McDonaldโs Corporation is an American operator and franchisor of fast food restaurants represented worldwide and the biggest fast food company in the world.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
OR
Commission File Number 1-5231
MCDONALD’S CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
(630) 623-3000
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark 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 þ No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
1,257,205,376
(Number of shares of common stock
outstanding as of September 30, 2004)
McDONALD’S CORPORATION
INDEX
Part I.
Financial Information
Item 1 -
Item 2 -
Item 3 -
Item 4 -
Part II.
Other Information
Item 5 -
Item 6 -
Signature
Exhibits
2
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEET
(unaudited)
September 30,2004
Assets
Current assets
Cash and equivalents
Accounts and notes receivable
Inventories, at cost, not in excess of market
Prepaid expenses and other current assets
Total current assets
Other assets
Investments in and advances to affiliates
Goodwill, net
Miscellaneous
Total other assets
Property and equipment
Property and equipment, at cost
Accumulated depreciation and amortization
Net property and equipment
Total assets
Liabilities and shareholders’ equity
Current liabilities
Accounts payable
Dividend payable
Income taxes
Other taxes
Accrued interest
Accrued restructuring and restaurant closing costs
Accrued payroll and other liabilities
Current maturities of long-term debt
Total current liabilities
Long-term debt
Other long-term liabilities and minority interests
Deferred income taxes
Shareholders’ equity
Preferred stock, no par value; authorized – 165.0 million shares; issued – none
Common stock, $.01 par value; authorized – 3.5 billion shares; issued – 1,660.6 million
Additional paid-in capital
Unearned ESOP compensation
Retained earnings
Accumulated other comprehensive income (loss)
Common stock in treasury, at cost; 403.4 and 398.7 million shares
Total shareholders’ equity
Total liabilities and shareholders’ equity
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
Quarters Ended
September 30
Nine Months Ended
Revenues
Sales by Company-operated restaurants
Revenues from franchised and affiliated restaurants
Total revenues
Operating costs and expenses
Company-operated restaurant expenses
Franchised restaurants – occupancy expenses
Selling, general, and administrative expenses
Other operating expense, net
Total operating costs and expenses
Operating income
Interest expense
Nonoperating expense, net
Income before provision for income taxes
and cumulative effect of accounting change
Provision for income taxes
Income before cumulative effect of accounting change
Cumulative effect of accounting change, net of tax benefit of $9.4
Net income
Per common share:
Cumulative effect of accounting change
Per common share–diluted:
Dividends declared per common share
Weighted average shares
Weighted average shares–diluted
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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Operating activities
Adjustments to reconcile to cash provided by operations
Depreciation and amortization
Changes in working capital items
Other
Cash provided by operations
Investing activities
Property and equipment expenditures
Purchases and sales of restaurant businesses and sales of property
Cash used for investing activities
Financing activities
Notes payable and long-term financing issuances and repayments
Treasury stock purchases
Stock option exercises
Cash used for financing activities
Cash and equivalents increase
Cash and equivalents at beginning of period
Cash and equivalents at end of period
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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, 2003 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 nine months ended September 30, 2004 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.
Change in Accounting Standard
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 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 noncash 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. There is not a material effect to the Company’s ongoing results of operations or financial position as a result of adopting SFAS No. 143.
Comprehensive Income
The following table presents the components of comprehensive income for the quarters and nine months ended September 30, 2004 and 2003:
Other comprehensive income (loss):
Foreign currency translation adjustments
Deferred hedging adjustments
Total other comprehensive income (loss)
Total comprehensive income
Accrued Restructuring and Restaurant Closing Costs
In 2003 and 2002, the Company recorded certain charges primarily related to the disposition of certain non-McDonald’s brands, restaurant closings, restructuring markets and eliminating positions. The Company made cash payments of $7.8 million during the third quarter and $36.0 million during the nine months ended September 30, 2004, primarily related to lease obligations. The remaining balance of $79.7 million at September 30, 2004 primarily related to lease obligations.
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-based employee compensation, calculated using the treasury stock method, of 11.7 million shares and 9.5 million shares for the third quarter 2004 and 2003, respectively, and 12.5 million shares and 5.0 million shares for the nine months ended September 30, 2004 and 2003, respectively. Stock options that were not included in diluted weighted-average shares because they would have been antidilutive were 83.5 million shares and 159.1 million shares for the third quarter 2004 and 2003, respectively, and 90.0 million shares and 167.1 million shares for the nine months ended September 30, 2004 and 2003, respectively.
Stock-Based Compensation
The Company accounts for all stock-based compensation as prescribed by Accounting Principles Board Opinion No. 25. The Company discloses pro forma net income and net income per common share, as provided by Statement of Financial Accounting Standards (SFAS) No. 123, as amended by SFAS No. 148,Accounting for Stock-Based Compensation.
