Arcos Dorados Holdings Inc (ARCO) 2014 Q3 法說會逐字稿

Good morning and welcome to the Arcos Dorados third-quarter 2014 earnings call. With us today are Woods Staton, Chairman and Chief Executive Officer; Sergio Alonso, Chief Operating Officer; the Company's Chief Financial Officer, German Lemonnier; and Daniel Schleiniger, Investor Relations Director.

A slide presentation accompanies today's webcast, which is also available in the Investor's section of the Company's website, www.arcosdorados.com/ir. As a reminder, all participants will be in listen-only mode. There will be an opportunity to ask questions at the end of today's presentation. (Operator Instructions). Today's conference call is being recorded.

At this time, I would like to turn the call over to Daniel Schleiniger. Please go ahead.

Thank you. Good morning.

Before we proceed, I would like to make the following Safe Harbor statement. Today's call will contain forward-looking statements and I refer you to the forward-looking statements section of our earnings release and recent filings with the SEC.

We assume no obligation to update or revise any forward-looking statements to reflect new or changed events or circumstances. In addition to reporting financial results in accordance with Generally Accepted Accounting Principles, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial results as compared with GAAP results, which can be found in the results -- in the press release filed with the SEC on Form 6-K.

I will now like to turn the call over to our Chairman, Woods Staton. Woods, please proceed.

Thank you, Dan. Hello everyone and thank you for joining us today.

Similar to the second quarter, our third quarter performance was strongly impacted by volume declines during the final two weeks of the FIFA World Cup. In addition, once the tournament was over, we encountered continued weakness in the operating environments of our key markets, which pressured our results.

As we mentioned in our last call, we have launched efforts to support our customers by offering more affordable dining options. While it is too early to come to any conclusions, we have seen a stabilization in volumes toward the end of the third quarter and into the fourth quarter.

During the quarter, slow economic growth, political uncertainty and rising inflation continue to dampen consumer spending in the region. Our largest market, Brazil, was particularly impacted by the overhang of FIFA World Cup in July. As a result, consolidated third-quarter results fell short of our already-lowered expectations.

Organic revenues grew 9.7% year over year, backed by a 7.4% increase in comparable sales. As predicted, although we were able to achieve further efficiencies in G&A and other cost items, our EBITDA margin deteriorated with promotional efforts designed to defend traffic in the current environment.

At the start of the fourth quarter, we are seeing some evidence of stabilizing volume trends, and are optimistic that we can benefit from a seasonal pick-up in consumer activity and the promotional campaigns that we've planned through year end. However, we now expect organic revenue growth to be on the low end of guidance.

Our 2014 opening schedule remains on track, and we expect to achieve our target of 84 new restaurants. 35 restaurants were opened this year till September 30th, of which approximately 60% are freestanding. As is customary, the bulk of openings would be concentrated in the fourth quarter, with completion of the remaining 49 units currently scheduled for the last three months of the year. Accordingly, our full year CapEx guidance remains unchanged at approximately $180 million.

In terms of EBITDA, our visibility of the remaining months of the year, particularly the traditionally strong month of December, has been impaired with a high level of volatility and deterioration in the macro environments in our markets. Currently, fourth quarter results are trending below forecast, due to promotional efforts to defend traffic and a rising cost environment.

Our focus on this market environment is two-fold. First, we will drive traffic by expanding our value platform and second, we will advance on our near-term plans to reduce leverage and increase profitability through additional cost savings and efficiency improvements.

Today, I would like to spend some time talking about the longer term aspects of this strategy. Having completed the first stage of our planning process for 2015 with a review of our capital allocation policy and in the context of lower free cash flow generation, which are challenging operating environment, I will be recommending to the Board of Directors at our December meeting to suspend the dividend payments for 2015. Instead, cash from operations would be used to repay debt, in particular short-term debt, so as to bring leverage back in line with our target ratio of around 2.5 times.

Capital expenditures we'll use selectively to fund new development next year. We expect overall expenditures to be lower and we will concentrate most of our new restaurant openings in our highest potential markets, particularly Brazil. Over the next two years or so, across the region, we plan to shift the higher percentage of unit growth to sub-franchisees as we increase our share of investments to upgrading our existing restaurant base. Around 30% of our openings this year will be sub-franchisee operated restaurants.

We are progressing in the intricate process of evaluating the optimal geographic presence, return and risk mitigation scenario for Arcos Dorados as we seek the leverage expansion through our current or new franchisees going forward.

