Pantry (PTRY) 10-Q 2007 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended December 28, 2006

Commission File Number : 000-25813

THE PANTRY, INC.

(Exact name of registrant as specified in its charter)

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

1801 Douglas Drive

Sanford, North Carolina 27330

(Address of principal executive offices and zip code)

(919) 774-6700

(Registrant’s telephone number, including area code)

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¨ Nox

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

COMMON STOCK, $0.01 PAR VALUE	22,782,075 SHARES
(Class)	(Outstanding at February 2, 2007)

THE PANTRY, INC.

FORM 10-Q

DECEMBER 28, 2006

TABLE OF CONTENTS

		Page
Part I—Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets (Unaudited)	3
	Condensed Consolidated Statements of Operations (Unaudited)	4
	Condensed Consolidated Statements of Cash Flows (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	30
Part II—Other Information
Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 6.	Exhibits	40

2

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

THE PANTRY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands)

	December 28, 2006		September 28, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	110,758	$	120,394
Receivables, net		62,586		68,064
Inventories		130,346		140,135
Prepaid expenses and other current assets		13,199		18,783
Deferred income taxes		8,594		8,348
Total current assets		325,483		355,724
Property and equipment, net		762,408		745,721
Other assets:
Goodwill		446,009		440,681
Other noncurrent assets		45,340		45,781
Total other assets		491,349		486,462
Total assets	$	1,579,240	$	1,587,907
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	2,088	$	2,088
Current maturities of lease finance obligations		3,807		3,511
Accounts payable		128,761		139,939
Accrued compensation and related taxes		15,944		19,676
Other accrued taxes		17,301		27,440
Self-insurance reserves		31,383		29,898
Other accrued liabilities		35,973		34,978
Total current liabilities		235,257		257,530
Other liabilities:
Long-term debt		601,693		602,215
Lease finance obligations		253,542		240,564
Deferred income taxes		72,417		72,435
Deferred vendor rebates		23,600		23,876
Other noncurrent liabilities		54,278		54,280
Total other liabilities		1,005,530		993,370
Commitments and contingencies (Note 4)
Shareholders’ equity:
Common stock, $.01 par value, 50,000,000 shares authorized; 22,687,240 issued and outstanding at December 28, 2006 and September 28, 2006		227		227
Additional paid-in capital		174,307		172,940
Accumulated other comprehensive income, net of deferred income taxes of $732 at December 28, 2006 and $762 at September 28, 2006		1,147		1,194
Retained earnings		162,772		162,646
Total shareholders’ equity		338,453		337,007
Total liabilities and shareholders’ equity	$	1,579,240	$	1,587,907

See Notes to Condensed Consolidated Financial Statements

3

THE PANTRY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended
	December 28, 2006			December 29, 2005
	(13 weeks)			(13 weeks)
Revenues:
Merchandise	$	349,239		$	316,648
Gasoline		1,031,901			998,675
Total revenues		1,381,140			1,315,323
Costs and operating expenses:
Merchandise cost of goods sold (exclusive of items shown separately below)		217,923			197,912
Gasoline cost of goods sold (exclusive of items shown separately below)		991,682			912,090
Operating, general and administrative		136,353			118,328
Depreciation and amortization		20,856			17,237
Total costs and operating expenses		1,366,814			1,245,567
Income from operations		14,326			69,756
Other income (expense):
Loss on extinguishment of debt		—			(1,832	)
Interest expense		(15,486	)		(14,433	)
Interest income		1,357			1,044
Miscellaneous		167			159
Total other expense		(13,962	)		(15,062	)
Income before income taxes		364			54,694
Income tax expense		(239	)		(21,723	)
Net income	$	125		$	32,971
Earnings per share:
Basic	$	0.01		$	1.48
Diluted	$	0.01		$	1.46

See Notes to Condensed Consolidated Financial Statements

4

THE PANTRY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

	Three Months Ended
	December 28, 2006			December 29, 2005
	(13 weeks)			(13 weeks)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	125		$	32,971
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		20,856			17,237
(Benefit) Provision for deferred income taxes		(234	)		47
Loss on extinguishment of debt		—			1,832
Stock compensation expense		883			628
Other		1,669			(180	)
Changes in operating assets and liabilities, net of effects of acquisitions:
Receivables		4,613			8,996
Inventories		10,699			9,403
Prepaid expenses and other current assets		4,019			2,709
Other noncurrent assets		(139	)		135
Accounts payable		(11,178	)		(9,091	)
Other current liabilities and accrued expenses		(14,886	)		4,225
Other noncurrent liabilities		(1,440	)		(1,663	)
Net cash provided by operating activities		14,987			67,249
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property and equipment		(19,375	)		(13,709	)
Proceeds from sales of property and equipment		3,250			1,239
Acquisitions of businesses, net of cash acquired		(21,768	)		(7,761	)
Net cash used in investing activities		(37,893	)		(20,231	)
CASH FLOWS FROM FINANCING ACTIVITIES
Principal repayments under lease finance obligations		(883	)		(720	)
Principal repayments of long-term debt		(522	)		(305,019	)
Proceeds from issuance of long-term debt		—			355,000
Proceeds from lease finance obligations		14,675			5,625
Proceeds from exercise of stock options		—			582
Payment for purchase of note hedge		—			(43,720	)
Proceeds from issuance of warrant		—			25,220
Excess income tax benefits from stock-based compensation arrangements		—			474
Other financing costs		—			(6,396	)
Net cash provided by financing activities		13,270			31,046
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(9,636	)		78,064
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		120,394			111,472
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	110,758		$	189,536
Cash paid during the period:
Interest	$	11,321		$	10,218
Income taxes	$	4,032		$	14,203
Non-cash transactions:
Accrued purchases of property and equipment	$	7,303		$	3,834

See Notes to Condensed Consolidated Financial Statements

5

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1—BASIS OF PRESENTATION

Unaudited Condensed Consolidated Financial Statements

The accompanying condensed consolidated financial statements include the accounts of The Pantry, Inc. and its wholly owned subsidiaries (references to “the Company,” “Pantry,” “The Pantry,” “we,” “us,” and “our” mean The Pantry, Inc. and its subsidiaries). All intercompany transactions and balances have been eliminated in consolidation. Transactions and balances of each of 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 December 28, 2006 and for the three months ended December 28, 2006 and December 29, 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 condensed consolidated financial statements included herein should be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 28, 2006.

Our results of operations for the three months ended December 28, 2006 and December 29, 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 2007” refer to our current fiscal year and references to “fiscal 2006” refer to our fiscal year which ended September 28, 2006.

Accounting Period

We operate on a 52-53 week fiscal year ending on the last Thursday in September. Our 2007 fiscal year ends on September 27, 2007 and is a 52 week year. Fiscal 2006 was also a 52 week year.

The Pantry

As of December 28, 2006, we operated 1,506 convenience stores located in Florida (442), North Carolina (327), South Carolina (237), Georgia (125), Tennessee (104), Mississippi (80), Alabama (77), Virginia (50), Kentucky (30), Louisiana (25), and Indiana (9). 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 1,484 locations, 981 of which sell gasoline under major oil company brand names including BP^®, Chevron^®, Citgo^®, or ExxonMobil^®.

