CrossAmerica Partners LP - Quarter Report: 2014 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

For the quarterly period ended June 30, 2014

OR

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  ¨

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  ¨

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  ¨    No  x

As of August 4, 2014, there were 11,194,203 common units and 7,525,000 subordinated units representing limited partner interests outstanding.

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LEHIGH GAS PARTNERS LP

FORM  10-Q

TABLE OF CONTENTS

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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)

The accompanying unaudited notes are an integral part of these

Unaudited Condensed Consolidated Financial Statements.

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Lehigh Gas Partners LP

Condensed Consolidated Statements of Operations

for the Three and Six Months Ended June 30, 2014 and 2013

(unaudited)

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

The accompanying unaudited notes are an integral part of these

Unaudited Condensed Consolidated Financial Statements.

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Lehigh Gas Partners LP

Condensed Consolidated Statements of Partners’ Capital and Comprehensive Income

(unaudited)

(Amounts in thousands, except unit data)

The accompanying unaudited notes are an integral part of these

Unaudited Condensed Consolidated Financial Statements.

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Lehigh Gas Partners LP

Condensed Consolidated Statements of Cash Flows

(unaudited)

(Amounts in thousands)

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The accompanying unaudited notes are an integral part of these

Unaudited Condensed Consolidated Financial Statements.

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Lehigh Gas Partners LP

Notes to Condensed Consolidated Financial Statements

As of and for the Six Months Ended June 30, 2014

(unaudited)

1. Organization and Basis of Presentation

Lehigh Gas Partners LP (the “Partnership”) engages in:

Effective with the April 30, 2014 acquisition of Pinehurst Petroleum, LLC and the resulting ownership of Petroleum Marketers, Incorporated (“PMI”) (see Note 3 for additional information), the Partnership now also engages in the operation of convenience stores and branded, quick-service restaurants.

The Partnership’s primary operations are conducted by the following consolidated, wholly-owned subsidiaries:

LGO is an operator of retail motor fuel stations that purchases all of its motor fuel requirements from the Partnership on a wholesale basis in accordance with the PMPA Franchise Agreement between LGO and LGW. 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 18.

The Partnership was founded in 2012 and completed its initial public offering (“IPO”) on October 30, 2012. In connection with the IPO, Lehigh Gas Corporation (“LGC”) and its subsidiaries and affiliates contributed a part of their business, which we refer to as the “Predecessor” of the “Predecessor Entity,” to the Partnership.

Interim Financial Statements

The accompanying interim condensed consolidated 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, 2013, 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, 2014, and the results of its operations and cash flows for the periods presented. Operating results for the three and six months ended June 30, 2014, are not necessarily indicative of the results that may be expected for the year ending December 31, 2014, or any other future periods. The balance sheet as of December 31, 2013, was derived from the consolidated financial statements for the year ended December 31, 2013. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted under the Securities and Exchange Commission’s (“SEC”) rules and regulations for interim financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the corresponding audited consolidated financial statements and accompanying notes for the year ended December 31, 2013, included in the Partnership’s Annual Report on Form 10-K, filed with the SEC.

Reclassifications

Certain reclassifications were made to prior period amounts to conform to the current year presentation. These reclassifications had no impact on net income or equity for any periods.

Composition of other current assets

Other current assets increased as a result of receivables for fuel rebates and other incentive programs, prepaid and/or refundable income taxes and the receivable recorded for the working capital settlement associated with the acquisition of PMI.

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2. Summary of Significant Accounting Policies

Revenue Recognition

Revenues from wholesale fuel sales are recognized when fuel is delivered to the customer. Revenues from retail fuel sales are recognized when fuel is sold to the customer. Substantially all revenues from fuel sales are from sales of gasoline, with the remainder comprised of diesel and other products.

Revenue from leasing arrangements in which the Partnership is the lessor is recognized ratably over the term of the underlying lease.

Retail food and merchandise sales are recognized net of applicable provisions for discounts and allowances upon delivery, generally at the point of sale.

Inventory

Motor fuel inventory consists of gasoline, diesel fuel and other petroleum products and is stated at the lower of average cost or market using the first-in, first-out method. No provision for potentially obsolete or slow-moving inventory has been made. The Partnership records inventory from the time of the purchase of motor fuels from third party suppliers until the retail sale to the end customer.

Food and merchandise inventory is valued at the lower of cost or market using the first-in, first-out method.

Asset Retirement Obligations

The Partnership is obligated by contractual or regulatory requirements or contingently obligated at the discretion of the lessor to remove certain equipment, such as underground gasoline storage tanks, or perform other remediation upon retirement of certain assets at sites at which the Partnership is the lessee. Certain states statutorily require removal of the underground storage tanks at a certain point in time. An asset retirement obligation is recognized in the period incurred, which is generally either at the time of lease inception or at the time a decision is made to close a site. Determination of the amounts recognized is based on numerous estimates and assumptions, including expected settlement dates and probability of occurrence, future retirement costs, future inflation rates and credit-adjusted risk-free rates. The Partnership’s asset retirement obligations, which are primarily included in other long-term liabilities in the balance sheets, totaled $2.1 million and $2.2 million at June 30, 2014 and December 31, 2013, respectively.

