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MCD > SEC Filings for MCD > Form 10-Q on 1-Nov-2012All Recent SEC Filings

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Form 10-Q for MCDONALDS CORP


1-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company franchises and operates McDonald's restaurants. Of the 34,010 restaurants in 119 countries at September 30, 2012, 27,470 were licensed to franchisees (including 19,673 franchised to conventional franchisees, 4,143 licensed to developmental licensees and 3,654 licensed to foreign affiliates (affiliates) - primarily Japan) and 6,540 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. In certain circumstances, the Company participates in reinvestment for conventional franchised restaurants. Under our developmental license arrangement, licensees provide capital for the entire business, including the real estate interest, and 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 and/or franchise restaurants within a market.
We view ourselves primarily as a franchisor and believe franchising is important to delivering great, locally-relevant customer experiences and driving profitability. However, directly operating restaurants is paramount to being a credible franchisor and is essential to providing Company personnel with restaurant operations experience. In our Company-operated restaurants, and in collaboration with 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 in the restaurants. We continually review, and as appropriate adjust, our mix of Company-operated and franchised (conventional franchised, developmental licensed and foreign affiliated) restaurants to help optimize overall performance.
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 generally 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. For the nine months ended September 30, 2012, the U.S., Europe and APMEA segments accounted for 32%, 39% and 23% of total revenues, respectively.
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. 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 customers' changing needs and preferences. McDonald's customer-focused Plan to Win-which concentrates on being better, not just bigger-provides a common framework for our global business while allowing for local adaptation. Through the execution of multiple initiatives surrounding the five elements of our Plan to Win-People, Products, Place, Price and Promotion-we have enhanced the restaurant experience for customers worldwide and grown comparable sales and customer visits in each of the last eight years. This Plan, combined with financial discipline, has delivered strong results for our shareholders.
The Company's growth priorities under the Plan to Win include: optimizing the menu with the right food and beverage offerings, modernizing the customer experience by upgrading nearly every aspect of our restaurants from service to designs, and broadening our accessibility through continued convenience and value initiatives. The combination of all of these efforts drove increases in comparable sales and customer visits in many countries despite global economic and competitive challenges and a relatively flat or contracting Informal Eating Out (IEO) market. Overall results also reflected sales and cost pressures, some of which were the result of planned strategic decisions, including actions taken to enhance our value platforms, and invest in technology and our Olympic sponsorship.
We expect our revenues and operating income will remain under pressure at least for the next few quarters. Our near-term focus is on increasing guest counts and market share by emphasizing exceptional value across the menu, including products offered at an affordable entry price point that may negatively impact average check. We plan to build on this foundation by featuring premium products and promotions that encourage purchases of higher margin products and generate a higher average check.


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Every area of the world contributed to global comparable sales, which increased 1.9% and 4.1% for the quarter and nine months 2012, respectively. On a consolidated basis, comparable guest counts increased 2.2% for the nine months 2012. Comparable sales are driven by changes in guest counts and average check, which is affected by changes in pricing and product mix. Generally, our goal is to achieve a balanced contribution from both guest counts and average check. U.S. comparable sales increased 1.2% for the quarter and 4.4% for the nine months amid broad competitive activity. During both periods, the U.S. showcased beverages, breakfast and classic core favorites; featured everyday value; and continued to upgrade McDonald's existing restaurant base with fresh, modern designs. Ongoing U.S. initiatives include optimizing the menu with premium product additions; modernizing our restaurants through reimaging and technology enhancements; and broadening accessibility with all-day everyday value and expanded operating hours.
Europe's emphasis on everyday affordability, premium product innovation and restaurant reimaging contributed to 1.8% comparable sales growth for the quarter and 3.4% for the nine months. Europe's strategic priorities include increasing local relevance by providing value across the menu complemented by a variety of promotional food events; enhancing the customer experience through ongoing restaurant reimaging and technology initiatives; and reducing our impact on the environment with energy management tools.
APMEA's comparable sales increase of 1.4% for the quarter and 2.5% for the nine months reflected the segment's unique value platforms, menu variety and convenience strategies. APMEA will continue efforts to become our customers' first choice for eating out by providing compelling value and menu variety and by focusing on the restaurant experience through convenience initiatives, such as expanding delivery service and extended operating hours. In addition, APMEA will grow by opening approximately 750 new restaurants, reimaging existing restaurants and elevating customer service and operations to drive efficiencies. Highlights from the Quarter and Nine Months 2012 Included:
• Global comparable sales increased 1.9% for the quarter and 4.1% for the nine months, with positive comparable sales in each geographic segment.

