McDonaldโs Corporation is an American operator and franchisor of fast food restaurants represented worldwide and the biggest fast food company in the world.
UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
Commission File Number 1-5231
McDONALD'S CORPORATION (Exact Name of Registrant as Specified in Its Charter)
Indicate by check ü whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes ý No o
Indicate by check ü whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).Yes ý No o
McDONALD'S CORPORATION
INDEX
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PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEET
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Basis of Presentation
The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements contained in the Company's December 31, 2002 Annual Report on Form 10-K. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been included. The results for the quarter and six months ended June 30, 2003 do not necessarily indicate the results that may be expected for the full year.
The results of operations of restaurant businesses purchased and sold were not material to the condensed consolidated financial statements for periods prior to purchase and sale.
Comprehensive Income
The following table presents the components of comprehensive income for the quarters and six months ended June 30, 2003 and 2002:
Restructuring and Restaurant Closing Costs
In second quarter 2003, the Company recorded a $14.0 million pretax charge in selling, general and administrative expenses for severance and other employee-related costs, in connection with streamlining restaurant development functions.
In first quarter 2002, the Company recorded $43.0 million (pre and after tax) of asset impairment charges in other operating expense, primarily related to the impairment of assets in certain existing restaurants in Chile and other Latin American markets and the closing of 32 underperforming restaurants in Turkey, as a result of continued economic weakness.
In fourth quarter 2002, the Company recorded $810.2 million of pretax charges ($656.9 million after tax) primarily related to: restructuring certain markets in the Middle East and Latin America; eliminating approximately 600 positions; reallocating resources and consolidating certain home office facilities; management's decision to close 719 underperforming restaurants primarily in the U.S. and Japan; and the write-off of software development costs.
The following table presents the activity included in accrued restructuring and restaurant closing costs in the Condensed consolidated balance sheet.
Per Common Share Information
Diluted net income per common share is calculated using net income divided by diluted weighted-average shares. Diluted weighted-average shares include weighted-average shares outstanding plus the dilutive effect of stock options, calculated using the treasury stock method, of 5.0 million shares and 17.4 million shares for the second quarter 2003 and 2002, respectively, and 1.9 million shares and 16.1 million shares for the six months ended June 30, 2003 and 2002, respectively. Stock options that were not included in diluted weighted-average shares because they would have been antidilutive were 163.8 million shares and 71.0 million shares for the second quarter 2003 and 2002, respectively, and 185.1 million shares and 91.9 million shares for the six months ended June 30, 2003 and 2002, respectively.
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Stock-Based Compensation
The Company accounts for stock options as prescribed by Accounting Principles Board Opinion No. 25 and includes pro forma information, as provided by Statement of Financial Accounting Standards (SFAS) No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation.
Pro forma net income and net income per common share were determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value of these options was estimated at the date of grant using an option pricing model. The model was designed to estimate the fair value of exchange-traded options that, unlike employee stock options, can be traded at any time and are fully transferable. In addition, such models require the input of highly subjective assumptions including the expected volatility of the stock price. For pro forma disclosures, the options' estimated fair value was amortized over their vesting period.
Variable Interest Entities
Prior to June 2003, the Company and six unaffiliated companies that supply the "McDonald's System" (McDonald's franchisees, suppliers and the Company) were equal owners of System Capital Corporation (SCC). In June 2003, the Company sold its share of SCC back to SCC. SCC's purpose is to provide funding to the McDonald's System and to build equity within SCC that will benefit the McDonald's System. The Company has determined that it is not required to consolidate or disclose information about SCC in accordance with Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities.
Changes in Accounting Standards
Asset retirement obligations — 2003
Effective January 1, 2003, the Company adopted SFAS No. 143, Accounting for Asset Retirement Obligations. The Statement requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, the cost is capitalized as part of the related long-lived asset and allocated to expense over the useful life of the asset. In first quarter 2003, the Company recorded a charge of $36.8 million after tax ($0.03 per diluted share) related to lease obligations in certain international markets to reflect the cumulative effect of this accounting change. The adoption of the new rule will not have a material effect on the Company's ongoing results of operations or financial position.
Goodwill — 2002
Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which eliminates the amortization of goodwill (and intangible assets deemed to have indefinite lives) and instead subjects it to annual impairment tests. The Company performed the initial required goodwill impairment test as of January 1, 2002, and recorded a charge of $98.6 million after tax ($0.08 per diluted share) in first quarter 2002 for the cumulative effect of this accounting change. The impaired goodwill was primarily in Argentina, Uruguay and other markets in Latin America and the Middle East, where economies had weakened significantly.
