Nov 5, 2013
Executives
Sofia Chellew – Director, IR Woods Staton – Chairman and CEO Sergio Alonso – COO Germán Lemonnier – CFO
Analysts
Jeronimo De Guzman – Morgan Stanley John Ivankoe - J.P. Morgan Philip Guson – Mitsubishi Securities Robert Schweich - Burnham Securities
Operator
Good morning everyone and welcome to the Arcos Dorados’ Third Quarter 2013 Earnings Conference Call. With us today are Woods Staton, Chairman and Chief Executive Officer; Sergio Alonso, Chief Operating Officer, the company's Chief Financial Officer, Germán Lemonnier; and Sofia Chellew, Investor Relations Director.
A slide presentation accompanies today's webcast, and this is available at the Investors section of the company's website, www.arcosdorados.com. As a reminder, all participants will be in a 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 and at this time, I would like to turn the conference call over to Ms.
Sofia Chellew. Please go ahead.
Sofia Chellew
Thank you. Hello everybody.
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 measures to the comparable GAAP results, which can be found in the press release filed with the SEC on Form 6-K. I would like to now turn the call over to our Chairman and CEO, Woods Staton.
Woods, please proceed.
Woods Staton
Thank you, Sofia. Hello everyone and thank you very much for joining us today.
I am very pleased to report double-digit underlying growth in our business in the third quarter, which is a testament to the strength of Arco Dorados’ operations as well as the McDonald’s brand throughout Latin America. Despite continued soft consumption across some of the markets, we achieved comparable sales growth of 12.6%, organic revenue growth of 18.5%, and organic adjusted EBITDA expansion of 25.8% in the quarter.
I am particularly pleased with the margin expansion achieved in Brazil despite the weakened environment. Since the start of the year, we are consistently expanding comparable sales and organic adjusted EBITDA on a sequential basis.
Part of this improvement reflects more favorable year-over-year comparison, which we noted earlier in the year would benefit second half results. Moreover, the results underscore the continued strong brand preference that exists in our region.
In an environment where economic and political uncertainty continue to impact several key markets, our team has drawn on decades of operating experience in Latin America to implement strategies focused on those areas within our control. We have a compelling marketing calendar and in the third quarter, the momentum created by the recent launch of the successful Chicken McBites product offering in many markets enhanced sales.
This resulted in broad based comparable sales growth across our four divisions reinforcing our dominant position within the region. Based on internal and available public data, in the third quarter, we once again outperformed our listed peers in terms of comparable sales and outpaced most consumption metrics in key markets.
In our largest market Brazil, we maintained our dominant position with the best coverage of any QSR in the country and across the region, we expanded our overall footprint to 1993 restaurants, up 113 year-over-year, contributing additional revenue. Alongside top-line growth, we also achieved strong growth in organic adjusted EBITDA through a strict focus those levers within our control.
During the quarter, we were able to lower most cost items as a percentage of sales, thanks our efforts to contain fixed cost and mitigate the impact of currency volatility, particularly in Brazil. Additionally, in October, we concluded a debt restructuring and successfully reduced our overall cost of funding, while extending the average maturity of our debt.
Given our strong results, for the first nine months of the year, we are confident that we will reach our revenue guidance and even expect to exceed organic adjusted EBITDA full year guidance. As the market leaders, we are operating from a position of strength and I remain confident that we will continue to profitably expand our business going forward.
I will now hand the call over to Sergio Alonso, who will go through Arco Dorados’ third quarter performance in more detail. Sergio?
Sergio Alonso
Thank you, Woods and hello everyone. Turning to Slide 3, our strong marketing calendar and solid execution has enabled us to overcome soft consumption growth across several key markets this year and the third quarter was no exception.
The successful Chicken McBites promotion was a key driver of sales in the quarter. And in addition, the family business also stimulated sales.
Because of these efforts, and the overall strength of our product portfolio, we were able to increase average check in line with inflation despite strong competition. Turning to Slide 4, Brazil’s revenues were flat in the quarter mainly due to the depreciation of the Brazilian Real.