New Accounting Guidance

Discontinued Operations

In April 2014, the Financial Accounting Standards Board issued Accounting Standard Update 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of an Entity, which revises the criteria to qualify as a discontinued operation and requires new disclosures. Under this guidance, a discontinued operation is (1) a component of an entity or group of components that has been disposed of or classified as held for sale that represents a strategic shift that has or will have a major effect on an entity’s operations and financial results or (2) an acquired business that is classified as held for sale on the date of acquisition. This guidance also permits companies to have continuing cash flows and significant continuing involvement with the disposed component.

The Partnership disposes of individual sites or groups of sites from time to time that generally do not represent a strategic shift and generally do not have a major effect on operations or financial results. As a result of this new guidance, these disposals will generally not meet the criteria for recognition as a discontinued operation. The Partnership has early adopted this guidance on a prospective basis effective January 1, 2014.

Revenue Recognition

In May 2014, the Financial Accounting Standards Board issued Accounting Standard Update 2014-09, Revenue from Contracts with Customers, which clarifies the principles for recognizing revenue and develops a common revenue standard under U.S. GAAP and International Financial Reporting Standards. Specifically, the core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services.

This guidance is effective January 1, 2017 and provides for modified retrospective transition. Management has not yet assessed the impact of adopting this guidance.

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3. Acquisitions

PMI Acquisition

On April 28, 2014, the Partnership exercised an option (“Option”) to purchase 100% of the membership interests of Pinehurst Petroleum, LLC (“Pinehurst”) from Joseph L. Smith III and John A. Kopfer, Jr. (“Smith/Kopfer”) for $4.0 million. Pinehurst’s sole asset was an Agreement and Plan of Merger among Pinehurst, PMI Merger Sub, Inc., a wholly-owned subsidiary of Pinehurst (“Sub”), Petroleum Marketers, Incorporated, (“PMI”), Petroleum Marketers, Incorporated Employee Stock Ownership Trust and Ronald R. Hare, in his capacity as representative (the “Merger Agreement”) pursuant to which Pinehurst agreed to acquire all of the shares of PMI for $73.5 million inclusive of an adjustment for working capital, through the merger (the “Merger”) of Sub and PMI. Under the terms of the Merger Agreement, the stockholders of PMI agreed to escrow $5.0 million for 25 months after the closing date to secure the indemnity provisions contained in the Merger Agreement for the benefit of Pinehurst. The Merger Agreement also contains customary representations, warranties, agreements and obligations of the parties, and termination, closing conditions and indemnity provisions. The transaction was funded with borrowings under the Partnership’s Credit Facility. On April 30, 2014, pursuant to the Option, the Partnership purchased all of the equity interests of Pinehurst ($2.0 million of the consideration has been included in accrued expenses and other current liabilities at June 30, 2014). Subsequent to such purchase, the Merger became effective and, as a result, the Partnership became the owner of PMI. The exercise of the Option and the Merger is referred to as the PMI Transaction.

The acquisition augmented the Partnership’s presence in Virginia and complements the existing Tennessee operations. The Partnership expects to realize material synergy upon integration of PMI. PMI operates two primary lines of business: convenience stores and petroleum products distribution. In its convenience store business, PMI operates 87 convenience stores and nine co-located branded quick service restaurants located in Virginia and West Virginia. The convenience stores distribute primarily branded fuel and operate under the PMI’s own proprietary convenience store brand, “Stop in Food Stores.” The petroleum products business distributes motor fuels and other petroleum products to customers throughout Virginia, West Virginia, Tennessee and North Carolina.

On May, 1, 2014, immediately subsequent to the effectiveness of the Merger, the Partnership caused PMI to divest its lubricants business (the “Lubricants Business”) to Zimri Holdings, LLC (“Zimri”), an entity owned by Smith/Kopfer for the sum of $14.0 million pursuant to an Asset Purchase Agreement (“APA”) between PMI and Zimri. The APA contains customary representations, warranties, agreements and obligations of the parties, as well as indemnity provisions. A trust controlled by Joseph V. Topper, Jr, Chairman and CEO of the general partner of the Partnership, financed the purchase of the Lubricants Business by Zimri pursuant to a loan to Zimri. The financing by Mr. Topper’s trust was approved by the Conflicts Committee of the board of directors of the general partner of the Partnership. It is anticipated that Zimri will re-sell the Lubricants Business to an independent third party at a later date. The Partnership is entitled to receive the profit, if any, from the sale of the Lubricants Business to an independent third party.

The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed at the acquisition date, the fair value of the net assets divested as part of the Lubricants Business and the preliminary fair values of the assets acquired and liabilities assumed net of the divestiture (in thousands):

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The fair value of inventory was estimated at retail selling price less costs and a reasonable profit allowance for the selling effort.

The above fair values of assets and liabilities acquired are provisional and based on information that was available as of the acquisition date. The Partnership believes the information provides a reasonable basis for estimating the fair values. The purchase price allocation is preliminary pending a final valuation of the assets and liabilities, including a final valuation of property and equipment, intangible assets and the impact of income taxes. 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 accounting for the transaction as soon as practicable, but no later than one year from the acquisition date.

