麥當勞 (MCD) 2018 Q2 法說會逐字稿

Hello, and welcome to McDonald's Second Quarter 2018 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 Flores, Investor Relations Officer for McDonald's Corporation.

Mr. Flores, you may begin.

Hello, everyone, and thank you for joining us.

With me on the call today 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.

Now 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.

Thank you, Mike.

Good morning, everyone.

We had another good quarter of results as we continue to execute our Velocity Growth Plan.

Our customers tell us they value and appreciate the moves we're making to elevate the McDonald's experience.

As we discussed a quarter ago, we're confident in our strategy as we continue the base rate work of running great restaurants, and as we put in place the most promising platforms for long-term sustained growth.

Our International Lead Market offer an important illustration of the successful approach, which reinforces the belief in our plan.

Markets such as U.K, Canada and France continue to perform well with strong sales and guest count growth.

These markets began establishing the foundation for today's success several years ago.

They developed holistic plans guided by rich local insights about our customers and initiated programs to offer delicious food, compelling value and great running modernized restaurants.

They also gained a line of the franchisees and enhanced engagement with restaurant employees, vital steps toward integrated and effective execution.

The result is that our customers visiting these restaurants today can easily see our commitment to providing them with a great experience.

With a solid platform in place, these markets also have been more effective in activating additional initiatives for growth such as digital and delivery.

We've demonstrated our ability to transfer winning ideas across our markets, and that's another reason for the continued confidence in our business.

As I mentioned last quarter, the U.S. is in the first year of executing an ambitious and holistic 3-year plan aligned with the Velocity strategy.

Many of the initiatives in the U.S. have been key drivers of the success in our international markets.

The U.S. business completed over 1,300 more Experience of the Future, or as we call it, EOTF, restaurant conversions in quarter 2. While this aggressive pace comes with some limited downtime, it essentially means we're providing customers with an improved and modernized experience in roughly 10 additional restaurants every day.

To date, we have total of over 5,000 EOTF restaurants, which is more than 1/3 of the U.S. estate, offering elevated hospitality and convenience to our customers.

While EOTF brings dramatic improvements to our restaurants, it is not the only major initiative the U.S. business executed during the quarter.

We also successfully completed the rollout of cooked-right-when ordered quarter pound burgers using fresh beef, continued to redefine convenience with delivery and refined our value offering, including our $1, $2, $3 national value platform.

We know the combination of key initiatives to improve the experience for our customers makes a difference.

Restaurants successful in executing multiple elements of the U.S. plan are achieving highest sales, guest counts and cash flow.

Earlier this week, I had the opportunity to join our U.S. President, Chris Kempczinski, and several hundred of our U.S. owner/operators who are meeting here in Chicago.

We're not yet where we need to be, but we're gaining more customer visits, and the front-end center focus of the discussion was growing guest counts in our largest business segments.

Together, we're taking on the lots with our owner/operators who are working with our U.S. leadership team on the greatest opportunities to strengthen and grow our business.

The U.S. business recently made changes in this organizational structure to better support the way we work with owner/operators to run great restaurants.

We've removed layers from the field organization, whilst increasing resources in key areas such as technology and field consulting.

A key element of the restructuring includes providing more consulting and better support for owner/operators as we execute together on the many initiatives of our bigger bolder vision 2020 U.S. plan.

We expect to see improved speed to market and decision-making as the U.S. becomes fit-for-purpose, and that better alignment enables us to provide a great experience to our customers and unlock the full potential of the plan.

This gives a high-level view of what's driving our business and now we'll share details of our results for the quarter.

Globally, comparable sales increased by 4% during the quarter, marking our 12 consecutive quarter of comparable sales growth.

Global comparable guest counts declined slightly during the second quarter, dropping by 0.3%.

Guest counts grew in all of our international operating segments.

In the U.S., quarterly guest counts decreased from a year ago.

Now Kevin will walk you through more details about our sales and guest count performance during the quarter.

Thanks, Steve.

Our strong global comp sales performance for the quarter reflects positive results in every business segment, led by the International Lead Market in Japan.

This quarter also marks the seventh consecutive quarter of positive guest count growth in all international segments.

Taking a look at the U.S. Comp sales increased 2.6% for the quarter, with a positive GAAP of 90 basis points versus QSR sandwich competitors.

A higher average check drove sales due to favorable product mix shifts and menu price increases.

The product mix shifts were a result of several factors, including a trade up to higher priced items such as our fresh beef quarter pound burgers and $1 $2 $3 Dollar Menu add-ons resulting in higher basket size.

An important part of our U.S. plan includes delivering a balanced mix of both higher average check and comparable guest count growth.

As I just mentioned, we're seeing positive benefits in average check.

However, we remain intensely focused on increasing customer visits.

As we've said in the past, we must be competitive on value.

We don't strive to win on value, but we won't lose either.

With a sluggish IEO market and the introduction of our $1 $2 $3 Dollar Menu at the beginning of the year, we've seen our competitors increase their attention on deals.

Therefore, we know that we need to be more aggressive to compete effectively.

While our $1 $2 $3 Dollar Menu is driving incremental sales and guest counts with our budget, basic, value customers, we need to do more to attract other customer groups.

In addition to the delicious food that customers can get at a low price every day, we know that certain customers are looking for a great deal in the marketplace.

