Earnings Call Transcript - MCD Q2 2022

Operator, Operator

Ladies and gentlemen, please stand by. Hello, and welcome to the McDonald's Second Quarter 2022 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. I would now like to turn the conference over to Mr. Mike Cieplak, Investor Relations Officer for McDonald's Corporation.

Mike Cieplak, Investor Relations Officer

Good morning, everyone, and thank you for joining us. With me on the call today are President and Chief Executive Officer, Chris Kempczinski; and Chief Financial Officer, Kevin Ozan. As a reminder, 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, along with their corresponding GAAP measures. Following prepared remarks this morning, we will take your questions. Please limit yourself to one question and reenter the queue for any additional questions. 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 Chris.

Chris Kempczinski, CEO

Thanks, Mike, and good morning, everyone. I'm proud to report that our Q2 performance was yet another demonstration of our broad-based business momentum, with global comp sales up nearly 10%, and most of our major markets continuing to grow market share. One thing is clear. The world continues to move in fast and often unforeseen ways. As we move forward, I want to offer up a few words about Kevin Ozan, who is joining today's call for the final time as McDonald's Chief Financial Officer. According to Kevin, this is his 30th earnings call as CFO; but who's counting? To say that Kevin has had a profound impact on McDonald's is an understatement, and I should note that this impact isn't coming to an end just yet. But as he transitions from his duties as CFO, it’s a perfect time to reflect on what he has done in this seat. When Kevin first took the reins as CFO in Q1 2015, comparable sales and guest counts were declining globally and across each geographic segment, and there were real questions about the growth outlook for the company. Rising customer and investor expectations demanded a clear vision and voice, which Kevin ably provided. He has shepherded McDonald's through unprecedented change time and again, leading the company's financial turnaround in 2015 and helping create our last two strategic growth plans, to navigating through a global pandemic and exiting a major market. During his time as CFO, the company increased system-wide sales by over 25% to more than $100 billion, increased the number of restaurants worldwide by more than 10% to nearly 40,000 restaurants, and returned over $50 billion to shareholders through dividends and share repurchases. As just one barometer of his impact, McDonald's stock has appreciated 150% during his tenure. Anyone who's worked with Kevin knows his leadership is as much about what he does as how he does it. His insightful strategic approach to the business is matched by his ability to make human connections at all levels and with all stakeholders across our system. It's safe to say that Kevin is one of the most beloved senior leaders in our organization. But like I said, Kevin is not going anywhere just yet. He's been promoted to a new elevated role as our Senior Executive Vice President of Strategic Initiatives, where he'll work closely with me until his retirement next year. I'll look to his counsel as we execute against our Accelerating the Arches strategy and identify areas where we can continue to evolve this strategy to meet the needs of customers long into the future. I expect we'll be sharing more down the road with all of you. Kevin, this isn't goodbye, not by a long shot, but on behalf of the entire McDonald's system, it's an opportune time to say thank you. Now on to the business operating environment. As we entered the year, we knew we were facing rising inflation, a surge in COVID-19 cases, and the return of government restrictions in many markets, exacerbating labor shortages and supply chain challenges. Over the last six months, the macro uncertainty has only increased. We now face war in Europe, inflation running at its highest levels in 40 years, and interest rates rising to levels we haven't seen in years. All of this is contributing to weak consumer sentiment around the world and the possibility of a global recession. We're mindful of these risks, and we're planning for a wider range of scenarios. While our McDonald's business continues to perform well, this is a very challenging environment for our McFamily, from restaurant teams, to franchisees, to suppliers. But we're united in our purpose to feed and foster the communities in which we operate, providing an affordable destination for a delicious meal. Now more than ever, that is what our customers are seeking, which is why we feel so well positioned and confident in our continued success. Our global system is aligned behind a comprehensive strategy that is centered on the customer. This is strengthening our brand, driving broad-based market share gains. I mentioned during our last quarter that we would provide an update on the state of our business in Russia. It became increasingly clear that the Russian war against Ukraine meant that McDonald's wouldn't be able to continue to operate in Russia in a way that would be accretive to our business objectives or aligned with our values. That's why in May, we announced that we would exit the market and sell our restaurants to a Russian buyer to be operated under a different identity. While the Golden Arches no longer shine in Russia, we are continuing to support our people in Ukraine and remain ever hopeful for a resolution of this conflict. Now for more on our Q2 numbers let me turn it over to Kevin, so he can give his 30th and final quarterly earnings readout. Kevin?

