Arcos Dorados Holdings Inc (ARCO) 2016 Q3 法說會逐字稿

Good morning and welcome to the Arcos Dorados' third quarter 2016 earnings call. A slide presentation will accompany today's webcast which will also be available in the investors' section of the Company's website, www.arcosdorados.com\ir. (Operator Instructions). Today's conference call is being recorded.

At this time, I'd like to turn the conference call over to Daniel Schleiniger, Senior Director of Corporate Communications and Investor Relations. Sir, please go ahead.

Thank you. Good morning, everyone, and thank you for joining us again today. With me on today's call are Sergio Alonso, our Chief Executive Officer; Marcelo Rabach, 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 statement 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 and unaudited financial statements filed today with the SEC on Form 6-K.

I would now like to turn the call over to our CEO, Sergio Alonso.

Thank you, Dan. Hello, everyone, and thank you for joining us today. Since communicating our three-year strategic plan in March of last year, we have focused on the basic drivers that we can most influence. Our results demonstrate the progress that we are making against our plan.

Within a challenging operating environment, we are delivering solid sales performance, capturing efficiencies in our restaurants, and maintaining G&A discipline. We have also advanced in our asset monetization program, which has allowed us to significantly reduce our leverage levels.

Turning to the third quarter, comparable sales grew 15.6%, and constant currency revenues increased 15.3% year over year; importantly, as reported revenues grew 2.9% in the quarter. We also achieved 140 basis points of consolidated EBITDA margin expansion versus the prior year quarter. The result was supported by three of our four divisions and reflects the operating leverage we have built into the business so far. Adjusted EBITDA also benefited from the recognition of inflows from our refranchising initiatives in the quarter.

Technology updates, along with other management actions, are driving improved restaurant-level efficiency and operating margins. Our newly streamlined cost structure resulted in a 10.5% year-over-year decrease in G&A in the third quarter. And we also reached close to 45 refranchising agreements by the end of September, with more than 35 restaurants operations already transferred to our sub-franchisees.

As competitive and promotional activity picks up in the region, we are making the necessary investments to reinforce loyalty in our existing customer base and attract new guests to our restaurants. Our redesigned affordability platform is performing well in our major markets, where consumers appreciate the wide selection of core products at affordable prices.

These operating and strategic initiatives are positioning us to leverage our recovery in economic growth in our region. We are optimistic that economists' and Central Bank expectations for modest economic growth in 2017 will materialize, both in Argentina and Brazil. But nevertheless, the rate of improvement is likely to be uneven in the short term.

Longer term, we will keep with the strategic direction of the global McDonald's system. Our investments will focus on modernizing restaurants, upgrading technology platforms, and bringing innovation to our menu offerings. The main objective of this investment will be to enhance the customer experience, which is already second to none in our region.

Over the last couple of years, we have worked to help our customers gain a better appreciation of our [enduring] quality and food preparation standards. Despite this effort, we have expanded our portas abertas, or open doors program, across all of our markets, with over 2 million visits so far this year.

The program invites our customers to get a behind-the-scenes look at our restaurants. And when we bring guests into our kitchens and pantries, we show them the high quality beef, chicken, bread products and condiments that go into their sandwiches. They also learn about our discipline, food safety standards, and also see the dedication and attention to detail that goes into the preparation of each one of the meals that we serve every day.

As the leading QSR brand in Latin America, we have also taken a leadership role in the industry, when it comes to being socially and environmentally responsible. Among our latest efforts to ensure that our ingredients are sustainably sourced, we recently made our first purchases of certified sustainable beef in Brazil, and also committed to transition to cage-free eggs by 2025.

We also believe that we have an opportunity to make a positive impact on the lives of Latin America's youth. We're leveraging our position as Latin America's largest generator of [first job], by entering into agreements with local governments and NGOs to support youth training and employment programs.

In summary, sustainability and corporate citizenship matter to us and to our customers. We are proud to take these leadership roles in Latin America.

I will now hand the call over the Marcelo for a review of the key drivers of third quarter top-line results.

