CrossAmerica Partners LP - Quarter Report: 2013 June (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2013

 

OR

 

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

 

For the transition period from to

 

Commission file number: 001-35711

 

Lehigh Gas Partners LP

(Exact name of registrant as specified in its charter)

 

 

610-625-8000

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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

 

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 x  No o

 

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.  (Check one):

 

 

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

 

As of August 7, 2013, there were 7,526,044 common units and 7,525,000 subordinated units representing limited partner interests outstanding.

 

 

Table of Contents

 

LEHIGH GAS PARTNERS LP

FORM 10-Q

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.		Financial Statements
UNAUDITED CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
Unaudited Condensed Consolidated Balance Sheets of Lehigh Gas Partners LP as of June 30, 2013 and December 31, 2012				4
Unaudited Condensed Consolidated Statements of Operations of Lehigh Gas Partners LP for the Three and Six Months Ended June 30, 2013 and Unaudited Condensed Combined Statements of Operations of Lehigh Gas Entities (Predecessor) for the Three and Six Months Ended June 30, 2012				5
Unaudited Condensed Consolidated Statement of Partners’ Capital and Comprehensive Income of Lehigh Gas Partners LP for the Six Months Ended June 30, 2013				6
Unaudited Condensed Consolidated Statement of Cash Flows of Lehigh Gas Partners LP for the Six Months Ended June 30, 2013 and Unaudited Combined Statement of Cash Flows of Lehigh Gas Entities (Predecessor) for the Six Months Ended June 30, 2012				7
Unaudited Notes to Condensed Financial Statements				9
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		28
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		43
Item 4.		Controls and Procedures		44
PART II.		OTHER
Item 1.		Legal Proceedings		45
Item 1A.		Risk Factors		45
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		45
Item 3.		Default Upon Senior Securities		45
Item 4.		Mine Safety Disclosures		45
Item 5.		Other Information		45
Item 6.		Exhibits		45
Signatures				46

 

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Explanatory Note

 

On October 30, 2012 (the “Closing Date”), we completed our initial public offering of a total of 6,000,000 common units representing limited partner interests, and on November 9, 2012, issued an additional 900,000 common units pursuant to the full exercise by the underwriters (the “Underwriters”) of their over-allotment option, all at a price of $20.00 per unit (the “Offering”).  We received aggregate proceeds of $125.7 million from the sale of the units, net of underwriting discounts and structuring fees, and $2.6 million of Offering related expenses.  Of this amount, approximately $36.7 million, including $16.7 million of net proceeds resulting from the exercise of the over-allotment option, were distributed to Joseph V. Topper, Jr., our chief executive officer, certain of Mr. Topper’s affiliates and family trusts, and to John B. Reilly, III, a member of the board of directors of our General Partner.

 

References in this Quarterly Report to “our Predecessor” or “Predecessor Entity” refer to the portion of the business of Lehigh Gas Corporation, or “LGC,” and its subsidiaries and affiliates contributed to Lehigh Gas Partners LP in connection with the Offering.  Unless the context requires otherwise, references in this Quarterly Report to “Lehigh Gas Partners LP,” “we,” “our,” “us,” or like terms, when used in the context of the periods following the completion of the Offering refer to Lehigh Gas Partners LP and its subsidiaries and, when used in the context of the periods prior to the completion of the Offering, refer to the portion of the business of our Predecessor, the wholesale distribution business of Lehigh Gas—Ohio, LLC, and real property and leasehold interests contributed to us in connection with the Offering by Joseph V. Topper, Jr., the chief executive officer and the Chairman of the board of directors of our General Partner and/or his affiliates.

 

References in this Quarterly Report to “our General Partner” or “Lehigh Gas GP” refer to Lehigh Gas GP LLC, the General Partner of Lehigh Gas Partners LP and a wholly owned subsidiary of LGC.  References to “LGO” refer to Lehigh Gas—Ohio, LLC, an entity managed by Joseph V. Topper, Jr.  All of LGO’s wholesale distribution business was contributed to us in connection with the Offering.  References to the “Topper Group” refer to Joseph V. Topper, Jr., collectively with those of his affiliates and family trusts that have ownership interests in our Predecessor.  A trust of which Joseph V. Topper, Jr. is a trustee owns all of the outstanding stock of LGC.  The Topper Group, including LGC, holds a significant portion of our limited partner interests.  Through his ownership of LGC, Joseph V. Topper, Jr. controls our General Partner.

 

Unless otherwise indicated, the financial results contained in this Quarterly Report are based upon our unaudited condensed consolidated financial results for the three and six months ended June 30, 2013, and the unaudited condensed combined financial results for the Predecessor Entity for the three and six months ended June 30, 2012.

 

References in this Quarterly Report to “lessee dealers” refer to third parties who operate sites we own or lease and we, in turn, lease such sites to the lessee dealers.  “Independent dealers” refer to third parties that own their sites or lease their sites from a landlord other than us.  “Sub-wholesalers” refer to third parties that elect to purchase motor fuels from us, on a wholesale basis, instead of purchasing directly from major integrated oil companies and refiners.

 

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PART I — Financial Information

Item 1.  Financial Statements

 

Lehigh Gas Partners LP

Condensed Consolidated Balance Sheets

(unaudited)

(Amounts in thousands, except unit data)

 

		June 30, 2013			December 31, 2012
Assets
Current assets:
Cash and cash equivalents		$	463		$	4,768
Accounts receivable, less allowance for doubtful accounts of $72 and $0 at June 30, 2013 and December 31, 2012, respectively		6,039			5,741
Accounts receivable from affiliates		18,755			8,112
Environmental indemnification asset - current portion		615			591
Assets held for sale		—			1,615
Other current assets		1,873			2,147
Total current assets		27,745			22,974
Property and equipment, net		240,036			243,022
Intangible assets, net		33,033			35,602
Environmental indemnification asset		647			586
Deferred financing fees, net and other assets		10,692			10,031
Goodwill		5,636			5,636
Total assets		$	317,789		$	317,851
Liabilities and partners’ capital
Current liabilities:
Lease financing obligations - current portion		$	2,533		$	2,187
Accounts payable		22,821			16,279
Motor fuel taxes payable		6,929			9,455
Income taxes payable		523			342
Environmental liability - current portion		615			591
Accrued expenses and other current liabilities		4,929			3,299
Total current liabilities		38,350			32,153
Long-term debt		185,856			183,751
Lease financing obligations		67,410			73,793
Environmental liability		647			586
Other liabilities		12,982			13,023
Total liabilities		305,245			303,306
Commitments and contingencies (Note 15)
Partners’ capital:
Limited Partners’ Interest
Common units—public (6,901,044 and 6,900,000 units issued and outstanding at June 30, 2013 and December 31, 2012, respectively)		124,186			125,093
Common units—affiliates (625,000 units issued and outstanding at June 30, 2013 and December 31, 2012)		(42,483		)	(42,399		)
Subordinated units—affiliates (7,525,000 units issued and outstanding at June 30, 2013 and December 31, 2012)		(69,159		)	(68,149		)
General Partner’s Interest		—			—
Total partners’ capital		12,544			14,545
Total liabilities and partners’ capital		$	317,789		$	317,851

 

The accompanying unaudited notes are an integral part of these

Unaudited Condensed Consolidated and Combined Financial Statements.