We remain committed to our strategy of opening a higher percentage of freestanding units, which provides great revenues per restaurant, multiple revenue generating opportunities and significantly more branding than the simple point of sale.

Cost savings, another key area of focus going forward. We've already taken steps that will yield an annualized reduction in G&A of at least $20 million. And during the third quarter, we achieved a 46-basis point year-over-year reduction in G&A as a percentage of revenue. Looking ahead to 2015, we plan to maintain G&A growth below inflation, resulting in a reduction in real terms.

Last quarter, we announced that we had begun working to identify and realize savings in our non-product purchasing process, which is a part of occupancy and other expenses. This effort has already yielded annualized savings of $7 million. Through the implementation of reverse auctions and scale-driven cost reductions among other initiatives, next year we expect this figure to increase to around $15 million. This is one of the key elements of our planning process for next year and beyond.

A further source of cost savings and margin improvements in 2015 is expected to come from systemwide advances in technology, which raise the efficiency of our operations. In recent months, we've been piloting a new scheduling system in Brazil, which has significantly lowered labor costs in test locations. Based on this initial success, we are now rolling out the system throughout Brazil and expect it to be fully implemented by July of next year. Thereafter, and assuming we achieve the results we expect, we will implement the system in Argentina by the end of 2015. Given these two markets account for half of our Company-operated restaurant base, we expect the rollout of a new system to substantially lower labor costs in 2015, with the full impact to be realized in 2016.

As a single brand with a single cooking system, we are in a unique position to capture scale advantages such as this. Despite current market conditions, we know that McDonald's continue to be the preferred brand in the minds of casual diners in Brazil. Based on our longstanding internal brand tracking surveys, when asked to rate the dominant branded QSRs in the country on a range of key metrics including value for money, convenience, decor and ingredient quality, respondents favored McDonald's over our competitors.

I'd also like to make a comment on the category. The majority of people who eat out in informal dining segment in Brazil do so at burger establishments. And the preferred venue for those people is McDonald's with four times the market share of the next branded QSR. In the current environment, the frequency of visits within the formal sector has declined. However, when growth in our markets recover, I am confident that continued brand preference for McDonald's along with steps that we are taking to improve our operational efficiencies will mean that we too will recover and at a faster pace than our peers.

I will now turn the call over to Sergio for more detailed look at our third quarter performance.

Thank you Woods, and hello everyone.

Please turn to slide 3. During periods of weak economic growth, our core strategy is to protect traffic and market share. During the quarter, we increased our focus on our GPPP platform and we continue to leverage the strength of the McDonald's brand in our marketing activities, focusing on the family experience and iconic products. As an example, towards the end of the quarter, we introduced the Super Mac and Mega Mac promotions in Brazil and have received a positive response from our customers.

Key third quarter marketing activities included the re-hit of Chicken McBites in the largest markets, the introduction of Danonino in the Happy Meal in Brazil, Argentina and Uruguay, and the inclusion of sandwiches such as the Triple Bacon with Cheese, the McBacon and the Duplo Pampa in our always attractive affordability platforms. Additionally, the dessert category performed well with introductions such as the McFlurry Oreo and the McFlurry Milka Choco Swing.

Looking ahead to the fourth quarter, we expect to drive top line growth to increase advertising of the GPPP platform, the rollout of products that have historically performed well and strong Happy Meal properties.

Please turn to slide 4. Consumer sentiment remained weak in Brazil in the third quarter due to low economic growth. As we discussed last quarter, the FIFA World Cup marked a once-in-a-lifetime marketing opportunity for the McDonald's brand in Latin America. However, during game days, we did experience a significant decline in traffic. The resulting increase of 3.7% in as-reported revenues in the third quarter was below our expectations. In organic terms, revenue growth was 3% as the Brazilian real appreciated modestly against the US dollar following several consecutive quarters of year-over-year declines.

Comparable sales declined 2.4% in the quarter. Growth in average check was offset by a decline in traffic, which in addition to the FIFA World Cup was impacted by a calendar shift in winter holidays, an ongoing soft consumption in the country.

Although we are not yet seeing growth in traffic, I am pleased to report that we did see a stabilization in traffic trends towards the end of the third quarter and at the start of the fourth quarter, which is evidence that our promotional activities are taking effect.