The fair value of land, buildings, and equipment was based on 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.

The $15.0 million fair value of the wholesale fuel supply agreements was based on 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 supply agreements over their estimated remaining useful life, using probability-weighted cash flows, generally assumed to extend through the term of the wholesale fuel supply contracts, and using discount rates considered appropriate given the inherent risks associated with this type of agreement. Management believes the level and timing of cash flows represent relevant market participant assumptions. The wholesale fuel supply agreements are being amortized on a straight-line basis over an estimated useful life of approximately 10 years.

Goodwill recorded is primarily attributable to the deferred tax liabilities arising from the application of purchase accounting.

Aggregate incremental revenues since the closing of the PMI Transaction included in the Partnership’s statement of operations were $173.8 million for the three and six months ended June 30, 2014.

The following is unaudited pro forma information related to the PMI acquisition as if the transaction had occurred on January 1, 2013 (in thousands):

Atlas Acquisition

On May 19, 2014, the Partnership completed its acquisition of 52 wholesale supply contracts, one sub-wholesaler contract, nine fee sites, six leasehold sites and certain other assets from affiliates of Atlas Oil Company (“Atlas”) for $35.0 million. In addition, the Partnership acquired certain short-term notes receivable associated with the wholesale supply and commission marketing contracts for $5.2 million, bringing total consideration to $40.2 million, subject to closing adjustments. The transaction was funded by borrowings under the Partnership’s Credit Facility and $4.0 million of proceeds from the sale of the Lubricants Business that were directed to an escrow agent as part of a Section 1031 like-kind exchange.

These assets are located in the Chicago, Illinois area and are branded BP. The wholesale supply contracts have a remaining average term of 15 years and the fee or leasehold sites are currently leased to third party commission agents. The short-term notes receivable relate to previously negotiated purchase agreements of certain sites by the dealers occupying the locations. All of the notes receivable relate to sites supplied under contracts acquired in this transaction. The notes receivable have a weighted average maturity of June 2015.

In connection with the acquisition, Sam Simon, Chairman and Chief Executive Officer of Atlas Oil Company, entered into a non-compete agreement that generally restricts him and entities controlled by him from (a) engaging in the wholesale distribution of motor fuel or owning or operating a retail motor fuel facility and/or convenience store within certain territories for one year after the closing date, and (b) constructing any new retail motor fuel facility and/or convenience stores within certain territories for five years after the closing date.

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

The above fair values of assets and liabilities acquired are provisional and based on information that was available as of the acquisition date. The Partnership believes the information provides a reasonable basis for estimating the fair values. The purchase price allocation is preliminary pending a final valuation of the assets and liabilities, including a final valuation of property and equipment, intangible assets and the impact of income taxes. 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 accounting for the transaction as soon as practicable, but no later than one year from the acquisition date.

The fair value of land, buildings, and equipment was based on 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.

The approximate $14.0 million fair value of the wholesale fuel supply agreements was based on 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 supply agreements over their estimated remaining useful life, using probability-weighted cash flows, generally assumed to extend through the term of the wholesale fuel supply contracts, and using discount rates considered appropriate given the inherent risks associated with this type of agreement. Management believes the level and timing of cash flows represent relevant market participant assumptions. The wholesale fuel supply agreements are being amortized on an accelerated basis over an estimated useful life of approximately 10 years.

The approximate $1.0 million fair value of the covenant not to compete was based on an income approach, with the fair value estimated to be the difference between the present value of after-tax cash flows with and without the covenant not to compete in place, 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 covenant not to compete intangible asset is being amortized on a straight-line basis over a 5-year period.

Aggregate incremental revenues for the acquisition since the acquisition date included in the Partnership’s statements of operations were $28.4 million for the three and six months ended June 30, 2014.

Acquisition Costs

Acquisition costs totaled $5.6 million and $0.3 million for the three months ended June 30, 2014 and 2013 and $5.9 million and $0.5 million for the six months ended June 30, 2014 and 2013, respectively. Such costs are included in selling, general and administrative expenses.

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4. Assets Held for Sale

The Partnership classified five and two sites as held for sale at June 30, 2014, and December 31, 2013, respectively. These assets were classified as held for sale at June 30, 2014, as they did not fit the Partnership’s strategy and are expected to be sold in 2014. Assets held for sale were as follows (in thousands):

5. Inventory

As noted previously, as a result of the PMI Transaction, the Partnership began recording food and merchandise inventory as well as motor fuel inventory at the sites it operates. Inventory consisted of the following (in thousands):

6. Property and Equipment

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

Depreciation expense, including amortization of assets recorded under sale-leasebacks and capital lease obligations, was $4.9 million and $3.8 million for the three months ended June 30, 2014 and 2013, and $9.4 million and $7.6 million for the six months ended June 30, 2014 and 2013, respectively.

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In addition to the business combinations discussed in Note 3, the following asset purchases and divestitures occurred in the six months ended June 30, 2014 and 2013:

7. Goodwill and Intangible Assets

Changes in goodwill consisted of the following (in thousands):

No impairment losses have been recorded to goodwill. See Note 3 for additional information on the acquisitions.

