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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2014

 

OR

 

o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 001-33274

 

TRAVELCENTERS OF AMERICA LLC

(Exact name of registrant as specified in its charter)

 

 

24601 Center Ridge Road, Suite 200, Westlake, OH 44145-5639

(Address of Principal Executive Offices)

 

(440) 808-9100

(Registrant’s Telephone Number, Including Area Code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o   No x

 

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

 

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

 

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

 

Number of Common Shares outstanding at August 18, 2014: 37,669,546 common shares.

 

 

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 TRAVELCENTERS OF AMERICA LLC

 

FORM 10-Q

 

March 31, 2014

 

IND EX

 

		Page
PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013	1
	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended March 31, 2014 and 2013	2
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013	3
	Notes to Condensed Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	26
	Warning Concerning Forward Looking Statements	27
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 6.	Exhibits	32
SIGNATURE		33

 

As used herein the terms “we”, “us”, “our” and “TA” include TravelCenters of America LLC and its consolidated subsidiaries unless otherwise expressly stated or the context otherwise requires.

 

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Part I.  Financial Information

 

Item 1.  Financial Statements

 

TravelCenters of America LLC

Condensed Consolidated Balance Sheets (Unaudited)

(in thousands, except share data)

 

		March 31,			December 31,
		2014			2013
Assets
Current assets:
Cash and cash equivalents		$	82,348		$	85,657
Accounts receivable (less allowance for doubtful accounts of $1,507 as of March 31, 2014, and $1,304 as of December 31, 2013)		157,207			105,932
Inventories		192,377			199,201
Other current assets		79,542			79,604
Total current assets		511,474			470,394
Property and equipment, net		706,600			704,866
Goodwill and intangible assets, net		48,475			48,772
Other noncurrent assets		33,283			33,250
Total assets		$	1,299,832		$	1,257,282
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable		$	192,675		$	149,645
Current HPT Leases liabilities		30,761			29,935
Other current liabilities		123,554			124,033
Total current liabilities		346,990			303,613
Noncurrent HPT Leases liabilities		341,120			343,926
Senior Notes due 2028		110,000			110,000
Other noncurrent liabilities		47,074			45,866
Total liabilities		845,184			803,405
Commitments and contingencies
Shareholders’ equity:
Common shares, no par value, 39,158,666 shares authorized at March 31, 2014, and December 31, 2013, and 37,625,366 shares issued and outstanding at March 31, 2014, and December 31, 2013		675,138			674,391
Accumulated other comprehensive income		661			834
Accumulated deficit		(221,151		)	(221,348		)
Total shareholders’ equity		454,648			453,877
Total liabilities and shareholders’ equity		$	1,299,832		$	1,257,282

 

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

 

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TravelCenters of America LLC

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited)

(in thousands, except per share data)

 

		Three Months Ended
		March 31,
		2014			2013
Revenues:
Fuel		$	1,589,646		$	1,625,107
Nonfuel		374,666			329,194
Rent and royalties		2,997			3,050
Total revenues		1,967,309			1,957,351
Cost of goods sold (excluding depreciation):
Fuel		1,497,329			1,548,179
Nonfuel		168,416			145,365
Total cost of goods sold (excluding depreciation)		1,665,745			1,693,544
Operating expenses:
Site level operating		199,649			183,933
Selling, general & administrative		26,796			23,227
Real estate rent		54,126			51,884
Depreciation and amortization		16,128			13,223
Total operating expenses		296,699			272,267
Income (loss) from operations		4,865			(8,460		)
Acquisition costs		(610		)	(115		)
Interest income		39			235
Interest expense		(4,075		)	(4,065		)
Income (loss) before income taxes and income from equity investees		219			(12,405		)
Provision for income taxes		276			170
Income from equity investees		254			436
Net income (loss)		$	197		$	(12,139	)
Other comprehensive income, net of tax:
Foreign currency translation adjustment, net of taxes of $(90) and $(53), respectively		(192		)	(126		)
Equity interest in investee’s unrealized gain (loss) on investments		19			(8		)
Other comprehensive income (loss)		(173		)	(134		)
Comprehensive income (loss)		$	24		$	(12,273	)
Net income (loss) per share:
Basic and diluted		$	0.01		$	(0.41	)

 

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

 

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TravelCenters of America LLC

Condensed Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

 

		Three Months Ended
		March 31,
		2014			2013
Cash flows from operating activities:
Net income (loss)		$	197		$	(12,139	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Noncash rent expense		(2,168		)	(2,129		)
Share based compensation expense		758			772
Depreciation and amortization expense		16,128			13,223
Income from equity investees		(254		)	(436		)
Amortization of deferred financing costs		169			154
Deferred income tax provision		276			85
Charge for doubtful accounts		301			22
Changes in assets and liabilities, net of effects of business acquisitions:
Accounts receivable		(51,676		)	(61,925		)
Inventories		7,001			3,004
Other current assets		65			635
Accounts payable and other current liabilities		40,561			73,278
Other, net		49			737
Net cash provided by operating activities		11,407			15,281
Cash flows from investing activities:
Proceeds from sales of improvements to HPT		5,795			22,409
Proceeds from asset sales		42			7
Acquisitions of businesses, net of cash acquired		(3,202		)	(9,367		)
Capital expenditures		(17,010		)	(32,535		)
Net cash used in investing activities		(14,375		)	(19,486		)
Cash flows from financing activities:
Proceeds from sale-leaseback transactions with HPT		268			246
Fees paid related to the issuance of common shares		(11		)	—
Proceeds from Senior Notes issuance		—			110,000
Sale-leaseback financing obligation payments		(589		)	(509		)
Payment of deferred financing fees		—			(4,748		)
Net cash provided by (used in) financing activities		(332		)	104,989
Effect of exchange rate changes on cash		(9		)	(9		)
Net increase (decrease) in cash		(3,309		)	100,775
Cash and cash equivalents at the beginning of the period		85,657			35,189
Cash and cash equivalents at the end of the period		$	82,348		$	135,964
Supplemental disclosure of cash flow information:
Interest paid (including rent classified as interest and net of capitalized interest)		$	3,989		$	1,997
Income taxes paid (net of refunds)		$	1		$	(48	)

 

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

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

 

1.                                       Basis of Presentation, Business Description and Organization

 

TravelCenters of America LLC, which we refer to as the Company or we, us and our, operates and franchises travel centers under the “TravelCenters of America,” “TA” or related brand names, or the TA brand, and the “Petro Stopping Centers” and “Petro” brand names, or the Petro brand, primarily along the U.S. interstate highway system.  Our travel center customers include trucking fleets and their drivers, independent truck drivers and motorists.  We also operate convenience stores with retail gasoline stations, primarily under the “Minit Mart” brand name, that generally serve motorists.  Our travel centers include, on average, over 25 acres of land and typically offer customers diesel fuel and gasoline as well as nonfuel products and services such as truck repair and maintenance services, full service restaurants, quick service restaurants, or QSRs, travel and convenience stores and various other driver amenities.  Our convenience stores have, on average, ten fueling positions and approximately 5,000 square feet of interior space offering merchandise and QSRs.  We also collect rents, royalties and other fees from our franchisees.