 

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Lehigh Gas Partners LP and Lehigh Gas Entities (Predecessor)

Condensed Consolidated and Combined Statements of Operations

for the Three and Six Months Ended June 30, 2013 and 2012

(unaudited)

(Amounts in thousands, except unit and per unit data)

 

		Lehigh Gas Partners LP Consolidated for the Three Months Ended June 30, 2013				Lehigh Gas Entities (Predecessor) Combined for the Three Months Ended June 30, 2012			Lehigh Gas Partners LP Consolidated for the Six Months Ended June 30, 2013				Lehigh Gas Entities (Predecessor) Combined for the Six Months Ended June 30, 2012
Revenues:
Revenues from fuel sales		$	228,719			$	299,647		$	447,023			$	575,979
Revenues from fuel sales to affiliates		248,704				186,762			491,569				321,529
Rent income		3,833				2,971			7,185				6,084
Rent income from affiliates		6,432				1,047			13,349				2,898
Revenues from retail merchandise and other		—				4			—				7
Total revenues		487,688				490,431			959,126				906,497
Costs and Expenses:
Cost of revenues from fuel sales		223,665				291,630			437,943				563,291
Cost of revenues from fuel sales to affiliates		241,772				183,208			478,735				315,375
Rent expense		3,900				2,795			7,784				4,862
Operating expenses		1,100				1,466			1,910				3,198
Depreciation and amortization		4,864				3,726			9,703				8,455
Selling, general and administrative expenses		3,820				5,267			7,399				10,558
Gains on sales of assets, net		(47		)		(1,892		)	(47		)		(2,973		)
Total costs and operating expenses		479,074				486,200			943,427				902,766
Operating income (loss)		8,614				4,231			15,699				3,731
Interest expense, net		(3,518		)		(3,501		)	(6,907		)		(6,893		)
Other income, net		593				347			1,097				1,065
Income (loss) from continuing operations before income taxes		5,689				1,077			9,889				(2,097		)
Income tax expense from continuing operations		220				—			663				—
Income (loss) from continuing operations after income taxes		5,469				1,077			9,226				(2,097		)
Income from discontinued operations		—				169			—				309
Net income (loss) and comprehensive income (loss)		$	5,469			$	1,246		$	9,226			$	(1,788	)
Limited partners’ interest in net income from continuing operations after income taxes		$	5,469			n/a			$	9,226			n/a
Net income allocated to common units		$	2,735						$	4,613
Net income allocated to subordinated units		$	2,734						$	4,613
Net income per common unit - basic and diluted		$	0.363						$	0.613
Net income per subordinated unit - basic and diluted		$	0.363						$	0.613
Weighted average limited partners’ units outstanding
Common units - basic and diluted		7,526,044							7,525,952
Subordinated units - basic and diluted		7,525,000							7,525,000

 

The accompanying unaudited notes are an integral part of these

Unaudited Condensed Consolidated and Combined Financial Statements.

 

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Lehigh Gas Partners LP

Condensed Consolidated Statement of Partners’ Capital

and Comprehensive Income

(unaudited)

(Amounts in thousands, except unit data)

 

		Limited Partners’ Interest
		Common Unitholders— Public					Common Unitholders— Affiliates					Subordinated Unitholders— Affiliates					General Partner’s Interest			Partners’
		Units		Dollars			Units		Dollars			Units		Dollars			Dollars			Capital
Balance, December 31, 2012		6,900,000		$	125,093		625,000		$	(42,399	)	7,525,000		$	(68,149	)	$	—		$	14,545
Equity-based director compensation		1,044		21			—		—			—		—			—			21
Net income and comprehensive income		—		4,230			—		383			—		4,613			—			9,226
Distributions paid		—		(5,158		)	—		(467		)	—		(5,623		)	—			(11,248		)
Balance, June 30, 2013		6,901,044		$	124,186		625,000		$	(42,483	)	7,525,000		$	(69,159	)	$	—		$	12,544

 

The accompanying unaudited notes are an integral part of these

Unaudited Condensed Consolidated and Combined Financial Statements.

 

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Lehigh Gas Partners LP and Lehigh Gas Entities (Predecessor)

Condensed Consolidated and Combined Statements of Cash Flows

(unaudited)

(Amounts in thousands)

 

		Lehigh Gas Partners LP Consolidated for the Six Months Ended June 30, 2013				Lehigh Gas Entities (Predecessor) Combined for the Six Months Ended June 30, 2012
Cash Flows Related to Operating Activities
Net income (loss)		$	9,226			$	(1,788	)
Adjustments to reconcile net income (loss) to net cash flows provided by operating activities:
Depreciation and amortization		9,703				8,486
Accretion of interest		23				152
Amortization of debt discount		—				410
Amortization of deferred financing fees		1,359				385
Amortization of (above) below market leases, net		(7		)		251
Gains on sales of assets, net		(47		)		(3,210		)
Provision for losses on doubtful accounts		72				25
Equity-based incentive compensation expense		978				—
Equity-based director compensation expense		21				—
Changes in certain assets and liabilities:
Accounts receivable		(370		)		925
Accounts receivable from affiliates		(10,643		)		(4,846		)
Inventories		—				256
Environmental indemnification asset		—				1,901
Other current assets		276				(741		)
Other assets		50				278
Accounts payable		6,542				8,327
Accrued expenses and other current liabilities		607				(102		)
Motor fuel taxes payable		(2,526		)		2,451
Income taxes payable		181				—
Environmental liability		—				(2,148		)
Other long-term liabilities		(1,320		)		1,687
Net cash flows provided by operating activities		14,125				12,699
Cash Flows Related to Investing Activities
Proceeds from sale of property and equipment		2,210				2,813
Purchases of property and equipment		(4,129		)		(805		)
Principal payments received on notes receivable		32				—
Cash paid in connection with acquisitions, net of cash acquired		—				(500		)
Net cash flows (used in) provided by investing activities		(1,887		)		1,508

 

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Lehigh Gas Partners LP and Lehigh Gas Entities (Predecessor)

Condensed Consolidated and Combined Statements of Cash Flows

(unaudited)

Continued

 

		Lehigh Gas Partners LP Consolidated for the Six Months Ended June 30, 2013				Lehigh Gas Entities (Predecessor) Combined for the Six Months Ended June 30, 2012
Cash Flows Related to Financing Activities
Borrowings under swing-line line-of-credit		40,808				—
Repayments of borrowings under swing-line line-of-credit		(40,808		)		—
Proceeds from borrowings under revolving credit facility		1,150				—
Proceeds from issuance of long term debt		—				9,500
Repayment of long term debt		—				(16,571		)
Repayment of lease financing obligations		(6,037		)		(391		)
Payment of deferred financing fees		(408		)		(117		)
Distributions paid on common and subordinated units		(11,248		)		—
Advances to affiliates		—				(4,730		)
Contributions from owners		—				2,957
Distributions to members		—				(4,922		)
Net cash flows used in financing activities		(16,543		)		(14,274		)
Net decrease in cash and cash equivalents		(4,305		)		(67		)
Cash and Cash Equivalents
Beginning of period		4,768				2,082
End of period		$	463			$	2,015
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest		$	5,551			$	5,946
Cash paid for income taxes		$	491			—
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Lessor indirect costs incurred and deferred rent income recorded related to new lease transaction between affiliate and unrelated third-party
Total assets		$	1,700			$	—
Total liabilities		$	(1,700	)		$	—
Issuance of note payable in connection with purchase of sites
Total assets		$	1,000			$	—
Total liabilities		$	(1,000	)		$	—
Transfer of assets and liabilities from Getty capital lease obligation and asset retirement obligation
Total assets		$	—			$	34,200
Total liabilities		$	—			$	(34,200	)
Transfer of assets and liabilities from Predecessor Entity to Affiliate
Total assets		$	—			$	588
Total liabilities		$	—			$	(588	)
Receipt of note receivable in connection with the sale of 32 locations		$	—			$	2,700

 

The accompanying unaudited notes are an integral part of these

Unaudited Condensed Consolidated and Combined Financial Statements.

