Arko Corp. (NASDAQ:ARKO) Q4 2023 Earnings Call Transcript

Arko Corp. (NASDAQ:ARKO) Q4 2023 Earnings Call Transcript February 28, 2024

Arko Corp. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings. Welcome to the Arko Corp. Fourth Quarter and Fiscal Year 2023 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to Jordan Mann, Senior Vice President of Corporate Strategy, Capital Markets and Investor Relations. Thank you. You may begin.

Jordan Mann: Thank you. Good morning and welcome to Arko’s fourth quarter and fiscal year 2023 earnings conference call and webcast. On today’s call are Arie Kotler, Chairman, President, and Chief Executive Officer; and Rob Giammatteo, Executive Vice President and Chief Financial Officer. Our earnings press release, annual report on Form 10-K for the year ended December 31, 2023 as filed with the SEC and our earnings presentation are available on Arko’s website at www.arkocorp.com. During our call today, unless otherwise stated, management will compare results to the same period in 2022. Before we begin, please note that all fourth quarter 2023 financial information is unaudited. During this call, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Please review the forward-looking and cautionary statements section at the end of our fourth quarter 2023 earnings release for various factors that could cause actual results to differ materially from forward-looking statements made during our call today. Any forward-looking statements made during this call reflect our current views with respect to future events and Arko will not update or revise forward-looking statements made on this call, whether as a result of new information or otherwise. On this call, management will share operating results on both a GAAP basis and a non-GAAP basis. Descriptions of those non-GAAP financial measures that we use, such as adjusted operating income and adjusted EBITDA and reconciliations of these measures to our results as reported in accordance with GAAP are detailed in our earnings release, in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, or in our 2023 fourth quarter earnings presentation posted on our website.

Additionally, management will share profit measures of our individual business segments along with fuel contribution, which is calculated as fuel revenue, less fuel costs and exclude intercompany charges by GPMP. And now I would like to turn the call over to Arie.

Arie Kotler: Thank you, Jordan. Good morning, everyone and thank you for joining us. Before getting into our financial results, I would like to start off with a few opening remarks. First, as I’m sure you saw earlier this year, we welcome Rob Giammatteo to the company to serve as Executive Vice President and Chief Financial Officer. We believe that Rob’s experience in directly relevant financial and transformation roles in retail and convenience will be extremely additive to the company that Don Bassell, our former CFO, has helped build over the years and will help drive enhanced financial performance as we continue to strengthen our business. To that end, I would like to personally welcome Rob to the Arko team and have already seen the value his experience has brought to the team since joining in January.

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Q&A Session

I would also like to thank Don for his contribution to the company, which have enabled the company to achieve significant growth and excellent performance. As we reported, Don will remain with the company until April 2024 to ensure a smooth transition to Rob. Second, reflecting on our first 3 years as a public company, we have significantly broadened our geographic footprint through acquisitions and have delivered approximately $166 million in net income that results in approximately $850 million in cumulative adjusted EBITDA over this period. In the past 18 months alone, we’ve closed on five acquisitions, adding almost 200 retail stores and approximately 520 new sites across our Wholesale and Fleet Fueling segments. I am very proud of our team and their incredible work to successfully integrate these assets.

We are confident that we bought attractive assets at attractive prices, delivered meaningful cash-on-cash return and provided us with scale and related synergies that have improved our relative competitive positioning. I wanted to touch briefly on our Pride acquisition, which we completed in December 2022 and included 31 Pride retail convenience stores and 1 store under construction that is now open. Since closing the acquisition in just over 1 year, we have earned back in adjusted EBITDA approximately 65% of Arko’s consideration paid for that transaction. This was driven by our successful integration, including the addition of over 1,000 items on average to the stores and the transition of Pride loyalty members to our fas REWARDS program.

We were able to increase merchandise margin in our Pride location by approximately 260 basis points from Q1 2023 to Q4 2023. We believe that rapid return and integration of Pride reflects the acquisition of good assets at a good price. As we move into 2024, we are focusing more of our management attention and other resources to further push, refine, and improve our organic growth strategy to drive performance at our retail stores and unlock the value of our Retail segment which is core to our business. I believe we have many levers to pull. Our team is focused on executing on our initiative, and later this year we are planning to host an Investor Day in which we will share with you our multiyear roadmap and specific milestones to enhance organic performance and drive shareholder value.