Intangible assets other than goodwill consisted of the following (in thousands):

The aggregate amortization expense, including amortization of above and below market lease intangible assets which is classified as rent expense, was $2.3 million and $1.1 million for the three months ended June 30, 2014 and 2013 and $3.8 million and $2.1 million for the six months ended June 30, 2014 and 2013, respectively.

See Note 3 for additional information on the acquisitions.

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8. Accrued Expenses and Other Current Liabilities

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

9. Debt

Debt outstanding was as follows (in thousands):

Credit Facility

In March 2014, the Partnership entered into an amended and restated credit agreement (the “Credit Facility”). The Credit Facility is a senior secured revolving credit facility maturing on March 4, 2019 with a total borrowing capacity of $450 million, under which swing-line loans may be drawn up to $10.0 million and standby letters of credit may be issued up to an aggregate of $45.0 million. The Credit Facility may be increased, from time to time, upon the Partnership’s written request, subject to certain conditions, up to an additional $100.0 million. All obligations under the Credit Facility are secured by substantially all of the assets of the Partnership and its subsidiaries.

Borrowings under the Credit Facility bear interest, at the Partnership’s option, at (1) a rate equal to the London Interbank Offering Rate (“LIBOR”), for interest periods of one week or one, two, three or six months, plus a margin of 2.00% to 3.25% per annum, depending on the Partnership’s total 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 1.00% to 2.25% per annum depending on the Partnership’s total leverage ratio. In addition, the Partnership incurs a commitment fee based on the unused portion of the revolving credit facility at a rate of 0.35% to 0.50% per annum depending on the Partnership’s total leverage ratio. The weighted-average interest rate on outstanding borrowings at June 30, 2014, was 2.8%. Letters of credit outstanding at June 30, 2014 and December 31, 2013 totaled $18.2 million and $12.3 million, respectively. The nominal amount of availability at June 30, 2014, was $160.3 million.

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The Partnership is required to comply with certain financial covenants under the Credit Facility. Effective July 2, 2014, the Partnership is required to maintain a total leverage ratio (as defined) for the most recently completed four fiscal quarters of less than or equal to 5.50:1.00 for the period of April 1, 2014, through September 30, 2014; and 5.00:1.00 for the period of October 1, 2014, through December 31, 2014, and 4.50:1.00 for periods thereafter, except for periods following a material acquisition. However, if an offering of Equity Interests (as defined) in the Partnership occurs after July 2, 2014, but prior to December 31, 2014, the total leverage ratio shall not exceed 4.50:1.00 for the fiscal quarter ending December 31, 2014; and the total leverage ratio shall not exceed 5.00:1.00 for the first two full fiscal quarters following the closing of a material acquisition or upon the issuance of Qualified Senior Notes (as defined) in the aggregate principal amount of $175,000,000 or greater. The Partnership is also required to maintain a senior leverage ratio (as defined) after the issuance of Qualified Senior Notes of $175,000,000 or greater of less than or equal to 3.50:1.00 and a consolidated interest coverage ratio (as defined) of at least 2.75 to 1.00.

The Credit Facility prohibits the Partnership from making distributions to its unitholders if any potential default or event of default occurs or would result from the distribution, or the Partnership is not in compliance with its financial covenants. 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.

10. Operating Leases

Operating Leases of Sites as Lessee

The Partnership leases sites from third parties under certain non-cancelable operating leases that expire from time to time through 2028.

The future minimum lease payments under operating leases as of June 30, 2014 were as follows (in thousands):

The future minimum lease payments presented above do not include contingent rent based on future inflation, future revenues or volumes, or amounts that may be paid as reimbursements for certain operating costs incurred by the lessor. Most lease agreements include provisions for renewals.

Getty Lease

In May 2012, the Predecessor Entity entered into a 15-year master lease agreement with renewal options of up to an additional 20 years with Getty. Pursuant to the lease, the Predecessor Entity leased 105 gas station sites in Massachusetts, New Hampshire and Maine (the “New England Sites”). The lease was assigned to the Partnership in November 2012. In December 2012, the agreement was amended to add an additional 25 sites in New Jersey. In December 2013, the agreement was further amended to add one site in Delaware and one site in Maryland. The Partnership pays fixed rent, which increases 1.5% per year. In addition, the lease requires contingent rent payments based on gallons of fuel sold. During the initial three years of the lease, the Partnership is required to make capital expenditures of at least $4.3 million plus $0.01 per gallon of fuel sold at the New England Sites. However, the Partnership is entitled to a rent credit equal to 50% of the capital expenditures up to a maximum of $2.1 million. During the initial 3.5 years of the lease, the Partnership is required to make capital expenditures of at least $1.0 million at the New Jersey sites.

Because the fair value of the land at lease inception was estimated to represent more than 25% of the total fair value of the real property subject to the lease, the land element of the lease was analyzed for operating or capital treatment separately from the rest of the property subject to the lease. The land element of the lease was classified as an operating lease and all of the other property was classified as a capital lease. As such, future minimum lease payments are included in both the lease financing obligations and operating lease tables above.

