McDonald’s Corporation — Q1 2015 Form 10-Q
Reporting period: Quarter ended March 31, 2015. Unaudited results; comparisons are with Q1 2014 unless stated otherwise. Unless noted, dollar amounts are U.S. dollars.
Business context and performance
McDonald’s operated or licensed 36,290 restaurants in 119 countries at quarter-end; 81% were franchised or licensed. Management said performance had not met expectations and identified an urgent need to reset and turn around the business.
Global comparable sales fell 2.3%, while comparable guest counts fell 4.7%. Comparable sales declined 2.6% in the U.S., 0.6% in Europe and 8.3% in APMEA; negative traffic affected all major segments. APMEA results were particularly pressured by continuing customer-perception effects from the 2014 supplier issue in China and Japan.
Financial results and liquidity
| Metric | Q1 2015 | Q1 2014 / change |
|---|---|---|
| Total revenue | $5.959 billion | $6.700 billion; down 11% reported, 1% in constant currencies |
| Operating income | $1.386 billion | $1.936 billion; down 28% reported, 20% in constant currencies |
| Combined operating margin | 23.3% | 28.9% |
| Net income | $811.5 million | $1.205 billion; down 33% |
| Diluted EPS | $0.84 | $1.21; down 31% |
| Company-operated restaurant margin | 14.3% | 16.1% |
| Franchised restaurant margin | 80.3% | 81.1% |
| Cash provided by operations | $1.700 billion | $1.907 billion |
| Capital expenditures | $392.6 million | $568.8 million |
Reported revenue and earnings were materially affected by weaker foreign currencies; currency translation reduced revenue by $700.7 million, operating income by $157.3 million and diluted EPS by $0.09. Company-operated margin dollars fell 23% (13% in constant currencies); franchised margin dollars fell 8% (1% in constant currencies). Higher food, labor and other operating costs, weaker comparable sales and poor results in certain markets contributed to margin pressure.
Cash and equivalents were $1.635 billion at March 31, down from $2.078 billion at December 31, 2014. Current assets were $3.593 billion and current liabilities $2.752 billion. Long-term debt was $14.292 billion, down from $14.990 billion at year-end; total debt obligations were reported as $14.3 billion. The filing estimates debt fair value at $16.1 billion. Operating cash flow exceeded capital expenditures by $1.3 billion. Financing used $1.593 billion, including $816.3 million in dividends and $606.4 million in treasury-stock purchases; the company separately reported repurchasing 6.6 million shares for $624.5 million during the quarter.
Interest expense rose 9% reported. The effective tax rate was 35.3%, compared with 32.4%, reflecting strategic charges with limited tax benefits and a less favorable mix of income. Comprehensive loss was $150.8 million, largely reflecting a $979.7 million foreign-currency translation loss, net of tax.
Material changes and unusual items
- Q1 operating income included $195 million of strategic charges, reducing EPS by $0.17: $85 million for asset write-offs and other refranchising-related charges, $72 million associated with planned restaurant closures and write-offs, and $38 million of U.S. restructuring charges.
- Management decided to close about 220 underperforming restaurants, primarily in the U.S. and China, and McDonald’s Japan decided to close about 130. These were additional to 350 previously planned global closures.
- Excluding currency translation and strategic charges, EPS declined $0.11, or 9%, according to management.
- On May 4, 2015, the company announced a new four-segment structure, effective July 1, 2015: U.S., International Lead Markets, High-Growth Markets and Foundational Markets.
Outlook, management plans and risks
The company does not provide specific EPS guidance. Management expected business pressures to continue at least through the first half of 2015. For 2015, it anticipated net restaurant additions contributing about 2 percentage points to systemwide sales growth in constant currencies; U.S. commodity-basket costs rising 1.5%–2.5% and European costs rising 2%–3%; interest expense increasing about 15%; an effective tax rate at the high end of the 31%–33% range; and capital expenditures of about $2.0 billion. It expected to open more than 1,000 restaurants and achieve approximately 300 net additions.
Longer-term plans included refranchising about 3,500 restaurants to reach approximately 90% franchised by the end of 2018; about $300 million in net annual SG&A savings, most by the end of 2017; and returning $8–$9 billion to shareholders in 2015, with the company targeting the upper end of its $18–$20 billion three-year cash-return goal by the end of 2016. These are forward-looking plans, not guarantees.
Key disclosed risks include intense competition and changing customer preferences; execution of the turnaround and refranchising plans; food safety and reputational exposure from the 2014 supplier issue; commodity, labor and other operating-cost increases; foreign-exchange volatility; dependence on franchisee performance and cooperation; and economic, regulatory, litigation, supply-chain and technology/security risks. Management said a 10% move in the same direction across the Euro, British Pound, Australian Dollar and Canadian Dollar would change annual diluted EPS by about $0.25.
The filing reported no material changes to the prior annual report’s market-risk or legal-proceedings disclosures. Management concluded disclosure controls were effective as of March 31, 2015, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether comparable sales, guest traffic and margins recover, particularly in the U.S., China and Japan.
- Actual costs, timing and operating effects of restaurant closures, restructuring and the announced turnaround.
- Progress toward refranchising, the 90% franchised target and the stated SG&A savings.
- Cash generation and balance-sheet capacity alongside planned dividends, buybacks and debt financing; reported cash and debt are point-in-time balances.
- Whether commodity costs, foreign exchange and the effective tax rate track management’s outlook.