Earnings Call: Q3 2017

Oct 24, 2017

Hello, and welcome to McDonald's October 24, 2017 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 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 are President and Chief Executive Officer, Steve Easterbrook Chief Financial Officer, Kevin Ozan and President of McDonald's USA, Chris Kuczynski. Today's 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 the 8 ks 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. Our momentum continues to build across the business in the Q3. Across all our operating segments, we serve more customers more often, driving global comparable sales up 6% and comparable guest count up 2.4%. This marks 9 consecutive quarters of global comparable sales growth and our 3rd consecutive quarter of comparable guest count growth. We're building a better McDonald's and winning back customers with great tasting food, compelling value, and an enhanced experience. In each of these areas, our markets have built sustainable platforms, integrated and grounded in deep local insights. They have enabled us to move with greater speed, efficiency and impact to meet the evolving needs of our customers. Whilst we've been building momentum across the McDonald's system and our performance is globally broad based, I'm particularly pleased that the U. S. Business has regained its stride. As Mike mentioned at the top of the call, we have Chris Kepchinski, President of McDonald's USA joining us today. Later in the call, Chris will provide insight into the drivers of U. S. Performance. To get us started, Kevin will provide texture on our financial results for the quarter. Thanks, Steve. As Steve mentioned, our positive comparable sales and guest counts in all segments reflect the momentum that continues to build across our system. I want to provide a little more context on how each segment contributed to our global performance for the Q3. U. S. Comp sales increased 4.1% for the quarter with a positive comp sales gap versus our QSR sandwich competitors. Chris will provide more details on the drivers of this performance in a few minutes. Comparable sales for the International Lead Market segment were up 5.7%, led by continued strong momentum in the UK and Canada and positive performance across the rest of the segment. High growth segment comp sales increased 6.2% with China continuing its strong performance as the most significant contributor and the segment's European markets delivering strong comps as well. And comparable sales for the foundational markets rose 10.2%, led by Japan's double digit comp performance along with positive results in each of the segment's geographic regions. Our Velocity Growth Plan is not only driving top line growth, it's also benefiting our operating performance. Earnings per share for the quarter grew more than 50 percent to $2.32 This included $0.56 of special items consisting of a gain on the sale of our businesses in China and Hong Kong and unrelated non cash impairment charges. Excluding these items and prior year strategic charges, our EPS was $1.76 up 9% or 7% in constant currencies over Q3 last year. Moving on to pricing and commodities. Our Q3 pricing in the U. S. Year over year was up 2.2%, which was slightly below food away from home inflation of 2.4%, as we continue to have a disciplined approach to menu pricing and provide our great tasting food at an affordable price. Commodity costs in the U. S. For the Q3 were up 1.5% versus last year. We continue to expect our U. S. Grocery basket to increase about 1% for the full year, reflecting the anticipated commodity pressure in the back half of the year. For the international lead markets, commodity costs were up more than 2.5% for the 3rd quarter, and menu prices were up about 1.5% year over year. Moving down the P and L. For the quarter, our positive comp sales, along with the combined impact of our major refranchising transactions, drove an increase in franchise margins of $219,000,000 and a decline in company operated margins of $148,000,000 On a percentage basis, consolidated company operated margins increased 70 basis points to 19.1% for the quarter. About half of the improvement was due to the benefit of having no depreciation expense for China and Hong Kong, as the assets were classified as held for sale until July 31. For the High Growth segment, about 3 quarters of the margin percent improvement can be attributed to this same benefit. On a percentage basis, we expect 4th quarter margins for the remaining company operated restaurants in the high growth segment to be similar to results reported in Q4 2016 as the segment will no longer have this depreciation benefit. Regarding G and A, at the beginning of the year, we indicated that we expected our G and A for the year to be down about 7% to 8% in constant currencies, with fluctuations between quarters due to the timing of spending. For the Q3, our G and A was down 4% in constant currencies, which resulted in total cost being down 8% through the 1st 9 months of the year. We now expect G and A cost to be down about 7% for the full year, which means 4th quarter G and A should be down a similar percentage to 3rd quarter. 3rd and 4th quarter G and A are higher than first and second quarter this year, primarily due to two main reasons: higher technology spending in the back half of the year as we continue to develop, enhance and deploy technology solutions like our global mobile app and kiosks and higher spend in the U. S. In the back half of the year as they deploy experience of the future, mobile and delivery. Our 3rd quarter effective tax rate was 33.2 percent and the 9 month tax rate was 32.8%. Given that, we now expect our tax rate for the full year to be 32% to 33%. Turning to foreign currencies. For the quarter, foreign currency translation benefited results by $0.02 per share. At current exchange rates, we expect a positive impact from foreign currency of $0.04 to $0.06 for the 4th quarter and about $0.01 for the full year. As usual, this is directional guidance only because rates will change as we move through the remainder of the year. Finally, as we communicated last month, we increased our quarterly dividend by 7% to $1.01 per share, the equivalent of $4.04 annually. This reinforces our confidence in the company's long term strategy and our expectation to return $22,000,000,000 to $24,000,000,000 to shareholders for the 3 year period ending 2019. Before I turn it back to Steve, I want to spend a minute on the achievement of a milestone in our strategic franchising initiative. The sale of our China and Hong Kong markets in the Q3 caps off our goal to refranchise 4,000 company owned restaurants, which will accelerate our growth in these markets, while creating a more stable stream of revenue and earnings. In just under 3 years, we've increased the percentage of franchise restaurants from 81% to 91%, and franchise margins will now comprise more than 80% of our total restaurant margin dollars going forward. We'll continue to optimize our ownership mix by refranchising restaurants