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Through June 30, 2014, four sites were terminated from the lease and the Partnership notified Getty of its intent to terminate eight additional sites from the lease. Any property and equipment or lease financing obligations associated with these sites were removed from the balance sheet, which resulted in a gain of $0.1 million, classified as a credit to rent expense for the six months ended June 30, 2014.

Operating Leases of Sites as Lessor

Motor fuel stations are leased to tenants under operating leases with various expiration dates ranging through 2028.

The future minimum lease payments under non-cancelable operating leases with third parties and operating leases with LGO as of June 30, 2014 were as follows (in thousands):

The future minimum lease payments presented above do not include contingent rent based on future inflation, future revenues or volumes of the lessee, or amounts that may be received as tenant reimbursements for certain operating costs. Most lease agreements include provisions for renewals.

On May 28, 2014, the Partnership entered into a Master Lease Agreement (the “Lease”) with LGO, with an effective date of June 1, 2014 which consolidated all of the individual leases then in effect into a single master lease. The terms and conditions of the Lease are substantially identical to the existing individual leases except as follows: the Partnership’s right to terminate each lease was deleted, and in its place, each party has the right to either sever, in the case of LGO, up to 7% of the leased premises each year, or recapture, in the case of the Partnership, up to 5% of the leased premises each year from the Lease at any time prior to the fifth anniversary of the commencement date (as defined) for such leased premises. Each party’s right is cumulative in that if a party does not sever or recapture, as applicable, the full amount of leased premises for which it has rights, then the non-utilized amount may be carried forward into subsequent years. The Lease was approved by the Conflicts Committee of the general partner of the Partnership.

11. Environmental Matters

The Partnership currently owns or leases sites where refined petroleum products are being or have been handled. These sites 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/or escrow agreements with various sellers in conjunction with several of their respective acquisitions, as further described below. Financial responsibility for environmental remediation is 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 table below presents a rollforward of the Partnership’s environmental liability for the six months ended June 30, 2014 and 2013 (in thousands).

At June 30, 2014, the Partnership was indemnified by third-party escrow funds, state funds or insurance totaling $1.4 million, which were 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 liabilities were 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 the Predecessor Entities (see the Annual Report on Form 10-K for the year ended December 31, 2013, for additional discussion of the Predecessor Entities). Under the Omnibus Agreement between the Partnership and LGC (the “Omnibus Agreement”), 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 IPO for contributed sites. Certain of the Predecessor Entities are beneficiaries 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 were identified as having existing environmental liabilities that are not covered by escrow accounts, state funds or insurance policies.

The table below presents a rollforward of the Predecessor Entities’ environmental liability for the six months ended June 30, 2014 (in thousands).

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

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12. Commitments and Contingencies

Purchase Commitments

The future minimum volume purchase requirements under the existing supply agreements are approximate gallons, with a purchase price at prevailing market rates for wholesale distribution. The following provides total future minimum volume purchase requirements (in thousands of gallons) for the following years:

In the event for a given contract year the Partnership fails to purchase the required minimum volume, the underlying third party’s exclusive remedies (depending on the magnitude of the failure) are either termination of the supply agreement and/or a financial penalty per gallon based on the volume shortfall for the given year.

Legal Matters

In the normal course of business, the Partnership has and may become involved in legal actions relating to the ownership and operation of its properties and business. In management’s opinion, the resolutions of any such pending legal actions are not expected to have a material adverse effect on its financial position, results of operations and cash flows. The Partnership maintains liability insurance on certain aspects of its businesses in amounts deemed adequate by management. However, there is no assurance that this insurance will be adequate to protect it from all material expenses related to potential future claims or these levels of insurance will be available in the future at economically acceptable prices.

Environmental Matters

See Note 11 for a discussion of the Partnership and the Predecessor Entity’s environmental liabilities.

13. Fair Value Measurements

The Partnership measures and reports 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.

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 2014 or 2013.

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As further discussed in Note 15, the Partnership has accrued for phantom units and profits interests granted as a liability and adjusts that liability on a recurring basis based on the market price of the Partnership’s common units each balance sheet date. Such fair value measurements are deemed Level 1 measurements.

Financial Instruments

The fair value of the Partnership’s accounts receivable and accounts payable approximated their carrying values as of June 30, 2014, and December 31, 2013, due to the short-term maturity of these instruments. The fair value of the Partnership’s long-term debt approximated its carrying value as of June 30, 2014, and December 31, 2013, due to the frequency with which interest rates are reset based on changes in prevailing interest rates. The fair value of debt, classified as a Level 2 measurement, was estimated using an income approach by discounting future cash flows at estimated current cost of funding rates, which incorporate the credit risk of the Partnership.

14. Partners’ Capital

In March 2014, the Partnership issued 4,172 common units to certain members of the board of directors of the Partnership’s General Partner as part of their 2013 compensation.

In March 2014, 92,683 common units were issued (net of units withheld for income taxes) to employees of LGC as a result of the vesting of phantom units (see Note 15 for additional information).

