Greetings, and welcome to the Arko Corp. Second Quarter 2022 Financial Results Conference Call. A question-and-answer session will follow the formal presentation. [Operator Instructions] I would now like to turn the conference over to your host, Ross Parman, Vice President of Investor Relations and Government Affairs. Please go ahead.

Thank you. Good morning, and welcome to Arko's Second Quarter 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, quarterly report as filed with the SEC and our earnings presentation are available on Arco's website at arkocorp.com. Before we begin, please note that all second 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 quarterly report on Form 10-Q for the quarter ended June 30, 2022, and 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 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.

Thank you, Ross. Good morning, everyone, and thank you for joining us. Arko strong results for the second quarter focus the resiliency and strength of our business model and our ability to execute our long-term growth strategy. Arko generated $31.8 million in net income, an increase of over 24% versus the prior year's second quarter. Adjusted EBITDA was an over-time second quarter high for the company at $79 million, marking comparable quarter year-over-year EBITDA growth for six straight quarters. As these strong results, so we accomplished a lot during our first half of the year, our performance and financial strength facilitated continued investment in our stores and hiring and retention programs as well as the repurchase of common stock, which we continue to view as a great use of capital and a declaration of our third quarterly dividend. I'm extremely happy with the performance of all areas of our business. This quarter, we navigated historic volatility and inflation by remaining focused on executing our strategy in stores and in fuel. In our stores, we maintained total market share and grew total store dollar sales. Merchandise margin increased 170 basis points to 30.4% compared to 28.7% in the second quarter of 2021. And second quarter same-store merchandise sales, excluding cigarettes, was 5.7% on a two-year stock basis. The marketing team has done a good job managing for inflation in key categories. In particular, this quarter, we saw growing frozen food, center of the store items, beer and other tobacco products. In terms of execution of our strategy, here is the short case study, building out frozen food offering was a strategic focus for us in prior quarters. The team moved quickly to implement this program and has executed it very well. It has rapidly gained ground and selling frozen fruit increased…

Thank you, Arie, and good morning, everyone. We had excellent results this quarter. Increased merchandise contribution and fuel contribution at same stores, combined with an increase in field contribution in our wholesale segment for the best second quarter in company history. The 2021 acquisitions of ExpressStop and Handy Mart also contributed to these results. And we're excited about the Quarles acquisition, which closed in late July. We are working with the highly experienced Quarles's team on integrating our operations now. Quarles become a fourth reporting segment for the company. This will keep our financial performance easily accessible for all investors and analysts. With the acquisition, the company is now engaging in fuel hedging positions. This system manage risk associated with an immaterial number of fuel transactions that have price risk until the actual fuel is delivered to the cardlock, where several customers buy based on the formula tied to the current RAC prices on the date of sale. This hedging applies to only approximately 2 million gallons per month associated with fleet fueling operations. Getting into the results. Merchandise margin dollars for the second quarter of 2022 increased by $9 million versus the prior year, while margin percent increased 170 basis points to 30.4% from 28.7%. I already noted this, but I would like to reiterate this point. We recorded excellent results in an elevated fuel price environment, but we believe our resilient strategy enables the company to also achieve strong results as fuel prices decline, as we've demonstrated in prior quarters. Whether prices are high or low, we strive to manage margin and volume to optimize overall fuel margin dollars. Retail fuel profitability, excluding intercompany charges for the second quarter of 2022 grew 15% this quarter to $13.7 million versus Q2 2021. The company increased retail fuel margin to…

Thanks, Don. I will close by saying that we believe we have the right long-term strategy in place as well as execution capability that make me confident about delivering growth for the long term. Our business has performed exceptionally well in a challenging environment. Our model is very resilient, and I believe we're well positioned to deliver future value to our stockholders. We are very excited about the second half of this year. We will now take your questions.

[Operator Instructions] Our first question comes from the line of Kelly Bania with BMO Capital Markets.

Hi, Arie and Don. This is Ben Wood on for Kelly. We wanted to start with the retail gallon same-store sales decline. And how did that come in relative to your own internal expectations for the quarter? And if you could just give us a cadence of same-store gallon sales over the quarter? Just trying to get a sense of how maybe peak gas and prices may have impacted gallons.