Kevin Ozan, CFO

Thanks, Chris, and thank you for the kind words. As Chris mentioned, global comp sales were up nearly 10% in the second quarter, demonstrating the continued resilience of our business, despite the challenging environment. In fact, when we look at our three-year comp growth with the US over 19% and our IOM and IDL segments both more than 15%, we see that our business around the world has been extremely resilient through the tumultuous last few years. Our quarterly results reflect strong underlying sales growth across all segments, a direct result of remaining customer-focused and executing against our strategy. In our international operated markets, we continued to gain QSR traffic share as markets showcased our iconic core equities and further capitalized on our digital channels. This fueled comp sales growth of 13% for the segment, with positive comps across all markets. Recovery in Germany and France continued, as remaining government restrictions eased early in the quarter. Germany built on their successful launch of loyalty at the end of last year and ran a Big Mac celebration campaign using mobile app offers to further drive digital adoption. In France, we highlighted our core burgers with strong marketing behind our triple cheeseburger, helping grow QSR market share to another record high level. Canada continued to prioritize convenience, as the market accelerated digital momentum with always-on loyalty messaging. We also featured a summer drink days promotion, highlighting our strong value proposition across all dayparts. Australia built on their first quarter launch of loyalty and accelerated digital engagement across the market with a strong lineup of mobile app offers. We partnered with Australian Pop Star, the Kid LAROI, whose famous order was available exclusively through our mobile app and McDelivery. In the UK, the return of the McSpicy Chicken Sandwich and Big Tasty promotion drove significant incremental sales. A daily digital sales calendar also helped build our digital customer base, leading up to the recent launch of Loyalty. While the expiration of VAT benefits impacted our quarterly comp sales in the market, we continue to grow QSR market share. Moving to the US, we posted positive comps across all dayparts in the second quarter, led by breakfast. Overall comp sales were up nearly 4% due to a higher average check supported by strategic price increases. We continue to focus on the everyday affordability that customers are looking for, across both our everyday value menu and digital offerings. Turning to the international developmental license markets, comp sales were up 16% in the quarter, largely driven by strong comps in Japan and Latin America. Japan achieved an impressive 27th consecutive quarter of positive comp sales with strength across our delivery and digital channels, and our growth at the dinner daypart continued with popular limited-time offerings across both chicken and beef. Recovery in China remains challenged with negative double-digit comp sales in the second quarter due to ongoing COVID resurgences and related lockdowns across key cities. This resulted in temporary restaurant closures throughout the country for most of the quarter. While operating conditions are challenging, restaurants remained focused on the consumer, offering core menu favorites and targeted digital coupons. And now I'll turn it back to Chris.

Chris Kempczinski, CEO

Thank you, Kevin. McDonald's is one of the most recognized and beloved brands on earth. Today, our opportunity is building on this recognition to keep up with customers and communities around the world and on every platform, whether it's our global mobile app or social media. I'm proud of McDonald's industry-leading digital and marketing initiatives that allow us to connect with even more customers in entirely new and creative ways, strengthening our relationships and better connecting our culture as we meet customers where they are. The investments we're making in digital, one of our biggest opportunities for growth, are beginning to bear fruit. In our top six markets, digital sales, which include mobile app, kiosk, and delivery, represented over $6 billion or nearly one-third of system-wide sales in the second quarter. With the launch of MyMcDonald's Rewards in the UK this month, we now have loyalty programs in nearly 50 markets, including all of our top six markets, and enrollment and participation continue to grow. Our loyal customers are highly engaged with us. Nearly 22 million of US loyalty members have been active in the last 90 days. MyMcDonald's Rewards has consistently driven more frequent visits and incremental sales in each of the markets as we've launched. Each reward a customer redeems and each preference a customer shares helps us power our personal touch. We can use this deeper understanding of our customers to create content and offers relevant to them through the channels they prefer. By tailoring messages, our customers feel more connected to McDonald's, ultimately driving engagement that increases both spend and frequency. It even means we can reunite with customers who haven't visited us in a while. We're also strengthening our iconic core menu. As I've mentioned before, in markets around the world, we're taking our leading burgers and making them even better by implementing enhanced cooking procedures and new buns, resulting in hotter, juicier, and tastier burgers. Spain was the latest market to launch these taste and quality improvements, driving incremental sales and giving our customers yet another reason to keep coming back for more. We'll also keep coming up with fresh spins on our classics, creating craveable moments for a new generation of McDonald's fans. In Germany, strong marketing and core menu campaigns, including the Big Mac celebration featuring the double Big Mac, drove strong comps for the quarter. In Australia, we leveraged the strength of our McCafe brand with the launch of the Australiano coffee in the second quarter and continue to grow our share in coffee. Of course, there's no better example of combining classic with modern relevance than our transformational marketing. And that's not just my opinion; it's the consensus of the marketing industry. McDonald's was repeatedly recognized this quarter for advertising that captures both hearts and minds. At the Cannes Lions last month, McDonald's and its marketing partners received multiple awards while simultaneously being named the most effective brand on the WARC Effective 100 for the third year running. We swept the global FE awards and were recognized as the number one most effective brand and marketer in the US. Over the past few months, we've continued to turn cultural moments into creative vehicles for the Golden Arches. In May, McDonald's commemorated Queen Elizabeth's Platinum Jubilee by recording a new version of our world-famous I'm Lovin' It jingle, making headlines and history. As Kevin mentioned, Australia launched our latest famous order with pop phenom The Kid LAROI. We created a significant brand moment in Canada with our annual McHappy Day campaign, raising nearly $6 million for Ronald McDonald House Charities and lifting sales and brand perceptions in the process. Our creative excellence has expanded our reach and made McDonald's not just more recognizable, but more relevant. It's this customer connection that is continuing to drive our business in new and exciting ways. Now to talk more about our second quarter financial performance, I'll hand it back to Kevin.

