OAK BROOK Oct 23, 2019 (Thomson StreetEvents) — Edited Transcript of Mcdonald’s Corp earnings conference call or presentation Tuesday, October 22, 2019 at 3:00:00pm GMT

* Kevin M. Ozan

* Stephen J. Easterbrook

Oppenheimer & Co. Inc., Research Division – MD and Senior Analyst

Stifel, Nicolaus & Company, Incorporated, Research Division – MD & Senior Analyst

* David E. Tarantino

Robert W. Baird & Co. Incorporated, Research Division – Co-Director of Research and Senior Research Analyst

Evercore ISI Institutional Equities, Research Division – Senior MD & Fundamental Research Analyst

Goldman Sachs Group Inc., Research Division – VP & Derivatives Research Strategist

Guggenheim Securities, LLC, Research Division – Director and Senior Equity Analyst

Sanford C. Bernstein & Co., LLC., Research Division – Senior Research Analyst

Hello, and welcome to McDonald’s Third Quarter 2019 Investor Conference Call. At the request of McDonald’s Corporation, this conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to Mr. Mike Cieplak, Investor Relations Officer for McDonald’s Corporation. Mr. Cieplak, you may begin.

Good morning, everyone, and thank you for joining us. With me on the call this morning are President and Chief Executive Officer, Steve Easterbrook; and Chief Financial Officer, Kevin Ozan.

I want to remind everyone that the forward-looking statements in our earnings release and 8-K filing also apply to our comments on the call today. Both of those documents are available on our website, as are reconciliations of any non-GAAP financial measures mentioned on today’s call with their corresponding GAAP measures. Following prepared remarks this morning, we will turn the call over for your questions. I ask that you please limit yourself to one question. And if you have more than one, please ask your most pressing first and then reenter the queue. Today’s conference call is being webcast and is also being recorded for replay via our website.

And now, I’ll turn it over to Steve.

Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [3]

Good morning, and thank you for joining us. Broad-based momentum across our markets resulted in a 5.9% increase in global comparable sales for the quarter in our 17th consecutive quarter of global comp sales growth. This was complemented by gains in global guest counts. Across every country, function and level in our system, we’re seeing improving discipline and robust levels of execution that are guided by our velocity growth plan, performance that is punctuated by culture that is embracing and leveraging innovation across every facet of our business.

Every quarter, I spend several weeks visiting restaurants and speaking with franchisees and market leaders around the world. I come away from these visits inspired by how our actions resonate with customers, never more so than today when our global economy presents many economic, social and political challenges and uncertainties. Across markets, our success follows a consistent formula: Put the customer first; strive to understand their needs and desires and constantly find ways to improve their experience; then empower our people to pull the levers that create delicious, feel-good moments for customers every visit, every day. And that is: Start with strong corporate leadership and system alignments around our vision; engage local franchisees who bring an entrepreneurial mindset, a unique understanding of how to drive growth in their markets, and skill at developing innovations that improve efficiency in the customer experience; leverage the delicious food that’s at the core of our menu; run effective value strategies rooted in deep customer insights; and provide outstanding customer experience by running great restaurants; and finally, layer in initiatives to accelerate and sustain growth.

Visiting markets this quarter, in St. Petersburg, I saw examples of how the team is pulling Velocity Growth Plan levers across Russia. In a tough economic environment, we are meeting customers’ needs for taste, quality and value. At the same time, we’re empowering our crew to complement McDonald’s delicious food with hospitality and convenience for our guests. Our Russian customers have taken notice. We’re serving more guests and delivering a better experience in our restaurants.

In Portugal, we’re seeing balanced growth across all dayparts and all menu platforms. Year-to-date, our core products are driving roughly half of comp sales growth, and McDelivery is providing a meaningful comp sales lift.

In Taiwan, which recently celebrated its second anniversary as a developmental license, or DL-lead market, results are showing the benefit of the DL model. Our partner brings strong local leadership, a passion for our brands, greater insight at a local level, and financial strength to invest in a purposeful roadmap for growth.

Finally, in Japan, where an aging population, declining labor force and softening consumer confidence are combining to create unique market pressures, our team has made strong gains by offering menu items that tap into local tastes, table service that resonates with guests, and continued promotion of our digital capabilities, we’ve grown comp sales in Japan for the last 4 years.

Across global markets, we’re serving up a proven formula that signals to our customers we care about them.

In my visits with franchisees across the U.S., it’s clear to me that excitement is returning to the system with execution of Bigger, Bolder Vision 2020, the ambitious plan we built with our franchisees. Average franchisee restaurant cash flow is moving in the right direction with 11 consecutive months of cash flow growth through September. We expect this trend to continue through the rest of 2019.

During the quarter, I spent time with next-generation franchisees. These are children or grandchildren of franchisees who grew up in the McDonald’s system, and as adults, share a long-term perspective on McDonald’s proud heritage. In Minneapolis and Louisville, as in global markets, they are executing the Velocity Growth Plan formula successfully. They’re running great restaurants, capturing the benefit from growth initiatives, and anticipating new ways to best serve our customers and crew in the future.

Across the U.S., we’re getting back to basics with the goal of running fast and friendly drive-thrus. We are providing tools in the kitchen to help prepare our food fast and with the highest quality standards. Running national drive-thru challenges which have resulted in improving speed of service; deploying new technology like drive-thru timers, which are now installed in 60% of the U.S. system to ignite crews’ competitive spirits; and making bold decisions to reduce the complexity of our menu. And it’s working. Thanks to these and other efforts, we’re seeing continued operational improvements. Customer satisfaction scores reach an all-time high in quarter 3, and seconds at the drive-thru have dropped by double digits year-over-year.