We need to better meet the expectations of these deal customers and give them reasons to visit us more frequently.

As I mentioned earlier this year, while we will maintain our $1 $2 $3 Dollar Menu as our everyday value platform, we'll also pulse-in deal offers from time to time.

For example, in second quarter, we featured the 2 for $4 breakfast sandwiches.

And beginning in early August, we'll have a 2 for $5 mix and match deal with some of our iconic sandwiches that we know our customers love.

Turning to the International Lead segment.

Comp sales were up 4.9% for the quarter with all markets posting positive comp sales and guest counts.

The U.K. continues to lead the segment with high single-digit sales increases for the quarter and continued momentum in France helped them achieve their highest ever market share.

Comp sales for the high-growth markets increased 2.4% for the quarter, driven by both Italy and Poland double-digit sales increases, partially offset by continuing challenges in South Korea.

Our growth plan accelerators of digital, delivery and EOTF have been critical contributors to these market success.

As our Experience of the Future incubator market, Poland is demonstrating what a difference it makes for customers when our restaurants successfully integrate all EOTF elements.

And across the Foundational markets, comp sales were up 6.8%.

Each geographic business unit within the segment contributed positively to results, with continued strong performance in Japan leading the segment.

Now I'll turn it back to Steve.

Thanks, Kevin.

The philosophy strategy is working, because it's grounded in evolving our business on the customer's agenda.

McDonald's customers have high expectations that we will offer great-tasting food, value for money and an experience offering enhanced convenience.

As we make significant progress in each of these areas, we are continuing to see customer satisfaction scores improve in most of our larger markets.

Our U.K. market, for example, continues to be one of our best performers as the market achieved robust sales again during the quarter.

Sales for the second highest on record in May.

And April set a best every mark for guest counts.

Many elements are coming together to drive this performance.

In addition to the success of iconic menu items such as the Big Mac, our Signature Beef Premium sandwiches continue to be popular with our customers in the U.K. France also found success with promoting sandwiches from the core of our menus, such as Big Macs, premium sandwiches like the Big Tasty and the McFirst and the Petits Plaisirs, which continued to provide customers delicious food at a compelling price point.

And as I mentioned, the U.S. also made strides in improving the taste of our food.

The cooked-when-ordered quarter pounders made with fresh beef are hotter and juicier.

We're pleased with the high customer awareness and enthusiastic responses.

Sales are up and market share gains indicate that within the large classic burger category, customers are choosing McDonald's more often.

Value essential is what many of our customers expect from McDonald's.

Kevin offered details earlier about the $1 $2 $3 Dollar Menu and how we're optimizing the U.S. value platform.

Our markets across the world also have value at the core of their strategies, utilizing extended always on, compelling everyday value platforms, plus rotating deals.

We're finding that the McDonald's mobile app is an increasingly effective way in extending appealing deals to our customers.

We've talked previously about markets successfully using a digital activation approach that customers appreciate with daily deals offered over several weeks or a month.

Our philosophy accelerators are continuing to gain traction and contribute to our business.

They represent significant opportunities to enhance the customer experience with greater convenience.

Today, I'll offer an update about the progress we've made with the delivery accelerator, the business impact we're seeing and what we expect in the future.

The delivery market continues to grow.

With the power proximity, McDonald's is well positioned to be a leader in delivery.

Across the globe, there are more than 1 billion people living less than 10 minutes from a McDonald's.

That gives us a significant advantage in quickly bringing delicious food to our customers in their homes, offices and college dorms.

We've been moving at a pace which is unprecedented in the McDonald's System.

Last July, delivery was available at about 7,800 McDonald's restaurants around the world.

We continue expanding and now delivery is available for more than 13,000 restaurants through 60 markets on 6 Continents.

Customers are responding.

Delivery is becoming a meaningful contributor to our sales.

In several of our top markets, delivery now represents as much as 10% of sales in those restaurants offering delivery.

Delivery requires virtually no additional investment and is tremendously effective in bringing profitable and incremental guest count.

They're continuing to see delivery orders of about double the size of a standard restaurant average check.

Our biggest opportunity remains in driving awareness.

When more customers learn and get their favorite McDonald's food delivered right to their door, we're confident we'll see delivery sales continue to grow.

With McDelivery Day out this month, we celebrate the success of enhancing convenience to our customers with delivery.

During the day, we engage with customers around the world and saw a surge in delivery activity in the markets participating in the campaign.

In the U.S., for example, we had the highest number of delivery transactions ever in a single day.

We also are able to leverage our fee for sponsorship during the World Cup to raise awareness about delivery.

A number of our markets, including Portugal and the U.K. run fun and effective promotions that reinforce the convenience on delivery.

Our strong relationship with UberEATS is one of the reasons delivery has been so successful for our business.

Over the past year, we booked effectively with UberEATS to optimize the delivery process.

We've taken steps to protect the quality of the food that travels from restaurants to our customers and improved operational efficiencies so orders are delivered as quickly as possible.

We're continuing to work closely with UberEATS to elevate the customer experience, introduce marketing promotions that should stimulate even more growth.

Delivery, like other elements of the philosophy plan, is contributing to our success now and offers untapped potential for us to capture in the future.

We'll look forward to sharing updates as we make additional progress.

Now Kevin will discuss more financial highlights in the quarter.

Thanks, Steve.

