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| MCD > SEC Filings for MCD > Form 10-K on 25-Feb-2009 | All Recent SEC Filings |
25-Feb-2009
Annual Report
OVERVIEW
Description of the business
The Company franchises and operates McDonald's restaurants. Of the 31,967 restaurants in 118 countries at year-end 2008, 25,465 were operated by franchisees (including 18,402 operated by conventional franchisees, 2,926 operated by developmental licensees and 4,137 operated by foreign affiliated markets (affiliates)-primarily in Japan) and 6,502 were operated by the Company. Under our conventional franchise arrangement, franchisees provide a portion of the capital required by initially investing in the equipment, signs, seating and dιcor of their restaurant businesses, and by reinvesting in the business over time. The Company owns the land and building or secures long-term leases for both Company-operated and conventional franchised restaurant sites. This maintains long-term occupancy rights, helps control related costs and assists in alignment with franchisees. Under our developmental license arrangement, licensees provide capital for the entire business, including the real estate interest, while the Company has no capital invested. In addition, the Company has an equity investment in a limited number of affiliates that invest in real estate and operate or franchise restaurants within a market.
We view ourselves primarily as a franchisor and continually review our mix of Company-operated and franchised (conventional franchised, developmental licensed and affiliated) restaurants to deliver a great customer experience and drive profitability. In most cases, franchising is the best way to achieve both goals. Although direct restaurant operation is more capital-intensive relative to franchising and results in lower restaurant margins as a percent of revenues, Company-operated restaurants are important to our success in both mature and developing markets. In our Company-operated restaurants, and in collaboration with our franchisees, we further develop and refine operating standards, marketing concepts and product and pricing strategies, so that only those that we believe are most beneficial are introduced Systemwide. In addition, we firmly believe that owning restaurants is paramount to being a credible franchisor and essential to providing Company personnel with restaurant operations experience. Our Company-operated business also helps to facilitate strategic changes in restaurant ownership.
The Company's revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees. Revenues from conventional franchised restaurants include rent and royalties based on a percent of sales along with minimum rent payments, and initial fees. Revenues from restaurants licensed to affiliates and developmental licensees include a royalty based on a percent of sales, and may include initial fees. Fees vary by type of site, amount of Company investment, if any, and local business conditions. These fees, along with occupancy and operating rights, are stipulated in franchise/license agreements that generally have 20-year terms.
The business is managed as distinct geographic segments. Significant reportable segments include the United States (U.S.), Europe, and Asia/Pacific, Middle East and Africa (APMEA). In addition, throughout this report we present "Other Countries & Corporate" that includes operations in Canada and Latin America, as well as Corporate activities. The U.S., Europe and APMEA segments account for 34%, 42% and 18% of total revenues,
respectively. France, Germany and the United Kingdom (U.K.), collectively, account for approximately 55% of Europe's revenues; and Australia, China and Japan (a 50%-owned affiliate accounted for under the equity method), collectively, account for over 50% of APMEA's revenues. These six markets along with the U.S. and Canada are referred to as "major markets" throughout this report and comprise over 70% of total revenues.
The Company continues to focus its management and financial resources on the McDonald's restaurant business as we believe the opportunities for long-term growth remain significant. Accordingly, in second quarter 2008, the Company sold its minority ownership interest in U.K.-based Pret A Manger for $229 million. In connection with the sale, the Company recognized a nonoperating gain. During the third quarter 2007, the Company sold its investment in Boston Market. In 2006, the Company disposed of its investment in Chipotle Mexican Grill (Chipotle) via public stock offerings and a tax-free exchange for McDonald's common stock. As a result of the disposals during 2007 and 2006, both Boston Market's and Chipotle's results of operations and transaction gains have been reflected as discontinued operations for all periods presented.
In analyzing business trends, management considers a variety of performance and financial measures, including comparable sales and comparable guest count growth, Systemwide sales growth, restaurant margins and returns.
Constant currency results exclude the effects of foreign currency translation and are calculated by translating current year results at prior year average exchange rates. Management reviews and analyzes business results in constant currencies and bases certain incentive compensation plans on these results because they believe this better represents the Company's underlying business trends.