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Segment Information
The Company operates in the food service industry and primarily operates and franchises quick-service restaurant businesses under the McDonald's brand (McDonald's restaurants). The Company also operates other restaurant concepts under its Partner Brands: Boston Market, Chipotle Mexican Grill and Donatos Pizzeria.
The following table presents the Company's revenues and operating income by geographic segment. APMEA represents McDonald's restaurant operations in Asia/Pacific, the Middle East and Africa.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
OPERATING RESULTS
n/m Not meaningful
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CONSOLIDATED OPERATING RESULTS
The Company operates in the food service industry and primarily operates and franchises quick-service restaurant businesses under the McDonald's brand (McDonald's restaurants). The Company also operates other restaurant concepts under its Partner Brands.
Impact of Foreign Currencies on Reported Results
While changing foreign currencies affect reported results, McDonald's lessens exposures, where practical, by financing in local currencies, hedging certain foreign-denominated cash flows and by purchasing goods and services in local currencies. Foreign currency translation had a positive impact on the growth rates of consolidated revenue, operating income and earnings per share for the quarter and six months, primarily due to the stronger Euro and British Pound.
Information in constant currencies excludes the effect of foreign currency translation on reported results. Management reviews and analyzes business results in constant currencies and bases certain compensation plans on these results because it believes these results better represent the Company's underlying business trends.
Net Income and Diluted Net Income Per Common Share
For the quarter, net income decreased $26.6 million or 5%, and diluted net income per common share decreased $0.02 or 5%. These results included a benefit from foreign currency translation of $34.4 million in net income and $0.03 in diluted net income per common share.
For the six months, income before the cumulative effect of accounting changes decreased $14.1 million or 2%, and diluted income per common share before the cumulative effect of accounting changes was flat at $0.66. Net income, including the cumulative effect of the accounting changes, increased $47.7 million or 6% and diluted net income per common share increased $0.05 or 9%. These results included a benefit from foreign currency translation of $59.9 million in net income and $0.05 in diluted net income per common share.
Diluted weighted average shares outstanding were lower for both periods compared with the prior year due to a less dilutive effect from outstanding stock options and shares repurchased during 2002.
In June, the Company repurchased $26.0 million of its common stock.
Cumulative Effect of Accounting Changes
Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations," which requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time the obligations are incurred. In first quarter 2003, the Company recorded a charge of $36.8 million after tax ($0.03 per diluted share) related to lease obligations in certain international markets to reflect the cumulative effect of this accounting change.
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which eliminated the amortization of goodwill and instead subjects it to annual impairment tests. As a result of the initial required goodwill impairment test, the Company recorded a charge of $98.6 million after tax ($0.08 per diluted share) in first quarter 2002 to reflect the cumulative effect of this accounting change. The impaired goodwill was primarily in Argentina, Uruguay and other markets in Latin America and the Middle East, where economies had weakened significantly.
Systemwide Sales and Revenues
Systemwide sales include sales by all restaurants, whether operated by the Company, by franchisees or by affiliates operating under joint-venture agreements. Management believes that Systemwide sales information is useful in analyzing the Company's revenues because franchisees and affiliates pay rent, service fees and/or royalties that generally are based on a percent of sales with specified minimum payments. These fees received from franchisees and affiliates along with sales from Company-operated restaurants are reported as revenues.
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Systemwide sales
Systemwide sales and revenues may grow at different rates during a given period, primarily due to a change in the mix of Company-operated, franchised and affiliated restaurants. For example, this mix is impacted by purchases and sales of restaurants between the Company and franchisees. For the six months ended June 30, 2003 and 2002, Company-operated restaurants generated about 30% of Systemwide sales and about 75% of revenues.
Total revenues
Systemwide sales increased 10% for the quarter and 7% for the six months. On a global basis, the increases in Systemwide sales and revenues were due to expansion for the quarter and the six months, and positive comparable sales for the quarter. On a global basis, comparable sales were negative for the six months.
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U.S. sales increased 8% for the quarter and 4% for the six months due to positive comparable sales and expansion. Strong customer response to the new premium salads and McGriddles breakfast sandwiches, popular Happy Meals, continued everyday value and focus on improved food taste and service, all contributed to the sales increases. The strong U.S. comparable sales performance continued in July. U.S. revenues increased at a higher rate than sales for both periods due to a slightly higher percentage of Company-operated restaurants.