Earnings per share for the quarter was $1.90, a 9% increase in constant currencies.

These results include $92 million of strategic charges primarily related to reorganizing our U.S. business unit, which Steve mentioned earlier.

Excluding these charges and prior year's strategic charges, earnings per share was $1.99, a 12% increase in constant currencies.

Business performance from comparable sales growth offset the impact of refranchising, while the quarter also benefited from a lower tax rate.

As I talk about our operating performance, I want to remind everyone that our second quarter results are compared against results last year prior to refranchising China and Hong Kong.

This was the most significant refranchising transaction in our history, which we completed last July.

As I've mentioned in the past, we measure the efficiency of our business by our operating margin, and this serves as a comprehensive gauge of our overall performance.

We've taken significant steps to capitalize on the strength of our business model, achieve efficiencies with our G&A and stabilize our P&L, all of which are yielding significant benefits to our operating margin as we continue to progress towards our target of mid-40s.

Year-to-date, our operating margin was 42%, up from 37% last year.

The largest and most important component of operating income is our franchise margins as over 80% of our total restaurant margin dollars now come from our franchise business.

For the quarter, every segment grew franchise margin dollars, led by the International Lead markets while global franchise margins totaled nearly $2.3 billion, a 9% increase in constant currencies.

Refranchising benefited the quarter, along with positive comp sales growth, partially offset by higher depreciation expense related to our EOTF partnering contributions in the U.S. Consolidated company-operated margins declined 80 basis points to 17.9% for the quarter.

That decrease was primarily driven by continued labor and commodity pressures across key markets.

Moving on to pricing and commodities.

Second quarter pricing in the U.S. year-over-year was up about 2%, which was below food-away-from-home inflation of 2.8%.

Commodity cost in the U.S. for the quarter were also up around 2% versus last year.

For the full year, we continue to expect our U.S. grocery basket to increase 1% and 2% as we anticipate commodity cost pressures will lessen in the fourth quarter.

For the International Lead markets, commodity costs were also up about 2% for the quarter, and we expect commodities to be up a similar percentage for the full year.

ILM menu prices averaged about 2.5% higher year-over-year.

Continuing onto G&A.

G&A for the second quarter increased 2% in constant currencies as a result of higher restaurant technology spending along with costs associated with our worldwide convention in April.

We continue to expect our full year G&A to decrease about 1% in constant currencies.

Our effective tax rate was 26% for the quarter.

While we may have additional adjustments this year as the guidance on tax reform continues to evolve, we still expect our full year tax rate to be in the 25% to 27% range.

Finally, looking at foreign currencies.

EPS benefited $0.05 per share for the quarter due to foreign currency translation.

Given the recent strengthening of the U.S. dollar and based on current exchange rates, we now anticipate FX will be a headwind of $0.02 to $0.04 for the third quarter with the full year FX benefit of about $0.07 to $0.09.

As usual, this is directional guidance only because rates will change as we move through the remainder of the year.

Now I'll turn it back to you, Steve.

The momentum in our business shows that the Velocity Growth Plan continues to gain attraction.

We're still in the early stages and we're confident there is plenty of growth left in this plan.

We recognize in the U.S. we're experiencing the challenge of a highly competitive environment, while executing an ambitious and complex multiyear plan.

We know we have a strong and agile leadership team and committed owner/operators working together and moving quickly to take the right actions for our business.

While we focus on business performance, we also continue to take steps that strengthen our brand.

During the quarter, we completed the transition of entirely moving our global headquarters from the suburb of Oak Brook to the heart of Chicago.

We marked the occasion with a grand opening in early June, when we were able to honor current and former leaders of our company who've done so much to help build the McDonald's brand.

This move has continued to energize our teams as they experienced a more open collaborative environment in our new headquarters and enjoy the dynamic neighborhoods of such a vibrant city.

Also in June, we generated brand excitement with our customers as we moved forward with the first in a series of cross-promotional campaigns in the U.S. with Disney.

We featured Happy Meal boxes and toys being with Disney's summer hit movie, Incredibles 2.

As you can see the broad-based success across our business illustrates the strength of our overall approach.

We look forward to sharing additional progress in the months ahead.

And I'll hand it back to Mike and we can take some questions.

Thank you, Steve.

We'll now open up the call for analyst and investor questions.

(Operator Instructions) Now the first question is from Sara Senatore with Bernstein.

I wanted to just ask about the emphasis on value.

And I guess, twofold.

One is into the extent that maybe the value platforms that you had at the beginning of the year weren't quite as strong as they needed to be.

I guess, are you confident that you've gotten ahead of that now because presumably there will be competitive response to anything new that you bring out?

And the second question really that is, is the issue tension with franchisees because again, it seems pretty apparent that value is going to be a very competitive space.

But your McOpCo margins have come under pressure.

So I wasn't sure if maybe that is what has kept you from being more aggressive.

Hi, Sara, I'll take that one.

I think here's what we did.

As you know, at the very start of the year, we launched the $1 $2 $3 Dollar Menu that establishes our kind of everyday entry value level, and we always said it's going to take us a month, sorry, quarter or 2 to fully be able to analyze consumer response through the dynamics across our business, whether it's from a top line sales, whether it's from guest count and also the margin implications.

We continue to be confident that platform is resilient and is delivering what we expect it to do.