Excluding the currency impact, revenues gained 12.8% year-over-year. System-wide comparable sales were at 5.6% primarily due to average check.
As Wood mentioned, we benefited from easier year-over-year comps across the region. However, I would like to point out that we are comparing with September of last year, there was a particularly strong bounce for traffic in Brazil due to the heavily successful Big Mac promotion at that time.
Despite this tough comparison, together we continued mix tightness from other consumer industries our third quarter results were strong. This reinforces our strategy of offering great value combined with a strong product portfolio and premium products.
Alongside Chicken McBites. Desserts like the Ice Cream Cone and McFlurry Platform also performed very well.
The net addition of 71 restaurants during the last 12 month period contributed $31.5 million to revenues in constant currency. Turning to Slide 5, revenues in the Latin America division increased 7.9% or 6.6% on an organic basis, year-over-year.
System-wide comparable sales returned to positive growth from the second quarter increasing 1.2% year-over-year despite the soft consumer environment. This reflects the strong performance of the Family business and the Desserts category primarily in Mexico.
And also in Mexico, comparable sales outgrew the broader retail sector according to data from the National Association of Supermarket and Department Stores which has been showing declines versus the prior year. The net addition of seven restaurants during the past year added $5.7 million to revenues in constant currency.
Please turn to Slide 6. In SLAD, revenues grew by 13.1% and 31.2% on an organic basis year-over-year.
Comparable sales have been improving throughout the year and during the quarter in the division. Successful marketing activities underpinned a 25% increase in comparable sales as this is an increase in guest counts.
Marketing initiatives including Chicken McBites along with the strengthening of our Family business benefiting sales and overall results. The net addition of 22 restaurants during the last year contributed $15.8 million to revenues in constant currency in the quarter.
Turning to Slide 7, the Caribbean division achieved revenue growth of 11.5%. Excluding currency variations, organic revenues increased by 22.7% year-over-year.
System-wide comparable sales grew 22.5% driven by increased average check, primarily on the back of price increases in Venezuela, as we continue to pass some higher cost in this country. Despite the negative traffic this has caused and the challenging condition in this market, we have gained share according to internal data.
Successful regional and local marketing campaigns, such as Chicken McBites in Colombia and the new Quarter Pounder Flavors in Puerto Rico, helped mitigate traffic declines in the division. The net addition of 13 restaurants during the last 12 month period contributed $5.2 million to revenues in constant currency during the quarter.
As you can see on Slide 8, gross openings of 129 restaurants on a consolidated basis, over the 12 month period ended September 30, resulted in a total of 1993 restaurants, 2157 Dessert Centers and 344 McCafe’s. Germán will now disclose our adjusted EBITDA generation and other financial metrics.
Germán Lemonnier
Thanks, Sergio. Please turn to Slide 9 to review our adjusted EBITDA performance.
Adjusted EBITDA increased 8.1% year-over-year to $90.4 million in the third quarter. Excluding special items and currency impacts, organic adjusted EBITDA was up 25.8% backed by top-line growth.
Additionally, with the exception of payroll, we were able to lower most cost items as a percent of sales in the quarter. This achievement reflected strong revenue growth, combined with certain hedges, G&A leverage, and other operating efficiencies.
The special items included an increase in corporate G&A when compared to a net gain of $2.9 million in the third quarter 2012 related to the CAD incentive plan, versus a small net charge in the third quarter 2013. The company also recognized an additional year-over-year benefit in third quarter 2013 of $0.8 million related to the temporary royalty waiver from McDonald’s Corporation for Venezuela.
The Adjusted EBITDA margin as a percent of total revenues increased by 16 basis points to 8.8% with improved margins in Brazil and NOLAD. Turning to Brazil, third quarter adjusted EBITDA grew 11.8% or 26% on an organic basis.
