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
For the quarterly period ended June 30, 2006
OR
For the transition period from to
Commission File Number 1-5231
McDONALD’S CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
McDonald’s Plaza
Oak Brook, Illinois
(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 x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ Nox
1,226,326,886
(Number of shares of common stock
outstanding as of June 30, 2006)
INDEX
Part I.
The following trademarks used herein are the
property of McDonald’s Corporation and its
affiliates: Boston Market, Chipotle Mexican
Grill and McDonald’s.
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PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEET
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
Notes payable
Accounts payable
Income taxes
Other taxes
Accrued interest
Accrued payroll and other liabilities
Current maturities of long-term debt
Total current liabilities
Long-term debt
Other long-term liabilities
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 shares
Additional paid-in capital
Unearned ESOP compensation
Retained earnings
Accumulated other comprehensive income (loss)
Common stock in treasury, at cost; 434.3 and 397.4 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
June 30,
Six 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 & administrative expenses
Impairment and other charges (credits), net
Other operating expense, net
Total operating costs and expenses
Operating income
Interest expense
Nonoperating income, net
Gain on Chipotle IPO and secondary sales
Income before provision for income taxes
Provision for income taxes
Net income
Net income per common share–basic
Net income per common share–diluted
Weighted average shares outstanding–basic
Weighted average shares outstanding–diluted
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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Operating activities
Adjustments to reconcile to cash provided by operations
Noncash charges and credits:
Depreciation and amortization
Income taxes audit benefit
Share-based compensation
Other
Changes in working capital items
Cash provided by operations
Investing activities
Property and equipment expenditures
Purchases and sales of restaurant businesses and sales of property
Sale of Chipotle shares, net
Cash used for investing activities
Financing activities
Notes payable and long-term financing issuances and repayments
Treasury stock purchases
Proceeds from stock option exercises
Excess tax benefit on share-based compensation
Chipotle IPO proceeds, net
Cash used for financing activities
Cash and equivalents increase (decrease)
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, 2005 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, 2006 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.
Recently Issued Accounting Standards
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, which is an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company expects to adopt this interpretation effective January 1, 2007, as required. We cannot reasonably estimate the impact of this Interpretation at this time.
In June 2006, the FASB ratified Emerging Issues Task Force (EITF) Issue 06-2, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences (EITF 06-2). Under EITF 06-2, compensation costs associated with a sabbatical should be accrued over the requisite service period, assuming certain conditions are met. The Company expects to adopt EITF 06-2 effective January 1, 2007, as required. We cannot reasonably estimate the impact of this Issue at this time.
Comprehensive Income
The following table presents the components of comprehensive income for the quarters and six months ended June 30, 2006 and 2005:
Other comprehensive income (loss):
Foreign currency translation adjustments
Deferred hedging adjustments
Total other comprehensive income (loss)
Total comprehensive income
Per Common Share Information
Diluted net income per common share is calculated using net income divided by diluted weighted average shares outstanding. Diluted weighted average shares outstanding include weighted average shares outstanding plus the dilutive effect of share-based employee compensation, calculated using the treasury stock method, of 12.9 million shares and 10.2 million shares for the second quarter 2006 and 2005, respectively, and 14.9 million shares and 15.5 million shares for the six months ended June 30, 2006 and 2005, respectively. Stock options that were not included in diluted weighted average shares outstanding because they would have been antidilutive were 41.8 million shares and 48.1 million shares for the second quarter 2006 and 2005, respectively, and 42.2 million shares and 46.5 million shares for the six months ended June 30, 2006 and 2005, respectively.
Share-based Compensation
Second quarter 2006 results include pretax expense of $27.5 million related to share-based compensation (stock options and restricted stock units (RSUs)) compared with $35.8 million in second quarter 2005. For the six months 2006, results include pretax expense of $66.4 million related to share-based compensation compared with $83.9 million in the six months 2005. For the full year 2006, the Company expects pretax share-based compensation expense to be approximately $125 million compared with $154.1 million in 2005.
