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MCD > SEC Filings for MCD > Form 10-Q on 1-May-2013All Recent SEC Filings

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Form 10-Q for MCDONALDS CORP


1-May-2013

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 34,565 restaurants in 119 countries at March 31, 2013, 27,970 were licensed to franchisees (including 19,893 franchised to conventional franchisees, 4,420 licensed to developmental licensees and 3,657 licensed to foreign affiliates ("affiliates") - primarily Japan) and 6,595 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 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," which includes operations in Canada and Latin America, as well as Corporate activities. For the quarter ended March 31, 2013, the U.S., Europe and APMEA segments accounted for 32%, 39% and 24% 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 ("Plan") provides a common framework for our global business while allowing for local adaptation. Through the execution of multiple initiatives surrounding the five pillars of our Plan (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 nine years. This Plan, combined with financial discipline, has delivered strong results for our shareholders since its inception.
The Company's global growth priorities under the Plan include: optimizing our menu with compelling 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, new store expansion and value initiatives. We believe these priorities are relevant, actionable and, combined with our competitive advantages, will drive long-term sustainable profitable growth. We remain committed to pursuing strategies and investments that strengthen our business momentum over the long term. In the quarter, global economic headwinds pressured performance, with global comparable sales and guest counts decreasing 1.0% and 1.9%, respectively. The Company also faced strong prior year comparable sales performance that included an additional day in 2012 due to leap year. Comparable sales are driven by changes in guest counts and average check, which are affected by changes in pricing and product mix. Generally, the goal is to achieve a balanced contribution from both guest counts and average check.
Comparable sales growth is needed to realize margin leverage. Although top-line comparisons with 2012 will begin to ease, we expect the challenging global economic environment to persist and the Informal Eating Out ("IEO") segment in many markets to remain flat or decline. These circumstances, combined with cost pressures, are expected to impact margins throughout 2013. Despite the challenges inherent in the external environment, we continue our efforts to build market share by leveraging our scale and strength to pursue opportunities within our global growth priorities.


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In the U.S., first quarter 2013 comparable sales decreased 1.2% due in part to the challenging eating-out environment. A balanced offering of premium, core, limited-time offers and compelling value options, including the addition of the new Grilled Onion Cheddar burger and the Hot n' Spicy McChicken to the Dollar Menu, contributed positively to the quarter's results. Looking ahead, the U.S. is focused on menu and convenience initiatives to drive performance. Additionally, ongoing restaurant reimaging and customer service initiatives continue to be a priority in enhancing the customer experience. In Europe, first quarter 2013 comparable sales decreased 1.1%, as positive results in the U.K. and Russia were more than offset by weaker performance in Germany, France and many other markets due to continuing economic uncertainty. Moving forward, Europe's business plans emphasize value across all day parts, offer compelling premium products and expand the brand's presence through extended operating hours and new restaurant growth. In addition, Europe continues to focus on enhancing the customer experience through ongoing restaurant reimaging and technology initiatives.
In APMEA, first quarter 2013 comparable sales decreased 3.3% primarily due to ongoing weakness in Japan and negative results in China. APMEA remains focused on driving performance by offering unique value platforms, accelerating growth at breakfast, modernizing the customer experience through ongoing restaurant reimaging, and broadening accessibility through service and convenience initiatives and new restaurant development. First Quarter Operating Results Included:
• Global comparable sales decreased 1.0%.

• Consolidated revenues increased 1% (1% in constant currencies).

• Consolidated operating income decreased 1% (flat in constant currencies).

• Diluted earnings per share was $1.26, up 2% (3% in constant currencies). Foreign currency translation had a negative impact of $0.01 on diluted earnings per share.

• The Company paid total dividends of $0.77 per share or $772.2 million and repurchased 3.7 million shares for $354.3 million.

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 2.5 percentage points to 2013 Systemwide sales growth (in constant currencies), most of which will be due to the 1,135 net traditional restaurants added in 2012.

• 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 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 2013, the total basket of goods cost is expected to increase 1.5-2.5% in the U.S. and 2.5-3.5% in Europe.

• The Company expects full-year 2013 selling, general and administrative expenses to increase approximately 2-3% in constant currencies, with fluctuations expected between the quarters.

• Based on current interest and foreign currency exchange rates, the Company expects interest expense for the full year 2013 to increase approximately 3-4% compared with 2012.

• 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 25 cents.

• The Company expects the effective income tax rate for the full-year 2013 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.