• Consolidated revenues were flat (up 4% in constant currencies) for the quarter and increased 2% (6% in constant currencies) for the nine months.

• Consolidated operating income decreased 4% (flat in constant currencies) for the quarter and were flat (increased 4% in constant currencies) for the nine months.

• Diluted earnings per share were $1.43 for the quarter and $3.98 for the nine months, decreased 1% (increased 4% in constant currencies) and up 1% (5% in constant currencies), respectively. Foreign currency translation negatively impacted diluted earnings per share by $0.08 for the quarter and $0.16 for the nine months.

• For the nine months, the Company repurchased 24.1 million shares for $2.3 billion and paid total dividends of $2.1 billion.

• The quarterly cash dividend increased 10% to $0.77 per share - the equivalent of $3.08 annually - effective for the fourth quarter 2012.

Outlook
While the Company does not provide specific guidance on earnings per share, the following information is provided to assist in forecasting the Company's future results.
• Changes in Systemwide sales are driven by comparable sales and net restaurant unit expansion. The Company expects net restaurant additions to add approximately 2 percentage points to 2012 Systemwide sales growth (in constant currencies), most of which will be due to the 872 net traditional restaurants added in 2011.

• 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 diluted earnings per share by about 3-4 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 2012, the total basket of goods cost is expected to increase 3.5-4.5% in the U.S. and 2.5-3.5% in Europe.

• The Company expects full-year 2012 selling, general & administrative expenses to increase approximately 6% in constant currencies, driven by certain technology investments, primarily to accelerate future restaurant capabilities, and costs related to the 2012 Worldwide Owner/Operator Convention in the second quarter and the 2012 London Olympics in the third quarter. The Company expects the magnitude of the increase to be confined to 2012.

• Based on current interest and foreign currency exchange rates, the Company expects interest expense for the full year 2012 to increase between 4% and 6% compared with 2011.


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• A significant part of the Company's operating income is generated outside the U.S., and about 35% 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 65% of the Company's operating income outside the U.S. If all four of these currencies moved by 10% in the same direction, the Company's annual diluted earnings per share would change by about 24 cents.

• The Company expects the effective income tax rate for the full-year 2012 to be 31% to 33%. 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 2012 to be approximately $2.9 billion. About half of this amount will be used to open new restaurants. The Company expects to open more than 1,300 restaurants including about 450 restaurants in affiliated and developmental licensee markets, such as Japan and Latin America, where the Company does not fund any capital expenditures. The Company expects net additions of about 900 restaurants. The remaining capital will be used for reinvestment in existing restaurants. Nearly half of this reinvestment will be used to reimage more than 2,400 locations worldwide, some of which will require no capital investment from the Company.

The Following Definitions Apply to these Terms as Used Throughout this Form 10-Q:
• Information in constant currency is calculated by translating current year results at prior year average exchange rates. Management reviews and analyzes business results excluding the effect of foreign currency translation and bases incentive compensation plans on these results because they believe this better represents the Company's underlying business trends.

• Systemwide sales include sales at all restaurants, whether operated by the Company or by franchisees. While franchised sales 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 records franchised revenues and are indicative of the financial health of the franchisee base.

• Comparable sales represent sales at all restaurants and comparable guest counts represent the number of transactions at all restaurants, whether operated by the Company or by franchisees, in operation at least thirteen months including those temporarily closed. Some of the reasons restaurants may be temporarily closed include reimaging or remodeling, rebuilding, road construction and natural disasters. Comparable sales exclude the impact of currency translation. Comparable sales are driven by changes in guest counts and average check, which is affected by changes in pricing and product mix. Management reviews the increase or decrease in comparable sales and comparable guest counts compared with the same period in the prior year to assess business trends. The number of weekdays and weekend days, referred to as the calendar shift/trading day adjustment, can impact comparable sales and guest counts. In addition, the timing of holidays can also impact comparable sales and guest counts.


