McDonald’s Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are in U.S. dollars; financial-statement figures are in millions unless noted. Comparisons are with the corresponding 2017 periods.
Business context
McDonald’s operates and franchises restaurants. At June 30, 2018, it had 37,406 restaurants in 120 countries, including 34,521 franchised or licensed and 2,885 company-operated. The company’s long-term goal is to be approximately 95% franchised. Refranchising, including the China and Hong Kong transaction in 2017, materially affects reported revenue and company-operated margins.
Financial performance
| Metric | Q2 2018 | Six months 2018 |
|---|---|---|
| Total revenue | $5,353.9; down 12% reported (14% constant currency) | $10,492.8; down 11% reported (14% constant currency) |
| Operating income | $2,262.3; down 1% reported (4% constant currency) | $4,405.4; up 2% reported (down 2% constant currency) |
| Net income | $1,496.3; up 7% reported (4% constant currency) | $2,871.7; up 10% reported (6% constant currency) |
| Diluted EPS | $1.90; up 12% reported (9% constant currency) | $3.62; up 14% reported (10% constant currency) |
| Cash provided by operations | Quarterly figure not separately discussed in MD&A | $2,984.0, up from $2,757.4 |
| Capital expenditures | $611.3 | $1,164.1 |
Global comparable sales rose 4.0% in Q2 and 4.7% year to date; systemwide sales increased 5% and 6%, respectively, in constant currency. Reported sales at company-operated restaurants fell 27% in both periods, while franchised revenue increased 11% in Q2 and 13% year to date. Management attributed the consolidated revenue decline primarily to refranchising.
Q2 franchised restaurant margin was 82.5%, versus 82.3% a year earlier; company-operated restaurant margin was 17.9%, versus 18.7%. Six-month consolidated operating margin was 42.0%, versus 36.9% (42.9% and 37.1%, respectively, excluding strategic charges). Reported margins reflect the changing franchised mix.
Cash, debt and liquidity
At June 30, cash and equivalents were $1,623.5, down from $2,463.8 at December 31, 2017. Current assets were $4,355.6 and current liabilities $2,970.3. Debt obligations totaled approximately $31.0 billion, up from $29.5 billion at year-end; this comprised $30,687.7 of long-term debt and $292.2 of current maturities. Shareholders’ equity was a deficit of $5,851.0.
Six-month operating cash flow exceeded capital expenditures by approximately $1.8 billion. Financing used $2.9 billion, including $3.24 billion of treasury-stock purchases and $1.58 billion of dividends; the company also issued $2.0 billion of long-term financing. Cash flow and debt figures are affected by refranchising activity and currency movements.
Material changes and unusual items
- Q2 included $92 million of pre-tax strategic restructuring charges, primarily related to U.S. restructuring; $85 million was attributed to the U.S. segment. Management’s adjusted results exclude these and certain other items.
- Year-to-date results included approximately $52 million, or $0.07 per diluted share, of additional tax expense from adjustments to provisional Tax Act estimates. The company said its Tax Act accounting remained incomplete and subject to clarification.
- Adoption of ASC 606 changed recognition of initial franchise fees to recognition over franchise terms, generally 20 years. The transition produced approximately $600 million of deferred revenue and related deferred-tax adjustments; the company expected about a $50 million negative effect on 2018 franchised revenue and margins.
- Foreign-currency translation benefited reported Q2 diluted EPS by $0.05 and six-month EPS by $0.13. The stronger euro and British pound were principal contributors.
- Refranchising reduced company-operated margin dollars but increased franchised margin dollars. Share repurchases also supported EPS by reducing diluted weighted-average shares.
Outlook, management commentary and risks
Management emphasized the Velocity Growth Plan, including restaurant modernization and technology (Experience of the Future), digital ordering and payment, and delivery. Delivery was available at more than 13,000 restaurants. The company said Experience of the Future was deployed in about one-third of restaurants globally and expected it in about half of U.S. restaurants by year-end 2018.
- 2018 net restaurant additions were expected to contribute about 1 percentage point to systemwide sales growth in constant currency. The company anticipated approximately 1,000 openings and about 600 net additions.
- Expected 2018 capital expenditures were approximately $2.4 billion, including about $1.5 billion for the U.S., primarily Experience of the Future.
- Management expected U.S. commodity costs to rise 1%–2% and International Lead commodity costs about 2%; SG&A to decline about 1% in constant currency; interest expense to increase 5%–7%; and the effective tax rate to be 25%–27%.
- The company did not provide specific EPS or comparable-sales guidance. It estimated that a 10% simultaneous move in the euro, British pound, Australian dollar and Canadian dollar would change annual diluted EPS by about $0.30.
Key risks include execution and returns on modernization, digital and delivery investments; competition and changing customer preferences; food safety and supply-chain disruption; franchisee financial and operational performance; labor and commodity-cost pressures; foreign-exchange exposure; tax uncertainty; cybersecurity and technology interruption; and legal, regulatory, geopolitical and economic developments. Management reported no material change in market-risk disclosures or legal-proceeding disclosures from the 2017 Form 10-K. Disclosure controls were assessed as effective, with no material change reported in internal control over financial reporting.
Important facts for investors to verify
- How much reported revenue and margin movement reflects refranchising, versus underlying comparable sales and systemwide performance.
- Whether adjusted earnings comparisons appropriately account for restructuring charges, currency effects and Tax Act adjustments.
- The final Tax Act accounting and the realized effect of ASC 606 on franchise revenue and margins.
- Debt growth, interest-cost expectations, negative shareholders’ equity, and the pace of buybacks and dividends relative to operating cash flow and investment needs.
- Progress and returns from Experience of the Future, digital and delivery initiatives, and the forecast restaurant openings and net additions.
- Exposure to currency, commodity, labor, franchisee, food-safety and technology risks, including whether stated outlook assumptions remain valid.