McDonald’s Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. Results are unaudited.
Business context and performance
McDonald’s operated or franchised 35,683 restaurants in 119 countries at June 30, 2014. The company’s revenues comprise company-operated restaurant sales and fees from franchised restaurants. Management described its priorities as improving value, marketing and operations, modernizing the customer experience, expanding convenience and building brand trust.
Global comparable sales declined 0.1% in Q2 and increased 0.2% for the first half. Comparable guest counts fell 3.0% for the six months, with negative traffic across major segments. Revenue growth benefited from restaurant expansion.
Key financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $7,181.7 | $7,083.8 | $13,882.0 | $13,689.1 |
| Operating income | $2,189.0 | $2,197.7 | $4,125.0 | $4,147.2 |
| Net income | $1,387.1 | $1,396.5 | $2,591.9 | $2,666.7 |
| Diluted EPS | $1.40 | $1.38 | $2.61 | $2.64 |
| Cash provided by operations | $1,487.0 | $1,509.8 | $3,394.3 | $3,196.7 |
Q2 revenue rose 1% (1% in constant currencies); first-half revenue rose 1% reported and 2% in constant currencies. Operating income was flat in Q2 and down 1% for the half as reported. Net income declined 1% and 3%, respectively. Diluted EPS increased 1% in Q2 but declined 1% for the half; fewer diluted shares supported EPS. Foreign exchange added $0.01 to Q2 EPS and reduced first-half EPS by $0.02.
Q2 company-operated restaurant margin was 17.1%, versus 17.7% a year earlier; franchised margin was 82.2%, versus 82.8%. First-half combined operating margin was 29.7%, versus 30.3%. Company-operated margin pressure reflected weaker traffic and higher commodity, labor, occupancy and other costs. Franchised margin dollars increased 2% in both periods, primarily on expansion.
Cash, liquidity, debt and shareholder returns
- Cash and equivalents were $3,670.6 at June 30, 2014, up from $2,798.7 at year-end 2013. Current assets were $5,913.7 and current liabilities $3,391.7.
- First-half capital expenditures were $1,158.4; operating cash flow exceeded capital expenditures by approximately $2.2 billion. Cash used for investing was $1,223.3.
- Debt obligations were $15.4 billion at June 30, compared with $14.1 billion at December 31, 2013. The increase primarily reflected $1.5 billion of bond issuances, partly offset by $538.7 million of repayments. Estimated debt fair value was $16.8 billion.
- The company paid $1.6 billion in dividends and repurchased 12.6 million shares for $1.2 billion during the first half. The declared dividend was $0.81 per share for Q2. A new $10 billion repurchase authorization took effect July 1, 2014.
Material changes and management commentary
- U.S. comparable sales declined 1.5% in Q2 and 1.6% for the half, amid broad-based challenges and negative guest counts.
- Europe comparable sales declined 1.0% in Q2 but increased 0.2% for the half; U.K. and France strength was offset by weakness in Germany.
- APMEA comparable sales increased 1.1% in Q2 and 1.0% for the half, supported by China and other markets but offset in part by continued weakness in Japan.
- Interest expense increased 6% in both periods, primarily due to higher average debt balances. The effective tax rate was 33.0% in Q2 and 32.8% for the half, above prior-year rates; the 2013 first-half rate included a tax benefit of nearly $50 million.
Outlook, risks and unusual items
- Management had expected full-year global comparable sales to be relatively flat, but said the forecast was at risk following the China supplier issue. The company said it could not reasonably estimate the issue’s full-year 2014 earnings impact. Affected markets—China, Japan and certain others—represent approximately 10% of consolidated revenue.
- Management expected net restaurant additions to contribute approximately 2.5 percentage points to 2014 systemwide sales growth in constant currencies. 2014 capital expenditures were expected to be $2.9–$3.0 billion, with approximately 1,000–1,100 net restaurant additions.
- Other 2014 expectations: U.S. and Europe commodity basket costs up 1%–2%; SG&A up approximately 4%–5% in constant currencies; interest expense up approximately 9%; effective tax rate of 31%–33%; and continued pressure on company-operated margins. The company does not provide specific EPS guidance.
- The company’s three-year cash return target for 2014–2016 was $18–$20 billion, supported in part by operating cash flow, additional debt and refranchising at least 1,500 restaurants.
- Key risks include food safety and supply disruption, intense competition and consumer price sensitivity, commodity and labor cost inflation, foreign-exchange exposure, economic and geopolitical uncertainty including Russia and Ukraine, and execution of menu, value, digital and customer-experience initiatives. Management said legal proceedings and market-risk disclosures had no material changes from the 2013 Form 10-K.
- The company was evaluating ASC 606 revenue-recognition guidance, effective beginning January 1, 2017. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Subsequent updates on the China supplier food-quality issue, customer recovery, affected-market sales and earnings impact.
- Whether guest counts and comparable sales improve, particularly in the U.S., Germany, Australia and Japan, and whether company-operated margins stabilize.
- Actual debt issuance, debt levels, interest expense and foreign-currency effects compared with management’s outlook.
- Progress against restaurant-opening, capital-spending and refranchising plans, and funding and execution of the $18–$20 billion cash-return target.
- Actual commodity, labor and SG&A costs, and the full-year tax rate relative to stated expectations.