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The pro forma information was 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.
Net income, as reported
Add: Total stock-based employee compensation included
in reported net income, net of related tax effects
Deduct: Total stock-based employee compensation
expense determined under fair value method for all
awards, net of related tax effects
Pro forma-net income
Net income per share:
As reported-basic
Pro forma-basic
As reported-diluted
Pro forma-diluted
Segment Information
The Company primarily operates and franchises McDonald’s restaurants in the food service industry. In addition, the Company operates certain non-McDonald’s brands that are not material to the Company’s overall results.
The following table presents the Company’s revenues and operating income by geographic segment. The APMEA segment represents McDonald’s restaurant operations in Asia/Pacific, the Middle East and Africa. The Other segment represents non-McDonald’s brands.
U.S.
Europe
APMEA
Latin America
Canada
Operating income (loss)
Corporate
Total operating income
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Description of Business
The Company primarily operates and franchises McDonald’s restaurants. In addition, the Company operates certain non-McDonald’s brands that are not material to the Company’s overall results. Of the more than 30,000 McDonald’s restaurants in over 100 countries, more than 8,000 are operated by the Company, approximately 18,000 are operated by franchisees and about 4,000 are operated by affiliates under license agreements. In general, the Company owns the land and building or secures long-term leases for restaurant sites regardless of who operates the restaurant. This ensures long-term occupancy rights and helps control related costs.
Revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees and affiliates. These fees primarily include rent, service fees and/or royalties that are based on a percent of sales, with specified minimum rent payments. Fees vary by type of site, amount of Company investment and local business conditions. These fees, along with occupancy and operating rights, are stipulated in franchise agreements that generally have 20-year terms.
The business is managed as distinct geographic segments: United States; Europe; Asia/Pacific, the Middle East and Africa (APMEA); Latin America; and Canada. In addition, throughout this report we present a segment entitled “Other” that includes non-McDonald’s brands. The U.S. and Europe segments account for approximately 70% of total revenues.
Strategic Direction
In early 2003, the Company introduced a comprehensive revitalization plan to increase McDonald’s relevance to today’s consumers as well as improve our financial discipline. We redefined our strategy to emphasize growth through adding more customers to existing restaurants. In line with this, we took a more disciplined approach to capital allocation and put a greater emphasis on controlling expenses. We aligned the System around our customer-focused Plan to Win, designed to deliver operational excellence and leadership marketing. This Plan contains aggressive goals and measures for success based on the five drivers of exceptional customer experiences—people, products, place, price and promotion.
In 2003, we made significant progress in operational excellence and leadership marketing. We also made progress from a financial perspective. We improved our comparable sales and Company-operated margin trends, reduced capital expenditures by $700 million, paid down about $900 million of debt, bought back stock and increased the dividend by 70%.
The progress has continued into 2004. We are focused on providing better service; further enhancing our food taste, menu variety and value offerings; and creating more relevant marketing. The Company has fortified its foundation and is positioned for future growth. We continue to exercise strong financial discipline by managing costs and using our significant and growing cash flow to invest in the business and strengthen our balance sheet. We continue to pay down debt and plan to return at least $1.3 billion to shareholders during the year through share repurchases and dividends.
For each quarter of 2004, McDonald’s increased customer visits, improved margins and delivered double-digit growth in earnings per share.
In the U.S., results were strong, especially in the face of increasingly difficult year-over-year comparisons. Our U.S. business has now posted comparable sales increases along with meaningful margin expansion for six consecutive quarters.
In Europe, high unemployment and low consumer confidence in Germany continue to negatively impact our growth and we expect these challenges to continue to impact our performance in the near-term. We are leveraging the strengths of our everyday value offerings to attract more consumers in this challenging economic environment. In the U.K., we are starting to make progress renewing consumer excitement in our Brand with enhanced food taste and variety and improved service.
For McDonald’s Asia/Pacific, Middle East and Africa segment comparable sales trends were strong in 2004, driven by efforts in Japan, Australia and China to distinguish our Brand through added value and menu variety.
Looking ahead, we will continue to face difficult sales comparisons as well as economic challenges in some key markets outside the U.S. Yet, we remain confident that our initiatives will continue to generate solid results and build on the foundation established last year.
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Our goal is to strengthen our business in the near term and to deliver sustainable growth and returns over the long term. For 2005 and beyond, we are targeting average annual Systemwide sales and revenue growth of 3 percent to 5 percent, average annual operating income growth of 6 percent to 7 percent, and annual returns on incremental invested capital in the high teens. These targets exclude the impact of foreign currency translation.