Kevin Ozan, CFO

Thanks, Chris. Our strong top-line performance resulted in adjusted earnings per share for the quarter of $2.55, an increase of 15% in constant currencies. This adjusted EPS excludes $1.2 billion of charges related to our exit from Russia and a gain of $270 million from the sale of Dynamic Yield. Adjusted EPS was hurt by $0.16 of currency as the dollar strengthened significantly in the second quarter. That was double the amount we estimated in our first quarter earnings call based on exchange rates at that time. Our G&A costs increased 10% in constant currencies for the quarter, reflecting higher investments in restaurant technology and incremental expenses related to our worldwide convention and proxy contest. As expected, company-operated margins were hampered by significant commodity and wage inflation as well as rising energy costs. Given macroeconomic conditions, we expect these inflationary pressures will continue to impact margins for the remainder of the year. Our company-operated margin dollars for the quarter were also negatively impacted by our exit from Russia, which was a heavily company-owned market. Even with these cost headwinds and our exit from Russia, our strong system-wide sales growth contributed to healthy flow-through to operating income. Total restaurant margin dollars grew $270 million in constant currency, as a result of sales-driven growth in franchise margins, which now make up nearly 90% of restaurant margin dollars. This resulted in an adjusted operating margin of 45% for the quarter. Lastly, based on current exchange rates, we expect FX to reduce third quarter EPS by about $0.14 to $0.16 and full-year EPS by roughly $0.40 to $0.50 again, double the impact that we estimated on our first quarter call. As we certainly saw last quarter, this is directional guidance only, as rates will likely fluctuate as we move through the year. Before I pass it back to Chris, I want to take a moment to say thank you. It's been an absolute privilege to serve as CFO of this iconic brand for over seven years. During this time, I’ve met many people who are on the call this morning, from analysts who follow our industry to investors in our company. I’ve had a lot of thought-provoking conversations with many of you. You offered your opinions and challenged me and my interactions with you over the years helped make me a better CFO and helped make McDonald's a better company. I’m extremely grateful for your engagement through the years and for the confidence you placed in us with your investments. I look forward to passing the baton to Ian Borden, whom I worked closely with on our senior leadership team for many years. We will continue to work together to ensure a smooth transition. Thank you again. And now back to Chris.

Chris Kempczinski, CEO

Thanks, Kevin. As we reflect on these results for the second quarter, I feel tremendous pride in the entire McDonald's system. I believe there has never been a better time to be part of the McDonald's brand. We have the right leadership and the right strategy at exactly the right time to take this iconic brand to even greater heights. As we announced over the past few weeks, we continue to assemble the right members of our global senior leadership team to help lead the next chapter for brand McDonald's, building on the successes made because of the outstanding contributions of former leaders. Because of McDonald's ability to provide a variety of opportunities and experiences at one of the world's most recognized and respected brands, our ability to recruit top talent and develop a deep bench is unparalleled in our industry. This only builds our confidence in executing on our strategic plan for the long term. As Kevin mentioned, stepping into the CFO role next is 30-year McDonald's veteran Ian Borden. Currently President of International, Ian has worked literally around the world for McDonald's in a variety of capacities. He brings a great mix of financial and field experience into the CFO role, and it will be great to have him now based in our Chicago headquarters. Additionally, Jill McDonald will be returning to McDonald's as President of our International Operated Market. Jill began her career as a marketer, eventually leading global marketing at British Airways. Jill then joined McDonald's as Chief Marketing Officer for our UK business in Northern Europe and later became the Managing Director for our UK business and President of Northern Europe. Jill is a seasoned veteran of the consumer industry, having served most recently as CEO of Costa Coffee. Her strong customer focus, passion for creative excellence, and commitment to innovation align well with my priorities, and I'm confident Jill will help accelerate the next phase of the IOM segment's growth. I'm also happy to share that Jo Sempels will continue to lead our international developmental license markets as President of IDO. Jo’s responsibilities will now include our large, fast-growing China business, which currently reports to Ian in his capacity as President of International. Meanwhile, Francesca DeBiase will be retiring as Global Chief Supply Chain Officer after more than three decades at McDonald's and over seven years in this role. I'm especially grateful to Francesca for stewarding our world-class supply chain through unprecedented disruptions and for spearheading sustainable solutions that are now standard practice throughout our system. While we'll miss Francesca, we're happy that Marion Gross will now be stepping into this role. Marion has been with McDonald's for 29 years, most recently as Chief Supply Chain Officer of McDonald's North America. I'm lucky to be surrounded by such great leaders who are also such good people. That's what McDonald's is all about, which is why we call ourselves the McFamily. With that, let's begin Q&A.