 

At March 31, 2014, our geographically diverse business included 248 travel centers in 43 U.S. states and in Canada , including 173 travel centers operated under the TA brand, and 75 travel centers operated under the Petro brand.  As of March 31, 2014, we operated 218 of these travel centers, which we refer to as Company operated sites, and our franchisees operated 30 of these travel centers. Of our 248 travel centers at March 31, 2014, we owned 34, we leased or managed 189, including 184 that we leased from Hospitality Properties Trust, or HPT, and franchisees owned or leased 25 from third parties.  We sublease to franchisees five of the travel centers we lease from HPT.

 

As of March 31, 2014, we operated 34 convenience stores in four states, primarily Kentucky.  Of our 34 convenience stores at March 31, 2014, we owned 27, we leased five, including one that we leased from HPT, and we operated two for a joint venture in which we own a minority interest.

 

We manage our business on the basis of one operating segment and, therefore, have one reportable segment. Our locations sell similar products and services, use similar processes to sell products and services, and sell products and services to similar customers. We sometimes make specific disclosures concerning fuel and nonfuel products and services because it facilitates our discussion of trends and operational initiatives within our business and industry.  We have only a single travel center located in a foreign country, Canada, and we do not consider the revenues and assets related to our operations in Canada to be material to us.

 

The accompanying condensed consolidated financial statements are unaudited.  These unaudited interim financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, applicable for interim financial statements.  The disclosures do not include all the information necessary for complete financial statements in accordance with GAAP.  These unaudited interim financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, or our Annual Report.  In the opinion of our management, all adjustments, which include normal recurring adjustments, considered necessary for a fair presentation have been included.  All intercompany transactions and balances have been eliminated.  While our revenues are modestly seasonal, the quarterly variations in our operating results may reflect greater seasonal differences because our rent and certain other costs do not vary seasonally.  For this and other reasons, our operating results for interim periods are not necessarily indicative of the results that may be expected for a full year.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers , which establishes a comprehensive revenue recognition standard for virtually all industries in GAAP. The new standard will apply for annual periods beginning after December 15, 2016, including interim periods therein. Early adoption is prohibited. We have not yet determined the effects, if any, adoption of this update may have on our consolidated financial statements.

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

2.                                       Earnings Per Share

 

Unvested shares issued under our share award plan are deemed participating securities because they participate equally in earnings with all of our other common shares.  The following table presents a reconciliation from net income (loss) to the net income (loss) available to common shareholders and the related earnings per share.

 

		Three Months Ended March 31,
		2014			2013
Net income (loss), as reported		$	197		$	(12,139	)
Less: net income (loss) attributable to participating securities		10			(755		)
Net income (loss) available to common shareholders		$	187		$	(11,384	)
Weighted average common shares (1)		35,783,417			27,698,301
Basic and diluted net income (loss) per share		$	0.01		$	(0.41	)

 

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(1)  Excludes unvested shares granted under our share award plan, which shares are considered participating securities because they participate equally in earnings and losses with all of our other common shareholders.  The weighted average number of unvested shares outstanding for the three months ended March 31, 2014 and 2013, was 1,841,949 and 1,837,905, respectively.

 

3.                                       Inventories

 

Inventories consisted of the following:

 

		March 31,			December 31,
		2014			2013
Nonfuel products		$	146,221		$	150,600
Fuel products		46,156			48,601
Total inventories		$	192,377		$	199,201

 

4.                                       Acquisitions

 

During the three months ended March 31, 2014, we acquired a travel center for $3,242, and we accounted for this transaction as a business combination.  The following table summarizes the amounts assigned, based on their fair values, to the assets we acquired and liabilities we assumed in the business combination described above.

 

Cash		$	40
Inventories		201
Other current assets		1
Property and equipment		3,074
Other noncurrent assets		16
Other current liabilities		(15		)
Other noncurrent liabilities		(75		)
Total purchase price		$	3,242

 

We have included the results of this travel center in our consolidated financial statements from its date of acquisition.  The pro forma impact of including the results of operations of this acquisition from the beginning of the period is not material to our condensed consolidated financial statements.

 

During the three months ended March 31, 2014 and 2013, we incurred $610 and $115, respectively, of acquisition costs for the legal, due diligence and related activities associated with our consideration and completion of possible and actual acquisitions, including for

 

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closed, pending and abandoned acquisitions, which amounts are included in our consolidated statements of operations and comprehensive income (loss).

 

As of March 31, 2014 , we had entered agreements to acquire two travel center properties for approximately $21,500 plus saleable inventory at cost. Subsequently, we entered agreements to purchase two additional travel centers for an aggregate of $5,900, plus saleable inventory at cost. During July 2014, we completed one of these acquisitions for approximately $14,000 plus saleable inventory at cost. We expect to complete the other acquisitions during 2014, but these purchases are subject to conditions and may not occur, may be delayed or the terms may change.

 

5.                                       Debt

 

Senior Notes

 

On January 15, 2013, we issued at par $110,000 aggregate principal amount of our 8.25% Senior Notes, or the Senior Notes, in an underwritten public offering.  The Senior Notes are our senior unsecured obligations.  The indenture governing our Senior Notes does not limit the amount of indebtedness we may incur.  We may issue additional debt from time to time.  The indenture also requires that we file our reports under the Securities and Exchange Act of 1934, as amended, or the Exchange Act, with the indenture trustee within a prescribed time period.  We did not maintain compliance with this covenant for the quarter ended March 31, 2014, but the filing of this Quarterly Report on Form 10-Q, or this Quarterly Report,  cures this non-compliance.  However, due to delays in filing our Form 10-Q for the period ended June 30, 2014, or our Second Quarter 10-Q, we expect that we will be unable to maintain compliance with this covenant for the quarter ended June 30, 2014.  Our failure to timely file our Second Quarter 10-Q, if not cured within a specified time period, could lead to an event of default under the indenture.

 

We estimate that the fair value of our Senior Notes was $115,148 based on the trading price (a Level 1 input) of our Senior Notes on March 31, 2014.  The fair value of the Senior Notes exceeds the book value because the Senior Notes were trading at a premium to their par value.

 

Revolving Credit Facility

 

Our $200,000 credit facility requires that we furnish our consolidated financial statements to our lenders within certain prescribed time periods.  As a result of an agreement with these lenders the time for us to deliver our financial statements for the period ended March 31, 2014, was extended until July 31, 2014, and we satisfied this extended requirement by delivering the required financial statements to our lenders by July 31, 2014.  Further, as a result of an agreement with these lenders, the time for us to deliver our financial statements for the period ended June 30, 2014, was extended until September 30, 2014.