However, I would say, because we have been aggressive, we have seen more competitive activity in the area of value broadly.

We've been able to decompose our trading performance to actually analyze the opportunity we believe we have in the area kind of meal deals as well the competition has been particularly strong.

So we believe that the $1 $2 $3 entry-level, if you just got a $1 or $2 in your pocket, it works.

It will add on to your meal combinations, it works.

It's the meal deal element where we think we need to be more competitive, and both Kevin and I still, from the phrase that Chris Kempczinski uses with the U.S which is "We will remain competitive on value.

We're not looking to win on value.

We will remain competitive." I can tell you as recently as this week and yes, having spent a good deal of time with a few hundred of our leadership owner/operators, we are able to analyze the detail.

We're able to galvanize ourselves together.

I'm not going to give a whole detail about it, but you can expect us to be reactive and far more agile in the way that we respond in the marketplace.

And the owner/operators are absolutely consolidated and behind that decision because they want to grow guest counts because they know that's the ultimate lifeline of our business.

So is there work to do?

Yes.

Are we happy with where we're at right now?

No, not entirely.

Are we confident that we've got the right plans in place and the support from the entire U.S. operator system?

Entirely.

So we're going to keep pushing on and competing hard.

Next question is from Andrew Charles with Cowen.

You called out 90 basis points outperformance versus quick service peers versus roughly, call it, 200 to 400 basis points level, you had been running over the last 5 quarters.

And so you kind of touched on it a little with the meal deals.

But what do you attribute to narrowing of that performance versus quick service peers, as Q2 did offer compelling value between $1 $2 $3 and the 2 for $4 breakfast sandwiches.

I would say, we're taking share on a sales point of view, but we're not taking share on the guest count.

So I mean, it still comes down to driving the guest count.

So yes, we put some activity in the marketplace.

What we're looking to do -- I mean, there's a number of initiatives that we have agreed upon across our U.S. business.

So for example, when you look at our breakfast performance overall, there's a point of our overall sales mix, as you know, and it has been a stronghold for us for many, many years.

But we've just begun to lose a little bit of share at that daypart in particular.

And as we've also explained in the past, we have changed our approach to how we market across the U.S. We moved a little bit more out of the local marketing dollars into the national marketing.

We believe, for example, that for getting the breakfast share back -- that's more of a local market activity, the tastes and wants of the consumers around the U.S. are pretty vastly different at that breakfast daypart, some are coffee led markets with the food supported or the food led markets that are beverage supported.

So we believe putting the power back into the local co-ops is the right way to go.

So yes, there's multiple facets to it.

We have taken share on the sales level for 72 of the last 78 weeks in the U.S. and that's a trend we expect to continue.

We want to get the traffic share back as well.

So we want to be greedy.

We plan to be greedy and win on both sales and guest count, and that's where we're galvanizing ourselves around.

The next question will be from Jeff Bernstein with Barclays.

Just touching on the company operator and I guess, maybe more importantly, the franchise profitability.

I think you said all constituents are behind you in terms of being more nimble.

But with the continued pressure on labor and I guess, to a lesser degree, food costs, it seems like you want to keep pricing below food-away-from-home.

But do you think the franchisees are okay with the near-term margin pressure?

Or do you think maybe that this inflationary environment is unusual and therefore, justifying a further bump in the pricing whether or not that's on premium while still keeping the value?

I'm just trying to gauge the franchisee sensitivity to this aggressive value push and their profitability?

Well, Kevin can certainly follow up.

I'll have the first stab at this one.

There are multiple dimensions to what grows obviously the cash flow.

And at the moment, the average check growth is strong, not a lot of that's coming through pricing, a lot of it's coming through mix.

With the increasing take-up of -- customers take up self-order kiosks, we got a higher average check there.

As we continue to roll out delivery, we get twice the average check there.

So I'm not so concerned about the average check increases as long as it's not being too forceful through just price itself because the consumer is so sensitive out there.

People are a little sensitive, they're a little cautious, and you got to stay in line.

We are very transparent with our overall base.

We engage with them day-to-day, week-to-week, month-to-month.

So we share with them exactly what they're going to expect from food cost and commodity increases.

What we can expect from utility increase.

What we can expect from new product margins.

So they are -- I mean, we all like to grow income, of course.

Are they still internally unified behind the plan?

We have them believe this long-term story, absolutely right.

And there's nothing we want to do more than grow further cash flow because that's such a great motivator for future investment and future confidence.

So in the immediate term, they're pragmatic, but we certainly have a desire to be growing, not just our own income and margins, but also their cash flows as well.

Next up is Brian Bittner with Oppenheimer.

Just following up on the conversation.

You tend to keep saying this thing on value, that you don't want to win on value, just want to be competitive.

But I think arguably, a large reason why sales trends have been so solid for a string of periods is because you've been winning on value.

So I guess, the main question is why not have a strategy to continue to win on value?

Is it because of the margin structure of value and is it the headwind it presents for franchisee profits?

Or is there some other reason why you don't want to necessarily win on value moving forward?

Well, I'll slightly dispute the fact that the sales growth has come from winning on value.

I think it's been multidimensional.

I think we're selling more premium products at top end of the menu with the Signature Crafted.

When you have a investment in the restaurants, we see the pickup in sales from the EOTF conversions, which are still delivering what we have seen elsewhere in the world, whereas a full modernization EOTF here in the U.S', we're getting mid-single-digit sales uplifts.