Mike Cieplak, Investor Relations Officer

Thank you. Our first question is from David Tarantino with Baird.

David Tarantino, Analyst

Hi. Good morning. First, I wanted to congratulate Kevin on a great career. You'll be missed by the investment community. And then, secondly, I guess, Chris, I wanted to ask about the situation in Europe, specifically again. And I know you called out a lot of macro challenges. And I was just wondering if you could comment specifically on whether you're starting to see any consumer behavior changes in your European business as a result of some of those pressures? And then I guess relatedly, you mentioned that you're planning for a lot of scenarios, and I was wondering if you could comment on what McDonald's might do if we were to see a more material downturn in consumer spending. Thanks.

Chris Kempczinski, CEO

Thanks, David. Well, as you saw in the announcement, we continue to have broad-based growth in, and our European business overall is performing quite well. I'm actually very happy with how the European business is performing. There's a few things that we're seeing consistently across that we are seeing, that we're gaining traffic and comp sales share in every major market where we operate; we feel great about that. We're gaining share in beef and chicken, which are priority areas for us. And we're doing quite well in delivery. I expect digital, particularly as we bring on the UK, is going to be a performer for us. So the headline is, Europe is doing very well for us. I think what is weighing on our mind and we're certainly attentive to is consumer sentiment as one area and a number of markets in Europe, France, for example, Germany is another market, Spain is another market we're seeing consumer sentiment down, and in many cases, down at record levels. So that's one area of concern. The second is, we do know that the inflationary pressures in Europe are elevated even beyond what we're seeing here in the US, and that has an impact on sentiment, but that also has an impact on what we're needing to do from a menu board standpoint and pricing. And so, I think while we look at Europe right now, and we're seeing strong results, it is a challenging situation. It's challenging for our franchisees. As you think about what we plan for under a variety of scenarios, it goes to essentially what are our marketing levers and what are our investment scenarios. And do we need to lean harder, for example, into the value end of our menu platform? That could be one scenario. On the other hand, if it continues at its current pace, maybe we don't need to lean in as hard as that. So, these are things that happen at a market level on a country-by-country basis, but the way our teams are looking at it is because of this uncertainty around consumer sentiment, we're just having to plan for more different scenarios, meaning having more flexibility in the marketing calendar to pivot if need be.

Mike Cieplak, Investor Relations Officer

Our next question is from John Glass with Morgan Stanley.

John Glass, Analyst

Thanks, good morning. Kevin, I want to extend my congratulations and best wishes. My question is similar but focused on the US. In the last quarter, you mentioned a slight shift in consumer behavior in the US, suggesting early signs of change. What is the current situation? What are the discussions like regarding pricing with the franchisees? While pricing has been adjusted to manage inflation, are you encouraging them to be more flexible with pricing given the shifting landscape in the US? How do you perceive pricing today compared to about 90 days ago?

Chris Kempczinski, CEO

Why don't I have Kevin hit this at the top, and then I'll cover anything he misses.

Kevin Ozan, CFO

Yes, I can take it. And thanks, David and John for your kind comments. Let me talk about the US and the comp and what drove the comp, and I think that will help talk about some of the trade down that you're discussing. Our Q2 comp of a little under 4% was driven completely by higher average check. Our guest counts were relatively flat. So, it really was check driven. That average check was driven, obviously, mainly by price increases. Year-over-year in the second quarter, our menu prices were up high single digits, relatively consistent with what I talked about in the first quarter; a little bit higher than that. We expect for the year to be in that high single-digit range for the full year. What we are seeing still is flow-through similar to what we've seen historically, still strong flow-through of roughly 70% or so. So, if you think about an 8%, 9% price increase with a 70% flow-through, the difference between that and our comp of a little under 4% was driven by two main things. First, one of the things I started talking about in the first quarter was a decline in units per transaction; that's partly driven by a reversion in the number of people per transaction. You'll recall during COVID, we had a significant shift in channels from front counter to things like delivery and drive-through, and that increased the number of people per order. What we're now seeing in the US, but also around the world, is a little bit back to some normal channels as restaurants open up. Delivery is still a little bit elevated versus where it was pre-COVID, but drive-through percentages are pretty much back to where they were pre-COVID. So, we're seeing a number of people per transaction go down. We knew that would happen at some point; we didn't exactly know the timing. The other thing to a lesser extent, and again, I mentioned last quarter is that we are seeing some trade down. We're seeing customers, specifically lower-income customers, trade down to value offerings and fewer combo meals. So those dynamics are driving both the comp and our pricing. We do, as we've talked about historically, work closely with our franchisees on pricing. We use a third-party adviser who advises the franchisees as well as the company on pricing; it's a consumer-based research approach. I've talked before about specifically this year how we're taking smaller, more frequent price increases because it gives us the flexibility to be able to see how consumers are reacting and then adjust if or when necessary. One of the most important things that we keep an eye on is, obviously, the cost pressures, both on the commodity and labor side, but we have to balance that with continuing to provide value for our customers. There are a couple of key metrics that we look at: one called good value for money, which is one of the customer scores we look at, and another is affordable options that I like. We still continue to do well on those metrics, which is the most important thing to make sure that our customers still perceive our offerings as value.

