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Edited Transcript of MCD earnings conference call or presentation 21-Oct-16 3:00pm GMT

OAK BROOK Oct 22, 2016 (Thomson StreetEvents) -- Edited Transcript of McDonald's Corp earnings conference call or presentation Friday, October 21, 2016 at 3:00:00pm GMT

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Corporate Participants

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McDonald's Corporation - VP of IR

McDonald's Corporation - President & CEO

* Kevin Ozan

McDonald's Corporation - EVP & CFO

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* Brett Levy

Robert W. Baird & Company, Inc. - Analyst

* John Glass

Piper Jaffray & Co. - Analyst

JPMorgan - Analyst

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Operator [1]

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Hello and welcome to McDonald's October 21, 2016 investor conference call. At the request of McDonald's Corporation, this conference is being recorded.

I would now like to turn the conference over to Mr. Chris Stent, Vice President of Investor Relations for McDonald's Corporation. Mr. Stent, you may begin.

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

Today's conference call is being webcast live and recorded for replay by webcast. Before I turn it over to Steve, I want to remind everyone that the forward-looking statements in our earnings release and 8-K filing also apply to our comments.

Both documents are available on, www.investor.mcdonalds.com, as are reconciliations of any non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures. And now I'd like to turn it over to Steve.

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Thank you Chris, and good morning everyone. I'm encouraged by the actions we've taken and the progress we've made as we execute our turnaround plan. Customer perceptions of McDonald's has steadily improved over the past 18 months, and the third quarter marks five consecutive quarters of comparable sales growth across all business segments, with many markets gaining share.

For the third quarter global comparable sales increased 3.5% and operating income was up 7% in constant currencies. Earnings per share rose 9% in constant currencies, excluding the impact of previously announced current and prior-year strategic charges, earnings per share per quarter increased 17% in constant currencies. Profitability has increased both for McDonald's and franchisees. At the restaurant level franchisee cash flows reached all-time highs in many markets including the US.

These results are a testament to our diligent execution of the turnaround plan as we put customers at the center of everything we do. We're at the point where we have begun to transition from a focus on revitalization to a mindset that is concentrated on strengthening the business to drive sustainable growth over the long term.

We expected performance through 2016 to be uneven and it has been. Markets such as the UK, Australia and Canada continue to grow sales and guest counts. Most markets including the US, France and Germany worked to overcome challenges of varying degrees.

We're mindful of the near-term headwinds we face, most notably in the US as we lapped the very successful introduction of All Day Breakfast which was immediately popular with customers. However we're not managing the Business quarter by quarter. In fact our commitment to investing in the Business is stronger now than ever. We've taken action in the areas that matter most to customers. In particular we're placing significant emphasis on food quality, the customer experience and value to give people more reasons to visit McDonald's.

We believe the long-term investments we're making in these areas provide the foundation on which we'll build as we work to be recognized as a modern progressive burger Company by customers.

In the area of food we're taking important steps on how our food is prepared and the ingredients we use. In the US we completed our transition to chicken not treated with antibiotics important to human medicine a year ahead of schedule. Introduced new buns that do not contain a high fructose corn syrup. And we've removed artificial preservatives from our popular Chicken McNuggets and customers have responded favorably to this news, and we've seen sales accelerate as a result. Following the announcements, sales of McNuggets increased nearly 10% and they are sustaining above previous levels.

We're also modernizing the customer experience in markets around the world as we evolve to the experience of the future. In Canada we're engaging with customers in simpler, less stressful ways by offering them more choices and how they order or pay. We now have dual-point service and self order kiosks in almost 90% of our traditional restaurants. In addition we're taking steps to redefine hospitality on both sides of the counter with dedicated guest experience leaders in all of Canada's traditional restaurants.

Finally, value. A critical priority in all markets. In Germany for example we have deployed a two-pronged approach. First we successfully added new layer to our value platform at mid tier price points. At the same time we're celebrating the quality and taste of our core products through strong marketing and promotional campaigns. These steps build on the new pricing structure we introduced earlier this year to strengthen our value platform and that is resonating well with the price-conscious German consumer.

