ITEM 1. BUSINESS
BUSINESS OVERVIEW
We are a holding company which, through our wholly owned subsidiaries, owns, operates and franchises travel centers along the North American highway system to serve long-haul trucking fleets and their drivers, independent truck drivers and general motorists. Our network is the largest, and only nationwide, full-service travel center network in the United States. At December 31, 2004, our geographically diverse network consisted of 160 sites located in 41 states and the province of Ontario, Canada. Our operations are conducted through three distinct types of travel centers:
- sites operated by us, which we refer to as company-operated sites;
- sites owned by us and leased to independent lessee-franchisees, which we refer to as leased sites; and
- sites owned and operated by independent franchisees, which we refer to as franchisee-owned sites.
Our travel centers are located at key points along the U.S. interstate highway system and in Canada, typically on 20- to 25-acre sites. Most of our network properties were developed more than 20 years ago when prime real estate locations along the interstate highway system were more readily available than they are today, making a network such as ours difficult to replicate. Operating under the "TravelCenters of America" and "TA" brand names, our nationwide network provides an advantage to long-haul trucking fleets by enabling them to reduce the number of their suppliers by routing their trucks within our network from coast to coast.
One of the primary strengths of our business is the diversity of our revenue sources. We have a broad range of product and service offerings, including diesel fuel and gasoline, truck repair and maintenance services, full-service restaurants, more than 20 different brands of fast food restaurants, which we refer to as quick service restaurants, or QSRs, travel and convenience stores and other driver amenities.
The U.S. travel center and truck stop industry in which we operate consists of travel centers, truck stops, diesel fuel outlets and similar facilities designed to meet the needs of long-haul trucking fleets and their drivers, independent truck drivers and general motorists. According to the National Association of Truck Stop Operators, or "NATSO," the travel center and truck stop industry is highly fragmented, with in excess of 3,000 travel centers and truck stops located on or near interstate highways nationwide. Further, only eight chains in the United States have 25 or more travel center and truck stop locations on the interstate highways, which we believe is the minimum number of locations needed to provide even regional coverage to truck drivers and trucking fleets.
HISTORY AND ORGANIZATION
We were formed in December 1992 by a group of institutional investors. We were originally incorporated as National Auto/Truckstops Holdings Corporation but changed our name to TravelCenters of America, Inc. in March 1997. We primarily have created our network through the following series of acquisitions:
- In April 1993, we acquired the truckstop network assets of a subsidiary of Unocal Corporation, which sites we refer to as the "Unocal network." The Unocal network included a total of 139 facilities, of which 95 were leased sites, 42 were franchisee-owned sites and two sites were company-operated sites.
- In December 1993, we acquired the truckstop network assets of certain subsidiaries of The British Petroleum Company p.l.c., which assets we refer to as the "BP network." The BP network included 38 company-operated sites and six franchisee-owned sites.
- In December 1998, we acquired substantially all of the truckstop network assets of Burns Bros., Inc. and certain of its affiliates, which assets we refer to as the Burns Bros. network. The Burns Bros. network included 17 company-operated sites, located in nine western and northwestern states.
- In June 1999, we acquired the travel center and truck stop network assets of Travel Ports of America, Inc. through the acquisition of 100% of the stock of Travel Ports. The Travel Ports network consisted of 16 company-operated sites in seven states, primarily in the northeastern region of the United States.
- In January 2003, we began operating in Canada through the acquisition of a travel center located in Ontario.
- In December 2004, we acquired eleven company-operated travel centers from Rip Griffin Truck Service Center, Inc., which assets we refer to as the Rip Griffin network. These eleven sites are located in seven states, primarily in the southwestern region of the United States.
Historically, until 1997, the Unocal network operated principally as a fuel wholesaler and franchisor, with relatively few company-operated sites. In contrast to the Unocal network, the BP network operated principally as an owner-operator of travel centers. In January 1997, we instituted a plan to combine the Unocal network and the BP network, which had been previously managed and financed separately, into a single network to be operated under the "TravelCenters of America" and "TA" brand names under the leadership of a single management team. Prior to combining the Unocal and BP networks, the Unocal network was operated through National Auto/Truckstops, Inc. and the BP network was operated through TA Operating Corporation, each of National Auto/Truckstops, Inc. and TA Operating Corporation being a wholly owned subsidiary of ours. At the time we approved the plan to combine our networks, there were 122 sites operating in the Unocal network and 49 sites operating in the BP network. In November 2000, National Auto/Truckstops, Inc. merged with and into TA Operating Corporation.
In July 1999, we signed an agreement with Freightliner LLC to become an authorized provider of express service, minor repair work and a specified menu of warranty repairs to Freightliner's customers through the Freightliner ServicePoint Program. Under the agreement, our truck repair facilities have been added to Freightliner's 24-hour customer assistance center database as a major referral point for emergency and roadside repairs and also have access to Freightliner's parts distribution, service and technical information systems. Freightliner, a DaimlerChrysler company, is a leading manufacturer of heavy trucks in North America. Freightliner also acquired a minority ownership interest in us at that time.
On May 31, 2000, we and shareholders owning a majority of our voting stock entered into a recapitalization agreement and plan of merger, as amended, with TCA Acquisition Corporation, a newly created corporation formed by Oak Hill Capital Partners, L.P. and its affiliates ("Oak Hill"), under which TCA Acquisition Corporation agreed to merge with and into us. This merger was completed on November 14, 2000. Concurrent with the closing of the merger, we completed a series of transactions to effect a recapitalization and a refinancing that included the following:
- TCA Acquisition Corporation issued 6,456,698 shares of common stock to Oak Hill and a group of other institutional investors, which we refer to as the Other Investors, for proceeds of $205.0 million and then merged TCA Acquisition Corporation with and into us. At the time of the merger, the Other Investors were Olympus Growth Fund III, L.P., Olympus Executive Fund, L.P., Monitor Clipper Equity Partners, L.P., Monitor Clipper Equity Partners (Foreign), L.P., UBS Capital Americas II, LLC, Credit Suisse First Boston LFG Holdings 2000, L.P. and Credit Suisse First Boston Corporation, each
of whom is an affiliate of certain of our former shareholders. Since that time, certain of these investors have sold their shares to other investors, including affiliates of certain of the Other Investors. Such sales of our shares are not frequent but could occur in the future.
- We redeemed all shares of our common and preferred stock outstanding prior to the closing of the merger, with the exception of 473,064 shares of common stock with a market value at that time of $15.0 million that were retained by continuing stockholders, and cancelled all then outstanding common stock options and warrants, for cash payments totaling $263.2 million.
- We repaid all amounts outstanding under our then existing debt agreements.
- We borrowed $328.3 million under a secured credit agreement with a group of lenders and issued units consisting of Senior Subordinated Notes due 2009 with a face amount of $190.0 million and initial warrants and contingent warrants that in the aggregate could be exercised in exchange for 277,165 shares of our common stock.
- We merged National Auto/Truckstops, Inc. with and into TA Operating Corporation.
Prior to the closing of the transactions described above, we issued 137,572 shares of common stock for cash proceeds of $3.7 million upon the exercise of stock options held by existing shareholders, which shares remained outstanding. After the transactions described above, Oak Hill owned 60.5% of our outstanding common stock, the Other Investors owned, in the aggregate, 32.7% of our outstanding common stock, Freightliner owned 4.3% of our outstanding common stock and certain members of our management owned 2.5% of our outstanding common stock. The total market value of our equity capitalization after these transactions was $220.0 million.
At December 31, 2004, we had two wholly owned subsidiaries, TA Operating Corporation, which is our primary travel center operating entity, and TA Franchise Systems Inc, which maintains our franchise agreements and relationships. TA Operating Corporation had the following direct or indirect wholly owned subsidiaries:
- TA Licensing, Inc.
- TA Travel, L.L.C.
- 3073000 Nova Scotia Company
- TravelCentres Canada Inc.
- TravelCentres Canada Limited Partnership
NETWORK DEVELOPMENT
Due to historical competition between the Unocal and BP networks, there were certain markets in which each of these networks had an existing site at the time we instituted our plan to combine these two networks. Likewise, there was competition in certain markets between our networks and the networks of Burns Bros. and of Travel Ports. In addition, there were certain franchisee-owned sites in the Unocal network that were not considered to be in strategic locations. Further, there were, and continue to be, locations on the interstate highway system that we consider to be strategic but in which we do not have an adequate presence. As a result, since 1997 we have significantly reshaped the composition of our network through the following:
- 17 company-operated sites were acquired from Burns Bros. in 1998;
- 16 company-operated sites in the Travel Ports network were acquired in 1999;
- 11 company-operated sites were acquired from Rip Griffin in 2004;
- 48 leased sites were converted to company-operated sites, two during 2004, six during 2003, five during 2002, three during 2000, five during 1998 and 27 during 1997;
- one franchisee-owned site was converted to a company-operated site during 2000;
- five new network sites were constructed, one in 2002, one in 2001, one in 2000 and two in 1999;
- six sites were razed and rebuilt, two in 1999, two in 2000, one in 2001 and one in 2003;
- five company-operated sites were added to our network through individual site acquisitions or management agreements, one during 2004, two during 2003 and two during 2000;
- franchise agreements covering 28 franchisee-owned sites were terminated, one in 2000 and 27 in 1997;
- 36 sites we owned were sold, two during 2004, three during 2003, three during 2002, four during 2001, two during 2000, five during 1999, two during 1998 and 15 during 1997;
- three franchisee-owned sites were added to our network, one in 2002, one in 1999 and one in 1998; and
- three company-operated sites were closed, one during 2003 (for which our selling effort continues), and two during 1999 (both of which have been sold - one in 2004 and one in 2002).
In 1997, we initiated a capital program to upgrade, rebrand and re-image our travel centers and to build new travel centers. Through December 31, 2004, we had completed full re-image projects at 37 of our sites at an average investment of $2.2 million per site. These full re-image projects typically include expanding the square footage of the travel and convenience store, adding a fast food court with two or three QSRs, upgrading showers and restrooms and updating the full-service restaurant. We also had completed smaller scale re-image projects at another 67 sites at an average cost of $0.3 million. In addition to improving our existing sites, we have identified several new interstate areas available for our network's expansion. We have designed a "prototype" facility and a smaller "protolite" facility to standardize our travel centers and expand our network into new geographic markets while also increasing our appeal to motorists. The prototype and protolite designs combine an improved and efficient facility layout with nationally branded QSRs and gasoline brands as well as expanded product and service offerings. Since May 1999, we have completed construction of eight prototype facilities and three protolite facilities. Further, we are currently developing one prototype facility, which we expect to open in 2006, and one protolite facility, which we expect to open in 2006. Most of our future expansion will be with the protolite format, which requires significantly less land and capital investment than the prototype design and enables us to quickly and cost efficiently gain a presence in smaller markets. We also intend to pursue strategic acquisitions and additional franchisee-owned sites. Our franchisees will also continue to invest additional amounts of their own capital for reimaging and other projects at the sites they operate.
REFINANCINGS
2000 Refinancing. As part of the transactions we completed to consummate our merger with TCA Acquisition Corporation and the related recapitalization, we completed a refinancing of our indebtedness, which refinancing transactions we refer to as the "2000 Refinancing." In the 2000 Refinancing, we issued $190 million of senior subordinated notes due 2009 and borrowed $328.3 million under an amended and restated credit agreement (which we refer to as the 2000 Credit Agreement) that consisted of a fully-drawn $328 million term loan facility and a $100 million revolving credit facility. The proceeds from these borrowings, along with proceeds from the issuance of common stock and other cash on hand, were used to:
- pay for the tender offer and consent solicitation for our 10 1/4% Senior Subordinated Notes due 2007, including accrued interest, premiums and a prepayment penalty;
- repay all amounts, including accrued interest, then outstanding under our existing amended and restated credit agreement;
- redeem in full all of our then existing senior secured notes and pay related accrued interest and prepayment penalties;
- make cash payments to certain of our then current equity owners, whose shares and unexercised stock options and warrants were redeemed and cancelled pursuant to the recapitalization agreement and plan of merger; and
- pay fees and expenses related to the financings and the merger and recapitalization transactions.
The $190 million of Senior Subordinated Notes were issued as part of units that also included warrants exercisable for 277,165 shares of our common stock.
2004 Refinancing. On December 1, 2004, we completed a refinancing, which we refer to as the "2004 Refinancing." In the 2004 Refinancing, we borrowed $500 million under an Amended and Restated Credit Agreement that we refer to as the 2004 Credit Agreement. The 2004 Credit Agreement included a fully-drawn $475 million term loan facility and a $125 million revolving credit facility under which $25 million was drawn at closing. The proceeds from these borrowings were utilized to:
- repay all amounts, including accrued interest, outstanding under the existing amended and restated credit agreement into which we had entered in November 2000 and which we refer to as the 2000 Credit Agreement;
- pay for the acquisition of the assets acquired from Rip Griffin;
- terminate the master lease facility under which since 1999 we built eight travel centers on land we owned, thereby gaining ownership of the improvements at those eight sites; and
- pay fees and expenses related to the financing and the acquisition transactions.
See "Liquidity and Capital Resources" in Item 7 for further discussion of our outstanding indebtedness.
OUR TRAVEL CENTERS
Our travel centers are designed to appeal to drivers seeking either a quick stop or a more extended visit. Substantially all of our travel centers are full-service facilities located on or near an interstate highway and offer fuel and non-fuel products and services 24 hours per day, 365 days per year.
Property. The layouts of the travel centers we own vary from site to site. The facilities we own are located on properties averaging 22 acres, of which an average of approximately 19 acres are developed. The majority of the developed acreage consists of truck and car fuel islands, separate truck and car paved parking and the main building, which contains a full-service restaurant and one or more QSRs, a travel and convenience store and driver amenities and a truck maintenance and repair shop. The remaining developed acreage contains landscaping and access roads.
Product and Service Offerings. We have developed an extensive and diverse offering of products and services to complement our diesel fuel business, which includes:
- Gasoline. We sell nationally recognized branded gasoline, consistently offering one of the top three gasoline brands in each geographic region. Of our 138 company-operated sites as of December 31, 2004, we offered branded gasoline at 105 sites and unbranded gasoline at 21 sites. Twelve company-operated sites do not sell gasoline.
- Full-Service and Fast Food Restaurants. Most of our travel centers have both full-service restaurants and QSRs that offer customers a wide variety of nationally recognized brand names and food choices. Our full-service restaurants, branded under our "Country Pride," "Buckhorn Family Restaurants," "Country Fare" and "Fork in the Road" proprietary brands, offer "home style" meals through menu table service and buffets. We also offer more than 20 different brands of QSRs, including Arby's, Burger King, Pizza Hut,
Popeye's Chicken & Biscuits, Sbarro, Starbuck's Coffee, Subway and Taco Bell. We generally attempt to locate QSRs within the main travel center building, as opposed to constructing stand-alone buildings. As of December 31, 2004, we had 172 QSRs in our company-operated sites, and 108 of our network travel centers offered at least one branded QSR.
- Truck Repair and Maintenance Shops. All but six of our network travel centers have truck repair and maintenance shops. The typical repair shop has between two and four service bays, a parts storage room and trained mechanics. These shops, which generally operate 24 hours per day, 365 days per year, offer extensive maintenance and emergency repair and road services, ranging from basic services such as oil changes and tire repair to specialty services such as diagnostics and repair of air conditioning, air brake and electrical systems. Our work is backed by a warranty honored at all of our repair and maintenance facilities. As of December 31, 2004, all but nine of our network sites that have truck repair and maintenance shops were participating in the Freightliner ServicePoint Program. Each of these nine sites was acquired from Rip Griffin in December 2004 and is expected to be added to the Freightliner ServicePoint Program during 2005.
- Travel and Convenience Stores. Each travel center has a travel and convenience store that caters to truck drivers, motorists, recreational vehicle operators and bus drivers and passengers. Each travel and convenience store has a selection of over 4,000 items, including food and snack items, beverages, non-prescription drug and beauty aids, batteries, automobile accessories, and music and video products. In addition to complete travel and convenience store offerings, the stores sell items specifically designed for the truck driver's on-the-road lifestyle, including laundry supplies and clothing as well as truck accessories. Most stores also have a "to go" snack bar installed as an additional food offering.
- Additional Driver Services. We believe that fleets can improve the retention and recruitment of truck drivers by directing them to visit high-quality, full-service travel centers. We strive to provide a consistently high level of service and amenities to drivers at all of our travel centers, making our network an attractive choice for trucking fleets. Most of our travel centers provide truck drivers with access to specialized business services, including an information center where drivers can send and receive faxes, overnight mail and other communications and a banking desk where drivers can cash checks and receive fund transfers from fleet operators. Most sites have installed telephone rooms with 15 to 20 pay telephones. The typical travel center also has a video game room and designated "truck driver only" areas, including a television room with a VCR and comfortable seating for drivers, a laundry area with washers and dryers and an average of six to 12 private showers.
Additionally, we offer truck drivers a loyal fueler program, which we call the RoadKing Club, that is similar to the frequent flyer programs offered by airlines. Drivers receive a point for each gallon of diesel fuel purchased and can redeem their points for discounts on non-fuel products and services at any of our travel centers.
- Motels. Twenty of our company-operated travel centers offer motels, with an average capacity of 40 rooms. Seventeen of these motels are operated under franchise grants from nationally branded motel chains, including Days Inn, HoJo Inn, Knight's Inn, Rodeway and Travelodge.
OPERATIONS
Fuel Supply. We purchase diesel fuel from various suppliers at rates that fluctuate with market prices and generally are reset daily, and resell fuel to our customers at prices that we establish daily. By establishing supply relationships with an average of four to five alternate suppliers per location, we have been able to effectively create competition for our purchases among various diesel fuel suppliers on a daily basis. We believe that this positioning with our suppliers will help our sites avoid product outages during times of diesel fuel supply disruptions. We have a single source of supply for gasoline at most of our sites that offer branded gasoline. Sites selling unbranded gasoline do not have exclusive supply arrangements.
Other than pipeline tenders, fuel purchases made by us are delivered directly from suppliers' terminals to our travel centers. We do not contract to purchase substantial quantities of fuel for our inventory and are therefore susceptible to price increases and interruptions in supply. We hold less than three days of diesel fuel inventory at our sites. We use pipeline tenders and leased terminal space to mitigate the risk of supply disruptions. The susceptibility to market price increases for diesel fuel is substantially mitigated by the significant percentage of our total diesel fuel sales volume that is sold under pricing formulae that are indexed to market prices, which reset daily. We do not engage in any fixed-price contracts with customers. We may engage, from time to time, in a minimal level of hedging of our fuel purchases with futures and other derivative instruments that primarily are traded on the New York Mercantile Exchange.
The Environmental Protection Agency has promulgated regulations to decrease the sulfur content of diesel fuel by 2006. The enactment of these regulations could reduce the supply and/or increase the cost of diesel fuel. A material decrease in the volume of diesel fuel sold for an extended period of time or instability in the prices of diesel fuel could have a material adverse effect on us.