Thank you, Sergio. Please turn to slide 3. Reported revenues grew by 2.9% during the quarter, as 15.3% constant currency growth more than offset the impact of currency depreciation in several of our key markets. Excluding Venezuela, reported revenues rose 2.8%, with 12.4% constant currency growth offsetting the strong currency depreciations, primarily in Argentina and Mexico.

Average check rose with pricing below inflation and a positive shift in mix to drive the increase in revenue, while traffic was slightly lower versus the prior year quarter.

Please turn to slide 4 for more detail on our divisional results. In Brazil, reported revenues increased 14.5%, driven by constant currency growth as well as the appreciation of the Brazilian real. Excluding the benefit of currency translation, constant currency revenues and comparable sales were each up mid-single digits.

Average check was the main driver of comparable sales growth. Traffic declined modestly, against a backdrop of continued weak consumer spending.

Key marketing activities in the quarter included the Novinhos Cheddar campaign and the McFlurry Kit Kat in the dessert category. We also added the McShake Ovomaltine, which surpassed expectations and is fast becoming a McDonald's customer favorite. During the quarter, we featured the Secret Life of Pets, and Talking Tom properties in the Happy Meal.

Moving to slide 5; NOLAD's revenues grew 1.4% in as-reported terms, or 8.6% on a constant currency basis. System-wide comparable sales grew 5.6%, supported by higher average check and a slight increase in traffic levels across the division. This improvement was driven by the Costa Rica and Panama operations, and the success of our revamped affordability platform in Mexico also contributed to NOLAD's performance in the quarter.

NOLAD's marketing initiatives in the quarter included; the launch of new affordability platforms both in Mexico and Panama, Talking Tom property in the Happy Meal, and the McFlurry Snickers in the dessert category.

Please turn to slide 6. The SLAD division's results were impacted by the continued weak consumption environment and economic recession in Argentina. Given these conditions, we are protecting customer traffic, with competitive pricing and promotional activity in the short term, as we are confident in the Argentine economy's long-term prospects.

SLAD's as-reported revenue decreased by 12% in the quarter, mainly as a result of the 62% depreciation of the Argentine peso versus last year. The division's constant currency revenues rose by 24.5%, primarily driven by average check growth, but also supported by an increase in traffic.

Marketing activities in the quarter included; the Grand Big Mac campaign, the Talking Tom property in the Happy Meal, and the McFlurry Abuela Goye in the dessert category.

Please turn to slide 7. Excluding Venezuela, the Caribbean division's as-reported revenues rose by 5.1%. Similar mid-single-digit increases in constant currency revenues and comparable sales were mainly driven by an increase in traffic. The strong performance in a number of key markets supported the divisional result.

Marketing initiatives in the quarter included; the Talking Tom property in the Happy Meal, the Grand Big Mac campaign, the McFlurry Jet Cruji, and the continuation of Almuerzos Colombianos.

Please turn to slide 8. For the trailing 12 months through September 30, we opened 33 new restaurants, resulting in a total of 2,140 restaurants. The bulk of openings took place in Brazil, where we see the highest long-term potential. The Company also added 133 Dessert Centers, bringing the total to 2,693. McCafes totaled 315, as of September 30, 2016.

We continue to expand our footprint in key markets, while also delivering a better customer experience. This experience starts with food, where we now offer premium sandwiches from the McDonald's Signature line, local favorite flavors in our desserts, and compelling value in our affordability platforms.

The customer experience will also benefit from our ongoing efforts and future plans to modernize our restaurant base, with improvements in technology, hospitality and decor, among other things. Many of these enhancements will be showcased when we roll out the first experience of the future restaurant pilots in our region.

Jose Carlos will now take you through a discussion of our adjusted EBITDA and key balance sheet metrics.

Thank you, Marcelo. Please turn to slide 9. In line with the outlook that we provided on our first quarter call, results have been challenging and uneven so far this year. Third quarter results rebounded with solid top-line performance, leveraging the efficiencies that we had built so far into our business.

