton, Kimberly Clark, Wesley Clark, Tracie Hunt, Eleanor Walters, Karen Meredith, Gilbert Breeden, LaCentia Thompson, and Mathesia Peterson, on behalf of themselves and on behalf of classes of those similarly situated vs. The Pantry, Inc.) seeking class action status and asserting claims on behalf of our North Carolina present and former employees for unpaid wages under North Carolina Wage and Hour laws. The suit also seeks an injunction against any unlawful practices, damages, liquidated damages, costs and attorneys’ fees. We have filed an Answer denying any wrongdoing or liability to plaintiffs in any regard. The suit originally was filed in the Superior Court for Forsyth County, State of North Carolina. On August 17, 2004, the case was removed to the United States District Court for the Middle District of North Carolina and on July 18, 2005, plaintiffs filed an Amended Complaint asserting certain additional claims under the federal Fair Labor Standards Act on behalf of present and former store employees in the southeastern United States and adding one additional named plaintiff, Chester Charneski. We filed a motion to dismiss parts of the Amended Complaint on August 23, 2005. The court has not yet ruled on that motion. We believe our employment policies and procedures comply with applicable law and intend to vigorously defend this litigation.
We are party to various other legal actions in the ordinary course of our business. We believe these other actions are routine in nature and incidental to the operation of our business. While the outcome of these actions and the above lawsuit cannot be predicted with certainty, we believe that the ultimate resolution of these matters will not have a material adverse impact on our business, financial condition or prospects.
Item 1A. | Risk Factors |
You should carefully consider the risks described below and under Part I. Financial Information—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 of such risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our securities could decline, and you may lose all or part of your investment.
Risks Related to Our Industry
The convenience store industry is highly competitive and impacted by new entrants.
The industry and geographic areas in which we operate are highly competitive and marked by ease of entry and constant change in the number and type of retailers offering the products and services found in our stores. We compete with other convenience store chains, gasoline stations, supermarkets, drugstores, discount stores, club stores, out of channel retailers, and mass merchants. In recent years, several non-traditional retailers, such as supermarkets, club stores and mass merchants, have impacted the convenience store industry by entering the gasoline retail business. These non-traditional gasoline retailers have obtained a significant share of the motor fuels market and their market share is expected to grow. In some of our markets, our competitors have been in existence longer and have greater financial, marketing and other resources than we do. As a result, our competitors may be able to respond better to changes in the economy and new opportunities within the industry. To remain competitive, we must constantly analyze consumer preferences and competitor’s offerings and prices to ensure we offer a selection of convenience products and services consumers demand at competitive prices. We must also maintain and upgrade our customer service levels, facilities and locations to remain competitive and drive customer traffic to our stores. Major competitive factors include, among others, location, ease of access, gasoline brands, pricing, product and service selections, customer service, store appearance, cleanliness and safety.
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Volatility of wholesale petroleum costs could impact our operating results.
Over the past three fiscal years, our gasoline revenue accounted for approximately 68.0% of total revenues and our gasoline gross profit accounted for approximately 29.7% of total gross profit. Crude oil and domestic wholesale petroleum markets are marked by significant volatility. General political conditions, acts of war or terrorism, and instability in oil producing regions, particularly in the Middle East and South America, could significantly impact crude oil supplies and wholesale petroleum costs. In addition, the supply of gasoline and our wholesale purchase costs could be adversely impacted in the event of shortage, which could result from, among other things, lack of capacity at United States oil refineries or the fact that our gasoline contracts do not guarantee an uninterrupted, unlimited supply of gasoline. Significant increases and volatility in wholesale petroleum costs could result in significant increases in the retail price of petroleum products and in lower gasoline gross margin per gallon. Increases in the retail price of petroleum products could impact consumer demand for gasoline. This volatility makes it extremely difficult to predict the impact future wholesale cost fluctuations will have on our operating results and financial condition. These factors could materially impact our gasoline gallon volume, gasoline gross profit and overall customer traffic, which in turn would impact our merchandise sales.