Adjusted EBITDA margins increased strongly by 135 basis points, 12.7% in the third quarter of 2013. Net income attributable to the Company was $19.6 million in the third quarter of 2013, while revenue growth was flat year-over-year, margin improvement was driven by the reduced food & paper costs, helped by the use of hedges to mitigate currency pressure, lower occupancy and other expenses as a percent of sales mainly due to lower energy rates.
But these costs were partially offset by increased G&A as well as higher payroll as a percent of sales due to the ongoing migration to fixed work schedules and higher employee benefit provisions because increases were have experience from the shift to fixed schedules are expected to stabilize going forward as we use turnover in headcount to modify work schedules. In NOLAD, adjusted EBITDA increased by 12.8% year-over-year to $8.1 million or by 11.2% on an organic basis.
Margins mainly benefited from increased comparable sales along with G&A leverage and lower food and paper costs as a percentage of sales. These factors more than offset increased payroll as a percentage of sales.
As a result, the adjusted EBITDA margin grew 34 basis points to 7.7%. Adjusted EBITDA in SLAD increased by 11.9% or 31.2% on organic basis.
Organic EBITDA benefited from increased sales which were partially offset by higher occupancy and other expenses. As a result, adjusted EBITDA margin from the division reached 12.5%.
Finally, in the Caribbean Division Adjusted EBITDA grew 2.9% to $19.2 million in the quarter. The company recognized its royalty waiver from McDonald’s Corporation for Venezuela of $2 million in the quarter, versus $1.3 million in the prior year period.
On an organic basis, adjusted EBITDA increased by 13.9% year-over-year. The adjusted EBITDA margin decreased 75 basis points to 9% as the higher dollar-denominated food and paper costs in Venezuela more than offset revenue growth and improvement in all other cost items in the division as a percent of sales.
Turning to Slide 10, third quarter non-operating results reflected the 107.7% increase in overall funding costs. The increase is mainly explained by the one-time charge of $12.7 million related to the debt transaction.
As a reference, in September, the company launched a Tender & Exchange Offer for its outstanding 2019 7.5% bonds and issue 2023 bonds at 6.625%. As a result of the transaction, we improved our overall debt profile by expanding the maturity and reducing the blended rate at a time when interest rate are predicted to increase.
Income tax expense for the quarter totaled $15 million compared to $11.4 million in the year-ago. The effective tax rate for the third quarter reflects the mentioned one-time charge related to the debt transaction as well as a recent tax reform in Puerto Rico.
As a reference, for the first nine months of the year, the effective tax has been similar to the previous year if we exclude the debt transaction and the official devaluation in Venezuela. Basic earnings per share were $0.09 in the third quarter of 2013 compared to $0.16 in the previous corresponding period.
Slide 11 contains our debt indicators. Cash and cash equivalents were $338 million at September 30.
Total financial debt was $911.5 million while net debt was $573.5 million and the net debt/Adjusted EBITDA ratio was 1.7 times. Capital expenditures amounted to $62.8 million in the third quarter.
This excludes the debt transaction that I had mentioned. The total principal amount of 2019 Existing Notes Tender was $208.8 million.
As a result, we issued a total of $473.8 million of 2023 notes and reduced the amount of the standing 2019 bonds from $308.6 million to $99.8 million. Along with the uses connected to the offer, the majority of the proceeds were also used to repay short-term debt around $60 million, unwind a cross currency swap around $10 million and for general corporate purposes.
In addition, the company has a call option for next year on its outstanding 2019 bonds and evaluating an early redemption. Given strong year-to-date growth in our consolidated results, we would like to confirm, our full year 2013 revenue growth of 15% to 18% and we believe we will exceed our guidance range for organic adjusted EBITDA growth of 8% to 10%.
Additionally, given recent reforms in Puerto Rico, we expect the effective tax rate to be in the range of 35% to 38% excluding any financial activities. As a reminder, guidance is in constant currency and excludes the special items in both years.
