Arcos Dorados Holdings Inc. (ARCO) Q1 2016 Earnings Report, Transcript and Summary

Welcome to the Arcos Dorados’ First Quarter 2016 Earnings Conference 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]. At this time, I would like to turn the call over to Daniel Schleiniger, Senior Director of Corporate Communications and 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 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 to 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 Acceptable Accounting Principles, we report certain non-GAAP financial results. Notably beginning with the reporting of the first quarter of 2016 we’re making a change to the presentation of our non-GAAP financial results. We will no longer be reporting organic results which exclude the effect from currency translation and certain special items from our GAAP results. The frequency and contributions of special items to our results has declined. However we will continue reporting constant currency performance as we believe that excluding the impact of currency fluctuations on our results continues to be an objective representation of our businesses underlying performance. 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 unaudited financial statements filed with the SEC on Form 6-K today. 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. The full year plan that we announced in March of last year is designed to improve efficiency of our operation, streamline our cost structure and strengthen our financial position. We achieved positive top line on margin performance in the first quarter with appealing menu offerings and the disciplined execution of our three year strategic plan despite a difficult a consumer environment in most of the region. Looking ahead, visibility remained slow and we’re planning for challenging conditions to continue through the end of 2016. During the first quarter comparable sales increased 15.9% benefiting from strong marketing promotions and the leap day. However throughout the end of the quarter we something new in consumer behavior primarily in Argentina and Brazil. Our sales performance along with improved operational efficiency contributed to a consolidated EBITDA margin expansion of close to 200 basis points versus the prior year quarter. The benefit from the roll-out of our new scheduling and forecast assisted in Brazil as well as from the real demonstration plan we implemented at the end of last year drove the margin improvement and will drive sustained savings into the future. By focusing on costs but are mostly under our control we’re streamlining our cost structure and capturing inefficiencies in our operation. Continuing margin expansion will depend partly on stabilization of local economies and the recovery in consumer spending. These factors will lead to improved top line results which will further leverage efficiencies that we’re building into the business. In addition to reducing our pre-cost structure and improving our operating efficiencies in the first quarter we advance on the other key elements of our plan. On the time of fourth quarter results in March we announced that we have find asset monetization agreements with more than half of our total targets. Since then we have collected additional proceeds from these agreements. With the largest footprint of any QSR brand in Latin America Arcos Dorados has a vast portfolio of real estate assets to support these effort. Our refinancing plan also remains on track, we continue to transfer the operations of refranchise restaurants like we work to negotiate additional agreement to refranchise company operated restaurants. We began 2016 in a strong financial position. At the end of March we signed a loan agreement with five brands in Brazil. The proceeds are being used to repay our Brazilian Reais denominated bond maturing in July. In fact last week we successfully completed a 10 year offer enable us to repurchase more than 2/3rds of the outstanding note prior to maturity. Looking at our fixed cost structure given the savings captured in the first quarter we expect to exceed our minimum target of 10% reduction in G&A well ahead of schedule. With the linear organization structural in place I'm confident that our efforts to boast revenue growth and lower fixed cost will result in stronger EBITDA margins over the coming years. The actions we are taking are driving improved operating performance challenging economic environment and we're positioning ourselves for the next cycle of economic growth. Arco Dorados enjoys significant scale and competitive advantages from being part of the global McDonald system including brand equity, menu offerings, global marketing strategy and digital presence. I'm just with McDonald's corporation we are innovating our own service to provide customers with more choice and flexibility. Last month we joined almost 14,000 owner operators, suppliers and employees from around the world at the biannual McDonald worldwide convention. Having heard the success stories from our counterpart elsewhere in the world I'm sure we will be able to apply many of those ideas to our Latin American operations I will now hand the call over to Marcelo for overview of our first quarter top line results in more detail.

