Arko Corp. (NASDAQ:ARKO) Q4 2022 Earnings Call Transcript

Arko Corp. (NASDAQ:ARKO) Q4 2022 Earnings Call Transcript February 28, 2023

Operator: Greetings, and welcome to the Arko Corp. Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. At this time all participants are in listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Ross Parman, Vice President, Investor Relations. Thank you. Please go ahead.

Ross Parman: Thank you. Good morning, and welcome to Arko’s fourth quarter and fiscal year 2022 earnings conference call and webcast. On today’s call are Arie Kotler, Chairman, President and Chief Executive Officer; and Don Bassell, Chief Financial Officer. Our earnings press release, annual report on Form 10-K for the year ended December 31, 2022 has filed with the SEC and our earnings presentation are available on Arko’s website at arkocorp.com. Before we begin, please note that all fourth quarter 2022 financial information 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, project and similar references to future periods.

These statements speak only as of today and 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 our press release, our annual report on Form 10-K for the fiscal year ended December 31, 2022, and our 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 adjusted EBITDA and free cash flow. While the company believes these non-GAAP, financial measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for our financial information presented in accordance with GAAP.

Please refer to our earnings press release for reconciliations of our non-GAAP measures to the most directly comparable GAAP measures. I would also like to note that we’re conducting our call today from our respective remote locations. As, such, there may be brief delays, cross talk or other minor technical issues during this call. We thank you in advance for your patience and understanding. And now I would like to turn the call over to Arie.

Arie Kotler: Thank you, Ross. Good morning, everyone. And thank you for joining us. Before we get started, I’m sure you will all love to hear that Don announced that he will retire after a distinguished 42-year career. Don is a great partner and resource. As we reported he will remain in the position for several on more quarters, leading the finance team while the search for his replacement is underway. Don’s time with the company has been marked by significant growth and excellent performance in our business. And 2022 was another year of strong results and continued expansion. This results emphasize that at our core, Arko is a retail convenience store operator. It is important to remember that the majority of our profits are generated in our stores.

Arko increased operating income by 18.9% or $33.7 million in Q4 2022, versus the prior year fourth quarter. Adjusted EBITDA increased 24.1% compared to Q4 2021 $72.4 million in Q4 2022 and increased 17.3% year-over-year to $301.1 million in 2022. Our balance sheet continued to be very strong. In Q4 the company recorded $69.5 million in net cash provided by operating activities and $43.8 million in free cash flow. For the year, Arko generated $209.3 million in net cash provided by operating activities and $110.7 million in free cash flow. This is a direct results of executing our core strategy, both in-stores and in fuel cells across the business. In 2022, we continue to successfully invest in many initiatives in our stores. Over the past four years we have realigned and expand our marketing and merchandising team, their strategic initiative have successfully led to continue gross profit expansion inside our stores.

Compared to 2020 merchandise contribution has grown by 23.4%. According to IRI in 2022, total dollar sales in our stores outpaced the market share during the string of our favourable assortment, loyalty and marketing programs. This includes key product categories like beer, wine, packaged beverages, packaged sweet snacks, frozen foods, alternative snacks and general merchandise. Q4 merchandise margin increased 50 basis points to 30.5% from 30% in Q4 2021. Merchandise margin expanded by 110 basis points to 30.4% for full year 2022 compared to 29.3% in 2021. Fourth quarter same-store merchandise sales excluding cigarettes increased 9.2% on a two-years tax basis. IRI data also shows that we maintain share in our competitive retailer market area including cigarettes and grew by 10 basis points excluding tobacco products.

Fourth quarter 2022 same-store sales including cigarettes increased 1.2%. It is worth noting that the concentration of same-store cigarette sales declined from 38.7% of in-store sales in Q4 2020 to 32.7% of in store sales in Q4 2022, due to change in consumer behaviour, and our margin optimization strategy. We continue to price tobacco products competitively to attract adult tobacco consumers however, our main in store focus is to lead with an assortment relevant to our customers and on developing our programs in higher margin items like food service, and dispense beverage categories. Our in-stores growth strategy is based on three key pillars. The first pillar is to grow sales in core destination categories for data driven decision that meet today’s customers need.