6

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

New Accounting Standards

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

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

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

NOTE 2—ACQUISITIONS

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

During the first three months of fiscal 2007, we purchased 14 stores and their related businesses in five separate transactions for approximately $21.6 million. All of the fiscal 2007 acquisitions were funded from available cash on hand and lease financing on acquired real property.

The table below provides information concerning the acquisitions we have completed in fiscal 2007:

Fiscal 2007
Date Acquired	Seller	Trade Name	Locations	Number of Stores
December 21, 2006	Graves Oil Co.	Rascal’s	Mississippi	7
Others (fewer than 5 stores)	Various	Various	Florida, North Carolina, South Carolina, and Tennessee	7
Total				14

7

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Following are the aggregate purchase price allocations for the 14 stores acquired during fiscal 2007. Certain allocations are preliminary estimates based on available information and certain assumptions management believes to be reasonable. These values are subject to change until certain valuations have been finalized and management completes its fair value assessments. We do not expect any adjustments to the fair values of the assets and liabilities disclosed in this preliminary opening balance sheet to be significant. The allocations were based on the fair values on the dates of the acquisitions (amounts in thousands):

Assets Acquired:
Inventories	$	911
Property and equipment, net		15,947
Total assets		16,858
Liabilities Assumed:
Deferred vendor rebates		125
Other noncurrent liabilities		69
Total liabilities		194
Net tangible assets acquired, net of cash		16,664
Non-compete agreements		65
Goodwill		4,878
Total purchase cost, including direct acquisition costs, net of cash acquired	$	21,607

We expect that goodwill associated with these transactions totaling $4.9 million will be deductible for income tax purposes over 15 years.

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

	2007		2006
Total revenues	$	1,383,669	$	1,325,137
Net income	$	225	$	33,333
Earnings per share:
Basic	$	0.01	$	1.49
Diluted	$	0.01	$	1.47

NOTE 3—GOODWILL AND OTHER INTANGIBLE ASSETS

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

8

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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

	Unamortized				Amortized
	Goodwill		Tradenames		Tradenames			Customer Agreements			Non-compete Agreements
Weighted-average useful life in years		N/A		N/A		3.0			10.2			28.5
Gross balance at September 28, 2006	$	440,681	$	2,800	$	2,850		$	1,347		$	9,614
Purchase accounting adjustments(1)		450		—		—			331			—
Acquisitions		4,878		—		—			—			65
Gross balance at December 28, 2006	$	446,009	$	2,800	$	2,850			1,678		$	9,679
Accumulated amortization at September 28, 2006					$	(1,352	)	$	(203	)	$	(2,560	)
Amortization						(237	)		(63	)		(154	)
Accumulated amortization at December 28, 2006					$	(1,589	)		(266	)	$	(2,714	)

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

The estimated future amortization expense for tradenames, customer agreements and non-compete agreements as of December 28, 2006 is as follows (amounts in thousands):

Fiscal year:
2007	$	1,401
2008		1,379
2009		620
2010		432
2011		361
Thereafter		5,445
Total estimated amortization expense	$	9,638

In accordance with our policy, we will conduct our annual impairment testing of goodwill in the second quarter of fiscal 2007 and our annual impairment testing of other intangible assets in the fourth quarter of 2007. 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 2007 and fiscal 2006.

NOTE 4—COMMITMENTS AND CONTINGENCIES

As of December 28, 2006, we were contingently liable for outstanding letters of credit in the amount of approximately $43.3 million primarily related to several self-insurance programs, vendor contracts and regulatory requirements. The letters of credit are not to be drawn against unless we default on the timely payment of the related liabilities.

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

9

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

these actions is inaccurate, or there are any significant adverse developments in these actions, our financial condition and results of operations could be adversely affected.

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

Environmental Liabilities and Contingencies

We are subject to various federal, state and local environmental laws. We make financial expenditures in order to comply with regulations governing underground storage tanks adopted by federal, state and local regulatory agencies. In particular, at the federal level, the Resource Conservation and Recovery Act of 1976, as amended, requires the U.S. Environmental Protection Agency to establish a comprehensive regulatory program for the detection, prevention and cleanup of leaking underground storage tanks (e.g., overfills, spills, and underground storage tank releases).

Federal and state regulations require us to provide and maintain evidence that we are taking financial responsibility for corrective action and compensating third parties in the event of a release from our underground storage tank systems. In order to comply with these requirements, as of December 28, 2006, we maintain letters of credit in the aggregate amount of approximately $1.3 million in favor of state environmental agencies in North Carolina, South Carolina, Virginia, Georgia, Indiana, Tennessee, Kentucky and Louisiana.

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

As of December 28, 2006 environmental reserves of approximately $1.0 million and $17.2 million are included in other accrued liabilities and other noncurrent liabilities, respectively. As of September 28, 2006 environmental reserves of approximately $1.0 million and $17.4 million are included in other accrued liabilities and other noncurrent liabilities, respectively. These reserves represent our estimates for future expenditures for remediation, tank removal and litigation associated with 270 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 $17.1 million of our environmental obligations will be funded by state trust funds and third party insurance; as a result we may spend $1.1 million for remediation, tank removal and litigation. Also, as of December 28, 2006 and September 28, 2006, there were an additional 532 and 534 sites, respectively, that are known to be contaminated sites that are the responsibility of, and 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 costs for which the timing of payments can be reasonably estimated are discounted using an appropriate rate to determine the reserve.

10

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

We anticipate that we will be reimbursed for expenditures from state trust funds and private insurance. As of December 28, 2006, anticipated reimbursements of $17.2 million are recorded as other noncurrent assets and $3.2 million are recorded as current receivables related to all sites. In Florida, remediation of such contamination reported before January 1, 1999 will be performed by the state (or state approved independent contractors) and substantially all of the remediation costs, less any applicable deductibles, will be paid by the state trust fund. We will perform remediation in other states through independent contractor firms engaged by us. For certain sites, the trust fund does not cover a deductible or has a co-pay which may be less than the cost of such remediation. Although we are not aware of releases or contamination at other locations where we currently operate or have operated stores, any such releases or contamination could require substantial remediation expenditures, some or all of which may not be eligible for reimbursement from state trust funds or private insurance.

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

NOTE 5—LONG-TERM DEBT

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

	December 28, 2006			September 28, 2006
Senior subordinated notes payable; due February 19, 2014; interest payable semi-annually at 7.75%	$	250,000		$	250,000
Senior credit facility; interest payable monthly at LIBOR plus 1.75%; principal due in quarterly installments through January 2, 2012		203,462			203,975
Senior subordinated convertible notes payable; due November 15, 2012; interest payable semi-annually at 3.0%		150,000			150,000
Other notes payable; various interest rates and maturity dates		319			328
Total long-term debt		603,781			604,303
Less—current maturities		(2,088	)		(2,088	)
Long-term debt, net of current maturities	$	601,693		$	602,215

We have outstanding $250.0 million of our 7.75% senior subordinated notes due 2014. The 7.75% senior subordinated notes are guaranteed by our subsidiaries, except three subsidiaries with no indebtedness and de minimis assets (see Note 12—Guarantor Subsidiaries).