Chris Kempczinski, CEO

I want to add to what Kevin mentioned about tracking food at home compared to food away from home. Currently, we are observing a significant gap, and by our calculations, it's the largest we've seen in 50 years. Food at home has increased in price much more rapidly than food away from home, such as at McDonald's and others in our industry. While I'm unsure of the exact impact, we believe there are benefits from this trend. Additionally, regarding Kevin's comment about value for money, we monitor this globally. I'm confident because in nearly every major market we operate, except for China and Spain, we lead our peers in terms of value for money. Even as we implement price increases, consumers are responding well, and our value scores remain strong.

Mike Cieplak, Investor Relations Officer

Our next question is from Andrew Charles with Cowen.

Andrew Charles, Analyst

Great. Thank you. And Kevin, congrats on a very successful tenure as CFO and best of luck to you and Ian in your new roles. My question for you, Kevin, is just around modeling the IOM segment. Can you help us think through what is a fair segment EBIT dollar embedded in your guidance, just given the many moving pieces of the Russia sale and the company-operated Ukraine market that's still largely closed on a temporary basis, that's just making this a very difficult segment to model?

Kevin Ozan, CFO

Yes. Thanks, Andrew. Let me give you a perspective on Russia. They were in our comp through the first quarter and then they wouldn't be in our results or comp beginning the second quarter. Russia represented roughly 2% of system-wide sales, about 7% of revenue and about 2% of operating income. So, if you use that for modeling purposes, that should get you to hopefully, the adjusted numbers that should be representative of our trends going forward.

Mike Cieplak, Investor Relations Officer

Our next question is from David Palmer with Evercore.

David Palmer, Analyst

Thanks. Kevin, congratulations on your career at McDonald's. Just a follow-up for you on pricing and inflation. Could you talk about inflation relative to pricing in the US and IOM in the quarter and how you see that gap progressing through the year to the degree that it might be closing? And I sense that that gap is relatively larger for IOM than it is in the US? And then, Chris, if I could just squeeze one more in, I'd just love to get your take about aside from getting ready for the need for value. What are the biggest improvement areas for the company that you see on the horizon; kind of thinking out a couple of years? You've teased out things like menu with chicken and beverage and technology benefits in CRM and the operations, but I'd love to get your sense about what's most important on the horizon. Thanks.

Kevin Ozan, CFO

Okay, you go Kevin. Let me provide some insights. Currently, for the second quarter year-over-year in the US, food and paper inflation is expected to be around 12% to 14% for the full year. The inflation rate is slightly higher than that in the second quarter and is anticipated to remain elevated in the third quarter as well. We expect it to ease somewhat in the fourth quarter, based on current information. Regarding labor, we are currently experiencing over 10% labor inflation. This is partly due to strategic wage rate increases implemented in our company-operated restaurants around mid-last year, which we will not start comparing against until the second half of this year. Consequently, more inflation impacts were felt in the first half of the year compared to the second. On the international front, the expected range for inflation is also around 12% to 14% for the year, but we may be at the higher end of that range internationally. Additionally, there is a broader range of scenarios to consider. Unlike in the US, we do not anticipate a moderation in their increases, which will likely be higher in the third and fourth quarters compared to the first and second quarters. Europe is certainly facing more severe inflation, especially in food and paper. Moreover, the impact varies significantly by country, with some nations dramatically affected by energy prices linked to Russian oil. Overall, the international market is expected to face greater challenges than the US and will experience prolonged inflation later in the year.