Despite the weak macroeconomic backdrop, I am pleased to report that McDonald's re-hit share increased versus the second quarter, which again shows that our marketing activities are taking hold. Key quarterly marketing activities included the re-run of Chicken McBites at the launch of McFlurry Talento Castanhas-do-Para and McFlurry Oreo in the dessert category. The Company's affordability platform performed as expected, and included the Crispy Tasty and Duplo Pampa in the quarter.

The net addition of 71 restaurants during the last 12 months period, of which more than half were freestanding units, contributed $24.4 million to revenues in constant currency during the quarter.

As you can see on slide 5, top line growth in NOLAD was also impacted by a weaker consumer environment and sharp drop in traffic around the FIFA World Cup. Reported revenues declined 7.8% year over year or 5.1% on an organic basis. Systemwide comparable sales were down 8.3%, due to declines in average check and traffic. The decrease in average check primarily reflected a shift in mix.

As part of our turnaround strategy in Mexico, we have been testing a new menu which enables consumers to personalize their dining experience and integrate more locally relevant flavors. We have been listening to our Mexican customers and we understand that the value, variety of choice and the ability to customize their meals. We believe that this new menu strategy will cater directly to these preferences leveraging the McMio cooking system in our Mexican restaurants to deliver a more relevant dining experience for them.

Once we have gathered sufficient information and have made the appropriate adjustment, we expect to rollout the concept to all of our Mexican restaurants.

Another initiative that is also gaining traction in Mexico and elsewhere in the region is our open doors program, or as we call it puertas abiertas. So far, we have guided over 250,000 guests to our Mexican kitchens so that they can see firsthand the high quality ingredients that we use and superior hygienic standards that we apply in our kitchens. We plan to expand this program which raises consumer perception in the quality and freshness of our ingredients.

Key quarterly marketing activities included the launch of Chicken Festival in Panama and the Big Mac Mania in Costa Rica as well as Happy Meal properties with great results. Finally, the net addition of eight restaurants in the last 12 months period contributed $4 million to revenues in constant currency.

Please turn to slide 6. SLAD achieved organic revenue growth of 19.5% versus the prior year period. However, taking into account the 48.4% year-over-year depreciation of the Argentine peso, reported revenues decreased by 12.2%. Comparable sales grew 18.5% in the quarter. This was driven by average check growth as the impact of the FIFA World Cup and the deterioration in the macroeconomic environment in Argentina brought about a slight decline in traffic.

Quarterly marketing activities include the return of Chicken McBites and the inclusion of the Triple Bacon with Cheese in the affordability platform. The dessert category performed well and included the launch of the McFlurry Tres Suenos and the McFlurry Milka Choco Swing. The net addition of eight restaurants in the last 12 months period contributed $6 million to revenues in constant currency.

Moving to slide 7, excluding Venezuela, the Caribbean division's revenue decreased by 2.9% both on an as reported and organic basis during the quarter. Comparable sales decreased 11.2% due primarily to negative traffic and the shift in mix in both Puerto Rico and Colombia.

Notable marketing activities in the division including the launch of Chicken McBites for the first time in Venezuela, the re-run of Chicken Bacon Onion, both beef and chicken, in Colombia and the McBacon platform, also beef and chicken, as part of the affordability platform in Puerto Rico among others. The net addition of six restaurants during the last 12 months period contributed $8 million to revenues in constant currency.

Overall, consolidated reported revenues excluding Venezuela decreased 2.9%, but were 6% higher on an organic basis year over year.

Please turn to slide 8. During the last 12 months, we extended our portfolio with the opening of 110 restaurants. As Woods mentioned, we continue to invest in freestanding restaurants which we regard as a long-term investment in our customers. Accordingly, just under half of our current portfolio is made up of freestanding restaurants, while more than 50% of our openings in 2014 will also be freestanding units.

At the end of September, our restaurant base reached 2,086 restaurants, and during the past 12 months we added 297 new dessert centers and 16 new McCafes, bringing the total to 2,425 and 344 respectively.

I will now hand you over to German for a discussion on our adjusted EBITDA and key balance sheet metrics.

Thanks, Sergio.

Please turn to slide 9. Our third quarter consolidated adjusted EBITDA declined 26.9%, but increased 11.7% on an organic basis versus the prior year quarter measured in constant currency. Excluding Venezuela, third quarter adjusted EBITDA was down 30.1% or 5.9% on organic terms. This decline was driven by higher food and paper and occupancy and other operating expenses, which more than offset lower G&A expenses as a percent of sales.