Non-fuel products supply. There are many sources for the large variety of non-fuel products that we purchase and sell. We have developed strategic relationships with several suppliers of key non-fuel products, including Freightliner LLC for truck parts, Bridgestone/Firestone Tire Sales Company for truck tires, and ExxonMobil for Mobil brand lubricants and oils. We believe that our relationships with these and our other suppliers are satisfactory and that supply of the non-fuel products we require is adequate.
Centralized Purchasing and Distribution. We maintain a distribution and warehouse center that services our network. The distribution center is located near Nashville, Tennessee and has approximately 85,000 square feet of storage space. Approximately every two weeks, the distribution center delivers products to our network sites using a combination of contract carriers and our fleet of trucks and trailers. In 2004, the distribution center shipped approximately $50.3 million of products. We believe the distribution center provides us with cost savings by using its consolidated purchasing power to negotiate volume discounts with third-party suppliers. The distribution center is also able to obtain further price reductions from suppliers in the form of reduced shipping charges, as suppliers need only deliver their products to the distribution center warehouse, as opposed to each site individually.
COMPETITION
The U.S. travel center and truck stop industry in which we operate consists of travel centers, truck stops, diesel fuel outlets and similar facilities designed to meet the needs of long-haul trucking fleets and their drivers, independent truck drivers and general motorists. The travel center and truck stop industry is highly competitive and fragmented. According to NATSO, there are in excess of 3,000 travel center and truck stops located on or near highways nationwide. Further, only eight chains in the United States have 25 or more travel center and truck stop locations on the interstate highways, which we believe is the minimum number of locations needed to provide even regional coverage to truck drivers and trucking fleets. There are generally two types of facilities designed to serve the trucking industry:
- full-service travel centers, such as those in our network, which offer a broad range of products and services to long-haul trucking fleets and their drivers, independent truck drivers and general motorists, such as diesel fuel and gasoline; full-service and fast food dining; truck repair and maintenance; travel and convenience stores; secure parking areas and other driver amenities; and,
- pumper-only truck stops, which provide diesel fuel, typically at discounted prices, with a more limited mix of additional services than a full-service travel center.
Fuel and non-fuel products and services can be obtained by long-haul truck drivers from a wide variety of sources other than us, including regional full-service travel center and pumper-only truck stop chains, independently owned and operated truck stops, some large service stations and fleet-operated fueling terminals.
We believe that we experience substantial competition from pumper-only truck stop chains and that this competition is based principally on diesel fuel prices. In the pumper-only truck stop segment, the largest networks, based on the number of facilities, are Pilot Travel Centers LLC, with approximately 250 sites, Flying J Inc., with approximately 165 sites, and Love's Travel Stops & Country Stores, Inc., with approximately 100 sites. We experience additional substantial competition from major full-service travel center networks and independent chains, which is based principally on diesel fuel prices, non-fuel product and service offerings and customer service. In the full-service travel center segment, the only large network, other than ours, is operated by Petro Stopping Centers, L.P., with approximately 61 sites. Our truck repair and maintenance shops compete with regional full-service travel center and truck stop chains, full-service independently owned and operated truck stops, fleet maintenance terminals, independent garages, truck dealerships, truck quick-lube facilities and auto parts service centers. We also compete with a variety of establishments located within walking distance of our travel centers, including full-service restaurants, QSRs, electronics stores, drugstores and travel and convenience stores.
A significant portion of all intercity diesel fuel consumption by trucking fleets and companies with their own trucking capability occurs through self-fueling at both dedicated terminals and at fuel depots strategically located across the country. These terminals often provide facilities for truck repair and maintenance. Our pricing decisions for diesel fuel and truck repair and maintenance services cannot be made without considering the existence of these operations and their capacity for expansion. We believe that a long-term trucking industry trend has been to reduce the use of these terminals and to outsource fuel, repair and maintenance services to maximize the benefits of competitive fuel pricing, superior driver amenities and reduced environmental compliance expenditures. However, during the past few years of historically high fuel prices, this long-term trend has been somewhat slowed, at least temporarily, as trucking fleets have utilized their existing terminals to supply an increased level of their fuel and repair service needs.
A potential additional source of competition in the future could result from the possible commercialization of state-owned interstate rest areas. Historically, these rest areas have been precluded from offering for sale fuel and non-fuel products and services similar to that of a travel center. State governments that want to earn additional revenues from these rest areas have repeatedly requested that the federal government allow for commercialization. Past attempts for such commercialization historically have been successfully opposed by a group of opponents that includes NATSO, fast food restaurant operators and others. If commercialized, these rest areas will increase the number of outlets competing with us for the business of highway travelers. It is possible we may have an opportunity to play a role in these commercialization efforts, which would reduce any negative effects of such commercialization on our travel center business. As of early 2005, language in the pending highway reauthorization bill clearly sets forth a continued ban on commercialization of state-owned interstate rest areas.
RELATIONSHIPS WITH THE OPERATORS AND FRANCHISEE-OWNERS
We enter into franchise agreements with operators and franchisee-owners of travel centers through TA Franchise Systems, and TA Franchise Systems collects franchise fees and royalties under these agreements. TA Franchise System's assets consist primarily of the rights under the original franchise agreements, the network franchise agreements and its trademark license from TA Licensing. TA Franchise Systems has no tangible assets.
Network Franchise Agreement
As of December 31, 2004, there were 16 sites operating under network franchise agreements. The more significant provisions of the network franchise agreement are described in the following paragraphs.
Initial Franchise Fee. The initial franchise fee for a new franchise is $100,000.
Term of Agreement. The initial term of the network franchise agreement is ten years. The network franchise agreement provides for two five-year renewals on the terms being offered to prospective franchisees at the time of the franchisee's renewal. We reserve the right to decline renewal under certain circumstances or if specified
terms and conditions are not satisfied by the franchisee. The average remaining term of these agreements, including all renewal periods, is approximately 18 years. The initial terms of the current network franchise agreements expire in July 2012 through October 2014.
Protected Territory. Subject to specified exceptions, including existing operations, so long as the franchisee is not in default under the network franchise agreement, we agree not to operate, or allow another person to operate, a travel center or travel center business that uses the "TA" brand, within 75 miles in either direction along the primary interstate on which the franchised site is located.
Restrictive Covenants. Except for the continued operation of specified businesses identified by the franchisee at the time of execution of the network franchise agreement, the franchisee cannot, during the term of the agreement, operate any travel center or truck stop-related business under a franchise agreement, licensing agreement or marketing plan or system of another person or entity. If the franchisee owns the franchised premises, the franchisee may continue to operate a travel center at the franchised premises after termination of the franchise agreement, but if the termination is for any reason other than a default by TA Franchise System, the franchisee is restricted for a two-year period from re-branding the facility with any other truck stop or travel center company or other organization offering similar services and/or fleet billing services.
Royalty Payments. Franchisees are required to pay us a continuing services and royalty fee generally equal to 3.75% of all non-fuel revenues. If branded fast food is sold from the franchised premises, the franchisee must pay us 3% of all net revenues earned directly or indirectly in connection with those sales after deduction of royalties paid to the fast food franchisor.
Advertising, Promotion and Image Enhancement. The network franchise agreement requires the franchisees to contribute 0.6% of their non-fuel revenues and net revenues from fast food sales to partially fund system-wide advertising, marketing and promotional expenses we incur. We are required to match the amounts of the franchisees' contributions.
Fuel Purchases and Sales. Under the network franchise agreement for those franchisees operating leased sites, we agree to sell to franchisees, and franchisees agree to buy from us, 100% of their requirements of diesel fuel. Those franchisees operating franchisee-owned sites are not required to purchase their diesel fuel from us. The franchisee agrees to purchase gasoline from only those suppliers that we approve in writing. The franchisee generally must pay a $0.03 per gallon royalty fee to us on all gallons of gasoline sold.
Non-fuel Product Offerings. Franchisees are required to operate their sites in conformity with guidelines that we establish and offer any products and services that we deem integral to the network.
Termination/Nonrenewal. We may terminate the network franchise agreement for the following reasons, among others:
- the default of the franchisee;
- our withdrawal from the marketing of motor fuel in the state, county or parish where the franchise is located; or
- the default or termination of the lease.
The foregoing reasons also constitute grounds for nonrenewal of the network franchise agreement. In addition, we can decline to renew the network franchise agreement for the following reasons, among others:
- we and the operator fail to agree to changes or additions to the network franchise agreement;
- we make a good faith determination not to renew the network franchise agreement because it would be uneconomical to us; or
- if we own the franchise premises, we make a good faith determination to sell the premises or convert it to a use other than for a truck stop or travel center.
If we do not renew the network franchise agreement due to any of the three foregoing reasons, we may not enter into another network franchise agreement relating to the same franchised premises with another party within 180 days of the expiration date on terms materially different from those offered to the prior franchisee, unless the prior franchisee is offered the right, for a period of 30 days, to accept a renewal of the network franchise agreement on those different terms. If we do not renew the network franchise agreement because we make a good faith determination to withdraw from the marketing of fuel in the area of the franchised premises, we may not sell the franchised premises or franchised business for 90 days following the expiration of the network franchise agreement. The prior franchisee does not have a right of first refusal on the sale of the franchised premises.
Network Lease Agreement
In addition to franchise fees, we also collect rent from those franchisees that operate a travel center owned by us. As of December 31, 2004, there were 12 leased sites. Each operator of a leased site that enters into a network franchise agreement also must enter into a network lease agreement. The more significant provisions of the network lease agreement are described in the following paragraphs.
Term of Agreement. The lease agreements we have with our franchisees have a term of ten years and allow for two renewals of five years each. We reserve the right to decline renewal under certain circumstances or if specified terms and conditions are not satisfied by the operator. The average remaining term of these agreements, including all renewal periods, is approximately 18 years. The initial terms of the current network lease agreements expire in July 2012 through December 2012.
Rent. Under the network lease, an operator must pay annual fixed rent equal to the sum of
- base rent agreed upon by the operator and us, plus
- improvement rent, if any, which is defined as an amount equal to 14% of the cost of all capital improvements we fund that we and the operator mutually agree will enhance the value of the leased premises and which cost in excess of $2,500, plus
- an annual inflator equal to the percentage increase in the consumer price index.
The base rent will not be increased by the improvement rent if the operator elects to pay for the capital improvements. If we and the operator agree upon an amortization schedule for a capital improvement funded by the operator, we will, upon termination of the network lease, reimburse the operator for an amount equal to the unamortized portion of the cost of the capital improvement. The operator is responsible for the payment of all charges and expenses in connection with the operation of the leased sites, including environmental registration fees and certain maintenance costs.
Use of the Leased Site. The operator must operate the leased site as a travel center in compliance with all laws, including all environmental laws. The operator must submit to quality inspections that we request and appoint a manager that we approve, who is responsible for the day-to-day operations at the leased site.
Termination/Nonrenewal/Transferability/Right of First Refusal. The network lease agreement contains terms and provisions regarding termination, nonrenewal, transferability and our right of first refusal which are substantially the same as the terms and provisions of the network franchise agreement.
Original Franchise Agreement with BP Network Independent Franchisees
There are six sites that continue to operate under the franchise agreements they had with TA Franchise Systems prior to the network franchise agreement being revised to its current form in 2002. The terms of these
franchise agreements are generally the same as the network franchise agreement, but they do not require the franchises to purchase their diesel fuel from us and their provisions vary. At the expiration of these agreements, the respective franchisees may be offered an option to renew their franchises under a form of our then-current franchise agreement for franchisee-owned sites.
Term of Agreement. In general, the initial terms of the original franchise agreements are 10 years. The original franchise agreements provide for one or two renewals for an aggregate of 10 years. The original franchise agreements offer no assurance that the terms of the renewal will be the same as those of the initial franchise agreements. We may decline renewal under some circumstances or if specified terms and conditions are not satisfied by the franchisee. The average remaining term of these agreements is approximately five years.
Protected Territory. So long as the franchisee is not in default under the franchise agreement, we agree not to operate, or allow another person to operate, a travel center or travel center business that uses the "TA" brand, within a specified area in either direction along one or more interstates at which the franchised site is located.
Restrictive Covenants. Although the restrictive covenants in the original franchise agreements may vary slightly from franchise to franchise, each franchisee is subject to restrictions that prohibit two or more of the following during the term of the franchise agreement and for two years after its expiration:
- operation of any other truck stop or travel center within its protected territory;
- operation of the franchise location under any national brand other than "TA";
- operation of the branded facility within a certain distance of any other TA facility; and
- operation of any competitive business or a business that trades upon the franchise within the area adjacent to the franchise location.
Royalty Payments. In general, we require franchisees to pay us a continuing services and royalty fee generally equal to 4% of all revenues earned directly or indirectly by the franchisee from any business conducted at or from the franchised premises, excluding fuel sales and sales of branded fast food. As part of the royalty fee, we generally require the franchisee to pay us $0.004 per gallon on all sales of qualified diesel fuel.
Advertising, Promotion and Image Enhancement. The network franchise agreement requires the franchisees to contribute 0.25% of all revenues, including revenues from fuel and fast food sales, to partially fund system-wide advertising, marketing and promotional expenses we incur, and mandates certain minimum franchisee expenditures on advertising. We are required to match the amounts of the franchisees' contributions towards the system-wide expenses.
Fuel Purchases and Sales. We do not require franchisees to purchase gasoline or diesel fuel from us. However, we charge royalty fees generally on diesel fuel sales as described above.
Non-fuel Product Offerings. Franchisees are required to operate their travel centers in conformity with our guidelines, participate in and comply with all programs that we prescribe as mandatory and offer any products and services we deem integral to the network.
Termination of an Original Franchise Agreement. We may terminate the franchise agreement upon the occurrence of certain defaults, upon notice and without affording the franchisee an opportunity to cure the defaults. When other defaults occur, we may terminate the franchise agreement if, after receipt of a notice of default, the franchisee has not cured the default within the applicable cure period. The franchisee may terminate the franchise agreement upon thirty days notice, if we are in material default under the franchise agreement and we fail to cure or attempt to cure the default within a reasonable period after notification.
REGULATION
Franchise Regulation. State franchise laws apply to TA Franchise Systems, and some of these laws require TA Franchise Systems to register with the state before it may offer a franchise, require TA Franchise Systems to deliver specified disclosure documentation to potential franchisees, and impose special regulations upon petroleum franchises. Some state franchise laws also impose restrictions on TA Franchise Systems' ability to terminate or not to renew its respective franchises, and impose other limitations on the terms of the franchise relationship or the conduct of the franchisor. Finally, a number of states include, within the scope of their petroleum franchising statutes, prohibitions against price discrimination and other allegedly anticompetitive conduct. These provisions supplement applicable antitrust laws at the federal and state levels.
The Federal Trade Commission, or the FTC, regulates us under their rule entitled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures." Under this rule, the FTC requires that franchisors make extensive disclosure to prospective franchisees but does not require registration. We believe that we are in compliance with this rule.
We cannot predict the effect of any future federal, state or local legislation or regulation on our franchising operations.
Environmental Regulation. Our operations and properties are extensively regulated by Environmental Laws that:
- govern operations that may have adverse environmental effects, such as discharges to air, soil and water, as well as the management of Hazardous Substances or
- impose liability for the costs of cleaning up sites affected by, and for damages resulting from disposal or other releases of Hazardous Substances.
We own and use underground storage tanks and aboveground storage tanks to store petroleum products and waste at our facilities. These tanks must comply with requirements of Environmental Laws regarding tank construction, integrity testing, leak detection and monitoring, overfill and spill control, release reporting, financial assurance and corrective action in case of a release. At some locations, we must also comply with Environmental Laws relating to vapor recovery and discharges to water. We have completed necessary upgrades to underground storage tanks to comply with federal regulations that took effect on December 22, 1998, and believe that all of our travel centers are in material compliance with applicable requirements of Environmental Laws.
We have received notices of alleged violations of Environmental Laws, or are otherwise aware of the need to undertake corrective actions to comply with Environmental Laws, at travel centers owned by us in a number of jurisdictions. We do not expect that any financial penalties associated with these alleged violations, or instances of noncompliance, or compliance costs incurred in connection with these violations or corrective actions, will be material to our results of operations or financial condition. We are conducting investigatory and/or remedial actions with respect to releases of Hazardous Substances that have occurred subsequent to the acquisition of the BP network and also regarding historical contamination at certain of the former Unocal, Burns Bros., Travel Ports and Rip Griffin facilities. While we cannot precisely estimate the ultimate costs we will incur in connection with the investigation and remediation of these properties, based on our current knowledge, we do not expect that the costs to be incurred at these properties, individually or in the aggregate, will be material to our results of operations or financial condition. While the matters discussed above are, to the best of our knowledge, the only proceedings for which we are currently exposed to potential liability, we cannot be certain that additional contamination does not exist at these or additional network properties, or that material liability will not be imposed on us in the future. If additional environmental problems arise or are discovered, or if additional environmental requirements are imposed by government agencies, increased environmental compliance or remediation expenditures may be required, which could have a material adverse effect on us. We have estimated the current ranges of remediation costs at currently active sites and what we believe will be our ultimate share for those costs and, as of December 31, 2004, we had a
reserve of $13.2 million for unindemnified environmental matters for which we are responsible, a receivable for estimated recoveries of these estimated future expenditures of $3.7 million and $5.3 million of cash in an escrow account to fund certain of these estimated expenditures, leaving an estimated net amount of $4.1 million to be funded from future operating cash flows. In addition, we have obtained environmental insurance of up to $35.0 million for unanticipated costs regarding certain known environmental liabilities and for up to $40.0 million regarding certain unknown environmental liabilities.
As part of the acquisition of the Unocal network, Phase I environmental assessments were conducted at the 97 Unocal network properties purchased by us. Under an environmental indemnification agreement with Unocal, Phase II environmental assessments of all Unocal network properties were completed by Unocal by December 31, 1998. Under the terms of this environmental agreement, Unocal was responsible for all costs incurred for:
- remediation of environmental contamination, and
- otherwise bringing the properties into compliance with Environmental Laws as in effect at the date of the acquisition of the Unocal network,
with respect to the matters identified in the Phase I or Phase II environmental assessments, which matters existed on or prior to the date of the acquisition of the Unocal network. Under the terms of this agreement, Unocal also was required to indemnify us against any other environmental liabilities that arise out of conditions at, or ownership or operations of, the Unocal network prior to the date of the acquisition of the Unocal network. In January 2004, a Buy-Out Agreement between Unocal and us became effective and Unocal's obligations to us under the April 1993 environmental agreement were terminated. In consideration for releasing Unocal from its obligations under the environmental agreement, Unocal paid us $2.6 million of cash, funded an escrow account with $5.4 million to be drawn by us as we incur related remediation costs, and purchased insurance policies that cap our total future expenditures and provide protection against significant unidentified matters that existed prior to April 1993. We are now responsible for all remediation at the former Unocal sites that we still own. We estimated the costs of the remediation activities for which we assumed responsibility from Unocal in January 2004 to be approximately $8.2 million at that time, which amount we expect will be fully covered by the cash received from Unocal and reimbursements from state tank funds.