in certain of our large mature markets like the U. S. Using the same financial rigor and discipline that we began a couple of years ago. And we'll continue to evaluate other markets to determine whether a developmental license model is the right model to efficiently grow in those markets. As I said at our March 1 Investor Day, our refranchising activity will have a dilutive impact on our revenue, operating income and EPS growth rates in the near term, making year over year comparisons through 2018 choppy. We received cash proceeds of about $1,600,000,000 from the China Hong Kong transaction, which we plan to use to repurchase shares. We expect the refranchising transactions completed over the last year will have a negative impact on EPS of a few cents per quarter until Q3 2018. Also, the depreciation benefit of about $100,000,000 that we realized this year will not reoccur in 2018. Going forward, our results for these markets include sales based royalties along with a 20% equity pickup for China Hong Kong. The critical moves we've made through our refranchising efforts will benefit our business for years to come as our strategic partners unlock the growth potential in these markets without the use of our G and A and capital resources, while we receive a steady stream of royalty income. And they will also lead to an increase in our operating margin on our way to our target of mid-40s under our new more heavily franchised and efficient business model. So in the near term, we're focused on growing comparable sales and guest counts, and we're pleased with our recent performance, which has benefited primarily from running better restaurants. At the same time, we're confident that our velocity accelerators of Experience of the Future, digital and delivery will continue to grow the business. Beginning in 2019, once we've lapped completion of the major refranchising transactions, we expect to return to revenue growth and also achieve the other long term financial targets that we've established, including steady and reliable earnings growth. Now I'll turn it back to Steve. Thanks, Kevin. At the top of the call, I talked about the growth platforms each market has built around menu, value and experience that are designed to grow guest counts by retaining the customers we have, regaining customer visits we've lost and converting casual customers to more committed customers. During the quarter, each market executed with innovative and compelling approaches to menu, value and convenience that drove incremental customer traffic and higher average check. Every major market now offers a range of premium chef crafted beef burgers and chicken sandwiches with artisan ingredients and enticing flavor profiles. In France, the signature beef and chicken line uses breads, meats, cheeses and sauces that capture the regional gastronomy of the country. The U. K. Is having great success in their modernized restaurants with their version of Signature Beef, inspired by the English Pub Burgers with thick juicy beef and beechwood smoked bacon, piled high with freshly prepared toppings on a brioche style pub. Canada's launch of the Seriously Chicken platform appeals to Canadians' preference for international flavors with local sourcing and provides a great complement to the market's popular Mighty Angus beef burgers. Italy took note of the success that France and the U. S. Had with Grand Mac, and Italians loved it. We know that customers motivated primarily by value and deals come more often and spend more. During the quarter, our markets offered compelling value across the breadth of the menu. For example, Japan, Italy, France and many other markets executed value programs and promotions that leveraged the strength of our popular Minions Happy Meal to drive incremental family business with value bundles and dessert specials. We are increasingly driving traffic and check growth in digital offers. Redemption of mobile offers continues to grow month on month with a meaningful portion of the redemptions representing incremental visits. Importantly, this is also building our base of digital users, increasing awareness and adoption as we deploy the mobile Auto K functionality of our mobile app. Although they did not have a material impact on our results for the quarter, we are making solid progress on the deployment of our Velocity Growth Plan Accelerators. We remain on track to deploy mobile order and pay to 20,000 restaurants by the end of the year, including all of our U. S. Restaurants. We continue to learn as we deploy, rapidly implementing updates to address challenges and opportunities as we expand in each successive market. We made significant progress with expanding delivery at scale throughout our markets. Over the course of the past 9 months, we've introduced delivery in over 5,000 restaurants across 20 countries. Along with the 3,500 restaurants in existing delivery markets across Asia and the Middle East, we now offer delivery in over 20% McDonald's restaurants around the world. We continue to improve the model as we scale, remaining on track to offer delivery in 10,000 total restaurants by the end of the year. We're taking learnings from our top performing delivery markets and spreading the best approaches around the world. We remain confident that delivery will be a powerful accelerator for our business as we look at markets where it's gaining traction. The 3rd velocity accelerator is rolling out Experience of the Future or EOTF. We are continuing with improvements inside our restaurants that make the customer experience more personal and less stressful. EOTF now has been deployed with all elements in roughly a quarter of the restaurants in the McDonald's system. As they approach full deployment, the UK and Canada are proving how powerful EOTF can be for our customers. And in France and Germany, where we rolled out EOTF to about 1 third of the restaurants in both countries, we're seeing similar results. And many of our other large international markets are not far behind. Successful execution of our growth strategy and in particular our digital delivery and Experience the Future initiatives requires the full support and commitment of our owner operators. Recently, I joined Chris on market visits to cities such as East St. Louis, Detroit, Cleveland and Salt Lake City. I saw many examples where we're successfully running better restaurants, which left me confident about the great alignment we enjoy with our owner operators in the U. S. We share a vision for the future and they're committed to driving the operational excellence that will be key to our success. Now, we'll hear more about the progress of our U. S. Business. Thanks for joining us today, Chris. Thank you, Steve. I appreciate the opportunity to join the call today and update everyone on the state of our U. S. Business. The U. S. Continues to demonstrate solid growth and I'm proud of our system and the progress we're making. As I look ahead to 2018, I'm excited about our pipeline of ideas and the growth potential they offer. For us, the key will be to execute at a really high level across a number of initiatives, and we're investing a lot of time and effort right now to get that right. Let me provide more insight into our Q3 performance, and then I'll talk about how we're preparing for 2018. During Q3, we grew comp sales 4.1%, resulting in a comp sales GAAP of 4.40 basis points versus the QSR sandwich competitors. Importantly, our comp sales growth was supported by positive guest count growth. This is our 3rd consecutive quarter of positive comp sales growth and 2nd consecutive quarter of positive comp guest count growth. For the past three quarters, we have posted a favorable comp GAAP versus QSR. We're particularly pleased with this performance because we had to overcome the headwinds of a sluggish overall IEO market that currently offers limited traffic growth. Our success can be attributed to several factors. 