 

6.                                       Accumulated Other Comprehensive Income

 

Accumulated other comprehensive income at March 31, 2014, consisted of the following:

 

		Foreign currency translation adjustment			Equity interest in investee’s unrealized gain (loss) on investments			Accumulated other comprehensive income
Balance at December 31, 2013		$	785		$	49		$	834
Foreign currency translation adjustment, net of tax of $(90)		(192		)	—			(192		)
Equity interest in investee’s unrealized loss on investments		—			19			19
Other comprehensive income (loss), net of tax		(192		)	19			(173		)
Balance at March 31, 2014		$	593		$	68		$	661

 

7.                                       Related Party Transactions

 

Relationship with HPT

 

HPT was our parent company until 2007 and is our principal landlord and our largest shareholder.  We were created as a separate public company in 2007 as a result of a spin off from HPT.  As of March 31, 2014, HPT owned 3,420,000 of our common shares, representing approximately 9.1% of our outstanding common shares.  One of our Managing Directors, Mr. Barry Portnoy, is a managing trustee of HPT.  Mr. Barry Portnoy’s son, Mr. Adam Portnoy, is also a managing trustee of HPT, and Mr. Barry Portnoy’s son-in-law, Mr. Ethan Bornstein, is an executive officer of HPT.  Our other Managing Director, Mr. Thomas O’Brien, who is also our

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

 

President and Chief Executive Officer, is a former executive officer of HPT.  One of our Independent Directors, Mr. Arthur Koumantzelis, was an independent trustee of HPT prior to our spin-off from HPT.

 

We have two leases with HPT, the TA Lease and the Petro Lease, pursuant to which we lease 185 properties from HPT.  Our TA Lease is for 145 properties that we operate primarily under the TA brand.  Our Petro Lease is for 40 properties that we operate under the Petro brand.  The TA Lease expires on December 31, 2022.  The Petro Lease expires on June 30, 2024, and may be extended by us for up to two additional periods of 15 years each.  We have the right to use the “TA”, “TravelCenters of America” and other trademarks, which are owned by HPT, during the term of the TA Lease.  We refer to the TA Lease and Petro Lease collectively as the HPT Leases.

 

The HPT Leases are “triple net” leases that require us to pay all costs incurred in the operation of the leased properties, including costs related to personnel, utilities, acquiring inventories, providing services to customers, insurance, real estate and personal property taxes, environmental related expenses, underground storage tank removal costs and ground lease payments at those properties at which HPT leases the property from the owner and subleases it to us.  We also are required generally to indemnify HPT for certain environmental matters and for liabilities which arise during the terms of the leases from ownership or operation of the leased properties and, at lease expiration, we are required to pay an amount equal to an estimate of the cost of removing underground storage tanks on the leased properties.

 

Effective January 2012 and 2013, we began to incur percentage rent payable to HPT under the TA Lease and the Petro Lease, respectively.  In each case, the percentage rent equals 3% of increases in nonfuel gross revenues and 0.3% of increases in gross fuel revenues at the leased properties over base amounts.  The increases in percentage rents attributable to fuel revenues are subject to a maximum each year calculated by reference to changes in the consumer price index.  Also, HPT has agreed to waive payment of the first $2,500 of percentage rent that may become due under our Petro Lease; HPT waived $152 of percentage rent under our Petro Lease for the three months ended March 31, 2014, pursuant to that waiver, and through the first quarter of 2014 has cumulatively waived $518 of the $2,500 of percentage rent to be waived.  The total amount of percentage rent (which is net of the waived amount) that we incurred during the three months ended March 31, 2014 and 2013, was $893 and $689, respectively.

 

Under the HPT Leases, we may request that HPT purchase approved amounts for renovations, improvements and equipment at the leased properties in return for increases in our minimum annual rent according to the following formula: the minimum rent per year will be increased by an amount equal to the amount paid by HPT multiplied by the greater of (i) 8.5% or (ii) a benchmark U.S. Treasury interest rate plus 3.5%.  During the three months ended March 31, 2014 and 2013, pursuant to the terms of the HPT Leases, we sold to HPT $6,063 and $22,655, respectively, of improvements we previously made to properties leased from HPT, and, as a result, our minimum annual rent payable to HPT increased by approximately $515 and $1,926, respectively.  At March 31, 2014, our property and equipment balance included $2,570 of improvements of the type that we typically request that HPT purchase for an increase in rent in the future; however, HPT is not obligated to purchase these improvements.  In June 2014, we sold to HPT $15,860 of improvements for an increase in minimum annual rent payable to HPT of $1,348.

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

 

The following table details amounts related to the HPT Leases and other leases that are reflected in real estate rent expense in our condensed consolidated statements of operations and comprehensive income (loss).

 

		Three Months Ended
		March 31,
		2014			2013
Cash payments to HPT under the HPT Leases		$	55,146		$	52,850
Change in accrued estimated percentage rent		618			666
Adjustments to recognize expense on a straight line basis		(341		)	(241		)
Less sale-leaseback financing obligation amortization		(589		)	(509		)
Less portion of rent payments recognized as interest expense		(1,470		)	(1,741		)
Less deferred tenant improvements allowance amortization		(1,692		)	(1,692		)
Amortization of deferred gain on sale-leaseback transactions		(96		)	(77		)
Rent expense related to HPT Leases		51,576			49,256
Rent paid to others (1)		2,607			2,607
Adjustments to recognize expense on a straight line basis for other leases		(57		)	21
Total real estate rent expense		$	54,126		$	51,884

 

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(1)          Includes rent paid directly to HPT’s landlords under leases for properties we sublease from HPT as well as rent related to properties we lease from landlords other than HPT.

 

The following table details amounts related to the HPT Leases that are included in our condensed consolidated balance sheets.

 

		March 31,			December 31,
		2014			2013
Current HPT Leases liabilities:
Accrued rent		$	18,764		$	18,041
Current portion of sale-leaseback financing obligation (1)		2,405			2,358
Current portion of straight line rent accrual (2)		2,438			2,382
Current portion of deferred gain on sale-leaseback transactions (3)		385			385
Current portion of deferred tenant improvements allowance (4)		6,769			6,769
Total Current HPT Leases liabilities		$	30,761		$	29,935
Noncurrent HPT Leases liabilities:
Deferred rent obligation (5)		$	150,000		$	150,000
Sale-leaseback financing obligation (1)		83,393			83,762
Straight line rent accrual (2)		52,252			52,901
Deferred gain on sale-leaseback transactions (3)		3,021			3,117
Deferred tenant improvements allowance (4)		52,454			54,146
Total Noncurrent HPT Leases liabilities		$	341,120		$	343,926

 

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(1)          Sale-leaseback Financing Obligation.   GAAP governing the transactions related to our entering the TA Lease required us to recognize in our consolidated balance sheets the leased assets at thirteen of the properties previously owned by our predecessor that we now lease from HPT because we subleased more than a minor portion of those properties to third parties, and one property that did not qualify for operating lease treatment for other reasons.  Accordingly, we recorded the leased assets at these properties at an amount equal to HPT’s recorded initial carrying amounts, which were equal to their fair values, and recognized an equal amount of liability that is presented as sale-leaseback financing obligation in our consolidated balance sheets.  In addition, sales to HPT of improvements at these properties are accounted for as sale-leaseback financing transactions and these liabilities are increased by the amount of proceeds we receive from HPT.  We recognize a portion of the total rent payments to HPT related to these assets as a reduction of the sale-leaseback

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

 

During 2012 and 2013, subleases to franchisees of ours at five of these properties were terminated and we began operating these properties directly.  The termination of these subleases qualified the properties for sale-leaseback accounting at which times we removed the related assets and liabilities from our consolidated balance sheet.  See note (3) below for further discussion regarding the deferred gains of $2,850 we recognized as part of these sublease terminations.