15. Equity-Based Incentive Compensation

In connection with the IPO, 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, profits interests, 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.

The Plan Administrator may terminate or amend the Plan at any time with respect to any common units for which a grant has not yet been made. The Plan Administrator also has the right to alter or amend the Plan or any part of the Plan from time to time, including increasing the number of common units that may be granted, subject to unitholder approval as required by the exchange upon which common units are listed at that time; however, no change in any outstanding grant may be made that would adversely affect the rights of a participant with respect to awards granted to a participant prior to the effective date of such amendment or termination, except that the board of directors of our General Partner may amend any award to satisfy the requirements of Section 409A of the Internal Revenue Code. The Plan will expire on the tenth anniversary of its approval, when common units are no longer available under the Plan for grants or upon its termination by the Plan Administrator, whichever occurs first.

In March 2014, the Partnership contributed its investments in its operating subsidiaries and certain other assets and liabilities to LGP Operations LLC (“LGP Operations”), a wholly-owned subsidiary of the Partnership. Also in March 2014, LGP Operations granted profits interests to certain employees of LGC, which are represented by Class B Units in LGP Operations. Upon vesting, Class B Unitholders will be entitled to receive cash distributions proportionate to those received by common unitholders. Class B Units are redeemable two years after they were granted, subject to certain limitations, for cash or common units at the discretion of the compensation committee of the board of directors of the General Partner.

Awards to Employees of Affiliates

The following is a summary of the award activity for the six months ended June 30, 2014.

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Awards vest 33% on March 15 of the year following the year of grant, 33% on March 15 of the second year following the year of grant, and 34% on March 15 of the third year following the year of grant.

The fair value of the non-vested awards outstanding at June 30, 2014, was $9.1 million. Compensation expense for the three months ended June 30, 2014 and 2013 was $1.0 million and $0.9 million, and for the six months ended June 30, 2014 and 2013 was $1.9 million and $1.0 million, respectively. Unrecognized compensation expense related to the non-vested awards is expected to be recognized over a weighted average period of 1.9 years.

It is the intent of the Partnership to settle the phantom units upon vesting by issuing common units and to settle the profits interests upon conversion by the grantee by issuing common units, as permitted under the Plan. However, the awards may be settled in cash at the discretion of the compensation committee of the board of directors of the General Partner.

Because the Partnership grants awards to employees of LGC, and because the grants may be settled in cash, the grants are measured at fair value at each balance sheet reporting date and the cumulative compensation cost recognized is classified as a liability, which is included in accrued expenses and other current liabilities on the balance sheet.

Awards to Members of the Board of Directors

During the six months ended June 30, 2014, the Partnership also granted the following awards to members of the board of directors of the General Partner as a portion of director compensation:

The fair value of the non-vested awards outstanding at June 30, 2014, was $0.3 million. Unrecognized compensation expense related to the non-vested awards is expected to be recognized through December 31, 2014.

16. Income Taxes

As a limited partnership, the Partnership is not subject to federal and state income taxes. Income tax attributable to the Partnership’s taxable income, which may differ significantly from income for financial statement purposes, is assessed at the individual level of the unitholder. The Partnership is subject to a statutory requirement that non-qualifying income, as defined by the Internal Revenue Code, cannot exceed 10% of total gross income for the calendar year. If non-qualifying income exceeds this statutory limit, the Partnership would be taxed as a corporation. The non-qualifying income did not exceed the statutory limit in any period.

Certain activities that generate non-qualifying income are conducted through a taxable corporate subsidiary, LGWS. Current and deferred income taxes are recognized on the earnings of LGWS. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and are measured using enacted tax rates.

As a result of the recognition of net deferred tax liabilities associated with the preliminary purchase price allocation related to the acquisition of PMI, the Partnership released $5.2 million of its valuation allowance against deferred tax assets in the second quarter of 2014. Since the purchase price allocation is preliminary, such release is subject to change and such change could be material. Further, in conjunction with the Partnership’s ongoing review of its actual results and anticipated future earnings, the Partnership continuously reassesses the possibility of releasing the remaining $1.9 million valuation allowance on its deferred tax assets. It is reasonably possible that a significant portion of the valuation allowance will be released within the next twelve months. The valuation allowance release was partially offset by the impact of certain nondeductible acquisition costs and the taxable gain on the sale of the Lubricants Business for which a portion related to nondeductible goodwill.

For the three and six months ended June 30, 2013, the Partnership recorded an increase in the valuation allowance of $0.1 million and $0.5 million, respectively.

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17. Net Income per Limited Partnership Unit

Under the Partnership Agreement, the holders of the incentive distribution rights (“IDRs”) have an interest in distributions from the Partnership that are increasing percentages starting at 15% of quarterly distributions out of the operating surplus (as defined) in excess of $0.5031 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 generally 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 2013. However, the distributions declared in March and May 2014 exceeded the threshold and so IDRs participated in these distributions as summarized on the statements of operations.

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The following provides a reconciliation of net income and the allocation of net income to the limited partners’ interest for purposes of computing net income per limited partner unit for the following periods (in thousands, except unit, and per unit amounts):

In August 2014, the Partnership declared a quarterly distribution, to be paid from the operating surplus, totaling $9.8 million or $0.5225 per unit.