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CONSOLIDATED OPERATING RESULTS
--------------------------------------------------------------------------------
                                                     Quarter Ended                   Nine Months Ended
Dollars in millions, except per share data        September 30, 2012                 September 30, 2012
                                                              % Increase/                        % Increase/
                                                  Amount       (Decrease)            Amount       (Decrease)
Revenues
Sales by Company-operated restaurants          $ 4,838.4                0        $ 13,944.1                2
Revenues from franchised restaurants             2,314.0                0           6,670.8                3
Total revenues                                   7,152.4                0          20,614.9                2
Operating costs and expenses
Company-operated restaurant expenses             3,914.4                1          11,392.6                3
Franchised restaurants-occupancy expenses          383.4                2           1,134.3                3
Selling, general & administrative expenses         620.9                7           1,830.7                6
Impairment and other charges (credits), net          6.2              n/m               6.2              n/m
Other operating (income) expense, net              (59.7 )              4            (155.7 )              6
Total operating costs and expenses               4,865.2                2          14,208.1                3
Operating income                                 2,287.2               (4 )         6,406.8                0
Interest expense                                   128.1                3             387.0                6
Nonoperating (income) expense, net                   5.5              (25 )             8.8              (42 )
Income before provision for income taxes         2,153.6               (5 )         6,011.0                0
Provision for income taxes                         698.6               (8 )         1,942.3                2
Net income                                     $ 1,455.0               (3 )      $  4,068.7               (1 )
Earnings per common share-basic                $    1.45               (1 )      $     4.02                1
Earnings per common share-diluted              $    1.43               (1 )      $     3.98                1

n/m Not meaningful


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Impact of Foreign Currency Translation
While changes in foreign currency exchange rates affect reported results, McDonald's mitigates exposures, where practical, by financing in local currencies, hedging certain foreign-denominated cash flows, and purchasing goods and services in local currencies. Management reviews and analyzes business results excluding the effect of foreign currency translation and bases incentive compensation plans on these results because they believe this better represents the Company's underlying business trends. Results excluding the effect of foreign currency translation (also referred to as constant currency) are calculated by translating current year results at prior year average exchange rates.

IMPACT OF FOREIGN CURRENCY TRANSLATION
Dollars in millions, except per share data
                                                                                                    Currency
                                                                                                 Translation
                                                                                             Benefit/ (Cost)
Quarters Ended September 30,                                 2012              2011                     2012
Revenues                                               $  7,152.4        $  7,166.3        $          (317.0 )
Company-operated margins                                    924.0             972.2                    (44.5 )
Franchised margins                                        1,930.6           1,934.6                    (84.0 )
Selling, general & administrative expenses                  620.9             580.9                     17.1
Operating income                                          2,287.2           2,394.7                   (111.5 )
Net income                                                1,455.0           1,507.3                    (73.9 )
Earnings per share-diluted                                   1.43              1.45                    (0.08 )

                                                                                                    Currency
                                                                                                 Translation
                                                                                             Benefit/ (Cost)
Nine Months Ended September 30,                              2012              2011                     2012
Revenues                                               $ 20,614.9        $ 20,183.3        $          (724.9 )
Company-operated margins                                  2,551.5           2,598.8                    (99.2 )
Franchised margins                                        5,536.5           5,374.2                   (185.8 )
Selling, general & administrative expenses                1,830.7           1,732.5                     40.4
Operating income                                          6,406.8           6,409.7                   (244.7 )
Net income                                                4,068.7           4,126.5                   (167.5 )
Earnings per share-diluted                                   3.98              3.94                    (0.16 )

Foreign currency translation had a negative impact on consolidated operating results for the quarter and nine months primarily due to the weaker Euro, along with most other currencies.
Net Income and Diluted Earnings per Common Share For the quarter, net income decreased 3% (increased 1% in constant currencies) to $1,455.0 million and diluted earnings per share decreased 1% (increased 4% in constant currencies) to $1.43. Foreign currency translation had a negative impact of $0.08 per share on diluted earnings per share.
For the nine months, net income decreased 1% (increased 3% in constant currencies) to $4,068.7 million and diluted earnings per share increased 1% (5% in constant currencies) to $3.98. Foreign currency translation had a negative impact of $0.16 per share on diluted earnings per share.
For the quarter and nine months, net income and diluted earnings per share growth in constant currencies were positively impacted by franchised margin dollars and a decrease in diluted weighted average shares outstanding, partly offset by higher selling, general and administrative expenses. The quarter also benefited from a lower effective income tax rate, while the nine months were negatively impacted by a higher effective income tax rate.
During the quarter, the Company repurchased 6.7 million shares of its stock for $596.8 million, bringing total repurchases for the nine months to 24.1 million shares or $2.3 billion. In addition, the Company paid a quarterly dividend of $0.70 per share or $703.8 million, bringing the total dividends paid for the nine months to $2.1 billion. The Company also declared a fourth quarter 2012 dividend of $0.77 per share, reflecting an increase of 10%, and expects total cash returned to shareholders to be at least $5.5 billion for 2012.