Wholesale cost increases of tobacco products could impact our operating results.
Sales of tobacco products have averaged approximately 9.0% of our total revenue over the past three fiscal years and our tobacco gross profit accounted for approximately 14.9% of total gross profit for the same period. Significant increases in wholesale cigarette costs and tax increases on tobacco products, as well as national and local campaigns to discourage smoking in the United States, may have an adverse effect on unit demand for cigarettes domestically. In general, we attempt to pass price increases on to our customers. However, due to competitive pressures in our markets, we may not be able to do so. These factors could materially impact our retail price of cigarettes, cigarette unit volume and revenues, merchandise gross profit and overall customer traffic.
Changes in consumer behavior, travel and tourism could impact our business.
In the convenience store industry, customer traffic is generally driven by consumer preferences and spending trends, growth rates for automobile and truck traffic and trends in travel, tourism and weather. Changes in economic conditions generally or in the southeastern United States specifically could adversely impact consumer spending patterns and travel and tourism in our markets. Approximately 40% of our stores are located in coastal, resort or tourist destinations. Historically, travel and consumer behavior in such markets is more severely impacted by weak economic conditions. If visitors to resort or tourist locations decline due to economic conditions, changes in consumer preferences, changes in discretionary consumer spending or otherwise, our sales could decline.
Risks Related to Our Business
Unfavorable weather conditions or other trends or developments in the southeastern United States could adversely affect our business.
Substantially all of our stores are located in the southeast region of the United States. Although the southeast region is generally known for its mild weather, the region is susceptible to severe storms including hurricanes, thunderstorms, extended periods of rain, ice storms and heavy snow, all of which we have historically experienced. Inclement weather conditions as well as severe storms in the southeast region could damage our facilities or could have a significant impact on consumer behavior, travel and convenience store traffic patterns as well as our ability to operate our locations. In addition, we typically generate higher revenues and gross margins during warmer weather months in the Southeast, which fall within our third and fourth fiscal quarters. If weather conditions are not favorable during these periods, our operating results and cash flow from operations could be adversely affected. We would also be impacted by regional occurrences in the southeastern United States such as energy shortages or increases in energy prices, fires or other natural disasters.
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Inability to identify, acquire and integrate new stores could adversely affect our ability to grow our business.
An important part of our historical growth strategy has been to acquire other convenience stores that complement our existing stores or broaden our geographic presence, such as our acquisition of 53 convenience stores operating under the Cowboys® banner in April 2005. Since 1996, we have successfully completed and integrated more than 52 acquisitions, growing our store base from 379 to 1,458 stores. We expect to continue to selectively review acquisition opportunities as an element of our growth strategy. Acquisitions involve risks that could cause our actual growth or operating results to differ adversely compared to our expectations or the expectations of securities analysts. For example:
• | We may not be able to identify suitable acquisition candidates or acquire additional convenience stores on favorable terms. We compete with others to acquire convenience stores. We believe that this competition may increase and could result in decreased availability or increased prices for suitable acquisition candidates. It may be difficult to anticipate the timing and availability of acquisition candidates. |
• | During the acquisition process we may fail or be unable to discover some of the liabilities of companies or businesses which we acquire. These liabilities may result from a prior owner’s noncompliance with applicable federal, state or local laws. |
• | We may not be able to obtain the necessary financing, on favorable terms or at all, to finance any of our potential acquisitions. |
• | We may fail to successfully integrate or manage acquired convenience stores. |
• | Acquired convenience stores may not perform as we expect or we may not be able to obtain the cost savings and financial improvements we anticipate. |
• | We face the risk that our existing systems, financial controls, information systems, management resources and human resources will need to grow to support significant growth. |
Our substantial indebtedness could adversely affect our financial health.