When we acquire new sites, we often add hundreds of items to the acquired stores. We focused on key merchandise that we know resonate with our customers. I will detail the benefits of this shortly in a brief case study of our Andy March acquisition. The second key pillar is using our fast rewards loyalty program to develop and strengthen the relationship with our customers. Our objective is to drive more trips inside stores while providing exceptional value. We ended the year with almost 1.3 million enrolled loyalty members replaced by the consumer response to our current loyalty initiatives that the customers continue to incrementally grow their total spend over the course of the year. Our loyalty and marketing is apparently resonating with them.

For example, our $0. 99 coffee program for enrolled members as at a very strong results, enrolled members purchase over 741,000 more cups of coffee in 2022, then in 2021. We are in the process of rolling out a new loyalty app which has many exciting new high value features for the benefits of our existing and new loyalty customers. We are in the final stages of preparing our stores for activation of our new loyalty app, and it will be available in the app store soon. Our goal is to increase new customer enrolment and enhanced customer engagement, with real time information like fuel pricing, and rewards balance. We will be able to target customers by their primary store with relevant high value in-store and in app deals, for our growing numbers or members.

We expect that order and delivery will be facilitated through the app, capitalizing on our partnership with third-party services that provide delivery at over 1000 of our stores. We will also be able to make age verified special offers to adult customers, 21 years an older. Our third pillar is expanding our package and fresh food offering including pizza, chicken prepared sandwiches, and many other options, to borrow and other QSR like offering are component of this pillar. Since establishing this franchise relationship, we now have 18 our location. We continue to expand our food offering and implement variety of food options. And we are making progress in identifying food offering at a price point that will resonate with our customers and that we can use across our stores.

Our goal is to increase margin trips, and average basket size. We know that we have long runway to significantly increase margin as we expand this important category to meet our customer needs. We believe that in our markets, we can create a value proposition to position our stores as a food destination. Updating areas of our store with a nice food and drink offerings has continued to work well for us. Unit sales have been to cup coffee increased 7.2% in 2022, and are trending up. We believe that through continuous improvement in each pillar, our core convenience store business is well positioned to deliver great results. Turning to fuel gross profit is the most important metric when analysing our performance. We believe our strategy to maximize fuel gross profit while maintaining competitive pricing has consistently proven itself in a volatile market environment.

We believe our strategy enables strong results as price decline, as they have from their peak in June 2022, with some volatility through Q3 and Q4, and as total gallons in the market decline. We compete in fuel market by market using a data driven approach based on a fuel strategy that we have also designed to attract customers into our stores. In 2022, we have L merchandise dollar share in our competitive retail market and areas, while significantly improving fuel gross profit. This led to on one hand, same store gallon decreasing by 8.3% in q4, compared to 0.2% decline in the prior year quarter, and for the year, same store gallon declined 8.1% compared to a 1.3% decline in 2021. On the other end, retail fuelled profitability groups to $104.3 million, a 16.3% increase compared to the $89.7 million in the fourth quarter of 2021.

For the year, we increased retail fuel gross profits by 19% to $416.2 million, compared to $349.9 million in 2021. We believe, based on 2022 national fuel volumes, that in all markets overall demand is likely to remain lower than in 2019. We also believe that cents per gallon is structurally higher than it was in the past, given pressures across the operating environment. OPEX continue to increase across our industry. The labour market is still competitive, and wage growth has been strong nationally. We believe our strategy is resilient across many price environments, as our results had shown. Turning to M&A. Capital allocation is one of the many things and we always think about the best areas to deploy capital. We have proven track records of discipline and consistent growth.

We believe that acquisition will continue to drive EBITDA growth, company’s return on invested capital across our many acquisition underscores that continue M&A is an effective use of capital. Our financial strength, financing ability and agreement with Oak Street continue to give us an advantage in our ability to move quickly and get deals done. Our balance sheet is strong, with manageable debt and favourable interest rates. Our industry continues to be highly fragmented. As a result, the overall deal pipeline is still strong, and we expect to expand our core convenience store business through our acquisition strategy. There are also opportunities to make accretive deals and acquire expertise in complementary areas that will grow the business.

We believe our stores can grow their food offerings. If we believe there’s an interesting opportunity or investment that can enhance our stores and create unique value proposition for our customers, we will closely examine the opportunity. We announced four highly accretive acquisition in 2022, of which we already close to Quarles and Pride. Before getting into further details I’d like to illustrate how we drive growth in new acquisitions. I want to walk through the 2022 performance of our Handy Mart acquisition that closed in November 2021. Quarter-over-Quarter, we monitor progress of all of our new acquisition. We fully reset 36 stores adding over 700 merchandise items. This is the value that we bring to our customers increasing mix within demand items.