In Europe, constant currency sales were relatively flat for the quarter and six months as restaurant expansion offset negative comparable sales. Continued negative results in the U.K. and Germany were offset by expansion in France and strong performances in Russia and Spain. Comparable sales trends in Europe continued to be negative in July. Revenues increased at a lower rate than sales for both periods, primarily due to a higher percentage of franchised restaurants in 2003.
Constant currency sales results in APMEA declined 4% for the quarter and the six months due to negative comparable sales in most markets. The segment's decline was driven by weak results in Japan and other key markets, compounded by concerns about SARS (Severe Acute Respiratory Syndrome). We expect the impact of SARS to be less in the second half of the year.
In Latin America, constant currency sales increased 8% for the quarter and 4% for the six months, primarily due to positive comparable sales in many markets. Revenues increased at a higher rate than sales for both periods, primarily due to a higher percentage of Company-operated restaurants in 2003.
Partner Brands sales and revenues increased in both periods, due to expansion and positive comparable sales at Chipotle Mexican Grill.
Combined Operating Margins
The following combined operating margin information represents margins for McDonald's restaurant business only and excludes Partner Brands.
Combined operating margins
Combined operating margin dollars increased $98.4 million or 8% for the quarter and $80.8 million or 4% for the six months. The U.S. and Europe segments accounted for more than 80% of the combined margin dollars in both periods of 2003 and 2002.
Consolidated food & paper costs decreased as a percent of sales for both the quarter and six months, while payroll costs and occupancy & other operating expenses increased as a percent of sales for both periods.
The U.S. Company-operated margin percent increased for the quarter primarily due to positive comparable sales. As a percent of sales, food & paper costs increased, while payroll costs and occupancy & other operating expenses decreased for the quarter. The U.S. Company-operated margin percent decreased for the six months due to an increase in food & paper costs and occupancy & other operating expenses as a percent of sales, partly offset by a decrease in payroll costs as a percent of sales.
The Company-operated margin percent in Europe declined for the quarter and six months. Payroll and occupancy & other operating expenses as a percent of sales increased for both periods, partly offset for the six months by lower food and paper costs as a percent of sales.
The decline in the consolidated franchised margin percent for the quarter and six months reflects higher occupancy costs due, in part, to an increased proportion of leased sites, partly offset by positive comparable sales for the quarter.
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Selling, General & Administrative Expenses
Selling, general & administrative expenses increased 16% for the quarter and 10% for the six months partly due to approximately $14 million in severance costs, primarily associated with streamlining restaurant development functions, and $11 million of incremental U.S. marketing costs. In addition, stronger foreign currencies impacted selling, general & administrative expenses by $17.9 million for the quarter and $29.6 million for the six months, contributing to the increases.
Other Operating (Income) Expense, Net
Equity in earnings of unconsolidated affiliates decreased for the quarter and six months due to weaker results from our Japanese affiliate in 2003. Other expense increased for both periods primarily due to about $25 million of costs in the U.S. as a result of management's decision to significantly reduce capital expenditures.
Operating Income
Operating income
Consolidated operating income decreased $19.0 million or 2% for the quarter, and increased $14.3 million or 1% for the six months.
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U.S. operating income decreased 3% for the quarter and 1% for the six months. Higher combined operating margin dollars were more than offset by higher selling, general & administrative expenses and higher other operating expenses for both periods.
Europe's operating income decreased 7% for both periods in constant currencies, primarily due to continued weak results in the U.K. and Germany.
APMEA's operating income decreased 43% for the quarter and 28% for the six months in constant currencies, primarily due to continued weak results in most markets. Results for the six months 2002 include $15.9 million of asset impairment charges in Turkey.
Latin America's operating results declined significantly for the quarter and six months as most markets in the segment continue to experience difficult economic conditions. In addition, Latin America's results for the six months were negatively impacted by the national strike in Venezuela. Results for the six months 2002 include $27.1 million of asset impairment charges.
INTEREST, NONOPERATING EXPENSE AND INCOME TAXES
Interest expense increased for the quarter and six months primarily due to stronger foreign currencies.
Nonoperating expense for the quarter reflected lower foreign currency translation losses in 2003 compared with 2002, while the six months reflected higher foreign currency translation losses in 2003 compared with 2002.