We have a significant amount of indebtedness. As of March 30, 2006, we had consolidated debt of approximately $814.4 million. As of March 30, 2006, our availability under our senior credit facility for borrowing was approximately $106.0 million (approximately $46.0 million of which was available for issuance of letters of credit).
Our substantial indebtedness could have important consequences to you. For example, it could:
• | make it more difficult for us to satisfy our obligations with respect to our debt and our leases; |
• | increase our vulnerability to general adverse economic and industry conditions; |
• | require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes; |
• | limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; |
• | place us at a competitive disadvantage compared to our competitors that have less indebtedness or better access to capital by, for example, limiting our ability to enter into new markets or renovate our stores; and |
• | limit our ability to borrow additional funds in the future. |
We are vulnerable to increases in interest rates because the debt under our senior credit facility is at a variable interest rate. Although in the past we have on occasion entered into certain hedging instruments in an effort to manage our interest rate risk, we cannot assure you that we will continue to do so, on favorable terms or at all, in the future.
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If we are unable to meet our debt obligations, we could be forced to restructure or refinance our obligations, seek additional equity financing or sell assets, which we may not be able to do on satisfactory terms or at all. As a result, we could default on those obligations.
In addition, the indenture governing our senior subordinated notes and our senior credit facility, which includes a term loan and a revolving credit facility, contains financial and other restrictive covenants that will limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our indebtedness, which would adversely affect our financial health and could prevent us from fulfilling our obligations.
Despite current indebtedness levels, we and our subsidiaries may still be able to incur additional debt. This could further increase the risks associated with our substantial leverage.
We and our subsidiaries are able to incur additional indebtedness. The terms of the indenture that governs our senior subordinated notes permit us to incur additional indebtedness under certain circumstances. The indenture governing our convertible notes does not contain any limit on our ability to incur debt. In addition, our senior credit facility permits us to incur additional indebtedness (assuming certain financial conditions are met at the time) beyond the $150.0 million available under our revolving credit facility. If we and our subsidiaries incur additional indebtedness, the related risks that we and they now face could intensify.
To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.
Our ability to make payments on our indebtedness, including without limitation any payments required to be made to holders of our senior subordinated notes and our convertible notes, and to refinance our indebtedness and fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
For example, upon the occurrence of a “fundamental change” (as such term is defined in the indenture governing our convertible notes), holders of our convertible notes have the right to require us to purchase for cash all outstanding convertible notes at 100% of their principal amount plus accrued and unpaid interest, including additional interest (if any), up to but not including the date of purchase. We also may be required to make substantial cash payments upon other conversion events related to the convertible notes. We may not have enough available cash or be able to obtain third-party financing to satisfy these obligations at the time we are required to make purchases of tendered notes.
Based on our current level of operations, we believe our cash flow from operations, available cash and available borrowings under our revolving credit facility, will be adequate to meet our future liquidity needs for at least the next 12 months.
We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our revolving credit facility in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness on or before maturity, sell assets, reduce or delay capital expenditures, seek additional equity financing or seek third-party financing to satisfy such obligations. We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all. Our failure to fund indebtedness obligations at any time could constitute an event of default under the instruments governing such indebtedness, which would likely trigger a cross-default under our other outstanding debt.
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If we do not comply with the covenants in our senior credit facility and the indenture governing our senior subordinated notes or otherwise default under them or the indenture governing our convertible notes, we may not have the funds necessary to pay all of our indebtedness that could become due.
Our senior credit facility and our indenture governing our senior subordinated notes require us to comply with certain covenants. In particular, our senior credit facility prohibits us from incurring any additional indebtedness except in specified circumstances or materially amending the terms of any agreement relating to existing indebtedness without lender approval. Further, our senior credit facility restricts our ability to acquire and dispose of assets, engage in mergers or reorganizations, pay dividends, or make investments. Other restrictive covenants require that we meet fixed charge coverage and leverage tests, as defined in the senior credit facility agreement. A violation of any of these covenants could cause an event of default under the senior credit facility.
