Arcos Dorados Holdings Inc. annual report, Q4 FY2014

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Arcos Dorados Holdings Inc. — FY 2014 Form 20-F

Business context and reporting period: Annual report for the fiscal year ended December 31, 2014; it is not a standalone Q4 report, and the filing does not provide clear Q4-only financial results. Arcos Dorados operates and franchises McDonald’s restaurants in 20 Latin American and Caribbean territories. Financial statements are audited and prepared under U.S. GAAP; amounts below are U.S. dollars.

Financial and operating performance

  • Revenue: $3.651 billion, down 9.5% from $4.033 billion in 2013. Company-operated restaurant sales declined 9.2% to $3.504 billion; franchised restaurant revenue fell 15.4% to $146.8 million. Management attributed the overall decline principally to local-currency depreciation against the U.S. dollar.
  • Comparable sales and systemwide sales: Constant-currency systemwide comparable sales grew 10.0% (8.5% at company-operated restaurants). Nominal systemwide sales declined 9.4%, while constant-currency systemwide sales increased 14.7%. Systemwide average restaurant sales fell to $2,268 thousand from $2,611 thousand, primarily reflecting currency translation.
  • Profitability: Operating income was $70.9 million, down 69.0%; operating margin was 1.9%, versus 5.7% in 2013. Net loss attributable to Arcos Dorados was $109.3 million, compared with net income of $53.9 million; diluted loss per share was $0.52. Adjusted EBITDA, a non-GAAP measure, was $251.7 million versus $344.5 million, with margin of 6.9% versus 8.5%.
  • Key unusual operating charges: Other operating expenses rose to $95.5 million from $15.1 million, including $50.9 million of long-lived-asset impairments, $2.0 million of goodwill impairment, and $19.4 million of Venezuelan inventory write-downs. Adjusted EBITDA excludes specified items, including impairments and certain other charges.
  • Cash flow and investment: Operating cash flow was $193.1 million, down from $217.0 million. Capital expenditures were $169.8 million, versus $313.5 million; net cash used in investing activities was $169.0 million. Financing provided $1.2 million, versus $102.3 million in 2013. Cash declined by $36.6 million to $139.0 million, including a $61.9 million adverse effect from exchange-rate changes.
  • Margins and costs: Food and paper costs were 35.5% of company-operated sales, up 0.5 percentage points. Payroll costs were 20.9%, down 0.1 points. Occupancy and other operating expenses were 28.5%, up 1.1 points. The filing cites inflation, input costs, Venezuelan exchange-rate accounting and weaker sales in certain markets as contributors.
  • Debt and liquidity: Total financial debt was $801.2 million, including $32.5 million short-term debt and $767.2 million long-term debt; cash was $139.0 million. Working capital was negative $94.9 million. The $75 million committed revolving facility had no balance due at year-end and matured August 3, 2015. Debt includes $469.0 million of 2023 notes and $255.0 million of 2016 notes; the latter mature July 2016.
  • Scale: The company had 2,121 systemwide restaurants at year-end, including 1,577 company-operated and 544 franchised. It opened 82 and closed 23 restaurants in 2014, compared with 130 openings and 16 closings in 2013.

Material changes versus 2013

  • Revenue declined 9.5% and operating income fell 69.0%; the company moved from net income to a $109.3 million net loss.
  • Foreign-currency exchange losses increased to $74.1 million from $38.8 million. Venezuela’s SICAD and SICAD II exchange-rate changes were significant contributors.
  • The Caribbean division reported an $88.7 million operating loss and negative $8.1 million Adjusted EBITDA, compared with positive operating income of $37.8 million and Adjusted EBITDA of $67.2 million in 2013. Results were heavily affected by Venezuela’s currency remeasurement and operating conditions.
  • Capital expenditures declined substantially, consistent with slower restaurant expansion and the stated shift toward existing restaurants; company-operated restaurant count nevertheless increased.
  • Cash and total assets declined; total liabilities also decreased, while year-end financial debt was higher than in 2013 ($801.2 million versus $785.0 million).

Outlook, risks and contingencies

  • Outlook and investment plans: Management expected 2015 capital expenditures of $90–$120 million, including 40–45 gross restaurant openings. The existing 2014–2016 McDonald’s commitments required at least $180 million of reinvestment and 250 openings; the company had proposed amending the plans to reflect regional economic conditions, with no assurance an amendment would be agreed.
  • Franchise agreement and covenants: McDonald’s master franchise agreements run generally through 2027 and require compliance with financial ratios, investment and opening plans. McDonald’s granted a six-month waiver of certain MFA ratios through December 31, 2014; an extension was under negotiation. The company also amended its bank-facility and equity-swap leverage thresholds after 2014 non-compliance and reported compliance with the revised thresholds. A material breach could permit McDonald’s to acquire interests in the business, in some cases at 80% of fair market value.
  • Venezuela and currency exposure: Venezuela’s hyperinflationary accounting, exchange controls, limited access to foreign currency, price and rent regulation, and risk of further devaluation materially affected results. Venezuela generated $187.6 million of 2014 revenue and a $75.0 million operating loss. Subsequent to year-end, Venezuela announced changes to its exchange mechanisms; management said access to U.S. dollars and future exchange-rate effects remained uncertain.
  • Other material risks: Argentina’s exchange controls and peso depreciation may hinder remittances and payments abroad. Broader risks include inflation, economic weakness, competition, commodity and labor costs, regulatory changes, supplier dependence, and the company’s reliance on McDonald’s brand and franchise rights.
  • Legal matters: The company recorded a $12.2 million net provision for contingencies after judicial deposits. It disclosed a possible loss range of $24–$34 million for certain tax and labor matters. Puerto Rican franchisee claims seek $66.7 million, a related claim seeks $30 million, and a franchisee association claim seeks $31 million; management stated it considered adverse final outcomes unlikely. Outcomes remain uncertain. Brazilian labor matters and other proceedings are also disclosed.
  • Dividends and controls: The company paid $50.0 million of 2014 dividends ($0.24 per common share); no 2015 dividend had been declared as of the report. Management and the auditor reported effective disclosure controls and internal control over financial reporting; the financial-statement audit opinion was unqualified.

Most important facts for investors to verify

  • Review the full Venezuela disclosures and the exchange rate used in subsequent reporting, including the effects on cash access, earnings, assets and potential impairments.
  • Confirm whether McDonald’s extended the MFA financial-ratio waiver and approved changes to the 2014–2016 opening and reinvestment commitments.
  • Assess liquidity against negative working capital, near-term debt maturities, lease obligations and the revolving facility’s August 2015 maturity.
  • Reconcile reported net loss and operating-income deterioration with impairment charges, currency losses and the company’s non-GAAP Adjusted EBITDA adjustments.
  • Track developments in the disclosed legal claims, the $24–$34 million possible-loss range, and the adequacy of recorded provisions.