This discussion and analysis of our financial condition and results of operations is provided to increase the understanding of, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying notes appearing elsewhere in this report. Additional discussion and analysis related to our business is contained in our Annual Report on Form 10-K for the fiscal year ended September 25, 2008. References to "the Company," "The Pantry," "Pantry," "we," "us" and "our" mean The Pantry, Inc. and its subsidiaries.

Safe Harbor Discussion

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

• Competitive pressures from convenience stores, gasoline stations and other non-traditional retailers located in our markets;
• Volatility in crude oil and wholesale petroleum costs;
• Political conditions in crude oil producing regions and global demand;
• Changes in economic conditions generally and in the markets we serve;
• Consumer behavior, travel and tourism trends;
• Wholesale cost increases of, and tax increases on, tobacco products;
• Unfavorable weather conditions or other trends or developments in the southeastern United States;
• Inability to identify, acquire and integrate new stores;
• Financial leverage and debt covenants;
• Changes in state and federal environmental and other laws and regulations;
• Dependence on one principal supplier for merchandise and two principal suppliers for gasoline;
• Dependence on senior management;
• Litigation risks, including with respect to food quality, health and other related issues;
• Inability to maintain an effective system of internal control over financial reporting; and
• Other unforeseen factors.

For a discussion of these and other risks and uncertainties, please refer to "Part II.-Item 1A. Risk Factors." The list of factors that could affect future performance and the accuracy of forward-looking statements is illustrative but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty. The forward-looking statements included in this report are based on, and include, our estimates as of May 5, 2009. We anticipate that subsequent events and market developments will cause our estimates to change. However, while we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if new information becomes available.

Executive Overview

We are the leading independently operated convenience store chain in the southeastern United States with 1,647 stores in 11 states as of March 26, 2009. Our stores operate under a number of select banners, with 1,530 of our stores operating under Kangaroo and Kangaroo Express, our primary operating banners. We derive our revenue from the sale of merchandise, gasoline and other 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 in the following ways:

• generating profitable growth through merchandising initiatives;
• sophisticated management of our gasoline business;
• benefiting from consumer trends towards convenience formats;
• leveraging our geographic economies of scale;
• benefiting from the favorable demographics of our markets;
• selectively pursuing acquisitions; and
• developing new stores.

The second quarter of fiscal 2009 began with a favorable environment in the energy markets as oil prices continued to fall, bottoming out at approximately $34 a barrel in early February and then gradually increasing the remainder of the quarter. The progressive increase in gasoline prices towards the latter part of the quarter offset early strong margins, which resulted in a margin of 11.2 cents per gallon for the second quarter of fiscal 2009, compared to 9.0 cents per gallon for the second quarter of fiscal 2008. Our net income for the second quarter of fiscal 2009 was $6.3 million, or $0.28 per share on a fully diluted basis, compared to a net loss of $5.1 million, or $0.23 per share on a fully diluted basis, for the second quarter of fiscal 2008.

During the second quarter of fiscal 2009 we made significant progress in improving the Company's leverage metrics. We acquired approximately $26.0 million in principal amount of our outstanding debt which resulted in a pre-tax gain on extinguishment of debt of approximately $6.7 million. This activity coupled with our first quarter payment of $22.8 million in principal outstanding under our senior credit facility brings our year-to-date debt and lease finance obligations reduction to approximately $53.1 million. In addition, our liquidity position has improved as our cash balance has grown to approximately $242.8 million as of the end of the second quarter of fiscal 2009.

These results were achieved despite continued declines in comparable store gasoline volumes and a deteriorating retail environment. These trends primarily reflect the continuing slowdown in U.S. consumer spending and increased unemployment. With fewer miles driven, demand for gasoline is reduced, which also impacts traffic in our stores and merchandise sales.

In the gasoline business, our volumes remained relatively soft with a 6.4 percent decline in comp store retail gas gallons. Again this quarter, a significant portion of the drop is attributable to diesel sales, which were down 22 percent in comparable stores versus a year ago. While miles driven in our markets in January/February improved to be down only 2.4% versus the Q4 decline of 6.3%, our region still trailed the national average which showed miles driven down 1.9%.

For the quarter, comparable store merchandise revenues were up 1.3 percent, versus a 3.0 percent decline in the first quarter. Our merchandise gross margin was 37.2 percent, up 170 basis points from our first quarter margin of 35.5 percent but down 30 basis points from a year ago. Both merchandise sales and margin results were positively impacted by cigarette cost increases and corresponding retail price increases taken in anticipation of the federal excise tax to support the State Children's Health Insurance Program (SCHIP In addition to the improvement in cigarette margin, we saw improved package beverage margins as a result of our 2009 reset. Finally, we were also able to improve shrink performance by our increased focus on operating efficiency.