Now let me turn over to Kevin for a deeper dive into our performance around the world.

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Kevin M. Ozan, McDonald’s Corporation – Corporate Executive VP & CFO [4]

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We’re pleased with our continued top line growth momentum. As Steve said, global comp sales increased 5.9% for the quarter and each of the operating segments contributed meaningfully to our growth. We also grew global guest counts.

In the U.S., we delivered another strong quarter of sales growth. Comp sales were up 4.8%, despite the increased competitive environment. While U.S. traffic was negative for the quarter and remains our biggest opportunity, we benefited again from a healthy average check increase, driven by both product mix changes and menu pricing.

Our iconic core menu continues to fuel results, from the fresh beef QPC and QPC deluxe line extension to core items featured in the Buy One, Get One for $1 national promotion. Our customers are showing us that our investment in fresh beef is paying off as we continue to grow burger share. Additionally, our Worldwide Favorites promotion that launched in quarter 2 and carried into quarter 3 resonated well, and customers especially love the stroopwafel McFlurry.

The sales benefit from our modernized restaurants also contributed to our overall U.S. comp performance for the quarter. We’ve converted about 1,500 restaurants to EOTF this year and remain on track to complete about 2,000 projects by year-end. The U.S. now has over 9,000 EOTF restaurants, or roughly 2/3 of the U.S. estate.

Turning outside the U.S., the International Operated Markets segment once again delivered strong, balanced results. Comp sales were up 5.6%, with every one of the markets growing comp sales for the quarter and nearly all of the markets also growing guest counts. The U.K., which delivered its 54th consecutive quarter of comp sales growth, continues to gain market share across nearly all dayparts, despite an increasingly competitive marketplace and declining consumer confidence. The market’s performance was highlighted by a promotional food event featuring double quarter pound burgers and spicy McNuggets, along with growth in delivery, driving record-high monthly sales and guest count volumes in the quarter.

France marked its 10th consecutive quarter of comp sales growth with continued all-time high market share. The market is successfully accelerating on premium and core burgers, a continued focus on their value platform and family business and delivery expansion.

Germany also marked its 10th consecutive quarter of comp sales growth. The quarter benefited from strong value messages and mobile offers along with maximizing contributions from EOTF.

Looking at the International Developmental Licensed Markets, which is now our largest segment by restaurant counts, comp sales were up 8.1%. Each geographic region grew both comp sales and guest counts, with Japan, China and Brazil as the largest contributors to the segment’s performance. I recently visited Latin America and had the opportunity to meet with Arcos Dorados, our strategic DL partner. Arcos has expanded McDonald’s footprint across the region by opening new restaurants, and they’re also making great progress in modernizing existing restaurants to EOTF. Using local expertise and innovation, Arcos is successfully executing their strategy of delivering an enhanced customer experience, providing the most relevant menu offerings and running great restaurants, despite the geopolitical and economic challenges they face.

Now I’ll turn it back to Steve to further talk about the growth accelerators driving our business.

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [5]

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As we’ve shared on prior calls, we’re moving with purpose to bring the biggest benefit to the most people in the shortest possible time. This means taking bold actions designed to serve more customers tomorrow than today.

Historically, we’ve achieved sustained compounding growth when we offer new customer experiences on top of a strong base of operational performance. When we launched our Velocity Growth Plan in 2017, we committed to 3 such new customer experiences, which we call our growth accelerators: Experience the future, digital and delivery. They’re all about giving customers more control over how they order, how they pay and how they receive their food. In a short period, we’ve moved from deployment to real business impact with each of these accelerators. Through our EOTF deployment, we’ve created more inviting dining environments, easier and faster ordering, and greater hospitality with guest experience leads focused on serving our customers’ needs. These efforts are clearly connecting with guests.

With digital, we’re working hard to fulfill customers’ desire for simpler, smoother and more personal engagement over our digital platforms, including kiosks, drive-thrus and our mobile app. Nowhere was the power of our emerging digital ecosystem more on display during the third quarter than in China. The market drove strong comp sales growth in part by delivering tangible, members-only benefits to our digital community, which now stands at 100 million registered members. Additionally, we benefit from the halo effect of promoting delivery to our growing digital network. We continue to move quickly to deploy Dynamic Yield, which technology improves our ability to offer customers what they’re likely to want using machine learning to make suggestions based on time of day, weather and popular menu items. The business case is driving rapid adoption. Dynamic Yield technology is now in over 9,500 U.S. drive-thrus, with full rollout to nearly every U.S. restaurant with an outdoor digital menu board expected by year-end. And we’re just getting started. Deployment across our existing drive-thru restaurants in Australia will be complete by year-end, and we’re scoping future deployment for additional markets and applications, eventually including kiosks and our global mobile app. Ultimately, Dynamic Yield will facilitate a range of personalization benefits where we can leverage knowledge of the customer and order patterns to provide a tailored experience in restaurants, at the drive-thru and on our app.

Another milestone on our journey to embrace technology to provide simpler, smoother and more personal customer engagement over our digital channels is the creation of McD Tech Labs, which is fueled by our acquisition of Apprente. Our new team, based in Silicon Valley, brings first-mover advantage in a must-win area for our system, voice technology. Apprente talent and technology comes with a promise of more efficient and accurate ordering at the drive-thru and a better experience for our customers. At the same time, we expect the technology to reduce complexity for our crew. Whether we look across the tech or consumer world, we see voice technology playing an increasing role in all our lives. And for McDonald’s, this is particularly significant because of the importance of drive-thrus to our portfolio.