When it's just adding the EOTF elements on modernized restaurant.

we're still getting 1% to 2% uplift.

So that has multiple levers at play that are driving the top line.

And the reality is we're looking to build a moat around the business.

And the more we invest in food quality, the more we invest on our employment proposition and enhance services, the better the technology relationships we have with our customers, the more modernized our restaurants become, the harder it will be for fewer to be able to compete with us.

And therefore, we're not intending to lead any race to the bottom here.

We just want to be competitive on value, and I retain that and we stand behind that.

Next caller is David Tarantino from Baird.

A couple of questions about the U.S. comps.

So first, could you talk about how the launch of fresh beef did relative to your expectations prior to that launch?

And then, secondly I was wondering if there were factors outside of this value discussion that might have hurt the comps in Q2.

And specifically lower throughput following the launch of fresh beef given the operational change there or a disruption from the remodeling activity.

If you could just comment on these last few factors as well.

Yes, I can talk to -- again, I'll try and address these as best as I can, David.

So fresh beef has been a significant operational rollout for us.

Let's, first of all, just recognize what we're doing here, really is a material change to the operating system on our largest beef patty.

And the great news is because the bars became so strong, the awareness levels at launch were around 80%, which is kind of way on the top end of any sort of promotional or launch activity you can only expect.

Consumer sentiment has been really high, and we believe we're taking share in that sort of bigger burger sort of category.

That said, it has been a slight operational compensation to us.

It adds a few seconds to service time.

The teams are on to that.

I mean, first of all, there's familiarity in the restaurant, which will help bring that down.

But also we're looking at other things we can do to simplify the operation to help bring our service times down.

So I think there's a larger increase particularly in the drive-thru.

It's less of an issue in-store at all, but it's mainly through the drive-thru.

And our teams are looking to address that.

Go ahead, Kevin.

I'll take little discussion on EOTF downtime, as you mentioned, David.

I guess, just to give a perspective.

EOTF downtime obviously depends on exactly what we're doing in any particular restaurant.

But roughly a week, 5 to 10 days or so would be kind of normal downtime.

But you also have to think about there's a little bit of an impact on what I'll call it collar days, kind of right before and right after that.

So you actually get a little bit more impact than just the days it's down.

Now that does have an impact on current quarter comp sales, guest counts and margins because as you would expect, labor becomes a little bit less efficient when you have a week of downtime.

So those stores that go down do have some near-term impact.

I think -- it may be a little bit more than we even thought, I think as we're getting into some of the projects, we want to make sure we're doing all the right things and getting in once and getting it done right.

We feel pretty good about when they come out of that downtime, though, when they reopen, what we're seeing is the markets or the restaurants increased sales similar to what we've seen internationally, which is the mid-single digit sales for people who do a full remodel and obviously less than that for people who just add the EOTF elements.

Just to add to that as well.

I mean, yes, we are a large business and sometimes, our numbers can be in millions and billions.

And kind of -- we just get used to that.

I want to put in context, we converted 1,300 restaurants in 90 days.

And that means across that pool, of 14 or 15 communities are waking up every day to a dramatically modernized restaurant and a much better experience.

So is there a little drag through this conversion period, yes, there is.

I wouldn't swap it for anything because the upside for the long term, actually, the medium as well as the longer term, is so evident to us as is evidenced by the performance out of Canada, out of U.K, out of France, out of Germany, out of Italy, out of Spain, out of Poland.

We know these are sales kickers and sustaining sales growth.

So we'll take a little short-term bit of pressure on that.

But I'm flinching our desire to modernize the space here in the U.S. and I'm proud of the team.

There's 1,300 restaurants in the pool, it's quite remarkable.

Our next question is from Karen Holthouse of Goldman Sachs.

Another one on U.S. store margins.

In prior quarters, you've talked about some pretty explicit almost one-time investments in training and getting the stores ready, ready for a lot of the initiatives that are in the pipeline.

Could you give us a little bit of color for what that sort of investment or what that sort of pressure in the quarter could have looked like?

Yes, thanks, Karen.

I think that pressure is dissipating.

We now have fresh beef in all of the locations.

So certainly, you would have seen for the first half of the year, for several months of the year, some training and investment as we were kind of ramping up to get fresh beef in everywhere.

I'd say that's starting to dissipate.

Now we will still see it here and there as we do EOTF restaurants because once a restaurant goes through EOTF, it generally takes a little bit of time to settle back in kind of normal because it is a change for the restaurant also.

So we'll see some of that continue as we convert EOTF.

But I'd say overall, the overall investment, if you will, is starting to dissipate from where it was at the end of last year, beginning of this year.

From an overall margin side, I'd say labor costs continue to be a pressure.

Commodities this quarter were still a little bit of a pressure.

And then the EOTF downtime as well as depreciation, will be another pressure in the near term as we go through these EOTF projects.

Next question is from Nicole Miller Regan with Piper Jaffray.

You've talked about this gap, right, of either in the U.S. you've done it early or the international markets that have done Experience of the Future or value delivery, et cetera.

And it's not -- it's at the higher comp than what the U.S. comp is.

So how important is the field management streamlining and change and support you can offer the franchisees in closing that gap and capitalizing on these opportunities?