On December 29, 2005, we entered into a senior 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 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.

The senior credit facility is secured by substantially all of our assets and is fully and unconditionally guaranteed by our existing and future, direct and indirect, domestic subsidiaries (other than D&D Oil Co., Inc., Shop-A-Snak Food Mart, Inc., and Marco Petroleum, Inc.). In addition, our borrowings under each of the term loan facility and the revolving credit facility bear interest, at our option, at the base rate (generally the applicable

11

THE PANTRY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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 December 28, 2006, there were no outstanding borrowings under the revolving credit facility and we had approximately $43.3 million of standby letters of credit issued under the facility. As a result, we had approximately $106.7 million in available borrowing capacity (approximately $46.7 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 December 28, 2006 to 5.32%.

The senior 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. As of December 28, 2006, we were in compliance with our covenants and restrictions.

We also have outstanding $150.0 million of senior subordinated convertible notes due 2012 (“convertible notes”). The convertible notes bear interest at an annual rate of 3.0%, payable semi-annually on May 15th and November 15th of each year, with the first interest payment paid on May 15, 2006. The convertible notes are convertible into our common stock at an initial conversion price of $50.09 per share, upon the occurrence of certain events, including the closing price of our common stock exceeding 120% of the conversion price per share for 20 of the last 30 trading days of any calendar quarter. The stock price at which the notes would be convertible is $60.11 and as of December 28, 2006, our closing stock price was $48.28. If, upon the occurrence of certain events, the holders of the convertible notes exercise the conversion provisions of the convertible notes, we may need to remit the principal balance of the convertible notes to them in cash (see below). As such, we would be required to classify the entire amount of the outstanding convertible notes as a current liability. This evaluation of the classification of amounts outstanding associated with the convertible notes will occur every calendar quarter. Upon conversion, a holder will receive, in lieu of common stock, an amount of cash equal to the lesser of (i) the principal amount of the convertible note, or (ii) the conversion value, determined in the manner set forth in the indenture governing the convertible notes, of a number of shares equal to the conversion rate. If the conversion value exceeds the principal amount of the convertible note on the conversion date, we will also deliver, at our election, cash or common stock or a combination of cash and common stock with respect to the additional conversion value upon conversion. If conversion occurs in connection with a change of control, we may be required to deliver additional shares of our common stock by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that we would be obligated to issue upon conversion of the convertible notes is 3,817,775.

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

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(Unaudited)

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.

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

Year Ended September:
2007	$	1,566
2008		2,091
2009		2,094
2010		2,098
2011		2,101
Thereafter		593,831
Total long-term debt	$	603,781

Substantially all of our net assets are restricted as to payment of dividends and other distributions.

NOTE 6—DERIVATIVE FINANCIAL INSTRUMENTS

We enter into interest rate swap agreements to modify the interest rate characteristics of our outstanding long-term debt and have designated each qualifying instrument as a cash flow hedge. We formally document our hedge relationships, including identifying the hedge instruments and hedged items, as well as our risk management objectives and strategies for entering into the hedge transaction. At hedge inception, and at least quarterly thereafter, we assess whether derivatives used to hedge transactions are highly effective in offsetting changes in the cash flow of the hedged item. We measure effectiveness by the ability of the interest rate swaps to offset cash flows associated with changes in the variable LIBOR rate associated with our term loan facilities using the hypothetical derivative method. To the extent the instruments are considered to be effective, changes in fair value are recorded as a component of other comprehensive income (loss). To the extent there is any hedge ineffectiveness, changes in fair value relating to the ineffective portion are immediately recognized in earnings (interest expense). When it is determined that a derivative ceases to be a highly effective hedge, we discontinue hedge accounting, and subsequent changes in fair value of the hedge instrument are recognized in earnings. Interest expense was reduced by $5 thousand and $2 thousand for the first quarter of fiscal 2007 and fiscal 2006, respectively, for adjustments for hedge ineffectiveness.

The fair values of our interest rate swaps are obtained from dealer quotes. These values represent the estimated amount we would receive or pay to terminate the agreement taking into consideration the difference between the contract rate of interest and rates currently quoted for agreements of similar terms and maturities. At December 28, 2006, prepaid expenses and other current assets and other noncurrent assets include derivative assets of approximately $58 thousand and $1.8 million, respectively. At September 28, 2006, prepaid expenses and other current assets and other noncurrent assets included derivative assets of approximately $107 thousand and approximately $1.8 million, respectively. Cash flow hedges at December 28, 2006 represent interest rate

13

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

swaps with a notional amount of $130.0 million, a weighted-average pay rate of 4.24%, and have various settlement dates, the latest of which is April 2009.

NOTE 7—STOCK-BASED COMPENSATION

Effective September 30, 2005 we adopted SFAS 123(R),Share-Based Payment (“SFAS 123(R)”), using the modified-prospective-transition method. Prior to the adoption of SFAS 123(R), we accounted for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25,Accounting for StockIssued to Employees. We recognized $883 thousand and $628 thousand in stock-based compensation expense in operating, general and administrative expenses during the first quarter of fiscal 2007 and fiscal 2006, respectively.

During the first quarter of fiscal 2007, we granted 253,000 options to purchase our common stock at purchase prices equal to the fair market value of the related common stock on the date the options were granted. These options had an aggregate fair value of $3.3 million, which will be amortized to expense over the options’ vesting periods.

NOTE 8—COMPREHENSIVE INCOME

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

	Three Months Ended
	December 28, 2006			December 29 2005
Net income	$	125		$	32,971
Other comprehensive income:
Net unrealized gains (losses) on qualifying cash flow hedges (net of deferred income taxes of $29 and $(67), respectively)		(47	)		106
Comprehensive income	$	78		$	33,077

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

	Three Months Ended
	December 28, 2006			December 29, 2005
Unrealized loss on qualifying cash flow hedges	$	(283	)	$	(237	)
Less: Reclassification adjustment recorded as interest income		236			343
Net unrealized gains (losses) on qualifying cash flow hedges	$	(47	)	$	106

14

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

NOTE 9—INTEREST EXPENSE AND LOSS ON EXTINGUISHMENT OF DEBT

The components of interest expense and loss on extinguishment of debt are as follows (amounts in thousands):

	Three Months Ended
	December 28, 2006			December 29, 2005
Interest on long-term debt, including amortization of deferred financing costs	$	9,721		$	9,850
Interest on lease finance obligations		6,139			5,347
Interest rate swap settlements		(386	)		(779	)
Fair market value change related to hedge ineffectiveness		(5	)		(2	)
Miscellaneous		17			17
Subtotal: Interest expense	$	15,486		$	14,433
Loss on extinguishment of debt		—			1,832
Total interest expense and loss on extinguishment of debt	$	15,486		$	16,265

The loss on extinguishment of debt for the three months ended December 29, 2005 represents a write-off of approximately $1.8 million of unamortized loan origination costs associated with the refinancing of our senior credit facility. For the three months ended December 28, 2006 we capitalized $333 thousand of interest.