Delivery is another area where we’ve moved rapidly to capture changing consumer habits around service and convenience. Once again, customers are responding. In fact, they’re now placing 10 McDelivery orders per second on average globally. So whilst we’re on this call, customers will likely place 36,000 McDelivery orders.

For 2019, we expect delivery to drive $4 billion, or roughly 4% of global system-wide sales. That’s up from $1 billion just 3 years ago. And it’s now available from about 23,000 McDonald’s restaurants in over 80 countries. Of note, our McDelivery global average check remains steady at 2x the average at restaurant check. Year-over-year, we continue to see double-digit or higher McDelivery comp sales increases across many of our major markets.

In the U.S., we saw an increase in average restaurant McDelivery orders in restaurants where we recently introduced DoorDash as an additional delivery partner. This result is consistent with our experience in other markets. The addition of multiple delivery partners in markets such as Italy, Canada, Russia and Spain help these markets reach new customer pools by appealing to customers primarily loyal to other apps and expanding coverage to geographies where existing partners may not have had a presence. As we add new delivery partners globally to reach new customers, we’re also keeping pace with an evolving delivery ecosystem.

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Delivery remains a big frontier for our business, and we still have a long way to go, even with our existing customers, to encourage awareness and trial. This year, over 50 markets participated in our third annual celebration of McDelivery, themed McDelivery Night In, doubling the number of participating markets from last year. McDelivery Night In generated a 25%-plus global McDelivery sales lift at Thursday. A halo effect on the following day drove the most ever delivery orders on a single day for us.

As we prioritize awareness and trial, we’re encouraged by data showing that new or lapsed users accounted for a significant portion of the global sales lift. We still have a lot of work ahead of us, but we’re moving forward with great speed, energy and excitement within McDonald’s. We’re confident there’s plenty of road ahead for success with McDelivery.

Now I’ll turn it back over to Kevin for a deeper dive into the financials.

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Kevin M. Ozan, McDonald’s Corporation – Corporate Executive VP & CFO [6]

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In prior quarters, I’ve talked about the re-franchising we’ve undertaken to stabilize our business model, the capital we’re investing in EOTF alongside our franchisees to modernize our restaurants and the additional technology investments we’re making to grow the business. I also discussed earlier this year that these strategic moves have created some short-term financial headwinds, like lower gains on sales of restaurants and higher depreciation and G&A expenses.

As we’re setting up our business for long-term growth, I want to take a minute to put our strong operating results for the quarter in perspective. We grew global comp sales by nearly 6%. We grew system-wide sales by 7% in constant currencies. That’s well over $1.5 billion of growth across the system. We grew constant currency revenue across each of our operating segments for the second consecutive quarter. Our franchise margin dollars were $2.5 billion, growing $150 million for the quarter or a 6% increase in constant currencies. We achieved an operating margin of 44%. And EPS for the quarter was $2.11, with growth in margins being offset by lower gains on restaurant sales and a higher tax rate. This performance reflects the strength and stability of our business model, as well as the ongoing actions we’re taking to position our business for sustained, long-term profitable growth.

In addition, consolidated company-operated margins increased 20 basis points to 18.6% for the quarter. U.S. company-operated margins increased 280 basis points to 15.6%, benefiting from comp sales growth and improved operational performance. IOM company-operated margins declined 60 basis points, but were still a healthy 21.3% as continued labor and commodity pressures more than offset comp sales growth.

In the U.S., third quarter pricing was up nearly 3%, while commodity cost increased about 2%, primarily due to higher beef costs. We still expect the full year U.S. grocery basket to be up about 2% to 3%.

Turning to G&A. Steve mentioned earlier that we’re committed to investing in our business for the long-term. As we’ve become more efficient with our day-to-day G&A to run the business, we’re choosing to invest in technology and R&D, such as our acquisitions of Dynamic Yield and Apprente, the creation of McD Tech Labs, and an increased focus on the back-of-the-house efficiencies for our restaurants.

Our year-to-date G&A spend is up 1% in constant currencies. And given our strategic investments, we expect full year G&A to be up about 1% to 2%. Our effective tax rate was 25.3% for the quarter, and we expect our full year tax rate to be relatively similar.

Foreign currency translation negatively impacted our third quarter results by $0.03 per share, given the continued strength of the U.S. dollar. Based on current exchange rates, we expect foreign currency translation to negatively impact Q4 earnings by $0.01 to $0.03, which would result in a full year headwind of $0.20 to $0.22. As usual, this is directional guidance only because rates will change as we move through the year.

And finally, in September, our Board of Directors approved an 8% dividend increase to the equivalent of $5 annually. This marked the company’s 43rd consecutive year of delivering a dividend increase for our shareholders and reinforces our confidence in the company’s long-term strategy. Through third quarter, we returned a cumulative $22.5 billion against our 3-year cash return share — to shareholders’ target of about $25 billion, which will be completed this year.

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [7]

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As we talk about change and embed a culture of innovation in how we work, it’s important to connect these efforts to our iconic global brand. For over 60 years, the strength of the McDonald’s brand has been our ability to offer a compelling menu of delicious and affordable food made with high-quality ingredients and complementing that with hospitality and convenience for our guests. An integral component of that brand magic is meeting consumers on their terms; in places where they congregate, whether it be in small towns or urban centers, on the sidelines of work or play, or in the various other places where communities come together. A brand at its essence is a promise, and our promise has largely remained unchanged over the years. What has changed are the ways in which we fulfill that promise.