 

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Lehigh Gas Partners LP and Lehigh Gas Entities (Predecessor)

Notes to Condensed Consolidated and Combined Financial Statements

(unaudited)

 

1. Organization and Basis of Presentation

 

The unaudited condensed consolidated financial statements as of June 30, 2013 and for the three and six months then ended are comprised of the Partnership which is a Delaware limited partnership, and the Partnership’s wholly-owned subsidiaries.  The Partnership was formed in December 2011 by Lehigh Gas GP LLC, a Delaware limited liability corporation, also formed in December 2011, to act as the General Partner of the Partnership.  The Partnership engages in the wholesale distribution of motor fuels, consisting primarily of gasoline and diesel fuels, and owns and leases real estate used in the retail distribution of motor fuels.

 

References to the unaudited condensed combined financial statements of “the Predecessor” or “Predecessor Entity” refer to the portion of the business of Lehigh Gas Corporation (“LGC”) and its subsidiaries and affiliates under common control (Energy Realty OP LP, EROP-Ohio Holdings, LLC, Lehigh-Kimber Petroleum Corporation, Lehigh-Kimber Realty, LLC, Kwik Pik-Ohio LLC and Kwik Pik Realty-Ohio LLC, which are collectively referred to as the “Lehigh Gas Entities”) that was contributed to the Partnership in connection with the Offering (the “Contributed Assets”). All of the Contributed Assets were recorded at historical cost as this transaction was considered to be a reorganization of entities under common control.  The Partnership issued common units and subordinated units to the shareholders, or their assigns, of the Predecessor Entity in consideration of their transfer of the Contributed Assets to the Partnership.

 

Accordingly, the accompanying unaudited condensed consolidated and combined financial statements are presented in accordance with SEC requirements for predecessor financial statements, which include the financial results of both the Partnership and the Predecessor Entity.  The results of operations contained in the unaudited condensed financial statements include the Partnership’s consolidated financial results for the three and six months ended June 30, 2013 and the Predecessor Entity’s combined financial results for the three and six months ended June 30, 2012.  The unaudited condensed consolidated balance sheets present the financial position of the Partnership as of June 30, 2013, and December 31, 2012.

 

The unaudited condensed consolidated financial statements include the accounts of the Partnership and all of its subsidiaries.  The Partnership’s operations are principally conducted by the following consolidated wholly-owned subsidiaries:

 

·                  Lehigh Gas Wholesale LLC (“LGW”), a Delaware limited liability company, which distributes motor fuels;

·                  LGP Realty Holdings LP (“LGPR”), a Delaware limited partnership, which functions as the property holding company of the Partnership; and,

·                  Lehigh Gas Wholesale Services, Inc. (“LGWS”), a Delaware corporation, which owns and leases (or leases and sub-leases) real estate and personal property, used in the retail distribution of motor fuels as well as provides maintenance and other services to lessee dealers and other customers (including Lehigh Gas—Ohio, LLC (“LGO”)).

 

As a result of the contribution of the Contributed Assets in connection with the Offering, the Partnership is engaged in substantially the same business and revenue generating activities as the Predecessor Entity, principally: (i) distributing motor fuels (using unrelated third-party transportation service providers)—on a wholesale basis to sub-wholesalers, independent dealers, lessee dealers, LGO, and others, and (ii) owning or leasing locations and, in turn, generating rent income from the lease or sublease of the locations to third-parties or LGO.

 

LGO is an operator of motor fuel stations that purchases motor fuel from the Partnership on a sub-wholesale basis and re-sells it on a retail basis.  LGO also leases motor fuel stations from the Partnership.  The financial results of LGO are not consolidated with those of the Partnership.  For more information regarding the Partnership’s relationship with LGO, see Note 16.

 

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Interim Financial Statements

 

The accompanying interim condensed financial statements and related disclosures are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) on the same basis as the corresponding audited financial statements for the year ended December 31, 2012, and, in the opinion of management, include all adjustments of a normal recurring nature considered necessary to present fairly the Partnership’s financial position as of June 30, 2013, and the results of its operations and cash flows for the periods presented. Operating results for the three and six months ended June 30, 2013, are not necessarily indicative of the results that may be expected for the year ending December 31, 2013, or any other future periods.  Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted under the SEC’s rules and regulations for interim financial statements.  These unaudited condensed financial statements should be read in conjunction with the corresponding audited financial statements and accompanying notes for the year ended December 31, 2012, included in our annual report on Form 10-K, filed with the SEC on March 28, 2013.

 

Significant Accounting Policies

 

The Partnership and the Predecessor Entity’s significant accounting policies are disclosed in the audited financial statements for the year ended December 31, 2012, included in our annual report on Form 10-K filed with the SEC on March 28, 2013.  Since the date of those financial statements, there have been no changes to the Partnership’s significant accounting policies.

 

Reclassifications

 

Certain reclassifications were made to prior period amounts to conform to the current year presentation.

 

Recent Accounting Pronouncements

 

The Partnership considers the applicability and impact of all new accounting guidance.  No new accounting guidance was adopted in 2013 that had or is expected to have a significant impact on the financial statements.

 

2. Acquisitions

 

In evaluating potential acquisition candidates, the Partnership considers a number of factors, including strategic fit, desirability of location, purchase price, and the ability to improve the productivity and profitability of a location and/or wholesale fuel supply agreement or distribution rights through the implementation of improved operating strategies.  The ability to create accretive financial results and/or operational efficiencies due to the relative operational scale and/or geographic concentration, among other strategic factors, may result in a purchase price in excess of the fair value of identifiable assets acquired and liabilities assumed, resulting in the recognition of goodwill.  The Partnership strives to make acquisitions accretive to partners’ capital and provide a reasonable long-term return on investment.  Goodwill recorded in connection with these acquisitions is primarily attributable to the estimated synergies and enhanced revenue opportunities.

 

With respect to the Dunmore Acquisition (as defined herein), the Partnership concluded the historical balance sheet and operating information concerning this acquisitions would not be meaningful to investors as the Partnership fundamentally changed the nature of the revenue producing assets acquired from the manner in which they were used by its seller.  Thus, presenting historical financial information regarding the acquisition may mislead investors.

 

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Dunmore

 

On December 21, 2012 (the “Dunmore Acquisition Date), the Partnership completed (the “Dunmore Closing”) its acquisition of certain assets (the “Dunmore Acquisition”) of Dunmore Oil Company, Inc. and JoJo Oil Company, Inc. (together, the “Dunmore Sellers”) as contemplated by the Asset Purchase Agreement, as amended (the “Dunmore Purchase Agreement”), by and among the Partnership, a subsidiary of the Partnership, the Dunmore Sellers, and, for limited purposes, Joseph Gentile, Jr. Pursuant to the Dunmore Purchase Agreement, the Dunmore Sellers sold to the Partnership substantially all of the assets (collectively, the “Dunmore Assets”) held and used by the Dunmore Sellers in connection with their gasoline and diesel retail outlet business and their related convenience store business (the “Dunmore Retail Business”). In connection with this transaction, the Partnership acquired the real estate of 24 motor fuel service stations, 23 of which are fee simple interests and one of which is a leasehold interest.