During the quarter, consolidated G&A declined by over 100 basis points as a percentage of revenue and was broadly flat year over year on a constant currency basis. This was mainly due to ongoing efficiencies from last year's reorganization which offset the inflation-driven growth of the Argentine peso-denominated component of our corporate expenses. We are ahead of schedule on achieving our targeted 10% G&A reduction by the end of this year.

Our consolidated adjusted EBITDA was 24% higher on an as-reported basis, or 55.9% higher in constant currency terms. The adjusted EBITDA margin expanded nearly 140 basis points to 8.1%. Efficiencies in payroll and G&A more than offset higher food and paper costs as a percentage of revenues during the quarter.

The result also included a benefit from the refranchising of some Company-operated restaurants. Excluding these inflows, consolidated adjusted EBITDA would have increased by about 60 basis points.

Please turn to slide 10. Adjusted EBITDA margin growth was underpinned by expansion in Brazil, the Caribbean and NOLAD divisions, with a positive contribution from the corporate segment. This was partially offset by margin contraction in the SLAD division.

In Brazil, adjusted EBITDA margin grew by about 260 basis points to 11%. The result was helped by our work over the past year to realize efficiencies in payroll, G&A and occupancy and other operating expenses, as well as the refranchising of Company-operated restaurants. Excluding refranchising inflows of $5.8 million, the EBITDA margin expanded by 100 basis points.

NOLAD's adjusted EBITDA margin continues to expand, gaining 150 basis points to 11.1% in the quarter. The margin benefited from the revenue growth above inflation in the division, as well as efficiencies in all cost line items.

For SLAD, results have been pressured by a difficult economic backdrop. In this context, we have kept pricing below inflation in Argentina this year, as we are supporting customer traffic with a view to a medium-term economic and consumption recovery in the country. The adjusted EBITDA margin contracted by 200 basis points to 10.3%, as efficiencies in payroll only partially offset higher food and paper and occupancy and other expenses as a percentage of revenues.

The Caribbean division, excluding Venezuela, saw healthy adjusted EBITDA margin expansion of 250 basis points to 6.1%. This was due to efficiencies in all key cost line items except payroll.

For the nine months ended September 30, our adjusted EBITDA margin expanded by 130 basis points, as ongoing gains from our cost efficiency programs were reflected in our restaurant operations and in G&A expenses. We continue executing various marketing initiatives to boost revenues and are cautiously optimistic for a recovery in consumer discretionary spending.

On slide 11, our non-operating results for the quarter included a $3.3 million foreign currency exchange loss, down from a loss of $27.9 million last year. This is primarily the result of a significantly stronger depreciation of the Brazilian real in the third quarter of 2015, as compared with the slight depreciation in the third quarter of this year.

Net interest expense was $18.2 million, up $3.7 million versus the prior year, due to higher interest expenses on the Brazilian real-denominated debt.

Our third quarter net loss was $1.8 million, versus a net loss of $35.9 million in the same period of 2015. This reflects stronger operating results and lower foreign currency exchange losses, which were partially offset by higher net interest and income tax expenses.

Please turn to slide 12 for our debt metrics. As of September 30, 2016, our net debt to adjusted EBITDA ratio was 2 times, which was well within our target range. The decrease from 2.3 times at the end of the second quarter reflects sequentially lower net debt, as well as the improved trailing 12 months' adjusted EBITDA performance.

We have made strong progress against our plan to reduce the Company's financial leverage. So far, our redevelopment plan has delivered over $93 million in cash, which was mostly applied to repay long-term borrowings. Cash flow improvements and capital expenditure controls have also helped to manage our debt levels.

As we move forward, we will continue to monitor and manage our debt ratios to ensure that our leverage is within our targeted range, and also in compliance with our commitments to McDonald's. The master franchise agreement with McDonald's requires the Company to maintain a minimum fixed charge coverage ratio of 1.5 times and a maximum leverage ratio of 4.25 times. As of September 30, 2016, the Company was in compliance with both the fixed charge coverage ratio at 1.67 times and the leverage ratio at 4.08 times.

I should note that the trailing 12 months' adjusted EBITDA figure includes a non-recurring $32.6 million net PIS/COFINS recovery recognized in the fourth quarter of 2015.

