Arcos Dorados Holdings Inc. (ARCO) Q1 2015 Earnings Report, Transcript and Summary

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 section 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 José Carlos Alcantara, our Chief Financial Officer. Before we proceed I would to like to take -- 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 would now like to turn the call over to our 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 [ph] in all of our markets. We are committed to ensuring that our guests continue to receive the very highest level of service which is the hallmark of McDonald’s system worldwide. Our commitment to customers extend 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 half a million guests participated in Mexico alone in the last 12 months and we recently launched the program throughout 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 regions. Organic revenues grew 10.3% year-over-year and 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 some currency and timing related expenses impacting the comparison with last year’s corporate G&A. I would not like to discuss our first quarter results and 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 forecast 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 implanted in Brazil by year end and in Argentina by early 2016. Once the roll out 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 and 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 U.S. 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 committing to enhancing shareholder value by monetizing some of our real estate assets. The strategy will capitalize and the appreciation of long standing assets that are either non-core or where the value far exceeds the assets operating potential. In doing so we expect to raise at least 200 million over the next three years which were used to reduce debts 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 operated by sub franchisees we plan to enhance margins and raise at least 50 million over the upcoming three years. We have identified the restaurants who really 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 we’ll focus on bringing more customers for 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 through a cyclical upturns in the region’s economy. I will now hand 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 6.9% in the first quarter. As reported revenues declined by 7.7% primarily due the depreciation of the Brazilian and Argentina currencies. Systemwide comparable sales rose 3.8% as average check growth more than offset a decline in traffic. Turning to slide three, Brazils first quarter’s revenues were impacted by this unique depreciation of the [Indiscernible] 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 [Indiscernible] revenues grew by 3% versus the prior year quarter. System wide comparable sales were level with the prior year period of SLAD’s consumption led to lower traffic levels and offset average growth. First quarter traffic was also impacted by our past year-over-year comparison as the marketing calendar was adjusted given 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 free-standing 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’ve seen in the restaurants where the system has already been implemented. This system will allow our employees to be better prepared to several customers throughout all the parts and thus ensure we continue to efficiently deliver the best customer experience. After rollout expands and our managers become more proficient with the system, I am confident that we would be able to deliver restaurant margin expansion over the next three years. On slide four, you will see that NOLAD revenues decreased 6.6% year-over-year, but were stable in an organic basis. System-wide comparable sales declined 2.4% due to a decline in traffic which offset growth in our 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 have taken 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 customer to create their own personalized meal combinations. McMio has been rollout 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 the goal of reaching more than 250 restaurants by the year end. Customer’s feedback has been very promising with consistent increases our check. Please turn to slide five. SLAD’s revenues increased 7.4% in the first quarter, excluding the 15% 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 divisions results on slide six, revenues excluding Venezuela decrease by 10.8% versus the prior year quarter mainly due to the depreciation of the Colombian Peso and the Euro which is utilize in several of the Caribbean market. 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’ve seen solid traction in Colombia, large marketing division that we believe a strong long-term potential. The company continues to focus on long-term growth offering relevant locations to its customers. As part of the 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 seven. We completed 77 new restaurants openings for the 12-month period ended on March 31, resulting in a total of 2,119 restaurants. And also in the period we added 255 Dessert Centers and 8 McCafés, bringing the totals to 2,526 and 335, respectively. We believe that we have the right market in place to navigate this period and continue to strengthen our brand position of the leader QSR Company in the region. We’re focusing on marketing actions or increasing consumer awareness of our quarterly offerings through programs as puertas abiertas. We also continue to put family first and catering to local preferences with offerings such as a new chicken meals in the Andean markets. In doing so we have been able to maintain market share in our largest market at a time where consumers are been more selective with their discretionary spending. And we will continue providing our guest 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 José Carlos for a discussion on our adjusted EBITDA and key balance sheet metrics. José Carlos Alcantara: Thank you, 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, non-product purchases and G&A expenses. The 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 in crucial consumer facing technologies in the future. Please turn to slide eight. First quarter consolidated adjusted decreased 16.8% but rose 35.5% on an organic basis year-over-year. Excluding Venezuela, adjusted EBITDA decline to 20.8% and was down 5.2% in organic terms. For the quarter, labor cost as a percentage of sales were flat year-over-year, while G&A as a percentage of revenues rose due to some currency and time-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 points contraction in the adjusted EBITDA margin to 5.4%. In the quarter, there are 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 base corporate expenses which was only partially offset by a modest evaluation of the Argentine 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 decline by more than 12% versus the prior year period. Turning to our divisional results on slide nine, 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 cost and G&A expenses were unchanged as a percentage of revenues versus three-year ago period. NOLAD’s adjusted EBITDA increased by 10.1% in the first quarter with the similar growth achieved on an organic basis. The adjusted EBITDA margin expanding more than a 100 basis points to 7.1%, thanks to lower G&A as a percentage of revenues combined with leverage 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 unification of SICAD and SICAD II into a single exchange mechanism called SICAD and established a new open market foreign exchange system called SIMADI. As of March 31, 2015, three foreign exchange rates were legally available: one, the official exchange rate settled at $6.30; two, the new SICAD exchange rate settled at $12; and three, the SIMADI exchange rate settled at 190. Considering that the SICAD II exchange rate no longer exists, the lack of operations at the SICAD exchange rate and our relative ability to access U.S. dollars to do the SIMADI mechanism, we began remeasuring the results of our Venezuelan business at the SIMADI exchange rate, beginning on March 1, 2015. As a result of the change to 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 Venezuelan the Caribbean divisions as reported adjusted EBITDA contracted 7.9%, primarily due to the depreciation of the Colombian peso and the 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 non operating results reflected a $2.3 million increase in foreign currency exchange losses. FX losses for the quarter were mainly driven by the change in the exchange rate used to measure the Venezuelan business and the depreciation of the Brazilian real. The latter generated 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 the MFA. McDonald’s has extended the waiver for clients with certain leverage ratios through the first quarter of 2015. We continue to monitor the situation, but do not foresee a materialize adverse effect on our business or financial results. As of March 31, our net debt to adjusted EBITDA ratio was 2.8 times. While inter years 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 that reduction. I will now hand the call back to Woods.

