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McDonald’s Corporation (NYSE:MCD) Evercore ISI Virtual Consumer & Retail Summit Conference June 16, 2020 11:00 AM ET

Company Participants

Chris Kempczinski – President and CEO

Kevin Ozan – CFO

Conference Call Participants

David Palmer – Evercore ISI

David Palmer

Good morning. David Palmer, Evercore ISI’s Food and Restaurant Analyst. I’m here today joined by our friends in McDonald’s. It’s our pleasure and honor to introduce Chris Kempczinski, President and CEO; and Kevin Ozan, Chief Financial Officer of the Firm.

Chris joined McDonald’s in 2015, overseeing global strategy and business development and innovation. He took over as CEO this last November. Before joining McDonald’s, Chris had senior positions at other leading companies such as Kraft, PepsiCo and BCG. Kevin has been at McDonald’s for over 20 years, rising through the ranks in the financial area of the firm. Thank you very much for being here, guys.

Kevin Ozan

Thanks for having us.

Chris Kempczinski

Thanks, David.

David Palmer

Just a few months ago, the McDonald’s 2020 story was supposed to be about the U.S. catching up to the Rest of the World in terms of its execution and growth. And obviously, it’s been a heck of a curveball throwing at you with the pandemic and it feels like the U.S. has been leading that reopen lately.

So perhaps you can reflect on what it was like when you are taking over as CEO, six or seven months ago and comment on the business as you see it today priorities during the COVID period, but just as importantly, I want to understand how you’re thinking about the set up for your business coming out it. Thanks.

Chris Kempczinski

Yes, no problem. Well, as you know, it’s been an interesting six or seven months in the role. And unfortunate in the sense that when we – when I came into this position, the business was performing at a high level. We were globally, I think, across almost every major market gaining share, we were in a situation where our franchisees were very healthy from a cash flow standpoint, where we had maybe an opportunity with around guest counts in the U.S. and so I was excited to see sort of our beginning of the year in 2020 because we got off to a very strong start in the U.S., particularly around guest counts. Yes, there were some weather and some other benefit of leap year, but overall we were in really good shape, heading into the year.

And then, as you noted, the pandemic struck and we had to do a quick audible in basically every single market where we operated. Our system, I thought did a remarkable job of pivoting, getting our restaurants either changed operationally in many cases going to drive-through and delivery-only, in other cases shutting them down. And we’re now through that phase and you’re seeing more and more going to the opening 95% of our restaurants today are open.

And so for us it’s now about accelerating the recovery and that’s why, about a month or so ago we announced a significant investment we were going to be making with our franchisees to go drive the marketing side of the ledger, and we’re going to now start the dine-in reopening, we’ve got about 1,000 dine-ins open in the U.S. and that will continue to grow over time. So it’s really about now just getting the momentum back that we had coming into the business.

David Palmer

Thanks for your update this morning. And it looks like the reopening process is really progressing. I’d love to dig into that. How you see the difference between the U.S., Europe and elsewhere? It looks like in terms of the sales rebuild rough numbers, the same-store sales have been approaching flat in certain markets and for those units that are reopening so fairly strong openings. I’d love to dig into what you’re seeing on the reopen by format and by market. So any comments there?

Chris Kempczinski

Yes. So in terms of reopening, like I said about 1,000 in the U.S., it’s happening in a I’d say pretty measured way in Europe. We’re still largely closed on dine-in Europe, but that will grow over time. I think, what we do see is when you do open the dine-in, you do get an incremental bump from that.

So there’s clearly, for us, I think, an incentive and a motivation to get the dine-ins open when we can do it in a safe and prudent way, but it’s going to be a slow sort of staging on that one. And a lot of it’s affected by what’s happening locally with government regulations, but also it’s around franchisee feeling comfortable.

And I should note, by the way, if you’re hearing this banging, a crazy situation where we have a window washer now outside of our office here. We had thought we had adjusted for every possible contingency. We did not check-in the window washing schedule. So I apologize for that, but he’s making good progress, and we probably only have a couple more minutes here.

