ARKO Corp.

Greetings and welcome to the ARCO Corp fourth quarter and fiscal year 2022 earnings conference call. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.

Thank you. Good morning and welcome to ARCO's fourth quarter and fiscal year 2022 earnings conference call and webcast. On today's call are Ari 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, as filed with the SEC, and our earnings presentation are available on ARCO's website at arcocor.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, crosstalk, or other minor technical issues during this call. We thank you in advance for your patience and understanding. Now, I'd like to turn the call over to Ari.

Thank you, Russ. Good morning, everyone, and thank you for joining us. Before we get started, I'm sure you all have heard 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 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. These results emphasize that at our core, ARCO is a retail convenience store operator. It is important to remember that the majority of our profits are generated in our stores. ARCO increased operating income by 18.9% to $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, ARCO generated $209.3 million in net cash provided by operating activities and $110.7 million in free cash flow. This is a direct result 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 has successfully led to continued 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 their markets showing the string of our favorable assortment, loyalty, and marketing programs. This includes key product categories like beer, wine, packaged beverages, packaged sweet snacks, frozen food, 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-year stock 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 behavior 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 dispensed beverage categories. Our in-stores growth strategy is based on three key pillars. The first pillar is to grow sales in core destination categories through data-driven decisions that meet today's customers' needs. When we acquire new sites, we often add hundreds of items to the acquired stores. We focus on key merchandise that we know resonates with our customers. I will detail the benefits of this shortly in a brief case study of our Andy Mart 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 initiative, loyalty customers continue to incrementally grow their total spend over the course of the year. Our loyalty marketing is apparently resonating with them. For example, our 99 cents coffee program for enrolled members has had a very strong result. Enrolled members purchased over 741,000 more cups of coffee in 2022 than in 2021. We are in the process of rolling out our new loyalty app, which has many exciting new iValue features for the benefit 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 enrollment and announce 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 iValue in-store and in-app deals for our growing numbers of 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 1,000 of our stores. We will also be able to make age-verified special offers to adult customers 21 years and older. Our third pillar is expanding our packaged and fresh food offering, including pizza, chicken, prepared sandwiches, and many other options. The Bauer and other QSR-like offerings are a component of this pillar. Since establishing this franchise relationship, we now have 18th of 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 announced food and drink offerings has continued to work well for us. Unit sales of bean 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 analyzing 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 a total gallons in the market decline. We compete in fuel market by market using data-driven approach based on a fuel strategy that we have also designed to attract customers into our stores. In 2022, we have held merchandise dollar share in our competitive retailer market areas while significantly improving fuel gross profit. This led to On one hand, same-store gallons decreasing by 8.3% in Q4 compared to a 0.2% decline in the prior year quarter, and for the year, same-store gallons declined 8.1% compared to a 1.3% decline in 2021. On the other hand, retail fuel profitability grew to $104.3 million, a 16.3% increase compared to the $89.7 million decline 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 our 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 continued to increase across our industry. The labor market is still competitive, and wage growth has been strong nationally. We believe our strategy is resilient across many price environments, as our results have 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. Companies return on invested capital across our many acquisitions underscore that continued 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 favorable 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 to 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 Qualls and Pride. Before getting into further details, I'd like to illustrate how we drive growth in new acquisition. I want to walk through the 2022 performance of our Endemart acquisition that closed in November 2021. Quarter over quarter, we monitor progress of all of our new acquisitions. We fully reset 36 stores, adding over 700 merchandise items. This is the value that we bring to our customers, increasing mix with in-demand items. We also implemented our fuel pricing system. For these numbers, I am comparing against seller-provided trailing 12-month figures from May 2021 when we conducted our due diligence. In-store margin have increased 6.9% from 31.3% to 33.5%. Merchandise contribution has grown 10.8%. As of December 31, 2022, we increased average cent per gallon by 6 cents. 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 in 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 is 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 drives us forward. Our teams have been very effective at improving marketing, in-store mix, and offering to drive sales at our newly acquired stores. The virtues 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 the 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 our southern retail territory into Alabama and Mississippi. We expect this transaction to close in the first quarter. The WTG acquisition is anticipated to close in the second quarter. This acquisition will significantly enhance the company's footprint in the attractive Permian Basin market, with 24 company-operated uncle convenience stores across western Texas. The company would also acquire 57 proprietary fleet fueling catalog sites strategically located in large industrial areas in west Texas and southeast New Mexico, and 52 private catalog sites. These sites service a diverse base of customers. The WTG acquisition fits very well in our business model and build on the fleet fueling business we acquired from Quartz in July 2022. We believe that fleet fueling is an excellent business and the timing of the Quartz acquisition and our rapid integration could not have been better. We realized strong cash flow because of fuel price volatility in the second half of 2022 since closing. The Quartz acquisition, which closed on July 22nd, 2022, contribute incremental adjusted EBITDA in 2022 of $20 million. This exceeds our expectation based on our modeling. We closed the price convenience holding acquisition on December 6th. This was our second deal for 2022. This strategic acquisition added 31 convenience stores plus a new two industry store that broke ground in July 2022. It expanded our New England territory into Massachusetts. We are on pace with our integration efforts and look forward to adding value to these stores with a larger assortment and new promotions. In addition to this acquisition, in 2022, we fully remodeled 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 increased our total EV charging network with 18 chargers installed across five stores in Massachusetts. Importantly, prior to our acquisition, Frye 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 availability in these markets. As part of our overall strategy, we pursue grants and subsidies across our footprint 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 Beards Run, Michigan. We continue to identify potential opportunities to install EV charging across 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.