NOTE 10—EARNINGS PER SHARE AND COMMON STOCK

Basic earnings per share is computed on the basis of the weighted-average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted-average number of common shares outstanding, plus the effect of outstanding warrants, stock options and convertible notes using the “treasury stock” method. Prior year diluted shares outstanding have been adjusted to properly reflect the impact of SFAS No. 123(R).

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

	Three Months Ended
	December 28, 2006		December 29, 2005
Net income	$	125	$	32,971
Earnings per share—basic:
Weighted-average shares outstanding		22,687		22,328
Earnings per share—basic	$	0.01	$	1.48
Earnings per share—diluted:
Weighted-average shares outstanding		22,687		22,328
Dilutive impact of options and convertible notes outstanding		318		281
Weighted-average shares and potential dilutive shares outstanding		23,005		22,609
Earnings per share—diluted	$	0.01	$	1.46

15

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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 348 thousand and 317 thousand for the three months ended December 28, 2006 and December 29, 2005, 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 three months ended December 29, 2005 computation because their inclusion would have been antidilutive. The aggregate number of shares of common stock, approximately 3.0 million, that we may issue upon exercise of warrants were excluded from the three months ended December 28, 2006 and December 29, 2005 computations as their inclusion would have been antidilutive.

NOTE 11—SUBSEQUENT EVENTS

On January 5, 2007, we signed a definitive agreement with Petro Express, Inc. to acquire 66 Petro Express^™ convenience stores in North Carolina (55) and South Carolina (11). The acquisition will include the wholesale fuels business of Carolina Petroleum Distributors of Charlotte, Inc. The acquisition, which is subject to regulatory approvals and customary closing conditions, is expected to close during our third fiscal quarter. We plan to finance the transaction with a combination of available funds and lease financing.

Subsequent to December 28, 2006, we completed the acquisition of 27 convenience stores, including 16 stores from Anglers Mini-Mart, Inc. in the Charleston, South Carolina market. These acquisitions were funded from available cash and lease financing on acquired real property.

NOTE 12—GUARANTOR SUBSIDIARIES

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

16

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

THE PANTRY, INC. AND SUBSIDIARIES

SUPPLEMENTAL COMBINING BALANCE SHEETS

December 28, 2006

(Dollars in thousands)

	The Pantry (Issuer)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries		Eliminations			Total
ASSETS
Current assets:
Cash and cash equivalents	$	110,758		$	—		$	—	$	—		$	110,758
Receivables, net		62,586			—			—		—			62,586
Inventories		130,346			—			—		—			130,346
Prepaid expenses and other current assets		13,197			2			—		—			13,199
Deferred income taxes		8,594			—			—		—			8,594
Total current assets		325,481			2			—		—			325,483
Investment in subsidiaries		71,773			—			—		(71,773	)		—
Property and equipment, net		762,408			—			—		—			762,408
Other assets:
Goodwill		446,009			—			—		—			446,009
Intercompany note receivable		(23,477	)		43,872			31,050		(51,445	)		—
Other noncurrent assets		45,283			57			—		—			45,340
Total other assets		467,815			43,929			31,050		(51,445	)		491,349
Total assets	$	1,627,477		$	43,931		$	31,050	$	(123,218	)	$	1,579,240
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	2,088		$	—		$	—	$	—		$	2,088
Current maturities of lease finance obligations		3,807			—			—		—			3,807
Accounts payable		128,761			—			—		—			128,761
Accrued compensation and related taxes		15,944			—			—		—			15,944
Other accrued taxes		17,301			—			—		—			17,301
Self-insurance reserves		31,383			—			—		—			31,383
Other accrued liabilities		36,038			—			—		(65	)		35,973
Total current liabilities		235,322			—			—		(65	)		235,257
Other liabilities:
Long-term debt		601,693			—			—		—			601,693
Lease finance obligations		253,542			—			—		—			253,542
Deferred income taxes		72,417			—			—		—			72,417
Deferred vendor rebates		23,600			—			—		—			23,600
Intercompany note payable		48,174			3,208			—		(51,382	)		—
Other noncurrent liabilities		54,276			2			—		—			54,278
Total other liabilities		1,053,702			3,210			—		(51,382	)		1,005,530
SHAREHOLDERS’ EQUITY:
Common stock		227			523			4		(527	)		227
Additional paid-in-capital		174,307			40,551			26,702		(67,253	)		174,307
Accumulated other comprehensive income, net		1,147			—			—		—			1,147
Retained earnings (deficit)		162,772			(353	)		4,344		(3,991	)		162,772
Total shareholders’ equity		338,453			40,721			31,050		(71,771	)		338,453
Total liabilities and shareholders’ equity	$	1,627,477		$	43,931		$	31,050	$	(123,218	)	$	1,579,240

17

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

THE PANTRY, INC. AND SUBSIDIARIES

SUPPLEMENTAL COMBINING BALANCE SHEETS

September 28, 2006

(Dollars in thousands)

	The Pantry (Issuer)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries		Eliminations			Total
ASSETS
Current assets:
Cash and cash equivalents	$	120,394		$	—		$	—	$	—		$	120,394
Receivables, net		68,064			—			—		—			68,064
Inventories		140,135			—			—		—			140,135
Prepaid expenses and other current assets		18,781			2			—		—			18,783
Deferred income taxes		8,348			—			—		—			8,348
Total current assets		355,722			2			—		—			355,724
Investment in subsidiaries		71,773			—			—		(71,773	)		—
Property and equipment, net		745,721			—			—		—			745,721
Other assets:
Goodwill		440,681			—			—		—			440,681
Intercompany note receivable		(23,477	)		43,872			31,050		(51,445	)		—
Other noncurrent assets		45,724			57			—		—			45,781
Total other assets		462,928			43,929			31,050		(51,445	)		486,462
Total assets	$	1,636,144		$	43,931		$	31,050	$	(123,218	)	$	1,587,907
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	2,088		$	—		$	—	$	—		$	2,088
Current maturities of lease finance obligations		3,511			—			—		—			3,511
Accounts payable		139,939			—			—		—			139,939
Accrued compensation and related taxes		19,676			—			—		—			19,676
Other accrued taxes		27,440			—			—		—			27,440
Self-insurance reserves		29,898			—			—		—			29,898
Other accrued liabilities		35,043			—			—		(65	)		34,978
Total current liabilities		257,595			—			—		(65	)		257,530
Other liabilities:
Long-term debt		602,215			—			—		—			602,215
Lease finance obligations		240,564			—			—		—			240,564
Deferred income taxes		72,435			—			—		—			72,435
Deferred vendor rebates		23,876			—			—		—			23,876
Intercompany note payable		48,174			3,208			—		(51,382	)		—
Other noncurrent liabilities		54,278			2			—		—			54,280
Total other liabilities		1,041,542			3,210			—		(51,382	)		993,370
SHAREHOLDERS’ EQUITY:
Common stock		227			523			4		(527	)		227
Additional paid-in-capital		172,940			40,551			26,702		(67,253	)		172,940
Accumulated other comprehensive income, net		1,194			—			—		—			1,194
Retained earnings (deficit)		162,646			(353	)		4,344		(3,991	)		162,646
Total shareholders’ equity		337,007			40,721			31,050		(71,771	)		337,007
Total liabilities and shareholders’ equity	$	1,636,144		$	43,931		$	31,050	$	(123,218	)	$	1,587,907

