McDonald’s Corporation — Q1 2018 Form 10-Q
Reporting period: Quarter ended March 31, 2018; unaudited results compared with the quarter ended March 31, 2017. McDonald’s operated or franchised 37,286 restaurants in 120 countries; 34,279 were franchised and 3,007 company-operated. Management’s long-term goal is to be approximately 95% franchised.
Financial performance
| Metric | Q1 2018 | Prior-year comparison |
|---|---|---|
| Total revenue | $5.139 billion | Down 9% reported; down 15% excluding currency translation |
| Operating income | $2.143 billion | Up 5% reported; flat excluding currency translation |
| Net income | $1.375 billion | Up 13% reported; up 8% excluding currency translation |
| Diluted EPS | $1.72 | Up 17% reported; up 12% excluding currency translation |
| Operating margin | 41.7% | 35.8% in Q1 2017 |
| Cash provided by operations | $1.645 billion | $1.544 billion in Q1 2017 |
| Capital expenditures | $552.8 million | $427.7 million in Q1 2017 |
| Long-term debt | $30.870 billion | $29.536 billion at December 31, 2017 |
| Cash and equivalents | $2.468 billion | $2.464 billion at December 31, 2017 |
Global comparable sales increased 5.5%, with comparable guest counts up 0.8%; systemwide sales increased 7% excluding currency translation. Franchised margin dollars rose 16% reported (10% excluding currency translation) to $2.123 billion, while company-operated margin dollars fell 32% reported (37% excluding currency translation) to $404.7 million, primarily reflecting refranchising. Company-operated restaurant margin declined to 16.0% from 17.5%; payroll and employee-benefit costs rose to 30.2% of sales from 27.8%.
Operating cash flow exceeded capital expenditures by approximately $1.1 billion. Investing activities used $359.1 million, and financing activities used $1.306 billion. Financing included $1.633 billion of treasury-stock purchases and $797.5 million of dividends. McDonald’s repurchased 10.4 million shares for approximately $1.7 billion and declared dividends of $1.01 per share. Shareholders’ equity was a deficit of $4.719 billion at quarter-end, versus a deficit of $3.268 billion at year-end 2017.
Material changes and unusual items
- Revenue declined mainly because refranchising replaces company-operated restaurant sales with lower reported franchise rent and royalty revenue. Company-operated restaurant count fell to 3,007 from 5,577 a year earlier, while franchised count rose to 34,279 from 31,328.
- Net income and EPS benefited from higher sales-driven franchise margins, a lower effective tax rate, favorable currency translation and fewer diluted shares following repurchases. Currency translation added $0.08 to diluted EPS.
- Reported results included approximately $52 million, or $0.07 per diluted share, of additional tax expense from adjustments to provisional Tax Act estimates. Excluding that item, management reported net income of $1.428 billion and diluted EPS of $1.79.
- The effective tax rate was 27.1%, compared with 32.8% in Q1 2017; excluding the provisional Tax Act adjustment, it was 24.4%. The company said Tax Act accounting remained provisional and could change.
- Adoption of ASC 606 deferred approximately $600 million of initial franchise fees and included approximately $150 million of associated deferred-tax adjustments. The filing reports a $450.2 million retained-earnings reduction on adoption, net of tax. The new standard is expected to reduce 2018 franchised revenue and margin by about $50 million; the Q1 impact was approximately $5 million.
- Debt fair value was estimated at $32.5 billion, compared with its $30.9 billion carrying amount. The filing reports no subsequent events requiring recognition or disclosure.
Outlook, management commentary and risks
- Management cited broad-based sales momentum and the Velocity Growth Plan, focused on restaurant execution, value, convenience, digital initiatives, delivery and restaurant modernization. EOTF modernization was deployed in about one-third of restaurants globally; about half of U.S. restaurants were expected to have it by year-end 2018.
- For 2018, management expected net restaurant additions to contribute approximately 1 percentage point to systemwide sales growth in constant currencies; approximately 1,000 restaurant openings and net additions of about 600 were planned.
- Expected 2018 capital expenditures were approximately $2.4 billion, including about $1.5 billion for the U.S., primarily EOTF modernization. Management expected U.S. commodity-basket costs to rise 1%–2% and International Lead segment costs to rise about 2%; SG&A to decrease about 1% in constant currencies; and interest expense to increase 5%–7%.
- The expected 2018 effective tax rate was 25%–27%, with quarterly volatility and possible effects from further Tax Act clarification. McDonald’s did not provide specific EPS or comparable-sales guidance.
- Management highlighted foreign-exchange exposure: about 40% of debt was denominated in foreign currencies, and a 10% common-direction move in the Euro, British Pound, Australian Dollar and Canadian Dollar could change annual diluted EPS by about $0.30.
- Key risks include execution and returns on refranchising, EOTF, digital and delivery investments; franchisee financial health and alignment; competition and changing customer preferences; labor, commodity and supply-chain costs; food safety and brand reputation; cybersecurity and technology disruptions; currency and tax uncertainty; regulatory and litigation exposure; and access to financing.
Important facts for investors to verify
- How much of the revenue decline and margin shift reflects refranchising versus underlying restaurant performance, and whether comparable-sales momentum is sustained.
- Whether franchisee sales, margins and financial health support the company’s continued shift toward a more heavily franchised model.
- Progress and returns on the planned $2.4 billion of 2018 capital spending, including EOTF, digital and delivery initiatives.
- Final Tax Act accounting and the effects of ASC 606 on reported franchise revenue and margins.
- Debt growth, interest-cost expectations, foreign-currency sensitivity, and the sustainability of dividends and share repurchases given the shareholders’ deficit.