Prior to the acquisition of the BP network, all of the 38 company-owned locations purchased by us were subject to Phase I and Phase II environmental assessments, undertaken at BP's expense. The environmental agreement with BP provides that, with respect to environmental contamination or non-compliance with Environmental Laws identified in the Phase I or Phase II environmental assessments, BP is responsible for:
- all costs incurred for remediation of the environmental contamination, and
- for otherwise bringing the properties into compliance with Environmental Laws as in effect at the date of the acquisition of the BP network.
The remediation must achieve compliance with the Environmental Laws in effect on the date the remedial action is completed. The environmental agreement with BP requires BP to indemnify us against any other environmental liabilities that arise out of conditions at, or ownership or operations of, the BP network locations prior to the date of the acquisition of the BP network. The time period for making new claims for indemnification from BP ended on December 11, 2004. BP must also indemnify us for liabilities relating to non-compliance with Environmental Laws for which claims were made before December 11, 1996. Except as described above, BP does not have any responsibility for any environmental liabilities arising out of the ownership or operations of the BP network after the date of the acquisition of the BP network. We cannot be certain that BP, if additional environmental claims or liabilities were to arise under the environmental agreement, would not dispute our claims for indemnification.
As part of the Burns Bros. acquisition, Phase I environmental assessments were conducted on all 17 sites acquired. Based on the results of those assessments, Phase II environmental assessments were conducted on nine of the sites. The purchase price paid to Burns Bros. was adjusted based on the findings of the Phase I and Phase II environmental assessments. Under the asset purchase agreement with Burns Bros., we released Burns Bros. from any environmental liabilities that may have existed as of the Burns Bros. acquisition date, other than specified non-waived environmental claims as described in the agreement with Burns Bros. As part of the Travel Ports acquisition, Phase I environmental assessments were conducted on all 16 sites acquired. Based on the results of those assessments, Phase II environmental assessments were conducted on five of these sites. As part of the Rip Griffin acquisition, Phase I environmental assessments were conducted on all eleven sites acquired. Under the asset purchase agreement with Rip Griffin we released Rip Griffin from any environmental liabilities that may have existed as of the Rip Griffin acquisition date, other than specified non-waived environmental claims as described in the agreement with Rip Griffin.
EMPLOYEES
As of December 31, 2004, we employed 11,510 people on a full- or part-time basis. Of this total, 11,094 were employees at our company-operated sites, 362 performed managerial, operational or support services at our headquarters or elsewhere and 54 employees staffed the distribution center. Except for eleven employees at one site, all of our employees are non-union. We believe that our relationship with our employees is satisfactory.
ITEM 2.
ITEM 2. PROPERTIES
Our principal executive offices are leased and are located at 24601 Center Ridge Road, Suite 200, Westlake, Ohio 44145-5639. Our distribution center is a leased facility located at 1450 Gould Boulevard, LaVergne, Tennessee 37086-3535.
Of our 138 company-operated sites and 12 leased sites in operation as of December 31, 2004, the land and improvements at 12 are leased, six sites are subject to ground leases of the entire site, five sites are subject to ground leases of portions of these sites, and one site is operated pursuant to a management agreement. We consider our facilities suitable and adequate for the purposes for which they are used. In addition to these 150 sites, we own two sites that will be developed as travel centers and one site that is closed and held for sale.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in various legal and administrative proceedings and threatened legal and administrative proceedings incidental to the ordinary course of our business. We believe we are currently not involved in any litigation, individually or in the aggregate, which could have a material adverse effect on our business, financial condition, results of operations or cash flows.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 2004.
PART II
ITEM 5.
ITEM 5. MARKET FOR OUR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market information. The outstanding shares of our common stock were issued in transactions not involving a public offering. As a result, there is no public market for our common stock.
Holders. As of December 31, 2004, the outstanding shares of our common stock were held of record by 36 stockholders.
Dividends. We have never paid or declared any cash dividends on our common stock. We intend to retain our future earnings, if any, to fund the development and growth of our business. Our future decisions concerning the payment of dividends on the common stock will depend upon our results of operations, financial condition and capital expenditure plans, as well as other factors as the board of directors, in its sole discretion, may consider relevant. In addition, our existing indebtedness restricts, and we anticipate our future indebtedness may restrict, our ability to pay dividends.
Recent sales of unregistered securities. During 2002 and 2003, we sold or issued the unregistered securities described below. None of the following transactions involved any public offering. All sales were made in reliance on Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), Rule 701 promulgated under the Securities Act and/or Regulation D promulgated under the Securities Act. These sales were made without general solicitation or advertising. The recipients in each such transaction represented their intention to acquire the securities for investment only and not with a view to sell or for sale in connection with any distribution thereof. In a series of sales to management, we sold the following:
- In 2002, we sold 7,302 shares at $31.75 per share. The proceeds from these sales were used for general corporate purposes.
- In 2003, we sold 10,000 shares at $30.26 per share. These shares had been purchased from the estate of a deceased former management stockholder at this same price. The proceeds from these sales were used to fund the related purchase.
Summary of Equity Compensation Plans. The following table sets forth information about all our equity compensation plans in effect as of December 31, 2004, which consisted solely of the 2001 Stock Incentive Plan, which plan was approved by our stockholders during 2001. All of our equity compensation plans currently in effect have been approved by our stockholders.
Equity Compensation Plan Information
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected historical consolidated financial data for each of the last five fiscal years. Such data should also be read in conjunction with "Management's Discussion and Analysis" and our audited consolidated financial statements included elsewhere in this annual report.
Notes to Selected Financial Data
(1) For the year ended December 31, 2000, income from operations was reduced by $22,004,000 of merger and recapitalization expenses incurred in connection with the transactions we completed to consummate our merger with TCA Acquisition Corporation and related recapitalization and by $20,910,000 of losses from the early extinguishment of debt related to the recapitalization. Prior to 2003, the loss from the early extinguishment of debt was classified, net of the related income tax benefits, as an extraordinary loss in our statement of operations and comprehensive income. Statement of Financial Accounting Standards No. 145, "Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002," which was issued in April 2002, required the reclassification into income from operations of the amount previously presented as an extraordinary loss.
(2) Beginning in 2002, as a result of adopting a new accounting pronouncement, we ceased amortization of our goodwill and trademark intangible assets.
(3) Reflects the operating results of 11 sites we acquired from Rip Griffin on December 1, 2004, beginning on the acquisition date.
(4) The capital expenditures amount for 2004 includes $65,162,000 invested to acquire the improvements at eight sites we had been leasing under the master lease facility we terminated in December 2004 in connection with the 2004 Refinancing. The amounts of cash flows used in investing activities and provided by financing activities for 2004 include the effects of the 2004 Refinancing as well as the Rip Griffin acquisition and the termination of the master lease facility.
(5) Adjusted EBITDA, as used here, is based on the definition of "EBITDA" in our bank debt agreement and consists of net income plus the sum of (a) income taxes, (b) interest expense, net, (c) depreciation, amortization and other noncash charges, (d) transition expense, (e) extraordinary losses and cumulative effects of accounting changes and (f) the costs of the merger and recapitalization transactions. We have included this information concerning Adjusted EBITDA because Adjusted EBITDA is a primary component for calculating the two key financial ratio covenants in our debt agreements, the interest coverage ratio and the leverage ratio. See further discussion of our debt covenant compliance and a reconciliation of net income (loss) to Adjusted EBITDA in the "Liquidity and Capital Resources" section of Management's Discussion and Analysis under the heading "Adjusted EBITDA and Debt Covenant Compliance." We also use Adjusted EBITDA as a basis for determining bonus payments to our corporate and site-level management employees and as a key component in the formula for calculating the fair value of our redeemable common stock and stock options. Adjusted EBITDA should not be considered in isolation from, or as a substitute for, net income, income from operations, cash flows from operating activities or other consolidated income or cash flow statement data prepared in accordance with generally accepted accounting principles. While the non-GAAP measures "EBITDA" and "Adjusted EBITDA" are frequently used by other companies as measures of operations and/or ability to meet debt service requirements, Adjusted EBITDA as we use the term is not necessarily comparable to similarly titled captions of other companies due to differences in methods of calculation. See further discussion and disclosure concerning Adjusted EBITDA under the heading "Adjusted EBITDA and Debt Covenant Compliance" in Item 7, Management's Discussion and Analysis. For 2004, the Adjusted EBITDA amount for debt covenant purposes was adjusted for the historical results of the sites acquired from Rip Griffin and the termination of the master lease agreement, each of which was funded through the 2004 Refinancing. The pro forma Adjusted EBITDA amount used in this calculation for 2004 was $153,802,000.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial position and results of operations is based upon, and should be read in conjunction with, our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management believes the critical accounting policies and areas that require the most significant judgments and estimates to be used in the preparation of our consolidated financial statements are the allowance for doubtful accounts, asset impairment, self-insured reserves, environmental liabilities, income tax accounting, and recognition of stock compensation expense related to stock options and redeemable common stock held by employees.
Allowances for doubtful accounts and notes receivable are maintained based on historical payment patterns, aging of accounts receivable, periodic review of our customers' financial condition, and actual write-off history. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying value of those assets, and when the carrying value of a long-lived asset to be disposed of exceeds the estimated fair value of the asset less the estimated cost to sell the asset. The net carrying value of assets not recoverable is then reduced to fair value. Our estimated cash flows are based on historical results adjusted to reflect the best estimate of future market and operating conditions. The estimates of fair value represent the best estimate based on industry trends and reference to market rates and transactions. If these estimates or their underlying assumptions change in the future, we may be required to record additional impairment charges for these assets.
For purposes of assessing our goodwill for impairment, we have determined that we are one reporting unit and that the estimated fair value of that reporting unit, based on a discounted cash flow analysis, exceeded its carrying value. With respect to our trademark intangible assets, the estimated fair value, based on a discounted cash flow analysis, exceeded the carrying value. Accordingly, we have not recognized an impairment charge with respect to any of our intangible assets. A number of assumptions and methods are used in preparing the valuations underlying these impairment tests, including estimates of future cash flows and discount rates. Applying significantly different assumptions or valuation methods could result in different results of these impairment tests. Similarly, defining the reporting unit differently could lead to a different result for goodwill. Our goodwill and trademark intangible assets will be assessed for impairment annually as of January 1 of each year.
We are partially self-insured, paying our own general liability, workers' compensation, and group health benefits claims, up to stop-loss amounts ranging from $150,000 to $500,000 on a per-occurrence basis. Provisions established under these partial self insurance programs are made for both estimated losses on known claims and claims incurred but not reported, based on claims history.
We establish an environmental contingency reserve when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. The estimates of these costs are based on our best estimates of our future obligations given current and pending laws and the currently available facts concerning each environmental incident, as well as our estimate of amounts recoverable under indemnification agreements and/or state or private insurance plans. Should the actual costs to remediate an incident differ from our estimates, or should new facts come to light or laws become enacted that modify the scope of our remediation projects, revisions to the estimated environmental contingency reserve would be required.
As part of the process of preparing our consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. The process involves estimating actual current tax expense along with assessing temporary differences resulting from differing treatment of items for financial statement and tax purposes. These timing differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We are required to record a valuation allowance to reduce our deferred tax assets if we are not able to conclude that it is more likely than not they will be realized, although we have not to date recognized such a valuation allowance as we believe realization of our deferred tax assets is more likely than not. Increases in the valuation allowance would result in additional expenses to be reflected within the tax provision in the consolidated statement of operations. For further discussion regarding the realization of our deferred tax assets, see the "Results of Operations - Income Taxes" section of this "Management's Discussion and Analysis."
Certain members of our senior management have purchased shares of our common stock pursuant to individual management subscription agreements. We have the right to repurchase, and the employees have the right to require us to repurchase, subject to certain limitations, at fair market value, these shares of common stock upon termination of employment due to death, disability or a scheduled retirement. These shares are classified as redeemable equity in our consolidated balance sheet. Prior to an initial public offering of our common stock, the fair market value is determined by a formula set forth in the agreement that can be modified by the Board of Directors. At the point in time that redemption of shares of redeemable common stock becomes probable, the fair value of the shares will be accreted to their estimated redemption value by a charge to nonredeemable stockholders' equity. Such a charge to nonredeemable stockholders' equity will occur only if our value, and therefore the fair value of our common stock, has increased. Our policy is to consider redemption of an individual stockholder's shares probable at the time that the stockholder provides notice of his or her intention to retire, dies or is declared disabled. In addition to these redeemable shares of common stock purchased by management employees, we have granted to certain of our executives non-qualified stock options to purchase 944,881 shares of our common stock under a stock incentive plan. Each option grant consists of 41.67% time options and 58.33% performance options. Time options become exercisable with the passage of time, while performance options become exercisable if certain investment return targets are achieved. Time options generally vest 20% per year over a period of five years. Performance options vest if Oak Hill achieves specified internal rates of return on specified measurement dates. The time options are subject to fixed plan accounting and, accordingly, no charge to earnings will be required with respect to them since the exercise price equaled the fair value at the date of grant. The performance options are subject to variable plan accounting and, accordingly, a non-cash charge to earnings will be required when it becomes probable that the performance triggers for such options will be achieved. Because our common stock is privately held, determining its value is subject to estimates and to factors, such as multiples being paid in the mergers and acquisitions market at the time of the measurement and/or the state of the capital markets at that time, that are not easily forecasted or controlled and which may not have a direct relationship to our financial results or condition. It is not possible to determine at this time, nor may it be possible until close to the end of the five-year performance period, whether it will be probable that we will achieve the performance triggers. It is not possible to predict whether any such required non-cash charge will be material to our results for the period in which the charge is recognized, as we expect that the performance triggers can only be attained as a result of a significant increase in our results of operations.
OVERVIEW
We are a holding company which, through our wholly owned subsidiaries, owns, operates and franchises travel centers along the North American highway system to serve long-haul trucking fleets and their drivers, independent truck drivers and general motorists. Our network is the largest, and only nationwide, full-service travel center network in the United States. At December 31, 2004, our geographically diverse network consisted of 160 sites located in 41 states in the United States and in the province of Ontario, Canada. Our operations are conducted through three distinct types of travel centers:
- sites operated by us, which we refer to as company-operated sites;
- sites owned by us and leased to independent lessee-franchisees, which we refer to as leased sites; and
- sites owned and operated by independent franchisees, which we refer to as franchisee-owned sites.
Our travel centers are located at key points along the U.S. interstate highway system and in Canada, typically on 20- to 25-acres sites. Most of our network properties were developed more than 22 years ago when prime real estate locations along the interstate highway system were more readily available than they are today, making a network such as ours difficult to replicate. Operating under the "TravelCenters of America" and "TA" brand names, our nationwide network provides an advantage to long-haul trucking fleets by enabling them to route their trucks within a single network from coast to coast.
One of the primary strengths of our business is the diversity of our revenue sources. We have a broad range of product and service offerings, including diesel fuel and gasoline, truck repair and maintenance services, full-service restaurants, more than 20 different brands of fast food restaurants, travel and convenience stores and other driver amenities.
The non-fuel products and services we offer to our customers complement our fuel business and provide us a means to increase our revenues and gross profit despite price pressure on fuel as a result of competition and volatile crude oil and petroleum product prices. For the years ended December 31, 2002, 2003, and 2004, our revenues and gross profit were composed as follows:
COMPOSITION OF OUR NETWORK
The changes in the number of sites within our network and in their method of operation (company-operated, leased or franchisee-owned) are significant factors influencing the changes in our results of operations. The following table summarizes the changes in the composition of our network from December 31, 2001 through December 31, 2004:
During 2004, we entered into a franchise agreement with a franchisee under which we expect to add one franchisee-owned location to our network in the second quarter of 2005. In February 2005, we sold one of our company-operated sites. We expect to convert one leased site to a company-operated site on March 31, 2005 upon the termination of the lease and franchise agreements covering that site.
SAME-SITE RESULTS COMPARISONS
As part of our discussion and analysis of operating results we refer to increases and/or decreases in results on a same-site basis. For purposes of these comparisons, we include a site in the same-site comparisons only for the period for which it was open for business under the same method of operation (company-operated, leased or franchisee-owned) in both years being compared. Sites are not excluded from the same-site comparisons as a result of expansions in the square footage of the sites or in the amenities offered at the sites.
RELEVANCE OF FUEL REVENUES
Due to the market pricing of commodity fuel products and the pricing arrangements we have with our fuel customers, fuel revenue is not a reliable metric for analyzing our relative results from period to period. As a result solely of changes in crude oil and refined products market prices, our fuel revenue balances may increase or decrease significantly, in both absolute amounts and on a percentage basis, without a comparable change in fuel sales volumes or in gross margin per gallon.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
Revenues. Our consolidated revenues for the year ended December 31, 2004 were $2,677.9 million, which represents an increase from the year ended December 31, 2003 of $501.6 million, or 23.1%, that is primarily attributable to an increase in fuel revenue but also resulted from increased non-fuel revenues.
Fuel revenue for the year ended December 31, 2004 increased by $445.6 million, or 29.4%, as compared to the year ended December 31, 2003. The increase was attributable principally to increased average selling prices for both diesel fuel and gasoline. Average diesel fuel and gasoline sales prices for the year ended December 31, 2004 increased by 31.1% and 26.4%, respectively, as compared to the year ended December 31, 2003, reflecting increases in commodity prices that were attributable to higher crude oil costs due to increased worldwide demand, refinery outages and other refined petroleum product supply disruptions. The fuel revenues price variance increase was somewhat offset by decreases in diesel fuel and gasoline sales volumes, primarily in wholesale fuel sales. Diesel fuel and gasoline sales volumes for the year ended December 31, 2004 decreased 0.2% and 4.3%, respectively, as compared to the year ended December 31, 2003. For the year ended December 31, 2004, we sold 1,338.0 million gallons of diesel fuel and 182.9 million gallons of gasoline, as compared to 1,341.1 million gallons of diesel fuel and 191.1 million gallons of gasoline for the year ended December 31, 2003. The diesel fuel sales volume decrease of 3.1 million gallons primarily resulted from a 9.9 million gallon decrease in wholesale diesel fuel sales volume that was partially offset by a 0.6% increase in same-site diesel fuel sales volumes and a net increase in sales volumes at sites we added to or eliminated from our network during 2003 and 2004. The gasoline sales volume decrease of 8.2 million gallons was primarily attributable to a 16.9 million gallon decrease in wholesale gasoline sales volumes that was partially offset by a 2.0% increase in same-site gasoline sales volumes and a net increase in gasoline volumes at company-operated sites we added to or eliminated from our network during 2003 and 2004. We believe the same-site diesel fuel sales volume increase resulted from an improved freight market in 2004 and our retail diesel fuel pricing in response to intense price competition, which factors were somewhat offset by an increase in the level of freight carried by train instead of truck and an increase in trucking fleets' self-fueling at their own terminals due to the wide fluctuations in, and high levels of, diesel prices in 2004. We believe the same-site increase in gasoline sales volume resulted primarily from increased general motorist visits to our sites as a result of our more aggressive retail gasoline pricing program as well as site improvements made as part of our capital investment program. We believe the decreases in wholesale sales volumes for both diesel and gasoline result from the sharp volatility in commodity prices during 2004 coupled with the high level of commodity prices.
