ARKO Corp. 2020 Form 10-K Summary
Business context and reporting period
ARKO Corp. filed its first annual report as a public company for the year ended December 31, 2020. The company became public through the December 22, 2020 business combination with Haymaker Acquisition Corp. II and Arko Holdings Ltd.; its common stock began trading on Nasdaq on December 23, 2020 and is also listed on the Tel Aviv Stock Exchange. The transaction was accounted for as a reverse recapitalization, so historical results primarily reflect Arko Holdings and GPM Investments, LLC.
ARKO operates convenience stores and fuel-distribution businesses through GPM. At year-end, it operated 1,330 retail stores and supplied fuel to 1,614 dealer-operated locations across 33 states and the District of Columbia. Its segments are retail, wholesale and GPMP, the fuel-distribution entity that supplies GPM and other customers.
Financial performance and key metrics
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Total revenue | $3.911 billion | $4.129 billion | Down 5.3% |
| Fuel revenue | $2.353 billion | $2.703 billion | Down 13.0% |
| Merchandise revenue | $1.494 billion | $1.375 billion | Up 8.6% |
| Operating income | $80.3 million | $1.3 million | Improved materially |
| Net income | $30.1 million | $(47.2) million | Turned profitable |
| Net income attributable to common shareholders | $9.9 million | $(43.5) million | Turned profitable |
| Basic and diluted EPS | $0.14 | $(0.65) | Improved |
| Adjusted EBITDA, net of incremental bonuses | $183.4 million | $78.2 million | Up 134.6% |
| Cash flow from operations | $173.8 million | $43.3 million | Up $130.5 million |
Fuel gallons sold increased to 1.207 billion from 1.108 billion, primarily because of the Empire Acquisition, while retail same-store fuel gallons declined 16.5% due largely to COVID-19. Consolidated fuel margin increased to 26.6 cents per gallon from 19.9 cents. Retail fuel margin increased to 31.9 cents per gallon from 20.7 cents, while wholesale fuel margin declined to 8.2 cents per gallon from 9.0 cents. Merchandise margin was 27.2%, compared with 27.1% in 2019.
Operating income benefited from higher fuel margins, increased same-store merchandise contribution and lower same-store expenses. General and administrative expense increased 36.2% to $94.4 million, including $7.8 million of incremental performance bonuses and costs related to the merger and acquisitions. The 2020 income tax benefit was $1.5 million, compared with $6.2 million of tax expense in 2019, partly because a U.S. deferred-tax valuation allowance was released.
Liquidity, debt and cash flow
- Cash and cash equivalents were $293.7 million at December 31, 2020, compared with $32.1 million at year-end 2019. Total cash, cash equivalents and restricted cash were $313.0 million.
- Cash flow from operations was $173.8 million. Investing cash outflow was $407.6 million, including $363.7 million for the Empire Acquisition and $44.6 million of capital expenditures. Financing cash inflow was $491.0 million.
- Long-term debt, net of current maturities and deferred financing costs, was $708.8 million, compared with $218.7 million in 2019. Including current debt, gross debt before deferred financing costs was approximately $749.8 million.
- Debt included $215.4 million of Ares term debt, $394.0 million drawn under the Capital One line, $32.4 million of GPMP PNC term debt, $27.9 million of M&T debt and $76.6 million of Series C bonds at year-end.
- The Capital One facility had $101 million of unused availability, and the PNC line had no borrowings outstanding. Approximately 96% of debt bore variable interest rates, although certain rates had been fixed at year-end.
- Contractual obligations included $904.8 million of debt obligations, $1.675 billion of operating lease payments and $582.8 million of financing lease payments, including principal and interest where applicable.
Material changes versus the prior comparable period
- The October 2020 Empire Acquisition added 84 company-operated convenience stores and fuel-supply relationships covering 1,453 dealer locations. Consideration included approximately $353 million paid at closing, $20 million of additional scheduled payments and potential contingent consideration of up to $45 million.