As Woods discussed in the opening remark, we continue to implement the efficiency improvements throughout the organization, and in the third quarter we achieved a 46 basis point year-over-year reduction in G&A as a percent of revenue. This come in top of the 43 basis point savings in the first half of the year.

The G&A leverage reflect the lower G&A rate and a headcount reduction at the end of 2013 and also during the second quarter of this year as well as the natural hedge for [basing] our corporate headquarters in Argentina.

Negative G&A and food and paper costs were not sufficient to offset higher occupancy and other operating expenses as a percent of sales. As a result, the adjusted EBITDA margins decreased 154 basis points to 7.3%, with market decline in [reflected] across all divisions. Excluding the Venezuela operations, the EBITDA margins decreased 89 basis points to 7.6%.

Turning to our divisional results, Brazil reported adjusted EBITDA decrease by 1.3%, and 4.8% on organic basis in the third quarter. As anticipated, increasing effort to protect market share and stimulate traffic via promotional activities resulted in deterioration in the adjusted EBITDA margin, which declined 61 basis points to 12.1%.

In the quarter, both G&A and payroll costs were lower as a percent of sales with related benefit from adjustment to variable compensation and little year-over-year comp. However, these factors were more than offset by higher food and paper costs linked to the shift in mix and occupancy and other operating expense as a percent of sales.

As we have previously disclosed, our food and paper costs in Brazil are 1% hedged against currency exposures in (inaudible) and we also always hedge 100% of our expected US dollar exposure to BRL for 2015.

Turning to NOLAD, adjusted EBITDA decreased by 19.5% year over year or 16.7% on organic basis. The adjusted EBITDA margin declined 97 basis points to 6.7% as the lower food and paper costs were more than offset by higher payroll cost and occupancy and other operating expenses as a percent of sales.

Adjusted EBITDA was down 27.4% in SLAD, but up 1.7% on organic basis. The adjusted EBITDA margin contracted 216 basis points to 10.3%, as the higher food and paper costs as a percentage of sales more than offset efficiencies in labor costs, G&A and occupancy and other operating expenses.

The increase in food and paper cost as a percent of sales was primarily due to the startup cost increases in excess of price adjustments in Argentina combined with a negative mix effect.

In the Caribbean division excluding Venezuela, adjusted EBITDA declined 26.3% as an on-reported basis and 26.9% as on an organic basis. Adjusted EBITDA margin dropped 103 basis points to 3.2% as the higher occupancy and other operating expenses as a percent of sales more than offset leverage in food and paper, payroll costs and G&A.

Our business in Venezuela continue to face a difficult and [dynamic] operating environment. However, it is important to mention that the division is also still generating cash in local currency terms and is not expected to require cash injections throughout the remaining of this year. We are able to obtain almost $3 million so far through the SICAD II mechanism, although the availability of US dollars in this mechanism declined over the course of the third quarter.

Turning to slide 10, non-operating results reflected a non-cash $7.7 million increase in FX exchange losses. FX losses for the quarter were mainly driven by the impact of the depreciation of the Brazilian real, which generated a loss on intercompany balance, partially offset by the gain related to the BRL-denominated long-term debt. An $8.8 million decrease in net interest expense also impacted non-operating results.

Net income was $240,000 compared to $19.6 million in the same period of 2013. The decline primarily reflects lower operating results and higher foreign exchange losses, which were partially offset by lower net interest and income tax expenses.

Earnings per share were almost zero in the quarter for 2014, compared to $0.09 in the previous corresponding period.

Slide 11 contains our debt indicators. Cash and cash equivalents were $94.8 million at September 30. Total financial debt was $886.5 million, while net debt was $791.7 million and the net debt to adjusted EBITDA ratio was 2.9 times.

As we've mentioned, the leverage ratio is expected to be going back in line with our target ratio of around 2.5 times by the end of 2015.

I will now hand the call back to Woods. Woods?

Thanks, German. Before I open up the call for questions, let me reiterate that we remain deeply committed to our markets. We have been in the region long enough to know that while cyclical our sector produces strong growth in times of robust economic activity. The steps that we are taking to streamline our organization now will not only improve our short-term results, but will also position us well for the next upturn in the cycle. And the investments we have made in platforms such as Made For You will allow us to leverage the global personalization initiatives being spearheaded by McDonald's.

Looking ahead to 2015, our focus is on defending traffic, containing those costs under our control, reducing leverage and strategically expanding our footprint. We have a strong marketing calendar in place that draws on tried and tested promotional activities and strong Happy Meal properties, with which we expect to drive top line growth in a slow economy.