 

(2)   Straight Line Rent Accrual.   The TA Lease included scheduled rent increases over the first six years of the lease term, as do certain of the leases for properties we sublease from HPT, the rent for which we pay directly to HPT’s landlords.  Also, under our leases with HPT, we are obligated to pay to HPT at lease expiration an amount equal to an estimate of the cost of removing the underground storage tanks we would have if we owned the underlying assets.  We recognize the effects of scheduled rent increases and the future payment to HPT for the estimated cost of removing underground storage tanks in real estate rent expense over the lease terms on a straight line basis, with offsetting entries to this accrual balance.

 

(3)  Deferred Gain on Sale-Leaseback Transactions .  This gain arose from our 2012 and 2013 terminations of subleases to franchisees for five properties we lease from HPT, which qualified these properties for sale-leaseback accounting and required us to remove the related assets and liabilities from our consolidated balance sheets, as further described in note (1) above, and from the sales of certain assets to HPT.  Under GAAP, the gain or loss from the sale portion of a sale-leaseback transaction is deferred and amortized into our real estate rent expense on a straight line basis over the then remaining term of the lease.

 

(4)  Deferred Tenant Improvements Allowance.   HPT committed to fund up to $125,000 of capital projects at the properties we lease under the TA Lease without an increase in rent payable by us, which amount HPT had fully funded by September 30, 2010, net of discounting to reflect our accelerated receipt of those funds. In connection with this commitment, we recognized a liability for the rent deemed to be related to this tenant improvements allowance.  This deferred tenant improvements allowance was initially recorded at an amount equal to the leasehold improvements receivable we recognized for the discounted value of the then expected future amounts to be received from HPT, based upon our then expected timing of receipt of those payments.  We amortize the deferred tenant improvements allowance on a straight line basis over the term of the TA Lease as a reduction of real estate rent expense.

 

(5)   Deferred Rent Obligation.   Pursuant to a rent deferral agreement with HPT, through December 31, 2010, we deferred a total of $150,000 of rent payable to HPT.  The deferred rent obligation is payable in two installments, $107,085 in December 2022 and $42,915 in June 2024.  This obligation does not bear interest, unless certain events of default or other events occur, including a change of control of us.

 

On August 13, 2013, the travel center located in Roanoke, VA that we leased from HPT under the TA Lease was taken by eminent domain proceedings brought by the Virginia Department of Transportation, or VDOT, in connection with planned highway construction.  The TA Lease provides that the annual rent payable by us is reduced by 8.5% of the amount of the proceeds HPT receives from the taking or, at HPT’s option, the fair market value rent of the property on the commencement date of the TA Lease.  In January 2014, HPT received proceeds from VDOT of $6,178, which is a substantial portion of VDOT’s estimate of the value of the property, and as a result our annual rent under the TA Lease was reduced by $525 effective January 6, 2014.  We and HPT have challenged VDOT’s estimate of the property’s value and expect that the ultimate resolution of this matter will take a prolonged period of time.  HPT entered a lease agreement with VDOT to lease for $40 per month this property through August 31, 2014, which lease term was recently extended through November 15, 2014.  We entered into a sublease for this property with HPT and, we plan to continue operating it as a travel center through November 15, 2014.  Under the terms of the TA Lease, we are responsible to pay the rent to VDOT under the lease agreement.

 

Relationship with RMR

 

Reit Management & Research LLC, or RMR, provides business management and shared services to us pursuant to a business management and shared services agreement, or our business management agreement.  One of our Managing Directors, Mr. Barry Portnoy, is Chairman, majority owner and an employee of RMR.  Mr. Barry Portnoy’s son, Mr. Adam Portnoy, is an owner of RMR and serves as President, Chief Executive Officer and a director of RMR.  Our other Managing Director, Mr. Thomas O’Brien, who is also our President and Chief Executive Officer, Mr. Andrew Rebholz, our Executive Vice President, Chief Financial Officer and

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

 

Treasurer, and Mr. Mark Young, our Executive Vice President and General Counsel, are officers of RMR.  RMR provides management services to HPT and HPT’s executive officers are officers of RMR.  Two of our Independent Directors also serve as independent directors or independent trustees of other companies to which RMR or its affiliates provide management services.  Mr. Barry Portnoy serves as a managing director or managing trustee of a majority of the public companies to which RMR or its affiliates provide management services and Mr. Adam Portnoy serves as a managing trustee of a majority of those companies.  In addition, officers of RMR serve as officers of those companies.

Pursuant to our business management agreement and property management agreement with RMR, we incurred aggregate fees of $2,854 and $2,483 for the three months ended March 31, 2014 and 2013, respectively.  These amounts are included in selling, general and administrative expenses in our condensed consolidated statements of operations and comprehensive income (loss).

 

Relationship with AIC

 

We, RMR and six other companies to which RMR provides management services each owned 12.5% of Affiliates Insurance Company, or AIC, an Indiana insurance company as of March 31, 2014.  As noted below, one of those shareholders has since had its AIC equity interests purchased by us and the other AIC shareholders pro rata.  A majority of our Directors and most of the trustees and directors of the other AIC shareholders currently serve on the board of directors of AIC.  RMR provides management and administrative services to AIC pursuant to a management and administrative services agreement with AIC.  As of March 31, 2014, we had invested $5,229 in AIC since its formation in 2008.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC as a majority of our Directors are also directors of AIC.  Our investment in AIC had a carrying value of $5,835 and $5,913 as of March 31, 2014 and December 31, 2013, respectively, which amounts are included in other noncurrent assets on our consolidated balance sheets.  We recognized a loss of $97 and income of $76 related to our investment in AIC for the three months ended March 31, 2014 and 2013, respectively.  In June 2014, we and the other shareholders of AIC renewed our participation in an insurance program arranged by AIC.  In connection with the renewal, we purchased a one-year property insurance policy providing $500,000 of coverage, with respect to which AIC is a reinsurer of certain coverage amounts.  We paid AIC a premium, including taxes and fees, of approximately $1,601 in connection with that policy, which amount may be adjusted from time to time as we acquire or dispose of properties that are included in the policy.  We periodically consider the possibilities for expanding our insurance relationships with AIC to include other types of insurance and may in the future participate in additional insurance offerings AIC may provide or arrange.  We may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we are not obligated to do so.  By participating in this insurance business with RMR and the other companies to which RMR provides management services, we expect that we may benefit financially by reducing our insurance expenses and by realizing our pro rata share of any profits of this insurance business.

 

On March 25, 2014, as a result of the removal, without cause, of all of the trustees of CommonWealth REIT, or CWH, CWH underwent a change in control, as defined in the shareholders agreement among us, the other shareholders of AIC, and AIC.  As a result of that change in control and in accordance with the terms of the shareholders agreement, on May 9, 2014, we and the other non-CWH shareholders purchased pro rata the AIC shares CWH owned.  Pursuant to that purchase, we purchased 2,857 AIC shares from CWH for $825.  Following these purchases, we and the six other remaining shareholders each owned approximately 14.3% of AIC.