Turning to our full year results. We delivered $290.4 million in adjusted EBITDA for 2023, holding performance within 3.5% of 2022, which had a record retail CPG of over $0.41 per gallon. We delivered this result in the context of a 3.4% decline in national OPIS fuel gallon demand, with a more pronounced decline in the fourth quarter. Our newly acquired businesses and continued momentum with our in-store merchandising efforts served to mostly offset lower gallon demand. As we have discussed in the past, we have directed our retail fuel pricing team to optimize fuel contribution at the site level. While we recognize this pricing strategy results in a tradeoff between gallons demand and CPG, we believe this is the correct strategy currently given market and consumer trend in the areas in which we operate.

We plan to maintain this pricing methodology while we evaluate this in the context of our overall multiyear roadmap. Total Retail fuel contribution for the year was $435 million, up close to 5% for the year. Turning to inside store sales. Many of our 2023 initiatives continue to show momentum due to our focus on our 3 key merchandising and marketing pillars: our fas REWARDS loyalty program; growing sales in core destination categories; and expanding our food and beverage service. I want to take a moment to touch on each of these pillars now. First, on our fas REWARDS loyalty program, we exceeded the 2 million enrolled member mark in the fourth quarter, and we continue to invest to drive new enrollment growth, deepen our relationship with existing customers, and offer our enrolled members valuable discounts that help address the ongoing inflationary pressure they’re facing.

We are pleased with what we are seeing from our loyal customers and believe there is significant untapped opportunity as we continue to evolve our loyalty program. In the fourth quarter of 2023, transaction size associated with enrolled loyalty members averaged $12.70 per transaction, or approximately 32% more than the $9.62 per transaction for non-enrolled members. As an example of the opportunity we see in front of us, in 2022, we enrolled approximately 283,000 members. In 2023, we enrolled another, approximately, 730,000 members. We believe this background underpins the opportunity of our loyalty program. We continue to work to accelerate new member enrollment and are leveraging our recently launched pizza program to deliver meaningful value for our enrolled loyalty members.

I will touch more on our pizza program in a moment. Turning now to our core destination categories, which are packaged beverages, candy, salty snacks, packaged sweet snacks, alternative snacks, and beer. These 6 categories accounted for over 50% of our merchandise contribution this quarter and for the full year. This concentration allows us to focus our assortment initiative on a narrow group of categories and leverage strong supplier partnerships that help drive total store sales. As a result of our ongoing work, penetration of the company’s core destination categories represented close to 43% of merchandise sales for the year. Food service proposition is a multiyear process with wins along the way. We are already building the foundation to support our long-term journey to establish ourselves as a food destination and establishing food service credibility.

In 2023, we added bean-to-cup coffee in 391 locations, including newly-acquired stores, bringing the offering to 945 locations. At the end of 2023, we collaborated with Tyson and launched a value-oriented chicken sandwich available for $2.99 for our enrolled loyalty members and available in 300 selected locations. And then, next, I’m very excited about our most recent food service launch. After almost a year of research and development, in January of this year, we launched our pizza offering as a take-and-bake at more than 1,000 stores and hot in approximately 225 of those stores. We have seen very positive customer reaction to the pizza with over 70% of those surveyed saying they will definitely purchase again. Our goal over the next several months is to have as many consumers as possible try this pizza and to roll out our pizza offering both take-and-bake and hot to significantly more stores.

The pizza is available to our enrolled loyalty members at a value-oriented price of $4.99 for a high-quality whole pie. In addition, as we shared in October 2023, we created and filled a new senior leadership role that is responsible for developing a companywide cross-functional food strategy and scaling it across our stores. We look forward to sharing more on this work as we move through the year. Starting this year, we are beginning to build 3 new stores, with the first expected to break ground in the next few weeks. These new stores will offer a great customer experience, including food service. As we continue to explore opportunities to expand our retail footprint, take a look at the cover of our presentation where you can see a picture of an unmanned express store on one of our Quarles cardlock location in the Richmond, Virginia, area that just opened 2 weeks ago.

I will now turn the call over to Rob to review financial results and share our thinking on 2024.

Rob Giammatteo: Thank you, Arie. Good morning, everyone. I wanted to take a brief moment to thank the talented Arko team for the warm welcome over these past 2 months. I’m excited to join the company on its journey toward realizing its full potential and very much look forward to meeting our covering analysts and speaking with many of you soon. Starting with full year 2023 results. As Arie referenced earlier, total company EBITDA of $290.4 million was down just over 3.5% from 2022. At the segment level, our Retail segment delivered approximately $315 million in adjusted operating income, essentially in line with 2022 results with the contribution from our recent acquisitions and continued same-store merchandise contribution growth offsetting reduced same-store fuel contribution.