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Gain on Chipotle IPO and Secondary Sales
In first quarter 2006, Chipotle Mexican Grill (Chipotle) completed an IPO of 6.1 million shares resulting in net proceeds of $120.9 million to Chipotle and a gain to McDonald’s of $32.0 million to reflect an increase in the carrying value of the Company’s investment as a result of Chipotle selling shares in the public offering. Concurrently with the IPO, McDonald’s sold 3.0 million Chipotle shares, resulting in net proceeds to the Company of $61.4 million and an additional gain of $19.2 million. In second quarter 2006, McDonald’s sold an additional 4.5 million Chipotle shares, resulting in net proceeds to the Company of $267.7 million and a gain of $197.4 million, while still retaining majority ownership. In addition, the Company expects to completely separate from Chipotle by the end of October through a tax-free exchange of Chipotle shares for McDonald’s stock, subject to market conditions.
Segment Information
The Company primarily franchises and operates 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, 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
The Company primarily franchises and operates 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 18,000 are operated by franchisees/licensees, over 4,000 are operated by affiliates and over 8,000 are operated by the Company. In general, the Company owns the land and building or secures long-term leases for both Company-operated and franchised restaurant sites. This ensures long-term occupancy rights, helps control related costs and improves alignment with franchisees.
While we view ourselves primarily as a franchisor, we continually review our restaurant ownership mix (that is our mix between Company-operated, conventional franchise, joint venture or developmental license) to deliver a great customer experience and drive long-term profitability, with a focus on underperforming markets and markets where direct restaurant operation by us is less attractive due to market size, business conditions or legal considerations. Company-operated restaurants are important to our success in both mature and developing markets. In our Company-operated restaurants, along with input from our franchisees, we can develop and refine operating standards, marketing concepts and product and pricing strategies, so that we introduce Systemwide only those that we believe are most beneficial. In addition, we firmly believe that owning restaurants is paramount to being a credible franchisor. Our Company-operated business also helps to facilitate changes in restaurant ownership as warranted by strategic considerations, the financial health of franchisees or other factors.
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/license agreements that generally have 20-year terms.
The business is managed as distinct geographic segments: United States; Europe; Asia/Pacific, 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 (e.g., Boston Market and Chipotle Mexican Grill (Chipotle)). The U.S. and Europe segments account for approximately 70% of total revenues.
Strategic Direction and Financial Performance
Over the past few years, the Company has remained aligned and focused on executing the Plan to Win, a combination of customer-centric initiatives designed to deliver operational excellence and leadership marketing implemented around five drivers of exceptional customer experiences – people, products, place, price and promotion. In line with our commitment to revitalize the brand by executing the Plan to Win, we have exercised greater financial discipline, delivered against the targets laid out in our revitalization plan and achieved many significant milestones. Our resulting financial strength and substantial cash generating ability is a testament to System alignment and focus on growing our existing restaurant business. Our progress has created the opportunity to return even greater amounts of cash flow to shareholders through dividends and share repurchases after funding investments in our business that offer solid returns.
Strategic initiatives aligned behind McDonald’s Plan to Win are strengthening our competitive position and delivering positive results worldwide. Our focused and disciplined approach to executing these initiatives continued to yield outstanding results throughout the first six months of 2006. Performance for the six months reflected more customer visits and enhanced profitability as we continued to connect with our customers and increase the relevance of our brand.
In the U.S., customer-centric business initiatives drove revenue, margin and operating income growth. McDonald’s U.S. performance continues to reflect the winning combination of compelling everyday value and innovative menu options.
In Europe, the three-tiered menu that offers premium, core and everyday low-price menu selections, as well as unique promotions that celebrate Europe’s enthusiasm for events like the World Cup, strengthened McDonald’s connection with consumers. We are pleased with Europe’s improving profitability and remain intent on building upon these strong results.
In Asia/Pacific, Middle East and Africa, the Company’s ongoing commitment to everyday value balanced with premium products that appeal to local tastes contributed to the segment’s strong performance.
