Arcos Dorados Holdings Inc (ARCO) 2015 Q1 法說會逐字稿

Good morning, and welcome to the Arcos Dorados first quarter 2015 earnings call. A slide presentation accompanying today's Webcast, which will also be available in the investor sections of the Company's Website, www.arcosdorados.com/ir. And as a reminder, all participants will be in listen-only mode. There will be an opportunity for you 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 conference over to Daniel Schleiniger, Director of Investor Relations. Please go ahead, sir.

Thank you. Good morning, everyone, and thank you for joining us today. With me on today's call are Woods Staton, our Chairman and Chief Executive Officer; Sergio Alonso, our Chief Operating Officer; and Jose Carlos Alcantara, our Chief Financial Officer.

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 press release filed with the SEC on Form 6-K.

I will now like to turn the call over to Chairman Woods Staton.

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

We entered 2015 well aware of the challenges we face in delivering improved financial results amid continued weak economic and consumption growth in the region. It is for this reason that we developed our three-year strategic plan to generate shareholder value through enhanced profitability, better cash flow generation, and a disciplined approach to capital allocation.

While we don't expect the operating environment to change materially in the near future, we are confident that this long-term strategic roadmap will result in a sustainable improvement in our financial position as we continue to focus on the customer experience, streamline our business, capture operating efficiencies, and extract value from certain assets.

Meanwhile, every day, we serve more than 4.3 million guests across Latin America. McDonald's remains a preferred QSR restaurant and is a QSR brand with the highest top of mind in all of our markets. We are committed to ensuring our guests continue to receive the very highest level of service, which is a hallmark of the McDonald's system worldwide.

Our commitment to customers extends beyond the front of the restaurant. Our puertas abiertas, or open doors, program invites families to go into our kitchens and learn where their food comes from and discover how their favorite meals are prepared.

Over 0.5 million guests participated in Mexico alone in the last 12 months. And we recently launched the program throughout the Arcos Dorados system. We expect well over 1 million customers to visit our kitchens in 2015.

Our customer focus, together with our three-year plan, will drive long-term brand loyalty and reinforce our leadership in the QSR segment. Having first presented our three-year plan two months ago, we have laid the foundation for each of the components, which I will update you on momentarily.

But, first, let me provide you with an overview of our quarterly results, which continue to be impacted by a challenging consumer environment, inflationary pressures, and the depreciation of key currencies in our region.

Organic revenues grew 10.3% year over year on a 9.4% increase in system-wide comparable sales from the first three months of the year. Each of our divisions delivered adjusted EBITDA margin expansion in the quarter, driven primarily by efficiencies achieved at the restaurant level. However, our consolidated adjusted EBITDA margin was flat versus last year due in large part to some currency and timing-related expenses impacting the comparison with last year's corporate G&A.

I would now like to discuss our first quarter results in the context of our long-term strategic plan, which includes concrete steps and initiatives to become leaner and more efficient. A key component is using technology to improve sales forecasts and labor scheduling in our restaurants. We expect to achieve at least 200 basis points of margin improvement at the store level over the next three years without impacting our excellent service levels.

As we mentioned last year -- last quarter, we began rolling out a new forecasting and scheduling technology in Brazil with significant potential for medium-term margin expansion. We expect it to be fully implemented in Brazil by year end and in Argentina by early 2016.

Once the rollout is complete in our two largest countries, we will also implement the system in our other countries over the next three years. Encouragingly, we have already seen significant productivity, employee, and most importantly, customer satisfaction improvements in the restaurants using the technology.

Another element of our strategic plan is to deliver further improvements in G&A. Last year, we achieved a 43 basis points reduction in G&A as a percentage of revenue. And we expect to reduce G&A expenses by another 10% on an absolute US dollar basis over the next three years.

This quarter, we made progress on this goal, reporting an absolute reduction in G&A year over year. Our strategy goes beyond improvements at the operating level. We are committed to enhancing shareholder value by monetizing some of our real estate assets.

The strategy will capitalize on depreciation of longstanding assets that are either noncore or where their value far exceeds the asset's operating potential. In doing so, we expect to raise at least $200 million over the next three years, which will be used to reduce debt and for other purposes without a material negative impact on EBITDA.