1st, we offered compelling consistent value programs across a number of tactics that clearly resonated with our customers. We continued our Dollar Any Size Soft Drinks program and supplemented it with the return of Mick Pick 2 for 5 that offered some exciting food deals. We're also starting to get real traction with the targeted mobile offers via app that are tailored to customers' unique buying preferences. 2nd, we've been able to capitalize on this increased traffic into our restaurants with menu news that drove customers to trade up to premium higher margin products. In Q2, we launched our signature crafted sandwich line available either in beef or chicken with 3 flavor combinations, Pico Guacamole, sweet barbecue bacon and maple bacon dijon. In August, we rotated in a new Sriracha flavor that gave the Sanders crafted line an extra kick. In September, we also reintroduced McCafe to the U. S. This meant a new, more modern look for the McCafe brand and new choices, including the reintroduction of our McCafe espresso line after a significant equipment upgrade across our system. The McCafe espresso products performed very well, reaffirming our systems confidence that McCafe can be a significant growth platform for us in the future. As we've seen with both Signature Crafted and McCafe, when we improve the taste and quality of our products to meet customers' rising expectations, they reward us with more business. Finally, we're seeing encouraging customer response to our velocity accelerators, including delivery, digital and experience of the future. Through our partnership with Uber Eats, we now offer delivery in 3,700 restaurants, and we're on track to reach 5,000 restaurants by year end. We're learning a lot about delivery and seeing particular success in dense urban metros with high penetration of younger customers like New York, Boston, Miami and Los Angeles. I truly believe we're just beginning to scratch the surface on this opportunity. We're also continuing to roll out mobile order and pay with a new curbside check-in option. I'm really excited about the potential of curbside to elevate the convenience at McDonald's to a whole new level for customers. We now have mobile order pay in over 6,000 restaurants, and we expect to reach all 14,000 restaurants by the end of the year. And last, we're making good progress with our Experience of the Future projects, and we're seeing comp sales lifts consistent with our targets. We currently have Experience of the Future deployed in 13% of restaurants and that number will increase significantly over the next couple of years. As the pace of activity in the U. S. Accelerates, it's critical that our restaurants are properly staffed and trained to execute at a high level. Our McCotSCO and operator organizations are investing in labor right now to train for initiatives like hot off the grill, hospitality curbside delivery. This will have a temporary impact on margins for the next 6 to 12 months as we work through our deployment calendar. We've seen this before in other markets like Canada, Australia and the U. K. When they've launched similarly aggressive plans, and we feel quite confident about our ability to manage through this short term situation. At the same time, we're also ramping up our internal project management capabilities to prepare, deploy and maximize each initiative. We've created dedicated project management offices at both the national and regional levels to ensure we anticipate resource bottlenecks and flex organizational capacity as needed. We aim to prove that size and speed do not need to be antithetical to one another. 2 years ago, Steve declared that McDonald's needed to run better restaurants and nowhere was that more evident than in the U. S. Market. As Steve mentioned, we recently visited a number of U. S. Cities, including East St. Louis, Cleveland, Detroit, Salt Lake, Houston, and it was really a proud moment for our owner operators to showcase their progress. On almost every dimension, the U. S. Is running better restaurants, and that's showing up in the business results. And at the same time, that pride and confidence in our performance is helping to energize the system to pursue an even more aggressive growth agenda. Almost 100% of U. S. Operators have now signed commitment letters in support of a holistic multiyear growth strategy that will update the entire system to EOTF, make important equipment upgrades to deliver better food and ensure we remain competitive on value. We're excited about what's to come in the U. S. And I look forward to updating you periodically on our progress. Now back to you, Mike. Thanks, Chris. We'll now open the call for analysts and investor questions. Now the first question is from David Palmer with RBC. David? Thanks. If I could just do one question for Kevin. You mentioned some facts speaking to this. Obviously, your profit growth excluding one times was very strong in the U. S. And in international lead, but was held back by other high growth and foundation markets. And clearly you're getting some refranchising and licensing actions dragging on that. I think originally you thought flat EBIT impact from these effects, these refranchising and licensing actions. Is that still the expectation? How much was the drag? And should we expect an equal tailwind perhaps starting in the Q3 in 2018? Thank you. Hey, David. Yes, so let me try and explain. As you mentioned, there's a lot of noise in this quarter and there will be for the next few quarters because of these refranchising transactions. So what we've said is, once these once you kind of lap these franchising transactions, so I'll say beginning in Q4 of 2018, that's when we get to what I'll call the new norm. Until then, it's going to be it's going to be a little rough on a comparison basis because you have 2 things going against you. 1 is kind of the results of these markets as wholly owned in 2017 compared to them as developmental license markets in 2018. And on top of that, you have this depreciation benefit that we received in 2017 that we won't have in 2018. Once we get through all of that, what we've said is essentially on a EPS level