If we default under our senior credit facility or either of the indentures governing our outstanding subordinated indebtedness because of a covenant breach or otherwise, all outstanding amounts could become immediately due and payable. We cannot assure you that we would have sufficient funds to repay all the outstanding amounts, and any acceleration of amounts due under our senior credit facility or either of the indentures governing our senior subordinated notes or our convertible notes likely would have a material adverse effect on us.
We are subject to state and federal environmental and other regulations.
Our business is subject to extensive governmental laws and regulations including, but not limited to, environmental regulations, employment laws and regulations, regulations governing the sale of alcohol and tobacco, minimum wage requirements, working condition requirements, public accessibility requirements, citizenship requirements and other laws and regulations. A violation or change of these laws could have a material adverse effect on our business, financial condition and results of operations.
Under various federal, state and local laws, ordinances and regulations, we may, as the owner or operator of our locations, be liable for the costs of removal or remediation of contamination at these or our former locations, whether or not we knew of, or were responsible for, the presence of such contamination. The failure to properly remediate such contamination may subject us to liability to third parties and may adversely affect our ability to sell or rent such property or to borrow money using such property as collateral. Additionally, persons who arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of such substances at sites where they are located, whether or not such site is owned or operated by such person. Although we do not typically arrange for the treatment or disposal of hazardous substances, we may be deemed to have arranged for the disposal or treatment of hazardous or toxic substances and, therefore, may be liable for removal or remediation costs, as well as other related costs, including governmental fines, and injuries to persons, property and natural resources.
Compliance with existing and future environmental laws regulating underground storage tanks may require significant capital expenditures and increased operating and maintenance costs. The remediation costs and other costs required to clean up or treat contaminated sites could be substantial. We pay tank registration fees and other taxes to state trust funds established in our operating areas and maintain private insurance coverage in Florida and Georgia in support of future remediation obligations.
These state trust funds or other responsible third parties including insurers are expected to pay or reimburse us for remediation expenses less a deductible. To the extent third parties do not pay for remediation as we anticipate, we will be obligated to make these payments, which could materially adversely affect our financial condition and results of operations. Reimbursements from state trust funds will be dependent on the maintenance and continued solvency of the various funds.
In the future, we may incur substantial expenditures for remediation of contamination that has not been discovered at existing locations or locations that we may acquire. We cannot assure you that we have identified all environmental liabilities at all of our current and former locations; that material environmental conditions not
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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 operating results and financial condition.
State laws regulate the sale of alcohol and tobacco products. A violation or change of these laws could adversely affect our business, financial condition and results of operations because state and local regulatory agencies have the power to approve, revoke, suspend or deny applications for, and renewals of, permits and licenses relating to the sale of these products or to seek other remedies. In addition, certain states regulate relationships, including overlapping ownership, among alcohol manufacturers, wholesalers and retailers and may deny or revoke licensure if relationships in violation of the state laws exist. We are not aware of any alcoholic beverage manufacturers or wholesalers having a prohibited relationship with our company.
Any appreciable increase in the statutory minimum wage rate or income or overtime pay or adoption of mandated healthcare benefits would result in an increase in our labor costs and such cost increase, or the penalties for failing to comply with such statutory minimums, could adversely affect our business, financial condition and results of operations.
From time to time, regulations are proposed which, if adopted, could also have an adverse effect on our business, financial condition or results of operations.
We depend on one principal supplier for the majority of our merchandise.
We purchase over 50% of our general merchandise, including most tobacco products and grocery items, from a single wholesale grocer, McLane Company, Inc., or McLane. We have a contract with McLane until April 2010, but we may not be able to renew the contract upon expiration. A change of suppliers, a disruption in supply or a significant change in our relationship with our principal suppliers could have a material adverse effect on our business, cost of goods, financial condition and results of operations.
We depend on two principal suppliers for the majority of our gasoline.