Please keep in mind that this is a three-year target. And we expect both the timing and the size of the cash flows to be uneven.

Our strategy also outlined the potential for refranchising existing restaurants. By increasing the mix of restaurants operating by some franchisees, we plan to enhance margins and raise at least $50 million over the coming three years.

We have identified the restaurants that we believe provide the greatest refranchising opportunities. Importantly, we are approaching this process in a thorough and thoughtful manner with our three-year timeframe in mind.

We remain committed to being the most accessible brand to consumers and will focus on bringing more customers to our existing base while opening new restaurants to serve future demand.

We are confident that the steps we are taking to improve our Company's performance and financial position will result in a significant improvement in shareholder value and position us for the cyclical upturns in the region's economy.

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

Thank you, Woods, and hello, everyone.

On a consolidated basis, organic revenues, excluding Venezuela, increased 6.8% in the first quarter. As reported, revenues declined by 7.7%, primarily due to the depreciation of the Brazilian and Argentinian currencies. System-wide comparable sales rose 3.8% as average check growth more than offset a decline in traffic.

Turning to slide 3, Brazil's first quarter revenues were impacted by the significant depreciation of the [real], which more than offset flat comparable sales and the contribution of new restaurant openings.

Reported revenues decreased by 14.6%, largely due to the 22% year-over-year depreciation of the real. In organic terms, revenues grew by 3% versus the prior-year quarter. System-wide comparable sales were level with the prior-year period, as soft consumption led to lower traffic levels and offset average check growth.

First quarter traffic was also impacted by a tough year-over-year comparison as the marketing calendar was adjusted, given the World Cup schedule and the Monopoly campaign launched in March last year, while in 2015, it launched at the end of April.

The net addition of 51 restaurants during the last 12-month period, of which over 60% were freestanding units, contributed $23.5 million to revenues on a constant currency basis during the quarter.

As Woods mentioned in his opening remarks, we are in the process of rolling out a new forecasting and scheduling system in our Brazilian restaurants. I am pleased with the pace of the rollout, which is expected to be completed by the end of this year. And I'm encouraged by the positive results we're seeing in the restaurant where the system has already been implemented.

This system will allow our employees to be better prepared to serve our customers throughout all the parts and thus ensure we continue to efficiently deliver the best customer experience.

As the rollout expands and our managers become more proficient with the system, I am confident that we will be able to deliver restaurant margin expansion over the next three years.

On slide 4, you will see that NOLAD revenues decreased 6.6% year over year, but were stable on an organic basis. System-wide comparable sales declined 2.4% due to a decline in traffic, which offset growth in average check. The net addition of three restaurants during the last 12-month period contributed $2.2 million to revenues in constant currency.

The competitive environment remains challenging in Mexico. However, we're taking the right steps to generate long-term positive trends in the division.

Last quarter, we mentioned we have been testing a new menu in Mexico called McMio, or McMine in English, which enables customers to create their own personalized meal combinations. McMio has been rolled out in 36 restaurants. And we expect to introduce the new menu platform in at least another 100 restaurants by the end of second quarter, with a goal of reaching more than 250 restaurants by the year end.

Customer feedback has been very promising, with consistent increases in average check.

Please turn to slide 5. SLAD revenues increased 7.4% in the first quarter. Excluding the 14% depreciation of the Argentine peso, revenues grew 21.7% in organic terms. System-wide comparable sales rose 22.1% with consistent improvement in our family business combined with inflation-driven average check growth. The net addition of three restaurants during the last 12-months period contributed $1.8 million to revenues in constant currency.

Now, turning to Caribbean division results on slide 6, revenues, excluding Venezuela, decreased by 10.8% versus the prior-year quarter, mainly due to the depreciation of the Colombian peso and the euro, which is utilized in several of the Caribbean markets.

Comparable sales were down 4.5%, primarily as a result of lower traffic due to a soft economic environment in Puerto Rico. On a positive note, we're seeing solid traction in Colombia, a large marketing division that we believe has strong long-term potential.

