Arcos Dorados Holdings Inc. — FY2018 Form 20-F
Period: Fiscal year ended December 31, 2018. This is an annual report, not a standalone fourth-quarter filing; Q4-only results are not clearly provided. Financial statements are audited under U.S. GAAP and presented in U.S. dollars.
Business context
Arcos Dorados is the largest independent McDonald’s franchisee by systemwide sales and restaurant count, operating in 20 Latin American and Caribbean countries and territories. At year-end it operated or franchised 2,223 restaurants: 1,540 company-operated and 683 franchised. Brazil contributed 43.7% of revenue, SLAD 27.4%, the Caribbean 15.7%, and NOLAD 13.2%.
Financial performance and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Total revenue | $3,081.6 million | $3,319.5 million |
| Operating income / margin | $123.5 million / 4.0% | $272.9 million / 8.2% |
| Adjusted EBITDA / margin | $258.0 million / 8.4% | $304.9 million / 9.2% |
| Net income attributable to Arcos Dorados | $36.8 million | $129.2 million |
| Operating cash flow | $179.7 million | $255.2 million |
| Capital expenditures | $197.0 million | $174.8 million |
| Cash and cash equivalents at year-end | $197.3 million | $308.5 million |
- Revenue fell 7.2% in reported dollars, while systemwide sales declined 6.3%. Management attributed reported-dollar declines mainly to currency depreciation, particularly in Argentina, Brazil, and Venezuela. Comparable sales growth was exceptionally high but distorted by Venezuelan hyperinflation.
- Operating income fell 54.8% and attributable net income fell 71.5%. Adjusted EBITDA declined 15.4%. The operating margin contracted 4.2 percentage points.
- Food and paper costs were 35.1% of company-operated sales, unchanged year over year. Payroll costs declined to 20.7% of company-operated sales, while occupancy and other operating costs rose to 27.4%.
- Net interest expense was $52.9 million. The effective tax rate was 56.5%, versus 29.2% in 2017, affected by Venezuelan remeasurement and inflation impacts and changes or expirations of tax loss carryforwards.
- Cash used in investing activities was $163.8 million; cash used in financing activities was $73.4 million, including $46.0 million of share repurchases and $20.9 million of dividends. The cash balance declined by $111.2 million, including a $53.7 million adverse effect from exchange-rate changes.
- Year-end working capital was negative $28.8 million (current assets $464.6 million versus current liabilities $493.3 million). Management stated liquidity was adequate for anticipated needs over at least the next 12 months.
- Long-term debt on the balance sheet was $626.4 million, with $4.2 million of current debt and a reported total financial-debt measure of $589.8 million after specified adjustments, including derivative fair value. The principal notes were $348.1 million due 2023 at 6.625% and $265.0 million due 2027 at 5.875%. The company reported compliance with its revolving-credit leverage covenant (ratio 0.97).
Material changes and unusual items
- Other operating results swung from $68.6 million of income in 2017 to $61.1 million of expense in 2018. The comparison was affected by substantial 2017 property-sale gains and higher 2018 Venezuela inventory write-downs. The filing gives differing write-down figures in its discussion and notes; the precise comparable amount should be checked against the financial-statement detail.
- 2018 included $19.1 million of long-lived asset and goodwill impairment charges and $11.0 million of reorganization and optimization costs, both excluded from management’s Adjusted EBITDA measure.
- Argentina was treated as highly inflationary under U.S. GAAP from July 1, 2018; Venezuela had been treated as hyperinflationary since 2010. Currency translation and remeasurement materially affected reported results and comparability.
- The company adopted ASC 606 in 2018, deferring initial franchise fees over franchise terms. It reported a $3.8 million cumulative reduction to opening retained earnings; management did not expect a material ongoing net-income effect.
- Operating lease obligations totaled $975.9 million at year-end. The company expected adoption of the new lease standard in 2019 to add approximately $860–$920 million of right-of-use assets and lease liabilities.
Outlook, commitments, and key risks
- For 2019, management expected capital expenditures of $270–$300 million and 80–85 gross restaurant openings. For 2017–2019, the contractual plan required 180 openings and $292 million of reinvestment; the company then expected at least 200 openings, at least $390 million of reinvestment, and approximately $660 million of total capital expenditures.
- McDonald’s growth support produced an effective royalty rate of 5.4% in 2018; the company projected approximately 5.9% for 2019. The master franchise agreements run through 2027, with a potential 10-year extension subject to McDonald’s decision during 2020–2024.
- Management cited weak macroeconomic and consumer trends in some major markets, inflation, currency volatility and reduced pricing flexibility as near-term challenges. Results are also exposed to food, labor, utility, and delivery costs and the ability to pass cost increases to customers.
- Venezuela presents heightened risks from hyperinflation, currency and price controls, restrictions on repatriating earnings, inventory and asset impairment, and potential government intervention. Argentina is also exposed to high inflation and possible renewed exchange restrictions.
- The company had $80 million of standby letters of credit supporting MFA obligations and substantial restaurant-opening and reinvestment commitments. Failure to meet MFA requirements could give McDonald’s termination or acquisition rights. The agreements require at least 50% of restaurants in each territory to be company-operated.
- Potential tax and labor losses were disclosed in a range of $188–$196 million, apart from a $28.5 million net contingency provision. The filing also identifies $181 million of possible tax exposure relating to 2009–2014 assessments for which no formal claims had been made. Puerto Rican franchisee claims and Brazilian labor matters remain relevant contingencies; management considered certain Puerto Rican losses remote.
- Auditors gave unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal controls as of year-end.
Most important facts for investors to verify
- Reconcile reported sales and the exceptionally high comparable-sales figures with constant-currency performance, especially the effects of hyperinflation and Venezuelan exchange-rate accounting.
- Confirm the amount, nature, and cash impact of Venezuela-related inventory write-downs, impairment charges, and any restrictions on accessing or repatriating local cash.
- Review cash-flow generation against planned 2019 capital spending, lease commitments, and dividends and repurchases; confirm liquidity and covenant headroom.
- Assess the $188–$196 million possible loss range, the separate $181 million tax exposure, and developments in the disclosed litigation and tax audits.
- Evaluate MFA renewal and compliance risk, including required reinvestment, restaurant openings, royalty obligations, and McDonald’s call-option rights.
- Consider governance and share structure: the controlling shareholder held approximately 77.9% of voting interests, and the company relied on foreign-private-issuer exemptions from certain NYSE governance standards.