Thanks, José Carlos. As we’ve described we are making the necessary 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 through 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. Program that enhances 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 it’s a huge achievement for a company such as ours. While we expect a 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 in shareholder value over the long term. Thank you for attention. I would now like to open the call up to questions.

Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from the location of Jeronimo De Guzman with Morgan Stanley. Please go ahead.

Hi, good morning. I wanted to start with a question on your corporate expenses, because when I look at the results from corporate they are 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 continue 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 José Carlos. José Carlos Alcantara: Yes Jeronimo as I mentioned in our script by now we have two basically one offs or impact from the G&A in the quarter. No inflation evaluation 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 2015. Additionally what we didn’t include here in the explanation script, there is two other factors that played out in the quarter in corporate G&A, one, we had some severance costs in the quarter related to some executives that exited and we also carried two CFOs for the quarter, so that’s an additional clearance that we don’t expect going forward. And but if you exclude the two items that I first alluded to absolute and absolute G&A would have decreased 12%, so total G&A.

Okay, but I guess just to clarify I mean I understand the variable compensation is something that’s a one off but the inflation is something that will recur, right. So if you are up about in case you are up this higher level of 40% I mean are you comfortable with that or do you think there is room to further control these G&A expenses given the weaker top line trends. José Carlos Alcantara: No I think there is room to further control. We expect that the Argentine peso will be valued at some point from now until the end of the year and that’s when you know the devaluation will catch up to that inflation, so again this is just the timing situation I think the Argentinean 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 are seeing recent trends if you are seeing any improvements in the trend now that the comparison based 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, but what can you do to get the traffic trends to improve?

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

Yes thank you Woods and morning to everyone. Well traffic in Brazil continues to be impacted by I would say a soft consumer environment and a shift also to the informal [ph] sector as you know as a consequence of this softer consumer environment people obviously are changing to into lower and less formal types of restaurants in the market. However, if you compare our performance for quarter -- Q1 against Q1 last year, I have to highlight that last year we’ve run monopoly campaign, which was a very strong in March, while this year we’ve started in late April, so we have that shift –timing shift I would say, that plays against 2015. Overall having said all that, considering that we foresee overall challenging consumption environment, we are focusing on protecting traffic obviously and market share enhancing our value proposition.