Non-fuel revenues for the year ended December 31, 2004 of $708.0 million reflected an increase of $58.5 million, or 9.0%, as compared to the year ended December 31, 2003. The increase was primarily attributable to a 6.0% increase in same-site non-fuel revenues and also attributable to the net increase in sales at the company-operated sites we added to or eliminated from our network during 2003 and 2004. We believe the same-site increase reflected increased customer traffic resulting, in part, from the significant capital improvements that we have made in the network under our capital investment program to upgrade our travel centers, an improved freight market and also from our fuel pricing strategy.
Rent and royalty revenues for the year ended December 31, 2004 reflected a $2.4 million, or 18.4%, decrease as compared to the year ended December 31, 2003. This decrease was attributable to the rent and royalty revenue lost as a result of the conversions of eight leased sites to company-operated sites during 2003 and 2004. This decrease was partially offset by a 3.5% increase in same-site royalty revenue and a 3.9% increase in same-site rent revenue.
Gross Profit (excluding depreciation). Our gross profit for the year ended December 31, 2004 was $530.8 million, compared to $501.5 million for the year ended December 31, 2003, an increase of $29.4 million, or 5.9%. The increase in our gross profit was primarily due to the increase in non-fuel sales volume that was partially offset by a decrease in diesel fuel sales volume, decreased fuel margin per gallon and decreased rent and royalty revenue, as discussed above.
Operating and Selling, General and Administrative Expenses. Operating expenses included the direct expenses of company-operated sites and the ownership costs of leased sites. Selling, general and administrative expenses included corporate overhead and administrative costs.
Our operating expenses increased by $19.5 million, or 5.7%, to $361.5 million for the year ended December 31, 2004 compared to $342.0 million for the year ended December 31, 2003. This increase was primarily attributable to a net increase resulting from company-operated sites we added to our network or eliminated from our network during 2003 and 2004 and a 3.5% increase on a same-site basis. On a same-site basis, operating expenses as a percentage of non-fuel revenues for 2004 were 51.0%, compared to 52.3% for the year ended December 31, 2003, reflecting the results of our cost-cutting measures at our sites and an increased level of non-fuel sales relative to our fixed costs.
Our selling, general and administrative expenses for the year ended December 31, 2004 were $43.2 million, which reflected a $2.6 million, or 6.5%, increase from the year ended December 31, 2003 that was primarily attributable to personnel costs.
Transition Expense. Transition expense included the costs incurred in converting the travel centers acquired from Rip Griffin to our operating model and standards. In December 2004, we incurred $0.7 million of such costs, primarily consisting of site training and deferred maintenance expenses. We expect to incur an additional $1.3 million of transition expenses during 2005 in connection with these sites.
Depreciation and Amortization Expense. Depreciation and amortization expense for the year ended December 31, 2004 was $58.8 million, compared to $60.4 million for the year ended December 31, 2003, a decrease of $1.6 million, or 2.7%, that was primarily due to an impairment charge of $0.9 million recognized in 2003 and a $0.5 million decrease in amortization expense that resulted from an intangible asset related to a noncompetition agreement becoming fully amortized in April 2003.
(Gain) loss on asset sales. For the year ended December 31, 2004, the gain on asset sales of $2.5 million primarily was generated from the sale of two company-operated sites, one closed site and our fractional shares of three aircraft, while the gain on asset sales of $1.5 million for the year ended December 31, 2003 primarily was generated from the sale of three company-operated sites.
Income from Operations. We generated income from operations of $69.3 million for the year ended December 31, 2004, compared to income from operations of $60.0 million for the year ended December 31, 2003. This increase of $9.3 million, or 15.5%, as compared to the 2003 period was primarily attributable to the increased level of non-fuel revenues and gross margin which was partially offset by the decreased level of diesel fuel sales volumes and fuel margins per gallon.
Gain on sale of investment. The gain on sale of investment of $1.6 million for the year ended December 31, 2004 resulted from the sale in April of our investment in Simons Petroleum, Inc. for cash proceeds of $9.1 million. We could receive an additional $2.0 million of proceeds if Simons achieves certain earnings targets and certain other conditions are met and representations and warranties are maintained. Due to the uncertainty surrounding the future realization of these receivables, the gain on sale we recognized did not reflect these amounts. We expect that these uncertainties will be resolved during 2005.
Interest and Other Financial Costs -- Net. Interest and other financial costs, net, for the year ended December 31, 2004 decreased by $0.9 million, or 1.9%, compared to the year ended December 31, 2003. This decrease primarily resulted from lower interest expense related to our Senior Credit Facility that was somewhat offset by a $1.7 million charge to expense in connection with the 2004 Refinancing. The reduction in interest expense related to our Senior Credit Facility primarily resulted from our reduced level of indebtedness for most of 2004 as compared to 2003 and was somewhat lessened by rising interest rates throughout 2004. The charge
recognized in connection with the 2004 Refinancing was related to a portion of the legal and other fees incurred in completing the 2004 Refinancing as well as the write-off of a portion of the deferred financing costs incurred in connection with the 2000 Refinancing. The increase in our debt level and reduction in our interest rate spread as a result of the 2004 Refinancing completed on December 1, 2004 had a slight favorable net effect on our interest expense that would equate to approximately $1.0 million annually.
Income Taxes. Our effective income tax rates for the years ended December 31, 2004 and 2003 were 36.3% and 34.0%, respectively. These rates differed from the federal statutory rate due primarily to state and foreign income taxes and certain nondeductible expenses, partially offset by the benefit of certain tax credits.
We have not recognized a valuation allowance for our net deferred tax assets, as we believe we are more likely than not to realize those assets. We need to generate $31.4 million of future taxable income to fully realize our net deferred tax assets. The existing level of pre-tax earnings generated in 2004 would be sufficient to generate enough future taxable income to fully realize our net deferred tax assets. The following table sets forth the historical relationship between pretax earnings for financial reporting purposes and taxable income for income tax purposes.
The following table sets forth the composition of our federal net operating loss carryforwards by their expiration dates.
Cumulative Effect of a Change in Accounting Principle. Effective January 1, 2003, we adopted FAS 143, "Accounting for Asset Retirement Obligations" and recognized a one-time cumulative effect charge of $0.3 million. There was no similar accounting principle change during 2004.
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Revenues. Our consolidated revenues for the year ended December 31, 2003 were $2,176.2 million, which represents an increase from the year ended December 31, 2002 of $305.4 million, or 16.3%, that is primarily attributable to an increase in fuel revenue.
Fuel revenue for the year ended December 31, 2003 increased by $275.7 million, or 22.3%, as compared to the same period in 2002. The increase was attributable principally to increases in diesel fuel and gasoline average selling prices. Average diesel fuel and gasoline sales prices for the year ended December 31, 2003 increased by 25.7% and 23.2%, respectively, as compared to the same period in 2002, primarily reflecting increases in commodity prices. The fuel revenue increase also resulted from an increase in our total fuel sales volumes. Diesel fuel sales volumes decreased 8.6 million gallons, or 0.6%, while gasoline sales volumes increased 30.5 million gallons, or 19.0%, as compared to the same period in 2002. For the year ended December 31, 2003, we sold 1,341.1 million gallons of diesel fuel and 191.1 million gallons of gasoline, as compared to 1,349.7 million gallons of diesel fuel and 160.6 million gallons of gasoline for the year ended December 31, 2002. The diesel fuel sales volume decrease resulted from a 4.5% decrease in same-site diesel fuel sales volumes, partially offset by a net increase in sales volumes at company-operated sites we added to or eliminated from our network during 2002 and 2003 of 24.0 million gallons and an increase in our wholesale diesel fuel sales of 2.5 million gallons, or 1.2%. The gasoline sales volume increase was primarily attributable to a 9.6% increase in same-site gasoline sales volumes and also resulted from a 2.7 million gallon net increase in gasoline sales volume at company-operated sites we added to or eliminated from our network during 2002 and 2003, as well as an 11.6 million increase in wholesale gasoline sales volume. We believe the same-site diesel fuel sales volume decrease resulted from a relatively flat level of trucking activity in the United States in 2003 as compared to 2002, in conjunction with an increase in the level of freight carried by train instead of trucks and an increase in trucking fleets' self-fueling at their own terminals due to the wide fluctuation in diesel costs this year and the absolute high level of diesel fuel prices. We believe the same-site increase in gasoline sales volume resulted primarily from increased general motorist visits to our sites as a result of our gasoline and QSR offering upgrades and additions under our capital program, as well as our competitive retail gasoline pricing.
Non-fuel revenues for the year ended December 31, 2003 of $649.5 million reflected an increase of $32.2 million, or 5.2%, from the same period in 2002. The increase was primarily attributable to the net increase in sales at the company-operated sites added to, or eliminated from, our network during 2002 and 2003, and also to an increase in non-fuel sales on a same-site basis of 2.4% for the year ended December 31, 2003 versus the same period in 2002. We believe the same-site increase reflected increased customer traffic resulting, in part, from the significant capital improvements that we have made in the network under our capital investment program to re-image, re-brand and upgrade our travel centers.
Rent and royalty revenues for the year ended December 31, 2003 reflected a $2.5 million, or 15.8%, decrease from the same period in 2002. This decrease was primarily attributable to the rent and royalty revenue lost as a result of the conversions of leased sites to company-operated sites, partially offset by a 2.5% increase in same-site royalty revenue that results from increased levels of retail sales by our franchisees, and a 2.1% increase in same-site rent revenue.
Gross Profit (excluding depreciation). Our gross profit for the year ended December 31, 2003 was $501.5 million, compared to $481.2 million for the same period in 2002, an increase of $20.3 million, or 4.2%. The increase in our gross profit was due to increased total fuel sales volumes, increased non-fuel sales, increased average total fuel margin per gallon and higher non-fuel profit margin percentage, partially offset by the decline in rent and royalty revenues. The increase in average total fuel margin per gallon resulted from unusually high margins in certain months in the first half of 2003 and is not indicative of an expected trend. On the contrary, fuel margins declined in the second half of 2003.
Operating and Selling, General and Administrative Expenses. Operating expenses included the direct expenses of company-operated sites and the ownership costs of leased sites. Selling, general and administrative expenses included corporate overhead and administrative costs.
Our operating expenses increased by $9.8 million, or 3.0%, to $342.0 million for the year ended December 31, 2003 compared to $332.2 million for the same period in 2002. This increase was attributable to an $8.8 million net increase resulting from company-operated sites we added to our network or eliminated from our network during 2002 and 2003, and a 0.7% increase in operating expenses on a same-site basis. The increases in
operating expenses were partially offset by the recognition of a $3.75 million cash receipt upon the settlement of a legal claim in the fourth quarter of 2003. On a same-site basis, operating expenses as a percentage of non-fuel revenues for the year ended December 31, 2003 were 52.4%, compared to 53.3% for the same period in 2002, reflecting the results of our cost-control measures at our sites.
Our selling, general and administrative expenses for the year ended December 31, 2003 were $40.5 million, which reflected an increase of $2.7 million, or 7.2% from the same period in 2002. This increase is primarily attributable to increased insurance premiums and increased legal and audit fees, as well as higher personnel costs driven largely by increased benefit costs.
Depreciation and Amortization Expense. Depreciation and amortization expense for the year ended December 31, 2003 was $60.4 million, compared to $60.3 million for the same period in 2002. This increase of $0.1 million, or 0.1%, was attributable to depreciation of an increased level of depreciable assets as compared to 2002 and an increase of $0.4 million related to asset retirement obligations, partially offset by a $1.2 million decrease in amortization of intangible assets and a $0.6 million decrease in the amount of impairment charges recognized in 2003 as compared to 2002.
Income from Operations. We generated income from operations of $60.0 million for the year ended December 31, 2003, compared to income from operations of $51.9 million for the same period in 2002. This increase of $8.0 million, or 15.5%, was primarily attributable to the increase in gross profit that was partially offset by the increase in operating expenses and selling, general and administrative expenses. The $0.4 million increase in gains on sales of property and equipment also contributed to the increase in operating income.
Interest and Other Financial Costs -- Net. Interest and other financial costs, net, for the year ended December 31, 2003 decreased by $4.5 million, or 8.8%, compared to 2002. This decrease resulted from the decline in interest rates during 2002 and 2003 as well as from the decrease in our indebtedness.
Income Taxes. Our effective income tax rates for the years ended December 31, 2003 and 2002 were 34.0% and a 3.2% benefit, respectively. These rates differed from the federal statutory rate due primarily to state income taxes and nondeductible expenses, partially offset by the effect of certain tax credits. The change between years in the effective tax rate was primarily the result of the change from a relatively low level of pre-tax income earned in 2002, as well as an adjustment in 2002 of estimated prior year tax liabilities, to a higher level of taxable income in 2003. As a result of the relatively low level of pre-tax earnings in 2002, permanent differences had a larger effect on the effective rate in 2002 than in 2003.
Cumulative Effect of a Change in Accounting Principle. Effective January 1, 2003, we adopted FAS 143, "Accounting for Asset Retirement Obligations." As of January 1, 2003, we recognize the future cost to remove an underground storage tank over the estimated useful life of the storage tank. A liability for the fair value of an asset retirement obligation with a corresponding increase to the carrying value of the related long-lived asset is recorded at the time an underground storage tank is installed. We will amortize the amount added to property and equipment and recognize accretion expense in connection with the discounted liability over the remaining life of the respective underground storage tank. The estimated liability is based on historical experiences in removing these tanks, estimated tank useful lives, external estimates as to the cost to remove the tanks in the future and regulatory requirements. The liability is a discounted liability using a credit-adjusted risk-free rate of approximately 12.8%. Revisions to the liability could occur due to changes in tank removal costs, tank useful lives or if new regulations regarding the removal of such tanks are enacted. Upon adoption of FAS 143, we recorded a discounted liability of $0.6 million, increased property and equipment by $0.2 million and recognized a one-time cumulative effect charge of $0.3 million (net of deferred tax benefit of $0.2 million).
RIP GRIFFIN ACQUISITION - PRO FORMA INFORMATION
On December 1, 2004, we acquired from Rip Griffin Truck Service Center, Inc. the assets related to eleven travel centers. The results from these eleven sites were included in our results, as discussed above, from that date. The following unaudited pro forma information presents our results of operations as if the acquisition of the Rip Griffin sites had taken place on January 1, 2003.
These pro forma results of operations have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred on January 1, 2003, or that may result in the future.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
Our principal liquidity requirements are to meet our working capital and capital expenditure needs, including expenditures for acquisitions and expansion, and to service the payments of principal and interest on outstanding indebtedness. Our principal source of liquidity to meet these requirements is operating cash flows. The revolving credit facility under the 2004 Credit Agreement provides us a secondary source of liquidity, primarily to better match the timing of cash expenditures to the timing of our cash receipts primarily due to effects of changes in petroleum product prices, the uneven level of capital expenditures throughout the year and the timing of debt and interest payments.
The primary risks we face with respect to the expected levels of operating cash flows are a decrease in the demand of our customers for our products and services, increases in crude oil and/or petroleum product prices and increases in interest rates. It is reasonably likely that interest rates and petroleum product prices will increase during 2005 from levels that existed during 2004, possibly to levels greater than that contemplated in our expectations. If the economy stagnates or worsens, our customers could be adversely affected, which could further intensify competition within our industry and reduce the level of cash we could generate from our operations. A one-percentage point increase in interest rates increases our annual cash outlays by approximately $5.0 million. A significant increase in diesel fuel and gasoline prices increases our cash investment in working capital and can also have a depressing effect on our sales volumes and fuel margins per gallon.
The primary risk we face with respect to the expected availability of borrowing under our revolving credit facility are the limitations imposed upon us by the covenants contained in the 2004 Credit Agreement. Should our level of sales volume or interest rate and petroleum products price levels vary adversely and very significantly from expectations, it is possible that we would need to reduce our capital expenditures or be effectively barred from further revolving credit facility borrowings in order to maintain compliance with our debt covenants, in the absence of a debt covenant waiver or an amendment to the related agreement. We were in compliance with all of our debt covenants throughout 2004 and as of December 31, 2004, and we expect to remain in compliance with all of our debt covenants throughout 2005. See "Adjusted EBITDA and Debt Covenant Compliance" below for further discussion.
We anticipate that we will be able to fund our 2005 working capital requirements and capital expenditures primarily from funds generated from operations, supplemented, to the extent necessary, from borrowings under our revolving credit facility. Our long-term liquidity requirements, including capital expenditures, are expected to be financed by a combination of internally generated funds, borrowings and other sources of external financing as needed. Our ability to fund our capital investment requirements, interest and principal payment obligations and working capital requirements and to comply with all of the financial covenants under our debt agreements depends on our future operations, performance and cash flow. These are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond our control. The expected level of capital expenditures, including business acquisitions but net of proceeds from asset sales, for 2005 is approximately $80 million. The 2005 capital investment plan is largely composed of growth-related projects such as expanding our truck repair and maintenance facilities, site re-image projects, adding QSRs, upgrading retail stores and restaurants, and building one new prototype travel center. The plan also includes approximately $9 million to rebrand and re-image the Rip Griffin sites acquired in December 2004. Given our forecasted level of cash flows from operations for 2005 and our planned level of capital expenditures, we expect that during 2005 we will make our scheduled debt repayments of $0.2 million and we will also repay the $25.0 million of outstanding borrowings under our revolving credit facilities. We also expect to refinance our Senior Subordinated Notes due 2009 no later than November 2005, at which time they are callable at 106.375% of their face value.
2004 REFINANCING
On December 1, 2004, we completed a refinancing, which we refer to as the "2004 Refinancing." In the 2004 Refinancing, we borrowed $500 million under an Amended and Restated Credit Agreement that we refer to as the 2004 Credit Agreement. The 2004 Credit Agreement included a fully-drawn $475 million term loan facility and a $125 million revolving credit facility under which $25 million was drawn at closing. The proceeds from these borrowings were utilized to:
- repay all amounts, including accrued interest, outstanding under the existing amended and restated credit agreement into which we had entered in November 2000 and which we refer to as the 2000 Credit Agreement;
- pay for the acquisition of the assets acquired from Rip Griffin;
- terminate the master lease facility under which since 1999 we built eight travel centers on land we owned, thereby gaining ownership of the improvements at those eight sites; and
- pay fees and expenses related to the financing and the acquisition transactions.
HISTORICAL CASH FLOWS
Net cash provided by operating activities totaled $97.1 million in 2004, $77.3 million in 2003 and $75.6 million in 2002. The $19.8 million increase in cash provided by operations for 2004 as compared to 2003 was primarily attributable to an increase in our operating profitability and a $14.8 million increase in cash generated from changes in working capital. The increases in the accounts receivable, inventories, and accounts payable balances for 2004 as compared to 2003 were attributable to the significant increases in diesel fuel and gasoline commodity prices in the United States that primarily resulted from significant increases in world crude oil prices. The $1.7 million increase in cash from operations in 2003 as compared to 2002 was primarily due to the $8.0 million increase in operating income and $4.6 million decrease in interest expense, partially offset by a $7.1 million reduction in cash generated from working capital changes.