BP® and Citgo® supply approximately 90% of our gasoline purchases. We have contracts with Citgo® until 2010 and BP® until 2009, but we may not be able to renew either contract upon expiration. A change of suppliers, a disruption in supply or a significant change in our relationship with our principal suppliers could have a material adverse effect on our business, cost of goods, financial condition and results of operations.
Because we depend on our senior management’s experience and knowledge of our industry, we would be adversely affected if senior management left The Pantry.
We are dependent on the continued efforts of our senior management team, including our President and Chief Executive Officer, Peter J. Sodini. Mr. Sodini’s employment contract terminates in September 2009. If, for any reason, our senior executives do not continue to be active in management, our business, financial condition or results of operations could be adversely affected. We cannot assure you that we will be able to attract and retain additional qualified senior personnel as needed in the future. In addition, we do not maintain key personnel life insurance on our senior executives and other key employees. We also rely on our ability to recruit store managers, regional managers and other store personnel. If we fail to continue to attract these individuals, our operating results may be adversely affected.
Litigation and publicity concerning food quality, health and other 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. We are also subject to a
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variety of other claims arising in the ordinary course of business, including personal injury claims, contract claims, or claims alleging violations of state and federal law regarding workplace and employment matters, discrimination and similar matters. Adverse publicity about these allegations may negatively affect us, regardless of whether the allegations are true, by discouraging customers from purchasing gasoline, merchandise or food service at one or more of our convenience stores. We could also incur significant liabilities if a lawsuit or claim results in a decision against us or litigation costs regardless of results, and may divert time and money away from our operations and hurt our performance.
Pending SEC matters could adversely affect us.
On July 28, 2005, we announced that we would restate earnings for the period from fiscal 2000 to fiscal 2005 arising from sale-leaseback accounting for certain transactions. In connection with our decision to restate, we filed a Form 8-K on July 28, 2005. The SEC issued a comment letter to us in connection with the Form 8-K, and we responded to the comments. In September, 2005 we received from the SEC a request that we voluntarily provide certain information to the SEC Staff in connection with our sale-leaseback accounting and our decision to restate our financial statements with respect to it. The request is part of an informal investigation, which the SEC has said is a fact-finding inquiry that does not mean that the SEC has concluded that we have broken any law or that the SEC has a negative opinion of any person, entity or security. We have cooperated with the SEC’s informal request. We are unable to predict whether this request will continue or result in any adverse action.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results. As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.
Effective internal control over financial reporting is necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed. The Sarbanes-Oxley Act of 2002, as well as related new rules and regulations implemented by the SEC, Nasdaq and the Public Company Accounting Oversight Board, have required changes in the corporate governance practices and financial reporting standards for public companies. These new laws, rules and regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002, have increased our legal and financial compliance costs and made many activities more time-consuming and more burdensome. These laws, regulations and standards are subject to varying interpretations in many cases. As a result, their application in practice may evolve over time as regulatory and governing bodies provide new guidance, which could result in continuing uncertainty regarding compliance matters. The costs of compliance with these laws, rules and regulations have adversely affected our financial results. Moreover, we run the risk of non-compliance, which could adversely affect our financial condition or results of operations or the trading price of our stock.
We have in the past discovered, and may in the future discover, areas of our internal control over financial reporting that need improvement. For example, during management’s fiscal 2005 Sarbanes-Oxley Section 404 assessment, two material weaknesses in internal control over financial reporting were identified (described in Part I. Financial Statements—Item 4. Controls and Procedures of this report). These material weaknesses result in a more than remote risk that a material misstatement of our annual or interim financial statements would not be prevented or detected.
We have devoted significant resources to remediate our deficiencies and improve our internal control over financial reporting. Although we believe that these efforts have strengthened our internal control over financial reporting and addressed the concerns that gave rise to the material weaknesses in fiscal 2005, we are continuing to work to improve our internal control over financial reporting. We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. 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.
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Other Risks
Future sales of additional shares into the market may depress the market price of our common stock.
