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MCD > SEC Filings for MCD > Form 10-Q on 31-Jul-2013All Recent SEC Filings

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Form 10-Q for MCDONALDS CORP


31-Jul-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 34,734 restaurants in 119 countries at June 30, 2013, 28,107 were licensed to franchisees (including 19,965 franchised to conventional franchisees, 4,479 licensed to developmental licensees and 3,663 licensed to foreign affiliates ("affiliates") - primarily Japan) and 6,627 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. 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 six months ended June 30, 2013, the U.S., Europe and APMEA segments accounted for 32%, 40% and 23% of total revenues, respectively.
Strategic Direction and Financial Performance The strength of the alignment among 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. Global comparable sales increased 1.0% for the quarter and were flat for the six months. The overall challenging environment, namely flat to declining informal eating out markets, diminishing ability to raise menu prices, ongoing cost pressures and heightened competitive activity, continued to pressure performance. On a consolidated basis, comparable guest counts decreased 1.2% for the six months. 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.
Looking ahead, we expect the overall challenging environment to persist, pressuring comparable sales performance and negatively impacting results for the remainder of the year. Despite the challenges inherent in the external environment, we are differentiating the McDonald's experience by uniting consumer insights, innovation and execution.


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U.S. comparable sales increased 1.0% for the quarter and decreased 0.1% for the six months. New product introductions across the four key growth categories of chicken, beef, breakfast and beverages, ongoing support for the Dollar Menu and greater accessibility to McDonald's classic core favorites supported the segment's sales performance. Sales results were also negatively impacted by the comparison against prior year promotional activity. Moving forward, U.S. business initiatives are designed to satisfy evolving customer expectations through a balanced approach to value, variety and convenience. Additionally, ongoing restaurant reimaging and customer service initiatives continue to be a priority in enhancing the customer experience.
In Europe, comparable sales decreased 0.1% and 0.6% for the quarter and six months, respectively, as negative results in Germany and France were partly offset by solid performance in the U.K. and Russia. Looking ahead, Europe remains focused on reigniting momentum with enhanced premium beverage and menu items and everyday affordability options across all dayparts. In addition, Europe continues to focus on enhancing the customer experience through ongoing restaurant reimaging and technology initiatives.
In APMEA, comparable sales decreased 0.3% and 1.9% for the quarter and six months, respectively, primarily due to negative results in Japan and China, partly offset by positive performance in many other markets. Australia also had a negative impact on the quarter. APMEA remains focused on driving performance by offering comprehensive 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.
Second Quarter and Six Months 2013 Operating Results Included:
• Global comparable sales increased 1.0% for the quarter and were flat for the six months.

• Consolidated revenues increased 2% (2% in constant currencies) for the quarter and six months.

• Consolidated operating income increased 2% (3% in constant currencies) for the quarter and increased 1% (1% in constant currencies) for the six months.

• Diluted earnings per share were $1.38 for the quarter and $2.64 for the six months, up 5% (6% in constant currencies) and 4% (5% in constant currencies), respectively. Foreign currency translation negatively impacted diluted earnings per share by $0.02 for the quarter and six months.

• For the six months, the Company paid total dividends of $1.5 billion and repurchased 8.1 million shares for $786.0 million.

Outlook
The Company expects the dynamics of the current environment to persist, namely flat to declining informal eating out markets, diminishing ability to raise menu prices, ongoing cost pressures and heightened competitive activity. As a result, the Company expects our results for the remainder of the year to remain challenged. 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 2.0-3.0% in Europe.