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• The Company expects capital expenditures for 2013 to be approximately $3.2 billion. Over half of this amount will be used to open new restaurants. The Company expects to open between 1,500 - 1,600 restaurants including about 500 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 between 1,200 - 1,300 traditional restaurants. The remaining capital will be used to reinvest in existing locations, in part through reimaging. More than 1,600 restaurants worldwide are expected to be reimaged, including locations in affiliated and developmental licensee markets that 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
Dollars in millions, except per share data        March 31, 2013
                                                            Increase/
                                                Amount     (Decrease)
Revenues
Sales by Company-operated restaurants        $ 4,445.4              0  %
Revenues from franchised restaurants           2,159.9              2
Total revenues                                 6,605.3              1
Operating costs and expenses
Company-operated restaurant expenses           3,726.0              2
Franchised restaurants-occupancy expenses        395.2              6
Selling, general & administrative expenses       596.5              1
Other operating (income) expense, net            (61.9 )          (56 )
Total operating costs and expenses             4,655.8              2
Operating income                               1,949.5             (1 )
Interest expense                                 128.1             (1 )
Nonoperating (income) expense, net                 4.6            n/m
Income before provision for income taxes       1,816.8             (2 )
Provision for income taxes                       546.6             (6 )
Net income                                   $ 1,270.2              0  %
Earnings per common share-basic              $    1.27              2  %
Earnings per common share-diluted            $    1.26              2  %


n/m Not meaningful
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 (Cost)
Quarters Ended March 31,                                    2013             2012                   2013
Revenues                                               $ 6,605.3        $ 6,546.6          $        (6.0 )
Company-operated margins                                   719.4            777.8                   (0.8 )
Franchised margins                                       1,764.7          1,739.7                  (12.0 )
Selling, general & administrative expenses                 596.5            592.5                   (0.7 )
Operating income                                         1,949.5          1,964.6                  (15.8 )
Net income                                               1,270.2          1,266.7                  (11.3 )
Earnings per share-diluted                             $    1.26        $    1.23          $       (0.01 )

Foreign currency translation had a minimal impact on consolidated operating results for the quarter.


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Net Income and Diluted Earnings per Common Share For the quarter, net income was flat (increased 1% in constant currencies) at $1,270.2 million and diluted earnings per share increased 2% (3% in constant currencies) to $1.26. Foreign currency translation had a negative impact of $0.01 per share on diluted earnings per share. Diluted earnings per share growth in constant currencies benefited from a 2% decrease in diluted weighted average shares outstanding.
During the quarter, the Company paid a quarterly dividend of $0.77 per share or $772.2 million and repurchased 3.7 million shares of its stock for $354.3 million.
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
                                                                                              Currency
Quarters Ended March 31,                           2013           2012     Inc/ (Dec)      Translation
Company-operated sales
U.S.                                          $ 1,071.7      $ 1,089.6             (2 )%            (2 )%
Europe                                          1,862.4        1,834.6              2                2
APMEA                                           1,331.6        1,306.5              2                1
Other Countries & Corporate                       179.7          201.5            (11 )            (10 )
Total                                         $ 4,445.4      $ 4,432.2              0  %             0  %
Franchised revenues
U.S.                                          $ 1,016.8      $ 1,012.7              0  %             0  %
Europe                                            724.0          700.9              3                3
APMEA                                             262.1          250.1              5                8
Other Countries & Corporate                       157.0          150.7              4                8
Total                                         $ 2,159.9      $ 2,114.4              2  %             3  %
Total revenues
U.S.                                          $ 2,088.5      $ 2,102.3             (1 )%            (1 )%
Europe                                          2,586.4        2,535.5              2                2
APMEA                                           1,593.7        1,556.6              2                2
Other Countries & Corporate                       336.7          352.2             (4 )             (2 )
Total                                         $ 6,605.3      $ 6,546.6              1  %             1  %

Consolidated revenues increased 1% (1% in constant currencies) for the quarter. The revenue growth was driven by expansion, partly offset by negative comparable sales, which were impacted by one additional day in 2012 due to leap year.
• In the U.S., the decrease in revenues for the quarter was due to negative comparable sales reflecting the challenging eating-out environment. The U.S. remained focused on a balanced approach to value and menu variety, while enhancing the customer experience through ongoing restaurant reimaging.

• In Europe, the constant currency increase in revenues for the quarter was driven by expansion, primarily in Russia (which is entirely Company-operated). Revenue growth was negatively impacted by a decrease in comparable sales, as positive results in the U.K. and Russia were more than offset by weaker performance in Germany, France and many other markets due to ongoing economic uncertainty.