Thank you, Sergio. Please turn to slide 3, the pickup in seasonal activity we saw at the end of 2015 extended into the first quarter. On a constant currency basis revenues grew 16% but by a 15.9% increase in comparable sales which is the highest quarterly result in more than five years. Average check of base the blending inflation rate and was partially offset by a low single digit decline in traffic. As has been the case for the last two years reported revenues reflect weaker local currencies mainly in Brazil, Argentina and Venezuela. Please turn to slide 4, for a closer look at our divisional results. In Brazil, the expansion in constant currency revenues was driven by a high single digit increase in comparable sales and the contribution of new restaurant opens. Double-digit average check growth reflected, price increases and the strong performance of two marketing initiatives, namely the Big Tasty campaign and the launch of a new premium burger, the ClubHouse from the McDonald's signature line. The dessert category continued to perform well this quarter with a McFlurry McFlurry Trufado Kopenhagen and the McFlurry Amor aos Pedaços. Average check growth of inflation but was partially offset by a mid-single digit decline in traffic. Despite the strong quarterly results we maintain a cautious outlook for Brazil, as the political climate and continued economic contraction have depressed retain sales and consumer spending. Turning to slide 5, growth in NOLAD's first quarter constant currency revenues and comparable sales was driven by an expansion in average check. Average check grew faster than inflation and was partially offset by a modest decline in traffic. Strong performance in Costa Rico and Panama supported by the introduction of the ClubHouse drove additional sales performance. The family business remains a key driver of results but by successful properties such as peanuts in the quarter. The category continues to be a strong contributor to results in Mexico. Please turn to slide 6, the slight division maintained double digit comparable sales on revenue growth in constant currency terms. The results were backed by average check growth and the low single digit increase in traffic. In Argentina we focused on promotional activities to enhance consumption and traffic levels. The premium ClubHouse burger, the Peanuts Happy Meal and McFlurry Suflair Duo in the dessert category also supported sales performance. Turning to the Caribbean divisions results on slide 7. Constant currency revenue growth excluding Venezuela reflected a low single digit increase in comparable sales. The result was supported by average check growth and slightly positive traffic. Colombia performed strongly while Puerto Rico remained under pressure from a difficult economic environment. Marketing initiatives in the quarter included the launch of the premium ClubHouse burger in Colombia, the Peanuts Happy Meal in most markets and the McFlurrym brownie in Puerto Rico. Please turn to slide 8, we opened 36 new restaurants during the last month, in the March the total of 2136 restaurants. Most of this openings took place in Brazil which is where we see the highest longer term return potential. Over the last 12 months we also added 136 Dessert Centers and 1 McCafe bringing the total to 2628 Dessert Centers and 319 McCafe's We’re mind to of the recurring economic budget and have adjusted our short term growth plans accordingly. Still we continue to invest in the modernization of our restaurants base with an emphasis on enhancing the customer experience. I will now hand the call over to Jose Carlos for a discussion of our adjusted EBITDA and key balance sheet metrics.