18

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

THE PANTRY, INC. AND SUBSIDIARIES

SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS

Three Months Ended December 28, 2006

(Dollars in thousands)

	The Pantry (Issuer)			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations		Total
Revenues:
Merchandise	$	349,239		$	—	$	—	$	—	$	349,239
Gasoline		1,031,901			—		—		—		1,031,901
Total revenues		1,381,140			—		—		—		1,381,140
Costs and operating expenses:
Merchandise cost of goods sold (exclusive of items shown separately below)		217,923			—		—		—		217,923
Gasoline cost of goods sold (exclusive of items shown separately below)		991,682			—		—		—		991,682
Operating, general and administrative		136,353			—		—		—		136,353
Depreciation and amortization		20,856			—		—		—		20,856
Total costs and operating expenses		1,366,814			—		—		—		1,366,814
Income from operations		14,326			—		—		—		14,326
Other income (expense):
Interest expense		(15,486	)		—		—		—		(15,486	)
Interest income		1,357			—		—		—		1,357
Miscellaneous		167			—		—		—		167
Total other expense		(13,962	)		—		—		—		(13,962	)
Income before income taxes		364			—		—		—		364
Income tax expense		(239	)		—		—		—		(239	)
Net income	$	125		$	—	$	—	$	—	$	125

19

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

THE PANTRY, INC. AND SUBSIDIARIES

SUPPLEMENTAL COMBINING STATEMENTS OF OPERATIONS

Three Months Ended December 29, 2005

(Dollars in thousands)

	The Pantry (Issuer)			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations		Total
Revenues:
Merchandise	$	316,648		$	—	$	—	$	—	$	316,648
Gasoline		998,675			—		—		—		998,675
Total revenues		1,315,323			—		—		—		1,315,323
Costs and operating expenses:
Merchandise cost of goods sold (exclusive of items shown separately below)		197,912			—		—		—		197,912
Gasoline cost of goods sold (exclusive of items shown separately below)		912,090			—		—		—		912,090
Operating, general and administrative		118,328			—		—		—		118,328
Depreciation and amortization		17,237			—		—		—		17,237
Total costs and operating expenses		1,245,567			—		—		—		1,245,567
Income from operations		69,756			—		—		—		69,756
Other income (expense):
Loss on extinguishment of debt		(1,832	)		—		—		—		(1,832	)
Interest expense		(14,433	)		—		—		—		(14,433	)
Interest income		1,044			—		—		—		1,044
Miscellaneous		159			—		—		—		159
Total other expense		(15,062	)		—		—		—		(15,062	)
Income before income taxes		54,694			—		—		—		54,694
Income tax expense		(21,723	)		—		—		—		(21,723	)
Net income	$	32,971			—		—		—		32,971

20

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

THE PANTRY, INC. AND SUBSIDIARIES

SUPPLEMENTAL COMBINING STATEMENTS OF CASH FLOWS

Three Months Ended December 28, 2006

(Dollars in thousands)

	The Pantry (Issuer)			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations		Total
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	125		$	—	$	—	$	—	$	125
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		20,856			—		—		—		20,856
Benefit from deferred income taxes		(234	)		—		—		—		(234	)
Stock compensation expense		883			—		—		—		883
Other		1,669			—		—		—		1,669
Changes in operating assets and liabilities, net of effects of acquisitions:
Receivables		4,613			—		—		—		4,613
Inventories		10,699			—		—		—		10,699
Prepaid expenses and other current assets		4,019			—		—		—		4,019
Other noncurrent assets		(139	)		—		—		—		(139	)
Accounts payable		(11,178	)		—		—		—		(11,178	)
Other current liabilities and accrued expenses		(14,886	)		—		—		—		(14,886	)
Other noncurrent liabilities		(1,440	)		—		—		—		(1,440	)
Net cash provided by (used in) operating activities		14,987			—		—		—		14,987
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment		(19,375	)		—		—		—		(19,375	)
Proceeds from sales of property and equipment		3,250			—		—		—		3,250
Acquisitions of businesses, net of cash acquired		(21,768	)		—		—		—		(21,768	)
Net cash provided by (used in) investing activities		(37,893	)		—		—		—		(37,893	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal repayments under lease finance obligations		(883	)		—		—		—		(883	)
Principal repayments of long-term debt		(522	)		—		—		—		(522	)
Proceeds from lease finance obligations		14,675			—		—		—		14,675
Net cash provided by financing activities		13,270			—		—		—		13,270
Net decrease in cash		(9,636	)		—		—		—		(9,636	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		120,394			—		—		—		120,394
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	110,758		$	—	$	—	$	—	$	110,758

21

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

THE PANTRY, INC. AND SUBSIDIARIES

SUPPLEMENTAL COMBINING STATEMENTS OF CASH FLOWS

Three Months Ended December 29, 2005

(Dollars in thousands)

	The Pantry (Issuer)			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations		Total
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	32,971		$	—	$	—	$	—	$	32,971
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		17,237			—		—		—		17,237
Provision for deferred income taxes		47			—		—		—		47
Loss on extinguishment of debt		1,832			—		—		—		1,832
Stock compensation expense		628			—		—		—		628
Other		(180	)		—		—		—		(180	)
Changes in operating assets and liabilities, net of effects of acquisitions:
Receivables		8,996			—		—		—		8,996
Inventories		9,403			—		—		—		9,403
Prepaid expenses and other current assets		2,709			—		—		—		2,709
Other noncurrent assets		135			—		—		—		135
Accounts payable		(9,091	)		—		—		—		(9,091	)
Other current liabilities and accrued expenses		4,225			—		—		—		4,225
Other noncurrent liabilities		(1,663	)		—		—		—		(1,663	)
Net cash provided by operating activities		67,249			—		—		—		67,249
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment		(13,709	)		—		—		—		(13,709	)
Proceeds from sales of property and equipment		1,239			—		—		—		1,239
Acquisitions of businesses, net of cash acquired		(7,761	)		—		—		—		(7,761	)
Net cash used in investing activities		(20,231	)		—		—		—		(20,231	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal repayments under lease finance obligations		(720	)		—		—		—		(720	)
Principal repayments of long-term debt		(305,019	)		—		—		—		(305,019	)
Proceeds from issuance of long-term debt		355,000			—		—		—		355,000
Proceeds from lease finance obligations		5,625			—		—		—		5,625
Proceeds from exercise of stock options		582			—		—		—		582
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		474			—		—		—		474
Other financing costs		(6,396	)		—		—		—		(6,396	)
Net cash provided by financing activities		31,046			—		—		—		31,046
Net increase in cash		78,064			—		—		—		78,064
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		111,472			—		—		—		111,472
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	189,536		$	—	$	—	$	—	$	189,536

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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 business is contained in our Annual Report on Form 10-K for the fiscal year ended September 28, 2006. References to “Pantry,” “The Pantry,” “we,” “us,” and “our” mean The Pantry, Inc. and its subsidiaries.

