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MCD > SEC Filings for MCD > Form 10-K on 24-Feb-2014All Recent SEC Filings

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Annual Report

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The Company franchises and operates McDonald's restaurants. Of the 35,429 restaurants in 119 countries at year-end 2013, 28,691 were franchised (including 20,355 franchised to conventional franchisees, 4,747 licensed to developmental licensees and 3,589 licensed to foreign affiliates ("affiliates")-primarily Japan) and 6,738 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 décor of their restaurant business, 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 or franchise restaurants within a market. We view ourselves primarily as a franchisor and believe franchising is important to both 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. The U.S., Europe and APMEA segments account for 31%, 40% and 23% of total revenues, respectively. The United Kingdom ("U.K."), France, Russia and Germany, collectively, account for 67% of Europe's revenues; and China, Australia and Japan (a 50%-owned affiliate accounted for under the equity method), collectively, account for 54% of APMEA's revenues. These seven markets along with the U.S. and Canada are referred to as "major markets" throughout this report and comprise 75% of total revenues.
In analyzing business trends, management reviews results on a constant currency basis and considers a variety of performance

and financial measures, including comparable sales and comparable guest count growth, Systemwide sales growth 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 we 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 the impact 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, whether operated by the Company or 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. Generally, pricing has a greater impact on average check than product mix. The goal is to achieve a balanced contribution from both guest counts and average check.

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 and weekend days 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. In addition, the timing of holidays can impact comparable sales and guest counts. These impacts vary geographically due to consumer spending patterns and have a more pronounced effect on monthly comparable sales and guest counts while the annual impacts are typically minimal.
? Systemwide sales include sales at all restaurants. 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.

? 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 cash used for investing activities (denominator), primarily capital expenditures. The calculation uses a constant average foreign exchange rate over the periods included in the calculation.

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. By leveraging our System, we are able to identify, implement and scale ideas that meet customers' changing needs and preferences. In addition, our business model

10 McDonald's Corporation 2013 Annual Report

enables McDonald's to consistently deliver locally-relevant restaurant experiences to customers and be an integral part of the communities we serve. McDonald's customer-focused Plan to Win ("Plan") provides a common framework that aligns our global business and allows for local adaptation. We continue to focus on our three global growth priorities of optimizing our menu, modernizing the customer experience, and broadening accessibility to Brand McDonald's within the framework of our Plan. Our initiatives support these priorities, and are executed with a focus on the Plan's five pillars - People, Products, Place, Price and Promotion - to enhance our customers' experience and build shareholder value over the long term. We believe these priorities align with our customers' evolving needs, and - combined with our competitive advantages of convenience, menu variety, geographic diversification and System alignment - will drive long-term sustainable growth.
To measure our performance as we strive to build the business, we have the following long-term, average annual constant currency financial targets:
? Systemwide sales growth of 3% to 5%;

? Operating income growth of 6% to 7%;

? ROIIC in the high teens.

In 2013, Systemwide sales growth was 1% (3% in constant currencies), operating income growth was 2% (3% in constant currencies), one-year ROIIC was 11.4% and three-year ROIIC was 20.2% (see reconciliation on page 23). Our operating income growth and returns fell below our long-term financial targets, reflecting the impact of soft comparable sales performance. In our heavily franchised business model, growing comparable sales is important to increasing operating income and returns.
In 2013, our comparable sales increased 0.2%, reflecting higher average check and negative comparable guest counts of 1.9%. Challenging conditions, including a flat or contracting informal eating out ("IEO") segment in most major markets, heightened competitive activity and consumer price sensitivity, continued to pressure performance. Furthermore, McDonald's customer-facing initiatives did not generate the comparable sales lift or customer visits necessary to overcome these headwinds.
In 2014, we do not expect significant changes in market dynamics given modest growth projections for the IEO segment. However, we continue to believe that our targets remain achievable over the long term.
The following is a summary of our 2013 sales performance and our initiatives within the three global growth priorities by major segment. U.S.
In the U.S., comparable sales declined 0.2% and comparable guest counts declined 1.6%. Guest visits were down as initiatives did not resonate as strongly as expected with customers amid a sluggish IEO segment and heightened competitive activity.
The U.S. introduced a number of significant new products (such as Premium McWraps, Egg White Delight McMuffins and an extended line-up of Quarter Pounder Burgers) and featured new limited-time food and beverage options to enhance the relevance of its product offerings.
Modernizing the customer experience continued through our reimaging program. During 2013, we completed about 700 restaurant reimages, of which the majority added drive-thru capacity. Currently, 45% of our restaurant interiors and exteriors reflect our contemporary restaurant design.

