McDonald’s Corporation — Q1 2017 Form 10-Q
Reporting period: Unaudited quarter ended March 31, 2017; comparable figures are for the quarter ended March 31, 2016 unless noted. Financial amounts are in U.S. dollars.
Business context and performance
McDonald’s operated or franchised 36,905 restaurants in 120 countries at quarter-end, with 31,328 franchised and 5,577 company-operated. The company is shifting toward a more heavily franchised model, with a long-term goal of approximately 95% franchised restaurants. Management launched its customer-focused Velocity Growth Plan, emphasizing food, value, restaurant modernization, digital ordering and delivery.
- Global comparable sales rose 4.0%; comparable guest counts increased 0.6%. Comparable sales were up 1.7% in the U.S., 2.8% in International Lead Markets, 3.8% in High Growth Markets and 10.7% in Foundational Markets & Corporate.
- Systemwide sales increased 4% reported and 5% excluding currency translation. Franchised sales increased 7% reported and 8% excluding currency translation.
Financial results
| Metric | Q1 2017 | Q1 2016 | Change / context |
|---|---|---|---|
| Total revenue | $5,675.9 million | $5,903.9 million | Down 4% reported; down 3% excluding currency translation |
| Operating income | $2,034.0 million | $1,780.3 million | Up 14% reported; up 16% excluding currency translation |
| Operating margin | 35.8% | 30.2% | Expanded 5.6 percentage points |
| Net income | $1,214.8 million | $1,124.8 million | Up 8% |
| Diluted EPS | $1.47 | $1.25 | Up 18%; currency translation reduced Q1 2017 EPS by $0.02 |
| Cash provided by operations | $1,544.0 million | $1,745.2 million | Down $201 million, primarily from working-capital changes |
| Capital expenditures | $427.7 million | $391.8 million | Operating cash flow exceeded capex by about $1.1 billion |
Company-operated restaurant margins were 17.5% of sales, compared with 15.4% a year earlier; franchised margins were 81.0%, compared with 80.7%. The effective income tax rate rose to 32.8% from 28.7%, primarily due to tax-reserve changes as audits progressed and tax costs associated with refranchising.
At March 31, 2017, cash and equivalents were $2,412.2 million; total current assets were $5,907.2 million and current liabilities were $3,220.7 million. Debt obligations were $27.2 billion, versus $26.0 billion at December 31, 2016, primarily reflecting net debt issuances. Shareholders’ equity was a deficit of $2,030.8 million. Cash used for financing was $587.2 million, including $770.6 million in dividends and $748.0 million in treasury-stock purchases. The company repurchased 6.3 million shares for $795.7 million during the quarter.
Material changes and unusual items
- Revenue declined as refranchising replaced company-operated restaurant sales with franchise rent and royalty revenue; franchised revenue rose 5% while company-operated sales fell 9%.
- Operating income benefited from stronger operating performance, G&A savings, improved Japan results, a U.S. restaurant-property sale gain and lower depreciation on China and Hong Kong assets classified as held for sale. The depreciation cessation added approximately $42 million to company-operated margins, with a similar benefit expected at least through Q2 2017.
- Other operating income included $60.0 million of gains on restaurant-business sales and $40.9 million of equity earnings from unconsolidated affiliates. A strategic U.S. restaurant-property sale contributed to the quarter’s results.
- The Nordics business sale closed during Q1 for approximately $450 million in cash, with no significant gain or loss. The proposed China and Hong Kong sale remained pending.
Outlook, risks and contingencies
- The company does not provide specific EPS guidance. It expects net restaurant additions to contribute approximately 1 percentage point to 2017 systemwide sales growth in constant currencies.
- For 2017, management expected U.S. commodity-basket costs to rise 0.5%–1.5%, International Lead costs to rise about 2%, SG&A to decline 7%–8% in constant currencies, interest expense to rise about 5%, and the effective tax rate to be 31%–33%.
- 2017 capital expenditures were projected at approximately $1.7 billion; management expected about 900 restaurant openings and net additions of about 400. It expected approximately 2,500 U.S. restaurants to include Experience of the Future elements by year-end. Mobile order and pay was planned for 20,000 restaurants in selected markets by year-end.
- Management identified execution of refranchising, cost savings and customer-experience initiatives; competition and changing consumer preferences; franchisee performance; labor, commodity and supply-chain costs; food safety; foreign exchange; regulatory and tax changes; and technology or cybersecurity incidents as key risks. A 10% move in the same direction across the euro, British pound, Australian dollar and Canadian dollar could change annual diluted EPS by about $0.25.
- The China and Hong Kong transaction, covering more than 2,600 restaurants, was expected to close in the second half of 2017 subject to customary conditions, including regulatory approvals. McDonald’s expected approximately $1.5 billion in cash proceeds, subject to adjustment, and an estimated $700–$900 million gain; it would retain a 20% interest and report the markets as an affiliate after closing.
- No material changes to previously reported legal proceedings were disclosed, and the filing reported no subsequent events requiring recognition or disclosure.
Important facts for investors to verify
- Whether comparable-sales and guest-count trends persist, and whether sales growth translates into durable earnings as refranchising continues.
- How much reported operating-income growth depended on property gains, affiliate results and temporarily lower depreciation.
- Completion, proceeds, gain and retained-interest terms of the China and Hong Kong transaction, including required approvals.
- Debt growth, cash generation and capital returns relative to the company’s stated operating and investment plans.
- Progress against 2017 cost, tax, commodity, capital-expenditure, restaurant-opening and modernization expectations.