Operating Highlights Included:
Outlook
The Following Definitions Apply to These Terms as Used Throughout This Form 10-Q:
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Forward-Looking Statements
A number of factors can affect our business, including the effectiveness of operating initiatives and changes in global and local business and economic conditions. These and other risks are noted in the Forward-Looking Statements at the end of Management’s Discussion and Analysis.
CONSOLIDATED OPERATING RESULTS
Quarter Ended
September 30, 2004
n/m Not meaningful
10
Net Income and Diluted Net Income Per Common Share
For the quarter, net income increased $231.0 million or 42%, and diluted income per common share increased $0.18 or 42%.
For the nine months, income before the cumulative effect of accounting changes increased $498.1 million or 36%, and diluted income per common share before the cumulative effect of accounting change increased $0.40 or 37%. Net income, including the cumulative effect of the accounting change, increased $534.9 million or 40% and diluted net income per common share increased $0.43 or 41%.
Diluted weighted average shares outstanding were lower for both periods compared with the prior year due to shares repurchased partially offset by higher dilution from outstanding stock options.
Cumulative Effect of Accounting Change
First quarter 2003 included a noncash charge of $36.8 million after tax ($0.03 per diluted share) for the cumulative effect of an accounting change that impacted lease obligations in certain international markets. See change in accounting standard note on page 6 for further discussion of this charge.
Impact of Foreign Currency Translation on Reported Results
IMPACT OF FOREIGN CURRENCY TRANSLATION ON REPORTED RESULTS
Dollars in millions
Quarters Ended September 30,
Combined operating margins*
Selling, general & administrative expenses
Net income per common share – diluted
Nine Months Ended September 30,
Income before cumulative effect of accounting change –
per diluted common share
Foreign currency translation had a positive impact on the growth rates of consolidated revenues, operating income and earnings per share for the quarter and nine months, primarily due to the strengthening of the Euro and British Pound.
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REVENUES
Company-operated sales
Total
Franchised and affiliated revenues
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In the U.S., the increase in revenues for the quarter and nine months is due to alignment, focus and discipline behind delivering menu variety, choice and value, better tasting food, more convenient hours, stronger marketing and improved service. Franchised and affiliated revenues increased at a higher rate than Company-operated sales for both periods due to a higher percentage of franchised restaurants in 2004 compared with 2003. We remain confident that our combination of initiatives will continue to generate solid results and build on the foundation established last year.
In Europe, the increase in revenues for both periods was due to strong comparable sales in Russia, which is entirely Company-operated, positive comparable sales in France and the U.K and expansion. Germany’s poor performance had a negative impact on the quarter.
In APMEA, the increase in revenues for the quarter and nine months was primarily due to strong performance in China and Australia as well as positive comparable sales in many other markets.
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The following table presents the percent change in comparable sales for the quarters and nine months ended September 30, 2004 and 2003:
McDonald’s Restaurants
* Excludes non-McDonald’s brands.
The following table presents Systemwide sales growth rates for the quarter and nine months ended September 30, 2004:
Other*
Total sales
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Operating Margins
COMPANY-OPERATED AND FRANCHISED RESTAURANT MARGINS –
McDONALD’S RESTAURANTS
Company-operated
Franchised
Combined operating margin dollars increased $152.3 million or 11% for the quarter (7% in constant currencies) and $590.1 million or 16% for the nine months (11% in constant currencies). The U.S. and Europe segments accounted for approximately 85% of the combined margin dollars and more than 75% of the increases in both periods of 2004.
In the U.S., the Company-operated margin percent increased in both periods primarily due to positive comparable sales, partly offset by higher commodity costs. Commodity cost increases are expected to have less of an impact during the remainder of the year.
In Europe, the Company-operated margin percent for both periods reflected improved margin performance in Russia and weak performance in the U.K. In addition, the quarter was negatively impacted by weak sales in Germany and higher food costs as a percent of sales in our three largest markets.
In APMEA, the Company-operated margin percent for both periods reflected strong comparable sales in Australia, improved operating performance in Hong Kong and China and poor performance in South Korea. In addition, 2003 margins for both periods benefited from SARS-related sales tax relief received from the Chinese government.
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The consolidated franchised margin percent increased for both periods primarily due to strong comparable sales in the U.S., partly offset by the impact of increased rent expense in part resulting from a higher proportion of sites being leased by the Company.
The following table presents margin components as a percent of sales:
Food & paper
Payroll & employee benefits
Occupancy & other operating expenses
Total Company-operated restaurant expenses
Company-operated margins
Selling, General & Administrative Expenses
Selling, general & administrative expenses increased 4% for the quarter (2% in constant currencies) and 8% for the nine months (5% in constant currencies), primarily due to higher performance-based incentive compensation. Selling, general & administrative expenses as a percent of revenues declined from 10.5% for the nine months 2003 to 10.2% for the nine months 2004 and as a percent of Systemwide sales declined from 3.9% in 2003 to 3.8% in 2004. Selling, general & administrative expenses for the nine months of 2003 included $14 million of severance costs, primarily associated with streamlining restaurant development functions, and $11 million of incremental marketing.
