McDonald’s Corporation — Q3 2014 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2014, compared with the same periods in 2013. McDonald’s operated or franchised 35,864 restaurants in 119 countries; 29,172 were franchised or licensed and 6,692 were company-operated.
Financial results
Amounts are in millions of dollars except per-share data. Percent changes are year over year.
| Metric | Quarter | Nine months |
|---|---|---|
| Revenue | $6,987; down 5% (4% in constant currencies) | $20,869; down 1% (flat in constant currencies) |
| Operating income | $2,073; down 14% | $6,198; down 6% (5% in constant currencies) |
| Net income | $1,068; down 30% | $3,660; down 13% |
| Diluted EPS | $1.09; down 28% | $3.69; down 11% |
| Cash provided by operations | $1,833 | $5,227, versus $5,247 |
| Capital expenditures | $659 | $1,817 |
Margins and operations: Nine-month combined operating margin was 29.7%, versus 31.2%. Company-operated restaurant margin was 15.7% in the quarter, down from 18.7%; franchised restaurant margin was 82.0%, down from 83.0%. Global comparable sales fell 3.3% in the quarter and 1.0% year to date; comparable guest counts fell 3.7% for the nine months.
Cash, liquidity and debt: Cash and equivalents were $2,826 at September 30, compared with $2,799 at December 31, 2013; short-term investments were $408. Nine-month operating cash flow exceeded capital expenditures by $3.4 billion. Debt obligations were $15.1 billion, up from $14.1 billion at year-end, primarily reflecting $1.5 billion of bond issuances, partly offset by $542 million of repayments. The filing estimates debt fair value at $16.5 billion. Current assets were $5,210 and current liabilities $4,180 at quarter-end.
Shareholder returns: The company returned $4.6 billion through dividends and repurchases year to date. It declared a fourth-quarter dividend of $0.85 per share, a 5% increase, and reported a three-year cash-return target of $18–$20 billion for 2014–2016.
Material changes and management commentary
- Management attributed roughly half of the operating-income decline in both periods to the supplier food-quality issue discovered in China in July, which affected China, Japan and other markets. The issue also drove lost sales, lower profitability and recovery-related expenses.
- Quarterly comparable sales declined 3.3% in the U.S., 1.4% in Europe and 9.9% in APMEA. APMEA operating income fell 55% in the quarter. Management said restoring the affected business to a normalized level could take at least another 6–9 months.
- U.S. results faced sustained competition, lower guest counts, and higher commodity and labor costs. Europe was affected by weak consumer confidence, Germany weakness and temporary closures in Russia and Ukraine.
- The effective tax rate was 44.4% for the quarter and 36.6% year to date, versus 33.0% and 31.9%, respectively, in 2013. Management cited increased reserves for foreign tax matters, including an unfavorable lower-court ruling. These matters reduced EPS by an estimated $0.26; the supplier issue by $0.15; and Russia/Ukraine closures by $0.01. Excluding these items, quarterly EPS would have been relatively flat year over year.
- Management is emphasizing a simplified, locally relevant menu, customer experience and digital initiatives, and redirecting general and administrative resources toward growth priorities. It expects to refranchise at least 1,500 restaurants by the end of 2016, primarily in APMEA and Europe.
Outlook, risks and contingencies
- Management expected operating pressures to persist into the fourth quarter. It estimated a further supplier-issue impact of $0.07–$0.10 per diluted share in Q4; the company did not provide specific EPS guidance.
- 2014 outlook included net restaurant additions contributing about 2.5 percentage points to systemwide sales growth; U.S. commodity-basket cost growth of 2.5%–3.0% and Europe growth of 0%–1%; SG&A growth of approximately 4%–5% in constant currencies; interest expense growth of approximately 9%–10%; and an effective tax rate of 35%–37%.
- Capital expenditures were expected to be approximately $2.7 billion in 2014, with about 900–1,000 net restaurant additions. Management expected approximately 1,000 restaurant reimages worldwide.
- Key risks include weak consumer demand and guest traffic, intense competition, wage and commodity inflation, foreign-exchange and interest-rate movements, food safety and supply disruptions, geopolitical instability, and legal, regulatory and tax matters. A 10% same-direction movement in the Euro, British Pound, Australian Dollar and Canadian Dollar was estimated to change annual diluted EPS by about $0.25.
- Unrecognized tax benefits increased by $450 million from the December 31, 2013 balance. The company said the balance could decrease by $640 million within 12 months as audits conclude and statutes expire; approximately $170 million of the increase could favorably affect the tax rate if resolved in the company’s favor. Management stated recorded liabilities were appropriate and adequate.
- No subsequent events required recognition or disclosure, and the filing reported no material change to previously disclosed legal proceedings or market-risk disclosures. The company was evaluating the impact of the revenue-recognition standard effective January 1, 2017.
Most important facts for investors to verify
- Whether comparable sales, guest traffic and margins recover, particularly in the U.S. and supplier-affected APMEA markets.
- Whether supplier-related sales and profit impacts, including the expected Q4 EPS effect, prove consistent with management’s estimates.
- How foreign tax audits and the unfavorable court ruling affect reserves, cash taxes and the effective tax rate.
- Whether cash generation supports the stated capital-spending, dividend, repurchase and refranchising plans while debt remains elevated.
- Whether commodity, labor, currency and geopolitical pressures continue to weigh on operating results.