Okay. So do you see, I mean do you see…

The next question comes from Mr. Amod Gautam with JPMorgan. Please go ahead.

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 free-standing 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 what’s going on with the economy in general. And as you can imagine we depend on mall traffic to do our sale. So, -- then also there’s another additional factor which is the new malls that have been opened – 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 free-standing 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 Brazil and then whether or not you started to lock in particular rate for 2016?

Yes. Let me pass it to Carlos. José Carlos Alcantara: Yes. Hi, Amod. As I mentioned we’re fully hedged in Brazil for food and paper exposure which is basically toys that we import from China and potatoes from Argentina. Our hedged for the full year is around 261. We’re also partially hedge 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 its little bit too early to start looking into that, but we’re obviously consider that as we start looking into our plans for 2016.

The next question comes from Mr. Everett Weinberger with UBS. Please go ahead.

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 off the Venezuelan business. Have you pursued a divestment and found no buyers or is it something you would never consider selling at one 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 U.S. or is this is a totally different environment than the U.S. and there really is no fast casual category yet eating into McDonald share there? Thank you.

Yes. Good morning, Everett. How are you?

I guess very well.

Regarding your first – great and good questions. In the case of Venezuela as you are 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’re operating. So we cannot and would not pick and choose what is good and what is bad. And I think eventually Venezuela will turnaround as you probably know in Venezuela we have the self-sustaining. We’re not putting any more money into the country. We operate with what we have. So it’s a challenge from a point of view operations, but I will tell you that one of the strongest brands that McDonald’s is strongest in Venezuela vis-à-vis other country. So we’re very proud of our Venezuelan operation, of our Venezuelan people and we will continue there operating amongst [Indiscernible] 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 that if you look at our markets, our biggest market potential is within formal eating out categories and bring as you ever burgeoning middle class, that middle class comes to us and where McDonald’s has a highest top of mind in all QSR, yes they are growing, but I would not say at this point. The challenge there would be in a more developed like the U.S. or some European countries.

The next question comes from Robert Schweich with Burnham. Please sir, go ahead. Your line might muted, sir. You are on the phone. You can go ahead.

Can you hear me now?

Yes, sir.

Hi, Bob, yes.

Sorry, they had phone. It didn’t seem to work well. Thank you. I was also interested in Venezuela but you’ve answered the question and I expect your answer. It is for investors discouraging that haven’t 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, secondary that I’m interested in is how does the change in tough management and the new plans in Chicago affect you?

Hi, Bob. Good to hear you. Good questions and we will report both with and without Venezuela. You have access the Venezuela numbers, but we’ll see we can make it more easy to look at. And as far as the top management changes in McDonald’s Corporations, obviously the effect is quite a bit, I mean, we are the largest franchisee in the world. We are very supportive of a changes that McDonald’s have announced regarding against 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 are pursuing will have a positive impact on McDonald system moving forward and that’s good for us. The world today is the smaller world given the social media and what happens in the other parts of the world impact 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 hand and moving forward.

Thank you.

Thank you, Bob.

[Operator Instructions] The next question comes from Veronica Armas [ph]. Please go ahead.

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

Yes. So let me pass to the José Carlos, so he can answer more precisely. José Carlos Alcantara: Hi, Vernonica [ph]. As you alluded yes, we obtain from McDonald’s a waiver through March 31, 2015. We’re monitoring the situation closely. This is very dynamic environment at this point. And we expect that continued conversations with McDonald’s will happen and they’ll 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.

And okay, but maybe you could give us a sense or where this covenants at levels they are? José Carlos Alcantara: That something we can go into detail. We can follow-up later on if you want and get some detail on the covenants, but again…

Okay. Sure. Okay. No problem. Thank you. José Carlos Alcantara: Thank you.

At this time we’ll turn a 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 next quarter and encourage you to reach up to the team with any questions you may have. Thank you and have a very good day.

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