The Company continues to focus on long-term growth, offering relevant locations to its customers. As part of that strategy, we closed 10 underperforming restaurants against three openings across the entire division. The combined contribution to constant currency revenues of the restaurants that were closed and opened was $1.8 million over the last 12-months period.

Please turn to slide 7. We completed 77 new restaurant openings for the 12-month period ended on March 31st, resulting in a total of 2,119 restaurants. And also, in the period, we added 255 Dessert Centers and eight McCafes, bringing the total to 2,526 and 335, respectively.

We believe that we have the right marketing plan in place to navigate this period and continue to strengthen our brand position as the leading QSR company in the region. We're focusing on marketing actions on increasing consumer awareness of our quality offerings through programs such as puertas abiertas.

We're also continuing to put family first and catering to local preferences with offerings such as the new chicken meals in the Andean markets. In doing so, we have been able to maintain market share in our largest markets at a time where consumers are being more selective with their discretionary spending.

And we will continue providing our guests with a relevant McDonald's experience while we work on improving our performance behind the counter to generate value for our shareholders in the long run.

I will now hand you over to Jose Carlos for a discussion of our adjusted EBITDA and key balance sheet metrics.

Thanks, Sergio.

As Woods mentioned, we are focused on streamlining our business and expanding margins through targeted cost reductions. Areas where we expect to capture efficiencies include labor costs, nonproduct purchases, and G&A expenses.

A key source of labor efficiencies will be the implementation of the new forecasting and scheduling system. This investment will also help us to improve inventory management and serve as a platform for back-of-the-house improvement and crucial consumer-facing technologies in the future.

Please turn to slide 8. First quarter consolidated adjusted EBITDA decreased 16.8%, but rose 35.5% on an organic basis year over year. Excluding Venezuela, adjusted EBITDA declined 20.8% and was down 5.2% in organic terms.

For the quarter, labor costs as a percentage of sales were flat year over year, while G&A as a percentage of revenues rose due to some currency and timing-related factors. Reported total G&A was 2.5% below the prior-year's level.

Additionally, occupancy and other operating expenses as a percentage of sales increased and, together with G&A, more than offset a margin improvement in food and paper, leading to a 10 basis point contraction in the adjusted EBITDA margin to 5.4%.

In the quarter, there were two key factors that contributed to a negative variance in our corporate G&A: one, $3.1 million related to the impact of high inflation on our Argentina-based corporate expenses, which was only partially offset by modest devaluation of the Argentinian peso; and two, $3.5 million related to a downward adjustment to the variable compensation accrual in the first quarter of 2014, which arose from a 2013 bonus payment that was lower than the actual accrual for that year.

Excluding these two factors, corporate G&A in the first quarter of 2015 would have declined by more than 12% versus prior-year period.

Turning to our divisional results on slide 9, Brazil's adjusted EBITDA contracted 11.7% but increased 5.4%, excluding the impact of currency depreciation. The adjusted EBITDA margin increased 36 basis points to 11%, due to food and paper efficiencies, helped by currency hedges, which more than offset higher occupancy and other operating expenses as a percentage of sales.

Both payroll costs and G&A expenses were unchanged as a percentage of revenue versus the year-ago period.

NOLAD's adjusted EBITDA increased by 10.1% in the first quarter, with similar growth achieved on an organic basis. The adjusted EBITDA margin expanded more than 100 basis points to 7.1%, thanks to lower G&A as a percentage of revenues combined with leveraged payroll cost and occupancy and other operating expenses. These factors more than offset higher food and paper costs as a percentage of sales.

In SLAD, adjusted EBITDA increased 12.6% on an as-reported basis and 28.9% in organic terms. The adjusted EBITDA margin expanded 51 basis points to 11.3%, driven by efficiencies in food and paper, payroll costs, and occupancy and other operating expenses.

Before I discuss the Caribbean division's results with you, I would like to update you on our Venezuelan operations. In February 2015, the Venezuelan government announced the unification of SICAD and SICAD 2 into a single exchange mechanism called SICAD and established a new open-market foreign exchange system called SIMADI.