 

LGO leases the sites from the Partnership and operates the Dunmore Retail Business.  In addition, as contemplated by the Dunmore Purchase Agreement, certain of the non-qualified income generating Dunmore Assets and certain non-qualified liabilities of the Dunmore Sellers were assigned by the Partnership to LGO.  LGO paid the Partnership $0.5 million for advanced rent payments.  The Dunmore Sellers are permitted to continue to operate certain portions of their business relating to sales of heating oil, propane and unbranded motor fuels.

 

Pursuant to the PMPA Franchise Agreement (the “Franchise Agreement”) by and between LGO and LGW, the Partnership is the exclusive distributor of motor fuels to all sites operated by LGO in connection with the Dunmore Retail Business.  In addition, the Partnership leases these sites to LGO pursuant to property lease agreements.

 

As consideration for the Dunmore Assets, the Partnership paid (i) $28.0 million in cash to the Dunmore Sellers; (ii) $0.5 million in cash to Mr. Gentile as consideration for his agreeing, for a period of five years following the Dunmore Closing, to not compete in the Dunmore Retail Business, to not engage in the sale or distribution of branded motor fuels, and to not solicit or hire any of the Partnership affiliates’ employees; and (iii) $0.5 million in cash to be held in escrow and delivered to the Dunmore Sellers upon the Partnership’s receipt of written evidence concerning the payment of certain of the Dunmore Sellers’ pre-closing tax liabilities.

 

The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed at the Dunmore Asset Purchase Agreement Acquisition Date (in thousands):

 

Land		$	6,500
Buildings and improvements		9,200
Leasehold improvements		500
Equipment and other		4,200
Wholesale fuel distribution rights		8,200
Total identifiable assets		$	28,600
Lease agreements with above average market value		200
Net identifiable assets acquired		28,400
Goodwill		600
Net assets acquired		$	29,000

 

The above estimated fair values of assets acquired and liabilities assumed are provisional and are based on the information that was available as of the Dunmore Acquisition Date to estimate the fair value of assets acquired and liabilities assumed in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations.”  The Partnership believes the information provides a reasonable basis for estimating the fair values but the Partnership is waiting for additional information necessary to finalize those amounts.  Thus, the provisional measurements of fair value reflected are subject to change, and such change could be significant.  The Partnership expects to finalize the valuation and complete the purchase price as soon as practicable, but no later than one year from the Dunmore Acquisition Date.  There were no cumulative adjustments, other than reclassifications within property and equipment, for the six months ended June 30, 2013.

 

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The fair value of land, buildings, and equipment (“tangible assets”) was determined using a cost approach, with the fair value of an asset estimated by reference to the replacement cost to obtain a substitute asset of comparable features and functionality, and is the amount a willing market participant would pay for such an asset, taking into consideration the asset condition as well as any physical deterioration, functional obsolescence, and/or economic obsolescence.  The buildings and equipment are being depreciated on a straight-line basis, with estimated useful lives of 20 years for buildings and 5 to 15 years for equipment.  Land is not depreciated.

 

The fair value of the wholesale fuel distribution rights was determined using an income approach, with the fair value estimated to be the present value of incremental after-tax cash flows attributable solely to the wholesale fuel distribution rights over their estimated remaining useful life, using probability-weighted cash flows, using discount rates considered appropriate given the inherent risks associated with this type of transaction.  Management believes the level and timing of cash flows represent relevant market participant assumptions.  The wholesale fuel distribution rights are being amortized on a straight-line basis over an estimated useful life of approximately 10 years.

 

Incremental rent income for the Dunmore Acquisition included in the Partnership’s Unaudited Condensed Consolidated Statement of Operations was $0.5 million and $1.0 million for the three and six months ended June 30, 2013.

 

All of the transactions between the Partnership and LGO that are described in the Dunmore Asset Purchase Agreement have been approved by the conflicts committee of the board of directors of the General Partner.

 

Express Lane

 

On December 21, 2012, LGWS entered into a Stock Purchase Agreement (the “Express Lane Stock Purchase Agreement”) with James E. Lewis, Jr., Linda N. Lewis, James E. Lewis, III and Reid D. Lewis (collectively, the “Express Lane Sellers”), pursuant to which the Express Lane Sellers sold to LGWS all of the outstanding capital stock (collectively, the “Express Lane Shares”) of Express Lane, Inc. (“Express Lane”), the owner and operator of various retail convenience stores, which include the retail sale of motor fuels and quick service restaurants, at various locations in Florida.

 

In connection with the purchase of the Express Lane Shares, LGWS acquired forty-one motor fuel service stations, one as a fee simple interest and forty as leasehold interests.  In connection with the purchase of the Express Lane Shares, on December 21, 2012, LGPR entered into a Purchase and Sale Agreement (the “Express Lane Purchase and Sale Agreement” and, together with the Express Lane Stock Purchase Agreement, the “Express Lane Agreements”) with Express Lane.  Under the Express Lane Purchase and Sale Agreement, LGPR acquired, prior to the Express Lane Purchaser’s acquisition of the Express Lane Shares, an additional fee simple interest in six properties and two fuel purchase agreements (collectively, the “Express Lane Property”) from Express Lane.

 

On December 21, 2012, LGPR completed the acquisition of the Express Lane Property from the Express Lane Sellers, as contemplated by the Express Lane Purchase and Sale Agreement.  In addition, on December 22, 2012, LGWS completed (the “Express Lane Closing”) the acquisition of the Express Lane Shares from the Express Lane Sellers, as contemplated by the Express Lane Stock Purchase Agreement.  The transactions contemplated by the Express Lane Agreements are together referred to as the “Express Lane Acquisition.”

 

As a result of the Express Lane acquisition, LGO leases the sites from the Partnership and operates Express Lane’s gasoline and diesel retail outlet business and its related convenience store business (the “Express Lane Retail Business”).  In addition, certain of the non-qualified income generating assets related to the Express Lane Retail Business and certain non-qualified liabilities of the Express Lane Sellers were assigned to LGO.  LGO paid the Partnership $1.0 million for advanced rent payments.  The Partnership has accrued $1.8 million of additional purchase price consideration for the net working capital of the Express Lane Retail Business (See Note 8), which is subject to final agreement between the Partnership and the Express Lane Sellers.

 

Pursuant to the Franchise Agreement, the Partnership is the exclusive distributor of motor fuels to all sites operated by LGO in connection with the Express Lane Retail Business.  In addition, the Partnership leases these sites to LGO pursuant to property lease agreements.

 

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Under the Express Lane Agreements, the aggregate purchase price (the “Express Lane Purchase Price”) for the Express Lane Property and the Express Lane Shares was $45.4 million, inclusive of $1.8 million of certain preliminary post-closing adjustments.  Of the Express Lane Purchase Price, LGWS paid an aggregate of $41.9 million to the Express Lane Sellers and placed an aggregate of $1.1 million into escrow, of which $1.0 million has been placed into escrow to fund any indemnification or similar claims made under the Express Lane Agreements by the parties thereto, and $0.1 million has been placed into escrow pending the completion of certain environmental remediation measures.  In addition to the Express Lane Purchase Price, LGPR also placed $0.6 million into escrow to indemnify the Express Lane Sellers for certain tax obligations resulting from the sale of the Express Lane Property.