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18. Related-Party Transactions

Revenues from Fuel Sales to LGO

In connection with the IPO, the Partnership and LGO entered into a PMPA Franchise Agreement pursuant to which the Partnership is the exclusive distributor of motor fuel to all sites operated by LGO for a period of 15 years. The Partnership has the right to impose the brand of fuel that is distributed to LGO. There are no minimum volume requirements that LGO is required to satisfy. The Partnership charges LGO the “dealer tank wagon” prices for each grade of product in effect at the time title to the product passes to LGO. Revenues and cost of revenues from fuel sales to LGO are separately classified in the statements of operations.

Revenues from Fuel Sales to Related Parties

In addition, the Partnership distributes motor fuel and leases property to a related party of the Chief Executive Officer of the General Partner. Total revenues amounted to $26.9 million and $26.4 million for the three months ended June 30, 2014 and 2013 and $50.9 million and $51.4 million for the six months ended June 30, 2014 and 2013, respectively. Accounts receivable amounted to $1.8 million and $1.1 million as of June 30, 2014 and December 31, 2013, respectively.

Operating Leases of Gasoline Stations as Lessor

The Partnership leases certain motor fuel stations to LGO under operating leases. See Note 10 for additional details. Rent income under these agreements is separately classified in the statements of operations.

Operating Leases of Gasoline Stations as Lessee

The Partnership leases certain motor fuel stations from related parties under operating leases cancelable by the Partnership. Rent expense under these agreements was $0.3 million and $0.3 million for the three months ended June 30, 2014 and 2013 and $0.6 million and $0.5 million for the six months ended June 30, 2014 and 2013, respectively.

Management Fees

The Partnership incurred $1.7 million and $1.7 million for the three months ended June 30, 2014 and 2013 and $3.4 million and $3.3 million for the six months ended June 30, 2014 and 2013, respectively, in management fees under the Omnibus Agreement classified as selling, general and administrative expenses in the statements of operations.

In connection with the acquisitions of PMI and Atlas discussed previously, the Partnership amended its Omnibus Agreement with its general partner and LGC with regards to the management fee payable by the Partnership to LGC effective July 1, 2014. The revised management fee consists of a base monthly fee of $670,000 per month and a variable fee of between zero and $0.003 per gallon for wholesale fuel distribution and $0.015 per gallon for retail fuel distribution at sites operated by the Partnership. LGC may waive all or any portion of the management fee to the extent that all or a portion of the management services are either purchased from another party or not required.

Effective July 1, 2014, the Partnership entered into a sublease with LGC whereby the Partnership is responsible for paying 54% of the required rent payments under the LGC lease as rent for its corporate offices. The term of the sublease is 15 years. Annual rent payments under this lease are $0.3 million. Since the management fee paid by the Partnership to LGC pursuant to the Omnibus Agreement incorporates rent for office space, no incremental expense will be incurred by the Partnership.

Commencing with the PMI acquisition, the Partnership incurred management fees with an affiliate for payroll and related benefits of $2.9 million for the three and six months ended June 30, 2014, which was classified as selling, general and administrative expenses in the statement of operations.

As discussed in Note 3, the Partnership caused PMI to divest the Lubricants Business to Zimri. There is a transition services agreement under which PMI provides services to Zimri. PMI charged Zimri $0.2 million for such services for the period from May 1, 2014 through June 30, 2014, classified as a reduction of selling, general and administrative expenses in the statement of operations. As part of the transition services agreement, the Partnership advanced $3.6 million to Zimri for working capital purposes. Such advance is anticipated to be repaid in the third quarter of 2014.

Maintenance and Environmental Costs

Certain maintenance and environmental monitoring and remediation activities are undertaken by a related party of the Partnership as approved by the conflicts committee of the board of directors of the General Partner. The Partnership incurred $0.4 million and $0.5 million with this related party for the three and six months ended June 30, 2014, respectively.

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Aircraft Usage

The Partnership uses aircraft owned by a group of individuals that includes the CEO and certain other members of the board of directors of the General Partner as approved by the disinterested members of the conflicts committee of the board of directors of the General Partner. The Partnership incurred $0.1 million for the use of these aircraft for the three and six months ended June 30, 2014.

19. Segment Reporting

Effective September 1, 2013, the Partnership engages in both the wholesale and retail distribution of motor fuels, primarily gasoline and diesel fuel. Effective with the PMI Transaction, the Partnership now also engages in the operation of convenience stores and branded quick-service restaurants. Given these changes, the Partnership is deemed to conduct its business in two segments: 1) the wholesale segment and 2) the retail segment. The Partnership’s measure of segment profit or loss is net income. Unallocated costs consist primarily of interest expense associated with the Credit Facility, selling, general and administrative expenses, income taxes and the elimination of the retail segment’s intersegment cost of revenues from fuel sales against the wholesale segment’s intersegment revenues from fuel sales. The profit in ending inventory generated by the intersegment fuel sale is also eliminated. Total assets by segment are not presented as the chief operating decision maker does not currently assess performance or allocate resources based on that data. Financial data for each segment is as follows (in thousands):