The world is different than it was in 1955. Different today even it was 4 years ago when we launched our turnaround. We’re keenly aware that we have to be ahead of these changes, investing, executing and growing with a deep sense of urgency and purpose. And our strong performance in the third quarter and over the past 17 quarters didn’t happen in the back queue. It’s the result of our people firmly committed to our Velocity Growth Plan and the culture of innovation that is driving that plan. That culture of innovation is rooted in our relentless focus on the customer experience, making the jobs of our Russian employees simpler and more rewarding, and building an operational foundation for long-term growth and competitive success.

Operational and marketing innovations have been embedded into our DNA since the opening of store #1 in Des Plaines, Illinois. Each time we innovate collectively with our franchisees and supply chain partners, whether by founding Hamburger University in 1961, introducing the Big Mac in 1968, opening the first drive-thru in 1975, introducing Extra Value Meals in 1991, launching All Day Breakfast in 2015, or accelerating delivery in 2017, we plant seeds that result in sustained growth for our business. Indeed, it’s through this approach that we’ve been able to grow guest counts; strengthen our 3-legged stool of employees, suppliers and franchisees; and build an enduring brand with a legacy of sustained growth. This is not to say our company and our industry won’t face challenges ahead. We have before and we will again. But by having the right people in the right places, supporting them with resources and investments they need and embedding a culture of innovation to how we work, we know we can deliver on our brand promise in any environment and sustain the growth trajectory which has defined this business for over half a century.

With that said, let’s begin our Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [2]

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Our first question is from Eric Gonzalez with KeyBanc.

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Eric Andrew Gonzalez, KeyBanc Capital Markets Inc., Research Division – Restaurants Analyst [3]

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You have a large hamburger competitor announcing its intention to enter the breakfast daypart with a big ad campaign and promising to drive a 10% sales mix almost immediately. I’m just wondering if you can comment or discuss your thoughts on how that might impact the industry in 2020, and if you see the industry shifting again towards heavy discounting in the morning. And I recognize you might not want to give too much away, but if you could comment on how you see this playing out among your competitors as they try protect its share would be really helpful.

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [4]

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Thanks, Eric. Steve here. And by the way, apologies to everyone if I’m coughing a little bit through this call. I’m just a bit under the weather at the moment. But yes, so breakfast, competitive daypart. I mean, we’ve seen competitors rank up — ramp up their activity during this year as well, actually. So having another entrant in next year will just ensure that market share fight remains as competitive as ever. I’m not sure if it’s really going to be in anyone’s huge best interest to have it too much value- or discount-led. But it is an important daypart for us to protect and grow. I think for us, we were encouraged this current quarter because breakfast has been a little behind the rest of the days’ performance until this quarter, and we’ve seen our breakfast sales growth pretty much in line with the sort of sales growth we’re seeing across the rest of the day. So I think that gives us encouragement that the actions that many of our local co-ops are taking to fight this at a local level are beginning to get some traction. So — but we operate in a competitive market, whether it’s breakfast or rest of day. So we’re used to fighting for our share, and we’ll carry on doing that the next year, for sure.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [5]

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Our next question is from Andrew Charles with Cowen.

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Andrew Michael Charles, Cowen and Company, LLC, Research Division – Director [6]

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Great. Kevin, you talked about year-to-date SG&A growth of roughly 1% with 4Q implied, obviously step up to make the full year guidance of 1% to 2%. And I guess, assuming the accelerating rate — exit rate of G&A in 2019 and the creation of McD Tech Labs to evaluate future technological opportunities, how should we think about what this means for 2020 G&A, with the Street broadly has you pegged at flat G&A dollars?

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Kevin M. Ozan, McDonald’s Corporation – Corporate Executive VP & CFO [7]

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Yes. Thanks, Andrew. So as I mentioned, our full year spend is expected to be up 1% to 2%. We’re up basically 1% through year-to-date. So obviously, you can do the math for fourth quarter. But as I mentioned in my prepared remarks, we’re more efficient on our day-to-day G&A. We’re choosing to invest in certain areas of technology and R&D, that’s Dynamic Yield, Apprente, McD Tech Labs and back-of-the-house [somewhat] efficiencies that are increasing the G&A certainly slightly this year. And my expectation is that G&A would be higher in 2020 than it is in 2019 mainly because, as you know, our acquisitions of both Apprente and Dynamic Yield happened midyear this year. So we’ll have kind of full year impact of those in 2020.

I’d say we believe these investments are really important to help set us up well for the long — for long-term growth, and so we believe they’re the right thing to do. As you know, over the last several years, we’ve lowered our G&A both in absolute dollars as well as significantly as a percent of sales. As a perspective in 2014, we were — G&A was 2.8% of sales. This year, we’ll be about 2.2% of sales. And really, what we’re focused on is driving growth and operating margin. And our belief is that we’re going to have to spend some money in order to be able to drive operating margin. That certainly has grown significantly, again, from about 29%, 30% back in 2014 to mid-40s now. So you should expect that G&A will be a little higher in 2020 than it is in ’19. But to us, it’s really about driving bottom line — top line and bottom line growth.