We do not expect a better macro and operating climate next year, but the absence of one-off events such as the FIFA World Cup will enable planned marketing activities to achieve their full potential, while easier year-over-year comparisons should also benefit results.

In addition, the top line growth, we expect margin improvement in 2015 as we take steps to control labor and other non-product costs as well as to continue to reduce our G&A expenses in real terms.

We are in the final stages of our planning cycle. By early 2015, I expect to come back to you with a more detailed look of our major goals for the coming years. Thank you for attention. I would now like to open the call up to questions.

(Operator Instructions). In order to accommodate all questioners, please ask one question only. If you have a follow-up, please rejoin the queue. We will now pause momentarily to assemble our roster.

Bob Ford, Bank of America Merrill Lynch.

I was hoping if you could discuss or give your CapEx plans for 2015 as well as discuss any store closure or sub-franchising plans as well as their associated costs for next year please.

We are revising our operating guidance for from -- we revised our operating guidance from 90 to 84 this year and we are still doing our plans for next year. So we still don't have the numbers, we will get back to you early next year with that.

As far as store closings are concerned, we have over the years have been closing non-performing stores as they show up, and so that's part of our opening and closing process. There is nothing that here we foresee that as a major in that sense.

And -- okay, and then the last part of your question on sub-franchisees, we are looking at the sub-franchisee system. We have the ability to go from up to 50% of our stores as per our MSA. Today around 75% of our restaurants are Company-operated and the remaining 25% is franchised. This year, just so you know, about 30% of the total openings are in the hands of sub-franchisees. And for the next two years or so, we plan to continue to shift from a higher percentage of our unit growth to our existing or new sub-franchisee base as we focus our investments on upgrading our existing restaurant base as I mentioned before. So I think something it's important to say here is, this is a very complex process and we need to make sure that we mitigate the potential risk of the shift in our current mix. That's about it, yes.

Jeronimo De Guzman, Morgan Stanley.

I have a question on your margin outlook for next year. I think you mentioned that you expect to have some margin recovery in 2015, but just wanted to see how you reconcile that with an outlook for likely still lower same store sales growth and also a value focus which should hit the food and paper costs. So are you saying that the G&A savings will help offset -- the G&A and labor pressures will help offset these other pressures on your margins?

Let me say, we are working as we said earlier on reducing G&A in real terms. We want the technology to help us with labor costs. But to give you more color on this question, let me pass you to German.

Yes. Hi Jeronimo. Well, as Woods mentioned, we are still working our planning process for next year and beyond. So -- but it's clear for the next couple of years, the economic trends are expected to be soft in our region in general. So we are taking opportunities that we already discussed in the speech, labor cost efficiencies which means material time to implementation of new technologies to help us to align incentives as they accrue and obtain a lot of savings coming from these sites. Other non-trade purchasing, we discussed several times, this is a new area. Woods mentioned that we can obtain additional shift in savings, $1 million savings next year in this particular area.

G&A, the goal this year is try to be below inflation. So we think it will be 5% of the total inflation in each country. So we believe that the food and paper will be stable because we don't want to put pressure on the consumer in the tough economic environment. We plan to reduce the debt with excess cash, so to deleverage the Company and we plan to work with the CapEx application. And as Woods mentioned, we are going to recommend to the Board in December 4 meeting to cancel the dividend payment for the next year. So it's too early to say anything about the plan, we are trying to be more efficient. But we'll provide to you more details, I will be giving you up next year.

Martha Shelton, Itau BBA.

Quick question for you regarding some of the payroll benefits that you mentioned that we'll see by the end of 2016. Can you quantify the expected benefits from the new labor scheduling system? I don't know if you can give us a dollar amount or as a percentage of sales. I guess what I am coming at is, do you think this will be enough to offset the royalty step-up that commences in 2017?

Yes, hi Martha. Look, we've had some pilots in Brazil that has been very encouraging. We now have 11 stores in Brazil working on this new system. As I said, results are encouraging. I don't want to extrapolate this early stage to the rest of the Brazilian Company or even to the whole Arcos Dorados, but I would say that we can get perhaps 0.5 point or even better out of all this. But it's all speculation. The pilots are giving much better number by the way. But that is going to help us without a doubt.

