ARKO Corp. Q1 FY2021 Earnings Call

Greetings, and welcome to ARCO Corporations First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Chris Mandeville, Managing Director of Investor Relations. Thank you. You may begin.

Thank you. Good morning, and welcome to ARCO’s first quarter fiscal year 2021 earnings conference call and webcast. On today’s call are Arie Kotler, Chairman and Chief Executive Officer; and Don Bassell, Chief Financial Officer. By now everyone should have access to the company’s earnings press release that was filed with the SEC this morning, and is also available on the Investor Relations section of ARCO’s website. Before we begin, please note that first quarter 2021 financial information reported in accordance with U.S. GAAP is unaudited. And during the course of this call management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of words such as will, may, expect, plan, intend, could, estimate and similar references to future periods. These statements are based on management’s current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements. Please refer to today’s press release, the company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020, and other filings with the SEC for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note that on today’s call management will refer to non-GAAP financial measures, including same-store measures, EBITDA and adjusted EBITDA. While the company believes the non-GAAP financial measures provide useful information for investors, the presentation of this information does not intend to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today’s press release for reconciliations to the most directly comparable GAAP measures. I’d also like to note that we are conducting our call today from our respective remote locations; as such, there may be brief delays, crosstalk or other minor technical issues during this call. We thank you in advance for your patience and understanding. And now, I’d like to turn the call over to Arie Kotler.

Thank you, Chris, and good morning, everyone. On today’s call, I will briefly review our financial highlights for the quarter ended March 31, 2021, and provide an update on our business. Don will then review our financial results in more detail before we take your questions. We are very pleased to report strong results for the first quarter of 2021. The headline is that our adjusted EBITDA was $42.3 million, up 150% versus the prior year period, while our profitability increased 17.5% in retail fuel and 16.5% in inside merchandise for the quarter, showcasing a great balance between what is going on in-store and at the pump. As vaccination distribution continued to expand, consumers showed greater willingness to venture out and about, and more importantly, ARKO is clearly positioned to benefit from increased consumer mobility as we approach the summer holidays and driving season. We have seen and currently continue to see tremendous improvement in our merchandise same-store sales trends, while gallons have been steadily recovering. Specific to our in-store performance, merchandise same-store sales grew 6% for the quarter, nicely ahead of the 4% plus quarter date trends we spoke to on our Q4 call on March 25. A trend shows steady acceleration, due in part to increased consumer mobility and greater transaction counts. Excluding cigarettes, our results are even more impressive, with same-store sales of 9.2%. Given that 2020 was a leap year, Q1 2020 had one additional day versus Q1 2021. Adjusting for 2020 to eliminate that additional day, our same-store sales and same-store sales ex-cigarettes would have been 7.2% and 10.4%, respectively. Also trending positively is what we saw in higher margin single-serve versus multipack sales in the packaged beverage and beer categories during Q1 versus the prior year. In addition, we have seen favorable sales shifts from lower margin categories, specifically cigarettes and beer in Q1 2021 versus the prior year. During the onset of the pandemic, consumers pantry-loaded lower margin items like beer and cigarettes, so we are seeing margin improvement in addition to top-line growth. While gallons sold were still down compared to a year ago due to the pandemic, fuel has been trending towards recovery as travel has picked up, with same-store gallons up half of 1% in March. Fuel margin expansion continues as the retail fuel margin increased 22% to $0.321 per gallon. I would now take a moment to provide an update on our acquisition strategy. We are very proud of our dedicated M&A efforts with regards to its well-developed target diligence and transaction execution, while the entire organization’s integration capabilities have also been impressive. Our industry is highly fragmented and ripe for consolidation as we believe that scale continues to become increasingly important, and our priority continues to be deploying capital at very attractive returns. On May 4, we announced that we received a $1 billion real property commitment from Chicago based real estate investment firm, Oak Street Real Estate Capital. Under and subject to the terms of the agreement, Oak Street has agreed to purchase and lease to us the underlying real estate associated with the acquisition of convenience store brands and fueling stations while we own and operate the related acquired businesses. We expect this partnership to enhance our financial flexibility and purchasing power and as a result allow us to be more aggressive with our M&A strategy. In March, we announced our planned acquisition of approximately 60 ExpressStop convenience stores in Michigan and Ohio, where ExpressStop is a highly regarded brand. The acquisition is currently on track to close soon. The Empire acquisition we closed in October 2020 was a highly strategic combination that meaningfully increased our scale and included direct operation of 84 convenience stores and the supply of fuel to more than 1,400 independently operating fueling stations in 30 states and the District of Columbia. We have been very pleased with the acquisition as evidenced by the 14 new dealer supply agreements that were signed in Q1, and we continue to realize anticipated synergies associated with this acquisition. Turning to our organic growth efforts, starting with our remodel program. As stated previously, we believe that we have significant embedded opportunity to optimize our store base and invest capital prudently into remodeling stores, and we remain focused on executing against this initiative. We completed our first remodel in Collinsville, Virginia, in late February; two more remodel projects started during the first quarter 2021. One site in Richmond, Virginia, is expected to be completed in June, and the other site in Rock Hill, South Carolina, is a raze and rebuild of a truck stop with an expected completion this September. The remaining seven of the 10 remodeling projects planned for 2021 are to take place in the Richmond and Fredericksburg, Virginia markets. We mentioned previously that in 2021, due to changing consumer preferences and desire to greatly expand our food offerings, we intend to add approximately 525 new grab-n-go coolers, of which approximately 63% have either been installed or are in the process. Additionally, we intend to add approximately 650 new frozen food freezers, of which approximately 62% have either been installed or are in the process. While it is too early to provide a full update on both projects, we are already seeing the results of the new equipment coupled with the planogramming efforts. On a same-store basis, the retail grab-and-go category sales increased 35.4% versus Q1 2020, and the margin percentage has increased from 21.3% in Q1 2020 to 34.9% for Q1 2021. Turning to the frozen food category, sales increased 55.1% versus Q1 2020, and the margin percentage for Q1 2021 is 44.2% versus 29.1% for Q1 2020. We discussed on our last call that we are announcing a loyalty program and focusing on customer engagement as we have added management to create a more customer-engaging, consistent, and nurturing experience across our network. I’m proud to report that our loyalty enrollment has met our expectations. We remain laser-focused on having the right assortment, the right value for our customers, and our strategic supplier partnership and planning process. Our DoorDash delivery partnership continues to scale. As of today, we now operate in over 625 sites, or nearly half of all the company-operated stores. In conclusion, our robust results continue to demonstrate our strengths and capabilities, and we believe we are extremely well-positioned to move forward with our differentiated strategy. I would like to now turn the call over to Don, who will walk you through our financial results.