If we or our existing stockholders sell shares of our common stock in the public market, including shares issued upon the exercise of outstanding options, or if the market perceives such sales or issuances could occur, the market price of our common stock could decline. As of May 1, 2006, there were 22,675,749 shares of our common stock outstanding, of these shares, 22,420,750 shares are freely tradable (unless held by one of our affiliates). Pursuant to Rule 144 under the Securities Act of 1933, as amended, or the Securities Act, during any three-month period our affiliates can resell up to the greater of (a) 1% of our aggregate outstanding common stock or (b) the average weekly trading volume for the four weeks prior to the sale. Sales by our existing stockholders also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate or to use equity as consideration for future acquisitions.
In addition, we have filed registration statements with the SEC that cover up to 5,100,000 shares issuable pursuant to the exercise of stock options granted and to be granted under our stock option plans. Shares registered on a registration statement may be sold freely at any time after issuance.
Any issuance of shares of our common stock in the future could have a dilutive effect on your investment.
We may sell securities in the public or private equity markets if and when conditions are favorable, even if we do not have an immediate need for capital at that time. In other circumstances, we may issue shares of our common stock pursuant to existing agreements or arrangements. For example, upon conversion of our outstanding convertible notes, we may, at our option issue shares of our common stock. In addition, if our convertible notes are converted in connection with a change of control, we may be required to deliver additional shares by increasing the conversion rate with respect to such notes. Notwithstanding the requirement to issue additional shares if convertible notes are converted on a change of control, the maximum conversion rate for our outstanding convertible notes is 25.4517 per $1,000 principal amount of convertible notes.
We have also issued warrants to purchase up to 2,993,000 shares of our common stock to an affiliate of Merrill Lynch in connection with the note hedge and warrant transactions entered into at the time of our offering of convertible notes.
Raising funds by issuing securities dilutes the ownership of our existing stockholders. Additionally, certain types of equity securities that we may issue in the future could have rights, preferences or privileges senior to your rights as a holder of our common stock. We could choose to issue additional shares for a variety of reasons including for investment or acquisitive purposes. Such issuances may have a dilutive impact on your investment.
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 of common stock by the company, senior officers or other affiliates; or |
• | Other general economic, political or market conditions, many of which are beyond our control. |
The market price of our common stock will also be impacted by our quarterly operating results and quarterly comparable store sales growth, which may be expected to fluctuate from quarter to quarter. Factors that may impact our quarterly results and comparable store sales include, among others, general regional and national economic conditions, competition, unexpected costs and changes in pricing, consumer trends, the number of stores we open and/or close during any given period, costs of compliance with corporate governance and Sarbanes-Oxley requirements, and other factors discussed in this Item 1A. Risk Factors and throughout Part I. Financial Information-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.
Our charter includes provisions that may have the effect of preventing or hindering a change in control and adversely affecting the market price of our common stock.
Our certificate of incorporation gives our board of directors the authority to issue up to five million shares of preferred stock and to determine the rights and preferences of the preferred stock, without obtaining stockholder approval. The existence of this preferred stock could make it more difficult or discourage an attempt to obtain control of The Pantry by means of a tender offer, merger, proxy contest or otherwise. Furthermore, this preferred stock could be issued with other rights, including economic rights, senior to our common stock, and, therefore, issuance of the preferred stock could have an adverse effect on the market price of our common stock. We have no present plans to issue any shares of our preferred stock.
Other provisions of our certificate of incorporation and bylaws and of Delaware law could make it more difficult for a third party to acquire us or hinder a change in management even if doing so would be beneficial to our stockholders. For example, our certificate of incorporation makes us subject to the anti-takeover provisions of Section 203 of the General Corporation Law of the State of Delaware. In general, Section 203 prohibits publicly-held Delaware corporations to which it applies from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. This provision could discourage others from bidding for our shares and could, as a result, reduce the likelihood of an increase in our stock price that would otherwise occur if a bidder sought to buy our stock.
