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MCD > SEC Filings for MCD > Form 10-Q on 6-May-2014All Recent SEC Filings

Show all filings for MCDONALDS CORP

Form 10-Q for MCDONALDS CORP


6-May-2014

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 35,493 restaurants in 120 countries at March 31, 2014, 28,774 were licensed to franchisees (including 20,369 franchised to conventional franchisees, 4,833 licensed to developmental licensees and 3,572 licensed to foreign affiliates ("affiliates") - primarily Japan) and 6,719 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 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 20­year 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 quarter ended March 31, 2014, the U.S., Europe and APMEA segments accounted for 31%, 40% and 24% 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. 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 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.
For the first quarter, global comparable sales increased 0.5%, reflecting higher average check and negative comparable guest counts of 3.1%. 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.
Looking ahead, the Company expects many of the challenges faced in 2013 to persist in 2014, namely heightened competitive activity, continued consumer price sensitivity and ongoing cost pressures amid flat to modest growth projections for the IEO segment. We remain focused on matters within our control, with the customer as our first priority. Our opportunities include better restaurant execution and optimizing current initiatives for greater customer relevance and broader consumer reach. We are prioritizing our near-term efforts on improving performance in key opportunity markets that are significant contributors to consolidated results, including the U.S., Germany,


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Australia and Japan. In addition, the Company is evaluating opportunities to optimize its capital and restaurant ownership structures, as well as G&A expenditures, while maintaining its existing long-term financial strength and philosophy.
The following is a summary of our first quarter sales performance and our initiatives within the three global growth priorities by major segment.

In the U.S., first quarter 2014 comparable sales decreased 1.7%, reflecting negative comparable guest counts amid challenging industry dynamics and severe winter weather. Our priority remains building guest traffic through greater customer relevance and improved restaurant execution. In addition, we are evolving our menu strategies to enhance the breakfast experience and to better balance affordability, core products, new choices and limited-time offers. We will continue to invest in new and existing restaurants, although the pace of our reimaging program will slow slightly compared to last year as we prioritize other kitchen investments.
In Europe, first quarter 2014 comparable sales increased 1.4%, reflecting positive performance in the U.K, France and Russia, partly offset by ongoing weakness in Germany. Looking ahead, Europe remains focused on growing the business through value menu enhancements, premium menu additions and limited-time offers, and we will continue to expand the breakfast daypart by leveraging our strong foundation in coffee. In addition, we remain committed to modernizing the customer experience through our ongoing restaurant reimaging and technology initiatives, and broadening accessibility by extending operating hours, optimizing drive-thrus and opening new restaurants.
In APMEA, first quarter 2014 comparable sales increased 0.8%, benefiting from positive results in China and many other markets, somewhat offset by weakness in Japan, and to a lesser extent, Australia. To strengthen performance, APMEA is pursuing customer-focused initiatives to deliver menu variety, increased convenience and branded affordability across the segment. In addition, we are focused on restaurant expansion and modernizing the customer experience through ongoing restaurant reimaging.
First Quarter Operating Results:
• Global comparable sales increased 0.5%.

• Consolidated revenues increased 1% (3% in constant currencies).

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

• Diluted earnings per share of $1.21, decreased 4% (2% in constant currencies). Foreign currency translation negatively impacted diluted earnings per share by $0.03.

• The Company paid total dividends of $0.81 per share or $801.7 million and repurchased 4.5 million shares for $432.4 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 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%-2% 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 2014 Worldwide Owner/Operator Convention and sponsorship of the Winter Olympics, 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.


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• 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.

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. Generally, pricing has a greater impact on average check than 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, 2014
                                                            Increase/
                                                Amount     (Decrease)
Revenues
Sales by Company-operated restaurants        $ 4,490.5              1  %
Revenues from franchised restaurants           2,209.8              2
Total revenues                                 6,700.3              1
Operating costs and expenses
Company-operated restaurant expenses           3,767.1              1
Franchised restaurants-occupancy expenses        417.1              6
Selling, general & administrative expenses       620.4              4
Other operating (income) expense, net            (40.3 )           35
Total operating costs and expenses             4,764.3              2
Operating income                               1,936.0             (1 )
Interest expense                                 135.5              6
Nonoperating (income) expense, net                17.2            n/m
Income before provision for income taxes       1,783.3             (2 )
Provision for income taxes                       578.5              6
Net income                                   $ 1,204.8             (5 )%
Earnings per common share-basic              $    1.22             (4 )%
Earnings per common share-diluted            $    1.21             (4 )%


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 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
                                                                               Benefit/
                                                                                 (Cost)
Quarters Ended March 31,                          2014           2013              2014
Revenues                                     $ 6,700.3      $ 6,605.3       $     (79.5 )
Company-operated margins                         723.4          719.4             (10.4 )
Franchised margins                             1,792.7        1,764.7             (18.5 )
Selling, general & administrative expenses       620.4          596.5               2.8
Operating income                               1,936.0        1,949.5             (28.8 )
Net income                                     1,204.8        1,270.2             (29.3 )
Earnings per share-diluted                   $    1.21      $    1.26       $     (0.03 )

Foreign currency translation had a negative impact on consolidated operating results for the quarter primarily due to the weaker Australian Dollar and many other foreign currencies, including the Russian Ruble and Canadian Dollar, partly offset by the stronger Euro and British Pound.