Chris Kempczinski, CEO

Yes. To answer your second question in terms of what I think are the biggest priorities over the next few years, if I use our MCD framework under Accelerating the Arches and start with the M, I think we have an opportunity to continue to improve on the marketing front and just get more consistently excellent around the world from a creative standpoint. Jill McDonald is going to be a part of helping to do that. I think we've made a lot of progress in the US. Still, I think there are opportunities for us to improve our creative in some of our international markets. So that's one area. Second is, as you move to the menu, core menu chicken for us continues to be, I think, a significant opportunity for us to improve our chicken portfolio. We've got some great global equities already in our McNuggets and with McChicken, but we also have some equities in McCrispy and McSpicy that we think we've got an opportunity to do more with globally. So that's going to be a priority area. Then digital. We talked about digital being a multi-year journey, but I'm incredibly encouraged by what we're seeing in digital. Just to give you a sense of what I think the opportunity is, if you look at Germany, France, the UK, China, digital is over half of the sales in those markets. In the case of China, it's over 80% of the sales in those markets. Compare that to the US, compare that to Canada, where it's maybe a quarter of the sales. So there's a big opportunity for us in North America to increase digital as a percent of sales. When you do that, your percent of identified customers goes up very dramatically. That opens up a whole range of things from service opportunities, pricing opportunities, etc. So I think digital for us is, we're starting to see the benefits. We just need to go harder and faster against that. We have a few other ideas. Part of what I wanted Kevin to help me with in this next phase, his next role that he's going to be in, is just working through a few other ideas that we think might put a little top spin on the plan. So we'll come back at some point later and talk about that.

Mike Cieplak, Investor Relations Officer

Our next question is from Dennis Geiger with UBS.

Dennis Geiger, Analyst

Great. Thanks for the question. And, Kevin, congratulations and best of luck, of course. Chris, you talked about a bunch of the strategic opportunities in Europe that you and the team are looking at. Curious if most of the levers that you mentioned are kind of similar to the US in thinking about how you navigate some of the challenges and plan for different scenarios. Or are there differences in the US in how you're thinking about navigating US macro challenges? If so, could you touch on some of those at all?

Chris Kempczinski, CEO

I believe there is likely more consistency than inconsistency. In Europe, we are noticing that a business primarily focused on dine-in has seen an increased demand for both dining and takeaway options since COVID. The digital service channel is gaining significant traction there, which opens up new opportunities that differ from the US market, where takeaway has traditionally been stronger. Regarding Europe, this is one area where we have more work to do. Additionally, we have a robust coffee business in several markets in Europe, and leveraging that to drive transactions presents another opportunity. Another focus in Europe is items like chicken, which tend to be more consistent. In contrast, the US team has made impressive strides over the past few years, reflected in strong long-term comparable sales growth. We are mainly concentrating on maintaining that momentum. As I've mentioned on various occasions and highlighted in our press release, the key is execution. This involves ensuring our restaurants are adequately staffed and that our teams are well-trained to deliver on service times, which significantly affects customer satisfaction. These are the main priorities for Jill and the team in the US.

Mike Cieplak, Investor Relations Officer

Our next question is from Lauren Silberman with Credit Suisse.

Lauren Silberman, Analyst

Thank you. And Kevin, I also echo my congrats. A follow-up on the value commentary. Can you expand on how you're thinking about everyday value and balancing the elevated cost in the US, whether that's dollar drinks or $1, $2, $3 menu? I guess what's the franchisee appetite for value? Should we see a more challenging environment? And then related, you offer an array of promos to the app. How do you think about your composition of value offers as it relates to digital versus in-store? Are we getting to a point where personalization might be something on the horizon? Thank you.

Chris Kempczinski, CEO

When you think about value, I think you touched on a number of things here, which is you have to think about value in a very targeted way. There are different products with different elasticities in different geographies. One thing I get excited about, particularly as we move more of the business to digital is the ability for us to be much more targeted in how and where we deliver that value. In the past, go back maybe 10 years ago, we didn't have the ability to deliver that sort of precision value, and you would end up having kind of a national deal that would hit everybody. We know that there's a lot of waste in that; there are people that are delivering value to under that scenario who probably would have still bought without it. What we're looking at doing, along with our pricing advisers, is exactly which products on the menu do you need to offer value to, to what degree, and then through what vehicle: Is it through an offer, is it through a menu price adjustment, or is it through some sort of promo? It ends up being a much more nuanced way that we’re able to look at value. Part of being more nuanced and it is, is how we’re able to push through this pricing without seeing a big falloff in the pass-through numbers that Kevin was talking about. It's tough to talk about value these days in kind of a one-size-fits-all approach because the beauty of what we're transitioning to is a much more targeted tailored approach to our value. But Kevin, I'll let you pick up on that.

Kevin Ozan, CFO

The only thing I'd add is, just to demonstrate what Chris was talking about, if you think about this transition or evolution, historically, we would have had a big national value menu. Today, value is primarily driven at a local level, specifically at the breakfast daypart. We do have a $1, $2, $3 nationally advertised value platform, but it's really complemented with a localized approach that allows the individual field offices to promote products that make sense in their local markets and based on their competitive set. We'll continue to have some national programs, whether it’s two for $6 or a buy one get one, but we've moved really more to a local approach, which then becomes ultimately a personalized approach, as Chris talked about.

Mike Cieplak, Investor Relations Officer

Our next question is from John Ivankoe with JPMorgan.