David Palmer

Yes. That’s good. I mean, one of the things I was really worried about at least bracing for impact on your update today was really that the fact that you have a bigger part of your business that’s walk-in, in Europe, for example, even where you have drive-through, you might have half the business in those units that’s walk-in. So could you talk to those numbers? I mean, what the rebuild has been like in those months

Chris Kempczinski

Yes. Well, I think it’s still important to recognize 75% of our restaurants have drive-through. And between drive-through and delivery, you can get pretty significant numbers in terms of just percent of the mix. As you know, there are some markets in Europe that have a lower drive-through penetration, U.K. is an example of one of our markets that has a lower drive-through penetration.

But I think, so far what we’ve seen is the demand is there. And for us, that’s probably the most important thing, which is just – is there consumer demand for our restaurants, for our product. And so long as that’s the case, then we can figure out sort of the other elements in terms of when we can get the dine-in open. But like I said, I think, that’s going to be a slower stage process particularly in Europe.

David Palmer

Yes, I was going to touch on that by market. You touched on Australia in your update today, is being one of those markets that was doing relatively well. As you think through this COVID period, which markets have impressed you with their resilience, perhaps Australia would be one, but which ones also are concerning you about their lack of resilience or you’re worried about little bit more of a COVID-related or maybe economic-related hangover from this pandemic.

Chris Kempczinski

Yes. Well, let me toss that to Kevin. I’ll get him in on the action a little bit here.

Kevin Ozan

Yes, it’s a good question, because things are very different market to market around the world in so many different ways, in terms of government assistance, in terms of consumer psyche, in terms of re-opening dates and plan. So it is difficult to go say that there is one way that things are working around the world.

To your point, Australia has probably been one of the stronger markets certainly as they remained open similar to the U.S., they’ve seen big increases in drive-through business and they’ve been kind of consistently remaining positive comp sales. Japan would be one of the other ones that has been strong and has remained positive comp sales through this. China, I think is an interesting country. It’s up and down.

As you’ve seen, some cities are getting kind of a second wave of COVID and are shutting down and reopening. So we’ve seen that before, we’re seeing that now with Beijing most recently. So China has been a little bit more up and down, I’d say than some of the other markets.

In Europe, in general, I feel pretty good about most of those markets as they’ve reopened. Germany, I think, is the one that’s probably remained open through this and part of the reason is because our dine-in business is lower there, we haven’t seen as kind of robust coming back as some of the other markets. I think consumers are a little bit more anxious to go out a lot and so you’re not seeing consumers out as much in Germany as you may be seeing in some of the other countries.

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David Palmer

The fact that you’re 90%-plus open in these markets even Europe now with U.K. coming on board lately, it does feel like maybe some of the worst scenarios in terms of financial health and financial bailouts for a lack of a better word might be off the table, but what are the ranges of things that you’re doing for franchisees out there? Obviously you have some general stuff, but what are some of the extremes?

Kevin Ozan

Yes, I mean, as you know, we talked about on our first quarter call, the most immediate thing we did right away was defer some rent and rent and royalties, because we needed to provide some immediate liquidity both to conventional franchisees and our developmental license partners. That was important just to provide them with some certainty, because to your point, a lot of the markets immediately shut down, so they weren’t operating restaurants.

What you do have though is a wide range by country in government assistance programs and social programs that help the companies and their employees when there are closures. So a lot of the markets in Europe even when they closed, the employees at least were receiving a high percentage of their normal pay from government and social assistance programs.

So there wasn’t the same level of concern for how employees were going to survive as there may have been even in the U.S. at the beginning. So in a lot of those European markets, our businesses have been able to withstand a couple of months of closures and not have severe financial impacts.

What we do have is we have more individual circumstances either where we’ve had some franchisees that may be took on some additional leverage in the last couple of years as they’ve done a whole bunch of experience of the future projects, maybe purchased some restaurants, so you do have individual circumstances where individual franchisees are potentially highly leveraged that we need to step in and help in some of those individual circumstances.

And the other one that we’ve noted in the release is as reopens start occurring depending on a franchisees portfolio of restaurants, they may have an inordinate number of their restaurants in travel centers and travel locations, in malls, in areas that aren’t coming back as quickly.