Net cash used in investing activities for 2004 was $235.2 million, as compared to $50.5 million in 2003 and $42.1 million in 2002. During 2004, we invested $125.5 million to acquire eleven operating travel centers from Rip Griffin and another $0.6 million to convert two leased sites to company-operated sites. We also generated proceeds of $13.8 million during 2004 from asset sales, including the sale of our stake in an equity investee. During 2004, we invested $65.2 million to acquire the improvements at eight company-operated sites that we had been leasing under
our master lease facility that we terminated as part of the 2004 Refinancing, and also invested another $57.7 million of capital expenditures across our network. During 2003, we invested $10.2 million to acquire two operating travel centers and to convert six leased sites to company-operated sites. In 2003 we also generated proceeds from asset sales of $3.9 million and invested $44.2 million of capital expenditures, including the purchase of a parcel of land on which to construct a future travel center. During 2002, we made capital expenditures of $42.6 million, invested $4.2 million to convert five leased sites to company-operated sites and generated proceeds from the sales of assets of $4.8 million.
During 2004, financing activities provided us $168.9 million of cash, primarily as a result of the 2004 Refinancing, which provided a net cash inflow of $203.9 million that primarily was used to acquire the Rip Griffin sites and to terminate the master lease facility (see the description of our indebtedness below). Prior to the 2004 Refinancing, during 2004 we had repaid $24.0 million and $13.6 million, respectively, of our term loan and revolving credit facility borrowings, including $21.8 million of mandatory term loan prepayments resulting from Excess Cash Flows generated in 2003 and from our sale of our investment in an equity investee. During 2003, we used $26.1 million of cash in financing activities, primarily paying down our term loan and revolving loan facility by $23.3 million. We used $39.3 million of cash in financing activities during 2002, primarily to reduce our debt. We made net repayments of outstanding borrowings under our revolving credit facility of $21.5 million and made scheduled debt payments of $3.4 million. We also reduced the amount of our outstanding checks in excess of funds on deposit by $14.1 million.
DESCRIPTION OF INDEBTEDNESS
The 2004 Credit Agreement provides senior secured financing of up to $600.0 million, consisting of a $475.0 million term loan facility that matures in December 2011 and a $125.0 million revolving credit facility that matures in December 2009, provided that both the term loan facility and the revolving credit facility will mature in October 2008 if we do not refinance our Senior Subordinated Notes due 2009 with qualified indebtedness prior to that time. We have pledged substantially all of our assets as collateral under the 2004 Credit Agreement. At December 31, 2004, we had outstanding revolving loan borrowings and issued letters of credit of $25.0 million and $27.7 million, respectively, leaving $72.3 million of our $125 million revolving credit facility available for borrowings. The term loan facility and the revolving credit facility bear interest at a rate equal to:
- in the case of the term loan facility, Adjusted LIBOR plus a spread of 1.75% or, at our election, the alternate base rate plus a spread of 0.75%; or
- in the case of the revolving credit facility, Adjusted LIBOR plus a spread that ranges from 2.25% down to 1.75% or, at our election, the alternate base rate plus a spread that ranges from 1.25% down to 0.75%. The spread in effect is based on our Leverage Ratio (as defined in the 2004 Credit Agreement) according to the following grid:
In addition to paying interest on outstanding principal under the 2004 Credit Agreement, we are required to pay a commitment fee to the lenders under the revolving credit facility equal to 0.50% per year of the unused commitments thereunder.
The 2004 Credit Agreement obligates us to make annual mandatory prepayments of term loan indebtedness equal to one-half of the Excess Cash Flow amount (as defined in the 2004 Credit Agreement) generated in the previous year. Before giving effect to any such prepayments that may be required in the future, and assuming our Senior Subordinated Notes due 2009 are appropriately refinanced prior to October 2008, the term loan facility will amortize each year in quarterly amounts, beginning on March 31, 2006, in the following aggregate principal amounts for each year set forth below.
Principal amounts outstanding under the revolving credit facility are due and payable in full at maturity in December 2009, provided however that if we have not refinanced our Senior Subordinated Notes due 2009 prior to October 1, 2008, the revolving credit facility will mature on October 1, 2008 and all outstanding principal amounts will be due and payable in full.
The 2004 Credit Agreement contains a number of covenants that, among other things, restrict our ability to dispose of assets, incur additional indebtedness, incur guarantee obligations, repay other indebtedness, make certain restricted payments and dividends, create liens on assets, make investments, loans or advances, make certain acquisitions, engage in mergers or consolidations, engage in material businesses other than our current businesses, make capital expenditures, enter into sale and leaseback transactions, or engage in certain transactions with affiliates.
We have outstanding at December 31, 2004, Senior Subordinated Notes due in 2009 with an aggregate face amount of $190 million. The Senior Subordinated Notes due 2009 were issued in November 2000. Our obligations under the notes are junior in right of payment to all of our existing and future senior indebtedness, including all indebtedness under the Senior Credit Facility. The indenture restricts, among other things, our ability to incur additional indebtedness, issue shares of disqualified stock and preferred stock, pay dividends or make certain other restricted payments and enter into certain transactions with affiliates, and prohibits certain restrictions on the ability of our subsidiaries to pay dividends or make certain payments to us, and contains certain restrictions on our ability to merge or consolidate with any other person or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of our assets.
In the event of a change in control (as defined in the relevant instruments) of the company, the total amount outstanding under the debt agreements described above may be declared immediately due and payable.
As of December 31, 2004, $3.9 million was outstanding under a note payable by us to a former operator of a site, which we refer to as the Santa Nella Note. The note bears interest at an annual rate of 5%, requires quarterly principal and interest payments of $98,000 through October 1, 2018 and is collateralized by the real estate and improvements located at the site.
ADJUSTED EBITDA AND DEBT COVENANT COMPLIANCE
Adjusted EBITDA, as used here, is based on the definition of "EBITDA" in our bank debt agreement and consists of net income plus the sum of (a) income taxes, (b) interest expense, net, (c) depreciation, amortization and other noncash charges, (d) transition expense, (e) extraordinary losses and cumulative effects of accounting changes
and (f) the costs of the merger and recapitalization transactions. We have included this information concerning Adjusted EBITDA because Adjusted EBITDA is a primary component for calculating the financial ratio covenants in our debt agreements. We also use Adjusted EBITDA as a basis for determining bonus payments to our corporate and site-level management employees and as a key component in the formula for calculating the fair value of our redeemable common stock and stock options. Adjusted EBITDA should not be considered in isolation from, or as a substitute for, net income, income from operations, cash flows from operating activities or other consolidated income or cash flow statement data prepared in accordance with generally accepted accounting principles. While the non-GAAP measures "EBITDA" and "Adjusted EBITDA" are frequently used by other companies as measures of operations and/or ability to meet debt service requirements, Adjusted EBITDA as we use the term is not necessarily comparable to similarly titled captions of other companies due to differences in methods of calculation.
We consider the 2004 Credit Agreement to be a material agreement. A majority of our outstanding indebtedness has been borrowed under the 2004 Credit Agreement. Further, the 2004 Credit Agreement requires us to maintain compliance with a variety of affirmative and negative covenants which primarily act to limit the types of business activities we can undertake; limits the amounts we can spend for items such as capital expenditures, dividends and distributions, investments, operating leases, etc.; and limits the amount of additional indebtedness we can incur and the liens that can be placed on our assets. We have maintained compliance with all of these covenants for all periods presented and expect to remain in compliance with all of the debt covenants to which we are subject through 2005. Of the many debt covenants to which we are subject, there are two primary financial ratio covenants against which our quarterly results are compared. These two key debt covenant financial ratios are (a) an interest expense coverage ratio and (b) a leverage ratio. The interest expense coverage ratio is calculated by dividing Adjusted EBITDA for the trailing four quarters by interest expense (excluding the interest expense related to the amortization of debt discount and deferred financing costs) for the trailing four quarters. The leverage ratio is calculated by dividing net debt by Adjusted EBITDA for the trailing four quarters. Net debt is calculated by subtracting from total debt the cash balance in excess of $2.5 million. Failure to meet either of the financial ratio debt covenants could result in the lenders under the 2004 Credit Agreement declaring our indebtedness under the 2004 Credit Agreement immediately due and payable. However, we believe the more likely consequence would be the negotiation of a waiver and/or amendment of the covenants, which is reasonably likely to require us to pay a significant amount of fees to the lenders and legal counsel and to further limit our ability to make cash disbursements, such as for capital expenditures. The following table sets forth the calculation of Adjusted EBITDA and information related to the debt covenant financial ratios.
(1) The first covenant test under the 2004 Credit Agreement is as of March 31, 2005. The required ratios presented are the requirements for that date. There are no required minimum or maximum ratio levels as of December 31, 2004.
(2) The 2004 Credit Agreement specifies amounts to be added to our actual Adjusted EBITDA amounts in order to determine pro forma Adjusted EBITDA amounts to be used in the covenant tests during 2005 in order to adjust for the historical results of the sites acquired from Rip Griffin and the termination of our master lease agreement, each of which transaction was funded through the 2004 Refinancing. The pro forma Adjusted EBITDA amount used in this calculation for 2004 was $153,802,000.
OFF-BALANCE SHEET ARRANGEMENTS
On September 9, 1999, we entered into a master lease program with a lessor that was used to finance the construction of eight travel centers on land we own. As part of the 2004 Refinancing, we purchased the leased assets from the lessor and terminated the master lease facility. We have no off-balance sheet arrangements as of December 31, 2004.
SUMMARY OF CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table summarizes our expected obligations to make future required payments under various types of agreements.
(1) Excludes interest. Also, the $225.0 million for 2008-2009 includes $25.0 million of revolving credit facility borrowings when they are contractually due, however, we intend to repay that amount during 2005.
(2) We have an obligation to make future payments to redeem common stock of certain of our management employees upon the death, disability or scheduled retirement of the employees. Neither the timing nor the amounts of any such payments can be accurately estimated and no amount for these payments is included in the table above. As of December 31, 2004, the aggregate amount of these future redemption payments, assuming our Board of Directors would not modify the formula for calculating the fair market value per share, would be approximately $6.5 million.
Our only commercial commitments of any significance as of December 31, 2004 were the $27.7 million of standby letters of credit we had outstanding.
LEVERAGED RECAPITALIZATION
On May 31, 2000, we and shareholders owning a majority of our voting stock entered into a recapitalization agreement and plan of merger, as subsequently amended, with TCA Acquisition Corporation, a newly created corporation formed by Oak Hill Capital Partners, L.P. and its affiliates, under which TCA Acquisition Corporation agreed to merge with and into us. This merger was completed on November 14, 2000. Concurrent with the closing of the merger, we completed a series of transactions to effect a recapitalization that included the following.
- TCA Acquisition Corporation issued 6,456,698 shares of common stock to Oak Hill and the Other Investors for proceeds of $205.0 million and then merged with and into us. We incurred $3.0 million of fees and expenses related to the issuance of these shares of common stock. These stock issuance costs were charged against additional paid-in capital.
- We redeemed all shares of our common and preferred stock outstanding prior to the closing of the merger, with the exception of 473,064 shares of common stock with a market value at that time of $15.0 million that were retained by continuing stockholders, and cancelled all outstanding common stock options and warrants, for cash payments totaling $263.2 million.
- All shares of treasury stock were cancelled.
After the transactions described above, Oak Hill owned 60.5% of our outstanding common stock, the Other Investors owned, in the aggregate, 32.7% of our outstanding common stock, Freightliner owned 4.3% of our outstanding common stock and certain members of our management owned 2.5% of our outstanding common stock. The total amount of our equity capitalization after these transactions, given the $31.75 per share merger consideration that was paid in our merger and recapitalization transactions, was $220.0 million. The transactions described above, which resulted in a change of control of us, have been accounted for as a leveraged recapitalization, as opposed to a purchase business combination, since the change of control was effected through issuance of new shares to our new control group in conjunction with a redemption of most of our then outstanding equity securities. We followed leveraged recapitalization accounting because of the significance of the ownership interest in us that was retained by continuing stockholders. In accounting for our leveraged recapitalization, we retained the historical cost bases of our assets and liabilities and consequently recorded charges totaling $179.0 million to our equity accounts upon the redemption of equity securities. This accounting treatment contrasts with that followed in a purchase business combination, in which a company reflects the new basis in its assets and liabilities of its new control group by increasing or decreasing its historical balances based on the estimated fair values at that time and avoids the charge to equity that accompanies the redemption of equity securities. Based on a limited appraisal of our owned network sites performed in connection with the merger and recapitalization transactions, the estimated fair value of our sites at June 15, 2000 was approximately $1.05 billion.
ENVIRONMENTAL MATTERS
We own and operate underground storage tanks and aboveground storage tanks at company-operated sites and leased sites that must comply with Environmental Laws. We have estimated the current ranges of remediation costs at currently active sites and what we believe will be our ultimate share for those costs and, as of December 31, 2004, we had a reserve of $13.2 million for unindemnified environmental matters for which we are responsible, a receivable for estimated recoveries of these estimated future expenditures of $3.7 million and $5.3 million of cash in an escrow account to fund certain of these estimated expenditures, leaving an estimated net amount of $4.1 million to be funded from future operating cash flows. We estimate that the gross cash outlays related to the matters for which we have accrued this reserve will be approximately $4.6 million in 2005; $3.0 million in 2006; $2.4 million in 2007; $1.7 million in 2008; $1.4 million in 2009 and $0.1 million thereafter. These cash expenditure amounts do not reflect any amounts for the expected recoveries as we cannot accurately predict the timing of those cash receipts. Under the environmental agreement entered into as part of the acquisition of the BP network, BP is required to provide indemnification for, and conduct remediation of, certain pre-closing environmental conditions.
We have obtained insurance of up to $35.0 million for known and up to $40.0 million for unknown environmental liabilities, subject, in each case, to certain limitations. While it is not possible to quantify with certainty our environmental exposure, we believe that the potential liability, beyond that considered in the reserve, for all environmental proceedings, based on information known to date, will not have a material adverse effect on our financial condition, results of operations or our liquidity. For further discussion of environmental matters, see the "Business - Regulation" section of this annual report and the footnotes to the audited consolidated financial statements included elsewhere in this annual report.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
FIN 46R. In December 2003, the FASB issued revised FIN 46R, "Consolidation of Variable Interest Entities." We must adopt this accounting guidance effective January 1, 2005. It had been our intention to consolidate into our consolidated financial statements the entity that was the lessor under our master lease program covering eight of our sites. However, as part of the 2004 Refinancing, we purchased the leased assets from the lessor and terminated the master lease facility, so we will not apply FIN 46R with respect to that terminated arrangement. We evaluated whether FIN 46R will require consolidation of our franchisees, and have determined that it will not.
FAS 123R. In December 2004, the FASB issued a revision of FAS 123, "Share-Based Payment" (FAS 123R). FAS 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The cost to be recognized will be measured based on the fair value of the equity or liability instruments issued. The scope of FAS 123R includes a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. FAS 123R replaces FAS 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees." As originally issued in 1995, FAS 123 established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that statement permitted entities the option of continuing to apply the guidance of APB 25 as long as the footnotes to the financial statements disclosed what net income would have been had the preferable fair-value-based method been used. At that time, we determined to continue to apply the guidance of APB 25 and make the required disclosures in our financial statement footnotes. Accordingly, we will be required to change our method of accounting for stock compensation costs. We will be required to adopt FAS 123R as of January 1, 2006. FAS 123R applies only to those awards granted or which become vested after the required effective date. We expect that the adoption of FAS 123R in the first quarter of 2006 will have no material effect on our results of operations, financial condition or cash flows.
FORWARD-LOOKING STATEMENTS
This annual report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future prospects, developments and business strategies. The statements contained in this annual report that are not statements of historical fact may include forward-looking statements that involve a number of risks and uncertainties. We have used the words "may," "will," "expect," "anticipate," "believe," "estimate," "plan," "intend" and similar expressions in this annual report to identify forward-looking statements. These forward-looking statements are made based on our expectations and beliefs concerning future events affecting us and are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control, that could cause our actual results to differ materially from those matters expressed in or implied by forward-looking statements. The following factors are among those that could cause our actual results to differ materially from the forward-looking statements:
- competition from other travel center and truck stop operators, including additional or improved services or facilities of competitors, and from the potential commercialization of state-owned interstate rest areas;
- the economic condition of the trucking industry, which in turn is dependent on general economic factors;
- increased environmental regulation;
- changes in governmental regulations;
- changes in interest rates;
- diesel fuel and gasoline pricing;
- availability of diesel fuel and gasoline supply;
- ability to refinance our Senior Subordinated Notes due 2009;
- success of new business ventures, including the risks that the Rip Griffin sites acquired and any other businesses or investments that we have acquired or may acquire may not be successfully integrated into our current business operations; and
- availability of sufficient qualified personnel to staff company-operated sites.
All of our forward-looking statements should be considered in light of these factors and all other risks discussed from time to time in our filings with the Securities and Exchange Commission. We do not undertake to update our forward-looking statements or risk factors to reflect future events or circumstances.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to commodity price risk and interest rate risk. Our fuel purchase contracts provide for purchase prices based on average market prices for diesel fuel and gasoline, exposing us to commodity price risk. We mitigate this risk exposure in several ways, but primarily by holding less than three days of diesel fuel inventory at our sites and selling a large portion of our fuel volume on the basis of a daily industry index of average fuel costs plus a pumping fee, which minimize the effect on our margins of sudden sharp changes in commodity market prices. We manage the price exposure related to sales volumes not covered by the daily industry index pricing formulae through the use, from time to time, on a limited basis, of derivative instruments designated by management as hedges of anticipated purchases. We had no open derivative contracts at any point in time during the year ended December 31, 2004.
The interest rate risk faced by us results from our highly-leveraged position and our level of variable rate indebtedness, the rates for which are based on short-term lending rates, primarily the London Interbank Offered Rate. From time to time, we may use interest rate protection agreements to reduce our exposure to market risks from changes in interest rates by fixing interest rates on variable rate debt and reducing certain exposures to interest rate fluctuation. Amounts due to or from interest rate protection agreement counterparties are recorded in interest expense in the period in which they accrue. During 2004, we were involved in no interest rate protection agreements.
The following table summarizes information about our financial instruments that are subject to changes in interest rates:
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements and Supplementary Data:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of TravelCenters of America, Inc.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of TravelCenters of America, Inc. and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 3, the Company adopted the provisions of Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" as of January 1, 2003.
/S/ PRICEWATERHOUSECOOPERS LLP
Cleveland, Ohio March 24, 2005
TRAVELCENTERS OF AMERICA, INC. CONSOLIDATED BALANCE SHEET
The accompanying notes are an integral part of these consolidated financial statements.
TRAVELCENTERS OF AMERICA, INC. CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
The accompanying notes are an integral part of these consolidated financial statements.
TRAVELCENTERS OF AMERICA, INC. CONSOLIDATED STATEMENT OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
TRAVELCENTERS OF AMERICA, INC. CONSOLIDATED STATEMENT OF NONREDEEMABLE STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS DESCRIPTION AND SUMMARY OF OPERATING STRUCTURE
We are a holding company which, through our wholly owned subsidiaries, owns, operates and franchises travel centers along the North American highway system to serve long-haul trucking fleets and their drivers, independent truck drivers and general motorists. At December 31, 2004, our geographically diverse nationwide network of full-service travel centers consisted of 160 sites located in 41 states and the province of Ontario, Canada. Our operations are conducted through three distinct types of travel centers:
- sites operated by us, which we refer to as company-operated sites;
- sites owned by us and leased to independent lessee-franchisees, which we refer to as leased sites; and
- sites owned and operated by independent franchisees, which we refer to as franchisee-owned sites.