We also implemented our fuel pricing system. For these numbers, I am comparing against seller provided trailing 12 months figures from May 2021, when we conducted our due diligence. In-store margin has increased 6.9% from 31.3% to 33.5%. Merchandise contribution has grown 10.8%. As of December 31 2022, we increase average cent per gallon by $0.6. In the two full quarters following the reset, merchandise sales increased 7.6% compared to the two quarters prior to resets. Most importantly, although adding an approximately $6 million in rent to Oak Street, we’ve increased store level EBITDA by approximately 30% in just one year. The purchase multiple was reduced from about 1.3 times to one time and our return on investment it’s 96%. This case study underscores an important part of our strategy in this highly competitive industry.

Being an effective capital allocator is essential. But capital allocation alone is not what makes our business successful. Execution in operation is what drive us forward. Our teams have been very effective at improving marketing, in-store mix, and offering to drive sales at our newly acquired stores. If you’re curious of our scale, and the efficiencies afforded us by our scale, allow us to compete market by market store by store every day. We plan to undertake similar value added measures in approximately 155 company operated convenience stores we expect to add to our network in the first half of this year. Once we close the remaining two acquisitions announced in 2022. The transit Energy Group acquisition will add approximately 135 convenience stores and expand ourselves and retail territory into Alabama and Mississippi.

We expected transaction to close in the first quarter. The WT TG acquisition is anticipated to close in the second quarter. This acquisition will significantly enhanced the company’s footprint in the attractive Permian Basin market, with 24 company operated unfilled convenience stores across western Texas. The company will also acquired 57 proprietary flip billing card looks like strategically located in large industrial areas in West Texas, and Southeast New Mexico and 52 Private Carlo sites. These sites service a diverse base of customers. The WTG acquisition fits very well in our business model and builds on the fleet fuelling business we acquired from Quarles in July 2022. We believe that fleet fuelling is an excellent business and the timing of the Quarles acquisition and our rapid integration could not have been better.

We realize strong cash flow because of fuel price volatility in the second half of 2022 since closing. The Quarles acquisition which closed on July 22 2022 contributes incremental adjusted EBITDA in 2022 of $20 million. This exceeds our expectation based on our modelling. We closed the price convenience holding acquisition on December 6. This was our second deal for 2022. This strategic acquisition at 31 convenience stores, plus the new to industry store that broke ground in July 2022. We can expand our New England territory into Massachusetts. We are on Page three for integration efforts and look forward to adding value to the stores with a larger assortment and new promotions. In addition to this acquisition in 2022, we fully remodelled six stores, and started the planning and engineering phase of an NDI store in Atlanta, Texas.

We expect construction of that project to be completed in 2024. We are also expanding our EV network. The Pride acquisition increase our total EV charging network with 18 charger installed across five stores in Massachusetts. Importantly, prior to our acquisition Pride was awarded a number of grants to expand its EV charging capacity in Massachusetts, which has aggressive EV targets. We plan to put these grants to use to expand EV chargers availabilities in these markets. As part of our overall strategy, we pursue grants and subsidies across our footprints to expand our EV charging capacity. We have six other active EV projects in various phases of development. On top of our chargers, currently in place in Marysville, Ohio, and Bertrand Michigan.

We continue to identify potential opportunities to install EV charging, of course our footprint. Our goal is to offer EV drivers convenience and amenities they seek in charging destination away from their home at areas where we identify sufficient potential demand. One more note, in December, we released our Environmental Sustainability, Social Responsibility, and Corporate Governance Report for the year 2021. We are currently working on the implementation of our sustainability work plans with a focus on long-term value creation. With that I will turn it over to Don.

Donald Bassell : Thank you, Arie, and thank you for the kind words. It’s no secret that I’m a convenience store fanatic. This is a great industry. And my colleagues and peers at Arko who share my passion are the reasons I enjoy coming to work every day. This is a great company, and a great company to work for. Our growth and strong performance, culminating in the company’s inclusion in the Fortune 500 list is a part of my professional life that I’ll always be proud of. The company has continued to record excellent results. Our in-store performance continues as our numerous initiatives gain traction. We’re making, excellent progress with our integration capabilities, which is great for the company. Our other segments have continue to generate stable writable cash flows that benefit our capital allocation.