at the beginning is we'll be relatively neutral because the proceeds we've gotten in, we will use to buy back shares. And so at an EPS level, we'll be effectively relatively neutral once we're able to buy all those shares and have them built into the calculation. Operating income in the near term will be down a little bit because the income we've given up as wholly owned is more in the near term than the income we'll get on a royalty basis, if you will, as a DL. On a free cash flow basis, it will be immediately accretive because the capital that we're saving from DL ing these markets effectively outweighs the operating income that I'm losing. So it will be immediately accretive to free cash flow. Our next question is from Sara Senatore with Bernstein. Sara? Hi. This is actually Anafoq representing Sara. So in terms of delivery, do you now have a large enough sample to draw some conclusions about the impact on comps? And also can you talk a little bit about profitability? One of the things we hear from some of the private companies we speak to is that it's difficult to make delivery profitable even when it's out sourced to 3rd parties and therefore doesn't require as much in upfront investments. Could you talk a little bit about what kinds of fixed and variable costs your franchisees incur and what kind of profitability you anticipate? Thank you. I'll have a stab at that one. So I mean, clearly, we're getting enough of an early read to be encouraged by delivery. So we have been very we pursued delivery has pursued a very aggressive rollout program. And our primary lead partner on this one has been Uber Eats. And effectively, we've looked to expand wherever Uber Eats has coverage around the world. And they've actually been doubling down on their expansion to help meet our ambition as well. So it's been working well as a partnership between the 2 of us. And yes, we're getting good early trading results. What we're finding is not surprisingly the number of guest counts per store per day does correlate pretty highly to awareness, consumer awareness of this. So the markets that have been able to more effectively promote and raise the customer awareness are getting higher take up per day. But it's certainly I'm not going to get into the actual comp buildup on this one, but it's a meaningful contributor in the restaurants that offer delivery. As I say, I want to just make sure we're guarded about what we're saying. We're in 5,000 restaurants so far out of 37,000. So it's meaningful in those that offer it, but clearly we've got some ways to go to get the further scale across the global system. In terms of profitability, it's important that it's that the vast majority of our business is incremental because the way that we are working with the 3rd party operators is obviously there is a commercial relationship between ourselves and the 3rd party operator that would take some of our margin. So we need certainly more than half of this business, if not more than that to be incremental. And we're certainly finding that we're well up that scale actually. It's really, really encouraging for us. And part of the reason we know that is because we're beginning to collect consumer data now as well. So we can actually get repeat visit information, daypart information and the fact that more than 60% of our business comes in evening and overnight, we know is reinforcing the fact this is an incremental business opportunity revenue stream that we weren't previously tapping into. But we're also getting very strong repeat business from those that use it as well, which again further encourages us. And one of the things we're focusing on internally is what is there that we can do to get the awareness of the fact that we're offering delivery higher up in consumers' minds. So yes, it's profitable. It's incremental business and we're looking to continue to go hard at this and we certainly are operational as are we as a corporation. Our next question is from Karen Holthouse with Goldman Sachs. Karen? Hi, thanks for taking the question. A question on U. S. Margins where you talked about some of those up front investments that you're making behind new initiatives. Is that what we're seeing at store level and year over year margin pressure? And then if so, when you talk about that sort of last 6 to 9 months, and then do you actually see costs go away? Or is just the So Yes. Hi, Karen. It's Chris. So certainly, what you're seeing in the trading results that we just you're seeing primarily labor related to the trading that I was talking about. There is some commodity inflation, but the biggest drag that we're facing right now is related to the labor investments that are being made. In terms of going forward, I think one of the pieces that remains to be seen for us is just what does the long term labor inflation look like in the U. S. And so we have seen with roughly 5% unemployment that labor inflation has been ticking up nationally. In addition, there's local legislation that's going on as well where minimum wage laws are increasing. So that long term could be a headwind, which just would require a faster growth rate than what we've historically seen. But I think right now, it's unclear where that goes. I think for us, certainly the investments that we're making right now on training, those are one time investments that would go abate in the next 6 to 12 months. And I think the longer term is we just need to keep our eye on labor inflation across the U. S. Karen, I'll just hook on the back of that as well because Chris is right. I guess the level of the tone of the conversations we have, not just with management teams, but with our owner operators clearly is, we have a really solid plan. I mean, Chris and the team have built an ambitious, very broad based plan. And having a plan is a great start, but you've got to execute it. Plan. And we've seen this wherever we have an execution plan. And we've seen this wherever we have an execution gap between the stretch and execution, it kind of catches us out as the customers get impacted. And we've also got some great recent experiences with UK and Canada and Australia who've all deployed ambitious multifaceted plans. And we've seen this kind of the trend where you'll invest a little more in the shorter term on the P and L in order to get the execution right, but the payback then comes over that medium to longer term. So I'm comfortable with where we're at. It doesn't mean we're blase about it, but this is not unexpected to us. And as I say, getting the execution right is our primary focus. Our next question is from Brian Bittner with Oppenheimer. Brian? Thanks. Thanks for taking the question. Can you just talk a little bit more about your national value platform strategy launching in the United States in early 2018? Any details you're willing to provide on that strategy would be helpful to us. And in addition to that, if you could just also address how you expect your U. S. Franchisees are going to strategize making incremental investments in value at a time when