The actions we are taking specific to our food, the customer experience and the value and telling customers about the changes are making a difference. Customer satisfaction has improved significantly, up more than 6% year to date in both the US and Canada with most major markets seeing improvements. This is a testament to the progress we have made since we refocused on running better restaurants as part of our turnaround plan in may of last year.

With that concept let's turn to performance by likes in the markets. Beginning with the US comparable sales remain positive for the third quarter at 1.3%. Customers love All Day Breakfast and the way we've continued to build on its success. Since its introduction last year customers are asked for even more choices so we recently launched the second phase of all day breakfast, expanded menu now includes muffins and biscuits as well as our beloved McGriddles all day in all US restaurants.

At the same time we're enhancing the experience to adapt alongside customers expectations. One of the most notable ways we're doing this in restaurants is by better integrating technology in visible, tangible ways. For example more than 90% of US restaurants now use digital menu boards. These new menu boards enable us to showcase the quality of our food was fresh photography. Because they're less congested and better organized the menus now do a better job highlighting the broad range of choices available.

The menu boards are also smart. They are built with a robust content management system that we haven't even begun tapping into yet. When fully enabled we'll be able to adjust what's featured on the menu based on time of day or even weather conditions. We'll be more relevant to customers as we remind them about our ice cream cones and McFlurries on a hot summer day or handcrafted hot McCafe beverages if it's chilly outside and they feel the need to warm up.

We also continue to emphasize value because we know how much budget-oriented customers count at McDonald's. Franchisees and customers alike have embraced the McPick2 platform. They appreciate the choice and flexibility it provides. In September we promoted McPick2 for $5 nationally plus other variations of McPick2 were offered at a local level. Some of our best performing regions offered beverage value to complement the McPick2 platform. We will continue to tap into these learnings both nationally and locally as we design future McPick offers.

Underpinning these efforts is a continued focus on running better restaurants. Our commitment to raising the bar with an emphasis on underperforming restaurants is making a difference. Customer satisfaction scores have improved the most for our bottom quintile restaurants and we've cut the customer satisfaction score gap between the top and bottom quintile performance nearly in half for our efforts to provide a better, more consistent, experience for customers in every restaurant, every time they visit.

Turning to the international lead markets segments, third quarter comparable sales were up 3.3% driven by positive performance across four of the five major markets with France being the exception. The UK, Australia and Canada delivered yet another quarter of comparable sales and guest count growth. These markets share similar elements that underlie their strong track records of success. Contemporary restaurant designs with over 90% of restaurants reimaged Compelling menu strategies tailored to local customer tastes such as the Spice it Up event in Canada, featuring spicy Sriracha Sauce on a country chicken or Angus beef sandwich. And a modern service experience that incorporates the elements of the experience of the future to provide customers with more choice and flexibility in how they order, what they order and how they are served. These elements amplify each other to create a notable difference for customers who then reward us by visiting more often.

I'm encouraged by the progress we've made in Germany, which I had a chance to experience firsthand while I visited the team there last quarter. Comparable sales were positive in the market for the third quarter. Earlier I mentioned the steps we've taken to strengthen our value platform. Combined with strong promotions featuring customer favorites like the Hamburger Royale with Cheese, these actions are making a difference in getting us back on track to grow top-line results once again.

That said I want to stress that growing guest counts remains a top priority. That is the key to winning back the share we have lost in recent years.

In France third quarter comparable sales were negative. This was driven in large part by ongoing macroeconomic challenges including a declining GDP, high unemployment and the continuing concerns for personal safety, which is impacting both inbound tourism as well as the French consumer. The customers appreciate the actions we've taken to strengthen our value offer, including further extensions of the well-regarded and successful Petits Plaisirs value platform.

We're also satisfying French consumers' growing appetite for premium burgers through strong promotional campaigns featuring customer favorites like the 280 burger and the Big Tasty. In addition we're introducing a new signature line of sandwiches in our experience of the future restaurants to give customers even more great tasting burger choices at the convenience and value they've come to appreciate at McDonald's.

In the high growth segment third quarter comparable sales were up 1.5%, driven by positive performance in Russia and most other markets, partially offset by negative comparable sales in China. Whilst third-quarter comparables sit sales in China were down 1.8%, results improved as the quarter progressed. Excluding the impact of temporary protests surrounding recent events related to the South China Sea, China's comparable sales would have been positive for the quarter. A strong focus on enhancing convenience through greater integration with third-party delivery providers, combined with aggressive core menu sampling events designed to offset the impact of the process, contributed to market share gains from its still challenging macroeconomic environment.