Comparable sales and comparable guest counts are key performance indicators used within the retail industry and are indicative of acceptance of the Company's initiatives as well as local economic and consumer trends. Increases or decreases in comparable sales and comparable guest counts represent the percent change in sales and transactions, respectively, from the same period in the prior year for all restaurants in operation at least thirteen months, including those temporarily closed. Comparable sales exclude the impact of currency translation. Some of the reasons restaurants may be temporarily closed include reimaging or remodeling, rebuilding, road construction and natural disasters. McDonald's reports on a calendar basis and therefore the comparability of the same month, quarter and year with the corresponding period of the prior year will be impacted by the mix of days. The number of weekdays, weekend days and timing of holidays in a given timeframe can have a positive or negative impact on comparable sales and guest counts. The Company refers to these impacts as calendar shift/trading day adjustments. These impacts vary geographically due to consumer spending patterns and have the greatest effect on monthly comparable sales and guest counts while the annual impacts are typically minimal. In 2008, there was an incremental full day of sales and guest counts due to the leap year.
Systemwide sales include sales at all restaurants, whether operated by the Company or by franchisees. While sales by franchisees are not recorded as revenues by the Company, management believes the information is important in understanding the Company's financial performance because these sales are the basis on which the Company calculates and
Return on incremental invested capital (ROIIC) is a measure reviewed by management over one-year and three-year time periods to evaluate the overall profitability of the business units, the effectiveness of capital deployed and the future allocation of capital. The return is calculated by dividing the change in operating income plus depreciation and amortization (numerator) by the adjusted cash used for investing activities (denominator), primarily capital expenditures. The calculation assumes a constant average foreign exchange rate over the periods included in the calculation.
Strategic direction and financial performance
The strength of the alignment between the Company, its franchisees and suppliers (collectively referred to as the System) has been key to McDonald's success over the years. This business model enables McDonald's to consistently deliver locally-relevant restaurant experiences to customers and be an integral part of the communities we serve. In addition, it facilitates our ability to identify, implement and scale innovative ideas that meet our customers' changing needs and preferences.
McDonald's customer-centered Plan to Win - which is focused on being better, not just bigger - provides a common framework for our restaurants yet allows for local adaptation. The Plan facilitates the execution of multiple initiatives surrounding the five factors of exceptional customer experiences - people, products, place, price and promotion. Through the execution of these initiatives, we have enhanced the McDonald's experience for customers worldwide, growing sales and guest counts in each of the last five years. This Plan, coupled with financial discipline, has delivered strong results for shareholders.
We have exceeded our long-term, constant currency financial targets of average annual Systemwide sales and revenue growth of 3% to 5%; average annual operating income growth of 6% to 7%; and annual returns on incremental invested capital in the high teens every year since the Plan's implementation in 2003, after adjusting 2007 for the Latin America developmental license transaction. Given the size and scope of our global business, we believe these financial targets are realistic and sustainable, enabling us to focus on those opportunities that best optimize long-term shareholder value.
In 2008, we continued to focus on our key global success factors of branded affordability, menu variety and beverage choice, convenience and daypart expansion, ongoing restaurant reinvestment and operations excellence. Locally-relevant initiatives around each of these success factors resonated with consumers' increasingly busy lifestyles and their growing demand for menu variety, value and simple, enjoyable eating-out experiences. As a result, every area of the world contributed to 2008 global comparable sales and guest counts increasing 6.9% and 3.1%, respectively, despite a challenging economic environment in many countries.
In the U.S., we continued to drive sales higher and increase our share of the informal eating-out market in 2008 due to our ongoing focus on breakfast, chicken, beverages, convenience and branded affordability. We extended our leadership in the breakfast and chicken categories with the launch of the Southern Style Chicken Biscuit for breakfast and Southern Style Chicken Sandwich for the remainder of the day. We profitably built greater visit frequency by leveraging our convenient locations, extended hours, drive-thru service and value-oriented local beverage promotions
that often featured our popular Iced Coffee and Sweet Tea. As part of our multi-year strategy to take advantage of the significant and growing beverage category, we began rolling-out espresso-based hot and cold specialty coffees. At year-end 2008, over 7,000 restaurants were offering the new specialty coffees, and we expect to complete the roll-out in mid-2009. To accommodate the related new equipment as well as enable potential future offerings such as smoothies, frappes and bottled beverages, construction is required in many restaurants. In most cases this construction also involves expanding and optimizing the efficiency of our drive-thru booth, which enables us to better serve even more customers, faster. The Company is investing capital to fund a portion of this construction-related reinvestment for franchised restaurants.