store level margins are declining from the labor investments and whatnot? Thanks. Sure. Well, one of the things that we have said to our franchisees in the U. S. Is, we don't have to win on value, but we can't lose on value. And that means we have to be competitive with our investments against the value program. And I think also, it's no surprise that over the last, call it 3 or 4 years since we rolled off Dollar Menu, we weren't as competitive as we needed to be on value. And so what you're going to see from us next year is us being really fully competitive with our nearing competitors with a value program there. It's been written about and I don't think it's any surprise that certainly our value program is going to be focused on $1, $2 $3 price points for an everyday value piece of it. Then there will also be deals that will pulse in and out throughout the year as a result of that. When you talk about the investment that is being asked of owner operators, one of the things that we talked about is that this plan has to be looked at holistically. And so while there is an investment that's being made on the value side, there are also some significant efficiencies that are being captured on the other side around particularly marketing and efficiencies that we're getting there, efficiencies that we're getting at the restaurant level. And so when you look at all of it on a blended we think that this is a balanced plan. And I think most importantly, the fact that our owner operators were at almost 100% signing up for it is probably the best testament that they felt comfortable with the value investments, being offset by some of the other things in the P and L. I think it's also worth noteworthy, Chris, that the commitment that's been signed up to is to have the national support. So the need for some of the local value initiatives is somewhat reduced because we're putting the national muscle to play here to support the program, which I think is exciting for us as we enter 2018. Next question is from Brett Levi with Deutsche Bank. Brett? You obviously started to talk more about coffee at your March Investor Day and once again reiterated that it's doing well. What can you share in terms of how much faster it's growing than your overall comp? What are you seeing in terms of daypart, breakfast, afternoon and attachments? And if I could, how is that doing in terms of traditional in store purchases versus your mobile order and the loyalty program? Thank you. Well, I think we're excited about coffee, in part because it's a huge category. It's a $30,000,000,000 business in the U. S. And it's growing mid to high single digits as a category. So we're excited about the category. It's high margin and we're under penetrated there. So as we built the plan, it was really about us getting after an opportunity where we think our McCafe brand has a lot of relevance. We're not going to get into the specifics of by product line item, how do those compare versus the average comp. But I would just say that certainly we saw the benefit in Q3 of really nice growth on our McCafe business. And as we look out over the next few years, we're expecting to use McCafe as really a platform for us to get additional growth. So we're excited about that. We think we have a good opportunity to get after it. It's really been a question of focus for us. We haven't consistently focused on this in the past and going forward, it's going to be a key area for us. I'd also just say from a global perspective, when you look at the overall velocity plan that we talk about, Brett, coffee and McCafe is at a different stage in different markets. But if you actually look at the key drivers behind the velocity plan on the retained category, but retaining customers, clearly a strong compelling coffee plays really well alongside clearly a strong compelling coffee plays really well alongside the food led breakfast advantages that we have. When you look at regain, then as we build our digital capabilities and loyalty and CRM, we think coffee will be because it's such a habitual purchase will play well against those customers who we want to encourage back more often. Then finally when we talk about converting casual customers to committed, we know coffee and snacking plays strongly against some of those more casual consumers. So each of our major countries has a different stage of development of their McCafe programs. But one thing I would say is coffee plays a part in all of those markets as we go forward. Our next question is from John Glass with Morgan Stanley. John? Thanks very much. Good morning. Two cost related questions. One is just on the SG and A. So as you've gotten further into technology, it sounds like there was maybe a little heavier spending this quarter. Do you still have the same confidence that you're going to achieve the overall SG and A goals that you laid out earlier? Or does this quarter make you think about you need to put more money into that in 2018? Can you just reiterate what those goals are and if they've changed at all? The other component of your business that's grown has been the gains on asset sales excluding the China. It's been still a few $100,000,000 a year. Does that effectively go to nil over the next couple of years as refranchising is complete? Or is that still an ongoing piece like it should trade in and out of markets for example? Yes, John, thanks. Let me start with the G and A. What I'd say is, right now, we're completely on track with where we expected to be this year. As I said in my remarks, we expected to be down about 7%, 8% in constant currencies. We still expect to be down about 7% for the year. Having said that, it probably is a little more back loaded this year than we probably thought at the beginning of the year. So the timing of it is a little bit more back loaded. But what we're seeing is, we're achieving significant savings from our refranchising and we're also seeing significant savings in our maintenance or running the business G and A. That's being partly offset by a significant increase in technology spending. So we're achieving net G and A savings and at the same time, we're shifting more of our existing spend from maintenance G and A to what I'll call investment G and A focused on growing the business. So I think overall, we feel a lot better today about where we're spending our G and A, but we are on track with kind of all of our original plans at this point. Regarding the gains, it's a good point. I think you'll probably still see gains in 2018 as we continue to refranchise in some of our conventional license markets, the U. S. And some of the international lead. After that, that will likely go down a little bit. We won't have as much of the refranchising transaction. We will still have restaurants that exchange hands in kind of normal course of business. So there will always be some restaurants that just as we always optimize our mix, we'll have some, but it probably won't be to the level that we've seen the last couple of years and maybe in 2018. After that, it will