As of March 31st, 2015, three foreign exchange rates were legally available: one, the official exchange rate settled at VEF6.3; two, the new SICAD exchange rate settled at VEF12; and three, the SIMADI exchange rate settled at above VEF190.

Considering that the SICAD 2 exchange rate no longer exists, the lack of operations at the new SICAD exchange rate and our relative ability to access US dollars through the SIMADI mechanism, we began remeasuring the results of our Venezuelan business at the SIMADI exchange rate beginning on March 1st, 2015.

As a result of the change to the SIMADI exchange rate, we booked a write-down of certain inventories, totaling $4.4 million, and impairment of long-lived assets amounting to $7.8 million and recognized a foreign currency exchange loss on our net monetary assets of $8 million.

Excluding Venezuela, the Caribbean division's as-reported adjusted EBITDA contracted 7.9%, primarily due to the depreciation of the Colombian peso and soft consumer environment in Puerto Rico, while organic adjusted EBITDA rose 8.6%.

The adjusted EBITDA margin increased by almost 10 basis points to 3%, as efficiencies in payroll, G&A, and occupancy and other operating expenses more than compensated for the higher food and paper costs.

Turning to slide 10, first quarter consolidated nonoperating results reflected a $3.3 million increase in foreign currency exchange losses. FX losses for the quarter were mainly driven by the change in the exchange rate used to remeasure the Venezuelan business and the depreciation of the Brazilian real. The latter generated a loss on intercompany balances, which was partially offset by a gain related to the BRL-denominated long-term debt.

Net interest expense was broadly stable year over year at $16.3 million.

The first quarter net loss reflects lower operating results, which included the impairment charge on Venezuelan fixed assets and higher foreign exchange losses.

Slide 11 contains our debt indicators. Beginning on June 30th of last year, we were not in compliance with the debt ratios established by the terms of [BMFA]. McDonald's has extended the waiver for our compliance with certain leverage ratios through the first quarter of 2015. We continue to monitor the situation, but do not foresee a material adverse effect on our business or financial results.

As of March 31st, our net debt-to-adjusted EBITDA ratio was 2.8 times. While interyear seasonality in our cash flows will likely lead to short-term variations in this metric, our plan over the next one to two years is to bring the year-end ratio back to our target of 2 times to 2.5 times.

This process will be facilitated by improved operating cash flows and reduced capital expenditures for new restaurant openings. In addition, cash raised from the redevelopment of some real estate assets and refranchising of existing restaurants will contribute to debt reduction.

I will now hand the call back to Woods.

Thanks, Jose Carlos.

As we've described, we're making the necessarily tactical adjustments to navigate through the current environment and deliver value for the benefit of our customers, our system, and our shareholders over the long term.

We are staying at the forefront of what is important to our customers by delivering the best food in the most inviting environment. We remain connected to our guests to interactions in the kitchen via our puertas abiertas program and through social media, with novel campaigns, such as the one we did utilizing Twitter and our partner the Coca-Cola Company.

Programs to enhance our food quality and the customer experience coupled with our continued scrutinization of G&A, optimize our asset base, and capture operating efficiencies are laying the foundation for sustainable and profitable growth.

I also want to share with you something that makes me very proud. For the second year in a row, we are among the top five best companies to work for in Latin America according to the Great Place to Work Institute. To be in the top five is a huge achievement for a company such as ours.

While we expect the short-term operating environment in our region to remain challenging, we have a resilient business model in place, significant competitive advantages, and experience in every type of operating environment. As we work to become leaner and more efficient, we will maintain our excellent customer experience levels to ensure sustainable growth in our business and shareholder value over the long term.

Thank you for attention. I would now like to open the call up to questions.

(Operator Instructions). Jeronimo De Guzman, Morgan Stanley.

Hi, good morning. I wanted to start with a question on your corporate expenses because, when I look at the results from corporate, they're up in about 65% in Argentine pesos, 40% if I take out the impact from the variable compensation that you mentioned. So, it seems like they continued to grow above the local inflation as they did in -- also in 2014.

So, just wanted to understand what is driving this pressure, and do you see any opportunities to reduce that going forward?

Hi, Jeronimo. Thanks for your question. Let me pass it to Jose Carlos.