Total merchandise revenue was $1.84 billion, up from $1.65 billion in 2022. Same-store merchandise sales were up 0.4% with same-store merchandise contribution up over 4%. Excluding cigarettes, same-store merchandise sales were up 2.5%. Same-store fuel gallon demand was down 5.3% for the year compared to national OPIS, which was down 3.4%. Same-store fuel margin of 38.6 CPG was down 2.7 CPG from a record 2022. The combined impact of lower fuel gallons and reduced CPG resulted in a same-store fuel contribution decline of approximately $46 million from full year 2022. Full year 2023 adjusted operating income of $79 million at our Wholesale segment was essentially in line with 2022, with contributions from acquisitions offsetting the impact of decline in fuel contribution from a record 2022.

Full year 2023 adjusted operating income at our Fleet segment of approximately $41 million was up just over $20 million from 2022, reflecting a full year of operations from Quarles versus a partial year last year and our WTG acquisition. Full year 2023 total company general and administrative expenses increased approximately $25 million compared to 2022, primarily due to our recent acquisitions. Full year 2023 net interest and other financial expenses increased by approximately $12 million compared to 2022, primarily due to a higher average outstanding debt balance and a higher average interest rate. And finally, full year 2023 net income was approximately $35 million compared to $72 million for 2022. Turning to fourth quarter 2023 results.

Our Retail operating segment delivered approximately $72 million in adjusted operating income for the quarter, which was down 3.3% from a year ago period. Merchandise sales and merchandise contribution were up 10.8% and 19.6%, respectively, reflecting a 240 basis point expansion in margin rate. Retail segment fuel gallons and fuel contribution were up 10.9% and 4.8%, respectively, to the year ago period. Operating expense was up 18.2% for the quarter, with the increase related almost entirely to our acquisitions. Growth in all aforementioned segment results was driven by our acquired businesses, which delivered in excess of 12 million in adjusted operating income to our Retail segment for the quarter. Same-store merchandise sales, excluding cigarettes, were down 1.8% versus the year ago period, while total same-store merchandise sales were down 2.8%.

Same-store merchandise contribution was up 3.9% to the year ago period, reflecting the strong underlying organic margin expansion related to our ongoing merchandise assortment work. Same-store fuel gallon demand was down 7.5% for the quarter compared to national OPIS, which was down 4.6%. Same-store fuel margin of 38.2 CPG was down 2.7 CPG from a record 2022. The combined impact of lower fuel gallons and reduced CPG resulted in a same-store fuel contribution decline of approximately $14 million from the year ago period. Same-store operating expenses were up less than 2%. Moving on to our Wholesale segment. Adjusted operating income was $18.1 million for the quarter versus $17.5 million in the year ago period, with total gallons up 7.2%. Growth was driven by acquisitions that closed in 2023, which delivered $2.4 million in adjusted operating income for the quarter.

For our Fleet segment, adjusted operating income was $9.7 million for the quarter versus $13.3 million in the year ago period, with total gallons up 11.8%, reflecting performance against abnormally high diesel margin per gallon and fuel volatility that we referenced in our 2022 year end call. Acquisitions that closed in 2023 delivered $2.2 million in adjusted operating income for the quarter. Total company general and administrative expense for the quarter was $38.1 million versus $39.3 million in the year ago period. Total company adjusted EBITDA of $65.5 million for the quarter was down $6.9 million from the prior year period, with the decline primarily due to reduced same-store fuel contribution. Net interest and other financial expenses for the quarter were $22.9 million, compared to $16.3 million in the year ago period.

Net income for the quarter was $1.1 million, compared to $12.9 million for the year ago period. Please reference our press release for a detailed reconciliation from total company net income to adjusted EBITDA. Turning to the balance sheet. Excluding lease-related financing liabilities, we ended the fourth quarter with $845 million in long-term debt, comprised of our 2029 senior notes, the draw on our Capital One line, and the remainder primarily related to real estate and equipment financing. Our $140 million ABL remains completely undrawn as we manage working capital needs from operating cash flow. We maintain substantial liquidity of approximately $830 million, including $218 million in cash on hand at year end, along with the remaining availability on our line of credit.

Of this total liquidity, approximately $460 million is attached to our Capital One line, which is reserved for M&A activity. Together with our outstanding Oak Street commitment of almost $1.5 billion, we are comfortable that our balance sheet has more than adequate flexibility to support both ongoing organic growth initiatives and M&A. Including investment capital, total capital expenditures for the quarter and full year 2023 were $35.6 million and $111.2 million, respectively. Turning to 2024, as you may have seen in our press release, we have initiated full year earnings guidance this quarter to help investors better understand our earnings outlook. We are currently modeling total company full year adjusted EBITDA in a range of $250 million to $290 million versus $290.4 million for 2023.

