Business context and reporting period
ARKO Corp. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2023. Through GPM Investments, it operates convenience stores and fuel retail, wholesale, and fleet-fueling businesses. At quarter-end, it operated 1,547 convenience stores, supplied 1,824 dealer locations, and operated 293 cardlock locations across more than 30 states and the District of Columbia.
The company completed the TEG acquisition on March 1, 2023 and the WTG acquisition on June 6, 2023; it also reflects the December 2022 Pride acquisition and July 2022 Quarles acquisition. Acquisitions materially affect period comparisons. TEG and WTG purchase accounting remained provisional at June 30.
Financial and operating performance
Amounts below are in millions, except per-share figures and margins.
- Second quarter revenue: $2,469.1, down 2.8% from $2,540.3 a year earlier. Fuel revenue fell 6.2% to $1,957.1, while merchandise revenue rose 12.2% to $484.6.
- Second quarter earnings: Operating income was $39.7 versus $48.3; net income attributable to ARKO was $14.4 versus $31.8. Net income attributable to common shareholders was $13.0, or $0.11 per diluted share, versus $30.3, or $0.24 per diluted share.
- Second quarter margins and adjusted performance: Fuel margin was 26.5 cents per gallon versus 27.0 cents. Merchandise margin improved to 31.9% from 30.4%, and merchandise contribution increased to $154.7 from $131.4. Adjusted EBITDA, a non-GAAP measure, was $86.2 versus $79.0.
- First-half revenue and earnings: Revenue increased 1.0% to $4,557.5 from $4,513.1. Operating income decreased to $48.6 from $67.6; net income attributable to ARKO decreased to $11.9 from $34.0, and diluted EPS was $0.07 versus $0.25. Adjusted EBITDA was $133.7 versus $129.2.
- First-half margins: Fuel margin was 25.6 cents per gallon versus 25.9 cents. Merchandise margin improved to 31.4% from 30.0%; merchandise contribution rose to $277.6 from $239.6.
- Cash flow: For the first half, operating cash flow was $46.0 versus $72.2. Investing used $235.2, primarily reflecting acquisitions and capital spending; financing provided $107.8. Cash and restricted cash declined $81.5 to $235.3, including $220.1 of unrestricted cash.
- Debt and liquidity: Debt, net, was $823.7 at June 30, up from $752.0 at year-end 2022. This included $444.0 of Senior Notes, $331.3 drawn on the Capital One line, and $44.4 of M&T debt. Management reported approximately $822 of liquidity: $220 of cash and $602 of available credit. Capital One’s facility was increased to $800 and extended to May 2028.
- Lease obligations and preferred stock: Recorded lease liabilities totaled approximately $1,715.3, including $1,486.5 operating and $228.8 financing lease liabilities. Series A redeemable preferred stock had a $100.0 million aggregate redemption value.
Material changes versus prior periods
- Second-quarter fuel revenue declined mainly because of lower average fuel prices and reduced same-store gallons; acquisition-related volume partly offset the declines. Same-store retail fuel gallons fell 2.6% in the quarter and 4.2% in the first half.
- Merchandise growth reflected acquisitions and improved same-store sales. Management cited merchandising initiatives and food offerings; same-store merchandise sales increased 0.7% in the quarter and 2.1% in the first half.
- Operating expenses rose in key areas: second-quarter store operating expenses increased 22.4% and general and administrative expenses increased 29.4%, with acquisition costs, higher personnel costs, and share-based compensation among the cited factors. Depreciation and amortization also increased with acquired assets.
- Interest and other financial expenses, net, increased to $20.2 in the quarter from $7.3, and to $33.8 in the first half from $23.3. The filing attributes the increases to higher debt at higher rates and less favorable fair-value effects on financial instruments, partly offset by higher interest income.
- First-half net income was also affected by lower operating income and higher expenses despite improved merchandise contribution and acquisition-related contributions. Management said lower fuel contribution at same stores and legacy wholesale sites partly offset acquisition and merchandise benefits.
Outlook, commentary, risks, and unusual items
- The filing provides no quantified earnings or revenue guidance. Management said existing cash and credit availability were adequate for obligations and liquidity needs for the foreseeable future, while noting that future financing needs depend on operating performance and may be affected by acquisitions, expenses, and other conditions.
- Planned capital priorities include acquisitions, store remodeling and rebuilding, and maintenance. The company expected to spend approximately $8 million during 2023 to upgrade substantially all fuel dispensers to be EMV-compliant.
- Management cited fuel-price volatility, competitive pressure on fuel margins, inflation and consumer purchasing power, labor costs, weather, acquisition execution and integration, and supplier dependence as business risks. The business is seasonal, with operating income historically stronger in the second and third quarters.
- Approximately 44% of debt bore variable interest rates. The company estimated that a 1 percentage-point rate increase would raise annual debt service by approximately $3.7 million. Capital One and other credit agreements include covenants and restrictions.
- Environmental obligations were $14.5 million, with estimated recoveries of $7.8 million from insurance and state funds. Management said routine legal matters were not expected to have a material adverse effect.
- ARKO paid $9.8 million in April to settle and terminate the Ares Put Option. It repurchased approximately 1.6 million common shares for $11.9 million in the first half; the buyback authorization was increased to $100 million. The company also paid common dividends of $0.03 per share in each of the first two quarters and declared another $0.03 quarterly dividend.
- TEG generated $317.1 million of revenue and a $2.7 million net loss from acquisition through June 30. The filing’s six-month pro forma figures, assuming certain acquisitions occurred at the start of each period, are $4,969.7 million revenue and $10.4 million net income for 2023; the company cautions these figures are not indicative of actual or future results.
- Management concluded disclosure controls and procedures were effective as of June 30, 2023; it reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether same-store fuel volume and margins stabilize, and whether merchandise growth and margin improvements persist.
- How the TEG, WTG, Pride, and Quarles businesses perform after integration, including final purchase-price accounting and the provisional acquisition valuations.
- Debt, variable-rate exposure, credit-facility availability and covenant headroom, together with the substantial operating and financing lease commitments.
- Whether operating cash generation can support acquisitions, capital spending, dividends, and share repurchases without further borrowing or sale-leasebacks.
- Potential dilution and capital-allocation effects from the redeemable preferred stock, warrants, equity awards, and deferred acquisition consideration.
- Changes in environmental remediation estimates, fuel-market conditions, labor costs, and consumer demand.