Thanks, Arie. It is great to be speaking with you all today about our strong first quarter results. Total revenue excluding fuel was $381 million, a 13.2% increase from the prior year period. This was a result of balanced contributions between strong same-store merchandise sales growth of 6% in the Empire acquisition, with Empire contributing 8.2% of the increase. Merchandise margin dollars increased by $13.9 million versus the prior year, while margin percent increased to 27.4% from 26.1%, largely due to a shift from low margin cigarette and beer sales to higher margin center store and packaged beverage sales. Empire retail sites accounted for $6.8 million of the increase. Retail fuel profitability, excluding intercompany charges for the quarter, increased $10.8 million or 17.5%. Empire accounted for $10.5 million of this increase. We saw strong year-over-year increases in fuel margin to $0.321 per gallon from $0.263 per gallon. Same-store fuel volumes declined 13.8% due to lower traffic levels related to the COVID-19 pandemic, but traffic improved throughout the quarter, reflecting Arie’s comments on increased consumer mobility. For the first quarter of 2021, wholesale fuel profitability, excluding intercompany charges, increased approximately $16.2 million compared to the prior year period, with the Empire acquisition accounting for approximately $16 million of the growth. Fuel contributions from non-consignment agent locations grew by $8.9 million compared to the prior year due to a 176 million gallon increase in fuel volume. Fuel margin cents per gallon for these locations decreased 0.9 cents versus the first quarter of 2020. The decrease in margin is due to the inclusion of Empire non-consignment sales, which includes spot market sales and longer-term contracts that are generally a lower margin than our historical ARKO contracts. Fuel margin contribution from consignment agent locations grew $7.3 million compared to the prior year, due to quarter-over-quarter increases in both volume of 32 million gallons and fuel margin cents per gallon of $2.08. Although volumes sold through consignment locations aggregated to 17% of the combined total, fuel margin dollars realized accounted for 47% of total fuel margin dollar contributions from wholesale. For the first quarter, store operating expenses increased $16.1 million or 12.5% versus the prior year due to $18.7 million of incremental expenses led by the Empire acquisition, along with a slight increase at the same stores, offset by savings at closed sites. General and administrative expenses increased by $7.8 million or 41.4% for the quarter as compared to the prior year, primarily due to expenses associated with the Empire acquisition, annual wage increases, and stock compensation expenses. Net interest and other financial expenses increased by $22 million to $28.6 million in the quarter due primarily to a non-cash fair value adjustment during the quarter of $12.1 million related to our outstanding public and private warrants. Additionally, during Q1, we redeemed all of our outstanding Israeli Bonds ahead of schedule, which resulted in $4.5 million in additional interest expense for the early redemption, but was significantly less than the full interest that would have been paid through maturity in 2024. The remainder of the increase was due to additional debt incurred with the Empire acquisition. The first quarter reflected a net loss of $14.7 million versus a net loss of $12.9 million for the prior year. Incremental earnings in Q1 related to strong fuel and merchandise results, which also benefited from the Empire acquisition, were offset by increased general and administrative, depreciation, and amortization expenses, along with increased interest expense and non-cash fair value adjustments, as just mentioned. Adjusted EBITDA was $42.3 million, an increase of $25.4 million or 150% compared to the first quarter of 2020. The Empire acquisition accounted for $13 million of that increase. Our balance sheet remains strong. On March 31, the company’s total liquidity was approximately $457 million, consisting of cash and cash equivalents of $205 million plus $31.8 million of restricted investments and approximately $200 million of unused availability under our lines of credit. Outstanding debt was $674.3 million, resulting in net debt of $437.5 million. These numbers are after using approximately $79 million to redeem these early bonds. For the quarter, net cash provided by operating activities was $11.3 million versus $23.9 million for the first quarter of 2020. Operating cash flow in Q1 2021 included approximately $13.6 million of incentive payments for 2020 and a one-time cash payment of $5.2 million related to the early redemption of Israeli Bonds. Q1 2020 included favorable working capital adjustments of approximately $16 million, which went away in Q3 2020. Capital expenditures were $17.5 million for the quarter compared to $12.1 million in the prior year. We ended the quarter with 1,324 retail sites and 1,625 wholesale sites. I am pleased that we have demonstrated our strengths and capabilities through yet another quarter of solid financial results. We continue to execute as we navigate through a constantly changing consumer environment, and we believe we are positioned to take our business to the next level. And with that, I will turn it back over to Arie.