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Net Income and Diluted Earnings per Common Share For the quarter, net income decreased 5% (3% in constant currencies) to $1,204.8 million, and diluted earnings per share decreased 4% (2% in constant currencies) to $1.21. Foreign currency translation had a negative impact of $0.03 on diluted earnings per share.
For the quarter, net income and diluted earnings per share benefited from higher restaurant margin dollars, but were negatively impacted by an increase in the effective income tax rate due to a prior year tax benefit of nearly $50 million, and higher selling, general and administrative expenses primarily due to costs related to the 2014 Winter Olympics. Diluted earnings per share also benefited from a decrease in diluted weighted average shares outstanding.
During the quarter, the Company paid a quarterly dividend of $0.81 per share or $801.7 million and repurchased 4.5 million shares of its stock for $432.4 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,           2014         2013    Inc/ (Dec)      Translation
Company-operated sales
U.S.                          $ 1,040.9    $ 1,071.7            (3 )%            (3 )%
Europe                          1,925.8      1,862.4             3                4
APMEA                           1,356.9      1,331.6             2                4
Other Countries & Corporate       166.9        179.7            (7 )              2
Total                         $ 4,490.5    $ 4,445.4             1  %             2  %
Franchised revenues
U.S.                          $ 1,013.2    $ 1,016.8             0  %             0  %
Europe                            786.4        724.0             9                4
APMEA                             261.9        262.1             0               10
Other Countries & Corporate       148.3        157.0            (6 )              8
Total                         $ 2,209.8    $ 2,159.9             2  %             3  %
Total revenues
U.S.                          $ 2,054.1    $ 2,088.5            (2 )%            (2 )%
Europe                          2,712.2      2,586.4             5                4
APMEA                           1,618.8      1,593.7             2                5
Other Countries & Corporate       315.2        336.7            (6 )              4
Total                         $ 6,700.3    $ 6,605.3             1  %             3  %

Consolidated revenues increased 1% (3% in constant currencies) for the quarter primarily due to expansion.
• In the U.S., revenues decreased for the quarter due to negative comparable sales, reflecting negative comparable guest counts amid challenging industry dynamics and severe winter weather.

• In Europe, the constant currency increase in revenues for the quarter benefited from expansion, primarily in Russia (which is almost entirely Company-operated), and positive comparable sales performance in the U.K., France and Russia, partly offset by negative results in Germany.

• In APMEA, the constant currency increase in revenues for the quarter was driven by China and other Asian markets due to positive comparable sales performance and expansion, partly offset by the impact of refranchising in Australia.


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The following table presents the percent change in comparable sales for the quarters ended March 31, 2014 and 2013:

COMPARABLE SALES
                               Increase/ (Decrease)
Quarters Ended March 31,*      2014            2013
U.S.                           (1.7 )%         (1.2 )%
Europe                          1.4            (1.1 )
APMEA                           0.8            (3.3 )
Other Countries & Corporate     6.1             5.6
Total                           0.5  %         (1.0 )%

* On a consolidated basis, comparable guest counts decreased 3.1% and 1.9% for the quarters 2014 and 2013, respectively.

The following table presents the percent change in Systemwide sales for the quarter ended March 31, 2014:

SYSTEMWIDE SALES
                                              Inc/ (Dec)
                                               Excluding
                                                Currency
Quarter Ended March 31, 2014 Inc/ (Dec)      Translation
U.S.                                 (1 )%            (1 )%
Europe                                7                4
APMEA                                (2 )              5
Other Countries & Corporate          (6 )             10
Total                                 1  %             3  %

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
                                                                           Inc/ (Dec)
                                                                            Excluding
                                                                             Currency
Quarters Ended March 31,            2014          2013    Inc/ (Dec)      Translation
U.S.                          $  7,338.1    $  7,376.6            (1 )%            (1 )%
Europe                           4,402.2       4,064.6             8                4
APMEA                            3,108.8       3,236.6            (4 )              6
Other Countries & Corporate      1,867.6       1,978.0            (6 )             11
Total*                        $ 16,716.7    $ 16,655.8             0  %             3  %

* Sales from developmental licensed restaurants and foreign affiliated markets where the Company earns a royalty based on a percent of sales totaled $3,548.5 million and $3,726.4 million for the quarters 2014 and 2013, respectively. Results were negatively impacted by the weaker Japanese Yen and Brazilian Real. 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,          2014     2013          2014          2013     Inc/ (Dec)      Translation
Franchised
U.S.                              82.5 %   82.9 %   $   836.1     $   843.2             (1 )%            (1 )%
Europe                            76.9     77.1         604.8         557.9              8                4
APMEA                             86.3     87.7         226.1         229.9             (2 )              8
Other Countries & Corporate       84.8     85.2         125.7         133.7             (6 )              8
Total                             81.1 %   81.7 %   $ 1,792.7     $ 1,764.7              2  %             3  %
Company-operated
U.S.                              17.3 %   17.4 %   $   180.1     $   186.8             (4 )%            (4 )%
Europe                            17.0     16.7         328.0         311.7              5                5
APMEA                             14.0     14.6         190.5         194.1             (2 )              2
Other Countries & Corporate       14.9     14.9          24.8          26.8             (7 )              1
Total                             16.1 %   16.2 %   $   723.4     $   719.4              1  %             2  %

Franchised margin dollars increased $28.0 million or 2% (3% in constant currencies) for the quarter primarily due to expansion.
• In the U.S., the franchised margin percent decreased for the quarter due to negative comparable sales and higher depreciation related to reimaging.

• In Europe, the franchised margin percent decreased for the quarter as positive comparable sales performance was more than offset by higher rent expense and the impact of refranchising in Germany and certain other markets.

• In APMEA, the franchised margin percent decreased for the quarter partly due to the impact of refranchising and higher rent expense in Australia. The margin percent decrease reflected a higher proportion of conventionally-franchised restaurants relative to developmentally-licensed and affiliate restaurants. While this has a dilutive effect on the franchised margin percent, it results in higher franchised margin dollars.

Company-operated margin dollars increased $4.0 million or 1% (2% in constant currencies).
• In the U.S., the Company-operated margin percent decreased slightly for . . .

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