 

Relationship with PTP

 

Petro Travel Plaza Holdings LLC, or PTP, is a joint venture between us and Tejon Development Corporation, or Tejon, that owns two travel centers and two convenience stores in California.  We own a 40% interest in PTP and operate the two travel centers and two convenience stores PTP owns for which we receive management and accounting fees.  The carrying value of our investment in PTP as of March 31, 2014 and December 31, 2013, was $18,023 and $17,672, respectively.  During each of the three months ended March 31, 2014 and 2013, we recognized management and accounting fee income of $200.  At March 31, 2014, and December 31, 2013, we had a net payable to PTP of $2,666 and $1,147, respectively.  We recognized income of $351 and $360 during the three months ended March 31, 2014 and 2013, respectively, as our share of PTP’s net income.

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

The following tables set forth the aggregate summarized financial information of AIC and PTP and does not represent the amounts we have included in our consolidated financial statements in connection with our investments in AIC and PTP.

 

		Three Months Ended March 31,
		2014			2013
Total revenues		$	26,467		$	27,599
Total cost of sales (excluding depreciation)		$	20,052		$	21,915
Operating income (loss)		$	(202	)	$	1,756
Interest expense, net		$	(121	)	$	(170	)
Net income		$	96		$	1,254

 

8.                                       Commitments and Contingencies

 

Commitments

 

As of March 31, 2014 , we had entered agreements to acquire two travel center properties for a total of approximately $21,500. During July 2014, we completed one of these acquisitions for approximately $14,000, plus saleable inventory at cost. We expect to complete the other acquisition during 2014, but this purchase is subject to conditions and may not occur, may be delayed or the terms may change.

 

Guarantees

 

In the normal course of our business we periodically enter into agreements that contain guarantees or indemnification provisions.  While we cannot estimate the maximum amount to which we may be exposed under these agreements, we do not believe that any potential guaranty or indemnification is likely to have a material adverse effect on our consolidated financial position or results of operations.

 

We offer a warranty of our workmanship in our truck service facilities, but we believe the annual warranty expense and corresponding liability are not material to us.

 

Environmental Matters

 

Extensive environmental laws regulate our operations and properties.  These laws may require us to investigate and clean up hazardous substances, including petroleum or natural gas products, released at our owned and leased properties.  Governmental entities or third parties may hold us liable for property damage and personal injuries, and for investigation, remediation and monitoring costs incurred in connection with any contamination and regulatory compliance.  We use both underground storage tanks and above ground storage tanks to store petroleum products, natural gas and waste at our locations.  We must comply with environmental laws regarding tank construction, integrity testing, leak detection and monitoring, overfill and spill control, release reporting and financial assurance for corrective action in the event of a release.  At some locations we must also comply with environmental laws relative to vapor recovery or discharges to water.  Under the terms of our leases, we generally have agreed to indemnify HPT for any environmental liabilities related to properties that we lease from HPT and we are required to pay all environmental related expenses incurred in the operation of the properties.

 

From time to time we have received, and in the future likely will receive, notices of alleged violations of environmental laws or otherwise have become or will become aware of the need to undertake corrective actions to comply with environmental laws at our locations.  Investigatory and remedial actions were, and regularly are, undertaken with respect to releases of hazardous substances at our locations.  In some cases we received, and may receive in the future, contributions to partially offset our environmental costs from insurers, from state funds established for environmental clean up associated with the sale of petroleum products or from indemnitors who agreed to fund certain environmental related costs at locations purchased from those indemnitors.  To the extent we incur material amounts for environmental matters for which we do not receive or expect to receive insurance or other third party reimbursement or for which we have not previously recorded a reserve, our operating results may be materially adversely affected.  In addition, to the extent we fail to comply with environmental laws and regulations, or we become subject to costs and requirements not similarly experienced by our competitors, our competitive position may be harmed.

 

At March 31, 2014, we had a gross accrued liability of $5,753 for environmental matters as well as a receivable for expected recoveries of certain of these estimated future expenditures of $1,667, resulting in an estimated net amount of $4,086 that we expect to

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

need to fund in the future.  We do not have a reserve for unknown current or potential future environmental matters.  Accrued liabilities related to environmental matters are recorded on an undiscounted basis because of the uncertainty associated with the timing of the related future payments.  We cannot precisely know the ultimate costs we will incur in connection with currently known or future potential environmental related violations, corrective actions, investigation and remediation; however, based on our current knowledge we do not expect that our net costs for such matters to be incurred at our locations, individually or in the aggregate, would be material to our financial condition or results of operations.

 

In February 2014, we reached an agreement with the California State Water Resources Control Board, or the State Water Board, to settle certain claims the State Water Board had filed against us in California Superior Court in 2010 relating to alleged violations of underground storage tank laws and regulations for a cash payment of $1,800; suspended penalties of $1,000 that may become payable by us in the future if, prior to March 2019, we fail to comply with specified underground storage tank laws and regulations; and our agreement to invest, prior to March 2018, up to $2,000 of verified costs that are directly related to the development and implementation of a comprehensive California Enhanced Environmental Compliance Program for the underground storage tank systems at all of our California facilities that is above and beyond minimum requirements of California law and regulations related to underground storage tank systems.  To the extent that we do not incur the full $2,000 of eligible environmental compliance costs by March 2018, the difference between the amount we incur and $2,000 will be payable to the State Water Board.  The settlement, which was approved by the Superior Court on February 20, 2014, also included injunctive relief provisions requiring that we comply with certain California environmental laws and regulations applicable to underground storage tank systems.  We made the $1,800 cash payment during the first quarter of 2014.  As of March 31, 2014, we have a liability of $1,759 recorded with respect to this matter, which amount is included in the gross accrued liability for environmental matters referenced above.  We believe that the probability of triggering any portion of the $1,000 of suspended penalties is remote and have not recognized a loss or a liability for that amount, but it is possible that such events will occur and some portion or all of the $1,000 may become due and payable and would be recognized as an expense at the time of the future event or events.

 

We have insurance of up to $10,000 per incident and up to $40,000 in the aggregate for certain environmental liabilities not known by us at the time the policies were issued, subject, in each case, to certain limitations and deductibles.  However, we can provide no assurance that we will be able to maintain similar environmental insurance coverage in the future on acceptable terms.

 

It is impossible to predict the ultimate effect changing circumstances and changing environmental laws may have on us in the future or the ultimate outcome of matters currently pending.  We cannot be certain that contamination presently unknown to us does not exist at our sites, or that material liability will not be imposed on us in the future.  If we discover additional environmental issues, or if government agencies impose additional environmental requirements, increased environmental compliance or remediation expenditures may be required, which could have a material adverse effect on us.  In addition, legislation and regulation regarding climate change, including greenhouse gas emissions, and other environmental matters and market reaction to any such legislation or regulation or to climate change concerns, may decrease the demand for our major product, diesel fuel, may require us to expend significant amounts and may negatively impact our business.  For instance, federal and state governmental requirements addressing emissions from trucks and other motor vehicles, such as the U.S. Environmental Protection Agency’s gasoline and diesel sulfur control requirements that limit the concentration of sulfur in motor vehicle gasoline and diesel fuel, as well as President Obama’s February 2014 order that his administration develop and implement new fuel efficiency standards for medium and heavy duty commercial trucks by March 2016, has caused us to add certain services and provide certain products to our customers at a cost to us and may decrease the demand for our fuel products and negatively impact our business.  Further, legislation and regulations that limit carbon emissions also may cause our energy costs at our locations to increase.