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [8]

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Just to hook on that, as well. I think if we take Dynamic Yield as an example, clearly, we’ve absorbed the incremental G&A that comes with the acquisition. I think part of how we challenge ourselves here is to generate the return on that investment as fast as you can, and I think we’ve been encouraged by the fact that we have the Dynamic Yield technology now in 9,500 drive-thrus in the U.S. And we’re pretty much rolled out across the entire Australian system as well now and with other of our larger international markets lining up. So we think it’s — we challenge ourselves in terms of being fiscally responsible. But growth is kind of the primary driver of all of our ambition, and I think these investments are enabling that, for sure.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [9]

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Our next question is from Katie Fogertey with Goldman Sachs.

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Katherine Irene Fogertey, Goldman Sachs Group Inc., Research Division – VP & Derivatives Research Strategist [10]

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You guys started to test out (inaudible) plant-based burger in Canada. I’m wondering, as you saw the quarter unfold, did you guys think that not having a meatless burger was a headwind to your sales? How are you thinking about that opportunity here?

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [11]

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We are interested in this, clearly. We’ve taken the plant-based product to Ontario, Canada. We’ve got 28 restaurants now. We only launched it with a couple of days of the quarter to go. So very early days. Clearly, there’s been competitive activity, which you’ll all be aware of, which I’m sure has helped create some more immediate interest, or some shorter-term, certainly, response — consumer response. I guess what we were interested in is really how best to position this, get a sense of the, as they call them, the flexi-tarian customer, really what is their appetite for this? No pun intended. But would it drive incremental visits? Is it an option just to switch out from time to time? We want to get the taste right, want to get the marketing right, want to get the operations right. So there’s a number of important factors that we’re learning quickly, and we think Ontario is a great spot because it’ll give us a good read across North America, frankly, but also into the developed markets in Europe as well. So we think the read across will be beneficial and help us speed up our intelligence on this. So more to come, clearly. But it’s an area of interest, for sure.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [12]

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Our next question is from Sara Senatore with Bernstein.

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Sara Harkavy Senatore, Sanford C. Bernstein & Co., LLC., Research Division – Senior Research Analyst [13]

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Question about technology spend, and then just a quick clarification on what Kevin just said. First, I guess you are spending a lot of money on technology, as you pointed out, and certainly, it makes sense to leverage scale to make these investments. But our sense is that a lot of your competitors, at least in the U.S., are doing — are also doing well perhaps without as much of an investment. And to your point about traffic, still a little bit of a headwind for you. So I guess, how do we have confidence that the amount that you’re spending, or the magnitude, is the right amount? That it isn’t perhaps too much, or there’s — that there is an ROI on this over time? And then just a clarification was, Kevin, you mentioned you wanted to see growing margin rate. So it sounded like you were growing margin, it sounded like you were talking about rate as opposed to margin dollars. So should we expect margin rate to continue to expand from here?

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Kevin M. Ozan, McDonald’s Corporation – Corporate Executive VP & CFO [14]

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Yes. Let me start with the last one first. Take care of that one, and then we’ll come back to the tech spend. When I talk about operating margin, I was talking about kind of the mid-40% range. But certainly, you should expect that operating margin dollars will grow. Just as a perspective, if I think about kind of our restaurant margin dollars, through year-to-date, through September, we’ve grown margin — restaurant margin dollars about $450 million in constant currency. So you should expect that our ambition is to continue to grow those margin dollars as we continue on, and our expectation is to continue growing those margin dollars.

Some offset to that will be G&A, obviously. And as I’ve mentioned, we think G&A will go up some in 2020, but certainly not anywhere close to offset growth in margin dollars, which should mean that our expectations in operating margin dollars would continue to grow.

Relating to tax spend, I’ll say a couple of things, and if Steve wants to chime in, he’s certainly welcome. I — it’s an interesting question, but I don’t know how to prove to you or convince you, let’s say, that we’re spending exactly the right amount. I’d say a couple of things.

One, I think we have certainly proven internally, and hopefully externally, that we have put discipline around our G&A processes and that we are investing in things that are driving growth for the business. As Steve mentioned, the way we look at our spend is to determine what kind of return we expect to get on that spend and that helps drive a determination of what we’ll spend. We were, as you know, certainly a couple of years ago, a little behind on our technology spending, so that we did have to spend some in the last couple of years, I’ll say, just to get infrastructure and things set up the right way.

And then, finally, I’d say our intent is to set ourselves up for sustainable long-term growth, and that’s why we’re investing in technology today. Our belief is those who aren’t investing in technology at some point will be behind and will need to catch-up. And we’d rather be a little bit ahead of the curve and spend the right amount that we think will drive future growth.

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [15]

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Yes, and I’d support that. I think they’re — I think part of the performance that we’re showing, say, through 2019 is the result of some of the technology spend that we’ve invested the last 2 to 3 years. And if I was to backtrack, say, 4 or 5 years, majority of our tax spend was [back-of-house type spend] just to keep the restaurants operating. Now, we’ve really gone much more consumer-facing. So that’s kind of a new area of spend for us. But we begin to see the results. I mean, as we see the self-order kiosk usage increase around the world, we see the average check growth that comes with it. As we invest in the outdoor digital menu boards, and then you can plug in Dynamic Yield capabilities, we start to see, again, average (inaudible) growth come from there. Or even just as simple as getting our infrastructure set up to enable us to meet home delivery, for example, and now integrating those apps into our global mobile app. This all takes investment, but it either makes — you see the driving visits or driving check, but it’s also driving some efficiencies.