• In APMEA, the constant currency increase in revenues for the quarter was driven by expansion, partly offset by the impact of negative comparable sales including China, which reflected the consumer sensitivity around the supply chain issue in the chicken industry.


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The following table presents the percent change in comparable sales for the quarters ended March 31, 2013 and 2012:

COMPARABLE SALES
                              Increase/ (Decrease)
Quarters Ended March 31,*      2013            2012
U.S.                           (1.2 )%          8.9 %
Europe                         (1.1 )           5.0
APMEA                          (3.3 )           5.5
Other Countries & Corporate     5.6            11.6
Total                          (1.0 )%          7.3 %

* On a consolidated basis, comparable guest counts decreased 1.9% and increased 4.8% for the quarters 2013 and 2012, respectively.

The following table presents the percent change in Systemwide sales for the quarter ended March 31, 2013:

SYSTEMWIDE SALES
                                                                                    Increase
                                                                                   Excluding
                                                                                    Currency
Quarter Ended March 31, 2013                                       Inc/ (Dec)    Translation
U.S.                                                                        0  %           0 %
Europe                                                                      2              2
APMEA                                                                      (3 )            1
Other Countries & Corporate                                                 3              9
Total                                                                       0  %           2 %

Franchised sales are not recorded as revenues by the Company, but are the basis on which the Company calculates and records franchised revenues and are indicative of the health of the franchisee base. The following table presents Franchised sales and the related increases/(decreases):

FRANCHISED SALES
Dollars in millions
                                                                                              Increase
                                                                                             Excluding
                                                                                              Currency
Quarters Ended March 31,                              2013            2012   Inc/ (Dec)    Translation
U.S.                                            $  7,376.6      $  7,377.5            0  %           0 %
Europe                                             4,064.6         3,985.8            2              1
APMEA                                              3,236.6         3,425.7           (6 )            2
Other Countries & Corporate                        1,978.0         1,889.1            5             11
Total*                                          $ 16,655.8      $ 16,678.1            0  %           2 %

* Sales from developmental licensed restaurants or foreign affiliated markets where the Company earns a royalty based on a percent of sales were $3,726.4 million and $3,891.9 million in 2013 and 2012, respectively. The remaining balance of franchised sales is derived from conventional franchised restaurants where the Company earns rent and royalties based primarily on a percent of sales.


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Restaurant Margins
FRANCHISED AND COMPANY-OPERATED RESTAURANT MARGINS
Dollars in millions
                                                                                                    Inc/ (Dec)
                                        Percent                Amount                                Excluding
                                                                                                      Currency
Quarters Ended March 31,             2013     2012          2013          2012     Inc/ (Dec)      Translation
Franchised
U.S.                                 82.9 %   83.4 %   $   843.2     $   844.4              0  %             0  %
Europe                               77.1     77.9         557.9         545.7              2                2
APMEA                                87.7     88.6         229.9         221.6              4                8
Other Countries & Corporate          85.2     85.0         133.7         128.0              4                9
Total                                81.7 %   82.3 %   $ 1,764.7     $ 1,739.7              1  %             2  %
Company-operated
U.S.                                 17.4 %   18.8 %   $   186.8     $   204.7             (9 )%            (9 )%
Europe                               16.7     17.5         311.7         321.7             (3 )             (3 )
APMEA                                14.6     16.9         194.1         220.4            (12 )            (12 )
Other Countries & Corporate          14.9     15.4          26.8          31.0            (14 )            (13 )
Total                                16.2 %   17.5 %   $   719.4     $   777.8             (8 )%            (7 )%

Franchised margin dollars increased $25.0 million or 1% (2% in constant currencies) for the quarter.
• In the U.S., the franchised margin percent decreased for the quarter due to higher depreciation related to reimaging and negative comparable sales performance.

• In Europe, while the franchised margin dollars increased for the quarter, the margin percent decreased due to higher rent expense and negative comparable sales performance.

• In APMEA, while the franchised margin dollars increased for the quarter, the margin percent decreased primarily due to negative comparable sales performance in Japan and the impact of the weaker Yen, which reduced Japan's favorable contribution to the segment's margin percent.

Company-operated margin dollars decreased $58.4 million or 8% (7% in constant currencies) for the quarter, reflecting negative comparable sales performance, which impacted our ability to overcome cost pressures.
• In the U.S., the Company-operated margin percent for the quarter decreased primarily due to higher labor and other operating costs.

• In Europe, the Company-operated margin percent for the quarter decreased due to higher crew labor, commodity costs and depreciation related to reimaging.

. . .

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