At December 31, 2004, our network consisted of 138 company-operated sites, 12 leased sites and 10 franchisee-owned sites. During 2004, we converted two leased sites to company-operated sites, sold two company-operated sites and added twelve existing company-operated sites to our network.
Our travel centers are located at key points along the U.S. interstate highway system and in Canada, typically on 20- to 25-acre sites. Operating under the "TravelCenters of America" and "TA" brand names, our nationwide network provides our customers with diesel fuel and gasoline as well as non-fuel products and services such as truck repair and maintenance services, full-service restaurants, fast food restaurants, travel and convenience stores and other driver amenities. We also collect rents and franchise royalties from the franchisees who operate the leased sites and franchisee-owned sites and, as a franchisor, assist our franchisees in providing service to long-haul trucking fleets and their drivers, independent truck drivers and general motorists.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of TravelCenters of America, Inc. and its wholly owned subsidiaries, TA Operating Corporation and TA Franchise Systems Inc., as well as TA Licensing, Inc., TA Travel, L.L.C., 3073000 Nova Scotia Company, TravelCentres Canada Inc., and TravelCentres Canada Limited Partnership, which are all direct or indirect wholly owned subsidiaries of TA Operating Corporation. Intercompany accounts and transactions have been eliminated.
Revenue Recognition
Sales revenues and related costs are recognized at the time of delivery of motor fuel to customers at either the terminal or the customer's facility for wholesale fuel sales and at the time of final sale to consumers at our company-operated sites for retail fuel and non-fuel sales. The estimated cost to us of the redemption by customers of our loyalty program points is recorded as a discount against gross sales in determining the net sales amount presented in our consolidated statement of operations.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
For those travel centers that we own but lease to a franchisee, rent revenue is recognized based on the rent payment due for each period. These leases specify rent increases each year based on inflation rates for the respective periods or capital improvements we make at the site. As the rent increases related to these factors are contingent upon future events, the related rent revenue is not recognized until it becomes accruable.
Franchise royalty revenues are collected and recognized monthly and are determined as a percentage of the franchisees' revenues. Initial franchise fee revenues are recognized at the point when the franchisee opens for business under our brand name, which is when we have fulfilled all of our initial obligations under the related agreements. Initial franchise fees for the years ended December 31, 2002, 2003 and 2004 were $100,000, $0 and $100,000, respectively.
Cash and Cash Equivalents
For purposes of the statement of cash flows, we consider all highly liquid investments with an initial maturity of three months or less to be cash.
Inventories
Inventories are stated at the lower of cost or market value, cost being determined principally on the weighted average cost method.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed on a straight-line basis over the following estimated useful lives of the assets:
Repair and maintenance costs are charged to expense as incurred, while major renewals and betterments are capitalized. The cost and related accumulated depreciation of property and equipment sold, replaced or otherwise disposed of are removed from the accounts. Any resulting gains or losses are recognized in operations.
Intangible Assets
Acquired intangible assets, other than goodwill, are initially recognized based on their fair value. Those intangible assets acquired in a business combination are initially recognized in accordance with FAS 141, "Business Combinations." FAS 141 requires an allocation of purchase price to all assets and liabilities acquired, including those intangible assets that arise from contractual or other legal rights or are otherwise capable of being separated or divided from the acquired entity (but excluding goodwill), based on the relative fair values of the acquired assets and liabilities. Any excess of acquisition cost over the fair value of the acquired net assets is recorded as goodwill. Costs of internally developing, maintaining, or restoring intangible assets that are not specifically identifiable, that have indeterminate lives or that are inherent in a continuing business and related to the entity as a whole are expensed as incurred. Intangible assets with finite lives are amortized on a straight-line basis over their estimated lives, principally the terms of the related contractual agreements giving rise to them. Goodwill and intangible assets with indefinite lives are not amortized but are reviewed on January 1 of each year (or more frequently if impairment indicators arise) for impairment (see Note 9).
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Internal-Use Software Costs
During the application development stage of an internal-use computer software project, we capitalize (i) the external direct costs of materials and services consumed in developing or obtaining the internal-use computer software, (ii) to the extent of time spent directly on the project, payroll costs of employees directly associated with and who devote time to the project, and (iii) related interest costs incurred. Internal and external costs incurred in the preliminary project stage and post-implementation stage, such as for exploring alternative technologies, vendor selection and maintenance, are expensed as incurred, as are all training costs. The costs of significant upgrades and enhancements that result in additional functionality are accounted for in the same manner as similar costs for new software projects. The costs of all other upgrades and enhancements are expensed as incurred.
Impairment of Long-Lived Assets
Impairment charges are recognized when the carrying value of a long-lived asset to be held and used in the business is not recoverable and exceeds its fair value, and when the carrying value of a long-lived asset to be disposed of exceeds the estimated fair value of the asset less the estimated cost to sell the asset. Such impairment charges are recognized in the period during which the circumstances surrounding an asset to be held and used have changed such that the carrying value is no longer recoverable, or during which a commitment to a plan to dispose of the asset is made. Such tests are performed at the individual travel center level. In addition, intangible assets are subjected to further evaluation and impairment charges are recognized when events and circumstances indicate the carrying value of the intangible asset exceeds the fair market value of the asset. Impairment charges are included in depreciation and amortization expense in our consolidated income statement.
Deferred Financing Costs
Deferred financing costs were incurred in conjunction with issuing long-term debt and are amortized into interest expense over the lives of the related debt instruments using the effective interest method (see Note 12).
Classification of Costs and Expenses
Cost of goods sold (excluding depreciation) represents the costs of fuels and other products sold, including freight. Operating expenses principally represent costs incurred in operating our sites, consisting primarily of labor, maintenance, supplies, utilities and occupancy costs. Transition expense represents the costs incurred to convert and integrate acquired sites into our network and include costs such as for training, employee relocation and deferred maintenance, all of which costs incurred during 2004 were in connection with the Rip Griffin acquisition. Costs of advertising are expensed as incurred.
Operating Lease Expense
Generally, rental on operating leases is charged to expense over the lease term as it becomes payable. Certain operating leases specify scheduled rent increases over the lease term. The effects of those scheduled rent increases, which are included in minimum lease payments, are recognized in rent expense over the lease term on a straight-line basis.
Stock-Based Employee Compensation
We account for our stock-based employee compensation plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. For
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
granted options that vest over time, no compensation expense is reflected in net income, as all of those options had an exercise price equal to or greater than the market value of the underlying common stock at the date of grant. For granted options that vest based on attaining certain measures of performance, compensation expense is recognized when it becomes probable that the performance triggers for such options will be achieved. The following table illustrates the effect on net income if we had applied the fair value recognition provisions of FAS No. 123 to stock-based employee compensation.
The fair value of these options used to calculate the pro forma compensation expense amounts was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: a risk-free interest rate of 5.5%, a dividend yield of 0.0%, a volatility factor of 0.0001%, and an expected life of the options of ten years.
Environmental Remediation
We provide for remediation costs and penalties when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. Remediation expenses are included within operating expenses in our consolidated statement of income. Generally, the timing of remediation accruals coincides with completion of a feasibility study or the commitment to a formal plan of action. If recoveries of remediation costs from third parties are probable, a receivable is recorded. Accruals are not recorded for the costs of remediation activities undertaken on our behalf by BP, at BP's sole expense (see Note 19). In our consolidated balance sheet, the accrual for environmental matters is included in other noncurrent liabilities, with the amount estimated to be expended within the subsequent year reported as a current liability within the other accrued liabilities balance.
Defined Contribution Plan
We sponsor a 401(k) defined contribution plan to provide eligible employees with additional income upon retirement. Our contributions to the plans are based on employee contributions and compensation and are recognized in operating expenses in the period incurred.
Asset Retirement Obligations
As of January 1, 2003, we began recognizing the future costs to remove our underground storage tanks over the estimated useful lives of each tank in accordance with the provisions of FAS 143, "Accounting for Asset Retirement Obligations." A liability for the fair value of an asset retirement obligation with a corresponding increase to the carrying value of the related long-lived asset is recorded at the time an underground storage tank is installed. We amortize the amount added to property and equipment and recognize accretion expense in connection with the discounted liability over the remaining life of the respective underground storage tank. The estimated liability is
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
based on historical experiences in removing these tanks, estimated tank useful lives, external estimates as to the cost to remove the tanks in the future and regulatory requirements. The liability is a discounted liability using a credit-adjusted risk-free rate. Revisions to the liability could occur due to changes in tank removal costs, tank useful lives or if new regulations regarding the removal of such tanks are enacted. See Note 3.
Income Taxes
Deferred income tax assets and liabilities are established to reflect the future tax consequences of differences between the tax bases and financial statement bases of assets and liabilities. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance.
Concentration of Credit Risk
We grant credit to our customers and may require letters of credit or other collateral. Allowances for doubtful accounts and notes receivable are maintained based on historical payment patterns, aging of accounts receivable, periodic review of our customers' financial condition, and actual write-off history.
Derivative Instruments
We recognize derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. We designate our derivatives based upon criteria established by FAS 133, "Accounting for Derivative Instruments and Hedging Activities." For a derivative designated as a fair value hedge, the change in fair value is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the risk being hedged. For a derivative designated as a cash flow hedge, the effective portion of the derivative's gain or loss is initially reported as a component of accumulated other comprehensive income (loss) and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. We use derivatives to manage risk arising from changes in interest rates. Our objectives for holding derivatives are to decrease the volatility of earnings and cash flows associated with changes in interest rates. See Note 20.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which estimation is practicable: the fair values of financial instruments classified as current assets or liabilities approximate the carrying values due to the short-term maturity of the instruments; the fair value of our fixed-rate indebtedness that is publicly traded is estimated based on the quoted price for those notes. The fair value of our fixed-rate indebtedness that is not publicly traded is estimated based on the current borrowing rates available to us for financings with similar terms and maturities (see Note 12); and the fair values of our interest rate protection agreements are based on bank-quoted market prices.
3. CHANGE IN ACCOUNTING PRINCIPLE
As of January 1, 2003, we began recognizing the future costs to remove our underground storage tanks over the estimated useful lives of each tank in accordance with the provisions of Statement of Financial Accounting Standards (FAS) No. 143, "Accounting for Asset Retirement Obligations." A liability for the fair value of an asset retirement obligation with a corresponding increase to the carrying value of the related long-lived asset is recorded at the time an underground storage tank is installed. We amortize the amount added to property and equipment and recognize accretion expense in connection with the discounted liability over the remaining life of the respective underground storage tank. The estimated liability is based on historical experiences in removing these tanks,
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
estimated tank useful lives, external estimates as to the cost to remove the tanks in the future and regulatory requirements. The liability is a discounted liability using a credit-adjusted risk-free rate of approximately 12.8%. Revisions to the liability could occur due to changes in tank removal costs, tank useful lives or if new regulations regarding the removal of such tanks are enacted.
Upon adoption of FAS 143, we recorded a discounted liability of $589,000, increased property and equipment by $172,000 and recognized a one-time cumulative effect charge of $253,000 (net of a deferred tax benefit of $164,000). The pro forma effects for the years December 31, 2001 and 2002, assuming the adoption of FAS 143 as of January 1, 2001, were not material.
A reconciliation of our asset retirement obligation liability, which is included within other noncurrent liabilities in our consolidated balance sheet, for the year ended December 31, 2003 was as follows:
4. RECENTLY ISSUED ACCOUNTING STANDARDS
FIN 46R. In December 2003, the Financial Accounting Standards Board (FASB) issued revised FASB Interpretation No. (FIN) 46R, "Consolidation of Variable Interest Entities." We must adopt this accounting guidance effective January 1, 2005. It had been our intention to consolidate into our consolidated financial statements the entity that was the lessor under our master lease program covering eight of our sites. However, as part of the 2004 Refinancing, we purchased the leased assets from the lessor and terminated the master lease facility, so we will not apply FIN 46R with respect to that terminated arrangement. We evaluated whether FIN 46R will require consolidation of our franchisees, and have determined that it will not. We adopted the disclosure requirements of FIN 46R in 2002 and 2003.
FAS 123R. In December 2004, the FASB issued a revision of FAS 123, "Share-Based Payment" (FAS 123R). FAS 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The cost to be recognized will be measured based on the fair value of the equity or liability instruments issued. The scope of FAS 123R includes a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. FAS 123R replaces FAS 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees." As originally issued in 1995, FAS 123 established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that statement permitted entities the option of continuing to apply the guidance of APB 25 as long as the footnotes to the financial statements disclosed what net income would have been had the preferable fair-value-based method been used. At that time, we determined to continue to apply the guidance of APB 25 and make
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
the required disclosures in our financial statement footnotes. Accordingly, we will be required to change our method of accounting for stock compensation costs. We will be required to adopt FAS 123R as of January 1, 2006. FAS 123R applies only to those awards granted or which become vested after the required effective date. We expect that the adoption of FAS 123R in the first quarter of 2006 will have no material effect on our results of operations, financial condition or cash flows.
5. ACQUISITION
On December 1, 2004, we acquired from Rip Griffin Truck Service Center, Inc. the assets related to eleven travel centers located in seven states, primarily in the southwestern region of the United States. The acquisition was completed to strengthen our presence in the southwestern United States and included the land, buildings, equipment, inventories and certain prepaid assets at the eleven travel centers. The results from these eleven sites were included in our consolidated financial statements from December 1, 2004.
The aggregate purchase price was $129,142,000, all of which was paid in cash or assumed liabilities. The acquisition was funded with borrowings under our 2004 Credit Agreement as part of the 2004 Refinancing (see Note 12). We expect that all of the goodwill resulting from this acquisition will be tax deductible. The following table summarizes the amounts assigned to the assets acquired and the liabilities assumed at the date of acquisition.
As part of our purchase accounting for this acquisition, we did not recognize a liability for the potential costs to bring the parking lot at one site into an acceptable condition. Until further testing is complete, any repairs are not considered probable and any related cost cannot be estimated. We also cannot estimate any third-party recoveries we may receive to reimburse some or all of the potential costs. We expect this pre-existing contingency, which we have assumed, will be resolved during 2005. Should an accrual be necessary, the amount of goodwill recognized would be increased. The following unaudited pro forma information presents our results of operations as if the acquisition of the Rip Griffin sites had taken place on January 1, 2003.
These pro forma results of operations have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred on January 1, 2003, or that may result in the future.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
During the years ended December 31, 2002, 2003 and 2004, we paid aggregate amounts of $4,243,000, $10,190,000 and $636,000, respectively, to convert five, six and two, respectively, leased sites to company-operated sites. These acquisitions are considered immaterial, individually and in the aggregate, for further disclosures.
6. COMPREHENSIVE INCOME
Income tax provision (benefit) related to other comprehensive income (loss) consisted of the following:
7. INVENTORIES
Inventories consisted of the following:
8. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
At December 31, 2004, we were holding for sale one former travel center that had been closed during 2003.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
9. GOODWILL AND INTANGIBLE ASSETS
Goodwill. Goodwill results from our business acquisitions and represents the excess of amounts paid to the sellers over the fair values of the tangible assets acquired. For the years ended December 31, 2002, 2003 and 2004, we recorded goodwill of $4,242,000, $1,999,000 and $23,314,000, respectively, in connection with converting leased sites to company-operated sites and, in 2004, the Rip Griffin acquisition (see Note 5). The changes in the carrying amount of goodwill for the years ended December 31, 2002, 2003 and 2004 were as follows:
Intangible Assets. Leasehold interest represents the value, obtained through the BP acquisition, of favorable lease provisions at one location, the lease for which extended 11 1/2 years from the date of the BP acquisition. The leasehold interest is being amortized over the 11 1/2 year period. Trademarks relate primarily to our purchase of the trademarks, service marks, trade names and commercial symbols from BP and Travel Ports. The trademarks have indefinite lives and, therefore, are not amortized. Other intangible assets primarily includes noncompetition agreements that are amortized over their contractual lives.
The net carrying amount of intangible assets is included within other noncurrent assets in our consolidated balance sheet. Intangible assets, net, consisted of the following:
Total amortization expense for our amortizable intangible assets for the years ended December 31, 2002, 2003 and 2004 was $1,896,000, $686,000 and $189,000, respectively. The estimated aggregate amortization expense for our amortizable intangible assets for each of the five succeeding fiscal years are $130,000 for 2005; and $60,000 for each of 2006, 2007, 2008 and 2009.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
10. OTHER ACCRUED LIABILITIES
Other accrued liabilities consisted of the following:
11. REVOLVING LOAN
We have available to us a revolving credit facility of $125,000,000. The revolving credit facility includes a $90,000,000 sublimit for letters of credit. The interest rate for each borrowing under this revolving credit facility is based, at our election, on either a prime rate-based alternate base rate (ABR) or an adjusted London Interbank Offered Rate (LIBOR). Added to either the ABR or LIBOR rates are the following interest rate spreads that decline as our Leverage Ratio (as defined in the 2004 Credit Agreement) declines:
Commitment fees are calculated as 0.5% of the daily average unused amount of the revolving loan commitment. At December 31, 2003 and 2004, there were outstanding borrowings under our revolving credit facilities of $13,600,000 and $25,000,000, respectively. There were $27,699,000 of available borrowings reserved for letters of credit at December 31, 2004. The revolving loan facility matures in December 2009. See Note 12 for additional information regarding this and all of our indebtedness.
12. LONG-TERM DEBT
On December 1, 2004, we completed a refinancing, which we refer to as the "2004 Refinancing." In the 2004 Refinancing, we borrowed $500,000,000 under an Amended and Restated Credit Agreement that we refer to as the 2004 Credit Agreement. The 2004 Credit Agreement included a fully-drawn $475,000,000 term loan facility and a $125,000,000 revolving credit facility under which $25,000,000 was drawn at closing. The proceeds from these borrowings were utilized to:
- repay all amounts, including accrued interest, outstanding under the existing amended and restated credit agreement into which we had entered in November 2000 and which we refer to as the 2000 Credit Agreement;
- pay for the acquisition of the assets acquired from Rip Griffin (see Note 5);
- terminate the master lease facility under which since 1999 we built eight travel centers on land we owned, thereby gaining ownership of the improvements at those eight sites; and
- pay fees and expenses related to the financing and the acquisition transactions.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Long-term debt (net of unamortized discount) consisted of the following:
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(a) On December 1, 2004, in connection with the 2004 Refinancing, we entered into a $600,000,000 Amended and Restated Credit Agreement with a group of lenders, which borrowing we refer to as the 2004 Credit Agreement. The 2004 Credit Agreement provides for a $475,000,000 term loan facility, which was fully drawn at closing, and a $125,000,000 revolving credit facility (see Note 11). Term loan principal payments of $1,187,500 are due at each quarter end, beginning March 31, 2006, through September 30, 2011, with the remaining balance due at maturity. The term loan facility matures on December 1, 2011 and the revolving credit facility matures on December 1, 2009, provided however that if we have not refinanced our Senior Subordinated Notes due 2009 with qualified indebtedness prior to October 1, 2008, the term loan and revolving credit facilities will mature on October 1, 2008.