Sure. Thank you. Well, as I mentioned on the call, higher prices did lead to lower volumes. There is no question about it, especially the market that we currently operate. But as I mentioned always, our strategy is to optimize margin. And that's basically what we did over here. We stay very competitive in the market we do business. And when price goes to $5, which I've never seen, by the way, through my entire career, obviously, in those markets, people driving less, coming more often to the store by driving less, and that's what really led to that. But as you can see, there is the overall results at the end of the day were to increase profitability while staying competitive over here.

Great. That's helpful. And then I guess -- following up on that, on the wholesale side, down look equally kind of challenged. What opportunities are you seeing for wholesale growth? Or does that more or less track in line with retail?

Those wholesale accounts, most of them are mom and pop. And the challenge that we saw in retail or at least a slowdown when price actually hit a $5 national leverage, I mean, they sold the same thing. And as you can see, their gallons are down probably at the same percentage that our gallons were down. But at the same time, we -- last time we sold $5 was sometime in the mid-June. And as you can see from the beginning of July, prices are down dramatically. I mean, we're talking around almost $1. And we see right now, all of a sudden, we see trends coming in a different direction. I mean, we see volume up right now because of that. And I think those guys are going to enjoy the same thing as we see over here on the retail side.

Okay. That's super helpful. And if I could sneak in just one more question on the merchandise inside store side, I'm wondering if you could just give us any more commentary on inflation in the quarter and what impact that had on prices. Were you able to pass everything through? And are you seeing more price increases coming down the line on the supplier side?

There's no question that we -- during the last quarter, we saw price increases, and we were able , of course, to continue to be very competitive, while have to increase some prices in some cases. I think what we actually were able to do is increase promotions with our oil customers and make sure that we actually provide great prices to all our customers. That's the reason we saw an increase in loyal customers. And as we continue during inflation, we see the difference between a loyal customer to a nonroyal customer. The loyal customers are spending over $90 more than the nonloyal customer. And I think that's going to continue to basically be the trend over here as we continue to go through inflation.

Our next question comes from the line of Bobby Griffin with Raymond James. Please proceed.

Good morning, buddies. Thanks for taking my questions. I guess, Arie and Don, the first question for us is back on retail gallons. And more just kind of curious, as you guys look at the strategy of maximizing fuel gross profit dollars, is there a certain level of gallon decline that you think starts to hurt the inside the store business from a traffic standpoint or something? So just anything there to help us circle up on how you think about balancing the gallon decline versus the GP when you think about inside the store as well.

Sure, sure, sure. So as I mentioned earlier, Bobby, the $5 mark, this is something that I don't think any one of us still during our career other than the people in California, of course. And we watch this very, very carefully. That's the reason I mentioned. We maintain our in-store market share, and this is based on IRI data. And this is something that we're always watching. We're always watching and making sure that we stay competitively. So when we talk about gallons down in lieu of increasing profitability, it's not that the gallons were there. It's not that -- I don't believe we lost market share. It's just the markets that we did business, people just drove less just because they don't have the discretionary income over there. I think that's really the reason for that. I don't believe that that impact any of our in-store visits. And as I said, I mean, we remain market share in the markets that we actually do business. But as you can see, we were able to increase profitability inside the stores because of that. I mean people are coming more often to the stores right now. They may have like small purchases, but they're actually coming in more often. And that's the reason while gallons are down, we make sure that we have the right items. We make sure we have the right promotions. We're working with manufacturers to be able to actually put the right promotion in place. That's also the reason why we are investing our time on reformatting our stores with coffee, with launches, with food service. Those are the things that we have to do while people are driving less. Again, I think that what we saw in June, that was something -- it's really historically. I never saw anything like this in my life. And I think that right now in July, you're going to see that it's actually turning in another direction when price of fuel is basically almost $1 less.

Okay. That's very helpful. And then, Don, on the store operating expenses, I think in the press release, you called out $8.4 million of personnel cost increase. Is that all just per hour cost? Or is there more hours being ran in the stores right now? Just trying to think of the difference between the labor side on a per hour basis and the number of hours you're running inside the stores.

Yes. Great question because it's a combination of a couple of things. Number one, obviously, the average wage we're paying is up as everybody is experiencing across the market. There are more hours being worked because the applicant pool is getting a little bit better, although not where we want it. But there's another factor in there, too. We're doing things -- we're still offering incentives. One of the things that we did, which I think our existing associates appreciate it is we offered a $500 for 500 hours for all employees so that we -- That's part of the numbers, too. So we offered that for anybody employed as of Memorial Day. So not just new employees, but employees who have not gotten any recognition for that are also getting something too. So I think it's a combination of all three. But I think one of the biggest drivers is the hourly wage itself going up.