In Europe, we posted record-high comparable sales growth in 2008. Every country contributed to this performance, which was led by France, the U.K., Russia and Germany. This success was driven in part by greater local customer relevance created by our tiered menu approach, featuring an effective combination of premium selections, classic menu favorites, everyday value and popular limited-time food promotions. We also connected with customers throughout the day with new sandwiches such as the Bacon Roll for breakfast in the U.K. and premium M burger in France, Germany and the U.K. We continued upgrading the McDonald's experience by reimaging more than 650 locations, primarily in the U.K. and Germany. In addition, we continued the roll-out of a new kitchen operating system - currently in about 5,000 of our European restaurants - to enhance operational efficiency and support greater menu variety. Open communication and transparency is especially important to European consumers. To build brand trust, we actively communicated the facts about McDonald's as an employer and highlighted the quality and nutrition of our food with the early launch of the Company's new global packaging design.
In APMEA, our momentum continued with nearly every country delivering positive comparable sales, driven by Australia, Japan and China. In addition, aggressive restaurant development in China - where we opened our 1,000th restaurant - contributed to revenue growth. Our performance was driven by strategic initiatives surrounding convenience, breakfast, core menu extensions and value. We further enhanced McDonald's convenience with drive-thru and delivery service, as well as expansion of extended hours to 60% (or about 5,000) of our restaurants in APMEA. We built on the momentum of our breakfast business, currently in 70% of our restaurants in APMEA, by raising customer awareness, trial and visit frequency with relevant marketing and new menu offerings like the egg, tomato and pepper McPuff in China. We also continued to appeal to customers with branded affordability platforms and locally-relevant new product launches such as the premium chicken line in Australia and New Zealand.
Our customer-centered strategies to drive global momentum also consider price and product mix as a means to enhance restaurant profitability. This approach is complemented by a focus on optimizing restaurant operations and effectively managing food and paper costs by leveraging our scale, supply chain infrastructure and risk management strategies. As a result, amid a volatile commodity environment, McDonald's delivered consolidated Company-operated restaurant margins of 17.6% - its highest in nine years.
Strong sales and margin performance positively impacted growth in cash from operations, which rose $1 billion to $5.9 billion in 2008. Our substantial cash flow, strong credit rating and continued access to credit provides us significant flexibility to
fund capital expenditures and debt repayments as well as return cash to shareholders.
In 2008, capital expenditures of $2.1 billion were primarily used to open 995 restaurants (590 net, after 405 closings) and reimage 1,450 locations. In addition, we believe strongly in returning cash to shareholders via dividends and share repurchases. In 2008, we returned $5.8 billion to shareholders, consisting of $1.8 billion in dividends and $4.0 billion in share repurchases. This brings total cash returned to $11.5 billion under our 2007-2009 $15 billion to $17 billion target. We are confident we will achieve this cash return target given the ongoing strength and stability of cash from operations and our continued evolution toward a more heavily franchised, less capital-intensive business model.
We believe locally-owned and operated restaurants are at the core of our competitive advantage, making us not just a global brand but also a locally relevant one. In addition, an optimized mix of franchised and Company-operated restaurants helps to maximize brand performance and further enhance the reliability of our cash flow and returns. To that end, in August 2007, the Company completed the sale of its businesses in Brazil, Argentina, Mexico, Puerto Rico, Venezuela and 13 other countries in Latin America and the Caribbean, which totaled 1,571 restaurants, to a developmental licensee organization. Under the new ownership structure, the Company receives royalties in these markets instead of a combination of Company-operated sales and franchised rents and royalties.
In addition, in 2007 we set a three-year target to refranchise 1,000 to 1,500 existing Company-operated restaurants between 2008 and 2010, primarily in our major markets. In 2008, we refranchised about 675 restaurants, increasing the percent of franchised restaurants worldwide to 80% from 78% at year-end 2007. This transition to a greater percentage of franchised restaurants is expected to affect consolidated financial statements as follows:
A negative impact on consolidated revenues as Company-operated sales shift to franchised sales where we receive rent and/or royalties, along with initial fees.
A decrease in Company-operated margin dollars and an increase in franchised margin dollars, while margin percentages will vary based on sales and cost structures of refranchised restaurants.
Fluctuations in Other Operating (Income) Expense due to gains and/or losses resulting from sales of restaurants.