Thanks, Don. Through all of this, we believe we are primed for growth to our strategic acquisition strategy and commitment to the customer experience, driving traffic and expanding margin at our existing stores. We are focused on aggressive growth and gaining market share. I would be remiss if I did not mention and sincerely thank our over 10,000 associates company-wide for their dedication and commitment to customers throughout the quarter. We appreciate everyone joining the call today and your interest in ARKO. I will now turn it over to the operator for questions.

Thank you. At this time, we’ll be conducting a question-and-answer session. Our first question comes from Bobby Griffin with Raymond James. Please proceed with your question.

Good morning, everybody. Thank you for taking my questions and congrats on a good start to 2021. I guess first, Arie, I want to circle back on the Oak Street partnership and maybe just talk a little bit more detail about what this partnership gives you guys. Would it give you now the ability to look at larger acquisition targets than maybe you previously did, or does this give you further ability to execute more transactions more frequently because of the additional financing flexibility?

Yes. Thank you, Bobby, and good morning. Well, the Oak Street Capital agreement that we signed gives us more flexibility, as you can imagine. I mean, the terms over here are much better than the terms that we had before, given our size and of course, given our performance. Yes, it’s going to give us an opportunity to look at much broader and bigger acquisitions, and will make us a little bit more aggressive and more attractive. But as I said, it’s a program that is already set, and given the amount of acquisitions and the activity in the marketplace right now, this is just another set to help us be more competitive.

Okay. And then maybe secondly, for me, going back to the Empire side of things—recently closed integration going well. Have you started to see some of the volume savings as you’ve basically doubled your fuel purchases when you acquired Empire, as those start to show up in the retail fuel margins that we’re looking at here for 1Q? Or have the contracts still not meaningfully started to renew yet, I guess?

Well, from a fuel standpoint, a lot of the synergies have already taken place in the retail business, along with the synergies coming from the merchandise sales—that’s something that we have already achieved and is taking place in terms of the 84 company-operated stores. We still have some room, and of course, there are always negotiations ongoing regarding the fuel supply contracts for the rest of the business over there. But the 84 stores have already achieved our goals over here. As we continue to negotiate and we just recently updated the planograms in those Empire stores, I’m assuming you’re going to see more results coming in the near future.

Yes. I was more asking about your prior existing large retail network; have you started to see the savings flow through on purchases of fuel because now you’re buying roughly 2 billion gallons versus the prior 1 billion gallons, just having a much more increased size of fuel purchases from the suppliers?

Sure. Yes. So the short answer is this is still ongoing. I mean, some of them have already been achieved, and some of them are budgeted and ongoing discussions as we speak.

Very good. Okay. And then lastly for me, Don, just quickly on the Israel Bonds—buying them back early, I believe at a little bit of a premium. Can you maybe talk about the reasoning behind why now and just help us connect the dots on that capital structure change?

Yes, sure. There are a couple of reasons. Number one, they had a pretty short maturity until June of 2024, and they had a relatively aggressive amortization during those three years. They were favorable interest, but because of the treaties between Israel and the U.S., that adds a little premium onto them. It was more related to the maturity approaching and the amount of amortization that we had to pay. We felt that there was a better way to finance that probably in the U.S. It was great for us during our growth and helped us tremendously, but given the short tenure left on it, it was probably better to pay it off. And we paid a whole lot less interest in doing that.