• The Company expects full-year 2013 selling, general and administrative expenses to remain relatively flat 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 2-3% 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 about $3.1 billion. Over half of this amount will be used to open new restaurants. The Company expects to open between 1,500 - 1,550 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
- 1,250 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                   Six Months Ended
Dollars in millions, except per share data          June 30, 2013                    June 30, 2013
                                                              Increase/                        Increase/
                                                 Amount      (Decrease)            Amount     (Decrease)
Revenues
Sales by Company-operated restaurants         $ 4,761.4               2  %      $ 9,206.8              1  %
Revenues from franchised restaurants            2,322.4               4           4,482.3              3
Total revenues                                  7,083.8               2          13,689.1              2
Operating costs and expenses
Company-operated restaurant expenses            3,919.5               3           7,645.5              2
Franchised restaurants-occupancy expenses         399.1               6             794.3              6
Selling, general & administrative expenses        607.0              (2 )         1,203.5             (1 )
Other operating (income) expense, net             (39.5 )            30            (101.4 )           (6 )
Total operating costs and expenses              4,886.1               3           9,541.9              2
Operating income                                2,197.7               2           4,147.2              1
Interest expense                                  129.8               0             257.9              0
Nonoperating (income) expense, net                  8.0             (47 )            12.6            n/m
Income before provision for income taxes        2,059.9               2           3,876.7              0
Provision for income taxes                        663.4               0           1,210.0             (3 )
Net income                                    $ 1,396.5               4  %      $ 2,666.7              2  %
Earnings per common share-basic               $    1.39               5  %      $    2.66              4  %
Earnings per common share-diluted             $    1.38               5  %      $    2.64              4  %


n/m Not meaningful

                                       13
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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 purchasing goods and services in local currencies, financing in local currencies and hedging certain foreign-denominated cash flows. 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 June 30,                                       2013             2012                   2013
Revenues                                                $  7,083.8       $  6,915.9          $        (2.5 )
Company-operated margins                                     841.9            849.7                   (0.5 )
Franchised margins                                         1,923.3          1,866.2                   (8.8 )
Selling, general & administrative expenses                   607.0            617.3                   (0.8 )
Operating income                                           2,197.7          2,155.0                  (13.3 )
Net income                                                 1,396.5          1,347.0                  (12.8 )
Earnings per share-diluted                              $     1.38       $     1.32          $       (0.02 )

                                                                                                  Currency
                                                                                        Translation (Cost)
Six Months Ended June 30,                                     2013             2012                   2013
Revenues                                                $ 13,689.1       $ 13,462.5          $        (8.5 )
Company-operated margins                                   1,561.3          1,627.5                   (1.3 )
Franchised margins                                         3,688.0          3,605.9                  (20.8 )
Selling, general & administrative expenses                 1,203.5          1,209.8                   (1.5 )
Operating income                                           4,147.2          4,119.6                  (29.1 )
Net income                                                 2,666.7          2,613.7                  (24.1 )
Earnings per share-diluted                              $     2.64       $     2.54          $       (0.02 )

Foreign currency translation had a negative impact on consolidated operating results for the quarter and six months.
Net Income and Diluted Earnings per Common Share For the quarter, net income increased 4% (5% in constant currencies) to $1,396.5 million and diluted earnings per share increased 5% (6% in constant currencies) to $1.38. Foreign currency translation had a negative impact of $0.02 on diluted earnings per share.
For the six months, net income increased 2% (3% in constant currencies) to $2,666.7 million and diluted earnings per share increased 4% (5% in constant currencies) to $2.64. Foreign currency translation had a negative impact of $0.02 on diluted earnings per share.
For the quarter and six months, net income and diluted earnings per share growth in constant currencies were positively impacted by higher franchised margin dollars and a lower effective income tax rate, partly offset by lower Company-operated margin dollars. A decrease in diluted weighted average shares outstanding also contributed to the growth in diluted earnings per share in both periods.
During the quarter, the Company paid a quarterly dividend of $0.77 per share or $771.1 million, bringing the total dividends paid for the six months to $1,543.3 million. In addition, the Company repurchased 4.4 million shares of its stock for $431.7 million, bringing total purchases for the six months to 8.1 million shares or $786.0 million.