An increase in combined operating margin percent.
An increase in return on average assets due primarily to a decrease in average asset balances.
Highlights from the year included:
Comparable sales grew 6.9% and guest counts rose 3.1%, building on 2007 increases of 6.8% and 3.8%, respectively.
Systemwide sales increased 11% (9% in constant currencies).
Company-operated margins improved to 17.6% and franchised margins improved to 82.3%.
Net income per share from continuing operations was $3.76, an increase of 16% after adjusting for the impact of the 2007 Latin America transaction.
Cash provided by operations totaled $5.9 billion and capital expenditures totaled $2.1 billion.
Returned $5.8 billion to shareholders through shares repurchased and dividends paid, including a 33% increase in the quarterly cash dividend to $0.50 per share for the fourth quarter - bringing our current annual dividend rate to $2.00 per share.
One-year ROIIC was 38.9% and three-year ROIIC was 37.5% for 2008.
Outlook for 2009
We will continue to drive success in 2009 and beyond by remaining focused on being better, not just bigger. We will do so by further enhancing our understanding of consumers' needs and wants; facilitating greater sharing and adoption of best practices and new ideas worldwide; and leveraging a strategic approach to implementing initiatives to drive the best bottom-line impact.
Despite challenging economic conditions, the McDonald's System is energized by our current worldwide momentum. We will continue to build on our strength in five key areas: maintaining the balance between price and value; maximizing the benefit of available capital by improving the relevance and contemporary feel of our existing restaurants; leveraging the equity and unique tastes of core menu favorites like the Big Mac, the Quarter Pounder with Cheese and our world-famous French Fries; continuing our financial discipline and evaluation of success measures to ensure these measures are driving actions that positively impact our restaurants; and furthering operations excellence by focusing on improved execution. As we do so, we are confident we can meet or exceed the long-term constant currency financial targets previously discussed.
In the U.S., our 2009 focus is to continue to build relevance and loyalty by staying connected to customers' needs for menu variety and beverage choice, everyday affordability and convenience. Our initiatives will include reminding customers of the enduring appeal of menu classics such as the Big Mac and encouraging trial of new sandwich and beverage options including specialty coffees. Also in 2009, we will continue to offer value across our menu from the Dollar Menu to our premium products, as well as our classic menu favorites and mid-tier offerings such as our Double Cheeseburger and Snack Wraps. These initiatives combined with the convenience of our locations, optimized drive-thru service, cashless transactions and longer operating hours will reinforce McDonald's position as our customers' preferred place and way to eat.
Our priorities in Europe remain upgrading the customer and employee experience, enhancing local relevance and building brand transparency. In 2009, we will continue upgrading our restaurants' ambiance through reimaging, including adding another 200 McCafes primarily in Germany and France. In addition, we will focus on optimizing our drive-thru service, completing the conversion of our kitchen operating system in most European restaurants and increasing total locations offering extended and 24-hour service. We also will strengthen our local relevance by complementing our tiered menu with new products and a relevant variety of limited-time food events featuring beef, chicken, desserts and coffee selections. In the area of brand transparency, we will remain open and accessible and will continue to inform consumers about our food quality and reputation as an employer.
In APMEA, our goal is to be consumers' first choice when eating out. To achieve this goal, locally-relevant strategies surrounding convenience, breakfast and branded affordability are essential in this diverse and dynamic part of the world. Convenience initiatives include leveraging the success of 24-hour or extended operating hours, offering delivery service and building our drive-thru
traffic. We will also aggressively continue to open new restaurants in China. We will further build our breakfast business in APMEA by increasing the number of locations where it is served, utilizing innovative marketing support and launching new products. At the same time, we will continue to highlight our classic menu favorites and offer locally-relevant extensions of these products. In addition, we are further leveraging a strategic pricing tool to optimize menu prices to drive sales and profits.
In 2009, we will continue to optimize the mix of franchised and Company-operated restaurants and will refranchise restaurants under the previously mentioned target. The speed with which we make progress toward this goal will depend on our ability to identify the appropriate prospective franchisees with the experience and financial resources in the relevant markets. We will also continue to evaluate several small markets in APMEA and Europe for potential transition to developmental license structures. We will only convert such markets when we believe that we have identified a qualified licensee and our business is ready for transition to optimize the transaction for the long-term.
