McDonald’s Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Financial statements are unaudited. Dollar amounts are in millions unless stated otherwise.
Business context and performance
McDonald’s franchises and operates restaurants worldwide. At September 30, 2018, it had 37,557 restaurants in 120 countries; 34,745 were franchised or licensed and 2,812 were company-operated. Its long-term goal is to be approximately 95% franchised. Management’s Velocity Growth Plan emphasizes customer experience, value, convenience, digital, delivery, and restaurant modernization.
Global comparable sales rose 4.2% in the quarter and 4.5% for the nine months. Systemwide sales increased 5% in constant currencies in the quarter and 6% for the nine months. Consolidated revenue declined largely because refranchising replaces company-operated sales with lower reported franchise revenue.
Financial results and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $5,369.4 | $5,754.6 | $15,862.2 | $17,480.2 |
| Operating income | $2,417.7 | $3,079.4 | $6,823.1 | $7,408.5 |
| Net income | $1,637.3 | $1,883.7 | $4,509.0 | $4,493.6 |
| Diluted EPS | $2.10 | $2.32 | $5.72 | $5.48 |
| Operating cash flow | Not separately highlighted | Not separately highlighted | $5,455.1 | $4,441.9 |
- Reported revenue fell 7% in the quarter and 9% for the nine months. Operating income fell 21% and 8%, respectively; net income fell 13% in the quarter and was approximately flat for the nine months. Diluted EPS fell 9% in the quarter and rose 4% for the nine months.
- Excluding the cited 2017 China and Hong Kong sale gain and related impairment charges, and 2018 strategic restructuring charges, management reported operating income growth of 2% in the quarter and 3% for the nine months; diluted EPS growth was 19% and 17%, respectively. Comparisons also reflect lower shares from repurchases and a lower effective tax rate.
- For the nine months, franchised restaurant margins increased 11% to $6,757.1, while company-operated margins decreased 28% to $1,332.2, primarily reflecting refranchising. Company-operated margin was 18.4% in the quarter versus 19.1% a year earlier. Reported nine-month operating margin was 43.0%, versus 42.4%; excluding specified unusual items, management reported 43.6% versus 38.4%.
- Nine-month capital expenditures were $1,867.9; operating cash flow exceeded capital expenditures by approximately $3.6 billion. Cash and equivalents were $2,574.5 at September 30, 2018.
- Long-term debt was $31,895.2, up from $29,536.4 at December 31, 2017. Debt fair value was estimated at $32.8 billion. Total shareholders’ equity was a deficit of $6,792.6, compared with a deficit of $3,268.0 at year-end 2017. Current assets were $5,553.1 and current liabilities $3,626.7.
- The company returned $6.6 billion to shareholders during the first nine months through repurchases and dividends. Nine-month repurchases were $4.3 billion and dividends paid were $2.4 billion. A fourth-quarter dividend of $1.16 per share was declared.
Material changes, outlook, and risks
- Refranchising reduced company-operated restaurant count by 418 year over year and contributed to lower consolidated revenue and company-operated margin dollars, while franchise revenue and franchise margin dollars increased. The 2017 China and Hong Kong refranchising also makes year-over-year High Growth Markets comparisons less comparable.
- The 2017 comparison included an approximately $850 million pretax gain on the China and Hong Kong business sale, partly offset by $111 million of unrelated impairment charges. First-nine-month 2018 results included $94 million of pretax strategic restructuring charges, including $85 million related to the U.S.
- ASC 606 adoption deferred about $600 million of initial franchise fees as long-term revenue and changed recognition to over franchise terms. Management expected the standard to reduce 2018 franchised revenue and margins by about $50 million. Tax accounting under the Tax Act remained provisional; the company recorded an additional $47 million tax cost in Q3 and expected to finalize the accounting in Q4.
- For 2018, management expected net restaurant additions to contribute about 1 percentage point to systemwide sales growth; U.S. and International Lead commodity basket costs to rise about 2%; SG&A to decline 1%–2% in constant currencies; interest expense to rise 6%–7%; and capital expenditures of approximately $2.5 billion. The expected full-year effective tax rate was 24%–26%, though final Tax Act adjustments could lower it. The company expected about 1,000 restaurant openings and net additions of about 600.
- Management raised its shareholder-return target to about $25 billion for the three-year period ending 2019. It did not provide specific EPS guidance. EOTF was deployed in more than 40% of restaurants globally, with about half of U.S. restaurants expected to have it by year-end 2018; delivery was available at more than 15,000 restaurants in over 65 markets.
- Key risks include execution and returns on modernization, digital and delivery investments; franchisee financial health and alignment; competition and changing consumer preferences; labor and commodity cost inflation; food safety and supply disruptions; currency and tax changes; cybersecurity and technology outages; and regulatory, litigation, and geopolitical risks. Management estimated that a 10% move in the Euro, British Pound, Australian Dollar, and Canadian Dollar in the same direction could change annual diluted EPS by about $0.30.
- The European Commission concluded in September 2018 that Luxembourg’s tax treatment of certain subsidiaries did not constitute state aid; the company reported no financial-statement impact. Management reported no material subsequent events and concluded disclosure controls were effective.
Important facts for investors to verify
- Underlying earnings comparisons: assess the impact of the 2017 disposal gain and 2018 restructuring charges, and confirm the basis for management’s adjusted growth figures.
- Refranchising effects: monitor comparable sales and systemwide sales alongside reported revenue, franchise margins, and company-operated margins.
- Debt and shareholder returns: track debt growth, interest expense, cash generation, repurchases, and dividends against the company’s negative equity position.
- Outlook assumptions: verify delivery and EOTF execution, capital spending, commodity costs, tax-rate finalization, and the stated restaurant-opening expectations.
- Accounting changes: review the final Tax Act measurement-period adjustments and the expected material balance-sheet effect of lease accounting adoption in 2019.