We broadened accessibility by opening 225 new restaurants, extending hours in more restaurants, and improving the efficiency of our drive-thru service with side-by-side or tandem ordering, and hand-held order taking. More than half of our restaurants now use one of these multiple order points to maximize drive-thru capacity. In addition, the U.S. evolved its value proposition with the recent introduction of Dollar Menu & More, which is intended to offer value and variety to our customers at various price points. Europe
In Europe, comparable sales were flat, while comparable guest counts declined 1.5%, as persistently low consumer confidence continued to negatively affect the IEO segment. Comparable sales results reflected positive performance in the U.K. and Russia, which were mostly offset by weak performance in Germany, where we are working on rebuilding brand relevance to address the current negative guest count trend.
In 2013, we remained focused on growing the business by emphasizing value menu enhancements, premium menu additions, limited-time offers and expansion of the breakfast daypart. We also successfully launched blended ice beverages in the U.K., which positively contributed to results.
In order to continue providing a relevant, contemporary customer experience, Europe completed about 470 restaurant reimages during the year. By the end of 2013, nearly 100% of restaurant interiors and 80% of exteriors were modernized. We increased our accessibility and convenience by opening 312 new restaurants, extending operating hours and optimizing our drive-thrus. We enhanced our value offerings in certain markets with multiple pricing tiers across our menu to appeal to a broad range of customers. For example, in France we launched the Casse-Croûte, a two-item meal for 4.50 Euro, which positively contributed to recent results in that market.
In APMEA, comparable sales declined 1.9% and comparable guest counts declined 3.8%. Our three largest markets experienced negative comparable sales, with Japan having the most significant impact. Though the challenges differ across the segment, overall performance was pressured amid slower economic growth, a highly competitive environment focused primarily on value, and issues such as Avian influenza in a few markets. In addition, softer than expected performance of new products and promotions did not overcome negative guest count trends. Throughout the segment, we focused on accelerating growth across all dayparts, with particular emphasis on dinner and the expansion of breakfast. APMEA held a National Breakfast Day, during which five thousand restaurants gave away five million Egg McMuffins to promote breakfast in the segment. We were also committed to enhancing local relevance with consumers, by balancing our global core menu with locally-relevant food and beverage choices, which included new flavor profiles designed to match local tastes.
We continued to make progress in our reimaging program, completing about 240 restaurant reimages during the year. By the end of 2013, over 65% of restaurant interiors and over 55% of exteriors were modernized.
We opened 731 new restaurants, including 275 in China. We deployed our convenience initiatives to more restaurants, including dessert kiosks, delivery service, drive-thrus and extended hours. In addition, we continued to evolve our everyday value platform by including more affordable menu options and promotional offers across dayparts and price points.

McDonald's Corporation 2013 Annual Report 11

Consolidated Operating Results
Globally, our approach to offering variety and value across the menu to our customers is complemented by a focus on driving operating efficiencies, and leveraging our scale and supply chain infrastructure to manage costs. In 2013, we maintained a full-year combined operating margin of 31.2%, as we grew revenues 2% and managed our expenses.
We continued our long-standing commitment to fiscal discipline and maintained a strong financial foundation. Cash from operations benefits from our heavily franchised business model as the rent and royalty income we receive from franchisees provides a stable revenue stream that has relatively low costs. In addition, the franchise business model is less capital intensive than the Company-owned model. We believe locally-owned and operated restaurants are important to McDonald's being not just a global brand, but also a locally-relevant one.
In 2013, cash from operations was $7.1 billion. Our substantial cash flow, strong credit rating and continued access to credit provided us flexibility to fund capital expenditures as well as return cash to shareholders. Capital expenditures of approximately $2.8 billion were invested in our business, of which more than half was devoted to new restaurant openings and the remainder was reinvested in our existing restaurants. Across the System, 1,438 restaurants were opened and over 1,500 existing locations were reimaged.
We continued to return all free cash flow (cash from operations less capital expenditures) to shareholders, and in 2013 returned $4.9 billion to shareholders consisting of $3.1 billion in dividends and $1.8 billion in share repurchases.
? Global comparable sales increased 0.2% and comparable guest counts declined 1.9%.