Thank you. I appreciate the details and the time here. Best of luck in the second quarter.

Thank you.

Our next question is from Kelly Bania with BMO Capital. Please proceed with your question.

Hi, good morning. Thanks for taking our questions. Arie, just curious as you begin to ramp up the remodels for this year. Any color on how the cost of those remodels are coming in just given kind of the lot of inflation in raw materials and wages and any update on what you’re seeing there?

Sure. So I think I mentioned that in our last call, the first store that we did in Collinsville, Virginia, cost around $650,000 to $675,000. And that was everything from scratch to finish. So when we talked earlier about averaging around $1 million per store, I think that we’ve just finished the last one, and it’s likely to be in line with that, maybe even close to the $1 million investment in those stores. We don’t see any major changes over here, although we’ve seen increased costs of raw materials.

Okay. That’s helpful. And just curious on CPG margins, particularly on the retail side—how that came in relative to your expectations. If it’s just a function of market dynamics that are driving those higher, or if you think there’s anything related to wage pressure across the retail landscape. Are you starting to see competitors offset that in retail margins, or is that more of a function of just the dynamics of the first quarter?

I think it’s both; it’s a dynamic of the first quarter. At the same time, remember, the price of fuel right now is at around $60 already. We are back to normal, probably as before the pandemic. Our team is doing a great job with the concentration on expanding margins in areas where we can. We’ve seen this support continue through our strategies since the pandemic started, so we will continue to pursue margin dollars as long as these strategies don't negatively impact inside sales.

Okay. That’s helpful. Maybe just one more from me; in terms of gallons, I think if I heard you correctly, you mentioned retail gallons were slightly positive in March. Just curious how that’s continued to progress and should we assume that wholesales are on a similar trajectory?

Well, since vaccinations took place, we see more people out there; people are driving more. Remember, we are right now entering the hundred days of summer, and with Memorial Day weekend coming up very soon, we expect to see more and more people getting out there versus what happened last year. If you remember last year, from March to May, people were basically just at home. So we see people driving more, taking more vacations, and we believe that gallons will really increase as we move towards summer right now, no question about that.

Thank you.

Our next question comes from Mark Astrachan with Stifel. Please proceed with your question.

Yeah. Thanks, and good morning, everyone. I guess I wanted to first ask about your merchandise same-store sales. So it implies for the quarter a bit of an acceleration on a year-over-year basis in March. I guess, one, how much of that was driven by stimulus, and two, any sort of thoughts on where we are in the June quarter? Maybe I’ll just start there and have a couple of follow-ups.

Sure. So I’ll start with, as you remember in March, I mentioned that our same-store sales were actually nowhere near 4%. No question that we saw a big acceleration in March. I think people are just getting out, people are getting more comfortable. People are getting vaccinated and driving more; we see more events happening outside. So I’m assuming that we’re going to continue to see increases in merchandise sales as long as people continue to get out there and feel more comfortable.

Okay. So any color you’re willing to provide on the June quarter so far?

We are not going to comment on the June quarter, but what I can tell you is that there are a lot of initiatives taking place in our stores. I mean, an example I just mentioned earlier: we are installing new freezers, expanding our grab-n-go. We have launched the fas REWARDS program, and we see more involvement in that since its launch. So as I said, there are several initiatives ongoing to ensure our same-store sales continue to perform.

Okay, got it. And then any sort of commentary you can provide on the events of the last week and how we should be thinking about the impact—both positive and negative—on the business as a whole? I’m also curious about the presumed benefit of people waiting in line for gas on merchandise sales as well.

Sure. I can’t give you a full picture. I can tell you that we operate in 33 states, and the areas that really got hurt are the Southeast all the way to Virginia. At the same time, we mainly deal in branded fuel. Because of our size and exposure, we managed to access resources from areas that weren't impacted. The interesting thing that we observed is that in Florida, for example, the market operates on a waterborne product, and the panic buying there was unbelievable, with people standing in line during the panic buying across various states that were not affected. Given that we are branded fuel, when the brand puts everyone on allocation, you can assume that the unbranded operators will be under pressure for a much longer period. They restarted the colonial pipeline yesterday night, so we anticipate that within the next few days, things will return to normal or close to it. The resources we managed to pull in from outside have been tremendously helpful.

Got it. Okay. Thank you.

Okay.

We have reached the end of the question-and-answer session. At this time, I’d like to turn the call back over to Arie Kotler for closing comments.

Thank you very much. And again, we’d like to thank each and every one of you for participating this morning, and we look forward to seeing you again on our next call after Q2. Thank you, and have a good day, everybody.

This concludes today’s conference. You may disconnect your lines at this time. And we thank you for your participation.