These governance provisions could affect the market price of our common stock. We may, in the future, adopt other measures that may have the effect of delaying, deferring or preventing an unsolicited takeover, even if such a change in control were at a premium price or favored by a majority of unaffiliated stockholders. These measures may be adopted without any further vote or action by our stockholders.
Item 4. | Submission of Matters to a Vote of Security Holders. |
On March 30, 2006, we held our Annual Meeting of Stockholders, during which our stockholders:
(1) Elected eight nominees to serve as directors each for a term of one year or until his successor is duly elected and qualified. The votes were cast as follows:
Name | Votes For | Votes Withheld | ||
Robert F. Bernstock | 20,952,282 | 147,247 | ||
Paul L. Brunswick | 20,903,869 | 195,660 | ||
Edwin J. Holman | 20,952,282 | 147,247 | ||
Terry L. McElroy | 20,948,807 | 150,722 | ||
Mark D. Miles | 20,952,057 | 147,472 | ||
Bryan E. Monkhouse | 20,903,874 | 195,655 | ||
Thomas M. Murnane | 20,894,887 | 204,642 | ||
Peter J. Sodini | 20,952,802 | 146,727 |
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(2) Ratified the appointment of Deloitte & Touche LLP as independent public accountants for the Company and its subsidiaries for the fiscal year ending September 28, 2006. The votes were cast as follows:
Votes For | Votes Against | Votes Withheld | ||||
Ratification of Deloitte & Touche LLP | 20,564,413 | 529,358 | 5,758 |
Item 6. | Exhibits. |
Exhibit Number | Description of Document | |
10.1 | Second Amended and Restated Credit Agreement dated December 29, 2005 among The Pantry, as borrower, R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and lender, Regions Bank and Wells Fargo, as co-syndication agents and lenders, Harris N.A. and Rabobank International as co-documentation agents and lenders, and the other financial institutions signatory thereto, as lenders (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006). | |
10.2 | Second Amended and Restated Pledge Agreement dated as of December 29, 2005 between The Pantry and R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as pledgors and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006). | |
10.3 | Second Amended and Restated Security Agreement dated as of December 29, 2005 between The Pantry and R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as obligors and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.3 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006). | |
10.4 | Independent Director Compensation Program (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 21, 2006). | |
10.5 | Summary of Amendment to Halloran Option Agreement. | |
10.6 | Summary of Amendments to Allumbaugh, Yarborough, III, and Starrett Option Agreements. | |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] | |
32.2 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] |
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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/ DANIEL J. KELLY | |
Daniel J. Kelly Vice President, Chief Financial (Authorized Officer and Principal | ||
Date: May 9, 2006 |
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EXHIBIT INDEX
Exhibit Number | Description of Document | |
10.1 | Second Amended and Restated Credit Agreement dated December 29, 2005 among The Pantry, as borrower, R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, as guarantors, Wachovia, as administrative agent and lender, Regions Bank and Wells Fargo, as co-syndication agents and lenders, Harris N.A. and Rabobank International as co-documentation agents and lenders, and the other financial institutions signatory thereto, as lenders (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006). | |
10.2 | Second Amended and Restated Pledge Agreement dated as of December 29, 2005 between The Pantry and R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as pledgors and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.2 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006). | |
10.3 | Second Amended and Restated Security Agreement dated as of December 29, 2005 between The Pantry and R. & H. Maxxon, Inc. and Kangaroo, Inc., subsidiaries of The Pantry, all as obligors and Wachovia, as administrative agent (incorporated by reference to Exhibit 10.3 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2006). | |
10.4 | Independent Director Compensation Program (incorporated by reference to Exhibit 10.1 to The Pantry’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 21, 2006). | |
10.5 | Summary of Amendment to Halloran Option Agreement. | |
10.6 | Summary of Amendments to Allumbaugh, Yarborough, III, and Starrett Option Agreements. | |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] | |
32.2 | Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.] |
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