Our balance sheet continues to be strong. We have a very good liquidity position as well. As at December 31 2022, we had cash and cash equivalents of approximately $299 million, our outstanding debt, excluding capital leases was approximately $752 million, resulting in net debt of $453 million. We continue to realize excellent cash flow. For the quarter net cash provided by operating activities was $69.5 million and $209.3 million for the year, versus $39.6 million for the fourth quarter of 2021 and $159.2 million for the prior year. After the expected closings of the TEG and WTG acquisitions, there will be approximately $575 million remaining under our Oak Street agreement. Getting into results of our convenience stores. Merchandize revenue for the fourth quarter of 2022 increased to $403.1 million versus $396.1 million in the prior year quarter.

For the year, merchandize revenue increased nearly 2% to $1.65 billion from $1.62 billion in 2021. Margin percentage year-over-year increased by 110 basis points to 30.4%. Capital expenditures increase both the result of spending supporting our initiatives and other investments in our stores, including six fullstory models and other unnecessary upgrades. Total capital expenditures were approximately $98.6 million for the year ending December 31 2022, which included the purchase of certainty properties being a cup of coffee equipment, upgrades to our fuel dispensers and other investments in our stores. This is compared to net capital expenditures of $73 million for the prior year, which is composed of $226.2 million net of $152.9 million of proceeds paid by Oak Street for two transactions accounted for as deemed sale leasebacks and the purchase of certainty properties.

In fuel, we continue to believe that margins have moved structurally higher given industry behind the client, increased credit card fees, higher operating expense to cost of labor. We believe our strategy of managing margin and volume while maintaining competitive pricing is key to optimizing profitability as a growing company. Retail fuel profitability, excluding intercompany charges for the fourth quarter of 2022 grew 16.3% this quarter, totaling $104.3 million. This was a $14.6 million increase versus Q4, 2021. For the year retail fuel profitability increased 19% to $416.2 million from $349.9 million in 2021. The company increased retail fuel margin to $0.414 per gallon for the year compared to $0.337 per gallon in 2021. Fourth Quarter convenience store operating expenses increased $13.6 million or 8.7% versus prior year, due to incremental expenses related to the product position, increased expenses, the same stores.

Same store credit card fees for the quarter increased by $0.7 million or 3.5%, while salaries and wages increased by $7 million or by 11.5% both compared to Q4 2021. For the year ended December 31 2022, store operating expenses increased $75.9 million, or 12.8%, as compared to the year ended December 31, 2021. This was due to approximately $36 million of incremental expenses related to product acquisitions, and the 2021 acquisitions and an increased expenses that same stores, including $32 million of higher personnel costs of 14.2% and $10.4 million of higher credit card fees are 14.5% due to higher retail prices. The increase in store operating expenses was partially offset by underperforming retail stores that we closed are converted independent dealers.

Moving to wholesale for the year. Wholesale fuel contribution, excluding intercompany charges increased approximately $9.7 million. This was primarily due to a 20.2% increase in fuel margin cents per gallon, which was partially offset by 7.7%, overall decline in volume, with gallons and gallons from fuel supply locations down 8.4% year-over-year. For the quarter wholesale fuel contributions, including intercompany charges decreased $1.8 million. Last quarter, we discussed the rapid integration of Quarles, which closed on July 22. We’re very pleased with this acquisition in business. This acquisition has produced strong cash flow in the second half primarily because of fuel price volatility. The acquisition added adjusted EBITDA of $20 million for the year.

We’re very happy with the excellent work done by the highly skilled Quarles team. The fleet fueling business generated fuel revenues of approximately $149.9 million for the fourth quarter and $270.7 million for the year. Fuel contribution excluding intercompany charges from the fleet fueling size was approximately $16.9 million for the quarter and $27.8 million a year. Fuel margin cents per gallon excluding intercompany charges for the proprietary car locks was $0.539 per gallon for the fourth quarter and $0.078 per gallon. At the third party Quarles locations. For the year, fuel margin cents per gallon excluding intercompany charges was $0.484 per gallon at proprietary locations and 6.5% per gallon at the third-party Quarles locations. Net interest and other financial expenses for the full year decreased by $11.8 million versus the prior year to $59.4 million.