And so it’s possible that someone who has a different portfolio of restaurants than someone who has got a lot of freestanding drive-through, we need to help out in those specific circumstances. So it’s really more targeted now. We talked about assistance now being much more targeted or is it the beginning, it was broad based now it’s targeted in temporary to help out individual circumstances, either in specific countries or specific franchisees.

David Palmer

And I wanted to dig a little bit back into the U.S. on the reopening. Obviously, you’re seeing certain states reopen earlier than others and you mentioned there is a thousand dining rooms out of your base in the U.S. that have been opened as well. So those are two different things. There is the reopening of the economy and then there is reopening of a part of your format. Could you talk about the two impacts and what that could mean for sales going forward?

Chris Kempczinski

Sure. So when we’re reopening the restaurant or markets are reopening, I think, one of the things we’re spending a lot of time on both from a customer standpoint, but also from a crew standpoint is really around safety. And so, we’ve introduced, there was some commentary about a month or so ago but we introduced a whole bunch of operational changes into the restaurant to ensure social distancing, protective barriers, different cleaning procedures, positioning guides, et cetera.

I think that – we worked our way through most of that now where I think the training has happened and we’ve been able to stand up those operational adjustments. I think what we’re now looking at is while us and the rest of the industry, the comp sales numbers are encouraging and that they’re getting – you’re showing a real improvement there, the traffic numbers in the industry are still down. They’re still down mid-teens and I think for us, we’re not going to be feeling like we are truly back to sort of a business as usual until we see those traffic numbers get much closer to where we were in pre-COVID.

And I think realistically that may take some time for that to happen. And so, it’s about how do we stimulate demand, which is what we’re talking about in the marketing side, get people more comfortable coming out to our restaurants, because they know we have the safety procedures in place and then hopefully, giving them a great experience, so that they’re willing to come back.

David Palmer

You – I can’t help but think about breakfast when you make that comment, because to some degree, while it was somewhat expected, the type of numbers you’re talking about in the U.S., I am reminded of how much breakfast might be holding you back. I mean, that is a daypart that’s been particularly hard hit. So I’m sure that’s on your mind as you think about the rebuild and I think you’ve held back on marketing during this crisis somewhat. Could you talk about the pace that you cannot exert yourself and perhaps cokes along the recovery?

Chris Kempczinski

Right. We’ve talked about from the beginning of this that we thought breakfast was going to be the most challenged daypart, and that was informed by all of our experience in the future remodels where we shut down restaurants and then we’ve reopened restaurants and breakfast is a habitual daypart once you disrupt that routine, it takes time to sort of rebuild it.

So as we went through the pandemic, we absolutely and we talked about it on our Q1 call about how we thought breakfast was going to be a pretty challenged daypart part. You’re right that as the pandemic struck particularly in the U.S. we pulled back from essentially all marketing activities in breakfast. It just was going to be a pretty low ROI, because we knew there weren’t going to be many people out there looking to go get breakfast.

So we are now, I think, just starting to turn the lights back on in terms of going after our breakfast business. But when you’re looking at daypart numbers at breakfast, it still is down industry-wide, the most of the three sort of major dayparts this is going to be one where I think it might vary a little bit market by market.

And so as opposed to it being a broad scale, national push that we do on breakfast, I think it’s probably going to first start regionally based on just people returning to patterns, but we’ve got a great breakfast business and we know a lot of people are interested in going after the breakfast business and as we said previously, we intend to defend it. So, I think, it is just making sure we’re doing it in a prudent way. We need to have customers out there looking for breakfast as a big part of it.

Kevin Ozan

And just as a perspective, in the U.S. right now, the breakfast daypart is more than half of our comp sales decline. Lunch and dinner are relatively flat, breakfast is obviously driving the overall comp negative.

Chris Kempczinski

Yes.

David Palmer

One thing I also wonder about is, what you’ve seen in drive-through versus without dining rooms, my perception is your franchisees are probably making money because they have less labor and you might be discovering how you might be able to do things better in the future just by seeing what you’re seeing with the drive-through, but could you talk – obviously, you’ve also streamlined the menu too. How has this COVID period perhaps instructed you about how you could do things differently or better and then perhaps what have you missed by having these dining rooms and lack of full menu?