Our full year earnings outlook corresponds to an average retail fuel margin of 36 CPG on the lower end and 40 CPG on the higher end of our guidance range. Please reference our press release for a full reconciliation of net income to adjusted EBITDA. And finally, some detail on our first quarter, which has historically contributed approximately 16.5% of our full year results. Based on quarter-to-date trends, we expect our first quarter to contribute less to the full year adjusted EBITDA than in prior years, representing 12 to 14% of our full year adjusted EBITDA guidance. Our guidance framework reflects our expectations for current trends to normalize coming out of the first quarter, along with our ability to leverage our food initiatives, loyalty program, and fuel pricing strategy, during the higher traffic summer period.

Our first quarter outlook corresponds to an average retail fuel margin of 35 CPG on the lower end and 39 CPG on the higher end of our guidance range. And with that, I’ll hand it back to Arie for closing remarks.

Arie Kotler: Thanks, Rob. I will close by saying that I’m extremely proud of the team here for all of its hard work in identifying, executing, and integrating five acquisition over the past 18 months. As I discussed earlier, 2024 is a year for us to focus on unlocking the value of our current assets for our stockholders. I’m excited about the work we are doing on our multiyear strategy roadmap and I’m looking forward to sharing with you later this year. I want to end by thanking the company’s almost 13,500 employees for their hard work and dedication. With that, we will open it up to questions.

Operator: Thank you. [Operator Instructions] Our first questions come from the line of Bobby Griffin with Raymond James. Please proceed with your question.

Bobby Griffin: Good morning. Bobby. Thanks for taking my questions. I guess first up for me, Arie, can you elaborate a little bit on the current trends you’re seeing in 1Q that is driving the delta and your expectations of the business versus the historical standards that we’re used to seeing in 1Q. And I guess I asked this in context, even versus our model, the retail margins that you guys are forecasting are not much off where we were forecasting 1Q retail margins, but the EBITDA performance is different than what we were thinking. So maybe any details around what is going on from a current trend standpoint driving that?

Arie Kotler: Sure. So you’re referring, Bobby- good morning, Bobby. Are you referring to Q4 or you’re referring to Q1?

Bobby Griffin: Q1. Q1 you guys are forecasting for the first quarter to be a lower percentage of the total year than it historically is. And the retail margins look pretty fine in the forecast for the first quarter. But you reference some current trends that are giving you pause or driving some of the lower benefit from the first quarter. So I’m just curious if you can elaborate on what these current trends are. Is it weakness in volume? Is it merchandise weakness? What is driving the delta here in the first quarter?

Arie Kotler: I think I will start first of all with fuel, and then I’ll let Rob, maybe chime in related to the merchandise. But related to fuel, as you know, Bobby, OPIS national is down close to 7% for the first quarter. This is something that we’re seeing over here, and we are also seeing a little of that softness when it comes to CPG. That’s, of course, always a tradeoff. So I think CPG and demand and low demand in the first quarter, it’s actually attribute a lot to that. We don’t like to blame the weather, but as you know, first quarter in January this year, we had some weather event across the country in the middle of January. And usually, the first quarter is the slowest quarter in this industry. And we saw the same thing, by the way, happening to us last year.

But I think one of the biggest thing over here is, of course, fuel drive – the demand down and CPG a little bit light, it’s something that drive it. But again, I can only speak based off today. Today we are still in February. We are heading next week into March, getting very, very close to the season. And things, of course, can change up and down during basically first quarter, beginning of second quarter.

Rob Giammatteo: Yes, Bobby, good morning. Just to add a little color to the guide. So quarter to date, the guide is based on a trend coming out of the fourth quarter. So we’ve got it positioned down high-single digits for retail gallons. Again, we’re not stepping out on the trend right now. We’re going to position things where the trends are given where they’re in January, February period. From a fuel margin range, we shared sequentially that we were $0.35 to $0.39 for the quarter. We have seen modest sequential improvement from December to January to February, but it has been modest. So again, we’re holding at that range that we shared in the prepared remarks. And then on the merchandising side, quarter to date, same-store sales are down mid-single digits.

I’ll note we’re up against a strong period last year. So on a 2-year stack, we’re running roughly flat, and you should be thinking about that for the full year. We’re using that 2-year run rate as we look at Q2 through Q4.