John Ivankoe, Analyst

Hi. Thank you. I wanted to get back to the comment on labor. And if you think the stores, and this is both US and IOM, are staffed to the extent that you can properly meet demand? In other words, do you have unmet demand that's in the system because of your staffing levels at the store? And if that is the case, I mean, are there any capital or technology type of investments in coming years that could allow you to reduce your demand for labor while increasing overall customer service? Thanks.

Chris Kempczinski, CEO

If I start with the US as an example, McOpCo is leading the way in this area. Our McOpCo business in the US is performing above our average. Despite various challenges, they are maintaining our target roster sizes and experiencing improvements in speed of service, which ultimately enhances customer satisfaction. This shows that it is possible to achieve our goals, although it requires significant effort. We have people eager to work, and one reason we implemented the EVP program is to ensure we communicate effectively as an employer to attract talent to our restaurants. Essentially, we believe we have a strategy and a playbook that can help us properly staff our restaurants if executed correctly. McOpCo is a prime example of this. Looking ahead, there's considerable interest in what automation can do. We have invested a lot of time and resources into exploring this, but there won't be a single solution for the industry. While ideas about robots may be popular, they aren't practical for most restaurants. The economics do not support it, and the necessary infrastructure updates for utilities and HVAC systems are substantial. Broadly speaking, you won't see a widespread automation solution anytime soon. However, there are ways we can improve with systems and technology, particularly by leveraging the data we gather on our customers. This can make tasks like scheduling and ordering easier, ultimately lessening labor demands in restaurants. But regarding a major automation solution, robots won't be appearing in our establishments. We need to focus on traditional methods, ensuring we are a great employer and providing our crew with a positive experience at work.

Mike Cieplak, Investor Relations Officer

Our next question is from Jeff Bernstein with Barclays.

Jeff Bernstein, Analyst

Great. Thank you very much. And, Kevin, congrats on the uptown moves and ultimate retirement. I had a bigger picture question just on franchise relations. Chris, I know you mentioned McFamily in your closing remarks, and it seems like it’s an ongoing balancing act, considering the very strong performance through the pandemic. I know you mentioned franchise profits at an all-time high to close last year. And now, obviously, there are seemingly some pressures to profitability, and there are more headlines in the press on changes in contracts and some frustrations from the franchisee side. So I am just trying to get a sense for whether you think there's been any change in how you think about the relations? As it relates to that, just because China is a big franchise market, is there any reason for concern on your end on the underlying fundamentals of the business? Do you really think it's purely COVID and therefore the recovery will follow suit as COVID concerns ease? Thank you.

Chris Kempczinski, CEO

Thank you for your question. To begin, I want to address this from a macro perspective. We have around 5,000 franchisees worldwide. It's important to understand that these franchisees are not a uniform group; they vary significantly in size and structure across different regions. Your question likely relates to some recent headlines concerning the US market. I'd like to highlight a few points. At McDonald's, we take pride in believing we are the best franchisor in our industry, a reputation we have built over the last 70 years. We can only maintain that title if we continuously have the best franchisees. The recent initiatives announced by our team in the US aim to ensure we retain this quality of franchisees, which ultimately secures our position as a leading franchisor. These initiatives involve two key areas: raising standards in certain aspects and improving accessibility for aspiring franchisees. Recently, the US team announced a commitment of $250 million towards financing options to attract new franchisees, particularly from among our restaurant crew who we hope will become future franchise owners. All recent announcements focus on reinforcing our status as an attractive choice for top franchisees. Such announcements come from a place of strength, which we have earned through our performance in the US over the years. Currently, we are in a favorable position where the demand for our restaurants greatly exceeds supply. Our existing franchisees are eager to expand their businesses by acquiring more restaurants and are looking to pass the operations on to their children, which is a positive trend. Simultaneously, we observe strong external interest, especially with accessible financing for potential new franchisees. Personally, I am enthusiastic about the demand for our restaurants surpassing supply; it positions us for better business outcomes. While there have been discussions about some people leaving the system, these individuals are capitalizing on the business's health and fetching high multiples of 8 to 10 times during sales, marking the best conditions we've seen in recent memory. So, taking a step back, my comments are mainly about the US market, but for high-performing franchisees, these developments signify growth opportunities and stabilize their equity. Concerns may arise for those who are not among our better-performing franchisees, and the US team is dedicated to supporting improvements in that area. Overall, our relationships with our 5,000 franchisees globally remain strong. When we have exceptional franchisees, this business generally thrives over time.

Kevin Ozan, CFO

On China, your question related to China. I think we still believe there's a huge opportunity in China. We're still committed to our China business. They have had a rough couple of years with all of the stops and starts with COVID, but we still expect to open roughly 800 restaurants this year. Hopefully, the economic environment can return to something relatively normal because we still believe in the opportunity in China and have a lot of confidence in our business there.