This report, including without limitation, our discussion and analysis of our financial condition and results of operations, contains statements that we believe are “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 and are intended to enjoy the protection of the safe harbor for forward-looking statements provided by that Act. These forward-looking statements generally can be identified by use of phrases such as “believe,” “plan,” “expect,” “anticipate,” “intend,” “forecast” or other similar words or phrases. Descriptions of our objectives, goals, targets, plans, strategies, costs and burdens of environmental remediation, anticipated capital expenditures, expected cost savings and benefits and anticipated synergies from acquisitions, anticipated costs of rebranding our stores, anticipated sharing of costs of conversion with our gasoline suppliers, and expectations regarding remodeling, rebranding, reimaging 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;

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

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

• 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 February 6, 2007. We anticipate

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that subsequent events and market developments will cause our estimates to change. However, while we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if new information becomes available in the future.

Executive 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 1,506 stores in eleven states as of December 28, 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, continuing to selectively pursue acquisitions and developing new stores.

The most significant item impacting our first quarter of fiscal 2007 was lower than expected gasoline margins. During the fourth quarter of fiscal 2006, we experienced a substantial decline in wholesale gasoline costs and our gasoline margin per gallon benefited. However, during the first quarter of fiscal 2007, we experienced a sustained period in which costs were very stable at margins below our historical norms. As a result, we achieved a gasoline margin per gallon of 8.6 cents during the first quarter of fiscal 2007 compared to 21.2 cents during the first quarter of fiscal 2006. We anticipate some volatility returning to the marketplace and believe that our margin per gallon will be more in line with historical norms for the remainder of fiscal 2007.

From a strategic standpoint we continued our aggressive regional store expansion growing our store count to 1,506 as of December 28, 2006. We have now acquired or agreed to acquire 133 convenience stores in fiscal 2007, more than the 113 acquired during all of fiscal 2006. During the first quarter of fiscal 2007 we acquired or agreed to acquire 67 convenience stores including 24 Sun Stop stores in Florida, Georgia and Alabama; and 16 Angler’s Mini-Mart stores in the Charleston, South Carolina market. In addition, on January 9, 2007, we announced a definitive agreement to acquire 66 Petro Express^™ stores in North Carolina and South Carolina. These acquisitions, which are subject to regulatory and other customary closing conditions, are expected to close in the second and third quarters of fiscal 2007. We believe these acquisitions are consistent with our tuck-in strategy and will enhance our market presence in the southeastern United States.

We believe the selected financial information presented below is important in evaluating the performance of our business operations. We operate in one business segment and believe the information presented in our Management’s Discussion and Analysis of Financial Condition and Results of Operations provides an understanding of our business segment, our operations and our financial condition.

Market and Industry Trends

During the first quarter of fiscal 2007, we experienced a relatively stable retail and wholesale gasoline cost environment as domestic crude oil prices peaked at approximately $64 per barrel in December 2006 and hit a low of approximately $56 per barrel in November 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 averaged approximately 12 cents per gallon on an annual basis.

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Results of Operations

The table below provides a summary of our selected financial data for our three months ended December 28, 2006 and December 29, 2005.

	Three Months Ended
	December 28, 2006			December 29, 2005
Selected financial data:
Merchandise margin [1]		37.6	%		37.5	%
Gasoline gallons (millions)		466.5			409.1
Gasoline margin per gallon [1]	$	0.0862		$	0.2117
Gasoline retail per gallon	$	2.21		$	2.44
Operating, general and administrative expenses as a percentage of the sum of merchandise revenue and gasoline gallons [2]		16.7	%		16.3	%
Comparable store data:
Merchandise sales %		1.9	%		5.0	%
Gasoline gallons %		2.0	%		4.6	%
Number of stores:
End of period		1,506			1,401
Weighted-average store count		1,497			1,399

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

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

Three Months Ended December 28, 2006 Compared to the Three Months Ended December 29, 2005

Merchandise Revenue.    Merchandise revenue for the first quarter of fiscal 2007 was $349.2 million compared to $316.6 million during the first quarter of fiscal 2006, an increase of $32.6 million, or 10.3%. The increase is primarily attributable to $27.9 million in revenue from stores acquired since September 30, 2005 and a 1.9%, or $5.9 million, increase in comparable store merchandise revenue compared to the first quarter of fiscal 2006. This increase was partially offset by lost revenue from closed stores of approximately $1.8 million.

Gasoline Revenue and Gallons.    Gasoline revenue for the first quarter of fiscal 2007 was $1.0 billion compared to $998.7 million during the first quarter of fiscal 2006, an increase of $33.2 million, or 3.3%. The increase in gasoline revenue is primarily attributable to $104.7 million in revenue from stores acquired since September 30, 2005 and an increase in comparable store gallons of 8.2 million, or 2.0%. These increases were partially offset by a 9.4% decline in the average retail price per gallon, to $2.21, and lost revenue from closed stores of approximately $3.2 million.

In the first quarter of fiscal 2007, gasoline gallons sold were 466.5 million compared to 409.1 million during the first quarter of fiscal 2006, an increase of 57.4 million gallons, or 14.0%, from a year ago. The increase is primarily attributable to 47.6 million gasoline gallons from stores acquired since September 30, 2005 and the comparable store gasoline gallon increase discussed above, partially offset by lost gasoline gallon volume from closed stores of approximately 1.3 million gallons.

Merchandise Gross Profit and Margin.    Merchandise gross profit was $131.3 million for the first quarter of fiscal 2007 compared to $118.7 million for the first quarter of fiscal 2006, an increase of $12.6 million, or 10.6%. This increase is primarily attributable to the increased merchandise revenue discussed above and a 10 basis point increase in merchandise margin to 37.6% for the first quarter of fiscal 2007 compared to 37.5% for the first quarter of fiscal 2006. We compute gross profit exclusive of depreciation or allocation of operating, general and administrative expenses. We believe the margin improvement is primarily due to improvements in

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services revenue, which increased $2.1 million, or 20.0%, from a year ago. The increase in services revenue is primarily the result of increased lottery commissions, car wash revenue and ATM fees.

Gasoline Gross Profit and Per Gallon Margin.    Gasoline gross profit was $40.2 million for the first quarter of fiscal 2007 compared to $86.6 million for the first quarter of fiscal 2006, a decrease of $46.4 million, or 53.5%. The decrease is primarily attributable to a decrease in our gross profit per gallon to 8.6 cents for the first quarter of fiscal 2007 from 21.2 cents in the first quarter of fiscal 2006. We compute gross profit exclusive of depreciation or allocation of operating, general and administrative 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 3.8 cents per gallon and 3.9 cents per gallon for the three months ended December 28, 2006 and December 29, 2005, respectively.