? Consolidated revenues increased 2% (2% in constant currencies).

? Consolidated operating income increased 2% (3% in constant currencies).

? Diluted earnings per share was $5.55, an increase of 4% (4% in constant currencies).

? Cash provided by operations was $7.1 billion.

? One-year ROIIC was 11.4% and three-year ROIIC was 20.2% for the period ended December 31, 2013.

? The Company increased the quarterly cash dividend per share 5% to $0.81 for the fourth quarter, equivalent to an annual dividend of $3.24 per share.

? The Company returned $4.9 billion to shareholders through dividends and share repurchases.

We are focused on delivering great-tasting, high-quality, affordable food and beverages and an exceptional experience for our customers. By leveraging our competitive advantages, we are well-positioned to pursue the long-term opportunities that exist in the over $1 trillion IEO segment.
We do not expect significant changes in market dynamics in 2014 given modest growth projections for the IEO segment. We will remain focused on matters within our control, with the customer as our first priority. We plan to strengthen our relationship with the customer through better restaurant execution and by further leveraging consumer insights in our efforts to optimize current initiatives for greater relevance and broader consumer reach.

We remain committed to adapting to keep pace with evolving customer needs and investing today to meet future demand. In addition, we are prioritizing our near-term efforts on improving performance in key opportunity markets that are significant contributors to consolidated results. These include Germany, Japan and the U.S., which have experienced weak or negative performance. We will continue to execute against our three global growth priorities to optimize our menu, modernize the customer experience and broaden accessibility to Brand McDonald's.
Our focus will be on our core classics, as well as menu items in the beef, chicken, breakfast and beverages categories, where we believe there is the most growth opportunity relative to other categories in the industry. In addition, we plan to introduce new ingredients and greater choice to broaden the appeal of our menu.
We will enhance the customer experience by continuing to reimage our building interiors and exteriors, expand our service offerings and develop our digital strategies. At the same time, we remain committed to Quality, Service and Cleanliness, which is foundational to everything we do in the restaurants. To broaden our accessibility, we plan to expand through geographically diversified new restaurant development, extend hours in more restaurants, improve the efficiency of our drive-thrus and provide more delivery service and dessert kiosks. In addition, we will continue to evolve our value platform, offering more choices at every price tier.
Furthermore, McDonald's is committed to growing our business sustainably and making a positive difference in society. Our key areas of focus include improving customer perceptions of our food, sustainable sourcing, providing job opportunities and training for our people, developing environmentally efficient restaurants and having a positive impact in the communities we serve. U.S.
In 2014, the U.S. will make adjustments designed to regain momentum, including providing greater customer relevance and better restaurant execution. Our 2014 menu strategies better balance affordability, core products, new choices and limited-time offers. We will also adjust the pace of product introductions to improve restaurant operations and marketing execution in order to provide a better customer experience. These initiatives are complemented by a consistent focus on core equities, such as breakfast. We will enhance the breakfast experience by emphasizing coffee through high-quality McCafé products paired with delicious foods - both existing and new. Bold new flavor extensions will be introduced to build upon our core and lay the groundwork for future innovations. We plan to open about 250 new restaurants and to continue our reimaging program by updating approximately 300 existing restaurants in 2014, a slightly slower pace as we prioritize other kitchen investments. Europe
In Europe, we plan to optimize the menu through value menu enhancements, premium menu additions and limited-time offers, and will continue to expand the breakfast daypart by leveraging our strong foundation in coffee. In addition, following the U.K.'s successful rollout of McCafé smoothies and frappés, we anticipate about 4,500 restaurants in Europe will have the blended-ice platform by the end of 2014.
To modernize the way we interact with our customers, we plan to leverage the use of technology, such as self-order kiosks and mobile and web ordering. We will focus on broadening accessibility by continuing to extend operating hours, optimizing drive-thrus, and expanding everyday value platforms. We plan to open over 300 new restaurants and reimage approximately 400 existing restaurants in 2014.