The Company remains focused on the core McDonald’s restaurant business as the opportunities are significant. Accordingly, McDonald’s Board of Directors approved the disposition of the Company’s remaining interest in Chipotle through a tax-free exchange of Chipotle shares for McDonald’s stock. Subject to market conditions, McDonald’s expects to file a registration statement relating to the exchange offer with the Securities and Exchange Commission in the coming weeks and anticipates that the transaction will be completed by the end of October.
We remain committed to returning value to shareholders through share repurchase and dividends. During the first six months of
2006, we bought back $1.8 billion or 53.0 million shares of McDonald’s stock.
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Overall, our strong quarterly financial performance reflects diligent execution of our fundamental business drivers. Our results confirm that our strategy of growing by improving our existing restaurants and focusing on the Plan to Win is the right strategy for McDonald’s, our customers and our shareholders. Our long-term goals remain unchanged: average annual Systemwide sales and revenue growth of 3% to 5%, average annual operating income growth of 6% to 7%, and annual returns on incremental invested capital in the high teens. These goals exclude the impact of foreign currency translation.
Operating Highlights Included:
Outlook
While the Company does not provide specific guidance on earnings per share, the following information is provided to assist in analyzing the Company’s results.
As previously announced, over the next three years, the Company will continue to pursue selling certain existing markets to developmental licensees. Under a developmental license, a local entrepreneur owns the business, including the real estate interest, and uses its capital and local knowledge to build the Brand and optimize sales and profitability over the long term. Under this arrangement, McDonald’s collects a royalty, which varies by
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market, based on a percentage of sales, but does not invest capital. We are in the process of identifying potential licensees in some markets and may complete a limited number of transactions this year. We may not recover our entire net investment in each of these markets and may therefore record impairment charges in future periods as we adjust our ownership mix. The timing and amount of any charges will depend on the circumstances of each transaction.
The Following Definitions Apply to These Terms as Used Throughout This Form 10-Q:
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CONSOLIDATED OPERATING RESULTS
Quarter Ended
June 30, 2006
% Increase /
(Decrease)
n/m Not meaningful
Net Income and Diluted Net Income per Common Share
For the quarter, net income was $834.1 million and diluted net income per common share was $0.67. The 2006 results included the following: $127.8 million after tax ($0.10 per share) of nonoperating income due to the secondary sale of Chipotle shares; $17.3 million after tax ($0.01 per share) of operating expenses primarily related to an impairment charge on the anticipated sale of a small market in Asia/Pacific, Middle East and Africa to a developmental licensee; and $13.5 million ($0.01 per share) of net incremental tax expense primarily related to the one-time impact from a tax law change in Canada. Second quarter 2005 net income was $530.4 million and diluted net income per common share was $0.42. The 2005 results included $112.0 million ($0.09 per share) of incremental tax expense resulting from the decision to repatriate approximately $3 billion in foreign earnings under HIA.
For the first six months of 2006, net income was $1,459.4 million and diluted net income per common share was $1.16. In addition to the second quarter items indicated above, results included operating expenses of $59.1 million after tax ($0.05 per share) primarily related to: a limited number of restaurant closings in the U.K. in conjunction with an overall restaurant portfolio review; costs to buy out certain litigating franchisees in Brazil, and an impairment charge on the sale of Bulgaria to a developmental licensee as well as a nonoperating gain of $45.6 million after tax ($0.04 per share) due to the IPO of Chipotle and the concurrent sale of Chipotle shares. For the first six months of 2005, net income was $1,258.3 million and diluted net income per common share was $0.98. The 2005 results included a tax benefit of $178.8 million ($0.13 per share) due to a favorable audit settlement of the Company’s 2000-2002 U.S. tax returns, in addition to the HIA tax expense recorded in the second quarter of 2005.
During the quarter, the Company repurchased 23.5 million shares for $804 million, bringing the total repurchases for the six months to 53.0 million shares or $1.8 billion.
Diluted weighted average shares outstanding for the second quarter and six months 2006 decreased primarily due to treasury stock purchases exceeding stock option exercises in 2005 and 2006.