Bobby Griffin: Thank you, Rob. Nice to meet you as well. Appreciate the details. Sorry, I should have started the question Q&A with that, but welcome to Arko. I guess on the merchandise side of things, can you maybe unpack that a little further and what you think is going on? Is it just a general weakness trend in the industry or is there some levers that you guys need to pull to maybe grow faster or in-line with the industry? Just anything there on that category. And if you believe you’re maintaining share there.

Arie Kotler: I can only tell you what I believe. I believe that this is a general trend in the industry. As I said, when you see the fuel demand down in the first quarter, we just see some softness in the market. And again, we’re talking right now about January, and we’re talking during the first 7 weeks of the quarter. And as you can expect, this is like the slowest time basically of the year. And given that we are providing guidance first time over here, we can only advise what do we see over the past few weeks. As I said, as we move towards March, April, May, towards the summer, we believe things will actually start to pick up again as we saw almost every year and we see the same thing.

Bobby Griffin: Thank you, I will jump back in the queue. And turn it over to somebody else.

Arie Kotler: Thank you, Bobby, appreciate the questions.

Operator: Thank you. Our next questions come from the line of Anthony Bonadio with Wells Fargo. Please proceed with your question.

Anthony Bonadio: Yes. Hey, good morning, guys. Thanks for taking my questions. So I just wanted to dig in a little bit on the fuel margin guidance. I guess what I’m trying to understand is why $0.36 to $0.40 per gallon is the right number. Maybe you can just walk us through the assumptions that got you to that and what you think might drive a decline versus what you saw in ‘23.

Rob Giammatteo: So, Anthony, as I mentioned earlier, we’re using trends, and we’re looking at the full year. So the reason why we’ve got a little bit of a disconnect between quarter and year is we’re using trends for the first quarter with what we’re seeing quarter to date. We’re using 2023 trends for the full year. So Q2 through Q4 are positioned on a slightly different basis. So you know that for last year, our fuel margin was off – CPG was off modestly versus the prior year, and our gallons were down 5% for the year. So the trend we’re using again on a full year basis for Q2 through Q4 is having that gallon demand down mid-single digit, and the CPG midpoint down about $0.01 from 2023 levels.

Anthony Bonadio: Okay, got it. And then just a little more on guidance. I know you mentioned that like 2-year flattish stack on merch comps, but I guess just how should we think about the other underlying assumptions there as we think about gallons, merch margins? And then I think the answer is no here, but are you assuming any M&A in that figure?

Rob Giammatteo: So, on merch margins, we are modeling continued expansion of merch margins. I would not be modeling at the same rate you did for last year, but we are expecting it up. So, again, we do intend to have that continue. And then again, to reiterate, the same-store gallons we have down mid-single digits, consistent with what we had for fiscal ‘23.

Arie Kotler: And I will answer the question regarding M&A, Anthony. So, as you know, we have over $2 billion in available liquidity to continue M&A. We’re going to continue to be disciplined, but the one thing that I mentioned during this call, and I want to reiterate. In the past 9 years, we closed over 25 acquisitions. Just in the past 18 months, we closed 5 large acquisitions. We had scale – I can say that we probably declare victory when it’s come to M&A. We bought a lot. And as much as I spent time on acquisition, my plan for 2024 is, again, let the M&A team continue to do what they’re doing on a regular basis. But my team, including myself, this is the time for us to peel the onion. I believe there is a lot of levers that we can pull.

I believe there is a lot of untaped opportunities that we have inside the stores, given the scale that we’ve built over here. And this is what we are going to do and this is what we are concentrating, starting with the pizza launch just 3 weeks ago and actually a month ago, starting with the pizza launch, we are going to invest in our stores, we are going to spend a lot of time in our stores to start basically to get into the weed and get all of those opportunities that are out there and just make sure that we are tapping on them.

Anthony Bonadio: Got it. Thanks, guys.

Arie Kotler: Thank you, Anthony.

Operator: Thank you. Our next questions come from the line of Kelly Bania with BMO Capital Markets. Please proceed with your question.

Kelly Bania: Good morning, and thanks for taking our questions. Welcome, Rob. Arie, I was wondering if you can maybe elaborate. I know you’re talking about an Analyst Day, but just elaborate a little bit more on the opportunities to drive organic growth. You talked about the Retail segment. We’ve seen the announcements about the pizza program. But should we expect that there’s going to be a pause on M&A for some time? And just help us understand where the opportunities are from an organic perspective?