12 McDonald's Corporation 2013 Annual Report

In 2014, APMEA's growth opportunities include menu variety, convenience, value evolution and restaurant expansion. We will balance core and limited-time offers and execute a series of exciting food events. APMEA will shift existing value platforms toward more compelling offers that resonate with customers and generate incremental visits, including "mid-tier" options to fill the gap between entry-level options and Extra Value Meals. Our efforts around reimaging will continue as we expect to modernize approximately 400 existing restaurants. Our plan is to open around 800 new restaurants, with about 300 expected in China. In addition, we will evolve our franchising strategy to include more conventional franchisees and developmental licensees, enabling an increased pace of development and enhanced profitability. Consolidated
In making capital allocation decisions, our goal is to make investments that elevate the McDonald's experience and drive sustainable long-term growth in sales and market share. We focus on markets that generate strong returns or have opportunities for long-term growth. We remain committed to returning all of our free cash flow (cash from operations less capital expenditures) to shareholders over the long-term via dividends and share repurchases.
McDonald's does not provide specific guidance on diluted 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 2014 Systemwide sales growth (in constant currencies), most of which will be due to the 949 net restaurants (1,098 net traditional openings less 149 net satellite closings) added in 2013.

? 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 change in comparable sales for either the U.S. or Europe would change 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 2014, the total basket of goods cost is expected to increase 1.0-2.0% in the U.S. and Europe.

? The Company expects full-year 2014 selling, general and administrative expenses to increase approximately 8% in constant currencies, with fluctuations expected between the quarters. The increase is primarily due to the impact of below target 2013 incentive-based compensation, expenses associated with our Worldwide Owner/Operator Convention and sponsorship of the Winter Olympic games, and costs related to other initiatives.

? Based on current interest and foreign currency exchange rates, the Company expects interest expense for the full year 2014 to increase approximately 5-7% compared with 2013.

? A significant part of the Company's operating income is generated outside the U.S., and about 40% 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 2014 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 2014 to be between $2.9 - $3.0 billion. Over half of this amount will be used to open new restaurants. The Company expects to open about 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 1,000 - 1,100 restaurants. The remaining capital will be used to reinvest in existing locations, in part through reimaging. Over 1,000 restaurants worldwide are expected to be reimaged, including locations in affiliated and developmental licensee markets that require no capital investment from the Company.

? The Company expects to return approximately $5 billion to shareholders through dividends and share repurchases in 2014.

                                    McDonald's Corporation 2013 Annual Report 13

Consolidated Operating Results
Operating results
                                                        2013                             2012              2011
Dollars and shares in millions,                    Increase/                        Increase/
except per share data                  Amount     (decrease)            Amount     (decrease)            Amount
Sales by Company-operated
restaurants                          $ 18,875              1 %        $ 18,603              2 %        $ 18,293
Revenues from franchised
restaurants                             9,231              3             8,964              3             8,713
Total revenues                         28,106              2            27,567              2            27,006
Operating costs and expenses
Company-operated restaurant
expenses                               15,579              2            15,224              3            14,838
Franchised restaurants-occupancy
expenses                                1,624              6             1,527              3             1,481
Selling, general &
administrative expenses                 2,386             (3 )           2,455              3             2,394
Other operating (income)
expense, net                             (247 )           (2 )            (244 )           (3 )            (237 )
Total operating costs and
expenses                               19,342              2            18,962              3            18,476
Operating income                        8,764              2             8,605              1             8,530
Interest expense                          522              1               517              5               493
Nonoperating (income) expense,
net                                        38            n/m                 9            (64 )              25
Income before provision for
income taxes                            8,204              2             8,079              1             8,012
. . .
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