Operating, General and Administrative Expenses.    Operating, general and administrative expenses for the first quarter of fiscal 2007 totaled $136.4 million compared to $118.3 million for the first quarter of fiscal 2006, an increase of $18.0 million, or 15.2%. 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 $14.3 million for the first quarter of fiscal 2007 compared to $69.8 million for the first quarter of fiscal 2006, a decrease of $55.4 million, or 79.5%. The decrease is primarily attributable to the decrease in gasoline gross profit and 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, and depreciation and amortization. EBITDA for the first quarter of fiscal 2007 totaled $36.7 million compared to EBITDA of $88.2 million during the first quarter of fiscal 2006, a decrease of $51.5 million, or 58.4%. The decrease is attributable to the decrease in income from operations discussed above.

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

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

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

	Three Months Ended
	December 28, 2006			December 29, 2005
EBITDA	$	36,706		$	88,196
Interest expense and loss on extinguishment of debt		(15,486	)		(16,265	)
Depreciation and amortization		(20,856	)		(17,237	)
Provision for income taxes		(239	)		(21,723	)
Net income	$	125		$	32,971

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

Interest 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 quarter of fiscal 2007 was $15.5 million compared to $14.4 million for the first quarter of fiscal 2006. The increase is primarily the result of an increase in our weighted-average borrowings as a result of the issuance of our 3.0% senior subordinated convertible notes (“convertible notes”) and increased lease finance obligations.

Liquidity and Capital Resources

Cash Flows from Operations.    Due to the nature of our business, substantially all sales are for cash and cash provided by operations is our primary source of liquidity. We rely primarily on cash provided by operating activities, supplemented as necessary from time to time by borrowings under our revolving credit facility, lease finance transactions, and asset dispositions to finance our operations, pay interest and principal payments and fund capital expenditures. Cash provided by operating activities declined to $15.0 million for the first quarter of fiscal 2007 compared to $67.2 million for the first quarter of fiscal 2006. The decrease in cash flow from operations is primarily attributable to the $55.4 million decrease in income from operations and changes in working capital. We had $110.8 million of cash and cash equivalents on hand at December 28, 2006.

Capital Expenditures.    Gross capital expenditures (excluding all acquisitions) for the first quarter of fiscal 2007 were $19.4 million. In the first quarter of fiscal 2007, we had proceeds of $3.3 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 quarter of fiscal 2007 were $13.4 million. We anticipate that net capital expenditures for fiscal 2007 will be approximately $130 million.

Our capital expenditures are primarily expenditures for store improvements, store equipment, new store development, information systems and expenditures to comply with regulatory statutes, including those related to environmental matters. We finance substantially all capital expenditures and new store development through cash flows from operations, proceeds from lease financing transactions, asset dispositions and vendor reimbursements.

Acquisitions.    During the first quarter of fiscal 2007, we purchased 14 stores in five separate transactions for approximately $21.6 million.

Cash Flows from Financing Activities.    For the first quarter of fiscal 2007, net cash provided by financing activities was $13.3 million. We entered into new lease financing transactions with proceeds totaling $14.7 million, including $12.0 million related to acquisitions. At December 28, 2006, our debt consisted primarily of $203.4 million in loans under our senior credit facility, $250.0 million of outstanding 7.75% senior subordinated notes and $150.0 million of outstanding 3.0% convertible notes. We also have outstanding $257.3 million of lease finance obligations

Senior Credit Facility.    We have outstanding a Second Amended and Restated Credit Agreement which 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 revolving credit facility has been, and will continue to be, used for our working capital and general corporate requirements.

As of December 28, 2006, we had no borrowings outstanding under the revolving credit facility and approximately $43.3 million of standby letters of credit had been issued. As of December 28, 2006, we have

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approximately $106.7 million in available borrowing capacity under the facility (approximately $46.7 million of which was available for issuances of letter of credit).

Senior Subordinated Notes.    We have outstanding $250.0 million of 7.75% senior subordinated notes due February 15, 2014. Interest on the senior subordinated notes is due on February 15 and August 15 of each year.

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

Shareholders’ Equity.    As of December 28, 2006, our shareholders’ equity totaled $338.5 million. The $1.4 million increase from September 28, 2006 is primarily attributable to an increase in additional paid-in capital related to stock-based compensation expense and the income tax benefit from the note hedge.

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 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.

We have entered into purchase agreements for 122 convenience stores with closings anticipated during our second and third fiscal quarters of 2007. We believe that cash provided by operations supplemented by funds available under our senior credit facility and lease financing will be sufficient for us to consummate these transactions. In addition, we are exploring other financing alternatives.

New Accounting Standards

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

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

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

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 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 December 28, 2006, including applicable interest rates, are discussed above, in “Item 1. Financial Statements—Notes to Condensed Consolidated Financial Statements—Note 6—Derivative Financial Instruments” and “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

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

Expected Maturity Date

as of December 28, 2006

(Dollars in thousands)

	Fiscal 2007			Fiscal 2008			Fiscal 2009			Fiscal 2010			Fiscal 2011			Thereafter			Total			Fair Value
Long-term debt	$	1,566		$	2,091		$	2,094		$	2,098		$	2,101		$	593,831		$	603,781		$	636,210
Weighted-average interest rate		6.12	%		6.15	%		6.24	%		6.33	%		6.33	%		6.72	%		6.35	%

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 December 28, 2006 and September 28, 2006, the interest rate on approximately 88% of our debt was fixed by either the nature of the obligation or through the interest rate swap arrangements. The annualized effect of a one percentage point change in floating interest rates on our interest rate swap agreements and other floating rate debt obligations at December 28, 2006, would be to change interest expense by approximately $700 thousand.

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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)

	December 28, 2006			September 28, 2006
Notional principal amount	$	130,000		$	130,000
Weighted-average pay rate		4.24	%		4.24	%
Weighted-average receive rate		5.40	%		5.52	%
Weighted-average years to maturity		1.96			2.21

As of December 28, 2006, the fair value of our swap agreements represented an asset of $1.9 million.

Qualitative Disclosures.    Our primary exposure relates to:

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

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

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

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

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

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 United States Securities and Exchange Commission’s rules and forms and such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure.

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. 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, on July 17, 2004 Constance Barton, Kimberly Clark, Wesley Clark, Tracie Hunt, Eleanor Walters, Karen Meredith, Gilbert Breeden, LaCentia Thompson, and Mathesia Peterson, on behalf of themselves and on behalf of classes of those similarly situated, filed suit against The Pantry, Inc. seeking class action status and asserting claims on behalf of our North Carolina present and former employees for unpaid wages under North Carolina Wage and Hour laws. The suit also seeks an injunction against any unlawful practices, damages, liquidated damages, costs and attorneys’ fees. We filed an Answer denying any wrongdoing or liability to plaintiffs in any regard. The suit originally was filed in the Superior Court for Forsyth County, State of North Carolina. On August 17, 2004, the case was removed to the United States District Court for the Middle District of North Carolina and on July 18, 2005, plaintiffs filed an Amended Complaint asserting certain additional claims under the federal Fair Labor Standards Act on behalf of present and former store employees in the southeastern United States and adding one additional named plaintiff, Chester Charneski. We filed a motion to dismiss parts of the Amended Complaint and on May 17, 2006, the court granted in part and denied in part our motion, with the result that the court will now determine if the case may proceed as a class action under state law and/or a collective action under federal law and if so, who among our present or former employees will be members of the classes. On January 16, 2007, plaintiffs filed a motion to file a Second Amended Complaint asserting on behalf of themselves and classes of those similarly situated state law claims for alleged unpaid wages in all eleven states in which we do business. Should the court decide that the case may proceed as a class action under state law or a collective action under federal law, we expect to defend any such claims on their merits. We believe our employment policies and procedures comply with applicable law and intend to vigorously defend this litigation.