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Revenues
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 franchised restaurants that are licensed to affiliates and developmental licensees include a royalty based on a percent of sales and generally include initial fees.

REVENUES
Dollars in millions
                                                                                          % Inc/
                                                                                           (Dec)
                                                                               %       Excluding
                                                                            Inc/        Currency
Quarters Ended September 30,                        2012          2011     (Dec)     Translation
Company-operated sales
U.S.                                           $ 1,152.6     $ 1,153.7         0               0
Europe                                           2,029.4       2,088.0        (3 )             7
APMEA                                            1,423.6       1,353.6         5               6
Other Countries & Corporate                        232.8         260.2       (11 )            (9 )
Total                                          $ 4,838.4     $ 4,855.5         0               4

Franchised revenues
U.S.                                           $ 1,103.9     $ 1,076.2         3               3
Europe                                             763.7         816.2        (6 )             4
APMEA                                              270.0         248.0         9              11
Other Countries & Corporate                        176.4         170.4         4              10
Total                                          $ 2,314.0     $ 2,310.8         0               5

Total revenues
U.S.                                           $ 2,256.5     $ 2,229.9         1               1
Europe                                           2,793.1       2,904.2        (4 )             6
APMEA                                            1,693.6       1,601.6         6               7
Other Countries & Corporate                        409.2         430.6        (5 )            (2 )
Total                                          $ 7,152.4     $ 7,166.3         0               4



                                                                                            % Inc/
                                                                                             (Dec)
                                                                                 %       Excluding
                                                                              Inc/        Currency
Nine Months Ended September 30,                      2012           2011     (Dec)     Translation
Company-operated sales
U.S.                                           $  3,394.6     $  3,285.0         3               3
Europe                                            5,858.6        5,895.0        (1 )             8
APMEA                                             4,032.5        3,809.3         6               6
Other Countries & Corporate                         658.4          716.3        (8 )            (6 )
Total                                          $ 13,944.1     $ 13,705.6         2               5

Franchised revenues
U.S.                                           $  3,206.5     $  3,039.4         5               5
Europe                                            2,211.2        2,271.7        (3 )             6
APMEA                                               765.6          702.5         9              10
Other Countries & Corporate                         487.5          464.1         5              11
Total                                          $  6,670.8     $  6,477.7         3               6

Total revenues
U.S.                                           $  6,601.1     $  6,324.4         4               4
Europe                                            8,069.8        8,166.7        (1 )             7
APMEA                                             4,798.1        4,511.8         6               6
Other Countries & Corporate                       1,145.9        1,180.4        (3 )             1
Total                                          $ 20,614.9     $ 20,183.3         2               6


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Consolidated revenues were flat (increased 4% in constant currencies) for the quarter and increased 2% (6% in constant currencies) for the nine months. The constant currency growth was driven primarily by positive comparable sales and expansion.
• In the U.S., revenues increased for the quarter and nine months due to positive comparable sales. Everyday value offerings, menu variety and the enhanced customer experience provided by reimaged restaurants contributed to results, despite broad competitive activity.

• In Europe, the constant currency increases in revenues for the quarter and nine months were primarily driven by strong comparable sales in Russia (which is entirely Company-operated) and the U.K., as well as expansion in Russia. France also contributed to the increase in revenues for both periods.

• In APMEA, the constant currency increases in revenues for the quarter and nine months were primarily driven by comparable sales increases in China, Australia and many other markets, as well as expansion in China.

The following table presents the percent change in comparable sales for the quarters and nine months 2012 and 2011:

COMPARABLE SALES
                                           % Increase
. . .
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