Mike Cieplak, Investor Relations Officer

Our next question is from Sara Senatore with Bank of America.

Sara Senatore, Analyst

Thank you. And of course, congratulations to everyone on their new roles, and it's great to see Jill coming back as an excellent re-addition. But I had two questions there about the outlook. The first is just unit growth in the US coming in slightly lower than the previous range. Is that because of challenges in the supply chain? We hear about constraints around equipment or labor and staffing. It doesn't seem like it's an access to capital issue given the multiples that are historically high. And then also on the guidance, you talked about mid-40s operating margin, again, slightly higher than prior. Is it a function of mix, like less company-operated or better topline? Because again, we're seeing costs come in very high. So, just trying to understand those relatively minor changes, please?

Kevin Ozan, CFO

Yes. Thanks, Sara. Let me take a shot at both of those. On the unit growth in the US, you're right, it's come down a little bit. That's mainly due to timing. Some permitting is taking a little bit longer in some areas. We still expect net unit growth in the US this year for the first time in several years, but it's certainly not an access to capital, as you mentioned. It really is just a timing thing, and we are finding that openings are taking a little bit longer between some supply chain challenges and some permitting timeframes. I think there's a backload that's making just getting through all the government processes take a little longer. On operating margin, we upped that guidance a little bit right after the Russia announcement. It really is a function primarily of selling our Russia business. The Russia business, as you know, was primarily company-owned and actually had an operating margin below our global average. By taking them out now, it actually helped improve the operating margin. It's just a function of mix in the near term. We do still believe that longer term, there's leverage to be gained both in operating margin and specifically on the G&A side that should help that operating margin longer term — not in 2022, but longer-term, that should help improve that operating margin going forward.

Mike Cieplak, Investor Relations Officer

Our next question is from Jared Garber with Goldman Sachs.

Jared Garber, Analyst

Hi. Thanks for taking the question. Just sort of two for me. I'm curious on daypart, if you're seeing any shift in daypart usage across the US system. I know you talked about some maybe some easing on the lower income side of the consumer, but wondering if you're seeing anything specific to any of the dayparts, whether that's breakfast, lunch, diner, or late-night that you'd like to call out. And then I also wanted to know if you could help quantify or provide some incremental color on the gains that you're seeing either on average check or frequency from the loyalty program, now that we've effectively launched one year past the launch in the US. Thanks.

Chris Kempczinski, CEO

I'll start with daypart and then let Kevin address any check commentary that we want to do around loyalty. The great thing about the US performance is, the growth that they're seeing is broad-based. It's across all dayparts. In fact, breakfast was the strongest performing daypart in the US comp, which we feel good about. It’s a change. If you remember, a few years ago, I think there were a bunch of questions about breakfast. If you also sort of zoom out and look at our performance, our daypart performance on a three-year stack in the US, incredibly consistent; breakfast, lunch, dinner, all north of 20% that we saw with a three-year stack from a daypart standpoint. Late night being the one area that we saw a significant impact over the last three years. So I would say, generally, we feel very good about the balance from a daypart standpoint and probably no noteworthy color that I would offer around differences by daypart. Kevin, I'll let you handle the loyalty question.

Kevin Ozan, CFO

Yes. Loyalty is an interesting dynamic related to check. Loyalty is really about driving frequency and increasing frequency. We are seeing definite increases in frequency everywhere where loyalty has gone in. If you take into account redemptions on the loyalty, you actually see a little bit lower average check because of the redemptions that occur there. However, it is significantly driving frequency. When you look at it total, it's clearly additive to sales. But if you just look at an actual average check and take into account redemptions, you end up with a little bit lower check because of that.

Mike Cieplak, Investor Relations Officer

As we near the bottom of the hour, we have time for one more question from Nicole Miller Regan with Piper Sandler.

Nicole Miller Regan, Analyst

Thank you. Good morning. In the US, could you discuss the impact of different income cohorts? Specifically, how does the lower-income group, which you've mentioned is visiting less frequently, affect overall spending? What insights can you share about who spends the most and the consequences of decreased visits from this group?

Chris Kempczinski, CEO

Yes. I know the question. I don't have the degree of precision on the data that I think you're looking for. Generally, what we know is happening is that there is a challenge on the lower income, but we are seeing trade down out of full-service restaurants and fast casual that's helping offset any of that impact. Net-net, what we saw in 2008, 2009, and what we expect is going to continue is that we're going to be a net beneficiary of all of that. That's our planning expectation; while there is going to be some shifting within the cohort or you describe it, net, our value positioning, we expect to be a winner out of all of that.

Mike Cieplak, Investor Relations Officer

Okay. Thank you, Chris. Thank you, Kevin. Thanks, everyone, for joining. Have a great day.

Operator, Operator

This concludes McDonald's Corporation's Investor Call. You may now disconnect.