We anticipate continuing our efforts to grow through new stores, remodels, acquisitions and expense controls. We will also continue to explore opportunities to reduce debt as we seek to balance growth with de-leveraging the business.

Market and Industry Trends

In February 2009, the President signed a bill reauthorizing the State Children's Health Insurance Program, which is to be funded primarily through increases in the federal excise taxes on cigarette and tobacco products. For cigarettes, the federal excise tax increased from $0.39 per pack to $1.01 per pack. We will attempt to pass on the increased cost to our customers, however, doing so will likely result in lower unit volumes and reduced merchandise margins in the future. The new law also includes a floor stocks tax for inventory as of March 31, 2009, which will apply to all tobacco products and which will be payable by July 31, 2009. We took steps to reduce our inventory on hand during the second quarter, however we estimate that our floor stocks tax payable will be approximately $4.0 million. Our business, financial condition and results of operations could be adversely affected if these increases in federal taxes on our tobacco products materially adversely impact our cigarette unit volume and revenues, merchandise gross profit and overall customer traffic.

In our markets, we saw our state weighted average unemployment rate increase to 9.6% during our second fiscal quarter up from 7.3% in the first fiscal quarter and 5.2% during the second fiscal quarter last year. While these factors and a slumping housing market have weighed on consumers, we saw sequential improvement in our merchandise comparable store sales. We anticipate gas prices will remain much lower than last year in the coming months but expect the challenging economic conditions might limit the benefits we could receive from having substantially lower gasoline prices.

During the second quarter of fiscal 2009, crude oil prices started the quarter at $38 per barrel and climbed to a high of $54 per barrel. We attempt to pass along wholesale gasoline cost changes to our customers through retail price changes; however, we are not always able to do so. The timing of any related increase or decrease in retail prices is affected by competitive conditions. As a result, we tend to experience lower gasoline margins in periods of rising wholesale costs and higher margins in periods of decreasing wholesale costs.

Results of Operations

The table below provides a summary of our selected financial data for the three and six months ended March 26, 2009 and March 27, 2008 (dollars and gallons, except per gallon data, in thousands):

                                 Three Months Ended                                    Six Months Ended
                         March 26,                 March 27,                 March 26,                    March 27,
                           2009                      2008                      2009                         2008
Selected financial
data:
Merchandise gross
profit [1]             $     144,812             $     142,498         $             283,493          $         288,861
Merchandise margin              37.2 %                    37.5 %                        36.4 %                     37.2 %
Retail gasoline
data:
Gallons                      492,245                   517,421                       991,918                  1,043,604
Margin per gallon      $      0.1120             $      0.0899         $              0.1857          $          0.0978
Retail price per
gallon                 $        1.84             $        3.10         $                2.14          $            3.01
Total gasoline
gross profit [1]       $      55,439             $      46,939         $             185,580          $         103,096

Comparable store
data:
Merchandise sales
increase
(decrease)                       1.3 %                    (3.4 %)                       (0.9 %)                    (1.3 %)
Merchandise sales
increase
(decrease)             $       4,718             $     (11,965 )       $              (6,991 )        $          (9,233 )
Gasoline gallons
decrease (%)                    (6.4 %)                   (3.4 %)                       (6.9 %)                    (3.1 %)
Gasoline gallons
decrease                     (33,041 )                 (15,718 )                     (71,261 )                  (28,160 )
Number of stores:
End of period                  1,647                     1,659                         1,647                      1,659
Weighted-average
store count                    1,648                     1,644                         1,650                      1,644

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

Three Months Ended March 26, 2009 Compared to the Three Months Ended March 27, 2008

Merchandise Revenue and Gross Profit. Merchandise revenue for the second quarter of fiscal 2009 increased $9.1 million, or 2.4%, from the second quarter of fiscal 2008. This increase is primarily attributable to an increase in comparable store merchandise revenue of 1.3%, or $4.7 million, as well as an increase in merchandise revenue from stores acquired since the beginning of the second quarter of fiscal 2008 of $3.2 million. The increase was also attributable to merchandise revenue of $2.7 million from newly constructed stores offset by lost merchandise revenue from closed stores of $2.4 million. Merchandise gross profit for the second quarter of 2009 increased $2.3 million, or 1.6%, from the second quarter of fiscal 2008. This increase is primarily attributable to higher merchandise revenue during the second quarter of fiscal 2009 offset by a 30 basis point decrease in merchandise gross margin to 37.2% for the second quarter of fiscal 2009 compared to 37.5% for the second quarter of fiscal 2008. The decrease in merchandise gross margin was primarily due to an unfavorable mix shift away from higher margin categories, and a decrease in food service margin offset by higher cigarette margins and improved shrink controls.