Well, it's a great question.

I'll take that.

I mean, the reality is building a strong aggressive, multidimensional plan is one thing.

Executing it is everything.

So what Chris and the team have done is taking a look at how can we can best reallocate our resources to where it's needed most.

And we are now in execution mode, and I tried to paint that picture a little bit last quarter and if you expect me to continue to paint it probably the next 6 or 7 quarters, in all honesty.

We were in execution mode.

Now we won't sit next to the plan a little bit along the way.

We will be agile.

But fundamentally, we know we have the right drivers in the right place.

And what we want to do is best support the owner/operators and help them execute to the highest level.

And I've typically said, I would say that 80% quality plan executed 100% every time over a perfect plan, executed 80%.

Because ultimately, it's the customer experience that really, really matters.

So the reorganization and the reallocation resources to help get stability and consistency into our technology platforms to make it easier to run the restaurants also just provide that consulting support.

We've got a -- we got project management offices set up.

We've got what we call tiger teams that will go and find the little hotspots anywhere and just help with the execution.

Actually, it's the boots on the ground, experienced field consultants who can help support and guide the owner/operators through this quite significant transitional phase that we're going through.

That's the whole purpose of it.

And I'm confident that it's going really be well-received by the operators and they're excited to receive more support.

Next question is from Will Slabaugh of Stephens.

I had a question on the International Lead Markets and other growth markets, if we could maybe translate those to what's happening in the U.S. or what may happen in the U.S. Can you talk about the evolution of average check and guest count that you've seen over time as you've undergone modernization and various value initiatives in those international markets, and now obviously we're seeing some benefits of those?

How should we translate that success to what we're seeing in the U.S. and maybe what potentially we'll see?

On income, I think it does differ by market because of the competitive environment differs by market.

But if I was to take a broad swipe at that, I would say, historically, what we've tended to see, and again, this is a generalization, with sales growth typically around half of that over time has come from guest count growth, and about half from average check.

And the majority of the average check growth has typically come from pricing.

What I do tend to see now in the International Lead Market is, yes, there's absolute guest count growth.

Actually, the average check growth is a little higher, but not because of pricing.

People will price in line with the market, in line with food-away-from-home, in line with the competitive environment.

But once you get those platforms in place, you tend to be able to leverage more at the premium end of your menu.

As I said -- mentioned before, the more customers that choose to order through the self-order kiosks tend to dwell a little longer and spend a little more and the average check's higher there.

As we roll out initiatives such as delivery, we're getting average check kicker there as well.

So I think what we'll tend to see is we still want that guest count growth, it wouldn't surprise me if the average check growth becomes a little more significant than the guest count growth.

But we're just absolutely not going to do that through price.

It's really through leveraging the investments we've made.

And once you get that quality base in place, it give you a lot of opportunity, you get your mix right, your basket size right and customers tend to dwell a little more and spend a little more.

Next question is from Alton Stump with Longbow.

Back to comments about the breakfast (inaudible) during the first half of the year outside of 2 for $4, bulk of your platform is $1 $2 $3, your recipe for cater is sort of focused on either of course the lunch and the dinner day part.

So I think my comment, I understand the fact that a lot of it should be local marketing.

But is there an opportunity from a national perspective to put more focus behind your breakfast offerings during the back half of the year?

Yes, I can take that or start that, Alton.

We've talked about breakfast has been a little bit of an opportunity for us for a little bit -- for a little while.

I think one of the things that happened was breakfast was really carried locally primarily last year, and we kind of had an abrupt change at the end of the year, where we really moved almost all of it to national.

And so I think what we've been spending the last several months is just to make sure we have the right balance.

You will see there's obviously breakfast products on $1 $2 $3 Dollar Menu.

As we've talked about, we will likely tweak $1 $2 $3 Dollar Menu as we go through the year.

So you could see little changes.

So there will be a big piece of breakfast that is included in the national platform, the $1 $2 $3.

But in addition to that, we need to make sure that we carry some important breakfast messages locally, because there is a difference, certainly, maybe even more or so in breakfast than other dayparts -- places like the South that really like biscuits is going to be very different than the Northeast or Northwest.

And so we just need to make sure we've got the night national value platform related to breakfast as well as the right local messages that can resonate with the individual local customers in each place.

The only other thing I'd say is breakfast guest counts remain negative.

So we still have an opportunity for that.

We did have positive comp sales in breakfast in the second quarter.

So we have seen at least a little bit of the trend start improving.

We still have a lot more way to go.

But we did see breakfast comp sales finally positive in the second quarter.

I think you can also probably at a national level expect to see us continue to invest and support the McCafé brand more broadly.

I think that has national -- a universally supported nationally across the U.S., whether that's drip coffee or the more premium coffees now with the investments we've made in quality equipment.

So I think that one lends itself on national.

But certainly, food led breakfast, in particular, we think is a more localized support, as Kevin has already mentioned.

Next question is from Greg Francfort with Bank of America Merrill Lynch.

I just have a housekeeping one and then another question.

Just on the 4,000 remodels you're doing this year, how many of those are full versus partial?

And then of the ones you're going to have left after this year, how many of those are going to be full versus partial remodel?

And then my other question is just, Steve, you talked about the average check being driven more by mix.

Is that a conscious decision you're making to take the brand a little more upscale over time?

Or is that sort of not how you're thinking about it?