 

Under the Express Lane Stock Purchase Agreement, the Express Lane Sellers have agreed not to compete in the retail motor fuel or convenience store business within the State of Florida for a period of four years following the Express Lane Closing.  In addition, pursuant to the Express Lane Stock Purchase Agreement, each of the Express Lane Sellers executed a general release in favor of LGWS, Express Lane and their respective affiliates.

 

The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed at the Express Lane Agreements acquisition date (in thousands):

 

Land		$	3,900
Buildings and improvements		7,700
Leasehold improvements		4,200
Equipment and other		11,700
Wholesale fuel distribution rights		15,000
Lease agreements with below average market value		2,600
Environmental indemnification assets		1,177
Net working capital		1,822
Total identifiable assets		$	48,099
Lease agreements with above average market value		2,500
Environmental liabilities		1,177
Total identifiable liabilities		3,677
Net identifiable assets acquired		44,422
Goodwill		993
Net assets acquired		$	45,415

 

The above estimated fair values of assets acquired and liabilities assumed are provisional and are based on the information that was available as of the respective closing dates of the Express Lane Acquisition to estimate the fair value of assets acquired and liabilities assumed in accordance with ASC 805, “Business Combinations.”  The Partnership believes the information provides a reasonable basis for estimating the fair values but the Partnership is waiting for additional information necessary to finalize those amounts.  Thus, the provisional measurements of fair value reflected are subject to change, and such change could be significant.  The Partnership expects to finalize the valuation and complete the purchase price as soon as practicable.  There were no cumulative adjustments, other than reclassifications within property and equipment, for the six months ended June 30, 2013.

 

The fair value of land, buildings and equipment (“tangible assets”) was determined using a cost approach, with the fair value of an asset estimated by reference to the replacement cost to obtain a substitute asset of comparable features and functionality, and is the amount a willing market participant would pay for such an asset, taking into consideration the asset condition as well as any physical deterioration, functional obsolescence and/or economic obsolescence.  The buildings and equipment are being depreciated on a straight-line basis, with estimated useful lives of 20 years for buildings and 5 to 15 years for equipment.  Land is not depreciated.

 

The fair value of the wholesale fuel distribution rights was determined using an income approach, with the fair value estimated to be the present value of incremental after-tax cash flows attributable solely to the wholesale fuel distribution rights over their estimated remaining useful life, using probability-weighted cash flows, using discount rates considered appropriate given the inherent risks associated with this type of transaction.  The Partnership believes the level and timing of cash flows represent relevant market participant assumptions.  The wholesale fuel distribution rights are being amortized on a straight-line basis over an estimated useful life of approximately 10 years.

 

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The fair value of the discount related to lease agreements with above/below average market value was determined using an income approach, with the fair value estimated to be the present value of incremental after-tax cash flows attributable solely to the lease agreements over their estimated remaining useful life, generally assumed to extend through the term of the lease agreements, and using discount rates considered appropriate given the inherent risks associated with this type of agreement.  The Partnership believes the level and timing of cash flows represent relevant market participant assumptions.  The discount related to lease agreements with above/below average market value is being amortized on a straight-line basis over the term of the respective lease agreements, with an estimated weighted average useful life of 5 years.

 

Aggregate incremental revenue for the Express Lane Acquisition included in the Partnership’s Unaudited Condensed Consolidated Statement of Operations was $34.4 million and $65.6 million for the three and six months ended June 30, 2013, respectively.

 

The following is unaudited pro forma information related to the Express Lane Acquisition as if the transaction had occurred on January 1, 2012 (in thousands):

 

		Lehigh Gas Entities (Predecessor) Combined
		Three Months Ended June 30, 2012			Six Months Ended June 30, 2012
Total revenues		$	552,601		$	1,024,575
Net loss		$	2,684		$	(1,350	)

 

All of the transactions between the Partnership and LGO related to the Express Lane Agreements have been approved by the conflicts committee of the board of directors of the General Partner.

 

3. Discontinued Operations and Assets Held for Sale

 

Discontinued Operations

 

As part of certain sale transactions, the Partnership may continue to distribute motor fuels on a wholesale basis to a divested site.  In addition, the Partnership and Predecessor Entity may have the right to monitor and, if necessary, impose conditions on the operations of a divested site to ensure that the purchaser is complying with the terms and conditions of the franchise agreement covering such site.  Accordingly, the Partnership and Predecessor Entity may have the ability to exert significant influence over the divested site and thus the Partnership and Predecessor Entity may have significant continuing involvement.  Such sites are not deemed discontinued operations.

 

The Partnership and Predecessor Entity classify locations as discontinued when operations and cash flows will be eliminated from ongoing operations and the Partnership and Predecessor Entity will not retain any significant continuing involvement in the operations after the respective sale transactions.  For the three and six months ended June 30, 2012, all of the operating results for these discontinued operations were removed from continuing operations and were presented separately as discontinued operations in the statement of operations.  The notes to the financial statements were adjusted to exclude discontinued operations unless otherwise noted.  The Partnership had no discontinued operations.

 

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The following operating results of the locations are included in discontinued operations for the periods presented (in thousands):

 

		Lehigh Gas Entities (Predecessor) Combined
		Three Months Ended June 30, 2012			Six Months Ended June 30, 2012
Revenues:
Revenues from fuel sales		$	1,342		$	2,558
Rent income		30			60
Total revenues		1,372			2,618
Costs and Expenses:
Cost of revenues from fuel sales		1,287			2,482
Operating expenses		3			6
Depreciation and amortization		15			33
Gains on sales of assets, net		(115		)	(238		)
Total costs and operating expenses		1,190			2,283
Operating income		182			335
Interest expense, net		(13		)	(26		)
Income from discontinued operations		$	169		$	309

 

Assets Held for Sale

 

The Partnership had classified five locations as of December 31, 2012, as held-for-sale.  In connection with the classification as held-for-sale, the Predecessor Entity recognized a loss of $0.9 million for the six months ended June 30, 2012.  The loss represents the impairment recognized to present the held-for-sale locations at the lower of cost or fair value, less costs to sell.  The fair values, less costs to sell were determined based on negotiated amounts in agreements with unrelated third parties.  No impairment was recognized in the three and six months ended June 30, 2013.  There were no assets held for sale at June 30, 2013.  Assets held for sale for the Partnership are as follows (in thousands):

 

		December 31, 2012
Land		$	1,351
Buildings and improvements		435
Equipment and other		163
Total property and equipment, at cost		1,949
Accumulated depreciation and amortization		(334		)
Assets held for sale		$	1,615

 

4. Property and Equipment

 

Property and equipment, net for the Partnership consisted of the following at (in thousands):

 

		June 30, 2013			December 31, 2012
Land		$	98,382		$	98,117
Buildings and improvements		110,840			108,508
Leasehold improvements		5,060			4,260
Equipment and other		61,650			60,972
Property and equipment, at cost		275,932			271,857
Accumulated depreciation and amortization		(35,896		)	(28,835		)
Property and equipment, net		$	240,036		$	243,022

 

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Depreciation expense, including amortization of assets recorded under sale-leasebacks and capital lease obligations, was approximately $3.8 million and $3.2 million for the three months ended June 30, 2013 and 2012, and $7.6 million and $7.1 million for the six months ended June 30, 2013 and 2012, respectively.