Okay. And then lastly from us, just on the realignment and streamlining, any early expectations about the savings that you think you could gain from that over a multiyear period? Or anything there to help us think about what the potential benefit could be once that's all done in the third quarter or into 2022?

Yes. We expect at a minimum, just at a minimum over $0.5 million a year, but we think it could be much higher than that. But at a minimum, from a starting place, we think it will be over $0.5 million.

Okay. I appreciate the details and best of luck in the second half. Thank you.

Our next question comes from the line of Anthony Bonadio with Wells Fargo. Please proceed.

Hey, good morning, guys. Congrats on the beat. So I just quickly wanted to ask on fuel margins. The OPUS data sort of continued to accelerate into July as prices have declined, which I think makes sense given what we've seen historically. Is that in line with what you guys are seeing so far in the first five weeks of Q3? And then how should we be thinking about what a more sustainable level looks like, assuming gas prices sort of level out again at some point in the foreseeable future?

I can't comment on Q3. The only thing I can comment on, Anthony, is that, yes, with price of fuel come down, and this is something that we saw historically, people are driving more, and we see an increase in gallons. There is absolutely a correlation between price of fuel declining and correlation of people driving more and getting out there. And I just think that at the end of the day, we are not relying only on fuel. I just want to make sure that everybody remember that. If you're looking on our insights inside sales, excluding cigarettes, and this is something very, very important, because we are a little bit different than some others. The health of our business is very, very good. We deliver increase of 170 basis points increase inside the stores. If you're really looking at the end of the day, our gross profit inside the store in lieu of that was $3.4 million up gross profit on a same store. And I think that's what you can see. I mean this is with $5 price of fuel, as you can imagine, what we are going to see when price of fuel is down for more than $1.

Got it. That's helpful. And then I guess just piggybacking on that, on merch margins, obviously, another solid quarter. It sounded like mix was a big contributor based on what you guys said in the PR in the prepared remarks. Can you just help us understand how much of that 170 basis points came from mix versus other factors? And then to what extent your different initiatives, things like the grab and go coolers, the new coffee machines are starting to play a role there?

Sure, sure. So the bigger driver this quarter, were actually frozen foods, as I mentioned, 81.5% with an increased margin of over 7%. -- sorry, a sweet snack was up also over 17.8% with an increase of 7%. And again, the same thing goes to the salty snacks, Alcohol, we see an increase in beer sales. I think the only thing we see right now is that given inflation, people may not buy 24 packs, they may go to 12 packs or six packs, but we see an increase in alcohol sales as well as well as OTP. OTP was another driver. I always mention that cigarettes continue to decline and cigarettes, of course, have a lower margin. However, OTP increased this quarter an additional 1.6% with margin basically increase of 4.22%. And that's a lot. Those categories are really the categories that are driving the increase in margin. And I believe we're going to continue to see that moving forward because of that.

That's helpful. Thanks so much, guys. Good luck.

Our next question comes from the line of Mark Astrachan with Stifel. Please proceed.

Thanks, and morning, everyone. Two quick questions for me. One, Arie, could you maybe talk a bit about the general drivers of heightened retail fuel margin that we're continuing to see today relative to pre-pandemic levels, just sort of broader strokes on why we're here? And I think we generally get kind of how to think about the ebbs and flows of gas prices up and down. And then second question, maybe building or asking slightly different some of the other questions on the same-store sales or even traffic into stores and trying to get a sense of relative magnitude of impact from higher fuel costs in June. So maybe if you could talk about cadence through the second quarter, we can kind of get a sense of how to think about it going forward and kind of looking backwards, if that makes sense. Thank you.