20. Subsequent Event

On August 6, 2014, the Partnership announced the sale of the Partnership’s general partner, Lehigh Gas GP LLC (the “General Partner”), to CST GP, LLC, a wholly owned subsidiary of CST Brands, Inc. (“CST Brands”), from LGC. Mr. Topper, the Chairman and CEO of the Partnership, will continue in his role as CEO and President of the Partnership and will join the Board of Directors of CST Brands. Mr. Topper and his affiliates and Mr. Reilly, a director of the General Partner, are not selling any of their ownership interests in the Partnership in the transaction and will continue to own subordinated and common units representing approximately 44% of the ownership interests of the Partnership. The transaction does not involve the sale or purchase of any of the common or subordinated units of the Partnership and the Partnership will continue to operate as a separate, publicly-traded, master limited partnership and maintain its current headquarters. The consummation of the sale is subject to various conditions and is expected to close early in the fourth quarter of 2014.

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Contemporaneously with and subject to the closing of the sale, the Partnership, LGC and LGO will enter into a series of transactions pursuant to which LGC will acquire the wholesale fuel supply for 78 locations in Pennsylvania and New York currently supplied by the Partnership and the fuel supply by the Partnership to such sites will be terminated for an aggregate purchase price and on terms to be approved by the conflicts committee of the board of directors of the General Partner. In addition, subleases for 12 of the sites, which are currently leased to the Partnership, will be assigned to LGC or its affiliates.

The General Partner manages the operations and activities of the Partnership. The Partnership is managed and operated by the board of directors and executive officers of the General Partner. Upon the consummation of the sale, CST Brands will control the General Partner and will have the right to appoint all members of the board of directors of the General Partner.

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in this Quarterly Report.

Forward Looking Statements

This Quarterly Report on Form 10-Q and oral statements made regarding the subjects of this Quarterly Report may contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, or the Reform Act, which may include, but are not limited to, statements regarding our plans, objectives, expectations and intentions and other statements that are not historical facts, including statements identified by words such as “outlook,” “intends,” “plans,” “estimates,” “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “approximately,” “predicts,” “anticipates,” “foresees,” or the negative version of these words or other comparable expressions. All statements addressing operating performance, events, or developments that we expect or anticipate will occur in the future, including statements relating to revenue growth and earnings or earnings per unit growth, as well as statements expressing optimism or pessimism about future operating results, are forward-looking statements within the meaning of the Reform Act. The forward-looking statements are based upon our current views and assumptions regarding future events and operating performance and are inherently subject to significant business, economic and competitive uncertainties and contingencies and changes in circumstances, many of which are beyond our control. The statements in this Quarterly Report are made as of the date of this report, even if subsequently made available by us on our website or otherwise. We do not undertake any obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Quarterly Report.

Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy. Achieving the results described in these statements involves a number of risks, uncertainties and other factors that could cause actual results to differ materially, including the following factors:

All written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements. You should evaluate all forward-looking statements made in this Quarterly Report in the context of these risks and uncertainties. We caution you that the important factors referenced above may not contain all of the factors that are important to you.

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Overview

We are a Delaware limited partnership formed to engage in the distribution of motor fuels, consisting of gasoline and diesel fuel, and to own and lease real estate used in the retail distribution of motor fuels. Since our Predecessor was founded in 1992, we have generated revenues from the wholesale distribution of motor fuels to retail sites and from real estate leases. In the third quarter of 2013, we also began generating revenues, on a select basis, through the retail distribution of motor fuels at sites operated by commission agents and in the second quarter of 2014, as a result of the PMI Transaction, we began generating revenues from the operation of convenience stores and branded quick-service restaurants.

Our primary business objective is to make quarterly cash distributions to our unitholders and, over time, to increase our quarterly cash distributions. We intend to make minimum quarterly distributions of at least $0.4375 per unit, per quarter (or $1.75 per unit on an annualized basis). Our declared distributions since May 2013 are summarized below:

The amount of any distributions is subject to the discretion of the board of directors of our General Partner which may modify or revoke our cash distribution policy at any time. Our partnership agreement does not require us to pay any distributions.

We believe consistent demand for motor fuels in the areas where we operate and the contractual nature of our rent income provide a stable source of cash flow. Cash flows from the wholesale distribution of motor fuels are generated primarily by a per gallon margin that is either a fixed or variable mark-up per gallon, depending on our contract terms. By delivering motor fuels through independent carriers on the same day we purchase the motor fuels from suppliers, we seek to minimize the commodity price risks typically associated with the purchase and sale of motor fuels. We also generate cash flows from rent income primarily by collecting rent from lessee dealers, LGO and non-gas tenants pursuant to lease agreements, the retail distribution of motor fuel at sites operated by the commission agents and the operation of convenience stores and branded, quick-service restaurants.

For the three and six months ended June 30, 2014, we distributed an aggregate of approximately 235.5 million and 395.1 million gallons of motor fuels, respectively. At June 30, 2014, we distributed motor fuels to 1,092 sites, comprised of the following classes of business: