Arcos Dorados Holdings Inc. (ARCO) Q1 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to the Arcos Dorados' First Quarter 2017 Earnings Call. A slide presentation will accompany today's webcast, which will also be available in the Investors section of the company's Web site, www.arcosdorados.com/ir. [Operator Instructions] At this time, I'd like to turn the call over to Daniel Schleiniger, Vice President of Corporate Communications and Investor Relations. 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 Mariano Tannenbaum, 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 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. We had a strong start to the year achieving important results and early progress on key initiatives included in the long-term strategic mission we communicated just a few weeks ago. Top line performance in the first quarter was strong and we enforced our [meeting] [ph] share in the main market in which we operate. Comparable sales excluding Venezuela increased 9.6% in the first three months of the year, while constant currency revenues rose 9.2%. These results were supported by positive traffic and solid average check growth in all divisions while excluding Venezuela. Marketing and promotional activity showcasing McDonald's core menu items successfully attracted more guests to our restaurants. Sales growth helped us to continue capturing operational leverage in our business and draw higher EBITDA margins. In the quarter, we achieved 70 basis points of consolidated EBITDA margin expansion and delivered higher year-over-year EBITDA margins in all divisions except NOLAD. In addition to delivering better operating results, we also continued the process of optimizing our long-term debt structure. At the end of the first quarter, we have successfully placed a new corporate bond which will extend the maturity and lower the cost of our long-term debt. The transaction which closed in early April further strengthens our balance sheet and allows us to focus on growing the business. Mariano will describe the terms of new bonds, the use of proceeds and a few other details pertaining to the transaction in a few minutes. As we mentioned on our most recent call, we have fortified the foundation of our business model by building efficiencies into our restaurant operations, meaningfully reducing our G&A expenses and lowering our total debt levels. These achievements helped to drive profitability improvement and EBITDA growth in 2016, as well as during the first quarter of this year. Our strategic focus continues to be driving customers to our restaurants. Offering compelling value across our menu board combined with modernizing and expanding our restaurant base will deliver an unmatched experience to our guests which should bring them back more often. Our customer satisfaction scores remain among the highest in the McDonald's system globally but we believe that we can do ever better. As we move forward with our modernization and expansion plans, we will capitalize on the potential of our footprint in Latin America. Our free standing restaurants will continue to deliver the best QSR experience in the region, while our [owned] [ph] stores will benefit from an eventual pickup in consumer activity. This year, we expect to complete the implementation of the Made For You kitchen platform in nearly all company-operated restaurants. We will also open or [reinvent] [ph] more restaurants with the experience of the future format this year and our guests are already noticing the upgrades to our restaurants, as well as to the quality of our customer service. The path to stronger growth is likely to be uneven in the short to medium term but I am confident that we are heading in the right direction. We continue to see signs of improved consumer [indiscernible] in many of our markets. With our strong operations and solid capital structure, we will leverage the strong potential of the McDonald's brand in the region to drive growth and create shareholder value. I will now hand the call over to Marcelo, who will review key drivers of first quarter top line performance.

Thank you, Sergio. Please turn to Slide 3. As Sergio mentioned, across the business we are prioritizing initiatives that make a real difference to our customers. Our focus is on capturing profit growth with core classic and appealing value offerings. In this respect, we have a solid to the year. Our redesigned affordability platform continued to generate positive momentum in our major markets, driving improved volume trends as well as margin expansion, partially as a result of our ability to generate cost savings with economies of scale. Our ability to grow on iconic McDonald's menu items such as the Big Mac and fries and to get these within our affordability platform is a strong competitive advantage. Our efforts to enhance the customer experience resulted in high teens comparable sales and constant currency revenue growth in the first three months of the year despite the tough year-over-year comparison. Excluding Venezuela, comparable sales outpaced inflation and we recorded our second consecutive quarter of positive total volume growth. Reported revenues increased 18.7% supported by the appreciation of the Brazilian real, which more than offset the depreciation of the Venezuelan bolivar, Argentine peso and Mexican peso. Constant currency revenue growth reflected the 19.4% expansion in system-wide comparable sales, which benefitted primarily from our average check growth but also positive traffic in the quarter. Please turn to Slide 4 for more details on our divisional results. In Brazil, reported revenues increased 24.7%, supported by the 19% year-over-year appreciation of the Brazilian real. Excluding these currency tailwinds, constant currency revenues grew 0.7%. Once again, the result was impacted by the re-franchising of certain company operated restaurants as company operated sales are replaced by the rental income received from sub-franchise. Total system wide in Brazil grew 5.6% versus the prior year quarter supported by a 3.7% growth in comparable sales during this period. The increase resulted from average check growth and slightly positive traffic. Also, keep in mind that we achieved mid-single digit comparable sales growth in the year ago quarter, making for higher basis for comparison. Key marketing activities in the quarter included the continuation of the new affordability platform Clássicos do Dia or Daily Classics, which drove volume growth. Also in the quarter, we launched the Original Mex premium burger as part of the Signature Line and the McFlurry Laka Diamante Negro, among others. Moving to Slide 5. NOLAD’s revenues declined 1.1% year-over-year as constant currency growth of 5.2% was more than offset by currency translation, mainly the 13% year-over-year depreciation of the Mexican peso. Comparable sales grew 3.7% during the quarter through a combination of average check growth and a modest increase in traffic. First quarter traffic was positive in the division despite the tough comparison with the first quarter of 2016. Last year, the Easter break fell in the first quarter and Mexico in particular benefit from an increasing traffic during this holiday period. In 2017, the Easter holiday break will fall in April. NOLAD's marketing initiatives in the quarter included the extension of the affordability platform McTrío 3x3, and the Martes de McDonald’s campaign in Mexico. Also during the quarter, we launched the Signature Line in Mexico with the introduction of the Club House premium burger. With the desserts category, we offered a Valentine-themed cone, among others. Please turn to Slide 6. We remain focused on driving profit and protecting market share in a weak economic environment in Argentina by delivering more value to our customers. In this context, as reported revenues grew 22.9% in the quarter as constant growth of 27% more than offset negative currency translation impacts resulting from the 9% year-over-year average depreciation of the Argentine peso. System-wide comparable sales increased 27.7%, primarily driven by average check growth and an increase in traffic. Successful marketing activities included the continuation of the new affordability platform, Combo del Día, and the Antojos campaign based on core menu items. Also in the quarter, we introduced the Cheddar & Bacon fries and the McFlurry Milka Oreo in the dessert category. Please turn to Slide 7. Excluding Venezuela, the Caribbean division's as reported revenues grew 5.2%. Constant currency revenue growth of 2.8% was supported by a 1.5% increase in comparable sales. The continued strong performance of our Colombian operations supported the divisional results. Marketing initiatives in the quarter included the launch of the Crispy Onion BBQ premium burger as part of the Signature Line, and the consolidation of Almuerzos Colombianos. Also in the quarter, we refreshed our affordability platform with the introduction of the Silvestre burger and included Sing, Lego Batman and Nerf in the Happy Meal. As you can see on Slide 8, for the 12 month period ended March 31, we opened 36 new restaurants, resulting in a total of 2156 restaurants. Most openings took place in Brazil which remains the focus of our expansion strategy over the next three years. We also added 160 dessert centers bringing the total to 2,777. McCafés totaled 316 as of March 31, 2017. While consumption trends are showing signs of improvement, the consumer environment in Latin America remains challenging. We are confident that our marketing strategies and focus on restaurant experience will protect our customer base and bring more guests to our restaurants in the near term while also accelerating a recovery in top line results as consumption trends pickup. As Sergio mentioned, we continue to innovate. Our first experience of the future restaurant pilot in Argentina, which includes self-order kiosk, digital menu books, dual point serving and other features, continues to perform well, and we have plans to add digital capabilities and enhance the use of technology across our restaurant base. Mariano, will now take you through a discussion of our adjusted EBITDA and key balance sheet metrics.

Thanks, Marcelo. Please turn to Slide 9. Solid top line growth in the quarter reflects our efforts to bring additional traffic to our restaurants and the adjusted EBITDA margin expansion we delivered demonstrates the leverage we have built into our operating model. As Sergio mentioned, we were particularly pleased with our efforts to continue optimizing our balance sheet. We have significantly reduced our net leverage over the last 12 to 18 months and have now restructured our long-term debt. The recent completion of the partial tender of our 2023 notes and the successful placement of our 2027 notes, extended the maturity of our long-term debt and reduced its overall cost without raising total to debt levels. Specifically, we issued $265 million of notes due in April 2027, which fund both the $45.7 million partial tender of our 2023 notes as well as the early repayment of our secured loan agreement and the related derivative instrument. The placement of the 2027 notes generated significant investor interest which allowed us to secure a very competitive 5.875% [indiscernible]. Upon completion of this transaction, we also entered into swap agreements to convert $300 million of our U.S. dollar exposure into Brazilian reais. This generated an effective pretax interest rate of around 12.4% compared with the more than 17% variable interest rate on the previous secured loan agreement. The FX exposure of our long-term debt currently stands at approximately 59% U.S. dollar and 41% Brazilian reais. We will continue to evaluate opportunities to balance the FX exposure of our long-term debt. So far, as a result of this transaction, we successfully improved our debt profile by extending the average maturity of our long-term debt from 4.5 years to 7.5 years, lowering the average cost and eliminating the security included in our previous secured loan agreement. Turning now to our operating results. Consolidated G&A fell 40 basis points as a percentage of revenues. Notably, G&A 11.9% year-over-year on a constant currency basis versus the first quarter of 2016, which was well below the estimated G&A blended inflation rate. Adjusted EBITDA was 30% higher than the prior year quarter, Brazil was the key contributor followed by SLAD and the Caribbean division. Net currency translation did not have a relevant impact on consolidated results in the quarter. Please turn to Slide 10. The adjusted EBITDA margin expanded 70 basis points due mainly to margin improvement in Brazil, SLAD and the Caribbean division, partly offset by margin contraction in NOLAD. Efficiencies in food and paper and G&A expenses as a percentage of revenues offset higher payroll and other operating income. In Brazil, the adjusted EBITDA margin rose 20 basis points to 12.4% reflecting efficiencies in food and paper cost. Occupancy and other operating expenses. This more than offset higher occupancy expenses from franchise restaurants and the negative variance in other operating income. For NOLAD, the adjusted EBITDA margin fell 280 basis points to 6.2%, reflecting the 1.1% decline in revenues, as Marcelo just discussed, along with higher food and paper cost, G&A and occupancy and other operating expenses as a percentage of revenues. In SLAD, the adjusted EBITDA margin rose 20 basis points to 9%, driven by efficiencies in food and paper cost and G&A expenses. This was partly offset by higher occupancy and other operating expenses and payroll as a percentage of revenues. The Caribbean division, excluding Venezuela, saw its adjusted EBITDA margin rise 110 basis points to 3.9%, reflecting efficiencies in payroll expenses, food and paper cost and occupancy expenses from franchise restaurants. On Slide 11, non-operating results reflected an $8.6 million foreign currency exchange loss versus a gain of $16.7 million last year. The depreciation of the Mexican peso caused a loss related to intercompany balance, was offset by a stronger Brazilian real. Net interest expense rose $2.2 million to $16.4 million in the quarter. Interest expenses were lower on the 2023 U.S. dollar notes due to the reduced principal balance from last year's successful debt reduction initiative, offset by higher interest expenses on the BRL-denominated debt. Net income for the first quarter was $40.6 million from $16.1 million a year earlier. Stronger operating results which included $52.5 million from our asset monetization initiatives, drove the improvement. So far, we have received cumulative cash proceeds of $128 million from the redevelopment of certain properties, primarily in Mexico. As mentioned previously, based on existing deals, we expect cumulative redevelopment proceeds since inception to total around $150 million by the end of 2017. From Slide 12, you can see our debt metrics. As of March 31, 2017, out net debt to adjusted EBITDA ratio was 1.7 times in line with the end of 2016. In summary, we successfully streamlined our business and optimized our long-term debt structure ahead of schedule. We are now in the early stages of strategic vision designed to increase restaurant volumes and achieve sustainable growth in our long-term cash generation. I am confident that we are in a sustainable path to growth. I will now hand the call back to Sergio.