(b) Interest accrues at variable rates based, at our election, on either adjusted LIBOR plus 1.75% or a prime rate-based alternate base rate plus 0.75%. We have the option to select which rate will be applied at the beginning of each loan period, the term of which, for LIBOR borrowings, varies, at our election, from one to six months and, for alternate base rate borrowings, extends until we elect to convert to LIBOR borrowings. At December 31, 2004, the term loan was comprised of borrowings at an average rate of 4.32% for interest periods that end in March 2005 and June 2005. Interest payments are due at each quarter end for interest related to alternate base rate borrowings and at the end of each loan period, but not less frequently than quarterly, for LIBOR borrowings.
(c) In November 2000, in connection with a refinancing that we refer to as the 2000 Refinancing, we entered into the 2000 Credit Agreement, which included a $328,000,000 term loan facility that had been fully drawn at closing of the 2000 Refinancing. The then outstanding balance of this 2000 Term Loan was repaid in full as part of the 2004 Refinancing.
(d) Interest accrues at variable rates based, at our election, on either adjusted LIBOR or a prime rate-based alternate base rate (ABR). Added to either the ABR or LIBOR rates are interest rate spreads of 0.75% to 1.25% for ABR borrowings and of 1.75% to 2.25% for LIBOR borrowings, depending on our Leverage Ratio (see Note 11). We have the option to select which rate will be applied at the beginning of each loan period, the term of which, for LIBOR borrowings, varies, at our election, from one to six months and, for alternate base rate borrowings, extends until we elect to convert to LIBOR borrowings. At December 31, 2004 we had $25,000,000 of alternate base rate borrowings at 6.5%. Interest payments are due at each quarter end for interest related to alternate base rate borrowings and at the end of each loan period, but not less frequently than quarterly, for LIBOR borrowings.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(e) On November 14, 2000, in connection with the 2000 Refinancing, we issued Senior Subordinated Notes with an aggregate face amount of $190,000,000. These notes were issued at a discount of 3.704% and each $1,000 note was accompanied by detachable warrants (see Note 15). The warrants had an aggregate fair value at issuance of $8,360,000. Based on the relative fair values of the notes and the warrants at the time of issuance, $8,050,000 has been recognized as unamortized debt discount in our balance sheet, as has been the original issue discount of the notes. The debt discount is being amortized into interest expense using the effective interest method over the life of the notes. Interest payments on these notes are due semiannually on May 1 and November 1. Optional prepayments are allowed under certain circumstances, any such payments reducing the required payment of $190,000,000 due on May 1, 2009. We expect to refinance these Senior Subordinated Notes no later than November 2005, at which time they are callable by us at 106.375% of their face value.
(f) On September 1, 1998, in connection with the purchase of the operating assets of a leased site, we issued a note payable to the former operator of the site for $4,919,000. The note bears interest at 5% and requires quarterly payments of principal and interest of $98,000 through October 1, 2018. The note was recorded net of a discount of $1,875,000. This note is collateralized by a mortgage interest in the related travel center.
Debt Extinguishments Expense and Debt Issuance Costs. As part of the 2004 Refinancing, we amended and restated our 2000 Credit Agreement, and the borrowings thereunder, as the 2004 Credit Agreement. As part of this refinancing, we paid fees of $7,355,000 to our lenders and $2,502,000 to other parties, such as law firms. We also charged to expense $562,000 of unamortized debt issuance costs incurred in connection with the 2000 Refinancing with respect to those lenders that did not continue as parties to the 2004 Credit Agreement. As a result, in 2004 we recognized a charge to debt extinguishment expense of $1,699,000 and we capitalized as deferred financing costs $8,720,000 of costs associated with the additional borrowings under the 2004 Credit Agreement. Debt extinguishment expense is included within the interest and other financial costs, net balance in our consolidated statement of income.
Pledged Assets. The borrowings under the 2004 Credit Facility are collateralized by mortgages on substantially all of our property and equipment, liens on all of our accounts receivable and inventories and security agreements related to our cash balances and significant operating contracts.
Change of Control. In the event of a change in control (as defined in the relevant instruments) of the company, the total amount outstanding under the debt agreements described above may be declared immediately due and payable.
Mandatory Prepayments. The 2004 Credit Facility obligates us to make annual mandatory prepayments of term loan indebtedness equal to one-half of the Excess Cash Flow (as defined in the agreement) amount generated in the previous year. For the years ended December 31, 2002 and 2003, we generated $22,627,000 and $25,312,000, respectively, of Excess Cash Flow and, therefore, prepaid $11,314,000 and $12,656,000, respectively, of the term loan the succeeding years. Under the 2004 Credit Agreement, the Excess Cash Flow calculation and mandatory prepayment are not required until 2006, and will be based upon 2005 cash flow results.
Debt Covenants. Under the terms of the 2004 Credit Facility, we are required to maintain certain affirmative and negative covenants, that, among other things, limit the amount of indebtedness we can incur, limit the amount of lease payments we can make, limit the amount of dividend payments and debt prepayments we can make, limit the amount of capital expenditures we can make and require us to maintain a minimum interest coverage ratio and a maximum leverage ratio. We believe we were in compliance with the covenants throughout 2004 and at December 31, 2004.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Under the terms of the Indenture for the Senior Subordinated Notes due 2009, we are required to maintain certain affirmative and negative covenants that, among other things, limit our ability to incur indebtedness, pay dividends, redeem stock or sell assets or subsidiaries. We believe we were in compliance with the covenants throughout 2004 and at December 31, 2004.
Future Payments. Scheduled payments of long-term debt in the next five years are $198,000 in 2005; $4,959,000 in 2006; $4,969,000 in 2007; $4,980,000 in 2008; and $219,992,000 in 2009.
Fair Value. Based on the borrowing rates currently available to us for bank loans and other indebtedness with similar terms and average maturities and the year-end quoted market price of the Senior Subordinated Notes due 2009, the fair value of long-term debt at December 31, 2003 and 2004 was $545,116,000 and $723,130,000, respectively.
13. LEASING TRANSACTIONS
As a lessee. We have entered into lease agreements covering certain of our travel center locations, warehouse and office space, computer and office equipment and vehicles. Most long-term leases include renewal options and, in certain cases, they include escalation clauses and purchase options. Future minimum lease payments required under operating leases that had remaining noncancelable lease terms in excess of one year, as of December 31, 2004, were as follows:
Rent expense under our operating leases is included in both operating expenses and selling, general and administrative expenses in our consolidated statement of operations and comprehensive income and consisted of the following:
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Contingent rent represents the increases or decreases in lease payments that result from changes after the inception of the lease in the factors on which the lease payments are based. For us, contingent rent relates to those leases that provide for increases in rent payments based on changes in the consumer price index, increases in rent payments based on the level of sales and/or operating results of the leased site, and changes in rent payments based on changes in interest rates, specifically LIBOR.
As a lessor. Fourteen of the travel centers we owned were leased to franchisees under operating lease agreements during all or a portion of the year ended December 31, 2004. During 2004, two of these leases were mutually terminated, and, as a result, these sites were converted to company-operated sites. At December 31, 2004, we had such lease arrangements in place at 12 of our sites. Our lease agreements provide for initial terms of ten years with two renewal terms of five years each. These leases include rent escalations that are contingent on future events, namely inflation or capital improvements. Rent revenue from such operating lease arrangements totaled $9,488,000, $7,564,000 and $5,655,000 for the years ended December 31, 2002, 2003 and 2004, respectively. At December 31, 2004, the cost and accumulated depreciation of the assets covered by these lease agreements was $34,657,000 and $19,109,000, respectively. Future minimum lease payments receivable under these operating leases as of December 31, 2004 were as follows:
14. REDEEMABLE EQUITY
At each of December 31, 2003 and 2004, there were 182,800 and 177,871 shares, respectively, of our common stock owned by certain of our management employees. We refer to these shares of common stock as management shares. For the purchase of management shares, each of the management employees who entered into the management subscription agreement received financing from us for no more than one-half of the purchase price of the management shares. In connection with this financing each management employee executed a note in our favor and a pledge agreement. At December 31, 2003 and 2004, the aggregate principal amount of such notes due us from the management employees was $1,022,000 and $983,000, respectively, and is reflected as a reduction to the redeemable common stock balance.
Under the terms of the management subscription agreements and other agreements governing the management shares, the management employees have rights to require us to repurchase the management shares at fair market value upon the employee's termination of employment due to death, disability or scheduled retirement. Repurchase will generally be for cash at the fair market value on the date of termination if termination is due to death or disability or scheduled retirement at or after age 62, or for cash in installments over a period of years at fair market value each year if termination is due to scheduled retirement prior to age 62. Prior to an initial public
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
offering of our common stock, the fair market value is determined by a formula set forth in the agreement that can be modified by the Board of Directors. The formula to calculate the fair market value is (A) the product of (1) a multiplier (currently 6.5) and (2) EBITDA (as defined in our bank debt agreement) for the most recent four consecutive full fiscal quarters, plus (B) consolidated cash and cash equivalents in excess of $10,000,000, minus (C) consolidated indebtedness, divided by (D) the total number of shares of common stock outstanding on a fully diluted basis assuming full conversion and exercise of all common stock equivalents and similar stock rights.
If there is a change of control of us which involves the sale by stockholders of their equity interest to a third party during the time that installments are being paid to the management employees, we will accelerate the installment payments at the time of the close of the change of control. In other cases of termination, we will have call rights at fair market value that generally will be exercised for cash, although in limited circumstances the call rights may be exercised by promissory note. In all cases, repurchase rights are restricted under law, credit agreements, financing documents and other contracts, and our board's good faith determination that repurchases would not cause undue financial strain on us. The 2004 Credit Facility and the Indenture for the Senior Subordinated Notes limit our ability to repurchase the management shares. The amount paid upon repurchase of any management shares will be reduced by the principal balance of and unpaid accrued interest on the related notes receivable. At the point in time that redemption of shares of redeemable common stock becomes probable, the fair value of the shares will be accreted to their estimated redemption value by a charge to nonredeemable stockholders' equity. Such a charge to nonredeemable stockholders' equity will occur only if our value, and therefore the fair value of our common stock, has increased. Our policy is to consider redemption of an individual stockholder's shares probable at the time that the stockholder provides notice of his or her intention to retire, dies or is declared disabled.
15. NONREDEEMABLE STOCKHOLDERS' EQUITY
Common stock and other nonredeemable stockholders' equity consisted of the following:
The numbers of outstanding shares of common stock in the table include the redeemable shares owned by certain of our management employees as discussed in Note 14.
MERGER AND RECAPITALIZATION
On May 31, 2000, we and shareholders owning a majority of our voting stock entered into a recapitalization agreement and plan of merger, as subsequently amended, with TCA Acquisition Corporation, a newly created corporation formed by Oak Hill Capital Partners, L.P. and its affiliates, under which TCA Acquisition Corporation agreed to merge with and into us. This merger was completed on November 14, 2000. Concurrent with the closing of the merger, we completed a series of transactions to effect a recapitalization that included the following.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- TCA Acquisition Corporation issued 6,456,698 shares of common stock to Oak Hill and other institutional investors for proceeds of $205,000,000 and then merged with and into us. We incurred $3,015,000 of fees and expenses related to the issuance of these shares of common stock. These stock issuance costs were charged against additional paid-in capital.
- We redeemed all shares of our common and preferred stock outstanding prior to the closing of the merger, with the exception of 473,064 shares of common stock with a market value at that time of $15,020,000 that were retained by continuing stockholders, and cancelled all outstanding common stock options and warrants, for cash payments totaling $263,153,000.
- All shares of treasury stock were cancelled.
After the transactions described above, Oak Hill owned 60.5% of our outstanding common stock, the Other Investors owned, in the aggregate, 32.7% of our outstanding common stock, Freightliner owned 4.3% of our outstanding common stock and certain members of our management owned 2.5% of our outstanding common stock. The total amount of our equity capitalization after these transactions, given the $31.75 per share merger consideration that was paid in our merger and recapitalization transactions, was $220,020,000. The transactions described above, which resulted in a change of control over us, have been accounted for as a leveraged recapitalization, as opposed to a purchase business combination, since the change of control was effected through issuance of new shares to our new control group in conjunction with a redemption of most of our then outstanding equity securities. We followed leveraged recapitalization accounting because of the significance of the ownership interest in us that was retained by continuing stockholders. In accounting for our leveraged recapitalization, we retained the historical cost bases of our assets and liabilities and consequently recorded charges totaling $178,965,000 to our equity accounts upon the redemption of equity securities. This accounting treatment contrasts with that followed in a purchase business combination, in which a company reflects the new basis in its assets and liabilities of its new control group by increasing or decreasing its historical balances based on the estimated fair values at that time and avoids the charge to equity that accompanies the redemption of equity securities.
OTHER COMMON STOCK ISSUANCES
During the year ended December 31, 2002, we issued 7,302 shares of common stock to certain members of management for cash and notes receivable (see Notes 14 and 18) aggregating $232,000.
PREFERRED STOCK
The board of directors has the authority to issue preferred stock in one or more classes or series and to fix the designations, powers, preferences and dividend rates, conversion rights, terms of redemption, and liquidation preferences and the number of shares constituting each class or series. Our authorized capital stock includes 5,000,000 shares of preferred stock with a par value of $0.00001. No preferred stock has been issued.
COMMON STOCK
Voting Rights. Each share of common stock entitles the holder to one vote on all matters submitted to a vote of our stockholders.
Dividends. Holders of common stock are entitled to receive dividends if, as and when declared by our board of directors out of funds legally available. Our debt agreements limit the amount of dividends we are able to pay.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Liquidation Rights and Other Rights. Upon our liquidation, dissolution or winding up, the holders of our common stock will be entitled to share pro rata in the distribution of all of our assets remaining after satisfaction of all of our liabilities and the payment of the liquidation preference of any outstanding preferred stock. The holders of our common stock do not have any conversion, redemption or preemptive rights.
Repurchase Rights. Certain members of our senior management have purchased shares of our common stock pursuant to individual management subscription agreements. We have the right to repurchase, and the employees have the right to require us to repurchase, subject to certain limitations, at fair market value, these shares of common stock upon termination of employment due to death, disability or a scheduled retirement. These shares are classified as redeemable equity in our consolidated balance sheet (see Note 14).
REGISTRATION RIGHTS
Under a stockholders' agreement to which all of our stockholders are party, certain of our stockholders have the right, under certain circumstances, to require us to register under the Securities Act of 1933 shares of our common stock held by them and allow them to include shares of common stock held by them in a registration under the Securities Act commenced by us.
COMMON STOCK WARRANTS
In connection with the issuance of our Senior Subordinated Notes due 2009 as part of our merger and recapitalization transactions, we issued warrants exercisable for shares of our common stock. The warrants were issued under a warrant agreement between us and State Street Bank and Trust Company (now US Bank), as warrant agent. We originally issued the warrants in connection with a private placement of 190,000 units, each unit consisting of one Senior Subordinated Note due 2009 and four warrants. Each warrant entitles its holder to purchase 0.36469 shares of our common stock at an exercise price of $0.001 per share, subject to anti-dilution adjustments under some circumstances. At the time of their issuance in November 2000, each warrant had a fair value of $11.579, or $31.75 per share for each share issuable upon the exercise of the warrants. The fair value of the warrants was initially recognized as unamortized debt discount and is being amortized into interest expense using the effective interest method over the life of our Senior Subordinated Notes. We have no warrants outstanding other than the 760,000 warrants issued as part of the unit offering in 2000.
Exercise of Warrants. The warrants may be exercised at any time. However, holders of warrants will be able to exercise their warrants only if the shelf registration statement is effective or the exercise of the warrants is exempt from the requirements of the Securities Act and only if the shares of common stock are qualified for sale or exempt from qualification under the applicable securities laws of the states or other jurisdiction in which the holders reside. Unless earlier exercised, the warrants will expire on May 1, 2009.
At our option, fractional shares of common stock may not be issued upon exercise of the warrants. If any fraction of a share of common stock would, except for the foregoing provision, be issuable upon the exercise of any warrants, we will pay an amount in cash equal to the current market value per share of common stock, as determined on the day immediately preceding the date the warrant is presented for exercise, multiplied by the fraction, computed to the nearest whole cent. The exercise price and the number of shares of common stock issuable upon exercise of a warrant are both subject to adjustment in certain cases.
No Rights as Stockholders. The holders of unexercised warrants are not entitled, as such, to receive dividends, to vote, to consent, to exercise any preemptive rights or to receive notice as our stockholders of any stockholders meeting for the election of our directors or any other purpose, or to exercise any other rights whatsoever as our stockholders.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
STOCK AWARD AND OPTION PLAN
2001 Stock Plan. During 2001, we granted to certain of our executives non-qualified stock options to purchase 944,881 shares of our common stock under a stock incentive plan our board of directors adopted in November 2000 and which was approved by a vote of our stockholders in 2001. All of the options have a term of 10 years from the date of grant, although the options will be terminated earlier if certain customary events occur. For example, if an executive's employment is terminated by us without cause or by the executive for good reason or due to death, disability or scheduled retirement, all vested options will expire 60 days following termination of employment. Under certain circumstances, the executive will be allowed to hold a limited portion of his unvested options for a longer period of time following termination of employment for further vesting. Each option grant consists of 41.67% time options and 58.33% performance options. Time options become exercisable with the passage of time, while performance options become exercisable if certain investment return targets are achieved. Time options generally vest 20% per year over a period of five years. Performance options vest if Oak Hill achieves specified internal rates of return on specified measurement dates. In general, the number of performance options that will vest is based upon Oak Hill achieving internal rates of return between 22.5% and 30.0% on a measurement date. A measurement date is generally defined as the earliest of (1) five years from the closing of the merger and recapitalization transactions (November 14, 2000), (2) specified dates following an initial public offering of our stock, depending on the date the initial public offering occurs, or (3) the date that at least 30% of our shares owned by Oak Hill are distributed to its limited partners or sold, except that a subsequent measurement date may occur if less than 100% of our shares owned by Oak Hill are so sold or distributed. Vesting is partially accelerated for time options following termination of employment due to death, disability or scheduled retirement. If a change of control occurs, the vesting of time options will fully accelerate. Option holders will have rights to require us to repurchase shares obtained upon the exercise of vested options upon a termination of employment due to disability, death or, subject to a six-month holding period, scheduled retirement, and, in certain limited cases, upon a change of control. In connection with our initial grant of options under this plan, we established and granted a discretionary pool of options that will be allocated periodically, first to new members of management who become option holders after the date of the initial grant, and then to other members on a pro rata basis. The total number of shares underlying the initial grant of options will not increase as a result. The time options are subject to fixed plan accounting and, accordingly, no charge to earnings will be required with respect to them since the exercise price equaled the fair value at the date of grant. The performance options are subject to variable plan accounting and, accordingly, a non-cash charge to earnings will be required when it becomes probable that the performance triggers for such options will be achieved. It is not possible to determine at this time, nor may it be possible until close to the end of the five-year performance period, whether it will be probable that we will achieve the performance triggers. It is not possible to predict whether any such required non-cash charge will be material to our results for the period in which the charge is recognized, as we expect that the performance triggers can only be attained as a result of a significant increase in our results of operations. The options granted to future participants in the option plan under the discretionary pool, including time options, also may be subject to a compensation charge.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Stock Option Status Summary. The following table reflects the status and activity of options under our stock plans:
The weighted-average exercise price was $31.75 per share for all outstanding options as of December 31, 2002, 2003 and 2004.