A capital plan for the full year includes approximately 130 gross openings, down from 140 previously. In addition, total capital expenditures are now expected to reach approximately $270 million from $208 million respectively, mainly due to the real devaluation.
I wanted to mention a recent development in Brazil. In October, the Brazilian authorities issued a preliminary rule in favor of the company regarding the employee meal program also known as the PAT, we are currently analyzing the legal implications to determine potential benefits.
I will now turn the call back to Woods, Woods?
Woods Staton
Thank you, Germán. Our strong third quarter results showcases strength of the McDonald’s brand in Latin America and our ability to execute targeted strategies to overcome challenging environments across our markets.
Strong population growth, untapped demand for our products and a burgeoning middle-class are driving the long-term expansion of the QSR segment. As the market leader, we have been at the forefront of this growth.
Our current footprint encompasses iconic locations throughout the region which our competitors will find extremely difficult to replicate. While the long-term growth prospects in the region remain unchanged, given current economic, political and political uncertainties, as well as currency volatility in some of our key markets, we are considering modulating the pace of our restaurant openings in the near term while we double our efforts to improve profitability and maintain sound debt levels and ratios.
Under such a plan, we would remain committed to opening a balanced portfolio of restaurants, not just points of sales. And growth in our largest market Brazil for the McDonald’s brand has almost three times the market share of its closest listed competitor will continue to be a priority.
While the moderation in the pace of openings will impact top-line growth, we are working to improve margins, increased G&A leverage, and provide more predictability to our food and paper costs. As such, we have already hedged part of the imported portion of our dollar costs for 2014.
This focus is in line with our guiding strategy, [foreign language] or recipe to win. And I am confident that advances in our profitability initiatives combined with the continued expansion of our footprint in key markets will set the stage for improved results in the coming years.
Thank you for your attention. I would now like to open the call up to questions.
Operator
(Operator Instructions) And our first question comes from Jeronimo De Guzman from Morgan Stanley. Please go ahead with your question.
Jeronimo De Guzman – Morgan Stanley
Hi, good morning. I had two questions, my first question was about your same-store sales growth in Brazil.
I wanted to see what you were thinking about the expected pace going forward. Now that you’ve lapsed the price increases in the value platform.
I just wanted to see what you can do to maintain ticket growth or potentially get more of your top-line growth from traffic gains.
Woods Staton
Yes, good morning, Jeronimo. Look, first of all, don’t forget we are comparing ourselves to last year where we had a very strong Big Mac promotion that ended around the middle of the month and for further color, I’ll pass it to Sergio so he can provide more information.
Sergio Alonso
I think it’s appropriate to mention that the Big Mac was run on part of our McFlurry Platform and it impacted all September and the large part of August last year. So we were competing with the tough base.
And on top of that, of course, I mean, the overall economic situation in the country is not as dynamic as we expected. It was projected actually at the end of last year.
So and as this year compasses, we stick to our strategy that led us to increased sales, mainly, protect margins. So – and also as Germán said, our revenue guidance remains exactly at the same level.
So, that indicates our confidence on the remaining part of the year.
Jeronimo De Guzman – Morgan Stanley
Okay, thanks. And then, just the separate question on the expansion, you mentioned a more moderate pace of unit growth.
I wanted to see what this means for – what you are thinking about for 2014 and if there is any specific regions or any specific countries, where you are focused on slowing down the expansion?
Woods Staton
Yes, we will provide more detailed guidance when we start going through our fourth quarter results in January, but this is a dynamic market, given the current environment, we expect to moderate unit openings in the near term. We are in a planning process right now.
We really don’t know where, but as you know, we will always focus on Brazil and we will focus on higher profitability.
Jeronimo De Guzman – Morgan Stanley
Okay, thank you.
Operator
(Operator Instructions) Our next question comes from John Ivankoe from J.P. Morgan.
Please go ahead with your question.
John Ivankoe - J.P. Morgan
Yes, hi. Great, several if I may.
First, that the Brazil labor lawsuit affects the third quarter margins in any way or is that a potentially going forward margin benefit?