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Impact of Foreign Currency Translation on Reported Results
IMPACT OF FOREIGN CURRENCY TRANSLATION ON REPORTED RESULTS
Dollars in millions, except per share data
Combined operating margins*
Net income per common share – diluted
Six Months Ended June 30,
Foreign currency translation had a minimal impact on consolidated revenues, operating income, net income and net income per common share for the quarter, but had a negative impact for the six months, primarily due to the weakening of the Euro.
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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.
REVENUES
Dollars in millions
Company-operated sales
APMEA*
Other**
Total
Franchised and affiliated revenues
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Consolidated revenues increased 9% for the quarter and 8% for the six months, primarily due to positive global comparable sales.
In the U.S., the increase in revenues for the quarter and six months was primarily driven by our popular breakfast menu featuring Premium Roast Coffee, new products like our Premium Chicken Sandwich line and Asian Salad, and continued focus on everyday value. In addition, Company-operated sales for both periods of 2006 benefited from restaurant ownership changes that took place since the second quarter 2005.
Europe’s constant currency increase in revenues for the quarter and six months was primarily due to strong comparable sales in France, Germany and Russia (which is entirely Company-operated). The quarter also benefited from positive comparable sales in the U.K., partly offset by the market’s Company-operated restaurant closings in the first quarter 2006 and restaurant ownership changes.
In APMEA, the increase in revenues for the quarter and six months was primarily due to strong comparable sales in Australia, as well as expansion and positive comparable sales in China. In addition, results reflected the consolidation of Malaysia, for financial reporting purposes, due to an increase in the Company’s ownership during the first quarter 2006. These increases were partly offset by the 2005 conversion of the Philippines and Turkey (about 325 restaurants) to developmental licensee structures under which the Company receives a royalty based on a percent of sales.
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The following table presents the percent change in comparable sales for the quarters and six months ended June 30, 2006 and 2005:
COMPARABLE SALES – McDONALD’S RESTAURANTS*
McDonald’s Restaurants
The following table presents the percent change in Systemwide sales for the quarter and six months ended June 30, 2006:
SYSTEMWIDE SALES
Total sales
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Operating Margins
FRANCHISED AND COMPANY-OPERATED RESTAURANT MARGINS –
McDONALD’S RESTAURANTS
Quarters ended June 30,
Franchised
Company-operated
Franchised margin dollars increased $80.8 million or 8% as reported and in constant currencies for the quarter and $126.2 million or 6% (8% in constant currencies) for the six months. The U.S. and Europe segments accounted for more than 85% of the franchised margin dollars in both periods.
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Company-operated margin dollars increased $104.2 million or 20% (19% in constant currencies) for the quarter and $156.9 million or 16% (17% in constant currencies) for the six months. The U.S. and Europe segments accounted for more than 70% of the Company-operated margin dollars in both periods.
The following table presents margin components as a percent of sales:
COMPANY-OPERATED RESTAURANT EXPENSES AND MARGINS AS A PERCENT OF SALES –
Food & paper
Payroll & employee benefits
Occupancy & other operating expenses
Total expenses
Company-operated margins
Selling, General & Administrative Expenses
Selling, general & administrative expenses increased 11% for the quarter (10% in constant currencies) and 8% for the six months (9% in constant currencies). These increases were primarily due to higher employee-related costs, including incentive-based compensation expense, and the timing of certain 2006 expenses, which include costs related to our biennial worldwide operator convention and our sponsorship of the Olympics. Selling, general & administrative expenses as a percent of revenues were 10.7% for both the six months of 2006 and 2005 and as a percent of Systemwide sales were 4.1% for 2006 compared with 4.0% for 2005. We expect spending to slow in the second half of the year, and for the full year, to decline as a percent of revenues and to be relatively flat to down slightly as a percent of Systemwide sales.
