MCD

Business Context and Reporting Period

Company: McDonald's Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2008
Business Overview: The Company operates and franchises McDonald's restaurants globally. As of March 31, 2008, the system comprised 31,439 restaurants in 118 countries. The portfolio includes 20,635 franchised restaurants (including 2,804 developmental licensees), 6,815 Company-operated restaurants, and 3,989 affiliate-operated restaurants. The Company continues to execute a strategy of refranchising Company-operated units to optimize capital allocation and margins.

Key Financial Metrics

Margins: Combined operating margin was 26.1% in Q1 2008, compared to 22.3% in Q1 2007. Franchised restaurant margins increased to 81.4%, while Company-operated margins were 16.5%.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 6% year-over-year. This was driven by a 17% increase in revenues from franchised and affiliated restaurants, partially offset by a 2% increase in Company-operated sales. The shift in revenue mix is due to the sale of the Latin America (Latam) business in August 2007 and ongoing refranchising.
• Profitability: Operating income rose 24% (16% in constant currencies). Net income increased 24% to $946.1 million. Diluted EPS grew 31% to $0.81, aided by a $0.05 per share currency benefit and share repurchases.
• Comparable Sales: Global comparable sales increased 7.4%. Europe led with an 11.1% increase, followed by APMEA at 9.4% and the U.S. at 2.9%.
• Debt Levels: Total debt obligations increased to $11.7 billion from $9.3 billion at year-end 2007. The Company issued approximately $2.1 billion in net debt in Q1 2008 to pre-fund maturities and take advantage of favorable market conditions.
• Shareholder Returns: The Company repurchased 37.1 million shares for $2.0 billion and paid dividends of $426.4 million ($0.375 per share).

Guidance, Outlook, and Risks

• Shareholder Returns: The Company expects to return $15 billion to $17 billion to shareholders through repurchases and dividends for the period 2007 through 2009.
• Capital Expenditures: Full-year 2008 capital expenditures are expected to be approximately $2 billion, funding the opening of roughly 1,000 new restaurants and reinvestment in existing units.
• Cost Outlook: U.S. beef costs are expected to be flat in 2008, while chicken costs may rise 5-6%. In Europe, beef costs are expected to rise 3-4% and chicken 6-8%.
• Interest Expense: Interest expense is expected to increase approximately 35% in 2008 compared to 2007 due to higher debt levels and rates.
• Refranchising: The Company plans to refranchise 1,000 to 1,500 Company-operated restaurants over the next three or more years.
• Risks: Key risks include the ability to remain relevant to customers, commodity price volatility, foreign currency exchange fluctuations (particularly the Euro and British Pound), and regulatory changes regarding nutrition and advertising. The Company noted that a 10% move in the Euro and British Pound could impact annual EPS by 8 to 9 cents.

Investor Verification Checklist

• Debt Maturity Profile: Verify the timing of debt maturities given the significant increase in total debt to $11.7 billion and the expectation of higher interest expense.
• Latam Royalty Performance: Monitor the royalty income from the Latin America developmental license to ensure it compensates for the loss of direct operating income from those markets.
• Commodity Hedging: Assess the effectiveness of hedging strategies against the projected 5-8% increase in chicken and beef costs in key markets.
• Refranchising Execution: Track the progress of the plan to refranchise 1,000-1,500 units to confirm the anticipated improvement in capital efficiency and margins.
• Currency Sensitivity: Evaluate the impact of foreign exchange rates on reported earnings, as approximately 55% of debt is denominated in foreign currencies and a significant portion of operating income is generated outside the U.S.