ARKO Corp.

Greetings and welcome to ARCO Corp Second Quarter 2023 Earnings Conference Call. At this time, all participants are on a listen-only mode. A 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. I would now like to turn the conference over to your host, Ross Parman. Thank you. You may begin.

Thank you. Good morning, and welcome to ARCO's second quarter 2023 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 quarterly report on Form 10-Q for the second quarter of 2023 is filed with the SEC, and our earnings presentation are available on ARCO's website at arcocorp.com. Before we begin, Please note that all second quarter 2023 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 quarterly report on Form 10-Q for the quarter ended June 30th, 2023, and our other filings with the SEC, including our annual report on Form 10-K, 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 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 reconciliation 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. And now, I'd like to turn the call over to Ari.

Thank you, Ross. Good morning, everyone. We appreciate you joining the call. First, I'd like to thank our approximately 14,000 employees for their hard work and dedication which I see first end every day. We have had a busy first half of 2023 and continue to execute our strategy of creating long-term shareholder value. I have great conviction that we are doing the right things. We have a deliberate focus on improving the performance of our retail stores, including our customer service and experience to our marketing and merchandising strategy, and of course, executing on a creative M&A transaction. Looking at our performance, I'm extremely happy with our results this quarter. Adjusted EBITDA for the quarter was $86.2 million compared to $79 million in the prior year quarter, an increase of 9.1%, including recent acquisitions. I encourage you to review our earning release, in which we provide more color when our recent acquisitions contributed to our performance. The headlines this quarter are Our strong organic growth in merchandise gross profits, which was offset by lower organic fuel gross profits and increased labor expense. At our retail stores, we continue to see the positive results of our many initiatives. Our strong and experienced merchandising and marketing team continue to work to maintain our trajectory of generating more gross profit inside our stores, by focusing their efforts on our three strategic key pillars, growing sales in core destination categories, our fast rewards loyalty program, and expanding our food and beverage service. As a result, merchandise gross profit dollars grew to $135.6 million, a 5% increase on the same store basis as compared to Q2 2022. Merchandise margin on the same store basis grew 130 basis points to 31.9% compared to 30.6% in Q2 2022. I'm very proud of these results. This quarter, same store merchandise sales excluding cigarettes grew 3.8% and same-store sales increased by 0.7% compared to Q2 2022. We consider a store to be a same-store beginning in the first quarter in which the store had a full quarter of activity in the prior year. I want to underscore why we believe that the same-store sales excluding cigarettes is an important metric for judging our performance. Our marketing and merchandising initiative intentionally focused on our core destination categories, which are packaged beverages, candy, salty snacks, packaged sweet snacks, alternative snacks, and beer. We measure our retail success on our ability to grow sales and profitability outside of cigarettes and in our core destination categories. We have executed on our strategy growing merchandise sales and gross profit, while decreasing our exposure to cigarettes. We encourage you to look at our second quarter presentation on arcocorp.com, where we have provided some information about this trend and our performance. I will detail some key metrics with all numbers comparing Q2 2023 to Q2 2020 over the last three years. As a result of our strategy, As a percentage of total merchandise sales, core destination categories have increased from 38.4% to 44.6%. Cigarettes have decreased from 38.2% to 29.6% of total merchandise sales. Since Q2 2020, gross profit dollars from core destination categories have grown 67%. while gross profit dollars from cigarettes have only increased 7.5%. In the same timeframe, all other categories, gross profit dollars have grown approximately 32%. The gross margin in core destination categories has expanded approximately 546 basis points, while cigarette gross margin has expanded by approximately 148 basis points. Turning to the progress of our three key merchandising and marketing pillars. Our first pillar is to grow sales in core destination categories through data-driven decision, execution, and strong supplier partnership. We define our core destination categories as those categories where we invest resources such as