McDonald’s Corporation — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 22, 2019. The filing is annual, with unaudited quarterly results also provided. McDonald’s operates and franchises restaurants in 120 countries. At year-end, 35,085 of 37,855 restaurants were franchised (about 93%); management’s long-term target is approximately 95% franchised.
Financial performance and position
| Metric | FY 2018 | Comparison / context |
|---|---|---|
| Total revenue | $21.03 billion | Down 8% from $22.82 billion; refranchising reduced reported revenue as company-operated sales shifted to franchise fees. |
| Systemwide sales | Up 6% (constant currency) | Global comparable sales rose 4.5%; comparable guest counts rose 0.2%. |
| Operating income | $8.82 billion | Down 8%; excluding specified impairment/restructuring charges and the prior-year China/Hong Kong sale gain, up 2%. |
| Operating margin | 42.0% | 41.9% in 2017; adjusted for specified items, 43.1% versus 38.8%. |
| Net income | $5.92 billion | Up 14%; effective tax rate was 24.2%, versus 39.4% in 2017. |
| Diluted EPS | $7.54 | Up 18%; $7.90 excluding specified 2018 and 2017 items, up 19%. |
| Cash from operations / capital expenditures | $6.97 billion / $2.74 billion | Free cash flow was $4.23 billion, up 14%; cash from operations increased 25%, primarily due to lower tax payments. |
| Debt and cash | Debt $31.08 billion; cash $0.87 billion | Debt was $29.54 billion and cash $2.46 billion at year-end 2017. Shareholders’ equity was a deficit of $6.26 billion. |
| Liquidity facilities | $3.5 billion committed credit line, unused | Management reported continued access to commercial paper and expects operating cash flows and borrowing capacity to fund obligations. |
Franchised margin dollars increased 9% to $9.04 billion and represented about 85% of combined restaurant margins. Company-operated margin dollars fell 24% to $1.75 billion, reflecting refranchising, EOTF-related costs, and labor and commodity pressures. McDonald’s returned $8.5 billion to shareholders through repurchases and dividends; it repurchased 32.2 million shares for $5.2 billion. The annual dividend declared was $4.19 per share, with the quarterly rate raised 15% to $1.16.
Q4 context: Unaudited fourth-quarter revenue was $5.16 billion versus $5.34 billion in Q4 2017; net income was $1.42 billion versus $0.70 billion, and diluted EPS was $1.82 versus $0.87.
Material changes versus 2017
- Refranchising continued: company-operated restaurants declined to 2,770 from 3,133, while franchised restaurants rose to 35,085 from 34,108. Company-operated sales fell 21%; franchised revenue increased 9%.
- Global comparable sales growth remained positive for a 14th consecutive quarter. U.S. comparable sales increased 2.5%, but guest counts fell 2.2%; international comparable sales rose 4.1%–7.1% across the disclosed segments.
- Reported operating income declined partly because 2017 included an approximately $850 million gain on the sale of the China and Hong Kong businesses. 2018 included approximately $140 million of non-cash impairment charges and $94 million of strategic restructuring charges.
- The U.S. federal tax-rate reduction contributed to the lower 2018 effective tax rate. 2018 also included about $75 million of net tax cost from adjustments to provisional Tax Act amounts.
- Capital expenditures rose 48% to $2.74 billion, primarily for existing restaurant reinvestment, including Experience of the Future (EOTF). Cash declined as operating cash was used for investment, debt service, dividends and repurchases.
- From January 1, 2019, the company moved to three reporting segments: U.S., International Operated Markets and International Developmental Licensed Markets.
Outlook, commentary and risks
For 2019, management expected net restaurant additions to contribute about 1 percentage point to Systemwide sales growth in constant currencies. It forecast U.S. commodity costs up 1%–2%, Big Five international market commodity costs up about 2%, SG&A down about 4% in constant currencies, and interest expense up about 10%–12%. Expected capital expenditures were approximately $2.3 billion, with roughly 1,200 openings and about 750 net additions. The company expected to return about $9 billion to shareholders in 2019. Long-term average annual targets were Systemwide sales growth of 3%–5%, operating margin in the mid-40% range, high-single-digit EPS growth and ROIIC in the mid-20% range.
Management emphasized the Velocity Growth Plan and investment in restaurant modernization, digital ordering and delivery. At year-end, EOTF was deployed in about half of the global system; Mobile Order & Pay was available in more than 22,000 restaurants and delivery in over half of the system. Management said delivery transactions typically had average checks 1.5–2 times non-delivery transactions, while noting that investments and initiatives may not earn expected returns.
- Key business risks include intense competition, changing consumer preferences, execution of digital, delivery and modernization investments, and the ability of franchisees to grow sales and fund initiatives.
- Other material exposures include food safety and supply interruptions; labor availability, costs and employment regulation; cybersecurity and privacy; foreign currency and commodity volatility; and environmental and regulatory changes.
- Tax contingencies include $1.34 billion of gross unrecognized tax benefits. Disputed IRS transfer-pricing matters were expected to be addressed in 2019 or 2020; the company said unrecognized benefits could decrease by up to $900 million within 12 months, though only part could benefit the effective tax rate.
- Debt obligations were $31.1 billion; about 91% was fixed-rate. Debt maturities include $2.4 billion in 2020, $2.2 billion in 2021, $2.3 billion in 2022 and $5.0 billion in 2023, subject to disclosed reclassifications. Management planned to issue long-term debt to refinance $2.1 billion maturing in 2019.
- Adoption of lease accounting in 2019 was expected to add approximately $10.5–$12.5 billion of right-of-use assets and lease liabilities to the balance sheet; management expected no material impact to any given year’s results from the accounting change.
- The company disclosed ordinary-course litigation and said it did not expect current matters to materially adversely affect financial condition or results, while acknowledging an unfavorable ruling could materially affect income in a period. The financial statements received an unqualified audit opinion; management and the auditor reported effective internal control over financial reporting.
Important facts for investors to verify
- How much of EPS and cash-flow growth reflects recurring operating performance versus lower taxes, refranchising, share repurchases and unusual gains or charges.
- Whether comparable sales growth can translate into guest-count improvement, particularly given the 2.2% decline in U.S. comparable guest counts.
- Whether EOTF, digital and delivery investments deliver expected returns and support franchisee economics as deployment continues.
- Debt service and refinancing capacity, shareholder distributions, and the balance-sheet impact of lease accounting.
- Progress and potential financial effects of IRS transfer-pricing disputes and other tax uncertainties.