 

The following site purchases and divestitures occurred in the six months ended June 30, 2013:

 

·                  In April 2013, the Partnership purchased one site in Pennsylvania for $0.7 million.

 

·                  In April 2013, the Partnership sold five sites in Ohio for $1.5 million, which were included in assets held for sale at December 31, 2012.  This transaction did not have a material impact on the results of operations for 2013.

 

·                  In May 2013, the Partnership sold one site in Kentucky for $0.7 million.  This transaction did not have a material impact on the results of operations for 2013.

 

·                  In May 2013, the Partnership repurchased four sites in Ohio for $7.1 million.  These sites were previously leased through sale-leaseback transactions that were accounted for as lease financing obligations with a remaining balance of $5.1 million.  The $2.0 million difference between the purchase price and the remaining balance of the lease financing obligation was recorded as an increase to property and equipment.

 

·                  In June 2013, the Partnership purchased two sites in Florida for $1.6 million, of which $0.6 million was paid in cash and the remaining balance was financed as a mortgage payable.  See Note 6 for additional details.

 

5. Goodwill and Intangible Assets

 

Intangible assets for the Partnership consist of the following (in thousands):

 

		June 30, 2013									December 31, 2012
		Gross Amount			Accumulated Amortization			Net Carrying Amount			Gross Amount			Accumulated Amortization			Net Carrying Amount
Wholesale fuel supply agreements		$	16,451		$	(8,121	)	$	8,330		$	16,451		$	(7,151	)	$	9,300
Wholesale fuel distribution rights		23,200			(1,160		)	22,040			23,200			—			23,200
Trademarks		134			(47		)	87			134			(40		)	94
Below market leases		3,322			(746		)	2,576			3,422			(414		)	3,008
Total		$	43,107		$	(10,074	)	$	33,033		$	43,207		$	(7,605	)	$	35,602

 

As noted above, the Partnership purchased two sites in Florida in June 2013.  Prior to the acquisition, there was a below market lease intangible asset associated with these sites since they were previously leased through the Express Lane acquisition.  This intangible asset was written off, resulting in a charge of $0.1 million for the three and six months ended June 30, 2013.

 

The aggregate amortization expense, including amortization of above and below market lease intangible assets which is classified as rent expense, was approximately $1.1 million and $0.5 million for the three months ended June 30, 2013 and 2012, and $2.1 million and $1.3 million for the six months ended June 30, 2013 and 2012, respectively.

 

There was no change in goodwill during the six months ended June 30, 2013.

 

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6. Debt

 

Credit Facility

 

On October 30, 2012, in connection with the Offering, the Partnership entered into a credit agreement among the Partnership, as borrower, and a syndicate of banks including KeyBank National Association, as administrative agent, collateral agent, letter-of-credit issuer, joint lead arranger and joint book runner (the “Credit Facility”).

 

The Credit Facility matures on October 30, 2015 and consisted of a $249.0 million senior secured revolving credit facility, a swing-line line-of-credit loan up to $7.5 million and standby letters of credit up to an aggregate of $35.0 million.  The Credit Facility had the ability to be increased, from time to time, upon the Partnership’s written request, subject to certain conditions, up to an additional $75.0 million.  All obligations under the Credit Facility are secured by substantially all of the assets of the Partnership and its subsidiaries.

 

On May 13, 2013, the Partnership entered into an amendment to the Credit Facility (the “Amendment”) to increase its credit line by $75.0 million to $324.0 million from $249.0 million.  Subject to the consent of the lenders, the Partnership has the ability under certain circumstances to further increase the amount that it may borrow by $100.0 million to $424.0 million.  The Amendment was treated as a modification under ASC 470-50-40, “Modifications and Extinguishments,” and, as a result, the Partnership recorded $0.4 million in deferred financing fees, which are included in deferred financing costs, net and other assets on the balance sheet at June 30, 2013 and are being amortized on a straight line basis over the remaining term of the Credit Facility.

 

The Partnership is required to comply with certain financial covenants under the Credit Facility.  The Partnership is required to maintain a combined leverage ratio (as defined) for the most recently completed four fiscal quarters of not greater than 4.75 to 1.00 through December 31, 2014, and 4.60 to 1.00 thereafter.  The Partnership is also required to maintain a combined interest charge coverage ratio (as defined) of at least 3.00 to 1.00.  The Partnership was in compliance with all financial covenants as of June 30, 2013 and December 31, 2012.

 

Borrowings under the Credit Facility, as amended, bear interest, at the Partnership’s option, at (1) a rate equal to the London Interbank Offering Rate (“LIBOR”), for interest periods of one, two, three or six months, plus a margin of 2.25% to 3.50% per annum, depending on the Partnership’s combined leverage ratio (as defined) or (2) (a) a base rate equal to the greatest of: (i) the federal funds rate, plus 0.5%, (ii) LIBOR for one month interest periods, plus 1.00% per annum or (iii) the rate of interest established by the agent, from time to time, as its prime rate, plus (b) a margin of 1.25% to 2.50% per annum depending on the Partnership’s combined leverage ratio. In addition, the Partnership incurs a commitment fee based on the unused portion of the revolving credit facility at a rate of 0.375% to 0.50% per annum depending on the Partnership’s combined leverage ratio.  The weighted average interest rate for the Credit Facility was 3.2% for the three and six months ended June 30, 2013.

 

A total of $7.6 million of deferred financing costs are being recognized as interest expense ratably over the term of the Credit Facility.  The $7.6 million of deferred financing costs resulted from the payment of $4.1 million in lender fees in connection with obtaining the Credit Facility, $3.1 million of the remaining unamortized balance of deferred financing costs associated with the (former) Predecessor credit facility and $0.4 million in lender fees in connection with Amendment.

 

The Credit Facility prohibits the Partnership from making distributions to unitholders if any potential default or event of default occurs or would result from the distribution, the Partnership is not in compliance with its financial covenants or the Partnership has lost its status as a partnership for U.S. federal income tax purposes.  In addition, the Credit Facility contains various covenants which may limit, among other things, the Partnership’s ability to grant liens; create, incur, assume, or suffer to exist other indebtedness; or make any material change to the nature of the Partnership’s business, including mergers, liquidations, and dissolutions; and make certain investments, acquisitions or dispositions.

 

There was $184.9 million and $183.8 million outstanding on the Credit Facility at June 30, 2013 and December 31, 2012, respectively, all of which is classified as long-term on the Partnership’s unaudited condensed consolidated balance sheet.  There was $14.6 million and $13.9 million outstanding under standby letters of credit at June 30, 2013 and December 31, 2012, respectively.

 

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Note Payable

 

In connection with the acquisition of two sites in Florida noted previously, the Partnership issued a $1.0 million note payable.  Interest accrues at 4.0% over a 15-year period with monthly payments of $0.007 million each over the first 5 years commencing August 1, 2013.  The 60th payment is a balloon payment for all outstanding principal and any unpaid interest.  The loan is secured by all the real and personal property at the two sites.