As previously discussed, our evolution toward a more heavily franchised, less capital-intensive business model has favorable implications for the amount of capital we invest, the strength and stability of our cash flow and our long-term returns. As a result, we expect free cash flow - cash from operations less capital expenditures - will continue to grow and be a significant source to fund total cash returned to shareholders. In addition, we expect our share repurchase activity will continue to yield reductions in our outstanding share count.
Finally, we will continue to be disciplined financially, remaining diligent about how and where we invest capital and selling, general and administrative expenses to grow our business. Consistent with the last few years, to drive sales and returns we will allocate nearly 50% of our $2.1 billion of planned 2009 capital expenditures toward reinvestments in existing restaurants, mainly related to the reimaging of locations in Europe and the rollout of the beverage strategy in the U.S. The remainder of our capital expenditures will primarily be used to build new locations.
McDonald's does not provide specific guidance on net income per share. The following information is provided to assist in analyzing the Company's results:
Changes in Systemwide sales are driven by comparable sales and net restaurant unit expansion. The Company expects net restaurant additions to add nearly 2 percentage points to 2009 Systemwide sales growth (in constant currencies), most of which will be due to the 709 net traditional restaurants added in 2008.
The Company does not generally provide specific guidance on changes in comparable sales. However, as a perspective, assuming no change in cost structure, a 1 percentage point increase in comparable sales for either the U.S. or Europe would increase annual net income per share by about 3 cents.
With about 75% of McDonald's grocery bill comprised of 10 different commodities, a basket of goods approach is the most comprehensive way to look at the Company's commodity costs. For the full year 2009, the total basket of goods is expected to rise about 5% to 5.5% in the U.S. and about 4% to 4.5% in Europe with more of this pressure occurring in the first half of the year. Some volatility may be experienced between quarters in the normal course of business.
The Company expects full-year 2009 selling, general & administrative expenses to decline, in constant currencies, although fluctuations may be experienced between quarters due to certain items in 2008 such as the biennial Worldwide Owner/Operator Convention and the Beijing Summer Olympics.
Based on current interest and foreign currency exchange rates, the Company expects interest expense in 2009 to be relatively flat compared with 2008. Interest income in 2009 is expected to decrease about 80% compared with 2008 due to expected lower average interest rates and average cash balances.
A significant part of the Company's operating income is generated outside the U.S., and about 45% of its total debt is denominated in foreign currencies. Accordingly, earnings are affected by changes in foreign currency exchange rates, particularly the Euro, British Pound, Australian Dollar and Canadian Dollar. Collectively, these currencies represent approximately 70% of the Company's operating income outside the U.S. If all four of these currencies moved by 10% in the same direction compared with 2008, the Company's annual net income per share would change by about 12 to 15 cents. Due to the recent strengthening of the U.S. Dollar relative to virtually all foreign currencies, full year 2009 revenues and operating income will likely be negatively impacted by foreign currency translation.
The Company expects the effective income tax rate for the full-year 2009 to be approximately 29% to 31%. In the normal course of business and based on the timing of certain transactions and events, some volatility may be experienced between the quarters resulting in a quarterly tax rate that is outside the annual range.
The Company expects capital expenditures for 2009 to be approximately $2.1 billion. About half of this amount will be reinvested in existing restaurants while the rest will primarily be used to open about 1,000 restaurants (950 traditional and 50 satellites). The Company expects net additions of about 650 restaurants (750 net traditional additions and 100 net satellite closings). These restaurant numbers include new unit openings (approximately 30%) in affiliated and developmental licensed markets, such as Japan and Latin America, where the Company does not fund any capital expenditures.
For 2007 through 2009, the Company expects to return $15 billion to $17 billion to shareholders through share repurchases and dividends, subject to business and market conditions. For 2007 and 2008 combined, the Company returned $11.5 billion to shareholders.
The Company continually reviews its restaurant ownership structures to optimize cash flow and returns and to enhance local relevance. The Company expects to refranchise 1,000 to 1,500 Company-operated restaurants between 2008 and 2010, primarily in its major markets, and by continuing to utilize its developmental license strategy. In 2008, the Company refranchised about 675 restaurants, primarily in its major markets.
In February 2009, consistent with its focus on the McDonald's restaurant business, McDonald's agreed to sell its minority interest in Redbox Automated Retail, LLC, an automated DVD rental service. The Company expects to recognize a nonoperating gain upon the closing of the transaction in first quarter 2009.
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