Sure. I had a hard time hearing the full question, Mark, the line was a little buzzy. I'm going to comment first of all on second quarter, as you said, with basically high fuel prices. As I said earlier, I think high fuel prices, especially in the market that we do business, we are a role in secondary markets, a lot of small town. I think that the issue is that -- I'm going to repeat it again. People were just driving less. And again, this is just because there's less money in their pockets. Again, I think that did not impact our in-store sales. Our in-store sales, as I said, are in line with our expectations. And I think the only difference is that the change in behavior over here was really that people came more often, and they just did small trips versus the trips that they did in the pandemic -- before the pandemic, people were coming in more often during the pandemic, people came less often, but bought big sizes, lot of sizes over there. And I think what we see right now is that it's coming back again. I think that we see people coming more often, driving less, but coming more often and just buying smaller baskets over here. I don't think this is, again, unless price of fuel will jump again over $5. I don't think this is something that will actually impact. As a matter of fact, I think, actually, it's going to improve our business dramatically as price of gas will be below the $4.

Mark, let me jump in. I don't think Arie could hear the first question about the increased margin level. One of the things also, I think, when we talked about this to think about is even though margins increased, I mean credit cards have gone up a tremendous amount. They went up $4.1 million due to higher retail prices. So most of our fuel is bought on credit cards. So when you see higher margin, we have to think of it after credit cards as the way most people think about it. We've also got a lot of increased cost due to inflation just to run the site, which were different than we had. You have increased labor costs, you have all kinds of costs going through. So these are things that our competitors are talking about. We've been in an area of increased margin. And I think no one knows what the future is going to hold, but there's a lot of cost drivers that kind of support some of what we're seeing because of the increased costs between labor, credit cards and also lower business that has happened since the pandemic started.

Our next question comes from the line of Karru Martinson with Jefferies. Please proceed.

Good morning. Historically, I feel like the industry has been able to hold or even expand margin as gas prices come down. Given the kind of unprecedented spike we had this summer, do you feel that those dynamics are still holding? Or is this a different situation?

Yes, I think the dynamic is still holding. I think as you mentioned, it really depends also -- volatility is great. It's always good to have volatility. But like you mentioned, historically, when price dropped dramatically, like in a very short period, and that's what we saw from the beginning of July. The same thing. I mean the price dropped really, really dramatically. Basically in almost a couple of weeks, price dropped by over $0.50, $0.60. And that's something that always is very, very helpful to maintain margin.

Okay. And then when you look out, certainly recognizing you just did the year 21st acquisition. What's the landscape look like today for additional tuck-ins for you guys or perhaps even a larger more transformative acquisition?

Sure. That's a good question. So I can tell everybody over here that the pipeline is very, very active. The pipeline is very, very active because a lot of small chain or midsized chain probably having a hard time operating in this environment. To be a very, very savvy operator. And I think that's a great opportunity for us. I mean this is one of our best areas that we practice over the past 10 years. We have enough liquidity. We have the deal-making ability, of course, and the strategic partnership with Oak Street, of course, will help us tremendously over the next few months basically to go after those acquisitions and there's some meaningful acquisitions out there that, of course, we are exploring.

Our next question comes from the line of Hale Holden with Barclays. Please proceed.

Hi, good morning. Kind of on the same theme there. I was wondering as you're considering M&A options, if either the higher financing costs that's out there in the market or the above normal kind of gas spread that's out there, fuel cost spread that's out there changes the way you're thinking about valuations or if you've seen sellers kind of bring down their valuations?

Sellers don't bring down valuation, as you can imagine. Everybody got a big expectation given that we see what is happening out there in terms of the amount of transaction out there. We believe that our strategy of pursuing deals at reasonable valuations are going just to continue. I mean we are not going to overpay for deals as we never paid over the past 21 acquisition that we did. I just think sellers' expectation is one thing. I think the market will determine who is out there. And as you mentioned, interest rate is going up. Our agreement with Oak Street, we have a commitment with Oak Street of $1.15 billion available basically for the next year, plus the cash on hand that we have in the line of credit that are available at a very, very attractive rate. I think this is something that's going to put us basically in a very, very good spot. As you guys remember, we raised our bonds at the fixed rates for a little bit over seven years. And I think that makes us very, very attractive in terms of the valuation that we can actually put on those deals.

Ladies and gentlemen, this concludes our question-and-answer session. And I'd like to turn the call back to Arie Kotler for any closing remarks.

Thank you, operator. And again, thank you, everybody, for joining us today. I would like to, of course, make sure that you guys enjoy the rest of the summer. I wish you all the best. And while you're enjoying the rest of the summer, just make sure you stop at one of our stores to try one of our excellent iced coffee cups. Enjoy the rest of the day. Thank you.

This concludes today's conference. Thank you for your participation. You may now disconnect.