Looking ahead, we remain committed to executing our strategic plan and are focusing on elements over which we have the most control. As the economic backdrop begins to recover, we are balancing our investment between modernizing our restaurant base and ensuring that we are well positioned to capitalize on Latin America's strong growth potential.

I will now hand the call back to Sergio.

Thank you, Jose Carlos. The measures we have put in place to strengthen our financial position are taking hold. We achieved positive top-line and margin performance in the quarter, thanks to the disciplined execution of our three-year strategic plan. We now have a leaner organization in place, and our performance has improved despite a challenging economic environment. We're also beginning to capture operational efficiencies in our restaurants with more opportunities still on the horizon.

In keeping with McDonald's globally, we're focused on enhancing the customer experience by updating restaurants and integrating technology to provide customers with a modern and progressive experience. All of our efforts should drive revenue growth and lead to higher EBITDA margins as consumer spending improves.

We are working side by side with McDonald's to develop our plan for the next three years in terms of openings and reinvestment. By our next earnings call, we expect to share the details of the plan with you, including updated outlooks for sales, margins and capital allocation.

I would like to end by sharing an important milestone for the McDonald's brand in Latin America. This month marks the 30th anniversary of the opening of the first McDonald's restaurant in one of our key markets, Argentina. And next year, Arcos Dorados will celebrate its 10-year anniversary. We are proud of the business we've built over the last decade, becoming the leading QSR brand in Latin America with operations in 20 countries and territories.

So thank you for your attention, and I will now open the call for questions.

(Operator Instructions). Martha Shelton, Itau BBA.

I just have a question regarding your remaining $125 million worth of monetization initiative. Has this been agreed to and, if so, when? Or if not, when will we get updates on that?

And my follow-up question regards Burger King in Mexico. Altea reported a mid-teens same store sales gain in 3Q 2016 in Mexico; is Arcos doing as well in Mexico? Thanks so much.

Martha, good morning. I take the first question then, Marcelo, you take the Mexico piece. On the redevelopment update asset monetization, as we said, more than $90 million we have already received in cash from the redevelopment initiatives so far. And most of those $90 million were applied to reduce our debt levels, mostly to the US dollar 2023 notes.

Of course, we're expecting additional proceeds that will also be applied to further debt reductions, but be always mindful of debt ratio target range. Of course, we are going to be monitoring the currency and credit markets, so we can evaluate our options for each one of the two that and we plan to lower. And then, finally, of course, we're still working through the pipeline of properties that we have.

On the refranchising deals, which is the second component of the asset monetization, as we mentioned, we already received around $8 million in cash so far out of the 35 restaurants that were already transferred. And we have 45 agreements already signed, so we're still on this [tranche]; 10 more restaurants to be transferred to our sub-franchisees. And we are in line with the redevelopment effort; we, obviously, continue working with the pipeline of restaurants that we have to complete this portion of the initiative. That is from the asset management monetization.

Regarding the BK and our performance in Mexico, Marcelo?

Yes. Good morning, Martha. As we show in the third quarter results from NOLAD, we had a strong quarter in NOLAD; particularly, we had positive traffic in the third quarter. As you know, we do not disclose numbers market by markets, but what I could say about Mexico is that we launched a very successful affordability platform, which is the McTrio 3x3.

This new platform brings more choices to our customers, and those choices are at very competitive price points, so we are seeing traction since this launch. And we continue to make some improvements in terms of operational execution in the market, so both components are gaining traction in Mexico.

Great. Thank you so much for those answers. And, Sergio, just a quick clarification, am I to understand that there is -- I initially understood that the asset monetization efforts would be $200 million related to the monetization of real estate and $50 million to refranchising. Am I to understand that now that your net debt to EBITDA is at 2 times, we're not going to see additional asset monetization efforts? Is that how I should interpret your comments? Thanks so much.

Jose Carlos, you want to take that?

Martha, good morning. No, I think that one thing that we have to consider, obviously, at the end of this quarter, September 30, we're at 2 times net debt. But as I mentioned in the opening remarks, we do have a non-recurring one-off benefit in our TTM adjusted EBITDA.

