McDonald's Corporation

Hello and welcome to McDonald's Fourth Quarter 2018 Investor Conference Call. At the request of McDonald's Corporation, this conference is being recorded. Following today's presentation, there will be a question and answer session for investors. At that time, investors only may ask a question by pressing star 1 on their touchtone phone. I would now like to turn the conference over to Mr. Mike Seabrook, Investor Relations Officer for McDonald's Corporation. Mr. Seplock, you may begin.

Good morning, everyone, and thank you for joining us. With me on the call are President and Chief Executive Officer Steve Easterbrook and Chief Financial Officer Kevin Ozan. Today's conference call is being webcast live and is also being recorded for replay on our website. Before I turn it over to Steve, I want to remind everyone that the forward-looking statements in our earnings release and 8K filing also apply to our comments. Both documents are available on www.investor.mcdonalds.com and are the reconciliations of any non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures. And now I'll turn it over to Steve. Thanks, Mike. We're pleased with our strong performance in 2018. Global comparable sales increased 4.5% for the year, reflecting our broad-based momentum across the McDonald's system. This was a year when we bought our customers greater convenience, choice, and value as we continued aggressively transforming our business. Customers rewarded us with more visits again last year, resulting in back-to-back years of global guest account growth for the first time since 2012. This achievement is even more notable at a time when informal eating out traffic growth has been muted. Most of our top markets excelled in 2018 and outperformed our competitors. The UK, for example, now has 51 consecutive quarters of like-for-like sales growth that continue to gain share in a shrinking market. Canada grew comparable sales and guest accounts for the quarter and the year, extending its 10-year run of success. With 19 consecutive quarters and comparable sales growth, Australia continued their momentum with offerings such as the successful all-day favourites and the benefit of rising delivery sales. Germany is outperforming competitors as customers enjoy modernized restaurants and the benefits of one of the most effective digital engagement programs in the McDonald's system. The market now has seven consecutive quarters of comparable sales growth and posted its best annual comparable sales growth percentage in 25 years. Italy continues to be one of our best performing markets. The foundation of their success starts with a great leadership team executing a solid growth plan. The market is also seeing positive results from investing in experience of the future and maximizing the business impact of other velocity growth plan initiatives such as digital and delivery. McDonald's is the out strong 2017 and forward that with an even better year in 2018. In the US, we're in the middle of the most ambitious program the market has ever undertaken. the U.S. is executing a significant number of initiatives at the same time. Still, in 2018, we grew sales while continuing to invest billions of dollars in the restaurants, making foundational changes in our business and staying focused on our customers. While we have much ahead of us, we made significant progress with a lot of hard work in 2018. The U.S. is a much more nimble organization today than it was at the start of 2018. We reduced the number of co-ops from nearly 200 to fewer than 60 and halved the number of field offices. The market trimmed down the number of local agencies it works with from dozens to fewer than 10. The most significant changes in the market resulted in giving our customers better tasting food, greater convenience and a better overall experience. One example in the U.S. is last year's national launch of cooked right when you order fresh beef quarter pound burgers, giving customers hotter and juicier burgers which they crave. In 2018, the U.S. converted about 4,500 restaurants to experience the future. That meant we reopened more than 10 new restaurants every day throughout the year, introducing local communities across the country to a dramatically different McDonald's. This is an aggressive pace with an ambitious agenda at a time when the U.S. market is experiencing intense competitive pressures. Chris Kempczynski and the U.S. leadership team remain engaged in collaborative and constructive dialogue with franchisees. At the end of 2018, they met face-to-face with franchisees in all 10 field offices across the country. Whilst we've made some tactical and timely adjustments to our plan, collectively we remain committed to the growth strategy. It gives McDonald's the best opportunity to win in what is becoming an increasingly competitive market share fight. I also meet regularly with franchisees throughout the U.S., and earlier this month I had the chance to visit with several of them in Louisiana and Georgia. I heard firsthand how much they appreciate the flexibility and our continued willingness to work with them in carrying out the plan. This is the right strategy for our business, and we're committed to driving shared success. When visiting our modernized restaurants, it's easy to see how the new ordering options, refreshed decor, and overall enhanced hospitality make a difference for our customers. We established a solid foundation in the US last year that will serve us well in 2019. Now Kevin will discuss our financial results for the fourth quarter and full year. Thanks, Steve. With a relentless focus on our growth strategy, we continued our strong sales momentum across most of our top markets, with global comp sales of 4.4% for the quarter. This marks our 14th consecutive quarter of global comp sales