But it’s not always about acquisitions either. So obviously, we’ve made a couple of acquisitions this year, which clearly gives us an incremental G&A, which we’ve just spoken about. But again, this is also just ongoing investment through our Innovation Center, around modernizing the equipment stack, if you like, and getting that kind of ecosystem functioning more effectively to help our managers and crew run the restaurants better. So I would say some of the proof points are out there already, but we’re excited about continuing to drive efficiencies through technology and also growth through technology. So more to come.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [16]

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Our next question is from David Palmer with Evercore.

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David Sterling Palmer, Evercore ISI Institutional Equities, Research Division – Senior MD & Fundamental Research Analyst [17]

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A question on earnings. Obviously, 2019 is not going to be a year of earnings per share growth. But there’s been significant drags in there, lease accounting, tax rate, D&A step-ups, currency, maybe 7-plus points of drag in all those things altogether. You mentioned G&A being somewhat higher for 2020. But just thinking about what you should do in 2020 in terms of earnings versus that high-single digit algorithm, what are some gives and takes aside from G&A that we should be thinking about? And then on free cash flow, is your CapEx outlook still the same with your CapEx dropping from about $2.3 billion in ’19 to about half that by 2023?

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Kevin M. Ozan, McDonald’s Corporation – Corporate Executive VP & CFO [18]

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Thanks, David. Okay. Let me try in going through all of that. So regarding 2020, I guess, let me first say this. We still have strong belief in our long-term algorithm and targets. So I’ll start with that. Regarding 2020, if I think about this year, just to put this year in perspective, that obviously leads into 2020. Year-to-date, again, September right now, we’ve put up a fixed 5.9% global comp, 5% in the U.S., 7% system-wide sales growth in constant currencies. And as I mentioned, to Sara’s question, that has resulted in about $450 million of restaurant margin growth in constant currencies year-to-date. We do have higher G&A this year because of the Dynamic Yield, Apprente. We will have higher G&A next year because of those, as well as just the amortization of some of the tech investments we’ve made.

As I think about the gives and takes, the other couple of things will be — this year, we’ll have nearly $200 million lower of restaurant gains. We will likely have some lower gains even next year, certainly not to the extent of this year. We will have continued incremental EOTF depreciation, again, not to the level of this year’s increase, which was roughly or a little bit over $100 million on franchise margins. We don’t expect the incremental to be as much in 2020, but we will still have some incremental depreciation on those. So that’s some of the pieces. What I would say is we feel good — well, let me go to CapEx first, I guess. CapEx, as you mentioned, it’ll be roughly $2.3 billion this year. Roughly similar amount next year. And then it should fall a bit below $2 billion after that. So that — regardless of that, we believe the free cash flow will continue to grow year upon year. That’s how our model shows it right now. And I’d say based on our algorithm and the way we looked at it, I feel good about the business model, I feel good about our ability to grow margins and drop that to the bottom line, I certainly feel good about our strategy and I feel good about the investments we’re making in technology and R&D that we think will help set us up well for long-term growth.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [19]

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Our next question is from John Glass with Morgan Stanley.

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John Stephenson Glass, Morgan Stanley, Research Division – MD [20]

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If I could just come back to maybe the current quarter in the U.S. and the comps, which at 4.8 were strong, but they weren’t as strong as the prior quarter, at least. And you’ve got building EOTF momentum. You talked about Dynamic Yield. You talked about expanding your aggregator networks. All those would point to better results, and they were slightly softer, at least sequentially. So what were the offsets? Were you seeing? How did traffic fare relative to last quarter? I think you were sort of optimistic, traffic got a little better last quarter, but maybe it wasn’t sustainable. So was it just the relapse that — to normalization? Maybe a little bit more color on what changed in the business third quarter in the U.S. versus the prior quarter?

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Kevin M. Ozan, McDonald’s Corporation – Corporate Executive VP & CFO [21]

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Yes. I’ll start, and then I’ll let Steve chime in just so he can save his voice a little bit. Traffic for third quarter, I’ll say there wasn’t a meaningful change in traffic trends in the third quarter for the U.S. versus the first couple of quarters. So it’s still negative. As I mentioned, it’s still our largest opportunity, but not a meaningful change in trend in the third quarter versus second quarter. You will recall, as we mentioned on our second quarter call, we had a couple benefits in second quarter, one related to the timing of the Easter holiday, one relating to some promotional activity we had related to Filet-O-Fish that helped second quarter, I’ll say, be a little bit above trend, if you will.

So third quarter, if you think about 2-year stacks, third quarter is relatively similar to first quarter. And the other thing I’d say related to — within the quarter, because I know there’s been some chatter out there about how the quarter got weaker for us as the quarter went on, all 3 months were relatively similar in terms of comp sales. So each month was between a 4.5 and 5.5 comp, so it’s not like the world fell off in August and September, anything like that. And the other thing I would say is there certainly was some competitive pressure, mid-August probably through mid-September, that seemed to lessen as we ended the quarter. So I think all of those factors kind of impacted our net results in the quarter. As you mentioned, EOTF is a benefit — third quarter benefit was relatively similar to second quarter benefit, and I would expect that to be similar in the fourth quarter before it starts leveling off for next year.

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [22]

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I think the only thing I would add is, if we kind of drill into our details of point ones here and point ones there, some of the work we’ve done on simplifying our menu has maybe had a little bit of resistance when we move away from, say, signature-crafted. Now the flip side is it’s helping us run better restaurants, and we saw our drive-thru service times in the U.S. improve by around 20 seconds across the quarter year-on-year. So I think we’re still making the right decisions for the long-term. But yes, there’s going to be a little bit of short-term resistance when you simplify the menu. So little bits and pieces, but no fundamental shift in momentum. I mean, it really was balanced sales growth across dayparts and across the menu actually, which I think is what’s giving us confidence, and some of the acceleration initiatives that we’ve launched are delivering consistently the sorts of performance that we’ve shared with you in the past.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [23]

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Our next question is from John Ivankoe with JPMorgan.