 

Predecessor Credit Facility

 

On December 30, 2010, the Predecessor Entity entered into a $175.0 million revolving term loan credit facility with a syndicate of lenders.  The term loan portion of $135.0 million was payable in quarterly principal amounts of $1.6 million, which payments commenced on September 30, 2011.  The revolving portion of the facility had a borrowing capacity of $40.0 million of which $15.0 million could have been drawn upon for operating purposes, $5.0 million could have been used for short term advances and $20.0 million could have been used to issue letters of credit.  The Predecessor Entity was subject to an initial fee of 25 basis points of the stated amount for any letters of credit issued.  Both the term and revolving portions of the credit facility would have matured on December 30, 2015.  During 2011, the Predecessor Entity increased the borrowing capacity under its term loan by $20.0 million in connection with the Shell acquisition.  In February 2012, the Predecessor Entity increased the borrowing capacity of the revolving facility by $8.0 million in order to pay off the term loan discussed below.  After these amendments, the term loan portion of the facility was $155.0 million and the borrowing capacity of the revolving credit facility was $48.0 million.

 

Borrowings under the revolving term loan credit facility bore interest at a floating rate which, at the Predecessor Entity’s option, could have been determined by reference to a LIBOR rate or a base rate plus an applicable margin ranging from 125 to 300 basis points.  Short term advances bore interest at a base rate plus an applicable margin.  The Predecessor Entity’s applicable margin was determined by certain combined leverage ratios at the time of borrowing as set forth in the credit agreement.  The Predecessor Entity was subject to a commitment fee of 50 basis points for any excess borrowing capacity over the outstanding principal borrowings under the revolver portion of the credit facility.  Interest incurred for the three and six months ended June 30, 2012, was $1.6 million and $3.2 million, respectively.

 

In connection with obtaining the revolving term loan credit facility, the Predecessor Entity paid $4.2 million in lender fees of which $2.6 million were allocated to the term portion of the facility and recorded as a discount to the carrying value of the debt.  The discount was being amortized into interest expense over the terms of the related debt.  The debt discount and deferred financing fees were being amortized into interest expense over the terms of the related debt.  For the three and six months ended June 30, 2012, amortization of debt discount and deferred financing fees was $0.4 million and $0.7 million, respectively.  All amounts under the Predecessor Entity’s credit facility were paid in full with proceeds from the Offering.

 

Term Loan

 

On December 30, 2009, the Predecessor Entity issued a promissory note.  The Predecessor Entity made monthly installment payments of $0.05 million, which included components of principal and interest up to the December 30, 2014 maturity date of the term loan.  Borrowings under the term loan facility bore interest at a floating rate, which were determined by reference to a base rate plus an applicable margin of 2.0%.  In February 2012, this term loan was paid in its entirety.  Interest incurred for the three months ended March 31, 2012 was $0.04 million.  In connection with obtaining the term loan, the Predecessor Entity paid $0.1 million in lender fees, which were recorded as a discount to the carrying value of the debt.  The debt discount was being amortized into interest expense over the term of the related debt.  Upon paying the term loan in its entirety in February 2012, the unamortized portion of the discount was immediately expensed.  For the three and six months ended June 30, 2012, amortization of debt discount was $0.05 million for both periods presented.

 

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Mortgage Notes

 

In June and December of 2008, the Predecessor Entity entered into several mortgage notes with two lenders for an aggregate initial borrowing amount of $23.6 million.  Pursuant to the terms of the mortgage notes, the Predecessor Entity made monthly installment payments that were comprised of principal and interest through maturity dates of June 23, 2023 and December 23, 2023.  Since the initial borrowing the Predecessor Entity had made additional principal payments.  The mortgage notes bore interest at a floating rate which could have been determined by reference to an index rate plus an applicable margin not to exceed 5.0%.  As of June 30, 2012, the weighted average interest rate was 4.0%.  Interest expense for the three and six months ended June 30, 2012, was $0.1 million and $0.3 million, respectively.  In connection with obtaining the mortgage notes, the Predecessor Entity incurred $0.2 million in related expenses that were recorded as deferred financing fees.  The deferred financing fees were being amortized into interest expense over the terms of the related debt.  Amortization of deferred financing for the three and six months ended June 30, 2012 was $0.01 million and $0.02 million, respectively.  All amounts under the Predecessor Entity’s mortgage notes were paid in full with proceeds from the Offering.

 

7. Lease Financing Obligations

 

The Predecessor Entity entered into sale-leaseback transactions for certain locations, and since the Predecessor Entity had continuing involvement in the underlying locations, the sale was not recognized and the leaseback or other arrangements were accounted for as lease financing obligations and are included in the table below.  The Predecessor Entity also leased certain fuel stations and equipment under lease agreements accounted for as capital lease obligations.  Certain of the lease agreements were assigned to the Partnership in connection with the Contribution Agreement.  The future minimum lease payments under these lease financing obligations as of June 30, 2013 are as follows (in thousands):

 

		June 30, 2013
Remaining in 2013		$	3,122
2014		6,354
2015		6,460
2016		6,465
2017		6,426
Thereafter		80,590
Total future minimum lease payments		109,417
Less Interest component		39,474
Present value of minimum lease payments		69,943
Current portion		2,533
Long-term portion		$	67,410

 

8. Accrued Expenses and Other Current Liabilities

 

Accrued expenses and other current liabilities for the Partnership consisted of the following at (in thousands):

 

		June 30, 2013			December 31, 2012
Interest expense		$	97		$	124
Professional fees		645			436
Express Lane working capital payable		1,791			1,791
Equity-based incentive compensation		978			—
Taxes other than income		594			40
Other		824			908
Total accrued expenses and other current liabilities		$	4,929		$	3,299

 

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9. Fair Value Measurements

 

The Partnership and the Predecessor Entity measure and report certain financial and non-financial assets and liabilities on a fair value basis.  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).  GAAP specifies a three-level hierarchy that is used when measuring and disclosing fair value.  The fair value hierarchy gives the highest priority to quoted prices available in active markets (i.e., observable inputs) and the lowest priority to data lacking transparency (i.e., unobservable inputs).  An instrument’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation.  The following is a description of the three hierarchy levels.

 

Level 1                                Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.  Active markets are considered to be those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2                                Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability.  This category includes quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in inactive markets.

Level 3                                Unobservable inputs are not corroborated by market data.  This category is comprised of financial and non-financial assets and liabilities whose fair value is estimated based on internally developed models or methodologies using significant inputs that are generally less readily observable from objective sources.

 

Transfers into or out of any hierarchy level are recognized at the end of the reporting period in which the transfers occurred.  There were no transfers between any levels in 2013 or 2012.

 

For assets and liabilities measured on a non-recurring basis during the year, accounting guidance requires quantitative disclosures about the fair value measurements separately for each major category.  See Note 3 for a discussion of impairment charges to reduce the net book value of assets held for sale to fair value less cost to sell.  Such fair value measurements were based on negotiated sales prices, or sales of comparable properties, and represent level 2 measurements.

 

Financial Instruments

 

The fair value of the Partnership’s financial instruments consisting of accounts receivable, accounts payable and debt approximated their carrying value as of June 30, 2013 and December 31, 2012.

 

10. Environmental Liabilities

 

The Partnership currently owns or leases properties where refined petroleum products are being, or have been handled.  These properties, and the refined petroleum products handled thereon, may be subject to federal and state environmental laws and regulations.  Under such laws and regulations, the Partnership could be required to remove or remediate containerized hazardous liquids or associated generated wastes (including wastes disposed of or abandoned by prior owners or operators), to remediate contaminated property arising from the release of liquids or wastes into the environment, including contaminated groundwater, or to implement best management practices to prevent future contamination.