increases, with each segment once again contributing to the growth. We also grew global guest counts for the quarter. Our top-line performance given the muted informal eating out environment in most of our major markets that Steve mentioned earlier. Looking across the segments, the international lead markets continue to outperform the competition, with comp sales up 5.2% for the quarter, led by the UK, Germany, and Australia. For the full year, every market in the ILM segment delivered both sales and guest count growth. something these markets haven't achieved since 2011. High-growth segment comp sales were up 4.8% for the quarter, with Italy, the Netherlands, and Poland delivering double-digit comp sales growth and positive comps across most of the segments. In the foundational markets, geographic regions. Turning to the U.S., comp sales were up 2.3% for the quarter, while comp guest counts remained negative. In 2018, the QSR environment in the U.S. proved challenging with aggressive promotional activity throughout the industry. Despite this, we achieved a positive comp sales gap of 100 basis points for the full year versus our QSR sandwich competitors. In the fourth quarter, U.S. sales continued to benefit from healthy average check increases from favorable product mix shifts and menu price increases. Value in deal offerings like the four for $6 classic meal deal, limited time offers like the glazed tenders and triple contributed to a higher average check. As I discussed on last quarter's earnings call, construction downtime and slower sales recovery related to the aggressive pace of modernization in the U.S. was a headwind in 2018. We've implemented processes to shorten project downtime and accelerate recovery to minimize the impact to the business as we continue our EOTF deployment. Turning to bottom line results, earnings per share was $1.97 for the quarter, an 18% increase in constant currencies after excluding current year impairment charges and tax reform related items in both the current and prior year. In addition to strong comp sales performance, EPF benefited from a lower than normal 19% effective tax rate for the quarter. setting pressure of $0.05 per share. Franchise margin dollars grew 6% in constant currencies for the quarter, reflecting sales-driven performance and conventional re-franchising. Franchise margin percent declined by 90 basis points as franchise revenue growth was more than offset, primarily by higher depreciation costs related to EOTF modernization in the U.S. Despite cost pressures around the world, like rising labor costs, sales growth and re-franchising benefits drove a 20 basis point increase in consolidated company-operated margins. 2018 was the first full year we began operating under our streamlined and more heavily franchised business model, and the benefits are reflected in our results. Our business continues to generate significant cash flows. In 2018, free cash flow was $4.2 billion, an increase of 14% over 2017. Our full-year restaurant margin dollars grew by over $100 million in constant currencies. And excluding current year and prior year special items, our 2018 operating margin was 43%, up over 4 percentage points from the prior year. In the U.S., Company-operated margins declined 190 basis points for the quarter. Wage pressures and continued investments in deployment of our key initiatives contributed to both higher labor costs and depreciation expense. Commodity costs were up about 2.5% for both the quarter and full year. Menu price increases were around 2% for the quarter as we looked to strategically balance For the international lead markets, commodity pressures eased for the quarter, up 1%, while the full year was up 2%. Menu prices increased about 2% year-over-year. G&A for the year was down 2% in constant currencies. I'll put our G&A savings into perspective in a few minutes when I review our outlook for 2019. Now I'll turn it back to Steve. Nearly two full years into executing the Velocity Growth Plan, our strategy remains focused on reigniting guest count momentum and regaining customer visits. We're visibly demonstrating to our customers how we're becoming a better McDonald's with a robust range of initiatives. With our focus on improving the taste of our delicious food, enhancing convenience, offering compelling value, and upholding the trust consumers place in our brand, and encourage more visits. We continuously strive to improve the taste of the iconic sandwiches at the core of our menu and introduce new items appealing to customers. During the quarter we had many examples in market that found success in encouraging visits and sales with many changes. Canada extended the successful launch of bagels earlier in the year by introducing all-day breakfast bagel sandwiches with fresh cracked eggs. In Spain, loaded fries were popular with customers seeking a snack, and many also enjoyed adding them onto a meal. Last year, Canada had a successful promotion introducing bacon on some of our classic sandwiches, and this week the U.S. launched a similar campaign to encourage more visits to our restaurants. We were pleased to see the attention generated with yesterday's Bacon Hour events, and the U.S. is following up by offering bacon on Big Macs and quarter powders, as well as cheesy bacon fries. Time and again, we see the importance customers place on getting their food hot and fresh with fast, friendly service. Customers notice a difference when we run great restaurants, so we continue to focus on improving the operations of our restaurants to provide customers with great all-round experience. I'm encouraged by the greater discipline we're demonstrating in many of our markets as they simplify menus, take other actions that reduce complexity and improve our ability to provide exceptional experiences for our customers. Serving delicious food and offering great service are vital. They're not the only requirements for maintaining strong trust with consumers. Public expectations of leading companies like McDonald's have never been higher. In December, we announced that we are partnering with suppliers and beef producers to reduce the overall use of antibiotics in our beef supply chain. This was the latest in a series of announcements throughout 2018 where we detailed bold targets for using our scale for good in addressing some of the world's most pressing challenges. In committing our resources, attention, and significant convening power and influence, we are demonstrating to our customers, employees, and other stakeholders that McDonald's is worthy of their trust. 