Yes, Jeronimo. As I mentioned in our script right now, we had two basically one-offs or impact in the G&A in the quarter, inflation devaluation difference in Argentina, which you alluded to, which accounted for approximately $3.1 million, and the adjustment in the accrual for variable compensation in the first quarter of 2014, which related to 2013.

Additionally, what we didn't include here in the explanation in the script, there's two other factors that played out in the quarter in corporate G&A. One, we had some severance cost in the quarter related to some executives that exited. And we also carried two CFOs for the quarter. So, that's an additional variance that we don't expect going forward.

And -- but, if you exclude the two items that I first alluded to, absolute -- in absolute G&A would have decreased 12%, so total G&A.

Okay. But, I guess, just to clarify, I understand the variable compensation is something that's a one-off, but the inflation is something that will recur, right? So, if you're up about -- in pesos, you're up this higher level, 40%, are you comfortable with that, or do you think there's room to further control these G&A expenses, given the weaker top line trends?

No, I think there's room to further control. We expect that the Argentine peso will devalue at some point from now until the end of the year. And that's when the devaluation will catch up to that inflation. So, again, it's just a timing situation. I think the Argentinian peso has been held because of political reasons at this point.

Okay. Thanks. And then just a question on Brazil. Wanted to know if -- how you're seeing trends, if you're seeing any improvement in the trend now that the comparison base from the Monopoly is no longer there, and just in general, what your outlook is for same-store sales in Brazil, whether you think that the traffic trends can improve, or what can you do to get the traffic trends to improve?

Yes, let me pass you to Sergio for that answer.

Yes, thank you, Woods. And morning, Jeronimo. Well, traffic in Brazil continues to be impacted by I would say a soft consumer environment and a shift also to the informal sector. As a consequence of this softer consumer environment, people obviously are changing to lower and less formal types of restaurants in the market.

However, if you compare our performance quarter -- Q1 against Q1 last year, I have to highlight that, last year, we ran Monopoly campaign, which was a very strong campaign, in March, while this year, we started in late April. So, we have that shift, a timing shift I would say, that plays against 2015.

Overall, having said all that, considering that we foresee an overall challenging consumption environment, we are focusing on protecting traffic, obviously, and market share, enhancing our value proposition.

Okay. So do you see -- ?

-- [Amod Galton], JPMorgan.

Hi, good morning. Thank you. The first question was just around -- there's been some news about malls kind of -- mall traffic, just because of oversupply in Brazil. And I was just wondering if maybe you could comment about the performance of your units in malls relative to freestanding units.

Yes, good morning. Well, malls are not performing as we would like them to perform. And I think that's a little bit of a measure of what's going on with the economy in general. And as you can imagine, we depend on mall traffic to do our sales.

So, then also, there's another additional factor which is that new malls that have been opening have had some tenant mix issues. And obviously, a mall that's not fully versed with tenants is a problem. So, they are not performing as well as our freestanding units.

Okay. And then the follow up was just around where the COGS hedging is for 2015 and in terms of what rate that the commodities are locked in, in Brazil, and then whether or not you've started to lock in a particular rate for 2016.

Yes, let me pass you to Jose Carlos for that.

Yes, hi, Amod. Yes, so, as I mentioned, we're fully hedged in Brazil for our food and paper exposure, which is basically toys that we import from China and potatoes from Argentina.

Our hedge for the full year is around 261. We're also partially hedged in other countries. We're partially hedged in Colombia and partially hedged in Chile for the year.

As related to your -- as your 2016 question, I think it's a little bit too early to start looking into that. But, we'll obviously consider that as we start looking into our plans for 2016.

Everett Weinberger, UBS.

Thank you. And good morning. Two questions. Number one, given the enormous challenges that the Venezuelan operation has presented Arcos in recent years and given it's not expected to improve, given the horrendous political and economic environment there, is there any possibility that you would divest yourself of the Venezuelan business? Have you pursued a divestment and found no buyers, or is this something you would never consider selling? At what point do you admit this is not a great investment and take action to stem the bleeding?