Woods Staton
Hi, John this is Woods. Yes, let me pass it to Germán so we can…
Germán Lemonnier
You want me to explain what?
Woods Staton
Is it the PAT, John, you are asking about?
John Ivankoe - J.P. Morgan
Yes, exactly.
Woods Staton
Okay, let me pass it to Sergio.
Sergio Alonso
Sure, John. How are you?
PAT at the beginning we said, let me give you some color on what it is exactly. PAT stands for Programa de Alimentação do Trabalhador which is – indicates that in Brazil, the labor law requires companies to provide a meals to its employees.
Okay, so, what it is – this subject is whether the meals are not provided to our employees, I can see their part of the salary or not leading to pay all taxes. So, Germán, do you want to?
Germán Lemonnier
Yes, Sergio, John, how are you? Relative to the – the rule is relatively new in October but it’s positive for us.
So we are analyzing this with our lawyers, because you the Brazilian laws are very complicated, but we – I should also say, there are benefits there for the past, for the provision and going forward, but I don’t feel comfortable right now to give a number. But, year-end, probably we will have a number that will be disclosed to the market.
John Ivankoe - J.P. Morgan
And could we, slightly separately on Brazil, talk about initiatives such as the CBB program in breakfast, how far along those programs are in the system and the future plans are to roll this out?
Woods Staton
Yes, John let me past it to Sergio who will give you an update on CBB.
Sergio Alonso
Yes, on CBB, what we are doing, if you recall, John, we already have the platform implemented in Puerto Rico and Mexico where we’re doing pretty well. In Brazil, the plan is to have by year-end, this year 2013, the biggest markets.
So with the equipment, so we will have the chance to market the new products early next year. So we are working at the very high pace to have all the restaurants with equipment installed and by 2014 you will have – being part of our marketing calendar, early 2014 all the CBB platform.
John Ivankoe - J.P. Morgan
And that will be the first time for national advertising for that?
Sergio Alonso
Yes.
John Ivankoe - J.P. Morgan
And could you remind me what percentage of your stores have breakfast and whether that’s increasing or is it relatively static at this point?
Sergio Alonso
Well, breakfast in Brazil, remember that, around 40% of our restaurant base in Brazil are placed in shopping malls. So, due to opening hours, we cannot offer breakfast, okay.
So I would say that the remaining portion around 60% we offer breakfast. Though it has to be said that we do not have the wide product range that McDonald’s has for instance in the States, or as such we have in Puerto Rico and Mexico is a more leaning approach in terms of product portfolio.
So relatively new category for us, so it’s growing and we are happy and of course it will be a medium-term business opportunity.
Operator
And our next question comes from Philippe Guson from Mitsubishi Securities.
Philip Guson - Mitsubishi Securities
Yes, good morning, my question I think is largely, or my two questions are largely for Germán. First question, with the – and this relates to your Mexican operations, Germán.
With the Congress in Mexico passing a new tax on both fast food and sugar drinks, can you kind of share with us what you think the impact will be on your business and what you can do to remediate perhaps a decline in volumes there? And then my second question is related to your leverage metric, if I make the adjustments for leases in the way that Moody’s does it, you are getting a little bit close to the higher end of the range that I feel comfortable with based on the current trading.
What is it, that you could do in terms of bring that leverage down if there were to be deterioration in operating performance or even in the currency translation that would push you above the 4.5 times? Thank you very much.
Woods Staton
Yes, let me answer the first part, this is Woods, the new legislation in Mexico regarding soft drinks and snack food does not affect us at all. So we – it just came out last week.
We are still trying to figure out some indirect impact, but it’s too soon to tell, but it doesn’t – at least it been here and I will pass it over to Germán for your second part of the question.
Germán Lemonnier
Well, okay, we follow closely the net debt to EBITDA ratio because we look at more representatives in our geography. We don’t have any point with leverage ratio including the leases from a covenant point of view with McDonald’s, with any bond holder.