I'll take the first one.

The question about how many are modernized versus nonmodernized or full versus partial, as you called it.

I'd say, this year should be relatively representative.

It's about 1/3 of what you'll call full or the complete and then about 2/3 of partial, where you just need the EOTF elements.

We will probably -- we're a little more skewed to McOpCo probably this year.

So about half of our McOpCo is staged or company-operated are complete at this point.

So it may be a little bit more front-loaded on the company-operated sites.

But in general, it should be similar between the -- about 1/3 full and about 2/3 partial this year and going forward.

With the second half, no, I wouldn't describe it as a conscious effort to sort of brand our market.

I mean, we don't want to alienate anyone and we will always stand for value.

But as we continue to invest in the brand, as you invest in quality and the promise of our food, you invest in the physical real estate, as you invest in technology, what you tend to do is broaden your customer base.

So I think, really, what we end up doing is appealing to a broader range of customers on more occasions more often.

That's what it's all about.

We just -- we want to do the things that positively impact the most people in the most areas as possible.

It's a -- I wouldn't say it's a conscious effort to take the brand upmarket, continuing to reinvest in the brand and keep it relevant for customers today is what it's all about, and it's a competitive marketplace.

We want to differentiate ourselves from the competition, and we believe we have some initiatives in place that will help broaden the gap between us and the others.

The next question is from Matt DiFrisco with Guggenheim.

I just have a follow-up on that and then also just want to know about, I know you don't like to talk about current trends but there's been some news about the salads and things like that.

I was just curious how that might have been resolved, impacted our how that might have manifested itself in trends.

But you also just mentioned about alienating a customer.

Obviously, I don't think you purposefully would want to ever chase away people.

But could you sort of narrow down the drag that was referred to from the conversion?

Is that -- is that manifesting itself in less frequency, you think from your customers?

Or is it a -- could you narrow that down to a specific cohort that may be of that lower-income demographic that perhaps, the value message has been a little bit diluted as you've been elevating the brand?

Or -- and they could come back or have you just seen simply less frequency from your existing customers?

Well, I'll take the salad one.

Yes, I mean, obviously, no one ever -- I mean, food safety and customer's well-being is our absolute #1 priority, first and foremost.

So as you know, we've been contacted by the public health authorities in Iowa and Illinois about certain infections across produce in those states.

We have removed existing lettuce blend from the identified restaurants, in actually around 3,000 restaurants as of July 23, someone said that's 3 days ago, all those restaurants have been fully replenished with the new supply and we continue to trade fully.

So I wouldn't say that has been material impact on our trading performance.

It's something you don't want to be associated with, something taken very seriously.

But from a trading perspective, it really hasn't been something that is particularly material.

I'll take the second one.

I tried talking in my script a little bit about kind of these 2 different customer groups.

There's one customer group that we call or that are called budget basics that are looking for kind of everyday predictable low prices.

And our $1 $2 $3 Dollar Menu has been successfully dealing or addressing those customers.

Where we've had a little bit of gap, if you will, is these deal customers, who are people that love fast food, but they will go to several different outlets based on who's got the best deal or who has a really compelling deal.

And I think that's the area where we haven't been as competitive as we've needed to be because some of our competition has stepped up on their deal side.

And so we've talked about we need to make sure on the deal side that we're competitive so that -- those customers are -- that's where we would have lost on based on frequency of customers, as you talked about.

So it's really just having those customers come back to us more frequently because we've got the compelling deals on a regular basis.

Next question is from John Glass with Morgan Stanley.

2 on comps.

First just on the global comp or the global traffic, but it declined for the first time in several quarters.

And I know you called out the U.S But I'm assuming U.S. is somewhat similar at least on a comp basis versus last quarter.

So are there international markets where traffic is still positive or maybe has decelerated, worth calling out, I know you said South Korea.

But are there other places that you are starting to see some traffic deceleration that would account for that global deceleration in traffic.

And earlier this year, I think you reduced the advertising spend in the U.S. as part of the rollout of the $1 $2 $3 Menu.

Do you think that's it all a root cause of perhaps some of the weakness or need to -- or said in other ways, is there need to reinvest in some advertising dollars in the U.S. as a way to drive traffic?

I'd say from a guest count perspective, I mean, clearly, the U.S. has come to be our largest market.

And therefore, if that goes weak or goes negative, that tends to drag things down.

Other somewhat more noticeable trends over the last, I'd say, 3 to 6 months have been China, where we're still getting like-for-like sales growth, but the guest count growth has gone negative in China through the quarter.

There has been a -- the impact within that market on the uncertainty of the trade discussions has -- I mean, clearly, hit the market, which in turn hits consumer confidence.

And so we're keeping close to that and adjusting our plans, so we can be competitive there.

And Russia continues to be hard work for us.

So we're getting negative guest counts there at the moment and now we're making some changes with our team there, but also with our strategy there, so we can compete slightly more fully.

On the advertising side, you're right, we reduced the contribution here in the U.S. for both owner/operators of the company.

I don't think our issue is around the percentage contribution.

I think what it takes is a little bit of time, that when you move from 180 co-ops down to 56 co-ops, when you move from 44 local marketing agencies to a roster of 5 local marketing agencies, there's just a transition time for it to settle down.

So are we running at peak performance year-to-date in terms of just the effectiveness and efficiency of our marketing?