Chris Kempczinski

I was talking to a franchisee yesterday, who is down in Alabama and he was telling me, one of the big revelations that he and his team have had coming through this is, they thought that they were running pretty close to capacity at drive-through and they found actually they’ve got a whole another level of capacity that they can get to around just focusing on some of the operational elements of this. And so, he said, it’s expanded our view of what’s possible through the drive-through.

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That said, I think, we’re going to make sure that over time in a prudent way, we’re meeting with customers who are looking for. And so limited menu served a purpose for a period of time, but we have to be also attentive to what the customers are looking for when they come to a McDonald’s.

And I think it’s going to vary market by market, it will vary country by country, but we will certainly add things back to the menu whether it goes all the way back to where we were pre-COVID, I think that’s probably unlikely, but I think it’s equally unlikely that we’re going to stay with the current menu, because ultimately the customers looking for a broader variety of menu items than what we currently have and we’ll be ready to meet that.

David Palmer

It did seem like you were doing some good things on speed of service even ahead of this. So perhaps there you’re showing yourself something in terms of that speed of service to the drive-through by pushing that much through it.

Chris Kempczinski

Yes. We’ve taken off another 25 seconds in the U.S. off drive-through times through the pandemic, which is to me it pretty impressive because it’s the only service channel that’s open right now, but it gets back to that point we’re learning what’s possible and maybe conventional wisdom of how much you could really do from a capacity standpoint, I think we’ve learned some things about that through this crisis.

David Palmer

And McDonald’s is already doing pretty well in terms of market share trends around the world before this. Frankly, we don’t know how the informal eating out market is doing outside the U.S. as well as you would know. Could you give us a sense of how you see the competitive landscape playing out and for example, would you be gaining shares rapidly in these other markets as you are in the U.S. and perhaps gain share out of the COVID period, even more than you would pre-COVID, would be interesting to hear about the competitive environment.

Kevin Ozan

Some of these markets are going to be difficult, because they literally have opened in the last month. And so, market share is even an odd concept when you had two months in general of a lot of closings in a lot of these markets.

Having said that, I think what we may see – what we are probably seeing in certain markets, you have some smaller local players that I’ll say you find this a little more challenging than some of us. And so, I don’t know that everybody similar to potential even in the U.S. that everybody is going to be able to reopen and thrive post-COVID.

In the U.S., there was probably a little bit more of an over-supply, I don’t know that we had as much of that issue internationally, But I do think some of the local players that had a close and only have a couple of units potentially, will have a little bit tougher time than the companies that have obviously broader scale and bigger scale in the markets to be able to operate.

So there potentially could be some opportunities from a competitive standpoint for us to expand our footprint, grow a little bit more in some of these countries, et cetera. So we are keeping our eye, because each country, it does have a little bit different competitive and recovery landscape.

Chris Kempczinski

Yes, I think, no surprise; the greater your exposure to dine-in and the lower your drive-through development from a competitor standpoint, the more challenged you’re going to be. And certainly with an IEO, the dine-in casual dine sector, I think, is going to be in at least the short to medium term under a lot of pressure. And if you don’t have a very well-developed drive-through component, I think that’s also going to be a challenged sector for a period of time here.

David Palmer

Ahead of this fireside, we’ve reached out to clients about their top questions and one of them was, when we covered which was international franchisee health, I think that was a concern. The other question we got quite a bit was around cash back to shareholders in the form of dividend. Are you remaining committed to that dividend and when can you possibly return to share buybacks?

Kevin Ozan

Yes. So I’d say our first couple or top priorities related to capital allocation haven’t changed, which are, first priority is to invest in the business for growth, that’s capital, that’s in these periods when things first happen, that’s providing some near-term assistance to franchisees that’s everything investing in the business to keep it running efficiently and growing.

Second is dividends. We’ve paid dividends for the last 40-plus years. We know that a lot of our investors highly value dividends. We have a higher percentage of retail shareholders and a lot of companies, we know those folks specifically count on those dividends. So dividends are important and those continue to be the second priority.

