McDonald’s Corporation — Q3 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the quarter and nine months ended September 30, 2017. McDonald’s franchises and operates restaurants; 33,746 of 36,976 restaurants were franchised, licensed or affiliated at quarter-end. Management’s long-term goal is to be approximately 95% franchised.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $5.75 billion | $6.42 billion | $17.48 billion | $18.59 billion |
| Operating income | $3.08 billion | $2.14 billion | $7.41 billion | $5.78 billion |
| Net income | $1.88 billion | $1.28 billion | $4.49 billion | $3.49 billion |
| Diluted EPS | $2.32 | $1.50 | $5.48 | $4.01 |
| Cash provided by operations | Not separately emphasized | Not separately emphasized | $4.44 billion | $5.24 billion |
- Q3 revenue fell 10% (12% in constant currencies); nine-month revenue fell 6%. Company-operated restaurant sales declined 23% in Q3 and 14% year to date, while franchised revenue rose 10% and 7%, respectively. Management attributed the consolidated revenue decline primarily to refranchising.
- Global comparable sales increased 6.0% in Q3 and 5.6% for the nine months. Q3 comparables: U.S. 4.1%, International Lead Markets 5.7%, High Growth Markets 6.2%, and Foundational Markets & Corporate 10.2%.
- Systemwide sales increased 7% in constant currencies for both Q3 and the nine months. These include franchisee sales, which are not recorded as company revenue.
- Q3 operating income rose 44% and diluted EPS rose 55% as reported. Excluding the China/Hong Kong sale gain and specified current- and prior-year strategic items, management reported operating income growth of 5% for Q3 and 10% for the nine months, and diluted EPS growth of 9% and 15%, respectively.
- Q3 franchised margin was 83.0%, versus 82.1% a year earlier; company-operated margin was 19.1%, versus 18.4%. Nine-month operating margin was 42.4%, versus 31.1%; excluding the cited gain and strategic charges, it was 38.4%, versus 33.0%.
- Nine-month cash from operations was $4.44 billion, down from $5.24 billion. Capital expenditures were $1.21 billion; cash from operations less capital expenditures was approximately $3.23 billion. The company cited working-capital changes and higher tax payments as factors in the cash-flow decline.
- Cash and equivalents were $2.67 billion at September 30, 2017, versus $1.22 billion at December 31, 2016. Debt obligations were $28.6 billion, up from $26.0 billion. Shareholders’ equity was a deficit of $3.48 billion, versus a $2.20 billion deficit at year-end 2016.
- For the nine months, the company repurchased $3.94 billion of shares and paid $2.29 billion in dividends. It declared a fourth-quarter dividend of $1.01 per share.
Material changes and unusual items
- On July 31, 2017, McDonald’s completed the sale of its China and Hong Kong businesses, covering more than 2,700 restaurants, for $1.6 billion in cash and retained a 20% ownership interest. The transaction generated an approximately $850 million pretax gain, including a fair-value adjustment to the retained interest. The businesses’ revenue mix shifted to affiliated royalty revenue.
- Q3 and nine-month results also included $111 million of unrelated pretax non-cash impairment charges. The 2016 comparison periods included strategic charges of $128 million for Q3 and $357 million for nine months.
- Refranchising, the sale-related accounting treatment and cessation of depreciation on China/Hong Kong assets classified as held for sale affected revenue, margins and period comparisons. The company reported 3,230 company-operated restaurants at quarter-end, compared with 6,056 a year earlier.
Outlook, management commentary and risks
- The company did not provide specific EPS guidance. Its 2017 outlook included approximately 1 percentage point of systemwide sales growth from net restaurant additions; SG&A down about 7% in constant currencies; interest expense up about 5%; and an effective tax rate of 32%–33%.
- Management expected 2017 commodity-basket costs to rise about 1% in the U.S. and 2% in International Lead Markets, capital expenditures of approximately $1.7 billion, and about 900 restaurant openings. It targeted approximately 2,500 U.S. Experience of the Future restaurants by year-end 2017 and completion of modernization by 2020.
- The Velocity Growth Plan emphasizes customer visits, restaurant modernization and technology, digital ordering and payment, and delivery. Management cited broad-based comparable-sales strength, G&A savings and improved operating performance.
- Principal disclosed risks include execution and returns from modernization, digital and delivery investments; reliance on franchisee performance and alignment; competitive and changing consumer conditions; labor and commodity costs; food safety and supply-chain disruptions; foreign-exchange exposure; cybersecurity and technology interruptions; and regulatory, tax, litigation and geopolitical risks.
- The company expected new lease accounting rules to materially affect the balance sheet, with no cash-flow effect; it was still evaluating income-statement effects. It expected the new revenue standard to defer recognition of initial franchise fees over franchise terms, with no material income-statement effect anticipated.
Important facts for investors to verify
- Separate underlying operating growth from the approximately $850 million China/Hong Kong gain, impairment charges, prior-year strategic charges and lower depreciation.
- Assess the ongoing impact of refranchising on reported revenue, cash flows, margins and dependence on franchisee sales and financial health.
- Review debt growth, interest costs, cash generation and substantial shareholder returns, including repurchases and dividends.
- Track comparable sales, guest counts, labor and commodity costs, and execution and returns from modernization, digital and delivery programs.
- Confirm realization of stated 2017 outlook and planned restaurant openings and U.S. modernization targets; these are forward-looking estimates, not guarantees.