The effective income tax rate for both periods in 2003 was 33.5% compared with 32.0% for second quarter 2002 and 33.0% for the six months 2002.
CASH FLOWS AND FINANCIAL POSITION
For the six months 2003, cash provided by operations totaled $1,238.0 million and exceeded capital expenditures by $617.5 million. Cash provided by operations was higher than in 2002, while capital expenditures decreased 20% for the six months primarily due to lower restaurant openings in 2003, partly offset by stronger foreign currencies. See the following OUTLOOK section for the Company's expectations regarding capital expenditures and other uses of cash from operations in 2003.
Debt obligations at June 30, 2003 totaled $9,854.0 million compared with $9,979.4 million at December 31, 2002. The decrease in 2003 is due to net payments of $390.9 million partly offset by the impact of changes in exchange rates on foreign currency-denominated debt ($231.6 million) and SFAS No. 133 noncash fair value adjustments ($33.9 million).
On July 15, 2003, the Company redeemed $200 million of 73/8% Debentures originally due 2033, at 104.635% of the principal amount plus accrued interest. The Company recognized an $11 million pretax loss in nonoperating expense on the early extinguishment of the debt in July 2003.
OUTLOOK
The information provided below is as of the date of this report and excludes any impact from changes in foreign currency exchange rates.
In 2002, the Company opened 1,363 traditional restaurants and 392 satellite McDonald's restaurants. Net of closings, worldwide restaurant additions totaled 1,015, with 781 net traditional and 234 net satellite restaurants. In 2003, the Company expects to open about 620 traditional restaurants and 340 satellite McDonald's restaurants, for a total of 960 new restaurants worldwide. Net of planned closings, worldwide restaurant additions are expected to total 360, with 200 net traditional and 160 net satellite restaurants. McDonald's expects new restaurants to add approximately one percentage point to sales growth in 2004.
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British Pound both move 10% (compared with 2002 average rates), McDonald's annual reported earnings per share would change by about 4 to 5 cents. Through year-to-date June 2003, foreign currency translation benefited diluted earnings per share by 5 cents.
FORWARD-LOOKING STATEMENTS
Certain forward-looking statements are included in this report. They use such words as "may," "will," "expect," "believe," "plan" and other similar terminology. These statements reflect management's current expectations regarding future events and operating performance and speak only as of the date of this report. These forward-looking statements involve a number of risks and uncertainties. The following are some of the factors that could cause actual results to differ materially from those expressed in or underlying our forward-looking statements: effectiveness of operating initiatives; success in advertising and promotional efforts; changes in global and local business and economic conditions, including their impact on consumer confidence; fluctuations in currency exchange and interest rates; food, labor and other operating costs; political or economic instability in local markets, including the effects of war and terrorist activities; competition, including pricing and marketing initiatives and new product offerings by the Company's competitors; consumer preferences or perceptions concerning the Company's product offerings; spending patterns and demographic trends; availability of qualified restaurant personnel; severe weather conditions; existence of positive or negative publicity regarding the Company or its industry generally; effects of legal claims; cost and deployment of capital; changes in future effective tax rates; changes in governmental regulations; and changes in applicable accounting policies and practices. The foregoing list of important factors is not all inclusive.
The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
1Return on incremental invested capital is defined as the change in operating income plus depreciation divided by the change in gross assets, and excludes the impact of changes in foreign currency exchange rates.
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SECOND QUARTER AND SIX MONTHS HIGHLIGHTS
FINANCIAL INFORMATION
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There were no material changes to the disclosure made in the Annual Report on Form 10-K for the year ended December 31, 2002 regarding this matter.
Item 4. Controls and Procedures
An evaluation was conducted under the supervision and with the participation of the Company's management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of June 30, 2003. Based on that evaluation, the CEO and CFO concluded that the Company's disclosure controls and procedures were effective as of such date to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Such officers also confirm that there was no change in the Company's internal control over financial reporting during the quarter ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II—OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
(1) In the election of directors, each nominee was elected by a vote of the shareholders as follows:
(2) The proposal to approve the appointment of independent auditors was approved by shareholders as follows:
(3) The shareholder proposal on animal welfare standards was not approved by shareholders as follows:
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Item 6. Exhibits and Reports on Form 8-K
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The following reports on Form 8-K were filed during the last quarter covered by this report, and subsequently through August 8, 2003.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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