After that what will likely change or what is changing for the near-term is, we have historically or certainly the last few years been at 3 to 3.5 times EBITDA from a leverage ratio standpoint, depending on which rating agency’s method of calculation you use. That’s elevated right now for two reasons.

One, in March, we went out and took out some additional debt in order to make sure that we were well capitalized going into this pandemic. And second, obviously our EBITDA is down this year, that’s not a great combination for debt to be up and EBITDA to be down.

And so, in the near-term, after investing in the business and paying dividends, we will look to reduce our debt to get back to kind of our pre-COVID debt ratio levels, which means that in the near-term we likely will not be buying back stock, because we’ll use that excess cash to pay down debt in the near-term, that’d be the one difference I’ll say versus where we’ve been the last few years.

Chris Kempczinski

And the only thing I would add on that is just I think thank God we had the leverage ratio that we did through this. Kevin and the team were certainly getting pressured, why not push their leverage ratios up the industry had higher leverage, thank God we did because it gave us the degree of maneuvering ability that we needed to support the business, support the franchisees and still meet the expectations of shareholders through it. So Kevin oftentimes doesn’t like to say, I told you so, but he is feeling a little bit of, I told you so on this one.

Kevin Ozan

No, I do think I do think these last few months though remind us of why it’s important to be financially strong. I’ll leave it at that, but it is – we’ve always thought it’s important. It’s just been a good reminder of why it’s important.

David Palmer

That was Kevin just saying, I told you so right there. So one of the related questions is about the franchisees spending on capital projects, the reimaging where there is a tail-end of that. And obviously, people want to get back to want to see the system getting back to unit growth, what are the prospects there?

Kevin Ozan

Yes. So we, in the first quarter – in our first quarter call we talked about expecting capital to be down about $1 billion this year and that’s because we kind of stopped two things both experience of the future projects, which were primarily in the U.S. and a lot of the new unit expansion going on, which was more outside the U.S., and that’s because obviously a lot of those markets outside the U.S. were essentially shut down. There wasn’t construction going on, we weren’t operating our restaurants, franchisees certainly weren’t going to go immediately invest in new restaurants.

The plus of what we are seeing actually right now is in the U.S. more so that the franchisees are – several franchisees are looking to start up again the experience of the future projects, which to me is a very positive sign of them wanting to invest in the business.

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So that billion dollars that we thought we were going to save may be a little bit less than that right now, because we have more franchisees coming forward that still want to get their experience of the future projects done.

So we won’t save as much capital probably as I have thought three months ago. But I actually view that as a positive, because the reason we won’t save as much is because franchisees are looking to go back and start reinvesting in the business again. That to me is a good sign of the health of the business, the health of the franchisees and their views on the future of the business.

Chris Kempczinski

The only thing I would add on that is, I think we’re really in a good position coming into this crisis, and that the majority of our system was remodeled, has been remodeled. And so I would hate to be embarking on it, a major remodeling coming out of the crisis, I’m much happier that we’re almost done and we’re talking about dealing with maybe a couple of thousand restaurants left in the entire system around remodeling. So that gives us I think just a lot more flexibility going forward.

Kevin Ozan

And on a new unit expansion, I mean we took a pause this year, but there is still a lot of opportunity, again primarily outside the U.S., but there is a lot of opportunity to grow units in our major markets and we expect to get back to kind of a normal rhythm in 2021.

David Palmer

Chris, I want to talk about digital. You were key architect of that strategy for McDonald’s and there’s some other concepts out there that didn’t have drive-throughs that had really the gun to their heads expand their digital ordering more perhaps by the consumer, but how is this maybe helped your digital mix, how is it helped you think about the digital opportunity going forward and what are the plans for McDonald’s there?

Chris Kempczinski

We’ve certainly seen digital increase through this crisis. We’re seeing mobile order pay increase, we’re seeing more curbside usage. And I think you hit on a good point there, which is, there is a little bit of an inverse correlation, I think, between digital usage and drive-through penetration.

So in markets where we have less drive-through penetration like China for example, you see really high digital usage. Similarly, you could say in the U.K., you see higher digital usage; Japan, higher digital usage.