The second question, are you seeing any evidence that McDonald's in Latin America is suffering from the migration to fast casual that is impacting McDonald's in the US, or is this a totally different environment than the US, and there really is no fast casual category yet eating into McDonald's share there? Thank you.

Yes, good morning, Everett. How are you?

Yes, I'm very well. Thank you.

Regarding your first -- great, and good questions. In the case of Venezuela, as you're aware, we have a master franchise agreement with McDonald's Corporation for all of the territories. And we're responsible for all of the territories and countries we operate in. So, we cannot and would not pick and choose what is good and what is bad. And I think, eventually, Venezuela will turn around.

As you probably know, in Venezuela, we have -- we're self-sustaining. We're not putting any more money into the country. We operate with what we have. So, it's a challenge from the point of view of operations. But, I will tell you that one of the strongest brands -- the McDonald's is strongest in Venezuelan vis-a-vis other countries. So, we're very proud of our Venezuelan operation, of our Venezuelan people. And we will continue there, operating amongst the difficulties as long as we can.

In regards to your second question regarding fast casual, fast casual grows all over the world. But, I would say to you that, if you look at our markets, our biggest market potential is with informal eating out categories and bring -- as we have a burgeoning middle class, that middle class comes to us. And we're -- McDonald's has the highest top of mind of any QSR. So, yes, they are growing. But, I would not say that, at this point, they are the challenge they would be in a more developed country, like the US or some European countries.

Robert Schweich, Burnham Securities.

Hi, Bob.

Hi. Sorry. The headphones didn't seem to work well. Thank you. I was also interested in Venezuela, but you've answered the question. And I accept your answer. It is for investors discouraging to have it excluded when, really, it is part of the Company. And it is a confusing situation. And I'd like to see you try and address that aspect as best you can in your results in the future. It's not a question. It's a comment related to the earlier discussion of Venezuela.

The second question, second area, that I'm interested in is, how does the change in top management and the new plans in Chicago or Oak Brook affect you?

Hi, Bob. Good to hear you. Good questions. And we report both with and without Venezuela. So, you have access to the Venezuela numbers. But, we'll see if we can make it more easy to look at.

And as far as the top management changes in McDonald's Corporation, obviously, they affect us quite a bit. We're the largest franchisee in the world. We're very supportive of the changes that McDonald's has announced regarding its future strategy. We know the new management Steve Easterbrook and like him very much. And we look forward to working with him.

And on a personal level, I think that the changes that they're pursuing will have a positive impact on the McDonald's system moving forward. And that's good for us. The world today is a smaller world, given the social media. And what happens in other parts of the world impacts us, whether we like it or not.

So, I think that we're in good hands. We're very confident that the brand is in good hands and moving forward.

Thank you.

Thank you, Bob.

(Operator Instructions). [Veronica Armas], [Lorraine Asset Management].

Hi. Thank you for taking my question. I wanted to ask you a little bit more about the covenant breach under the master franchise agreement. Just wanted to know if you think that this three-month additional waiver is enough to reverse the situation, if you think you will be requesting more waivers, and basically what are the consequences of this? Thank you.

Yes. Let me pass you to Jose Carlos, who can answer you more precisely.

Hi, Veronica. No, as you alluded to, yes, we obtained from McDonald's a waiver through March 31st, 2015. We're monitoring the situation closely. This is a very dynamic environment at this point. And we expect that continued conversations with McDonald's will happen. And they'll be supportive if we need to obtain additional waivers in the quarters to come. But, we don't expect that this will impact our ability to operate the business or our financial strength.

Okay. But, maybe you could give us a sense or where these covenants at the levels they are. Is it possible, or -- ?

-- Yes, we can -- that's something that we can go into detail. We can follow up later on, Veronica, if you want. And you can get some detail on the covenants. But, again -- .

-- Okay. Sure. That's okay. No problem. Thank you.

Okay.

At this time, we will turn the conference back over to Mr. Woods Staton. Please go ahead.

Thank you, all, for joining us today. And thank you for your questions and attention. We look forward to speaking with you the next quarter and encourage you to reach out to the team with any questions you may have in the interim. Thank you, and have a very good day.

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