likely go down a little bit. Our next question is from Peter Saleh with BTIG. Peter? Great. Thank you for taking the question. Just curious if you could comment a little bit on speed of service in the U. S. And how the experience of the future restaurants are comparing on speed of service ticket times versus the rest of the system? Are they moving faster? Are they moving slower? Any sort of color would be helpful. Yes. Well, so I'd say what we typically see is as we're deploying whether it's EOTF, some of the menu news, etcetera, we typically do see a slight uptick in service times, call it, on the order of 5 seconds or so. And then certainly, as the crew and our restaurants get more experienced in whatever the initiative is, we expect to claw most, if not all of that back over time. I think it's for us, when you look at the experience of the future, one of the things that makes it difficult to really do the from to on that is because as we bring in experience of the future with curbside, you start introducing all sorts of new ways for the customer to interact with the brand. And so maybe in the past, they would just go through the drive through because frankly, they didn't see going into the restaurant as a great experience. Now they want to go into the restaurants because it's an updated modernized experience where you can get table service there. And so it's really I think what we're seeing with experience in the future is that customers are choosing new ways to interact with the brand that makes it difficult for us to compare. I think the more relevant metric really for us is we look at customer satisfaction. We look at customer satisfaction prior to EOTF and after EOTF. And what we're seeing there are significant improvements on the order of 3 to 5 point improvements in overall customer satisfaction. So for us, that gives us reassurance that they are enjoying the initiatives that we're deploying with EOTF and they're having a better experience. I think it's I mean, Chris is absolutely right. I think part of our broader philosophy around Experience of the Future is putting that choice and control in the hands of customers, whether it's how they order, what they order, how they choose to pay and how they're served. And we want to be providing faster service for those customers that really want fast service. But at the same time, not everyone wants to be rushed and therefore we're providing more alternatives. Chris' example of curbside is absolutely spot on. Or maybe you're entering the restaurant and you've got a family with you and you just want to dwell a little more on the kiosk and take some time ordering, it's just a much more enjoyable experience. So I guess this is allowing the customer to have that range of choices and then they can therefore, if you like, self select the way they experience McDonald's. And as I say, where we are more advanced in the rollout of Experience of the Future, the customer satisfaction is noticeably higher. And Chris is already beginning to see that in the U. S, which is encouraging. But again, not surprising. We're confident in the plans we have. Our next question comes from Jeff Farmer with Wells Fargo. Jeff? Thank you. Just following up on value quickly. So on recent calls, you noted that a few of the 22 U. S. Regions have already been more aggressively pursuing. I think it was the McPick options in combinations of dollar $2 beverages. So I'm just curious how those 3 to 4 regions have performed on a same store sales basis relative to the rest of the system? And if that magnitude of outperformance can sort of tell us anything about or potentially what we could be seeing from value as we get into 2018? Yes. I think, as you know, with McPick, certainly this year, there was a heavy local element to it. So we had different regions pursuing different MCPick strategies, both the price points that they would hit, but frankly also the items that they would be selling for. And so it's difficult to do the comparison that you're talking about because it's not just what item at what price point, but it's also where was the starting price point for that. In general, I think the point that you're making though is an accurate one, which is we think that we still have had an opportunity to get more competitive on value. Again, we're not trying to win on value, but we can't lose on value. And so I think what you're going to be seeing from us going forward is really for us consistently to stay competitive on value. And I think the other thing, as I mentioned earlier in the call, is more of that investment now going forward is going to be done and driven at the national level than at the local level, which I think plays to our strength from a marketing communication standpoint where we can really drive that message. Our next question is from Will Slabaugh with Stephens. Will? Yes. Thanks, guys. I had a question on the U. S. Franchisee base. It seems there's been a fairly aggressive push to both improve as you referenced earlier and then naturally consolidate that franchisee base as a result of some meaningful investments required to get to an EOTF format or otherwise. So can you give us an update on how you're thinking about the current domestic franchisee base and how that may change over the coming years as some of this consolidation likely occurs? Sure. Well, so one, I think being relatively new to McDonald's, I'd say one of the things that has really been a highlight for me is getting to know our U. S. Owner operators. And I'd tell you there, it's in a very impressive group in terms of what they're able to drive. And so you're seeing that in the results here. Our point of view and certainly all of my discussions with the owner operators in the U. S. Has been, I would love for every single one of them who's currently in the system today to remain in the system. And so there is no, from our vantage point, concerted effort to try to change the franchisee base or have it look different. But that said, we do have expectations around performance. And as you said, as we said earlier, running better restaurants is the foundation. And we were not consistently running the type of restaurants in the U. S. That we were expecting to. And so step 1 has been, we have really level set what the standard is for performance in the U. S. At the same time, we've outlined a pretty what we think is exciting and ambitious growth plan, but it is one that's going to require investment. And so as you put those 2 together, as you put together a performance expectation along with an investment expectation, we are seeing some owner operators are deciding now is a good time to exit the system. And I think for us, while we certainly are sorry to see folks go, we would rather have that conversation where we're all operating from just a very transparent set of expectations. So I think over the next couple of years, we're probably going to continue to see some evolution of this. But by and large, I think the U. S. Franchise system as you see it today is going to be the same one that