Other Operating (Income) Expense, Net
OTHER OPERATING (INCOME) EXPENSE, NET
Gains on sales of restaurant businesses
Equity in earnings of unconsolidated affiliates
Other expense
For the nine months, equity in earnings of unconsolidated affiliates results increased primarily due to stronger performance in the U.S. and improved results from our Japanese affiliate. For the quarter, results were negatively impacted by a deferred tax adjustment in Japan.
Other expense for both periods of 2004 reflected higher losses on asset dispositions and lower provisions for uncollectible receivables. In addition, other expense for the nine months of 2004 included a $13 million write-off of goodwill in Thailand.
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Operating Income
OPERATING INCOME
In the U.S., operating income increased for the quarter and nine months primarily due to higher combined operating margin dollars.
In Europe, for the quarter and nine months, operating income in constant currencies benefited from strong performance in Russia and positive results in France, but were negatively impacted by weak results in the U.K. Results in Germany had a negative impact on the quarter but benefited the nine months. We expect the economic challenges in Germany to continue to impact our performance in the near-term.
In APMEA, operating income in constant currencies for both periods benefited from Australia’s performance as well as improved performance in Hong Kong and China, partially offset by poor performance in South Korea. Third quarter 2003 included the sales tax relief benefit in China, which negatively impacted APMEA’s 2004 quarterly operating income growth rate by 5 percentage points. In addition, the nine months included the goodwill write-off in Thailand.
In Latin America, both periods of 2003 reflected significantly higher provisions for uncollectible receivables.
INTEREST, NONOPERATING EXPENSE AND INCOME TAXES
Interest expense decreased for the quarter and nine months due to lower average interest rates and debt levels, partly offset by stronger foreign currencies.
Nonoperating expense decreased for the quarter primarily due to a loss on the early extinguishment of debt in 2003 as well as higher interest income in 2004.
The effective income tax rate was 22.6% for third quarter 2004 and 28.5% for the nine months 2004 compared with 33.5% for both periods in 2003. The lower income tax rates in 2004 were primarily due to a transfer of shares between subsidiaries and a change in assumptions about the utilization of certain loss carryforwards. These items primarily impact 2004.
CASH FLOWS AND FINANCIAL POSITION
The Company generates significant cash from operations and has substantial available credit capacity to fund operating spending and discretionary spending such as capital expenditures, debt repayments, dividends and share repurchases.
17
Cash provided by operations totaled $2,956.2 million and exceeded capital expenditures by $2,160.7 million for the nine months. Cash provided by operations increased $688.0 million due to strong operating results, primarily in the U.S., and changes in working capital, partly offset by higher income tax payments.
Cash used for investing activities totaled $744.7 million for the nine months, a decrease of $160.4 million due to lower capital spending and lower purchases of restaurant businesses. Capital expenditures decreased $82.5 million or 9% for the nine months primarily due to lower restaurant openings in 2004 and timing of expenditures related to remodels.
Cash used for financing activities totaled $1,147.4 million for the nine months, an increase of $101.3 million primarily due to higher share repurchases, partly offset by higher proceeds from stock options exercised.
Debt obligations at September 30, 2004 totaled $8,863.3 million compared with $9,730.5 million at December 31, 2003. The decrease in 2004 was due to net repayments of $779.7 million, the impact of changes in exchange rates on foreign currency-denominated debt of $59.3 million and SFAS No. 133 noncash fair value adjustments of $28.2 million.
As a result of the above activity, the Company’s cash balance increased $1,064.1 million from December 31, 2003 to $1,556.9 million at September 30, 2004. For the full year, the Company expects capital expenditures to be approximately $1.5 billion to $1.6 billion, debt repayments to be approximately $800 million to $900 million and to return at least $1.3 billion to shareholders through dividends ($0.55 per share or $691 million payable December 1, 2004) and share repurchases.
RESTAURANT INFORMATION
The following table presents restaurant information by ownership type:
Restaurants at September 30,
Operated by franchisees
Operated by the Company
Operated by affiliates
Systemwide restaurants
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.
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, 2003 regarding this matter.
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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 September 30, 2004. 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 September 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
The following table presents information related to repurchases of common stock the Company made during the three months ended September 30, 2004.
Issuer Purchases of Equity Securities
Period
July 1-31, 2004
August 1-31, 2004
September 1-30, 2004
Item 6. Exhibits
Exhibit Number
Description
19
20
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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.
(Registrant)
November 5, 2004
/s/ Matthew H. Paull
Matthew H. Paull
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