Net interest and other financial expenses for the quarter were $16.3 million, compared to $16.2 million for the prior year quarter. Net income for the quarter was $12.86 million versus $12.93 million from the prior year period. Net income for the year increased 21.1% to $72 million, compared to $59.4 million for the prior year. Adjusted EBITDA was $72.4 million, an increase of $14.1 million, compared to the fourth quarter of 2021. For the year, adjusted net of incremental bonuses was $301.1 million. This number has increased 64.2% Since 2020, showing the rapid pace of our progress. This has been another great year for the company. As a result of our strong results and desire to enhance returns for stockholders, Arko’s board directors declared a quarterly dividend of $0.03 per share of common stock to be paid on March 21, 2023 stockholders record as of March 9 2023.

And now I’ll turn the call back over to Arie.

Arie Kotler : Thanks, Don. I will close by saying that we believe that we have the right long term strategy in place as well as execution capabilities to deliver growth for the long-term. I want to thank the company over 12,000 employees for their hard work and dedication. I believe that our excellent results for the quarter and for the year are a great tailwind as we start 2023 and mark a decade of rapid growth at the company. Now we will take your questions.

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Q&A Session

Operator: Thank you. The floor is now open for questions. The first question today is coming from Bobby Griffin of Raymond James. Please go ahead.

Unidentified Analyst: Good morning. This is on for Bobby Griffin. Thank you for taking our questions. First, I just wanted to touch on kind of some of the main initiatives for 2023. Given the Oak Street partnership renews in May and assuming that the cap rate will increase given current interest rate trends. Does that change the focus for M&A to a little more focused on some of the other initiatives within the store for EBITDA growth in 2023.

Donald Bassell : Thank you, this is a great question, say hello to Bobby. No, I don’t think that — I don’t think it’s going to change anything. There is no question that cap rates might move a little bit given interest rates continue to rise. But, I just saying that given our size and our economy of scale, I think our transaction continued to be very lucrative. As you remember, in the past we showed 38% return on our capital in the past. And right now, in this presentation, we basically showing 59%. So, the worst can happen is we go back to the 38% return on capital, which is still a great return on capital for us. But I don’t think anything will basically change dramatically over here. I think we’re going to continue to grow through acquisition. And at the same time we have all of the other opportunities that I describe on the call, which include the people inside the store.

Unidentified Analyst: Okay, that’s very helpful. And then maybe secondly, for us, just touch on the cost environment in the box a little bit. Are you currently continuing to see significant year-over-year cost pressures or our store OpEx costs starting to behave a little bit better?

Donald Bassell : I think the cost OpEx start to actually settle a little bit. As you can see year-over-year, we have an increase of almost $75 million $80 million increase in OpEx inside the stores, which that’s what, by the way, what drove the CPG, or the gross profit dollars in outside the store, a little bit higher given the environment. I think we’re going to see those things settled, as we enter into 2023, but I’m assuming that we’re going to continue to see increase, maybe not significant, as we saw in 2021 and 2022. But we’ll still see some kind of increase in 2023.

Unidentified Analyst: Okay, thank you so much. And best of luck here in 2023.

Donald Bassell : Thank you for your time.

Operator: Thank you. The next question is coming from Hill Hogan of Barclays. Please go ahead.

Unidentified Analyst: Hi, good morning. I guess two or three questions. The first one is I heard your comments on retail fuel margins being structurally higher, just given the cost environment for independence, but they were still pretty high in the fourth quarter. And maybe you could just give us a range of where you thought they might be on a on a go forward basis for the next year or two because $0.40 was pretty high.

Donald Bassell : So I think the $0.40 gets really a demonstration of basically of our capability of increasing gross profit dollars. As I tell people in this environment, I don’t talk CPG anymore, I talk gross profit dollars. As I mentioned earlier, and we have a presentation out there, OpEx are up $75 million from basically from 2021. And I tell people, the only way to pay for that is actually to increase the margin outside the store. That’s the only way to pay. I mean, in order for you to pay $75 million increase in OpEx, you need to almost 15% increase inside the store, which is not possible, it’s just not possible. So I believe that, as we’re going towards this inflation cycle, as we go towards basically interest rates rising, cost of supply rising wages, basically increases over here, I think the margin basically going to be supported up, just because all of those reasons that everybody has, by the way, the same the same issues.