we're going to be talking about in a few years. Next question is from Alton Stump with Longbow Research. Alton? Thank you and good morning. If you go back to delivery, it's not just over early on with the roll here in U. S. But can you just walk through kind of what you're finding as to if there's any certain categories, whether it's casual or if it's pizza or otherwise that you guys think you're gaining share from as a result of the rollout delivery? Delivery is already a significant market and I guess the reason we've addressed this with such urgency is apart from in certain Asian and Middle Eastern markets, we just weren't participating. And given societal trends, given consumer trends, we currently see it growing. So for us we were a little late to enter, but I think we've entered with more muscle and intense than probably most other competitors could possibly match. I mean, you may have heard me say before, but across our top 5 or 6 markets around the world, 75% of our customers live within 3 miles of McDonald's. So frankly, there is no other restaurant business on the planet that's closer to more of the global population than we are. And we think that therefore that lends itself really well to not just visiting their local McDonald's, but also having delivery from their local McDonald's. What are the sort of trends that we're seeing? We're certainly seeing it appeal to the younger consumer. We're seeing some great results around college towns. As I say from a daypart perspective, we see SKUs likely later, so into evenings and overnights. There tends to be more group orders. So we see the average check somewhere between 1.5 to 2 times, a typical average check-in a restaurant. So I think it's really is beginning to clearly demonstrate to us that this is an incremental business for us. It's an incremental revenue stream for us. But we're learning with every day and every week and every market we bring on board, each market we bring on board now is just a little wiser than the previous one because we're building up the experience and knowledge. And we've also got an opportunity ahead of us that we've yet to be innovating around packaging, innovating around bundling different menu items and other potential business opportunities further down the line. I think our view was, let's get into the game, let's show our intent, let's learn really quickly and then we'll continue this kind of progress over perfection mentality where we can fine tune as time goes on. But it's encouraging to us. And as I say, you can expect us to move from about 8,500 restaurants today to probably north of 10,000 by the end of this year and expect to see the trend continue. Our next question is from Matt DiFrisco with Guggenheim. Matt? Thank you. I just have a follow-up question with respect to the margin comment in the U. S. I'm just curious as far as I look at digital and I look at the experience of the future, it seems like the some international markets and regions have been a little bit faster to roll it out yet. We didn't see that type of margin pressure or labor pressure. Can you talk about the dynamics in the U. S. That are now manifesting sort of this labor pressure? Is it with things that are already introduced into the store? Or is this a market that you have to invest in front of the curve where it's waiting then for the same store sales leverage to flow through beyond sort of the 6 to 9 month period that you said you're going to experience labor leverage? Yes, Matt. I'll start and then Chris can add more texture again back to the U. S. But I guess one thing that's just fair to call out is when we went to the new segment structure, we did so because we wanted to increase the transparency and accountability of what's driving our business. So when we look, for example, at the international lead markets, not all 5 markets rolled out at the same time. So therefore, if 1 or 2 markets was feeling a little more margin pressure because they were at the front end, there was a couple of markets that hadn't really embarked on it who still had strong margins. So as you can see that kind of impact got blended into a 5 markets segment results. Here clearly with the U. S, it's a segment of its own and therefore there's no other market to blend it into. But part of the way we're looking to manage this business is and we've said our geographic spread is one of our, we believe, competitive advantages of us as a business. We can have certain markets do some of the heavy lifting while some are investing through this cycle. And ultimately, we are running this business for the long term. And if there's a shorter term impact, we are I would like to think we've demonstrated ourselves as being fiscally responsible as leaders of this business. But if that's the investments required to get the job done properly, that's what we're going to keep doing. But Chris, if there's anything more you want to add? Yes. I think just to maybe give a concrete example, I mean, as we've laid out 2018, we have a number of initiatives that are going to be hitting the market in 2018. One of the biggest ones, the first one that's going to be coming out is, we call it hot off the grill, sometimes referred to as fresh beef. But right now, we're actually bringing on a number of regions onto this platform as we convert over our supply chain. When we bring on hot off the grill or fresh beef into a market, we actually have a 6 week training curriculum that the entire restaurant goes through and it's a very intensive training curriculum that they have to go to actually starting with the operator. The operator first goes through training and then we literally take every single one of those crew members with both an off-site and then an in store training experience. All the time that's spent on training for hot off the grill implementation, all of that counts against your labor and none of it is revenue producing. But it's the sort of thing that we think is required to really make sure that when we do roll off rollout hot off the grill that we execute it at a really high standard. So that's just one example, but we have a number of other initiatives that have the similar type of training and preparation curriculum that's going with it that obviously puts a short term burden on what needs to be done at the restaurant. Next question is from Greg Francfort with Bank of America Merrill Lynch. Greg? Hey, guys. Can you just talk a little bit more about the European consumer? I know we've heard from some of your suppliers and also just generally in the industry strength out of Europe. And I'm wondering what do you think is driving that and maybe how sustainable that is? Yes, thanks Greg. I guess it's a mixed picture and certain of the metrics that we see are somewhat contradictory to a certain degree. I mean, there's depending on which country you're talking, there's a little bit of nervousness in terms of consumer confidence. We're seeing consumer confidence in the UK get a little weaker as the uncertainty over Brexit continues. I think one thing