people, technology, space, and capital. Same-store sales in these categories for Q2 this year increased by 5.6% as compared to the prior year period, with 12.2% same-store growth in candy. Importantly, margin in these core destination categories on a same-store basis grew 150 basis points year over year. These categories were approximately 65% of our Q2 same-store sales, excluding cigarettes, and 45% of our total same-store sales. We work to ensure that our stores meet our high-space assortment standards for these core destination categories and that we offer our customers the right assortment and value proposition. This reinforces my belief that we are doing the right things by way of assortment and marketing. This is the ARCO way, which we quickly implemented in a recent acquisition. We previously provided an update on our success at Endymart. This is not a one-off. We are seeing similar progress in our newly acquired Pride location, where we added approximately 1,000 items into stores. At this location, Merchandise margin increased 290 basis points to 34.8% compared to Q1 2023. Moving to the second pillar of our Fast Rewards loyalty program, we are very pleased with the results from the major upgrade of our loyalty app, which rents live on March 28th. We believe that our program develops and enhance our relationship with our customers, drives more trips with our existing customers, and attract new loyal customers. To support the growing of our loyalty program, on May 17, we launched our 100 Days of Summer Loyalty Enrollment Offer, and new customers who are enrolled with a valid email address and phone number are rewarded with $10 in fastbacks delivered to their new app wallet. We are seeing increased cadence of enrollment and, importantly, of marketable loyalty members. At the end of Q2 of this year, we had 1.48 million enrolled members, and we are just getting started. Marketable members, which are loyal customers with whom we can communicate, are up approximately 37% over the prior year period and 10.5% higher than the prior quarter. In fact, since we launched our new app in March, we added more than 205,000 net enrolled marketable members. We know that enrolled marketable members make more trips and spend more in our stores than non-enrolled members. In Q2, enrolled members made an average of almost six more trips per month versus non-enrolled members. For the same period, they also spent on average more than $60 per month more than non-enrolled members. Given the increased frequency and spend of enrolled members, We are very excited about the upside opportunities as our program gains more traction. Our third pillar is expanding our food and beverage services, and we are making great progress. This includes branded food franchises, packaged, fresh, and frozen food offerings, including pizza, chicken, roller grills, and hot, cold, and frozen dispensed beverages. Although we have a lot of upside to grow our food and beverage offerings, I want to highlight our existing capabilities. We currently have 150 plus branded food franchises, 160 plus in-store delis, 160 plus hot grab-and-go units, 1,200 plus cold grab-and-go units, 370 plus roller grills, and over 700 bean-to-cup coffee stores. We have expanded Bintu Cup Coffee by 135 stores since the first quarter of 2023. Branded franchise food sales increased 10.4% on a same-store basis in the second quarter as compared to the prior year. Our grab-and-go sales have increased 13.4% in Q2 2023 as compared to the prior year period. We are happy with this performance, but know we have more to achieve and plan to grow in this category. particularly in a way that allows us to control our own destiny. We are targeting approximately 120 more stores for oil grills by the end year end of 2023. We have targeted an additional approximately 230 stores for food or bean to cup coffee expansion by the end of 2023. We continue to challenge ourselves on our food and beverage service offering and how we can continue to improve. Our objective is to improve our performance in each pillar. I believe this will position our core convenience store business for further growth, delivering great results while exceeding our customers' expectations. As you know, I like to get out with the team, keep our fingers on the pulse at our retail stores, and check the performance of our operation. I and several senior executives recently surprised visited many stores. We walk into the stores unannounced, speak to our associates and managers, and truly inspect each store. I believe we have made a lot of progress on our merchandise execution, but believe we still have more to go. We understand that excellent customer experience and service is a necessity and is core to our business. The operations team goal is for merchandise and marketing plans to be closely followed and mix and assortment in each location executed to our strategy and always in stock. We will continue to invest in updating key areas of our