And I think the important thing to say here is it's not just a question of taking people off their scheduled shifts and lowering the experience of the customers. What we are doing here is we are going -- becoming much more efficient in the allocation of our people per hour. So to do this without lowering quality standards and to do it effectively is quite a feat, so we are very happy with that.

Roy Yackulic, Bank of America Merrill Lynch.

Yes. I'm wondering if you can talk about free cash flow expectations next year and where we might expect leverage to peak before you start to turn it down to your target of 2.5?

Yes, let me pass you to German.

Yes, several things to comment on that. First of all, we usually have a healthy balance sheet and the business with strong long-term prospects. But you must remember, as of June 1st, we began to capture FX exchange rate in Venezuela and we brought from a lower churn rate to 50 and that create a significant impact in non-cash impact in our TTM EBITDA. Basically, this non-cash impact to the net debt to EBITDA ratio goes to 2.9 times as of [September 3].

In 2015, we expect to reduce the net debt to EBITDA ratio for the following reason. One, if the full year debt to EBITDA ratio would no longer affected by the non-cash impact relative to the translation of Venezuela to SICAD II. That is very important because the impact was significant this year. The EBITDA ratio should also benefit from stepped up as everybody mentioned, to take it to the underlying profitability of our business and efficiency of our business. And excess cash will be [focused] on debt reduction, focused more in short-term debt reduction and remember we are planning to not take dividend next year. And basically with that measures, we plan to reach the -- around 2.5 times the debt to EBITDA at the end of 2015.

John Ivankoe, JPMorgan.

Great, thank you. Just wondering if kind of your current economic outlook in Brazil, your competitive outlook in Brazil has maybe affected your thoughts of how many ultimate McDonald's that you think could be in the market. And quite frankly, I don't remember even what that target is. But considering what kind of the way that you'd be in the markets today and you understanding the trade areas better than any of us on the call, how many McDonald's units do you think that you could successfully have in taking economic growth and competition into consideration? And a follow-up as well.

Hi John, the potential for Brazil in the long-term it's still there and it's still very much, it's very present. So I think what we are going through right now is a cyclical thing in Brazil. You know we're having problems with stores, some restaurants that we opened recently, because all the tenants (inaudible) shopping centers. But those are things that are temporary, so I would say that our long-term view of Brazil has not changed at all.

The consumer environment remains weak today and the economists are predicting a deceleration in growth and that is in from 0.1 to 1% growth for next year. I think it's too early to tell what (inaudible) is going to do. In response to all of this challenging environment, we are focusing on protecting traffic and market share with value propositions. And we've also been focusing on variables within our control.

We've locked in some of the key inputs. We've implemented hedges, the environments to stabilize some dollars (inaudible) costs like toys and some inputs, french fries at 238 and we've already started hedging for 2015. We have a very strong marketing calendar for next year, plus as we've mentioned before, some easy comps to control properly this year.

But I think the important thing to mention here is that Brazil's long term fundamentals are backed by very, very strong long term demographic trends, burgeoning middle class we've always talked about and the preference for convenience.

Jeronimo De Guzman, Morgan Stanley.

Hi. Just one clarification and a follow-up question. I think you mentioned you're hedged at 238, is that for 2015 in Brazil for FX? And then the follow-up I had was on Venezuela. I noticed that the EBITA margin was negative this quarter. The EBITDA was slightly negative. And just wanted to see what drove that because I thought the underlying EBITDA would still be positive, if you kind of once you remove all the impacts that you had in the prior quarters.

The hedge I mentioned of 238 was for 2014. And to answer the question on Venezuela, I'll pass you to German.

Yes, you're right. The 238 is the hedge in 2014. And Venezuela, improvement in margin in the last quarter was basically created because some reversion in account between the Venezuela operating business and the distribution center. It's normally that you try to keep up the cost increases, trying to giving advantage specifically in some accounts, every several time you review the account and if there are any difference in favor or against the Company, we adjust the account. Obviously, with 80 plus inflation and basic evaluation in Venezuela, it's very difficult to [consolidate] account. So basically we adjust the accounts in Venezuela. But it's more related to that in term of margin, but the economic or improvement in any macro environment there.

Martha Shelton, Itau BBA.

Thanks for the follow-up. So really quickly on Mexico, can you tell me if you're losing market share to Burger King in Mexico or/and the informal sector? And then also a follow-up is, I'm not sure if I heard you correctly regarding non-product input cost savings, was that $15 million or $50 million for 2015? And if you could give some examples of these savings. Thanks.