 

Legal Proceedings

 

Beginning in December 2006, a series of class action lawsuits was filed against numerous companies in the petroleum industry, including our predecessor and our subsidiaries, in U.S. district courts in over 20 states.  Major petroleum refiners and retailers were named as defendants in one or more of these lawsuits.  The plaintiffs in the lawsuits generally alleged that they are retail purchasers who purchased motor fuel at temperatures greater than 60 degrees Fahrenheit at the time of sale.  One theory alleged that the plaintiffs purchased smaller amounts of motor fuel than the amount for which defendants charged them because the defendants measured the amount of motor fuel they delivered by volumes which, at higher temperatures, contain less energy.  A second theory alleged that fuel taxes are calculated in temperature adjusted 60 degree gallons and are collected by governmental agencies from suppliers and wholesalers, who are reimbursed in the amount of the tax by the defendant retailers before the fuel is sold to consumers.  These “tax” cases allege that, when the fuel is subsequently sold to consumers at temperatures above 60 degrees, the retailers sell a greater volume of fuel than the amount on which they paid tax, and therefore reap unjust benefit because the customers pay more tax than the retailer pays.  A third theory alleged that all purchasers of fuel at any temperature are harmed because the defendants do not

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

 

use equipment that adjusts for temperature or disclose the temperature of fuel being sold, and thereby deprive customers of information they allegedly require to make an informed purchasing decision.  All of these cases were consolidated in the U.S. District Court for the District of Kansas pursuant to multi-district litigation procedures.  On May 28, 2010, that Court ruled that, with respect to two cases originally filed in the U.S. District Court for the District of Kansas, it would grant plaintiffs’ motion to certify a class of plaintiffs seeking injunctive relief (implementation of fuel temperature equipment and/or posting of notices regarding the effect of temperature on fuel).  On January 19, 2012, the Court amended its prior ruling, and certified a class with respect to plaintiffs’ claims for damages as well.  A TA entity was named in one of those two Kansas cases, but the Court ruled that the named plaintiffs were not sufficient to represent a class as to TA.  TA was thereafter dismissed from the Kansas case.  Several defendants in the Kansas cases, including major petroleum refiners, have entered into multi-state settlements.  Following a September 2012 trial against the remaining defendants in the Kansas cases, the jury returned a unanimous verdict in favor of those Kansas defendants, and the judge likewise ruled in the Kansas defendants’ favor on the sole non-jury claim.  In early 2013, the Court announced its intention to remand three cases originally filed in federal district courts in California back to their original courts.  On April 9, 2013, the Court granted plaintiffs’ motion for class certification in connection with the California claims in the California cases.  On August 14, 2013, the Court granted summary judgment for the defendants with respect to all California claims in the California cases, and in February 2014, the U.S. District Court for the Northern District of California entered judgment in favor of the defendants with respect to those claims.  The plaintiffs in the California cases all dismissed their non-California claims against TA, except for one individual plaintiff, who continues to assert claims based on purchases of fuel in states other than California.  In January 2014, TA was dismissed with prejudice in all the non-California cases in all states in which it remained a defendant at that time.  Therefore, the only case in which TA remains a defendant is the case in which one remaining plaintiff is pursuing non-California claims.  We believe there are substantial factual and legal defenses to the allegations made in this remaining case.  While we do not expect that we will incur a material loss in this case, we cannot estimate our ultimate exposure to loss or liability, if any, related to the lawsuit.

 

On April 6, 2009, five independent truck stop owners, who are plaintiffs in a purported class action suit against Comdata Network, Inc., or Comdata, in the U.S. District Court for the Eastern District of Pennsylvania, filed a motion to amend their complaint to add us as a defendant, which was allowed on March 25, 2010.  The amended complaint also added as defendants Ceridian Corporation, Pilot Travel Centers LLC and Love’s Travel Stops & Country Stores, Inc.  Comdata markets fuel cards which are used for payments by trucking companies at truck stops.  The amended complaint alleged antitrust violations arising out of Comdata’s contractual relationships with truck stops in connection with its fuel cards.  The plaintiffs sought unspecified damages and injunctive relief.  On March 24, 2011, the Court dismissed the claims against TA in the amended complaint, but granted plaintiffs leave to file a new amended complaint.  Four independent truck stop owners, as plaintiffs, filed a new amended complaint against us on April 21, 2011, repleading their claims.  On May 6, 2011, we renewed our motion to dismiss the complaint with prejudice while discovery otherwise proceeded.  The Court denied our renewed motion to dismiss on March 29, 2012, and we filed an answer to the complaint on April 30, 2012.  During December 2013, we entered into settlement discussions among the co-defendants and the plaintiffs that continued into 2014.  On February 28, 2014, we entered into a Definitive Master Class Settlement Agreement with the plaintiffs, or the settlement agreement.  The settlement agreement provides for the Company and the co-defendants to pay an aggregate of $130,000 to a settlement fund for class members, including $10,000 from us, in exchange for the dismissal with prejudice of the litigation and the unconditional release of all claims that class members brought or could have brought against us and the co-defendants with respect to the litigation and related actions.  The settlement agreement is subject to the approval of the Court.  On March 17, 2014, the Court preliminarily approved the settlement agreement, authorized notice to the class and scheduled a hearing for July 14, 2014, at which hearing the Court granted its final approval of the settlement.  We recognized a $10,000 loss in connection with this matter in December 2013 and made the cash payment in March 2014.

 

In addition to the legal proceedings referenced above, we are routinely involved in various other legal and administrative proceedings, including tax audits, incidental to the ordinary course of our business, none of which we expect, individually or in the aggregate, to have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

9.                                       Income Taxes

 

The income tax provision for the 2014 first quarter reflects an effective tax rate of 58.4%, which is higher than our current estimated annual effective tax rate for the year ending December 31, 2014, of 42.5% as a result of foreign net operating loss carryfowards generated in the quarter for which no benefit was recognized because we have concluded it is more likely than not that we will be unable to realize those deferred tax assets.  Our current estimated annual effective tax rate of 42.5% is higher than the federal statutory tax rate primarily due to state income taxes and certain items that are not deductible for federal income tax purposes.  For the three months ended March 31, 2013, our income tax provision differed from the amount of benefit expected to be calculated at statutory rates primarily due to the impact of our valuation allowance, which was reversed in the fourth quarter of 2013.  For the 2013 first quarter, we included in tax expense $85 for certain state taxes on operating income that were payable without regard to our tax

 

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TravelCenters of America LLC

Notes to Condensed Consolidated Financial Statements (Unaudited)

(in thousands, except share and per share amounts )

 

loss carryforwards.  During the three months ended March 31, 2013, tax expense also included $85 related to a noncash deferred liability that arose from the amortization of indefinite lived intangible assets for tax purposes but not for GAAP purposes and foreign currency translation adjustments that were unavailable to offset our deferred tax assets while we maintained a valuation allowance against our net deferred tax assets.