So, when you get back to what’s the value of digital, it’s about a convenience benefit in many cases. Certainly there is a value benefit comes sometimes with the digital offerings, but it’s really about solving customers need for convenience. And so, I think coming out of this part of what we need to do and you’ve mentioned this in the past and I agree with you on this.

Right now, what we’re doing in digital is, I think we’re doing all the things you would expect us to do, but I don’t know if we’ve turned it into yet a differentiated capability for us. And that’s a thing I’m keen to work with the team on coming out of this is how do we really build some differentiation into it. Loyalty is an area that always gets talked about a fair bit. The trick with loyalty is we just – it can’t impede the speed of the drive-throughs.

And so, how do you design a loyalty program that is improving the customer experience and not slowing down the customer experience, and we’ve got loyalty in several markets, we’re testing it also in other markets. I do expect we’re going to have a loyalty program that’s expanded to all of our major markets, but we haven’t laid it exactly what that configuration looks like yet.

David Palmer

All right. Ahead of this virus, the U.S. is really humming along and actually traffic was doing very well too. And so, perhaps you have a comment on why you think your traffic was finally positive, which was certainly a targeted thing for you, but also there is some plans for this year when you get back to doing the plan, whether that’s breakfast, chicken and other.

Chris Kempczinski

Yes. So coming into the year, you’re right we were seeing traffic numbers that were pretty strong and I think what I was encouraged by with that is, it was pretty broad based. So, you didn’t isolate, it wasn’t like there was just a menu idea that was driving it, where it was just a value program, it was everything from speed of service improvements to menu news to value, et cetera, pretty broad base which was given us confidence about sustainability or durability.

You talk about now coming out of this, we had some other plans that were in place in the U.S., this is going to be up to Joe Erlinger, our U.S. President, working with the local owner operators there to figure out the right time to get to do this. So for example, chicken when you get after chicken, we put those plans on the shelf until we had more visibility.

I know they’re having conversations about, we certainly believe there is a big opportunity for us in chicken, when is the right time to go after that. We had some news that we were going to do around baked goods at breakfast, we put that on halt when you bring those ideas in.

So I’d say all of these are live conversations that are going on right now. Part of what the U.S. is also thinking about and talking about is, they now have a significantly bigger war chest because of our financial investment that we’ve made around increased marketing. So where do they really want to go heavy and more to come on that. But, as I’m sure you know, the conversations are going on right now.

David Palmer

Yes, I guess, when we are thinking about your sales, you mentioned that point about the traffic being down perhaps breakfast being a part of that and – but yet you’ve had these monster check increases that have been probably family orders. I guess what we’re wondering from now on is can you hold on to the good stuff that you’ve gotten in terms of those bulk orders.

And this may be the sub-urban order that’s happening. And can you benefit with reopening those dining rooms and hold on, is there any part of this stuff that’s been – can be sticky, you can hold on to the good stuff as you rebuild that commuter stuff, how are you thinking about the stickiness of some of those things you’ve gotten as the reopen happens?

Chris Kempczinski

Right. Certainly, I think there – so it’s really about are the consumer behaviors, enduring behaviors or are they just kind of a moment in time. I think as we think about COVID, there are certainly going to be parts of it that I think are going to be more enduring, so consumer’s orientation to more take-away less dine-in more eating at home, I think those are enduring changes to customer behavior.

And so I do think that that lends itself to what you’re talking about family size order larger check types of orders, I think that will stick to the – maybe not at the same level, but I think that’s going to be something that does continue. The question will just be fast-forward three years from now, four years from now as things hopefully get back to sort of business as usual, the consumers revert all the way back to where they were pre-COVID, that’s for us the $64,000 question.

But I think as we look at over the next couple of years, we think that because COVID is still in our view going to be around in a factor in people’s thinking many of the changes that you’re seeing right now are going to be certainly enduring through the short to medium term.

David Palmer

We run out of time, guys. But it’s been a great chat. Thank you very much and all the best until we chat at the quarter. Thank you.

Chris Kempczinski

All right. Thanks, David.

Kevin Ozan

Thanks, David.

Question-and-Answer Session

Q –