Thank you, Marcelo. The measures we put in place to streamline our cost structure last year have started to pay off. We achieved double digit increases in two key components of our cost structure, payroll and G&A in the first three months of the quarter. A key source or efficiency in our first quarter results were payroll costs. Last year we rolled out a scheduling and forecasting system in Brazil which is driving improvement restaurant level margins. In the first quarter, our consolidated payroll costs declined by about a 100 basis points as a percentage of sales and we expect to continue capturing leverage in our payroll costs going forward. The reorganization and optimization plan implemented at the end of last year also drove over 100 basis points of G&A leverage in the first quarter. And will allow us to deliver annualized cost savings of at least $20 million in absolute terms this year. When we first announced our 10% G&A reduction target last year we set a timeline of the year end 2017. Given our progress to-date we should achieve this goal well ahead of schedule. Together the improved payroll and G&A results more than offset food and paper cost pressures during the quarter. Turning to adjusted EBITDA performance on slide 9, first quarter adjusted EBITDA increased 15.2% as growth in constant currency terms more than offset currency translation impact mainly in Brazil, Venezuela and Argentina. All divisions contributed positively to adjusted EBITDA during the quarter with the exception of SLAD was a significant devaluation of the Argentine peso and shifting mix negatively impacted EBITDA results. On a constant currency basis adjusted EBITDA grew 67%. Excluding Venezuela adjusted EBITDA increased 1.4% and 38.1% in constant currency terms. The adjusted EBITDA margin expanded by almost 200 basis points to 7.3% driven by efficiencies in payroll and G&A which were partially offset by higher food and paper costs as a percentage of sales. On slide 10, you can see that we achieved adjusted EBITDA margin expansion across all operating divisions except SLAD during the quarter. In Brazil, the adjusted EBITDA margin expanded by more than 250 basis points to 12.2%, as efficiencies in the payroll G&A and occupancy and another operating expenses more than offset increases in food and paper cost as a percentage of sales. The NOLAD division continues to deliver adjusted EBITDA margin expansion backed by improved operational performance and productivity. The adjusted EBITDA margin expanded by more than 280 basis points to 9% in the first quarter driven by efficiencies in all key cost items. SLAD's adjusted EBITDA margin contracted by a 170 basis points to 8.8% driven by higher food and paper and payroll costs partially offset by efficiencies in G&A expenses and occupancy expenses from franchise restaurants. Food and paper costs rose as a percentage of sales in the quarter primary due to a mix shift related to the company's focus on promotional activities as well as input cost increases related to currency depreciation in the Argentine operation. Excluding Venezuela, the adjusted EBITDA margin of the Caribbean division expanded by almost 60 basis points to 3.8% mainly driven by efficiencies in G&A and occupancy and other operating expenses as a percentage of sales. Turning to slide 11, first quarter non-operating results reflected a $16.7 million foreign exchange gain compared with a loss of $23.7 million last year. The foreign exchange gain was mainly due to the appreciation of the Brazilian Reais which generated gain related to intercompany balances partially offset by a loss on Brazilian Reais denominated long-term debt. In addition, lower foreign exchange losses related to the Venezuela devaluation effect also positively impacted non-operating results. Net interest expense declined by $2.1 million year-over-year to $14.3 million in the quarter due to lower U.S. dollar interest payments on the 2016 bonds as a result of the devaluation of Brazilian Reais. First quarter net income totaled $16.1 million compared to a loss of $28.2 million in the year ago period. The improvement reflects higher operating results, coupled with a positive variance in foreign exchange results and lower net interest expense. These were partially offset by a negative income tax expense variance. As a reminder, last year's operating results were impacted by an impairment charge totaling $7.8 million on Venezuelan fixed assets. Slide 12 contains our debt metrics. As of March 31, 2016, our net debt to adjusted EBITDA ratio was 2.5 times, essentially unchanged versus the end of last year. The variance reflects seasonal working capital requirements and depreciation of the Brazilian Reais during the first quarter of this year. The prioritization of cash flow improvement, a temporary reduction in capital expenditures and proceeds from our asset monetization strategy have brought the ratio back within our target range of 2 to 2.5 times. While we expect some seasonal fluctuation throughout 2016, we should end the year within our targeted range. As Sergio mentioned, at the end of March we signed a 4-year loan agreement in Brazil. The 613.9 million secured loan to our Brazilian subsidiary has a fully amortizing payment schedule with no prepayment penalty. It bears interest at the interbank market reference or CDI interest rate plus 4.5%. Interest payments will be quarterly beginning next month and principal payments will be made semi-annually as of September 2017. The loan is secured by certain credit and debit card receivables arising from sales in some of our Brazilian subsidiary company operated restaurants. When we announced the agreement, we had already repurchased a portion of the Brazilian Reais bond, bringing the loan proceeds broadly in line with the outstanding principal amount. Since this time, we launched a tender offer for the remaining Brazilian Reais notes and as we announced last week, we were successful in repurchasing two-thirds of the outstanding notes prior to maturity at par. As of today approximately 205 million of the revision of principal amount of the Brazilian Reais bond remains outstanding and will be repaid on or before maturity with the remaining proceeds from the loan agreement. Turning to our asset monetization plans. We have agreements in place to redevelop properties and refranchise Company operated restaurants representing more than half of our asset monetization's goal. To-date, we have received proceeds of more than 14 million from these agreements. We are progressing within the time frame that we laid-out for both initiatives and are on track to achieve the total targeted amounts. In summary, we continue focusing on the costs that are mostly under our control to realize efficiencies and our positioning Arcos Dorados to capture the opportunity of the McDonald's brand in Latin America. I will now hand the call back to Sergio.

Thanks Jose Carlos. Our first quarter results demonstrate clear progress against each component of our three year strategic plan. The ultimate goal of the plan is to strengthen our leadership position in Latin America and be as the forefront of next cycle of economic growth. I have worked in this region for decades as have many of my colleagues and we know from experience that economic growth in Latin America, it's cyclical. In the future, as we have done in the past it will rebound. The measures we have put in place to strengthen our financial position are taking goal. We began this year with a leaner organization and our performance improvement despite the challenging economic environment. We're seeing better operational efficiencies and higher margins in our restaurants. Our efforts to increase revenue grow and lower fixed cost should lead to higher EBITDA margins in future years. And at the same time, proceeds from the monetization of certain real estate assets, will reduce our net debt, and enhance shareholder value. We're on track to achieve the target outlined in our three year plan and are pleased with our results so far. We are planning for our larger markets to continue facing headwinds and ascertain in 2015 that we expect will further impact consumer behavior, but we are managing the business for the long term and our focus remains on executing against our strategies. We remain confident in the potential of the McDonald's brand in Latin America and have a clear plan for sustained long term profitable growth. In line with McDonald's globally, we will continue working with our core menu items to sustain [indiscernible] as well as piloting technology platforms in our excellence to enhance the customer experience. So thank you for your attention and I would now open the call for questions.

[Operator Instructions]. Our first question today comes from Robert Ford from Bank of America Merrill Lynch. Please go ahead with your question.

I was hoping if you could touch a little bit on Venezuela in terms of the energy crisis and what you're doing to cope with the situation there and I was curious if you had any exposure to Alimentos [indiscernible] in Venezuela, please.