stores that we believe are essential for continued growth. We are more committed than ever driving long-term, sustainable inside sales growth, expanding margin and gross profit dollars, and we know that there is a runway for improvement and growth. Turning to fuel, total fuel contribution increased to $156 million compared to $130.8 million in the prior year quarter, an increase of $25.2 million. At our stores, on the same store basis, retail fuel gross profit for Q2 was down 5.1% as compared to the prior year period. This reflects the impact from both declining gallon sold of 2.6% and slightly lower cent per gallon, 1.1 cent on a same-store basis, both as compared to the prior year period. I will note that according to OPIS data, volume is down year over year in each of the regions in which we operate. Second quarter retail cent per gallon on a same-store basis was 40.3 cents against 41.4 cents in the prior year period, as we continue to cycle elevated cents per gallon from 2022. We still believe that structurally higher margin will remain. Margin operators with their cost structure and operating pressures are one of the main factors of this assessment. Looking ahead for Q3, we do not expect retail fuel margin as remarkable as the prior year period. In Q3 2022, we netted retail cent per gallon of 44.8 cents, which was exceptional, and we do not believe that high margin is reflective of a normal quarter. As always, we continue pursuing our strategy of fuel gross profit optimization. Turning to M&A, following the closing of the Quals and Pride acquisition in 2022, we closed the TEG acquisition on March 1st, 2023. TEG added 135 convenience stores and expanded our southern retail territory into Alabama and Mississippi. We also added 181 dealer locations. As I mentioned earlier, we are encouraged by early results at the Pride stores that we recently reset to our standards. We believe we will have similar results at the TEG stores that we recently reset. WTG, which we closed on June 6, 2023, added 24 company-operated uncle convenience stores, and significantly announced the company's footprint into the attractive western Texas market. This is our second closing in 2023. We expect this to add approximately $14.9 million of adjusted EBITDA on an annualized basis, including expected synergies. As part of this acquisition, we added 68 gas card-granted split-fueling card lock sites and 43 private catalog sites, one of the largest fleet fueling operation in West Texas. Approximately 75% of 2022 fuel cells by volume at WTG catalog location were diesel. In addition, the WTG business issues fuel cards that provide customers with access to a nationwide network of fueling sites. ARCO's fleet fueling segments expect to leverage its leading marketing and operation knowledge to manage fleet fueling sites and create value for our customers. We see a major opportunity to leverage our expertise at Quals to improve the operation at our newly acquired Cardlock sites. This is clearly a complementary acquisition, and we are pleased with the results so far. During the second quarter, GPM Petroleum upsided its credit line by $300 million, to $800 million and extended in maturity until May of 2028. There is $602 million of availability under our line of credit as of June 30th, 2023. In all, ARCO currently has access to more than $2 billion in available funding for continued M&A activity. We continue to see tremendous opportunity ahead of us in our acquisition strategy with a deep pipeline of potential opportunities. We believe our successful track record of making a creative acquisition will continue to enhance value for our stockholders. Lastly, I'd like to welcome a new pride location to our footprint. On June 30th, we opened our newest location in South Windsor, Connecticut. I encourage those in the area to come visit. This location is beautiful. almost 5,000 square foot store, offering indoor and outdoor sitting to enjoy Chester chicken and our food and beverage program. The location is equipped with a drive-thru to offer our guests even more convenience. There are 40 parking spaces for our customers, 16 retail fuel pumps, and 10 high-flow diesel pumps, along with a truck parking area. We have additional new units in the pipeline that are in various stages of development, and I look forward to adding more into the future. One last point before I turn the call over to Don. We continue to make progress on electric vehicle front. As we are always monitoring the EV transition, I will note that there is very limited penetration in our core footprint. That said, we assess installation on a site-by-site basis and with a view on return on capital. We were among the first to install EV charging capabilities in Wisconsin, and we now have 15 EV charging locations with 62 ports across nine states. I remain excited about the many achievable opportunities in front of us. Thank you for your time today. And with that, I will now turn the call over to Don.