we do see more consistently, which is positive certainly for society and putting money in people's pockets is unemployment is typically declining across all of our major markets. And there's better stability and growing consumer confidence in France and we're seeing the same in Italy as well. Germany continues to be a somewhat more mixed picture. But overall, we're not seeing it as a significant any of these metrics as a significant tailwind, nor do we think we're kind of having to cycle straight into a strong headwind either. I guess the reality for us, our mental approach in every single one of these markets is, let's assume there's only going to be very modest market growth overall. And therefore, let's take the attitude this is a market share fight. And you're going to be either be winning or losing customers. Let's make sure we're on the right end of that battle. Our next question is from Jeff Berenstain with Barclays. Jeff? Great. Thank you very much. I guess Steve or Chris, I mean the U. S. QSR burger category, it seems like the largest players have most recently been sustaining or even accelerating momentum. And I know if you look back over the past decade or so, it has been historically very difficult to maintain that for a sustainable period. So I'm just wondering maybe what you think has changed in QSR or maybe the dynamic that's changed meaningfully or what do you think maybe the share is coming from that's led to this most recent resurgence across broader QSR? And Kevin, could you just clarify what you said earlier just from an accounting standpoint, I want to make sure I understood. You said 20% equity pickup with the China Hong Kong shift. Just want make sure that's going to flow through the equity and earnings line and just how much you might think that's going to be starting this quarter or what we should think of as a run rate? Thanks. I think 3 of us will have a go at that. Jeff, that was a multifaceted. If I give a broader perspective on the way that we're looking to grow our business is, I'm not interested in the comp cycle. And you hear people talk about it and next quarter's comp will depend on what the same comp was a year ago. I think ultimately what we're looking at and we've seen it successful in a couple of our more mature markets is build the platforms of growth that give you long term sustaining growth. So you're not in that short term cycle. You don't get direct into it. So I think there's certainly a and Chris can talk to the QSR entry in the US. But certainly as we build our experience of the future, our digital platforms delivery convert the consumers who are somewhat more casual to our brand. We think that we are building sustaining platforms that are important for us. But Chris, maybe you want to add? Yes. And so I think just to build on that, it is a relatively flat market. But I think what we're seeing is that when you're really sharp with your proposition that you're offering the customer, the food that you're offering at the value that you're doing with the experience, when you've really got a compelling proposition to put forth, you can gain significant share. And so certainly the comp gap that we've been seeing, our comp gap has been widening over the last three quarters. And I'm very excited about what we've got in the pipeline going forward. I think as I said at the opening on my comments, the absolute key for us is going to be to execute. But I think if we execute, and again, we stay really sharp with the proposition that we're offering customers, I don't see any reason why we couldn't sustain that performance, but it's on us to demonstrate it. And then Jeff, regarding your question on kind of China, Hong Kong going forward, It will be accounted for similar to how we account for Japan today, which is we'll get a royalty up in franchise revenues and then we'll pick up 20% of their net earnings down in the line called equity and earnings of unconsolidated fillets within our other operating income. So that's what it will be beginning, I guess, a little bit beginning this quarter, but really beginning more next quarter. And then regarding size of it, I guess, what I would remind you of is, remember that China and Hong Kong in total were less than 5% of our consolidated operating income. So we have time for one more question, and that will be David Tarantino with Baird. David? Hi, good morning. My question is on your digital strategy. And Chris, maybe you can comment, I think you mentioned that there's a building database of digital users. I wonder if there's any metrics you can share around that and where you expect that to go over time? And then lastly, on the mobile order and pay adoption specifically, I know it's early days, but can you talk about the adoption rates you're seeing in the restaurants you've had at the longest and what you're planning to do to drive adoption as you move through next year? Yes. Well, so I'd say, we are still in the early innings in honor of the World Series, in the early innings of digital, But we're seeing, I think, a really nice start to it. We've had almost 30,000,000 downloads. I would say we're roughly 9,000,000 active users, meaning who are in it on a monthly basis that we're seeing there. And we're seeing strong offer momentum, which is really currently the primary benefit that we're delivering through the app. As we're rolling out now mobile order pay, the power is going to be to then bring together the offer with the ability to do mobile order pay. Right now, what we're doing mostly in our restaurants with the rollout of mobile order pay is we're really at this point focused on getting the operations right. So getting, for example, the crew to understand when a curbside order comes up, how do they take that order, how do they go out and bring the food to the customer. So right now, I'd say we're spending a lot of time on mobile order pay, yes, as we're deploying it, but really make sure we've got the operational muscle there because what will happen then in 2018 is we're going to flip the marketing switch on it and start to drive really much more increased usage. But certainly, we've learned from some of the other activity out there. We want to make sure that we're ready when we do flip on the marketing switch that we're ready to handle the business with it. But still early innings. We do think that it's a significant opportunity for us, and we would expect in the future it becomes a more significant part of the comp. So we've reached the top of the hour and now I'd like to turn it over to Steve who has a few closing remarks. Yeah, very briefly. Our Velocity Growth strategy is working and you can see the proof in our performance. Even as we've made a lot of progress, we know we still have a lot more to do. We'll continue focusing our energy on aligning our entire organization around disciplined execution that will allow us to deliver on the full potential of our plan. Thank you. This Thank you. This concludes McDonald's Corporation Investor Conference Call. You are now free to disconnect.