 

The Partnership maintains insurance of various types with varying levels of coverage that is considered adequate under the circumstances to cover operations and properties.  The insurance policies are subject to deductibles that are considered reasonable and not excessive.  In addition, the Partnership has entered into indemnification and escrow agreements with various sellers in conjunction with several of their respective acquisitions, as further described below.  Financial responsibility for environmental remediation is an issue negotiated in connection with each acquisition transaction.  In each case, an assessment is made of potential environmental liability exposure based on available information.  Based on that assessment and relevant economic and risk factors, a determination is made whether to, and the extent to which the Partnership will, assume liability for existing environmental conditions.

 

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The Partnership’s environmental liability was $1.3 million and $1.2 million at June 30, 2013 and December 31, 2012, respectively.  The liability relates to sites acquired or leased since the IPO.  The Partnership made payments of $0.1 million and recorded an additional accrual of $0.2 million in the three months ended June 30, 2013.

 

The Partnership is indemnified by third-party escrow funds of $0.2 million and state funds or insurance totaling $1.1 million, which are recorded as indemnification assets.  State funds represent probable state reimbursement amounts.  Reimbursement will depend upon the continued maintenance and solvency of the state.  Insurance coverage represents amounts deemed probable of reimbursement under insurance policies.

 

The estimates used in these reserves are based on all known facts at the time and an assessment of the ultimate remedial action outcomes.  The Partnership will adjust loss accruals as further information becomes available or circumstances change.  Among the many uncertainties that impact the estimates are the necessary regulatory approvals for, and potential modifications of remediation plans, the amount of data available upon initial assessment of the impact of soil or water contamination, changes in costs associated with environmental remediation services and equipment and the possibility of existing legal claims giving rise to additional claims.

 

Environmental liabilities related to the contributed sites have not been assigned to the Partnership, and are still the responsibility of certain of the Predecessor Entities.  The Omnibus Agreement (further described in Note 16) provides that certain of the Predecessor Entities must indemnify the Partnership for any costs or expenses that the Partnership incurs for environmental liabilities and third-party claims, regardless of when a claim is made, that are based on environmental conditions in existence prior to the closing of the Offering for contributed sites.  Certain of the Predecessor Entities are the beneficiary of escrow accounts created to cover the cost to remediate certain environmental liabilities.  In addition, certain of the Predecessor Entities maintain insurance policies to cover environmental liabilities and/or, where available, participate in state programs that may also assist in funding the costs of environmental liabilities.  Certain sites that were contributed to the Partnership, in accordance with the Contribution Agreement, were identified as having existing environmental liabilities that are not covered by escrow accounts, state funds or insurance policies.

 

The following table presents a summary roll forward of the Predecessor Entity’s environmental liabilities, on an undiscounted basis, for the six months ended June 30, 2013 (in thousands):

 

		Balance at December 31, 2012			Additions 2013			Payments in 2013			Balance at June 30, 2013
Environmental liabilities		$	21,208		$	301		$	1,766		$	19,743

 

A significant portion of the Predecessor Entities’ environmental reserves have corresponding indemnification assets.  The breakdown of the indemnification assets is as follows (in thousands):

 

		June 30, 2013			December 31, 2012
Third-party escrows		$	7,353		$	7,988
State funds		3,519			4,051
Insurance coverage		5,737			6,037
Total indemnification assets		$	16,609		$	18,076

 

11.       Equity-Based Incentive Compensation

 

In connection with the Offering, the General Partner adopted the Lehigh Gas Partners LP 2012 Incentive Award Plan (the “Plan”), a long-term incentive plan for employees, officers, consultants and directors of the General Partner and any of its affiliates, including LGC, who perform services for the Partnership.  The maximum number of common units that may be delivered with respect to awards under the Plan is 1,505,000.  Generally, the Plan provides for grants of restricted units, unit options, performance awards, phantom units, unit awards, unit appreciation rights, distribution equivalent rights, and other unit-based awards, with various limits and restrictions attached to these awards on a grant-by-grant basis.  The Plan is administered by the board of directors of the Partnership’s General Partner or a committee thereof, which is referred to as the Plan Administrator.

 

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Previously, the board of directors had determined to grant up to 500,000 phantom units under the Plan to employees of LGC, other than the chief executive officer of our General Partner, within 180 days after the closing of the Offering.  In this regard, on March 15, 2013, the Partnership granted 446,420 phantom units to certain LGC employees under the Plan.  The fair value of each phantom unit is equal to the closing price of the common units on the date of grant.  The awards vest ratably over a three-year service period.  The estimated fair value of the units expected to vest is recognized ratably over the vesting period as compensation expense.  Total unrecognized compensation cost related to the non-vested phantom units totaled $9.1 million as of June 30, 2013, which is expected to be recognized over a weighted average period of 2.7 years.  Compensation expense for the three and six months ended June 30, 2013 was $0.9 million and $1.0 million, respectively.  The fair value of the non-vested phantom units outstanding as of June 30, 2013, was $11.0 million.

 

The following is a summary of the phantom unit award activity for the six months ended June 30, 2013:

 

Non-vested at January 1, 2013		—
Granted		449,420
Forfeited		(5,174	)
Non-vested at June 30, 2013		444,246

 

It is the intent of the Partnership to settle these phantom units upon vesting by issuing common units, as allowed under the Plan.  However, the awards may be settled in cash at the discretion of the board of directors of the General Partner.

 

12. Partners’ Capital

 

In connection with the closing of the Offering, pursuant to an agreement with the Predecessor, the Predecessor contributed certain assets, liabilities, operations and/or equity interests (the “Contributed Assets”) to the Partnership.  In consideration of the Contributed Assets, the Partnership issued and/or distributed to the Predecessor an aggregate: 625,000 common units, representing 8.3% of the common units outstanding, and 7,525,000 subordinated units, representing 100% of the subordinated units outstanding, which comprise 54.1 % of the aggregate total common units and subordinated units outstanding.  The Partnership issued a total of 6,900,000 common units, including 6,000,000 common units in connection with the initial public offering and 900,000 common units in connection with the underwriter’s over-allotment option.  In January 2013, the Partnership issued an aggregate of 1,044 units to members of the board of directors of the Partnership’s General Partner related to director compensation.

 

13.       Net Income per Limited Partnership Unit

 

Under the Partnership Agreement, our General Partner’s interest in net income from the Partnership consists of incentive distribution rights (“IDRs”), which are increasing percentages, up to 50% of quarterly distributions out of the operating surplus (as defined) in excess of $0.6563 per limited partner unit.  The Partnership’s undistributed net income is generally allocable pro rata to the common and subordinated unitholders, except where common unitholders have received cash distributions in excess of the subordinated unitholders.  In that circumstance, net income is allocated to the common unitholders first in support of such excess cash distribution paid to them and the remainder of the net income is allocable pro rata to the common and subordinated unitholders.  Losses are general allocable pro rata to the common and subordinated unitholders in accordance with the Partnership Agreement.

 

In addition to the common and subordinated units, the Partnership has identified the IDRs as participating securities and computes income per unit using the two-class method under which any excess of distributions declared over net income shall be allocated to the partners based on their respective sharing of income specified in the Partnership Agreement.  Net income per unit applicable to limited partners (including common and subordinated unitholders) is computed by dividing the limited partners’ interest in net income, after deducting any incentive distributions, by the weighted-average number of outstanding common and subordinated units.  There were no participating IDRs for the six months ended June 30, 2013.

 

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