2018 also marked a year of significant progress with each of our velocity-accelerated delivery, experience of the future, and digital. We will take action in 2019 to capture additional growth opportunities within the velocity strategy. Delivery momentum continues and is now available to over 19,000 restaurants, more than half of our global system. It took us almost 20 years to grow our annual delivery business in the Middle East and Asia to $1 billion. Over the past two years, delivery has become a $3 billion business for both McDonald's Company and franchise restaurants globally. Delivery continues to grow rapidly as we expand through additional restaurants and third-party providers, as well as benefiting from strong same-store sales momentum. Many of our major markets such as the US, France and the UK achieved delivery sales growth in the high double digits in restaurants offering the service for more than 12 months. And other markets such as Canada, Italy and Russia grew even more. We're confident that delivery offers additional growth potential for our business. Even with the momentum we already have established, we know we have an opportunity to let more customers know that McDonald's will bring meals to their homes, offices, and college dorm rooms. Driving awareness begins with encouraging more customers to try delivery. We talked before about the high satisfaction among our delivery customers and their willingness to reorder, and we continue to see those trends hold steady throughout 2018. We've placed a high priority on identifying the winning ideas developed by individual markets and spreading them elsewhere within the McDonald's system. UK, Canada, and Australia are leaders within McDonald's and are developing innovative approaches to help restaurants with high order volumes. In Australia, awareness more than doubled through a major campaign that promoted delivery within restaurant sites, engaging social media outreach, PR activity, and advertising. And in its own awareness campaign, Uber Eats in Australia featured McDonald's demonstrating the strength of our partnership. We also continue to bring learnings from China, our most developed delivery market, to help our newer delivery markets, especially related to restaurant operations. As we've said previously, our commitment to everything we do with this growth accelerator is our commitment to make delivery easy and convenient for our customers, which will help us maximize the competitive advantage of our business. Now I'll turn to another one of our Velocity Accelerators, Experience of the Future. With refresh decor, new ordering options, and an enhanced focus on providing a more enjoyable visit to our restaurants, we're introducing a new hospitality experience to McDonald's customers. Our guest experience leaders have been key to a better customer experience, which we've seen drive high customer satisfaction in sales and ultimately strong business results. With about half of our restaurants around the world converted to EOTF, we have many more customers experience modernized restaurants and enhanced hospitality. We've identified an opportunity to be more consistent in ensuring restaurants adopt proven best practices for engaging with customers in our updated restaurants. We've made significant progress, for example, in the U.S. in training 10 assist the customer with kiosk orders, or bring trays of Big Macs and fries to a customer's table. We're encouraged by the impact on our business as we continue to enhance hospitality and complete more projects. Restaurants that have introduced experience to the future elements continue to perform in line with our expectations for higher sales and customer satisfaction. Customer expectations for the way they interact with brands continue to rise. We have made additional progress in 2018 holding up digital platforms, making the McDonald's experience simpler and more personalized for our customers. In the years ahead, we will continue making strides through digital channels to reward customers with good value and relevant offers, as well as incorporating fun experiences they appreciate from our brand. These opportunities are possible because of the extensive work we've completed in deploying technology throughout the McDonald's system. including self-order kiosks in nearly 17,000 restaurants, digital menu boards in more than 21,000 restaurants, and new capabilities for mobile order and pay that's available in over 22,000 restaurants. Now Kevin will discuss our outlook for 2019. Over the last several years, we've fundamentally enhanced the strength and stability of our business. In anticipation of being substantially complete with our re-franchising efforts, we established long-term average annual financial targets set to begin this year. These targets reflect our confidence in our ability over the long term to increase system-wide sales 3% to 5%, maintain our operating margin in the mid-40% range, deliver earnings per share growth in the high single digits, capital in the mid-20% range. The strength and reliability of our significant and