Yes, let me pass you to Sergio, so he can give you some color on that.

So I'm going to take the first part of the question about competition in Mexico. Well, given the strong competition that we face in the country, both from informal and formal players, our value offering of new products and categories, they combined have been a key part of our strategy to remain competitive in the market. Just for you to have an example, in this quarter, we continued with the Habanero Ranch on the hamburger category, McFlurry Milky Way on the dessert, good proposition Happy Meals of risottos.

As a consequence of that, we saw guest counts per restaurants per month to increase actually in the last couple of quarters. And that obviously led us to believe that when compared to branded competitors, we're gaining share, those out of discussion and quite clear. You can put this also when you compare to the performance of our comp sales with that of our formal public branded competitors in the market.

Regarding the informal sector, where we all know that in Latin America this is a situation where it is pretty common I'd say, in most of the region, when the economy sort of stabilize or trend to end in a weak cycle, obviously people tend to increase the visits to informal venues because of the obviously as a consequence of them not paying taxes they can have lower prices. But that's a -- we believe a temporary situation and as long as the economies recoup, they are bound to recoup, then we will gain those customers back, okay. Can you take the second part on the --

Yes, and I think I mentioned $15 million not $50 million. I wish it were $50 million, but it's $15 million.

John Ivankoe, JPMorgan.

Great, thanks for the follow-up. Regarding growth in franchisees or even re-franchising, I mean is it still the case and I just want to make sure that I understand it that the franchisee royalty gets paid up to MCD and where you make the money is basically on the rental income from the land and the building. In other words, that franchisees grow well at least for a while that growth still happened on your CapEx or is there perhaps another alternative to a more capital like model where you can benefit from that? Thanks.

Yes, John. Look as you said, the royalty payments flow straight up to the McDonald's Corporation. And as you also said, we make income on the rental income from the sub-franchisees.

So now what we are doing is we're looking at the maps of all the countries, but for us you will see how we can restructure and refit the franchisees versus the -- our own Company-owned stores to get maximum benefit not only from an economic point of view, not only from a cost savings point of view or capital allocation point of view, but also from a long-term operating view.

So we -- it's work in progress and there are a lot of -- it's a complicated process. But yes, we are looking at it and it's something that holds potential.

[Renata Komanova].

Can you give more clarity on -- you mentioned in the beginning of the call that you want to increase the freestanding stores and I thought that they were lower return and the same goes to increasing sub-franchisees. So if you can give more clarity on that.

Yes, how are you? The -- we're here for the long term. This is a long term business and we can -- we're always talking about having a balanced view to our growth. So we have -- a large part of our stores are freestanding, they are more expensive. The return might be a bit slower, but over the time we will gain truly what McDonald's is all about. We're giving them a drive thru, we're giving them -- the ability to have 24-hour service, I mean 24-hour service to people. You would have Playland, you also have birthday parties. So this is what McDonald's really is all about.

Now, we also want to go to where people go; food courts and mall stores, so we continue with that. But I think the key word here [Renata] is that we are looking at balanced growth of our real estate portfolio. and we're very comfortable with what we're doing. It's something has worked for McDonald's in the past in all over the world, so we're not going to reinvent anything in this sense.

And as far as the sub-franchisees, we mentioned also they're going to be doing the same kind of things because it's -- it depends on what you want to do and how best you want to exploit. The opportunity is in a new city or an existing city. So I think that their strategy and our strategy with them will be very similar to a strategy we have with our own stores.

Robert Schweich, Burnham Securities.

I have two questions. My recollection of the sub-franchisee was often those would be located in the markets that are more distant and where you don't have the mechanism of control. And I'm wondering in your thinking in this area, are you changing your point of view on that aspect of it because it's not clear and perhaps you might -- do you have a number that John Ivankoe asked for as your ultimate goal in Brazil, about the long-term target? Now that's all one question.

The second question that I have is a macroeconomic question. I think that -- I think we would all agree that the significant part of Arcos Durados issues these days are the difficulties in not only foreign exchange, but the cyclical downturn that's occurred particularly in Brazil. And I am wondering if you would comment your views on the effect and the outcome of the election in Brazil and the impact that this might have going forward?

The sub-franchisee part, as I mentioned, this is the -- we are looking at this for the -- tactically for the next two years. We are still working out. It's not necessary a long-term thing. But yes, you are right. We are going to look at areas where they are more distant from the main centers and we also might do some re-engineering of cities. I mean there are some cities where we have our own stores, our own restaurants plus franchisee stores. And clearly, there if -- we might have them only as Arcos Dorados stores or we'll have them only as a franchisee store. So there is the re-engineering part and also there is a growth part. But you are right.