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John William Ivankoe, JP Morgan Chase & Co, Research Division – Senior Restaurant Analyst [24]

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Actually, a follow-up on that as well. You obviously mentioned improving drive-thru times, which is obviously important in record guest satisfaction scores. I mean, these are things that would normally have driven a positive traffic comp for McDonald’s maybe in the past. The comments that you made on franchisee store-level cash flow, 11 months, I think, of positive year-on-year cash flow, how much of that was due to some of the changes that you made from a promotional perspective? And what’s the postmortem on giving more of the value back to some of the local partners? Are you in a place where you think you’re optimizing profitability in traffic? Or might there be kind of a shift in balance, if you will, in 2020, where we might see more value inwards to drive traffic maybe to some extent at the sake of profitability?

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [25]

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John, as you know, it is that delicate balance. So I mean, to get the consistent top line growth and having profitable growth around (inaudible) price is clearly critical. We want — it drives their motivation, it drives their confidence, it drives their ability and willingness to keep reinvesting in the initiatives as we — as we’ve identified them. But yes, we don’t want to give up customers. And it’s fair to say that the guest count declines, we do see — there’s a couple of things I can share with you. One is the lower average check level. So clearly, there is a value component in there, and it’s just a case of how do we address that? Is that more at a local level, or is it at a national level? Though I know our U.S. team’s working through that. Another way we cut and dice this is across the U.S., we have 56 co-ops. And if we look at the fourth quartile, the most challenge-performing co-ops — see, clearly, 25% of our cost, but actually more than half of our guest count decline’s explained in those 14. So we’re putting more support and activity into those co-ops to see if we can just sort of pull up that tail, which then will ultimately lift us collectively as well. And we’re beginning to see traction there as well. So there’s a number of different ways we’re approaching this. But we want to remain competitive on value, clearly.

Getting back to the drive-thru service times. Yes, we will see incremental visits as we continue to improve service. And then fundamentally, we are a quick-service restaurant, and our trends had been heading the wrong way for too many years. And I’m delighted at how much traction we’re getting there, given the (inaudible) this year. And [we know] customers will notice 20 seconds, particularly the time-pressed customers, those busy peak hours with us, the breakfast rush or lunch time. Those savings, they don’t necessarily notice it on just one visit. But as we consistently run better restaurants, we believe that will obviously put us in a strong competitive position going forward.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [26]

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All right. Next question is from David Tarantino with Baird.

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David E. Tarantino, Robert W. Baird & Co. Incorporated, Research Division – Co-Director of Research and Senior Research Analyst [27]

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Just a question on the technology investments you made, and specifically Dynamic Yield. I guess what I was wondering is if you could comment on what you’re seeing so far as you roll that out and in terms of the customer response or the business impact. And how do you see that evolving as, I guess, customers get more accustomed to using the technology?

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [28]

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Yes, well, at the moment, we’ve effectively rolled out — the core capability of Dynamic Yield is kind of what we’d say is a suggestive sell. The beauty of this is there is nothing the customer has to adjust to. They almost don’t know that this experience is happening for them. It’s — we’ve got dynamic digital menu boards. And effectively, as they start to place their order, the menu boards respond to that ordering process, and therefore, are more likely to suggest items a customer will want and less likely to show items that a customer’s less likely to want. And of course, machine learning helps you improve that. And to be given the transaction levels we have across our business, we can learn pretty really — very quickly.

But there’s further capabilities, as we’re learning. So for example, there’s an area now where they can offer trending now, which will actually pick up items either in a restaurant or a local group of restaurants that are proven to be particularly popular at that point in time. So there’s kind of, again, another level of, let’s call it dynamic interaction going there. And again, at this point, we’re only really talking about having it on the outdoor digital menu board. But suffice to say, the team — part of the investment we’re making in the business with talent and expertise is to look to how can we integrate that into the self-order kiosk and perhaps ultimately in the global mobile app as well. So I think we’re early stages, already very encouraged about the results we’re seeing. The speed with which we can execute and roll this out, deploy this, is really giving us a lot of confidence that we can get this across — I guess, we’ve now got our outdoor digital menu boards in over 10,000 restaurants in the U.S. And the majority of our former international lead markets are pretty much fully deployed as well. The U.K. has got a little bit of catching up to do. But as I say, this is encouraging operators to invest in the technology because they’re seeing the return. And as I say, this is just for the core basic capability, and there’s more we can add to it.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [29]

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Our next question is from Matt DiFrisco with Guggenheim.

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Matthew James DiFrisco, Guggenheim Securities, LLC, Research Division – Director and Senior Equity Analyst [30]

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I just had a couple of follow-up questions. I guess can you just comment on how that 3% price should look going forward? Is that something that is going to be held in? And then I think in previous quarters, you described how much that was contributing to the check. In 2Q, it was about 1/3 of the check or so. If you could just sort of draw that line for us.

And then a clarification. I think you mentioned on the prepared remarks, hamburger share was gained, or you gained hamburger share, but your traffic was negative. Does that imply then there was some near-term increased competitive pressure around chicken, and you lost a little bit of business on the chicken side in the near-term in the U.S.?