Probably not.

Do we believe we have the structure in place where the contribution we make now we believe should be certainly sufficient from a share of voice, return on marketing spend and therefore, basically be more effective and more efficient.

So there's no plans to change the marketing contribution.

It's just what we do with it which is most important.

Next question is from John Ivankoe of JPMorgan.

I know you don't comment or maybe can't control, I should say, staffing levels for franchisees in the U.S. or what franchisees pay their labor.

But I would -- I just want to have sense of the overall staffing environment that the franchisees are facing on a market-by-market basis.

And if you think the current labor market in any way is affecting some of your execution levels, that maybe you alluded to in terms of fresh beef being a little bit slower through the drive-thru or any other factors in terms of processing peak-hour transactions.

Yes, John, it's Kevin.

It's a good and fair question.

I'd say labor staffing -- it's a tight labor market out there.

I think it's fair to say.

And so labor staffing is a challenge, both for us and the franchisees.

But that's the industry.

So I don't know -- I don't know that we have an any worse than anybody else and I don't know that we can or should or do use that as an excuse.

I do think it is a tough labor market right now to make sure you've got the right staffing levels.

And maybe because we're going through EOTF and all these other things right now, that you see a little bit of impact of that.

But long-term, we have to figure out that equation.

We've got to be able to figure out how to be efficient with our labor and be able to operate effectively.

Near term, I think it's a fair point.

You know unemployment is obviously very low.

And so certainly, depending on state-by-state or area-by-area, it does have an impact.

But -- so we're trying to do everything we can to invest in our employees, invest in training, to make sure that we can attract the right labor for us.

But it is -- it's a challenge right now in the industry, I think.

I think part of what we're doing, because there's a fight for talent and it's not just the U.S. actually.

It's a lot of our mature markets, partly because there is less mobile labor, let me put it that way.

So it's less migration across Europe.

The impacts of Brexit means there's been an exodus, if you like certainly sector workers out of U.K. We can begin to see that impact here in the U.S. So we've got to fight that little bit harder to, first of all, gain the talent and then retain it.

So that's why we committed $150 million over the next 5 years to Archways to Opportunity, for example, where we should be providing education and training opportunities and career development and personal development opportunity to our people.

So whatever we can do to try and differentiate ourselves from others in the service sector is really important to us right now.

So we're doubling down on, if you like, the added value that we can offer our employees as well as the day-to-day as well work.

Next question is from Chris O'Cull with Stifel.

Kevin, it sounded like from your comments that the $1 $2 $3 Value Menu may evolve to include some regional variation.

I wanted to see if that was true.

And then also is the plan to design local meal deals to be more competitive in lower cost markets where we see competition priced to that local market rather than international level?

Yes, Chris.

So let me try a couple of other things there.

The $1 $2 $3 will have a national -- it's a national platform.

There are and will be some options, if you will, that local markets depending on where they are can draw down and put on the $1 $2 $3 Menu.

So you will see some items that are on -- in certain markets, depending on where they're located.

So the general platform is national.

There will be certain products that will be on nationally.

But locally, people will have an option of either adding or swapping out a couple of products here and there.

The second part about deal.

Most of the deals will likely be national deals.

So things like the 2 for $4 breakfast that we had.

The 2 for $5 sandwich that we're going to have starting August and other deal platforms of that we're anticipating will generally be national platforms.

So I think most of the deal will be at a national level.

Okay, we've got time for one more question.

And that will be Matt McGinley with Evercore.

The question is on the International Lead and looking at the level of comp you've had over the past handful of quarters and then looking at not a whole lot of margin flow-through.

Given your farther along with EOTF, I don't think the investment levels are the same there.

But I believe delivery is becoming a bigger part of the mix there.

I'm curious if that, that could be having a bigger drag on the comp than perhaps other initiatives or other investments that you're making.

And if that -- sort of spend continues, do you think that, that same level of overall rule of thumb in terms of the comp growth would have the same level of impact on the earnings on a go-forward basis.

Yes, Matt, I'll take that.

I'd say we're really pleased with the comp growth that we've been getting in the International Lead Market because it's been pretty broad-based.

You see all 5 of the main markets in that International Lead segment doing pretty well.

They're all in pretty good shape with Experience of the Future.

Some of them -- Germany and France, probably still have a little bit ways to go but the restaurants look really good.

We're getting sales.

In general, those markets, I guess, from our perspective, we're throwing up franchise margins of 81% and McOpCo margins this quarter of over 21%.

So I think in general, we're pretty pleased with the level of margin.

Now you will see -- you do see a little bit of percentage hurt maybe because of delivery to your point.

As delivery percentage of the sales grow, the percentage margin on those is a little lower percentage because you've got commission to pay, but I'll certainly take the additional dollars we're getting from those sales to give up a little of that percentage.

So I think we're pretty pleased with the margin flow-through in those International Lead segments.

All I'd say on some of that is we're taking share in each one of those markets as well.

So yes, we wanted to carry the bottom line.

But from a competitive position perspective, we just get stronger and stronger compared to the rest.

So it's the share gains we know are long-term winner for us.

But they are returning some pretty good profitability and some great top line and solid guest count growth as well.

So that completes our call.

Thank you, everyone.

Have a great day.

This concludes McDonald's Corporation Investor Conference Call.