Impairment and Other Charges (Credits), Net
In the second quarter, the Company recorded $22.1 million of expense primarily related to an impairment charge on the anticipated sale of a small market in APMEA to a developmental licensee ($14.7 million) and asset write-offs and other charges primarily in APMEA ($7.4 million). For the six months of 2006, the expense totaled $108.2 million. In addition to the second quarter items, this total included the following items recorded in the first quarter: the closing of 25 restaurants in the U.K. in conjunction with an overall restaurant portfolio review ($41.8 million); costs to buy out certain litigating franchisees in Brazil ($29.0 million); an impairment charge on the sale of Bulgaria to a developmental licensee ($7.8 million); and asset write-offs in APMEA ($7.5 million).
The six months of 2005 included $18.7 million of income from a favorable adjustment to certain liabilities established in prior years due to lower than originally anticipated employee-related and lease termination costs.
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Other Operating Expense, Net
OTHER OPERATING (INCOME) EXPENSE, NET
Gains on sales of restaurant businesses
Equity in earnings of unconsolidated affiliates
Other expense
Other expense for the six months of 2005 reflected a $24.1 million charge related to a supply chain arrangement in Europe.
Operating Income
OPERATING INCOME
In the U.S., results increased for the quarter and six months primarily due to higher combined operating margin dollars, partly offset by higher employee-related costs, including incentive-based compensation expense.
In Europe, operating results for the quarter reflected strong performance in France, Germany and many other markets, as well as improved results in the U.K. Results for the six months increased due to strong performance in France and many other markets, as well as improved results in Germany, partly offset by costs related to the Olympics. For the six months 2006, results included impairment and other charges totaling $49.6 million and results for the six months 2005 included a supply chain charge of $24.1 million. These two items combined, negatively impacted the constant currency operating income growth rate for the six months by 4 percentage points.
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In APMEA, results for both periods were positively impacted by strong performance in Australia and improved results in China. Results for the quarter and six months 2006 included impairment and other charges totaling $23.3 million and $30.8 million, respectively.
In Latin America, results for the six months 2006 reflected continued strong sales performance across most markets, more than offset by $27.5 million of impairment and other charges, primarily due to the buy out of certain litigating franchisees in Brazil.
Corporate results for the quarter and six months 2006 reflected higher incentive-based compensation and costs related to our biennial worldwide operator convention. Results for the six months 2005 included an $18.7 million favorable adjustment to certain liabilities established in prior years.
Interest Expense
For the quarter and six months, interest expense increased due to higher average debt levels as a result of activity related to HIA. In fourth quarter 2005, the Company repatriated approximately $3 billion of foreign historical earnings under HIA. The repatriation was funded through local borrowings in certain markets.
Nonoperating Income, Net
NONOPERATING (INCOME) EXPENSE, NET
Interest income
Translation (gain) / loss
Interest income increased for both periods primarily due to higher cash levels mainly due to HIA-related activity.
In first quarter 2006, Chipotle completed an IPO of 6.1 million shares resulting in net proceeds of $120.9 million to Chipotle and a gain to McDonald’s of $32.0 million to reflect an increase in the carrying value of the Company’s investment as a result of Chipotle selling shares in the public offering. Concurrently with the IPO, McDonald’s sold 3.0 million Chipotle shares, resulting in net proceeds to the Company of $61.4 million and an additional gain of $19.2 million. In second quarter 2006, McDonald’s sold an additional 4.5 million Chipotle shares, resulting in net proceeds to the Company of $267.7 million and a gain of $197.4 million, while still retaining majority ownership. In addition, the Company expects to completely separate from Chipotle by the end of October through a tax-free exchange of Chipotle shares for McDonald’s stock, subject to market conditions.
Income Taxes
The effective income tax rate was 33.9% for second quarter 2006 compared with 43.3% in second quarter 2005. The 2006 tax rate included net incremental tax expense of $13.5 million (representing approximately 1 percentage point of the tax rate) primarily relating to the one-time impact from a tax law change in Canada. The higher tax rate in 2005 included an additional expense of approximately $112.0 million (representing about 12 percentage points of the second quarter tax rate) related to the Company’s decision to take advantage of the one-time opportunity provided under HIA.