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

Item 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 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

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supermarkets, club stores and mass merchants, have impacted the convenience store industry by entering the gasoline retail business. These non-traditional gasoline retailers have obtained a significant share of the motor fuels market and their market share is expected to grow. In some of our markets, our competitors have been in existence longer and have greater financial, marketing and other resources than we do. As a result, our competitors may be able to respond better to changes in the economy and new opportunities within the industry. To remain competitive, we must constantly analyze consumer preferences and competitors’ offerings and prices to ensure we offer a selection of convenience products and services consumers demand at competitive prices. We must also maintain and upgrade our customer service levels, facilities and locations to remain competitive and drive customer traffic to our stores. Major competitive factors include, among others, location, ease of access, gasoline brands, pricing, product and service selections, customer service, store appearance, cleanliness and safety.

Volatility of wholesale petroleum costs could impact our operating results.

Over the past three fiscal years, our gasoline revenue accounted for approximately 72.7% of total revenues and our gasoline gross profit accounted for approximately 32.2% of total gross profit. Crude oil and domestic wholesale petroleum markets are marked by significant volatility. General political conditions, acts of war or terrorism, and instability in oil producing regions, particularly in the Middle East and South America, could significantly impact crude oil supplies and wholesale petroleum costs. In addition, the supply of gasoline and our wholesale purchase costs could be adversely impacted in the event of a shortage, which could result from, among other things, lack of capacity at United States oil refineries or the fact that our gasoline contracts do not guarantee an uninterrupted, unlimited supply of gasoline. Significant increases and volatility in wholesale petroleum costs could result in significant increases in the retail price of petroleum products and in lower gasoline gross margin per gallon. Increases in the retail price of petroleum products could impact consumer demand for gasoline. This volatility makes it extremely difficult to predict the impact future wholesale cost fluctuations will have on our operating results and financial condition. These factors could materially impact our gasoline gallon volume, gasoline gross profit and overall customer traffic, which in turn would impact our merchandise sales.

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

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

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

In the convenience store industry, customer traffic is generally driven by consumer preferences and spending trends, growth rates for automobile and truck traffic and trends in travel, tourism and weather. Changes in economic conditions generally or in the southeastern United States specifically could adversely impact consumer spending patterns and travel and tourism in our markets. Approximately 34% 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.

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Risks Related to Our Business

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

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

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

An important part of our historical growth strategy has been to acquire other convenience stores that complement our existing stores or broaden our geographic presence. Since 1996, we have successfully completed and integrated more than 75 acquisitions, growing our store base from 379 to 1,506 stores. We expect to continue to selectively review acquisition opportunities as an element of our growth strategy. Acquisitions involve risks that could cause our actual growth or operating results to differ significantly from our expectations or the expectations of securities analysts. For example:

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

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

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

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

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

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

Our substantial indebtedness could negatively impact our financial health.

We have a significant amount of indebtedness. As of December 28, 2006, we had consolidated debt, including lease finance obligations, of approximately $861.1 million. As of December 28, 2006, our availability under our senior credit facility for borrowing was approximately $106.7 million (approximately $46.7 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;

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

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

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

• limit our ability to borrow additional funds in the future.

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

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

In addition, our senior credit facility and the indenture governing our senior subordinated notes each 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 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 incur additional indebtedness, the related risks that we and they now face could increase.

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

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

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

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

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

If we do not comply with the covenants in 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 the indenture governing our senior subordinated notes require us to comply with certain covenants. In particular, our senior credit facility prohibits us from incurring any additional indebtedness except in specified circumstances or materially amending the terms of any agreement relating to existing indebtedness without lender approval. Further, our senior credit facility restricts our ability to acquire and dispose of assets, engage in mergers or reorganizations, pay dividends, or make investments. Other restrictive covenants require that we meet fixed charge coverage and leverage tests, as defined in the senior credit facility agreement. A violation of any of these covenants could cause an event of default under the senior credit facility.

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

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

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

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

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

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

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

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

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

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

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

We purchase over 50% of our general merchandise, including most tobacco products and grocery items, from a single wholesale grocer, McLane Company, Inc., 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 sold, financial condition and results of operations.

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

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

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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.

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

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

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

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

Pending SEC matters could adversely affect us.

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

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

Effective internal control over financial reporting is necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be harmed. The Sarbanes-Oxley Act of 2002, as well as related new rules and regulations implemented by the SEC, Nasdaq and the Public Company Accounting Oversight Board, have required changes in the corporate governance practices and

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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. These material weaknesses resulted in a more than remote risk that a material misstatement of our annual or interim financial statements would not be prevented or detected.

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

Other Risks

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

If we or our existing stockholders sell shares of our common stock in the public market, including shares issued upon the exercise of outstanding options, or if the market perceives such sales or issuances could occur, the market price of our common stock could decline. As of February 2, 2007, there were 22,782,075 shares of our common stock outstanding; of these shares, 22,527,076 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.

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

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

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

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

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

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

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

• Additions or departures of key personnel;

• Actions taken by our competitors;

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

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

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 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

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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 6. Exhibits

Exhibit Number	Description of Document
10.1	Employment agreement dated October 11, 2006 by and between Melissa H. Anderson and The Pantry, Inc. (incorporated by reference to Exhibit 10.48 to The Pantry’s Annual Report on Form 10K for the year ended September 28, 2006) (represents a management contract or compensatory plan or arrangement).
10.2	Fourth Amendment to Amended and Restated Addendum to Distributor Franchise Agreement dated December 18, 2006 between CITGO Petroleum Corporation and The Pantry, Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission).
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, Finance, Chief Financial Officer and Secretary (Authorized Officer and Principal Financial Officer)
Date: February 6, 2007

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EXHIBIT INDEX

Exhibit Number	Description of Document
10.1	Employment agreement dated October 11, 2006 by and between Melissa H. Anderson and The Pantry, Inc. (incorporated by reference to Exhibit 10.48 to The Pantry’s Annual Report on Form 10K for the year ended September 28, 2006) (represents a management contract or compensatory plan or arrangement).
10.2	Fourth Amendment to Amended and Restated Addendum to Distributor Franchise Agreement dated December 18, 2006 between CITGO Petroleum Corporation and The Pantry, Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a confidential treatment filing with the Securities and Exchange Commission).
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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