Gasoline Revenue, Gallons and Gross Profit. Total gasoline revenue for the second quarter of fiscal 2009 decreased $732.5 million, or 44.2%, from the second quarter of fiscal 2008. This decrease is primarily attributable to the 40.6% decrease in the average retail price per gallon to $1.84 and a decrease in gasoline gallons sold. Retail gasoline gallons sold for the second quarter of fiscal 2009 decreased 25.2 million gallons, or 4.9%, from the second quarter of fiscal 2008. The decrease is primarily attributable to a decrease in comparable store gasoline gallons sold of 33.0 million gallons, or 6.4% offset by the increase of 4.7 million gallons sold by stores acquired since the beginning of the second quarter of fiscal 2008. Newly-constructed stores accounted for an increase in gasoline gallons sold of 4.4 million offset by lost gallons from closed stores of 2.0 million. The decrease in comparable store gasoline gallons sold was primarily due to decreased consumer demand for gasoline due to a decline in miles driven and a 22% decline in comparable diesel volume. Excluding diesel, our comparable store gasoline volumes were down 4.4%.

Gasoline gross profit for the second quarter of fiscal 2009 increased $8.5 million, or 18.1%, from the second quarter of fiscal 2008. The increase is primarily attributable to the 2.2 cent increase in retail gross profit per gallon to 11.2 cents for the second quarter of fiscal 2009 from 9.0 cents in the second quarter of fiscal 2008. The increase in retail gross profit per gallon is primarily due to declining wholesale fuel costs during the second quarter of fiscal 2009 and decreased credit card fees resulting from a lower average retail price per gallon. The second quarter of fiscal 2008 included hedging losses of approximately $8.5 million or 1.6 cents per gallon. We compute gross profit exclusive of depreciation and allocation of store operating and general and administrative expenses. We present gasoline gross profit per gallon inclusive of credit card processing fees and cost of repairs and maintenance on gasoline equipment. These fees totaled 4.0 cents per gallon and 5.5 cents per gallon for the three months ended March 26, 2009 and March 27, 2008, respectively.

Store Operating and General and Administrative. Store operating and general and administrative expenses for the second quarter of fiscal 2009 increased $923 thousand, or 0.6%, from the second quarter of fiscal 2008. This increase is a result of higher utilities costs, taxes and licenses and telecommunication expense, offset by improvements in store labor and other cash controls. Average per store operating expenses for the second quarter of fiscal 2009 remained consistent with the second quarter of fiscal 2008.

Depreciation and Amortization. Depreciation and amortization expenses for the second quarter of fiscal 2009 decreased $496 thousand, or 1.9%, from the second quarter of fiscal 2008.

Income from Operations. Income from operations for the second quarter of fiscal 2009 increased $10.4 million, or 79.7%, from the second quarter of fiscal 2008. This increase is primarily attributable to the increase in gasoline gross profit, partially offset by increases in store operating and general and administrative expenses, each of which are discussed above.

EBITDA and Adjusted EBITDA. We define EBITDA as net income before interest expense, net, gain/loss on extinguishment of debt, income taxes and depreciation and amortization. Adjusted EBITDA includes the lease payments we make under our lease finance obligations as a reduction to EBITDA. EBITDA for the second quarter of fiscal 2009 increased $9.7 million, or 24.1%, from the second quarter of fiscal 2008. Adjusted EBITDA for the second quarter of fiscal 2009 increased $9.4 million, or 32.9%, from the second quarter of fiscal 2008. These increases are primarily attributable to the variances discussed above.

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

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

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

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

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

                                                        Three Months Ended
                                                     March 26,      March 27,
                                                        2009           2008
       Adjusted EBITDA                               $   37,975     $   28,579
       Payments made for lease finance obligations       11,778         11,499
       EBITDA                                            49,753         40,078
       Gain on extinguishment of debt                     6,693              -
       Interest expense, net                            (20,883 )      (21,873 )
       Depreciation and amortization                    (26,273 )      (26,769 )
       Income tax (expense) benefit                      (2,952 )        3,485
       Net income (loss)                             $    6,338     $   (5,079 )

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

                                                            Three Months Ended
                                                         March 26,      March 27,
                                                            2009           2008
   Adjusted EBITDA                                       $   37,975     $   28,579
   Payments made for lease finance obligations               11,778         11,499
   EBITDA                                                    49,753         40,078
   Gain on extinguishment of debt                             6,693              -
   Interest expense, net                                    (20,883 )      (21,873 )
   Income tax (expense) benefit                              (2,952 )        3,485
   Stock-based compensation                                     988            860
   Changes in operating assets and liabilities              (17,527 )      (15,568 )
   Other                                                      1,879         (2,120 )
   Net cash provided by operating activities             $   17,951     $    4,862
   Net cash used in investing activities                 $  (10,127 )   $  (38,753 )
   Net cash (used in) provided by financing activities   $  (19,834 )   $   25,276