Thank you, Mariano. Our long-term strategic outlook builds on the achievements of the past two years, while expanding our footprint throughout the region and modernizing our restaurant base. Although market conditions in many of our key countries remain challenging, we feel that we have taken appropriate steps to navigate the recent turbulence in our markets. We believe that our marketing and investment plans for the next several years will deliver further growth in our business and value to our shareholders. Before I open the call up for questions, I wanted to share a few highlights from our ongoing efforts to have a positive impact on our employees lives and on the communities that we serve. Arcos Dorados is the largest provider of first employment in Latin America. We support youth employment and we provide opportunities for the region's young people to acquire the basic skills they need in order to succeed within any professional environment. We also make continuous investments in training our employees and as well as in partnering with other public and private entities to offer educational opportunities at our McDonald's University in Sao Paulo, Brazil. In fact, the Dean of our McDonald's University, Igor Ferreira, was named leader of the year by the Global Council of Corporate Universities just last month. Our portas abertas or Open Doors program continues to showcase our food preparation process, the freshness of our ingredients and the cleanliness of our kitchens. So far this year, we have already hosted more than 1 million guests in our kitchens. We will soon issue a comprehensive report with an update on all of our social engagement initiatives. We remain committed to our community, the environment and all our stakeholders. So thank you for your attention. I will now like to open the call to questions.

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

Sergio, I just wanted to ask with respect to the redevelopment and refranchising revenue. So I think they are different things, right. I get the 150, right. I understand that redevelopment is capped at 150. As you indicated 128 of the 150, if I understand the comments correctly. But I want to ask, if you are still anticipating revenues from refranchising at about $50 million. And when you consider the increase in the [indiscernible] ceiling in Brazil next year, how does that influence your thoughts on refranchising efforts or your projected mix in terms of the new store expansion for Brazil.

Yes. Good morning, Bob. Let me cover first the refranchising piece and then I will let Mariano provide more details on the 128 to 150 of the redevelopment. Bob, you might recall in this during the last Q4 2016 call in the sense that we will continue to review franchising opportunities in our markets, particularly or remarkably in Brazil, as part of our efforts to maximize the operating model. The reality is that we will use future in flows from this indicatives primarily to reinvest in the business. I mean as you are aware, we announced our plan for the next two years cycle. But the refranchising effort has been part of the asset monetization initiative we think with it. As I said before we will continue that, it's by the way part of the normal [ways] [ph] and vision, that’s what we do. In a geography as wide as we have, we are always looking for opportunities to optimize the, we have their ownership structure, right. So we do not foresee any significant change in the ownership split that we have. It's [228] [ph], 70:30, 75:25, will be in that range as it was so far. Mariano, why don’t you cover the 128, 150?

Hi, Bob. Regarding the redevelopment, so far we have received around $128 million in cash, which so far has mostly been applied towards debt reduction. As we mentioned in the last call, we are expecting for 2017 to achieve additional proceeds of around $22 million and as we also mentioned in the last call, the company decided to stop the initiative at that amount. So we are not expecting any further redevelopment proceeds beyond those $150 million we announced in the previous call.

[Operator Instructions] We have no other questions at this time so I would like to turn the conference back over to Sergio Alonso for any closing remarks.

Okay. So thank you for your question, Bob, today and your attention. We certainly look forward to speaking with you again in the next quarter. And 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.

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