In Russia the economy remains difficult and consumer purchasing power continues to decline. Despite these challenges we're growing comparable sales and guest count and gaining market share. Specifically, our performance is a result of our heightened focus on value as well as our successful marketing campaigns to grow the breakfast day part.

And I would be remiss if I did not mention Japan where comparable sales increased 17.7% in the third quarter. Diligent execution of the market's comprehension turnaround plans, which include strong promotions, exciting menu variety, compelling value and a more modern restaurant experience is enhancing McDonald's relevance to customers and contributing to sustained momentum in this market.

As we look to the future we recognize the importance of having the right structure, the right people, a common focus and lastly greater accountability across the entire McDonald's system. We've taken steps forward in all four areas to set the proper foundation for long-term growth.

First the right structure. Building on last year's [shift to] segments of similar markets we took further steps in the third quarter to transition to a leaner, more efficient and more nimble organization. This will enable us to better share expertise, improve efficiencies and drive down costs, taking greater advantage of our size and scale. Kevin will provide further details in a moment.

Second the right talent. An important component of our turnaround plan has always been to ensure we have the right people in the most critical positions. Management changes have been and continue to be an anticipated part of the process. That's why we focus on a blend of promoting individuals who are ready to take on additional responsibilities, continuing to develop leaders that have the right skills necessary to grow the business and attracting new executives into the business provide fresh energy and innovative thinking. I'm confident in the recent selections we have made.

This includes Chris Kempczinski. He's succeeding Mike Andres as president of McDonald's USA effective 1 January. As part of a thoughtful transition, Chris is already spending significant time with Mike and our franchisees in the field.

In the high growth segment Joe Erlinger has made an immediate impact upon stepping into the role of President in these markets. He knows these markets well, having been CFO of the segment and the former Managing Director of Korea.

Third a common focus, in addition to making forward progress on running great restaurants we're putting greater emphasis on accelerating initiatives that will bring more customers into our restaurants more often. This includes the experience of the future which we're looking to roll out at greater speed in the US. We look forward to sharing more details of those plans as they are finalized.

And lastly accountability. We have made great progress executing our turnaround plan. Now we're starting to balance those efforts with a greater focus on longer-term growth. It will take all of our franchisees, employees and suppliers working together and holding each other accountable to achieve our ultimate goal of becoming the modern progressive burger Company. We have a long-term view on our potential and the opportunities that exist. I'm confident in the actions we're taking to run better restaurants and the investments we are making. We're getting the right people, foundations and platforms in place to properly grow the business and reassert McDonald's global brand leadership. Thanks very much and now I'll turn it over to Kevin.

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Thanks Steve, and good morning everyone. We are pleased with our third-quarter results. By staying keenly focused on our customers, we maintain positive momentum while continuing to make meaningful strides toward building a better McDonald's. Since Steve talked about sales and earnings per share I will focus on margins and G&A. I will also provide an update on the key outlook items and the recent progress we have made against our financial targets.

Starting with the performance drivers for the quarter. Franchise revenues continue to become an increasingly significant portion of our revenue stream as we evolve to a more heavily franchised organization. For third-quarter, franchise revenues increased 6% in constant currencies reflecting strong comparable sales and the impact of refranchising.

For the quarter, franchise margin dollars exceeded $2 billion, a 6% increase in constant currencies and contributed over $100 million to our growth in global operating income. This solid performance reflects sales driven improvements across all segments led by results in the international lead markets. In addition, we maintain strong global franchise margins of over 82%. These results are a testament to the benefits of transitioning toward a more predictable and stable revenue stream.

Growth in Company operated margins also contributed about $75 million to our growth in global operating income as Company operated margins rose to more than $730 million, an 11% increase in constant currencies. Company operated margins climbed 260 basis points with the US and China leading the overall improvement. Our emphasis on running better restaurants from enhanced conveniences to tighter operating controls is yielding a better experience for our customers as well as improved restaurant profitability. In the US the Company operated margin percent increased 450 basis points for the quarter, reflecting positive comparable sales and a favorable...


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