As far as foreign exchange and the business cycles being a challenge for us, yes. And in Brazil, I don't want to comment on politics. But I think Brazil is a long-term story. We hear things that Brazil and the present government is taking steps to become more business friendly, and we look at that very happily. And -- but we are expecting the short term to be challenging, no matter what the outcome of what Dilma does as far as her cabinet is concerned. They have been experiencing a slow in economic activity for a while, and we believe that 2015 would be just another one of these challenging years. I mean every month, we've had a recollection -- a collection of the GDP growth for the 2014. Having said all of that, we are very confident that the long-term of Brazil is huge and it has a huge potential for our business.

And the story of Latin America, it's a gold economy. And so we are trying to position our Company as best we can, so we can go through the different cycles. And we are working hard at that. It's a lot of work and we are there.

Mostafa Maleki, Jadara Capital.

Two questions. First one is what's the expected uplift in average unit volumes between a freestanding restaurant and a regular one? And what percent of the mix, of the restaurant mix do you expect freestanding ones to be in say five years?

Then the second question is regarding your debt, and in particular where you stand vis-a-vis any of your debt covenants?

Yes. Let me pass the first part of the question to Sergio on the source of restaurants and then I will pass to German to answer you on the debt covenants.

To complete what you mentioned about the freestandings and the difference between these type of restaurants and the other (inaudible), aside from the difference in investment, the reality is that freestandings, they have more capacity to grow over time. There we only depend on ourselves and our capacity to attract customers where we provide the full experience with Playlands, with McCafes, also with drive thru, which is a market that we dominate in Latin America. So they typically have a higher potential to grow over the years.

If you compare the performance of a drive-thru restaurant, a freestanding with a shopping mall, in the shopping mall we always depend on the ability of the mall to attract traffic, okay. We are not self-sufficient there and we are at the expense of increasing competition. For instance, a new shopping mall opened in some city, which is something that really happened with us, particularly in Brazil in the last couple of years.

So, again in spite of being more intensive in terms of capital requirement, we prefer to sustain a significant share of freestanding units because we believe that that is the way to differentiate our brand from the others.

Okay. In term of covenants, for the most important the long-term debt don't have any covenants. So we are free of covenants in the BRL debt and the 2023 bound debt. We have some covenant with a short-term credit line with Bank of America that was waived last quarter. So we don't see any problem with that. And if needed, the Bank of America could again write the covenant down without penalties. At the same time, we have some ratio that we need to cover with McDonald's Corporation particularly fixed charge coverage ratio and leverage ratio as expenditure or the main reason of this covenants relation was the one-time charge of manufacturing in Venezuela, McDonald's property rate, the ratio for the record 2014 knowing that in 2015 this one-time non-cash impact in our P&L will disappear and then the waiver would be no longer necessary. So, in summary, we don't have any concern in term of covenants in our debt.

Mark Jason, Invesco.

I also was asking about the covenants, but besides that, I'd like to hear more specific comment on free cash flow and how you intend to generate free cash flow going forward. I know you spoke about your stores being freestanding, which building those stores are obviously we know that you've some of the best goes towards the CapEx, higher CapEx, lower free cash flow. When do you anticipate or how are you anticipating to improve your free cash flow situation?

All right. Let me pass you to German.

Okay. Again there are a lot of ways to see that in the short-term next year, (inaudible) you'll see several times we are going to eliminate the dividend for 2015, that's approximately $50 million. We have a plan for our cost initiative -- cost reduction initiatives, technology, G&A. So we plan to increase our EBITDA or cash flow coming from operations.

We plan to reduce the capital allocation for growth, trying to balance the free cash flow we need to reduce our short-term debt. That is basically because what we have. We don't want to increase our debt. In fact we clearly want to reduce our debt and with the mix in percentage (inaudible) fee and including technology general reductions, we plan to create cash flow coming from operations, and with that eventually the future of free cash flow.

To stay within the hour, this concludes our question-and-answer session. I would like to turn the conference back over to Woods Staton for any closing remarks.

Thank you. Well, thank you all of you for your questions and your attention today. We look forward to speaking with you the next quarter. And in the interim, the team remains available to meet with all of you and answer any questions you might have. Thank you and have a very good day today.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.