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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
                                                                                             Currency
Quarters Ended June 30,                           2013           2012     Inc/ (Dec)      Translation
Company-operated sales
U.S.                                        $  1,164.0     $  1,152.4              1  %             1  %
Europe                                         2,058.0        1,994.6              3                3
APMEA                                          1,333.6        1,302.4              2                1
Other Countries & Corporate                      205.8          224.1             (8 )             (7 )
Total                                       $  4,761.4     $  4,673.5              2  %             2  %
Franchised revenues
U.S.                                        $  1,118.4     $  1,089.9              3  %             3  %
Europe                                           779.1          746.6              4                3
APMEA                                            255.9          245.5              4                9
Other Countries & Corporate                      169.0          160.4              5                9
Total                                       $  2,322.4     $  2,242.4              4  %             4  %
Total revenues
U.S.                                        $  2,282.4     $  2,242.3              2  %             2  %
Europe                                         2,837.1        2,741.2              3                3
APMEA                                          1,589.5        1,547.9              3                3
Other Countries & Corporate                      374.8          384.5             (3 )              0
Total                                       $  7,083.8     $  6,915.9              2  %             2  %

                                                                                           Inc/ (Dec)
                                                                                            Excluding
                                                                                             Currency
Six Months Ended June 30,                         2013           2012     Inc/ (Dec)      Translation
Company-operated sales
U.S.                                        $  2,235.7     $  2,242.0              0  %             0  %
Europe                                         3,920.4        3,829.2              2                3
APMEA                                          2,665.2        2,608.9              2                1
Other Countries & Corporate                      385.5          425.6             (9 )             (9 )
Total                                       $  9,206.8     $  9,105.7              1  %             1  %
Franchised revenues
U.S.                                        $  2,135.2     $  2,102.6              2  %             2  %
Europe                                         1,503.1        1,447.5              4                3
APMEA                                            518.0          495.6              5                9
Other Countries & Corporate                      326.0          311.1              5                8
Total                                       $  4,482.3     $  4,356.8              3  %             3  %
Total revenues
U.S.                                        $  4,370.9     $  4,344.6              1  %             1  %
Europe                                         5,423.5        5,276.7              3                3
APMEA                                          3,183.2        3,104.5              3                2
Other Countries & Corporate                      711.5          736.7             (3 )             (1 )
Total                                       $ 13,689.1     $ 13,462.5              2  %             2  %


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Consolidated revenues increased 2% (2% in constant currencies) for the quarter and six months, driven by expansion. For the quarter and six months, comparable sales and guest counts were pressured by challenging economic and IEO industry conditions.
• In the U.S., the increase in revenues for the quarter was driven by expansion and positive comparable sales performance. Expansion drove results for the six months. Innovative new menu options in key growth categories, ongoing support for the Dollar Menu and greater accessibility to McDonald's classic core favorites helped support performance. Sales results for the quarter were negatively impacted by the comparison against prior year promotional activity.

• In Europe, the constant currency increase in revenues for the quarter and six months was driven by expansion, primarily in Russia (which is entirely Company-operated). Revenue growth was also impacted by positive comparable sales in the U.K. and Russia, mostly offset by weaker performance in Germany and France.

• In APMEA, the constant currency increase in revenues for the quarter and six months was driven by expansion, partly offset by negative comparable sales, primarily in China. Results in China reflected the impact of Avian influenza, which diminished through the quarter.

The following table presents the percent change in comparable sales for the quarter and six months ended June 30, 2013 and 2012:

COMPARABLE SALES
                                      Increase/ (Decrease)
                              Quarters Ended       Six Months Ended
                                 June 30,             June 30, *
                             2013       2012       2013        2012
U.S.                          1.0  %     3.6 %     (0.1 )%      6.1 %
Europe                       (0.1 )      3.8       (0.6 )       4.4
APMEA                        (0.3 )      0.9       (1.9 )       3.2
Other Countries & Corporate   6.6        9.1        6.1        10.2
Total                         1.0  %     3.7 %      0.0  %      5.4 %

* On a consolidated basis, comparable guest counts decreased 1.2% and increased 3.0% for the six months 2013 and 2012, respectively.

The following table presents the percent change in Systemwide sales for the quarter and six months ended June 30, 2013:

SYSTEMWIDE SALES
. . .
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