- Empire contributed $377.8 million of revenue and a $7.7 million net loss from the acquisition date through year-end. The acquisition added approximately $194 million of wholesale fuel-supply-contract intangible assets and approximately $40.0 million of goodwill; purchase accounting remained provisional at year-end.
- Retail revenue declined 11.9% because lower fuel revenue more than offset merchandise growth. Retail operating income increased to $200.0 million from $90.5 million.
- Wholesale revenue increased to $418.0 million from $164.9 million, and wholesale operating income increased to $3.5 million from $0.1 million, primarily because of Empire.
- Total assets increased to $2.740 billion from $1.847 billion, while total liabilities increased to $2.422 billion from $1.652 billion. The company also issued $100 million of Series A redeemable preferred stock.
Guidance, outlook, management commentary, risks and unusual items
Management did not provide formal numerical revenue or earnings guidance in the filing. Its stated strategy is to continue acquisitions in existing and contiguous markets, remodel stores, expand foodservice and private-label offerings, improve loyalty and merchandising programs, and use technology such as contactless checkout, order-ahead and delivery services. Management identified nearly 700 potential remodel candidates and expected to remodel approximately 360 sites over three to five years, targeting pre-tax returns of at least 20% on store investments.
Management stated that COVID-19 reduced traffic, fuel volumes and foodservice sales but that the overall 2020 impact was positive because of unusually strong fuel margins and increased convenience-store merchandise demand. The ultimate effect of the pandemic remained uncertain.
- Fuel margins, fuel demand and wholesale fuel prices are volatile; the company does not hedge fuel purchases.
- COVID-19, weather, supply disruptions, competition, tobacco regulation, labor costs and changing transportation patterns could adversely affect results.
- The company depends heavily on major fuel suppliers and merchandise distributors. Principal fuel-supply agreements expire at various dates through March 2026.
- Environmental compliance, underground storage tanks, remediation obligations and asset-retirement obligations create potential liabilities. Environmental obligations totaled $13.5 million, partly offset by $5.6 million of anticipated recoveries.
- Approximately 30% of retail locations had fuel dispensers upgraded for EMV compliance at year-end. The company expected to be substantially complete by the end of 2022 and could bear liability for fraudulent dispenser transactions before completion.
- Credit agreements impose leverage, distribution, borrowing and other covenants. A default could accelerate debt and terminate lending commitments. The company reported compliance with all debt covenants at year-end.
- LIBOR transition creates uncertainty for variable-rate debt. A 1% increase in applicable interest rates would increase annual debt service by approximately $4.3 million.
- The Empire purchase included contingent consideration and significant valuation judgments. Grant Thornton identified the valuation of Empire wholesale fuel-supply contracts as a critical audit matter.
- The Series C bonds, with a $76.6 million carrying balance at year-end, were scheduled for full redemption on March 30, 2021 for approximately $79 million.
- On March 8, 2021, ARKO agreed to acquire 61 Midwestern convenience stores for approximately $102 million plus inventory and cash, subject to closing conditions; the filing states that completion was not certain.
The company did not plan to pay cash dividends on common stock in the foreseeable future. Principal stockholders and management controlled approximately 67% of voting stock, creating substantial voting concentration.
Important facts for investors to verify
- Verify the sustainability of 2020’s elevated fuel margins and the recovery of same-store fuel volumes after COVID-19.
- Review the final purchase accounting for Empire, including the $194 million fuel-contract intangible asset, $40 million goodwill balance and contingent consideration.
- Assess leverage, maturities, covenant headroom, variable-rate exposure and the effect of the Series C bond redemption.
- Evaluate whether operating cash flow can fund acquisitions, remodels, EMV upgrades, lease obligations and debt service without additional financing.
- Monitor integration results from Empire and the announced 61-store acquisition, including realized synergies and any additional contingent payments.
- Review preferred-stock conversion, redemption, dividend and voting terms, as well as dilution from approximately 18.4 million warrants and other equity-linked instruments.
- Assess environmental reserves, supplier volume commitments, fuel-supplier concentration and the potential costs of regulatory or environmental changes.