We account for our stock-based employee compensation plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. For the years ended December 31, 2002, 2003 and 2004, no stock-based employee compensation cost is reflected in net income, as all time options granted under those plans had an excise price equal to the market value of the underlying common stock on the date of grant and the vesting of the performance options is not considered to be probable. See Notes 2 and 4 for further discussion of our stock-based employee compensation.
16. INCOME TAXES
The (benefit) provision for income taxes was as follows:
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The difference between taxes calculated at the U. S. federal statutory tax rate of 35% and our total income tax provision is as follows:
For 2003, income tax benefits of $164,000 allocated to the cumulative effect of a change in accounting principle of $417,000 differ from the amount calculated at the federal statutory rate osf 35% by $18. This difference is due to state taxes and graduated tax rates.
Deferred income tax assets and liabilities resulted from the following:
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the composition of our federal net operating loss carryforwards by expiration date.
Realization of our net deferred tax assets is dependent on future taxable income. We believe it is more likely than not such net deferred tax assets will be realized and, accordingly, we have not recognized a valuation allowance with respect to our net deferred tax assets. Most of our net operating loss carryforwards were generated as a result of our merger and recapitalization transactions in November 2000. The remainder of our net operating loss carryforwards result largely from depreciation and interest deductions and the trends for these items relative to operating income are expected to decline, enabling us to generate sufficient taxable income to utilize net operating loss carryforwards. However, ultimate realization of our net deferred tax assets could be negatively affected by market conditions and other variables not known or anticipated at this time.
Our federal income tax returns for 2001 through 2004 are subject to examination by the Internal Revenue Service and certain of our state income tax returns for various states for various years from 1996 through 2004 are subject to examination by the respective state tax authorities. We believe we have made adequate provision for income taxes and interest that may become payable for years not yet examined.
17. EQUITY INVESTMENT
We owned a 21.5% of the voting stock of Simons Petroleum, Inc., a privately-held company that is a diversified marketer of diesel fuel and other petroleum products to trucking fleets and other customers in the energy-related and trucking industries, until April 9, 2004 when we sold the Simons shares we owned. The carrying value of this investment, which was included in other noncurrent assets in our consolidated balance sheet, as of December 31, 2003 was $7,462,000. The equity income earned from this investment for the years ended December 31, 2002, 2003 and 2004 was $718,000, $764,000 and $194,000, respectively. Summarized condensed financial information of this investee follows. In the tables below, income statement data for 2004 is shown for the three months ended March 31, 2004, and balance sheet data is shown as of March 31, 2004, as that was the last full month prior to the sale of our investment in Simons.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
After the sale on April 9, 2004, Simons was no longer an equity investee of ours and, therefore, no longer a related party. The following disclosures include transactions and balances related to our business activities with Simons only for the period while we were a Simons stockholder. During the years ended December 31, 2002 and 2003 and the period from January 1, 2004 through April 9, 2004, diesel fuel provided by Simons accounted for $183,217,000, $228,827,000, and $70,652,000, respectively, of our cost of goods sold and we made sales of diesel fuel to Simons in the amounts of $2,888,000, $3,328,000, and $152,000, respectively. We also lease a travel center from Simons and the rent expense related to this site for the years ended December 31, 2002, 2003 and 2004 was $408,000, $408,000 and $102,000 respectively. At December 31, 2003, our receivables from Simons were $150,000, respectively, while our payables to Simons were $49,000.
We received proceeds from the sale of our Simons shares of $9,073,000. This sale represented a prepayment event under the 2000 Credit Agreement and, therefore, in April 2004 we made a mandatory prepayment of our term loan borrowings in the amount of $9,073,000. The merger agreement pursuant to which we sold these shares provides two opportunities for us to receive additional sales proceeds in late 2005: we could receive an additional $921,000 based on Simons achieving specified earnings targets, and we could receive $1,053,000 that was paid into escrow at closing if certain conditions are met and certain representations and warranties are maintained. Due to the uncertainty surrounding the future realization of these receivables, the gain on sale we recognized in 2004 of $1,615,000 does not reflect these amounts.
18. RELATED PARTY TRANSACTIONS
Certain members of our senior management have purchased common stock pursuant to management subscription agreements (see Note 15 - Repurchase Rights). As a result of such purchases, we have notes and related interest receivable from the management stockholders totaling $1,490,000 and $1,514,000 at December 31, 2003 and 2004, respectively. We also had transactions with an equity investee that are described in Note 17.
19. COMMITMENTS AND CONTINGENCIES
GUARANTEES
In the normal course of business we periodically enter into agreements that incorporate indemnification provisions. While the maximum amount to which we may be exposed under such agreements cannot be estimated, it is the opinion of management that any potential indemnification is not expected to have a material adverse effect on our consolidated financial position or result of operations. We also offer a warranty of our workmanship in our truck maintenance and repair shops, but the annual warranty expense and corresponding liability are immaterial.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
ENVIRONMENTAL MATTERS
Our operations and properties are extensively regulated through environmental laws and regulations ("Environmental Laws") that (i) govern operations that may have adverse environmental effects, such as discharges to air, soil and water, as well as the management of petroleum products and other hazardous substances ("Hazardous Substances"), or (ii) impose liability for the costs of cleaning up sites affected by, and for damages resulting from, disposal or other releases of Hazardous Substances. We own and use underground storage tanks and aboveground storage tanks to store petroleum products and waste at our facilities. We must comply with requirements of Environmental Laws regarding tank construction, integrity testing, leak detection and monitoring, overfill and spill control, release reporting, financial assurance and corrective action in case of a release from a storage tank into the environment. At some locations, we must also comply with Environmental Laws relating to vapor recovery and discharges to water. We believe that all of our travel centers are in material compliance with applicable requirements of Environmental Laws. While the costs of compliance for these matters have not had a material adverse impact on us, it is impossible to predict accurately the ultimate effect changing laws and regulations may have on us in the future. We incurred capital expenditures, maintenance, remediation and other environmental related costs of approximately $3,947,000, $4,750,000 and $4,365,000 in 2002, 2003 and 2004, respectively.
We have received notices of alleged violations of Environmental Laws, or are aware of the need to undertake corrective actions to comply with Environmental Laws, at company-owned travel centers in a number of jurisdictions. We do not expect that any financial penalties associated with these alleged violations, or compliance costs incurred in connection with these violations or corrective actions, will be material to our results of operations or financial condition. We are conducting investigatory and/or remedial actions with respect to releases of Hazardous Substances at a number of our sites. While we cannot precisely estimate the ultimate costs we will incur in connection with the investigation and remediation of these properties, based on our current knowledge, we do not expect that the costs to be incurred at these properties, individually or in the aggregate, will be material to our results of operations or financial condition. In March 2004, we received notification from the Pennsylvania Underground Storage Tank Insurance Fund ("USTIF") that, as a result of our appeal, USTIF had reversed its denial of our claim for reimbursement of corrective action costs incurred or to be incurred to remediate a diesel fuel release at our Harrisburg site. USTIF has agreed that our claim is eligible for reimbursement. Accordingly, in March 2004, we recognized a $1,600,000 receivable for the recovery of the related corrective action costs, with an offsetting reduction of operating expenses. The expenses had been recognized by us in previous years, primarily in September 2003 when we expensed $1,335,000 as a result of USTIF's original denial of our claim.
While the matters discussed above are, to the best of our knowledge, the only proceedings for which we are currently exposed to potential liability, we cannot be certain that additional contamination does not exist at these or additional network properties, or that material liability will not be imposed in the future. If additional environmental problems arise or are discovered, or if additional environmental requirements are imposed by government agencies, increased environmental compliance or remediation expenditures may be required, and this could have a material adverse effect on us.
Under the environmental agreement entered into as part of the acquisition of the BP network, BP is required to provide indemnification for, and conduct remediation of, certain pre-closing environmental conditions. Until January 2004, Unocal similarly was required to provide indemnification for, and conduct remediation of, certain environmental conditions that existed prior to our April 1993 acquisition of the Unocal network. In January 2004, a Buy-Out Agreement between Unocal and us became effective and Unocal's obligations to us under the April 1993 environmental agreement were terminated. In consideration for releasing Unocal from its obligations under the environmental agreement, Unocal paid us $2,609,000 of cash, funded an escrow account with $5,415,000 to be drawn on by us as we incur related remediation costs, and purchased insurance policies that cap our total future expenditures for these matters at $9,648,000 and provide protection against significant unidentified matters that existed prior to April 1993. We are now responsible for all remediation at the former Unocal sites that we still own.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
We estimate the costs of the remediation activities for which we assumed responsibility from Unocal in January 2004 to be approximately $8,248,000 which amount we expect will be fully covered by the cash received from Unocal and reimbursements from state tank funds. Accordingly, we recognized no income or expense as a result of entering into the Unocal Buy-Out Agreement. Of the cash paid to us by Unocal, $1,000,000 was to reimburse us for the future costs of administering the remediation projects assumed from Unocal and was recorded as a deferred credit that will be recognized to offset our costs as the related remediation activities are completed.
We have obtained insurance of up to $35,000,000 for known environmental liabilities (which includes the insurance coverage purchased by Unocal as described above) and up to $40,000,000 for unknown environmental liabilities, subject, in each case, to certain limitations and deductibles. While it is not possible to quantify with certainty the environmental exposure, in our opinion, the potential liability, beyond that considered in the reserve we have recorded, for all environmental proceedings, based on information known to date, will not have a material adverse effect on our financial condition, results of operations or liquidity.
At December 31, 2004, we had a reserve for environmental matters of $13,156,000, a receivable for expected recoveries of certain of these estimated future expenditures and cash in an escrow account to fund certain of these estimated future expenditures, leaving an estimated net amount of $4,123,000 to be funded from future operating cash flows. The following table sets forth the various amounts recorded in our consolidated balance sheet as either current or noncurrent assets or liabilities.
The following table sets forth the estimated gross amount of the cash outlays related to the matters for which we have accrued the environmental reserve. These cash expenditure amounts do not reflect any amounts for the expected recoveries as we cannot accurately predict the timing of those cash receipts. These estimated future cash disbursements are subject to change based on, among other things, changes in the underlying remediation activities and changes in the regulatory environment.
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
PENDING LITIGATION
We are involved from time to time in various legal and administrative proceedings and threatened legal and administrative proceedings incidental to the ordinary course of our business. We believe we are currently not involved in any litigation, individually or in the aggregate, which could have a material adverse effect on our business, financial condition, results of operations or cash flows.
20. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
We attempt to manage the risk arising from changes in interest rates by using derivative financial instruments such as interest rate swaps. On November 14, 2000, we entered into an interest rate swap agreement with a notional principal amount of $80,000,000 to exchange our variable rate of LIBOR plus 3 25% with a fixed interest rate of 6.0875%. The swap agreement matured on December 15, 2002. We had no swap agreements in place throughout 2003 and 2004 and as of December 31, 2003 and 2004.
To qualify for hedge accounting, derivative contracts must meet defined correlation and effectiveness criteria, be designated as hedges and result in cash flows and financial statement effects which substantially offset those of the position being hedged. Amounts receivable or payable under derivative financial instrument contracts, when recognized, are reported in our consolidated balance sheet. Pursuant to the provisions of FAS 133, we determined that the interest rate swap agreement was 100% effective and qualified for cash flow hedge accounting.
During the year ended December 31, 2002, the fair value of the swap agreement increased until its maturity on December 15, 2002, resulting in the recognition of an increase in other comprehensive income of $1,920,000 (net of tax).
21. OTHER INFORMATION
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
22. SUPPLEMENTAL CASH FLOW INFORMATION
23. CONDENSED CONSOLIDATING FINANCIAL STATEMENT SCHEDULES
The following schedules set forth our condensed consolidating balance sheet schedules as of December 31, 2003 and 2004 and our condensed consolidating statement of income schedules and condensed consolidating statement of cash flows schedules for the years ended December 31, 2002, 2003 and 2004. In the following schedules, "Parent Company" refers to the unconsolidated balances of TravelCenters of America, Inc., "Guarantor Subsidiaries" refers to the combined unconsolidated balances of TA Operating Corporation and its domestic subsidiaries, and "Nonguarantor Subsidiary" refers to the combined balances of TA Franchise Systems Inc. and our Canadian subsidiaries that are included only since their formation in January 2003. "Eliminations" represent the adjustments necessary to (a) eliminate intercompany transactions and (b) eliminate our investments in our subsidiaries.
The Guarantor Subsidiaries, (TA Operating Corporation, TA Licensing, Inc., and TA Travel, L.L.C ), are direct wholly-owned subsidiaries of ours and have fully and unconditionally, jointly and severally, guaranteed the indebtedness of TravelCenters of America, Inc., which consists of the 2004 Credit Agreement and the Senior Subordinated Notes due 2009 (see Note 12).
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED CONSOLIDATING BALANCE SHEET SCHEDULES:
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED CONSOLIDATING STATEMENT OF INCOME SCHEDULES:
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS SCHEDULES:
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
TRAVELCENTERS OF AMERICA, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer, after conducting an evaluation, together with other members of our management, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report, have concluded that our disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 (c)) were effective to ensure that information required to be disclosed by us in our reports filed or submitted under the Securities Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the "SEC").
(b) Changes in internal controls. There were no changes in our internal controls over financial reporting that occurred during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
In December 2004, we entered into an employment agreement, dated as of January 1, 2005, with Joseph A. Szima, our Senior Vice President, Marketing, and an Officer of us. This agreement was on substantially identical terms in all material respects to the employment agreements we have with our other officer employees, except for the salary amount. The employment agreement commenced on January 1, 2005, and has a two-year term with automatic extensions of the second year at the end of each year through age 65, unless notice of non-renewal is given at least one year in advance. The agreement provides for an annual salary of $208,000, which amount may be increased but not decreased by action of the board of directors or its delegate, based on individual and company performance objectives, ranging from 0% to 75% of base salary, with 75% of base salary being the target bonus. If we terminate Mr. Szima's employment without cause or Mr. Szima resigns with good reason, Mr. Szima will be eligible to receive, among other things, a pro rata bonus for the year of termination, 24 months' base salary, plus two-times target bonus. Mr. Szima agrees that during the employment term and for the 24-month period that he is entitled to receive certain severance payments following a termination of employment by us without cause or by his resignation for good reason he will refrain from competing with us.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning our directors and executive officers required by this item is incorporated by reference to the material appearing under the headings "Our Directors and Officers," "Code of Ethics," and "Committees of the Board of Directors" in Exhibit 99.1 to this annual report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation required by this item is incorporated by reference to the material appearing under the heading "Executive Compensation" in Exhibit 99.1 to this annual report.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain of our beneficial owners and management required by this item is incorporated by reference to the material appearing under the heading "Security Ownership of Certain Beneficial Owners and Management" in Exhibit 99.1 to this annual report.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions required by this item is incorporated by reference to the material appearing under the heading "Certain Relationships and Related Transactions" in Exhibit 99.1 to this annual report.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning principal accounting fees and services required by this item is incorporated by reference to the material appearing under the heading "Principal Accounting Fees and Services" in Exhibit 99.1 to this annual report.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
A. Documents filed as part of this report:
1. Financial Statements
Financial statements filed as part of this report are listed in the Index to Consolidated Financial Statements and Supplementary Data on page 38 of this annual report.
2. Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
(a) Uncollectible accounts and notes receivable charged off, net of amounts recovered.
All other schedules are omitted because they are not applicable, not material or the required information is shown in the financial statements listed above.
3. Exhibits
Reference is made to the Exhibit Index set forth at page 83 of this annual report.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE SECURITIES EXCHANGE ACT OF
No annual report or proxy statement has been furnished to our security holders. We shall furnish to the Securities and Exchange Commission for its information, at the time copies of such material are furnished to our security holders, four copies of every proxy statement, form of proxy or other proxy soliciting material sent to more than ten of our security holders with respect to our annual meeting. The foregoing material shall not be deemed to be "filed" with the Securities and Exchange Commission or otherwise subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, except to the extent that we specifically incorporate it in this Form 10-K by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TRAVELCENTERS OF AMERICA, INC.
March 31, 2005 By: /s/ James W. George (Date) -------------------------------- Name: James W. George Title: Executive Vice President, Chief Financial Officer and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities on the date indicated.
Signature Title Date
/s/ Edwin P. Kuhn Chairman of the Board of Directors March 31, 2005 - -------------------------- Edwin P. Kuhn
/s/ Timothy L. Doane President, Chief Executive Officer March 31, 2005 - -------------------------- and Director (Principal Executive Timothy L. Doane Officer)
/s/ James W. George Executive Vice President, Chief March 31, 2005 - -------------------------- Financial Officer and Secretary James W. George (Principal Financial Officer and Principal Accounting Officer)
/s/ Robert J. Branson Director March 31, 2005 - -------------------------- Robert J. Branson
/s/ Michael Greene Director March 31, 2005 - -------------------------- Michael Greene
/s/ Steven B. Gruber Director March 31, 2005 - -------------------------- Steven B. Gruber
/s/ Louis J. Mischianti Director March 31, 2005 - -------------------------- Louis J. Mischianti
/s/ Rowan G. P. Taylor Director March 31, 2005 - -------------------------- Rowan G. P. Taylor
EXHIBIT INDEX
EXHIBIT INDEX
EXHIBIT INDEX
(a) Incorporated by reference to exhibits filed with our Annual Report on Form 10-K for the year ended December 31, 1997.
(b) Incorporated herein by reference to exhibits filed with our Annual Report on Form 10-K for the year ended December 31, 1998.
(c) Incorporated herein by reference to exhibits filed with our Quarterly Report on Form 10-Q for the quarter ended September 30, 1999.
(d) Incorporated herein by reference to exhibits filed with our Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.
(e) Incorporated herein by reference to exhibits filed with our Registration Statement on Form S-4 filed on December 21, 2000.
(f) Incorporated herein by reference to exhibits filed with our Pre-Effective Amendment No. 1 to our Registration Statement on Form S-4 filed on January 18, 2001.
(g) Incorporated herein by reference to exhibits filed with our Annual Report on Form 10-K for the year ended December 31, 2000.
(h) Incorporated herein by reference to exhibits filed with our Annual Report on Form 10-K for the year ended December 31, 2001.
(i) Incorporated by reference to exhibits filed with our Annual Report on Form 10-K for the year ended December 31, 2002, that was filed on March 26, 2003.
(j) Incorporated by reference to exhibits filed with our Annual Report on Form 10-K for the year ended December 31, 2003.
(k) Incorporated by reference to the exhibit filed with our Current Report on Form 8-K filed December 17, 2004.
(l) Incorporated by reference to the exhibits filed with our Current Report on Form 8-K filed on December 6, 2004.
+ Filed herewith
* Executive compensation plans.