So, again, what we're monitoring is making sure that we are between our target range of 2 to 2.5. We still have pipeline that we're working through that we could potentially get to the $200 million. There's no change in the plan at this point, so we continue working through the pipeline and you should expect more news in our next call.

Jeronimo De Guzman, Morgan Stanley.

I had a question on your restaurant efficiencies. You mentioned that you still see opportunities to capture new restaurant operating efficiencies, and I just wanted to better understand where you see some areas of opportunities still there?

And, I guess, related to that, given the success that you've had with automated scheduling in Brazil, I wanted to understand what are your plans currently for rolling that out in other markets?

Yes. Sure, Jeronimo. Jose Carlos, why don't you address the first part and then Marcelo can talk about the scheduling?

Morning, Jeronimo. As we've said, I think, in the past, the Kronos implementation in Brazil has been very successful and has generated a lot of efficiencies in payroll and better productivity. We're also focusing on other items aside from restaurant payroll, but G&A, occupancy and other expenses, so we continue focusing on efficiencies throughout the P&L.

We continue to look at the further deployment of technology in our other markets. Having said that, as we've said in the past, the biggest opportunity has been in Brazil, but there's still opportunity in the markets. And I'll pass it to Marcelo a little bit to expand some other initiatives that we're doing on the restaurant level productivity.

Yes, hello. Good morning, Jeronimo. When we get Kronos we prioritized Brazil, even that it was a country where we know we will most benefit from the new system. And a rollout to other markets will be a function of the expected benefit in that market, versus other investment priorities on a move-forward basis. We are currently finalizing our investment plan for the next three years, which may include the implementation of Kronos in additional markets.

Okay, thanks. And maybe just a separate question then on the cost side as well. I wanted to see if you had an update on the FX hedging Brazil for 2017 and whether, being at a lower FX level, you see that as an opportunity for margins, or do you see that also as an opportunity to have more competitive pricing, going forward?

Sure. Jose Carlos?

Yes. Jeronimo, we stopped hedging our projected 2017 exposure in Brazil. As of today, we've hedged 50% of the first semester at an average exchange rate of BRL3.45 to $1. Again, as we've always said, we don't speculate in terms of hedging. We just try to provide our countries and markets with predictability with regards to their costs. We'll continue monitoring the market and we'll potentially continue hedging as we progress.

Now, we've also started hedging some exposure in Colombia; 50% in the first quarter and approximately COP3,000 to $1. So it's something that we continue to monitor and continue to act upon.

Robert Ford, BofA Merrill Lynch.

I was hoping you could walk me through the tax line. It was much bigger than I would have thought and I wasn't sure if that's the tax on the restaurant sales, or the income from the joint use projects, or if there's some portion which is non-cash.

Yes. Morning, Bob. Yes, I understand the question. Jose Carlos?

Morning, Bob. Yes, the variation in the income tax, year to date versus 2016 versus year to date 2015, mainly explained by the better performance of the Brazil division this year versus last year. Obviously, we have a complex tax situation in -- we operate in 20 countries and most of our accounting year to date is based on estimates.

The actual full-year tax expense impact you'll see in the next quarter when we [true] up all of our tax provisions. Again, that's something that we continue to monitor and it's something that, I think, will be normalized in the next quarter. And also, potentially we can take you through an offline discussion in a lot more detail if you want, because it's a little bit more complex than I can handle right now on the call.

That would be very helpful. In the past there has been issues with respect to the deductibility of the royalty fees in Brazil, where they're not fully deductible and I wasn't sure if that's influencing the number this quarter.

No, not this quarter. That does not influence.

Okay. And then, one other thing, and that is, if you could touch on the wage outlook. The inflation is near 9% in Brazil, it's running at 40% in Argentina, and I was just wondering what you guys are anticipating in terms of wage adjustments as we go into 2017, please.

The reality is that we are about to enter negotiations in both markets regarding what has to be expected for wage increases, or minimum wage increases. Remember that our salaries are normally tied to minimum wage evolution. Situations in both markets are different.