The difference between Moody’s and Fitch for example is, Fitch knows that in Latin America the majority of the leases can be finished or terminated without any big penalty, normally between two to three months of payment. So, this ratio, we follow the ratio, but it’s not forcing us to any drastic decision that we can manage that.
Operator
(Operator Instructions) And we have a follow-up question from John from Ivankoe from J.P. Morgan Please go ahead with your follow-up.
John Ivankoe - J.P. Morgan
Yes, thank you. I wondered if there was an appropriate time to begin the talk about how Arcos Dorados may sponsor the World Cup in 2014.
Woods Staton
Yes, John, good question. We are lucky as a brand to be related to the World Cup as well as the Olympics all over the world.
The World Cup will be held next year in Brazil which is the World Champion. It’s going to be a huge party.
It’s going to be very good for our brand. And, it’s going to help build an exciting market calendar.
We have a player escort program. We have launched promotions.
As you probably remember, McDonald’s is involved with training the Olympics hosts in London. We are doing the same thing with the FIFA Volunteers.
So that’s a great thing for us to show ourselves off. And so we are working diligently on capitalizing this great event for Brazil and as we get more news, we will let you know.
John Ivankoe - J.P. Morgan
Okay, and can you tell us what the hedge rate was for fiscal 2014? I assume that you were referring to Brazil and if I remember correctly, I think it was 210 in fiscal 2013?
Woods Staton
Yes, let me pass it to Germán.
Germán Lemonnier
Hi, John. Again, at the last year, we tend to be very proactive in terms of hedges.
You know we hedge – but in the case of Brazil all the 2013 we are advancing the 2014. We almost have three tenth of – part of the year closed, all the six first months, big part of the third quarter and a small part in the fourth quarter.
We are continuing to see windows to try to lock at all the food and paper imported parts in Brazil, but at the same time we are doing hedges in other countries with opportunities like Colombia, Chile and Uruguay. We continue to try to be predictable, not to beat the market.
John Ivankoe - J.P. Morgan
Okay, and last one for me I promise. You showed a foreign currency, I guess, gain in the quarter, I mean and that had been a loss recently I presume because of Venezuela, could you shed some light on that?
Woods Staton
Thank you, I’ll pass it to Germán.
Germán Lemonnier
Yes, because, in the quarter, there was a significant Real appreciation in September that offset the impact in the first two months of the quarter. It was a special quarter only because of the appreciation of the Real in September.
Operator
(Operator Instructions) Our next question comes from Robert Schweich from Burnham. Please go ahead with your question.
Robert Schweich - Burnham Securities
I know that you prefer to give us more definitive information that at the end of the year, but I don’t think it’s correct for you to make a big point Woods at the end of your presentation that you plan to moderate expansion for the year 2014 and not give us some idea of what this implies. Does this imply that the 130 units of this year will go down below 100 or does this imply maybe 120, can you give us some order of magnitude even though you haven’t finalized your plans?
Woods Staton
Hi, Bob. We – it’s very tough for me to talk about the future where the dynamic situation in Latin America.
As you’ve seen the predictions of gross domestic product growth in all of the countries that we are in, missed their mark this year and I don’t want to get ahead of ourselves. I think, we have to maintain our debt ratios.
We are working on profitability and we will grow as fast as we can and as fast as we think is sound, but, Brazil, just – we will keep being as aggressive and as competitive as we can, but we need to be careful. It’s a dynamic market.
And, more to come in the next few months, we are still in our planning phase.
Operator
(Operator Instructions) And at this time, I am showing no additional questions. I would like to turn the conference call back over to Woods Staton for any closing remarks.
Woods Staton
Well, thank you all for joining us today. It was a strong quarter and we are pleased with the results today.
Our IR team is available to answer any questions and I look forward to speaking to you again soon. Thank you very much and good bye.
Operator
And ladies and gentlemen, that does conclude today’s conference call. We do thank you for attending.
You may now disconnect your telephone lines.