10.                                Other Information

 

Interest expense consisted of the following:

 

		Three Months Ended March 31,
		2014			2013
Interest related to our Senior Notes and Credit Facility		$	2,680		$	2,373
HPT rent classified as interest		1,470			1,741
Amortization of deferred financing costs		169			154
Capitalized interest		(260		)	(325		)
Other		16			122
Interest expense		$	4,075		$	4,065

 

We capitalize the portion of the interest expense that is attributable under GAAP to our more significant construction projects over the duration of the respective construction periods.  Capitalized interest is amortized to depreciation and amortization expense over the estimated useful life of the corresponding asset.

 

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

 

Overview (dollars in thousands)

 

The following discussion should be read in conjunction with the financial statements included elsewhere in this Quarterly Report and in our Annual Report.

 

Our revenues and income are subject to potentially material changes as a result of the market prices and availability of fuel.  These factors are subject to the worldwide petroleum products supply chain, which historically has incurred price and supply volatility and, in some cases, shocks as a result of, among other things, severe weather, terrorism, political crises, wars and other military actions and variations in demand that are often the result of changes in the macroeconomic environment.  During the first quarter of each of 2014 and 2013, fuel prices generally trended downward after relatively sharp increases early in the quarter, ending at a somewhat lower price than at the start of the quarter.  Recent gains in fuel supplies and sources within the United States and Canada have helped to maintain relative market price stability, but as export markets and capabilities increase for fuel that price stabilization factor may be less effective.  We expect that changes in our costs for fuel products can largely be passed on to our customers, but often there are delays in passing on price changes that can affect our fuel gross margins.  Although other factors have an effect, during periods of rising fuel commodity prices fuel gross margins per gallon tend to be lower than they otherwise may have been, and during periods of falling fuel commodity prices fuel gross margins per gallon tend to increase.  Also, fuel price increases and volatility can have negative effects on our sales and profitability and increase our working capital requirements.  For more information about fuel market risks that may affect us and our actions to mitigate those risks, see Part II, Item 4, “Quantitative and Qualitative Disclosures About Market Risk” in this Quarterly Report and Part II, Item 7A, “Qualitative and Quantitative Disclosures About Market Risk” in our Annual Report.

 

We believe that recent U.S. economic data has been mixed, though generally positive, and the strength and sustainability of any economic expansion is uncertain.  The condition of the U.S. economy generally, and the financial condition and activity of the trucking industry in the U.S. specifically, impacted our historical financial results, and we expect that they will continue to impact our financial results in future periods.  The trucking industry is the primary customer for our goods and services.  Freight and trucking demand in the U.S. historically generally reflects the level of commercial activity in the U.S. economy.  During the period from 2013 through the first quarter of 2014, the U.S. economy slowly improved and the financial condition and activity level in the trucking industry similarly slowly improved; however, these improvements appear to be uneven and may not affect all market participants equally.  Further, recent improvements in U.S. export activity have been driven in large part by increased sales of natural resources, such as oil and gas, and by other products that typically are not transported by trucks; and, accordingly, such increased export activity has not resulted in proportional increases in trucking activity within the U.S.

 

We believe that during the second half of 2013 and continuing through the first quarter of 2014, demand for fuel by trucking companies was negatively affected as compared to the prior year by the new regulatory hours of service rules for truck drivers, which went into effect in July 2013, and the driver shortage in the trucking industry.  These factors increase trucking company costs and lead trucking companies to focus on fuel efficiency and shippers to divert some business away from trucking.  Technological innovations permitting and regulatory changes encouraging or requiring improved fuel efficiency of motor vehicle engines and other fuel conservation practices employed by trucking companies have accelerated and continue to reduce demand for diesel fuel, including by reducing the amount of diesel fuel required to drive a given amount of trucking miles.

 

As a result of the aforesaid factors, fuel sales volumes on a same site basis for the first three months of 2014 declined compared to the prior year and the level of fuel sales volume continues to be below that experienced before the recent U.S. economic recession, which we believe began to impact the trucking industry in late 2007.  Despite the year over year declines in fuel sales volumes, our fuel gross margins per gallon for the 2014 first three months increased on a same site basis over the prior year.  We believe fuel margin per gallon in the first quarter of 2014 was affected by (i) the pricing under our fuel supply contracts, which favorably impacted our fuel purchase costs during periods of certain fuel market supply disruptions during the first quarter of 2014, which abated prior to the start of the second quarter of 2014, and (ii) our continued focus on managing our fuel pricing to balance sales volume and profitability considerations.

 

The increase in net income during the three month period ended March 31, 2014, as compared to the same period of the prior year is largely due to an increase in fuel gross margin per gallon and the continued improvement of operations at sites we acquired in 2011 through 2013.

 

We have invested or expect to invest $337,470 in the aggregate since the beginning of 2011 to acquire and improve 31 travel centers and 31 gasoline/convenience stores.  While the interest, depreciation, maintenance and similar expenses related to or resulting from our acquisitions and ownership of these sites are reflected in our results for the periods since each acquisition, our expected financial results from these acquired properties are not yet fully reflected in our results of operations.  We believe that the improvements we have made and plan to make at these travel centers may continue to improve the financial results at these locations. Typical improvements we make at acquired travel centers include adding truck repair facilities and national branded QSRs, paving

 

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parking lots, replacing outdated fuel dispensers, installing diesel exhaust fluid dispensing systems, changing signage, installing point of sale and other IT systems and general building and cosmetic upgrades.  The improvements to travel center properties we acquire are often substantial and require a long period of time to plan, design, permit and complete, and after completed then require a period of time to become part of our customers’ supply networks and produce stabilized financial results.  We estimate that the travel centers we acquire generally will achieve stabilized financial results in approximately the third year after acquisition, but actual results can vary widely from this estimate due to many factors, some of which are outside our control.

 

We acquired 31 gasoline/convenience store properties for $67,922 on December 16, 2013.  These convenience stores are high volume fuel locations with larger interior space for merchandise and food offerings than typical convenience stores and appear to have limited need for near term capital investment.  In addition, we do not expect these convenience stores to require a lengthy period to achieve stabilized financial results.  Nearly all of our existing travel centers currently offer gasoline for motorists, and most of these convenience stores’ customer offerings are similar to certain of the products and food services available at our travel centers.  Accordingly, we currently expect we may be able to realize synergies in purchasing and merchandising customer offerings at these convenience stores which may make the financial returns we realize on our investment similar to that expected for our travel center acquisitions.

 

The table below shows the number of properties we acquired by year of acquisition, the amounts we have invested in these properties through March 31, 2014, and the amounts we currently expect to invest in the near term in these properties after March 31, 2014.