growing cash flow enables us to return about $25 billion to shareholders over the three-year period ending this year, including our 15% dividend increase announced last September. Over the last two years, we've returned over $16 billion toward this target through share repurchases and dividends. Looking at 2019, we anticipate some headwinds this year around labor costs, EOTF-related depreciation in the U.S., commodities, and foreign currency translation, which will put some pressure on EPS growth this year. Higher depreciation expense in the U.S. will continue to impact both franchise and company-operated margins over the next couple years. Franchise-related depreciation expense will increase by about $100 million year-over-year in 2019. And depreciation on company-owned restaurants will also increase about $15 million, both driven by the accelerated pace of the OTF. We expect commodity increases in the U.S. of 1% to 2% for the year, and an increase of about 2% in our key markets outside the U.S. Based on current exchange rates, we also anticipate currency pressures to continue for the first half of this year. At today's rates, we expect currency to negatively impact EPS by 8 to 10 cents in the first quarter and 13 to 15 cents for the full year. As usual, this is directional guidance only because rates will change as we move through the year. We continue to exercise strong financial disciplines. and we expect about a 4% G&A reduction in constant currencies for the year. At current exchange rates, this will result in total G&A of roughly $2.1 billion. Since the beginning of 2015, we will have achieved gross G&A savings of over $600 million. After reinvesting some of this back into areas to drive growth, like technology, we'll be down net about $500 million. We've mentioned that most of our major re-franchising transactions are complete. We will continue to re-franchise some restaurants to conventional licensees across markets such as the UK and US, but to a much lesser extent. As a result, we expect gains on restaurant sales this year to be about $200 million less than 2018. Moving on to capital, we ended 2018 with capital expenditures of $2.7 billion. Although this was slightly higher than initially planned for the year, we completed about 4,500 EOTM projects in the U.S., well exceeding our original plan of 4,000 projects. As we've also noted, inflation in the overall construction industry has also been a pressure on EOTM project costs. We currently expect to spend roughly $2.3 billion of capital in 2019. Nearly a billion of that capital will be dedicated to completing approximately 2,000 EOTF projects in the U.S. Our recent adjustments to the U.S. plan now provide the ability to more evenly balance remaining EOTF projects between 2019 and 2020. While we have provided an option for franchisees to extend projects beyond 2020 at a reduced partnering level, most franchisees are choosing to complete their projects over the next couple of years. So we expect to be substantially complete with the OTF by the end of 2020. New restaurant development continues to be an important component of our growth equation. We plan to open roughly 1,200 new restaurants this year. We will spend approximately $600 million of our capital to open about 300 restaurants in our wholly owned markets. Our developmental licensees and affiliates will spend their capital for the remaining 900 openings, nearly half of which are planned in China. This is a demonstration of how the financial resources and capabilities brought by our opportunities for accelerated expansion. As we enter 2019, I'm confident that we're well-positioned to deliver sustained, long-term profitable growth for the system and our shareholders. With our strong performance in 2018, you can see why we're confident in our strategy. We have a lot of growth potential remaining in the core of the Velocity Growth Plan and the accelerators. provides a solid foundation guiding our business as we begin 2019. We also recognise there are significant challenges as we enter the new year. Kevin shared several of the financial headwinds to growth that we're facing, and as you've seen, consumer uncertainty is growing from France to China to the UK and elsewhere across the globe in response to tightening economies and shifting political environments. Still, we remain optimistic The investments we've already made in modernizing thousands of our restaurants have placed us in a strong position. We will continue to prioritize investments in our restaurants and our business so we can keep advancing as a leading global brand in our dynamic consumer landscape. In the fight for market share, some will succeed and others won't. We intend to keep positioning McDonald's on the winning side. And now I'll hand it over to Mike who can lead Q&A. Thanks, Steve. We will now open a call for analyst and investor questions. As a reminder, please press star 1 if you have a question and pound 1 to remove yourself from the queue. To give as many people as possible the opportunity to ask questions, please limit yourself to one question. Our first question is from Eric Gonzalez with KeyBank.

Hey, good morning. Hope you guys are staying warm out there. I have a few questions related to your capital spending plans. Based on your 19 guidance, it seems like you're expecting to spend roughly the same amount in the US business this year versus last year, yet you're expecting to complete roughly half the number of EOTF projects. I guess the question is, has the EOTF project cost materially increased or are there other areas of spending that you haven't previously considered? Also, how should we think about capital spending plans for the out years in 2020 and 2021? given some of the projects are being delayed and considering McDonald's co-investment rate will decline to 40%. Thanks.