Well, I believe this is no secret to anyone, the Venezuelan operations are facing a very, very challenging economic and consumer environment. So obviously, we're trying to protect the business and protect our leadership position in the market, but I believe it is important to remark that Venezuela is for us a cash self-sufficient operations. We are not in need nor we expect to inject cash into the country or the market this year to sustain the new operations and development. In terms of the developments of the market for numbers, Venezuela is slightly above 1% of revenues. Just a reminder, we had a negative EBITDA in Venezuela last year of around $8 million so as we said we'll try to protect, do everything we can in a very tough and challenging environment to protect the business because we all know that Venezuela was once a fantastic market for brand McDonald's and we expect that situation will come back hopefully soon, but in the meantime, we're not in need of pumping money into the market.

I would like to add we have no exposure to and [indiscernible] in Venezuela. So we are not planning any impact from that situation in our business.

Our next question comes from Martha Shelton. Please go ahead with your question.

I just wanted to see if you could offer a little bit more color regarding the NOLAD operations. Again, we're seeing very good EBITDA margin expansion. So if you could perhaps give a little bit of color into the performance of the Mexico operations, same store sales, traffic. I'm just what you're seeing there if you are seeing consumers trading up. Thanks so much.

Well, as you mentioned we have another strong quarter from NOLAD despite you mentioned that Panama and Costa Rica contributed a lot to those results. The first thing that we’re seeing positive trends in terms of revenues and margin from Mexico. Last year, we made introduction of [indiscernible] which brings a more choice for our customers, along with improvements in operational execution, we saw a positive impact in ground metrics in the last quarters. So we obviously aim to sustain this improvement and the next phase will be offering new affordability platform in order to bring more customers to our restaurants and continue to gain traction in Mexico.

Our next question comes from Jeronimo De Guzman from Morgan Stanley. Please go ahead with your question.

I wanted to see if you could talk a little bit more about the same-store sales trends that we saw in Brazil during the quarter, and more specifically I mean there is a mix between the ticket in traffic. I mean, what do you think is driving the continued trend towards tickets above inflation while traffic trends are still in the mid-single digit negative side and then also wanted to hear -- if you could give us more color on what you mentioned about seeing more of a deceleration towards the end of the quarter. So wanted to see what kind of trends you were seeing towards March or what kind of trends you're seeing at the start of the second quarter?

The reality is that in the case of the Brazil, we ended the year with the positive momentum in sales with sort of carry over into the first quarter of this year 2016. We had a very strong marketing calendar in the market, including what we call core line extensions like Big Tasty with wider range of products around the Big Tasty platform and also [indiscernible] we also have emphasis and the affordability the platform with the launch of a new platform towards the end of the quarter, and we also have a really robust offering in terms of results with the [Technical Difficulty] with very local existing brands. The reality is that as a consequence of all these initiatives, we had a positive change in product mix, basically enhancing and help increase the average check that explains the gap between the positive sales compared to inflation and then as we said, a slightly negative trend in volumes indices [ph], which we believe also is a testimony of what is happening in the market beyond our businesses. Again this is no secret to anyone either. The overall business environment is very challenging in most businesses are suffering or declining volumes. Having said that, I believe it is worth to remark that in this environment, we were able to gain market share, we believe our [indiscernible] business this is branded QSR companies. So obviously our goal long term is to protect traffic as we always said, that hasn't changed, and won't change because that goes up -- the business we have. But the reality is that, considering the market conditions today, and as we said Jose Carlos and Marcelo as well in their parts, we are seeing sort of a continuation of the situation at least in the next upcoming months even when it's going in the market both in terms of the economy reality and some uncertainty in the political outlook as well.

So just to clarify, you're seeing still strong trends continuing?

Now what we’re seeing is, I was referring to volumes, we had negative volumes obviously, our focus remains to sustain traffic as much as we can.

[Operator Instructions]. Our next question comes from Ed Santevecchi from Nomura. Please go ahead with your question.

Can you just give us an update on CapEx for the full year, are you still expecting kind of that $90 million to $120 million range or should we expect revision lower, I guess you maybe guiding towards the lower end of that range? And then secondly can you just give us a general update on your strategy towards hedging some of that FX risk?

Yes, our guidance for CapEx spending this year still remains in the same range $90 million to $120 million, that has not changed. As with respect to hedging, our strategy has been to, as we mentioned in the past, hedge some of our food and paper exposure, that in our markets vary market by market in Brazil for example, I think we've said 20%, it's paper [indiscernible] and potatoes that we import into Brazil and then we monitor that and then hedge as we redeem accordingly. So for this year in 2016 in Brazil we're fully hedged for the entire exposure we have in Brazil at this point, at an average rate of approximately BRL4.1 to the dollar.

Sorry, in Brazil you’re hedge just on the input costs?

Just on input costs. We do not hedge translation, just transaction exposure.

[Operator Instructions]. And ladies and gentlemen, at this time it's showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

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

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