In Brazil, there is a mechanism that is linked to a decision made by the government, and that implies that all salaries tied to minimum wage has to be increased in that same direction. We know that we may get an increase in minimum wage, probably 1 or 2 points on top of inflation. That is the assumption we're working on but, as I said before, it's not confirmed yet.

In the case of Argentina, the process is different. It's a negotiation on a union base that is conducted about this time of the year, and is composed by two different adjustments that are done the following year, considering that Argentina has a much higher inflation rate.

It is a situation that we're monitoring because it's important; it has a big impact on our numbers. But surely, what I can tell you is that we do not expect a gap between inflation and wages increases the size we had in the past. That is for sure.

Paola Mello, Citi.

I was wondering if you guys could walk us through the same store sales of Brazil. This is a good acceleration, compared to virtually zero growth that you guys reported in 2Q, so if you could walk us through the performance month over month, maybe not exactly the number but at least the big trends? And if that is something that you guys believe that is going to continue over the course of this year and eventually the beginning of next year? Thank you.

Let me take the first part and then, Marcelo, you can expand what I say. We do not provide same store sales information on a month-by-month basis, Paola. But having said that, what we can say is that we have seen a pickup in activity, even though consumer spending, as we all know, remains soft in market. We have done significant enhancement in our affordability platform in the market, started at the end of the first quarter.

Having said that, a significant portion of what happened in this year, because we were facing a really, really tough comparison, basically due to a very successful campaign that we run last year with Happy Meal and the Minions property. That, obviously, created a significant tough comparison, as I said.

But again, in the context of a very still soft consumer environment, obviously, our initiatives, our bargaining initiatives, are designed, obviously, to stimulate and retain volumes in the market.

I think that you said almost everything, Sergio. But, as you mentioned, in this third quarter the toughest part of the quarter was a comparison with the Minions campaign that run in the month of July last year. And we came out of the second quarter where we had a very tough comparison with the Monopoly promotion last year. That's why, maybe, Paolo, you are seeing a pickup. But, as Sergio mentioned, we are taking all the measures to improve these indicators in the market.

Okay. Thank you.

(Operator Instructions). Robert Schweich, Burnham.

You partly answered the question on tax rate, which concerned me, but I'll have to call in later on that. Two other questions. At what point might the Company be in a position to reconsider establishing a dividend?

Secondly, could you discuss your market share figures, your recent market share figures, in Brazil?

Okay, Bob, good morning. This is Sergio. I'll give you, first, the answer on the dividend piece. As you know, dividends are a decision of the Board, and the Board has decided that dividends will not proceed for this year, 2016. They will not declare. For the next year, 2017, obviously that continues to be a decision of the Board. The Board will make a determination, obviously, before the end of this year.

In terms of market share, I will talk about perspective on competition and what we are seeing in the region overall, perhaps with a focus on Brazil. Look, Bob, we're clear leaders in all of the markets and we have been able to maintain the leadership position, even in this very competitive, very promotional environment with consumer spending declining in most of the markets.

It's also appropriate to say that competitive activity within our category of [informal QSR] industry has increased very significantly in Brazil. But not only in Brazil; I would say in most of other markets.

So given all that conditions what we're doing, if we're emphasizing the value, the quality of our menu items or we're looking for differentiation in what is at the core of our proposal, which is customer experience, which is service, quality, which is product offerings and value, real value, not necessarily price, but value, because we know that we have to be very careful on how do we run the business in this environment, but at the same time, having prepared our business to capture the future opportunities once the economies recover.

It's not, we believe, only a matter of running the actual times, but also sustain the business for the future when, as we believe, probably in the next year, or second half of next year, economies in the bigger markets will begin to show some signs of recovery.

Thank you.

Ladies and gentlemen, at this time, we've reached the end of the question and answer session. I would like to turn the comments back over to CEO, Mr. Sergio Alonso, for any closing remarks.

Well, thank you, all, for your questions, and your attention today; obviously, we look forward to speaking with you for the next quarter release. As always, in the interim, our team remains available to meet with you and answer any questions that you may have. So thank you very much and enjoy the rest of your day.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.