 

		Site Count		Cash Acquisition Cost (1)			Renovation Cost Incurred Through March 31, 2014			Estimated Renovation Cost to be Spent
Properties acquired in 2011		6		$	36,333		$	47,737		$	—
Properties acquired in 2012		14		46,910			33,630			—
Properties acquired in 2013 (2)		41		111,602			20,446			32,095
Properties acquired in 2014 first quarter		1		2,999			816			4,902
Total		62		$	197,844		$	102,629		$	36,997

 

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(1)          Includes only cash amounts paid that were recorded as property and equipment or intangible assets.  Excludes acquired working capital assets and asset retirement obligation assets.

(2)          Includes 31 convenience stores acquired in December 2013.

 

The operations at many of the 31 travel centers acquired since the beginning of 2011 have not yet reached the stabilized financial results we currently expect to ultimately achieve.  As of March 31, 2014, the travel centers we have acquired since the beginning of 2011 have been owned by us for an average of 19 months, and the planned renovations have been completed at only 24 of these properties for an average of 16 months.  The 31 convenience stores we acquired on December 16, 2013, do not require significant renovations.

 

The table below shows for the periods presented the gross revenues in excess of cost of goods sold and site level operating expenses for the properties we began to operate for our own account since the beginning of 2011, whether by way of acquisition from franchisees or others or takeover of operations upon termination of a franchisee sublease, from the beginning of the period shown (or the date we began to operate such property for our own account, if later).  Because sites were acquired at various dates during the periods presented, these amounts are intended to indicate directional trends only.

 

		Revenues in Excess of Cost of Goods Sold and Site Level Operating Expenses
		Three Months Ended March 31,						Twelve Months Ended March 31,
		2014			2013			2014			2013
Properties acquired in 2011 (6 sites)		$	3,858		$	1,611		$	11,684		$	5,917
Properties acquired in 2012 (14 sites)		4,089			2,103			16,086			2,897
Properties acquired in 2013 (41 sites)		2,232			61			5,113			388
Properties acquired in 2014 (1 site)		(184		)	—			(199		)	—
Total		$	9,995		$	3,775		$	32,684		$	9,202

There can be no assurance that industry conditions will not deteriorate or that any one or more of the risks identified under the

 

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Table of Contents

 

sections “Risk Factors,” “Warning Concerning Forward Looking Statements” or elsewhere in our Annual Report; under the section “Warning Concerning Forward Looking Statements” or elsewhere in this Quarterly Report; or some other unidentified risk will not manifest itself in a manner which is material and adverse to our results of operations, cash flow or financial position.

 

Summary of Site Counts

 

The changes in the number of our sites and in their method of operation (company operated, franchisee subleased and operated, or franchisee owned and operated) can be significant factors influencing the changes in our results of operations.  The following table summarizes the changes in the composition of our business from December 31, 2012 through March 31, 2014:

 

		Company		Franchisee Subleased and		Franchisee Owned and				Company
		Operated		Operated		Operated		Total		Operated
		Travel		Travel		Travel		Travel		Convenience		Total
		Centers (1)		Centers		Centers		Centers (1)		Stores (2)		Sites
Number of locations at December 31, 2012		206		6		29		241		4		245
January - March 2013 Activity:
Acquired sites		1		—		—		1		—		1
Acquisition of franchised travel centers		1		—		(1	)	—		—		—
Number of locations at March 31, 2013		208		6		28		242		4		246
April - December 2013 Activity:
Acquired sites		5		—		—		5		31		36
Acquisition of franchised travel centers		3		(1	)	(2	)	—		—		—
Conversion of convenience store to travel center		1		—		—		1		(1	)	—
Terminated franchised travel centers		—		—		(1	)	(1	)	—		(1	)
Number of locations at December 31, 2013		217		5		25		247		34		281
January – March 2014 Activity:
Acquired sites		1		—		—		1		—		1
Number of locations at March 31, 2014		218		5		25		248		34		282

 

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(1)          Includes in each period presented two travel centers we operate that are owned by a joint venture in which we own a minority interest.

(2)          Includes in each period presented two convenience stores we operate that are owned by a joint venture in which we own a minority interest.

 

Operating Segment

 

We manage our business on the basis of one operating segment.  Please refer to the condensed consolidated financial statements included in Item 1 of this Quarterly Report for revenue, operating profit and asset data.  We have only a single travel center located in a foreign country, Canada, and the revenues and assets related to our operations in Canada are not material.  The following table sets forth the composition of our total revenues by type for each of the three months ended March 31, 2014 and 2013.

 

		Three Months Ended March 31,
		2014		2013
Revenues:
Fuel		80.8	%	83.0	%
Nonfuel		19.0	%	16.8	%
Rent and royalties from franchisees		0.2	%	0.2	%
Total revenues		100	%	100.0	%

 

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Relevance of Fuel Revenues

 

Due to volatile pricing of our fuel products purchases and our pricing of fuel products to customers, we believe that fuel revenue is not a useful basis for analyzing our results of operations from period to period.  As a result solely of changes in commodity fuel prices, our fuel revenue may materially increase or decrease, in both absolute amounts and on a percentage basis, without a comparable change in fuel sales volumes or in fuel gross margin.  We consider fuel volumes and fuel gross margin to be better measures of comparative performance than fuel revenues.  However, fuel pricing and revenues can materially impact our working capital requirements; see “Liquidity and Capital Resources” below.

 

Results of Operations (dollars in thousands)

 

Three months ended March 31, 2014 compared to March 31, 2013

 

The following table presents changes in our operating results for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013.

 

		Three Months Ended March 31,						$			%
(dollars in thousands)		2014			2013			Change			Change
Revenues:
Fuel		$	1,589,646		$	1,625,107		$	(35,461	)	(2.2	)%
Nonfuel		374,666			329,194			45,472			13.8	%
Rent and royalties		2,997			3,050			(53		)	(1.7	)%
Total revenues		1,967,309			1,957,351			9,958			0.5	%
Cost of goods sold (excluding depreciation):
Fuel		1,497,329			1,548,179			(50,850		)	(3.3	)%
Nonfuel		168,416			145,365			23,051			15.9	%
Total cost of goods sold (excluding depreciation)		1,665,745			1,693,544			(27,799		)	(1.6	)%
Operating expenses:
Site level operating expenses		199,649			183,933			15,716			8.5	%
Selling, general & administrative expense		26,796			23,227			3,569			15.4	%
Real estate rent		54,126			51,884			2,242			4.3	%
Depreciation and amortization expense		16,128			13,223			2,905			22.0	%
Total operating expenses		296,699			272,267			24,432			9.0	%
Income (loss) from operations		4,865			(8,460		)	13,325			N/M	%
Acquisition costs		(610		)	(115		)	(495		)	430.4	%
Interest income		39			235			(196		)	(83.4	)%
Interest expense		(4,075		)	(4,065		)	(10		)	0.2	%
Income (loss) before income taxes and income from equity investees		219			(12,405		)	12,624			N/M	%
Provision for income taxes		276			170			106			62.4	%
Income from equity investees		254			436			(182		)	(41.7	)%
Net income (loss)		$	197		$	(12,139	)	$	12,336		N/M	%

 

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