Gain on Extinguishment of Debt. The gain on extinguishment of debt of $6.7 million during the second quarter of fiscal 2009 represents a gain on the buyback of approximately $23.0 million in principal amount of our 3.0% senior subordinated convertible notes due 2012 ("convertible notes") and $3.0 million in principal amount of our 7.75% senior subordinated notes due 2014 ("subordinated notes"). We recognized a gain of $6.4 million and $705 thousand related to the repurchase of our convertible notes and our subordinated notes, respectively, offset partially by the write-off of $438 thousand of unamortized deferred financing costs.

Interest Expense, Net. Interest expense, net is primarily comprised of interest on our long-term debt and lease finance obligations, net of interest income. Interest expense, net for the second quarter of fiscal 2009 was $21.0 million compared to $21.9 million for the second quarter of fiscal 2008. This decrease is primarily due to the reduction in the principal outstanding on our debt and changes in the interest rates on our variable rate debt. Please refer to "Part
I.-Item 1. Financial Statements-Notes to Condensed Consolidated Financial Statements-Note 4-Long-Term Debt" for a discussion of the interest rates on our variable rate debt.

Six Months Ended March 26, 2009 Compared to the Six Months Ended March 27, 2008

Merchandise Revenue and Gross Profit. Merchandise revenue for the first six months of fiscal 2009 increased $3.9 million, or 0.5%, from the first six months of fiscal 2008. This increase is primarily attributable to the merchandise revenue from stores acquired since the beginning of fiscal 2008 of $6.0 million, partially offset by a decrease in comparable store merchandise revenue of 0.9%, or $7.0 million. Newly-constructed stores accounted for an increase of $6.7 million in merchandise revenue offset by lost revenue from closed stores of $4.9 million. Merchandise gross profit for the first six months of 2009 decreased $5.4 million, or 1.9%, from the first six months of fiscal 2008. This decrease is primarily attributable to an 80 basis point decrease in merchandise gross margin to 36.4% for the first six months of fiscal 2009 compared to 37.2% for the first six months of fiscal 2008. The decrease in merchandise gross margin was primarily due to an unfavorable mix shift away from higher margin categories, and a decrease in food service margin offset by higher cigarette margins.

Gasoline Revenue, Gallons and Gross Profit. Total gasoline revenue for the first six months of fiscal 2009 decreased $1.1 billion, or 33.1%, from the first six months of fiscal 2008. This decrease is primarily attributable to the 28.9% decrease in the average retail price per gallon to $2.14 and a decrease in gasoline gallons sold. Retail gasoline gallons sold for the first six months of fiscal 2009 decreased 51.7 million gallons, or 5.0%, from the first six months of fiscal 2008. The decrease is primarily attributable to a decrease in comparable store gasoline gallons sold of 71.3 million gallons, or 6.9%. The decrease in comparable store gasoline gallons sold was primarily due to decreased consumer demand for gasoline as evidenced by a decline in miles driven in our markets. Newly-constructed stores accounted for an increase of 12.4 million gallons, offset by lost gallons sold from closed stores of 4.1 million.

Gasoline gross profit for the first six months of fiscal 2009 increased $82.5 million, or 80.0%, from the first six months of fiscal 2008. The increase is primarily attributable to the 8.8 cent increase in retail gross profit per gallon to 18.6 cents for the first six months of fiscal 2009 from 9.8 cents for the first six months of fiscal 2008. The increase in retail gross profit per gallon is primarily due to declining wholesale fuel costs during the first six months of fiscal 2009 and decreased credit card fees resulting from a lower average retail price per gallon. We compute gross profit exclusive of depreciation and allocation of store operating and general and administrative expenses. We present gasoline gross profit per gallon inclusive of credit card processing fees and cost of repairs and maintenance on gasoline equipment. These fees totaled 4.3 cents per gallon and 5.1 cents per gallon for the six months ended March 26, 2009 and March 27, 2008, respectively.

Store Operating and General and Administrative. Store operating and general and administrative expenses for the first six months of fiscal 2009 increased $8.9 million, or 3.0%, from the first six months of fiscal 2008. This increase is a result of higher utilities costs, repairs and maintenance expense, store lease expense and stock-based compensation expense. Average per store operating expenses for the first six months of fiscal 2009 increased 1.3% from the first six months of fiscal 2008 primarily due to increased utilities, telecommunications and repairs and maintenance expenses.

Depreciation and Amortization. Depreciation and amortization expenses for the . . .