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Kevin M. Ozan, McDonald’s Corporation – Corporate Executive VP & CFO [31]

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Okay, I’ll start. Price, Matt, let me start with how we think about it. I think we’ve talked before, but we look at various things. Certainly, food-away-from-home is one guidepost. But also, we look at — and the pricing we talk about is pricing system-wide, which as you know, 95% of those restaurants are run by franchisees determining that pricing.

But certainly, I think as they consider their pricing, they’re also looking at cost pressures, whether that’s labor, commodities, et cetera. And it’s really about trying to strategically balance, offsetting some of those cost pressures with kind of what a customer’s willing to pay. So there isn’t a pure formula that 3% — and I think we said nearly 3% — it actually was a little bit below 3%, but close to 3%. And the impact in our comp is actually a little less than that because while the peer price — what I quoted are peer price increase, but you get a little bit resistance. And so the actual contribution to comp ends up being a little bit below that. But it still is roughly that 1/3, 2/3, about 1/3 from price, roughly 2/3 from product mix for various reasons, including Dynamic Yield, kiosk usage, delivery, all the things that we’ve been talking about. So that’s the story on pricing.

Related to the burger share, so what we said that in the U.S., we did gain hamburger share in this quarter. I think it’s fair to assume with everything going on in the quarter with chicken, that we did go a little bit the opposite way on chicken. So I think that’s a fair conclusion.

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [32]

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I’ll only add to that. If you look at the top 11 markets, we actually gained IEO share and QSR share in all 10 of the largest markets beyond the U.S. as well, including some extremely strong gains in markets like the U.K., Russia, Australia, France is at an all-time market share high, for example. So I think we have proven to be competitive and driving the broader market dynamic around the world actually, which is helping underpin the sales momentum and visitor momentum.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [33]

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Our next question is from Chris O’Cull with Stifel.

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Christopher Thomas O’Cull, Stifel, Nicolaus & Company, Incorporated, Research Division – MD & Senior Analyst [34]

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Steve, there’s been a lot of discussion about how Dynamic Yield tech supports suggestive selling. But I would think the new digital menu boards would also allow the company to do a better job of price optimization, meaning stores could be able to adjust prices more frequently. Can you describe how the new menu boards or digital boards will change kind of the company’s approach to pricing?

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Stephen J. Easterbrook, McDonald’s Corporation – President, CEO & Director [35]

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Yes, we typically try to avoid that, and partly just because I think it’s part of the brand promise we have with customers, is just that reliability in knowing what their typical meal or combination costs. So it has been discussed in times, though. And I know others out there, and that’s kind of, if you like, the ultimate dynamic pricing capability. But that’s not really kind of underpinning the way we want to do business, and so we stay away from that. We try to have a careful, thoughtful approach with our kind of pricing consultants, if you like, and we just make periodic adjustments and just give customers that kind of assurance and reliability.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [36]

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Our next question is from Brian Bittner with Oppenheimer.

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Brian John Bittner, Oppenheimer & Co. Inc., Research Division – MD and Senior Analyst [37]

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First, just a clarification on David Palmer’s question on 2020. Kevin, should we be interpreting your answer in a way that we should be modeling 2020? Is it below algorithm year for earnings, or no? And just on the store-level margins in the U.S., a meaningful trend change in the margins there, up 280 bps this quarter. Can you just dive a little deeper on what specifically changed in the margin dynamics this quarter for the U.S. versus the last several quarters? And should we expect it to continue?

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Kevin M. Ozan, McDonald’s Corporation – Corporate Executive VP & CFO [38]

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Yes. Let me talk about the U.S. margins first. In my prepared remarks, I mentioned kind of what I called operational performance improvements. And really, what that means, as unexciting as this may be, is it’s kind of the basics of running better restaurants. We keep talking about just running better restaurants and getting more efficient in running restaurants, but it’s things like reducing complexity in the restaurants, simplifying procedures, focusing on efficiencies of the drive-thru, being more diligent with our labor scheduling and staffing, basic food control. So it’s all the stuff that we talk about when it’s kind of just managing a restaurant really well. And I think putting more of a focus on that has helped our company operated folks focus on that.

To be fair, I think the other piece I would just throw in there a little bit is there’s less disruption going on this year than there was last year from a couple standpoint — a couple pieces. One, we are almost completed with EOTF and the company-operated restaurants. So by the end of this year, we’ll have all of the EOTF projects that our company-operated restaurant’s completed. That’s one thing that is a distraction and a disruption to the restaurants. The other thing, as you know, is we’ve been re-franchising over the last several years, and that becomes a little bit of a disruption, certainly to the company-operated business. So the fact that, that’s more stable and we’ve kind of settled in where we are now I think helps just the stability of running the restaurants on the company-operated side. So all of those things, I think, go into play into why we saw some of that improvement this year. I think as we look forward in the near-term in the U.S., we still do have some pressures like the EOTF depreciation, some labor cost. But I think kind of similar range that we’ve been in the 15% to 16-ish percent range in the U.S. is probably a reasonable way to think about it going forward.

Regarding kind of 2020. In the fourth quarter, we’ll give more detail and go through our actual outlook that’ll provide more detailed guidance. I’ll leave what I said for now as general guidance. I mean certainly, we’ll get into more details as we get to year-end. We’re in the midst of going through our detailed planning right as we speak, and so I don’t want to go too far ahead before we actually complete that process.

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Mike Cieplak, McDonald’s Corporation – Senior Director of IR [39]

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That completes our call this morning. Thanks, everybody, for joining us. Have a good day.

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Operator [40]

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This does conclude McDonald’s Corporation’s investor conference call.



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