The effective income tax rate was 32.7% for six months 2006 compared with 28.7% in 2005. The impact of the second quarter 2006 net incremental tax expense was offset by a portion of the 2006 Chipotle IPO gain in the first quarter that was not tax affected. The income tax rate in 2005 included a benefit of $178.8 million due to a favorable audit settlement of the Company’s 2000-2002 U.S. tax returns, partly offset by the additional expense of $112.0 million discussed above (the net of both items benefited the 2005 six month rate by about 4 percentage points).
Cash Flows and Financial Position
The Company generates significant cash from operations and has substantial credit capacity to fund operating and discretionary spending such as capital expenditures, debt repayments, dividends and share repurchases.
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Cash provided by operations totaled $1,494.6 million and exceeded capital expenditures by $823.2 million for the six months. Cash provided by operations decreased $250.9 million compared to the six months in 2005 primarily due to higher income tax payments, partly offset by stronger operating results.
Cash used for investing activities totaled $286.9 million for the six months, a decrease of $362.1 million. Higher capital spending was more than offset by the proceeds from the sales of Chipotle shares and the redemptions of short-term investments. Capital expenditures increased $68.9 million for the six months consistent with the Company’s strategy to increase investment in existing restaurants, primarily in the U.S.
Cash used for financing activities totaled $2,177.7 million for the six months, an increase of $1,262.0 million primarily due to higher net debt repayments and share repurchases, partly offset by proceeds from the Chipotle IPO.
As a result of the above activity, the Company’s cash balance decreased $970.0 million from December 31, 2005 to $3,290.4 million at June 30, 2006. For the full year, the Company expects capital expenditures to be approximately $1.8 billion and debt repayments to be at least $1.4 billion. In 2006 and 2007 combined, the Company expects to return at least $5 billion to $6 billion to shareholders through a combination of dividends and share repurchases. McDonald’s stock acquired with the proceeds from the Chipotle share sales, as well as through the planned exchange offer, will be incremental to this amount.
Debt obligations at June 30, 2006 totaled $9,506.5 million compared with $10,140.1 million at December 31, 2005. The decrease in 2006 was primarily due to net repayments of $1,025.1 million and SFAS No. 133 noncash fair value adjustments of $78.7 million, partially offset by the impact of changes in exchange rates on foreign currency-denominated debt of $435.8 million and the consolidation of Malaysia.
In June 2006, the FASB ratified Emerging Issues Task Force (EITF) Issue 06-2, Accounting for Sabbatical Leave and Other Similar Benefits Pursuantto FASB Statement No. 43, Accounting for Compensated Absences (EITF 06-2). Under EITF 06-2, compensation costs associated with a sabbatical should be accrued over the requisite service period, assuming certain conditions are met. The Company expects to adopt EITF 06-2 effective January 1, 2007, as required. We cannot reasonably estimate the impact of this Issue at this time.
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Restaurant Information
The following table presents restaurant information by ownership type:
Restaurants at June 30,
Operated by franchisees
Operated by the Company
Operated by affiliates
Systemwide restaurants
Risk Factors and Cautionary Statement Regarding Forward-Looking Statements
This report includes forward-looking statements about our plans and future performance, including those under Outlook. These statements use such words as “may,” “will,” “expect,” “believe” and “plan.” They reflect our expectations and speak only as of the date of this report. We do not undertake to update them. Our expectations (or the underlying assumptions) may change or not be realized, and you should not rely unduly on forward-looking statements.
Our business and execution of our strategic plan, the Plan to Win, are subject to risks. By far the most important of these is our ability to remain relevant to our customers and a brand they trust. Meeting customer expectations is complicated by the risks inherent in our operating environment. The informal eating out segment of the restaurant industry, although largely mature in our major markets, is also highly fragmented and competitive. We have the added challenge of the cultural, economic and regulatory differences that exist among the more than 100 countries where we operate. We also face risk in adapting our business model in particular markets. The decision to own restaurants or to operate under conventional franchise, license or joint venture agreements is driven by many factors whose interrelationship is complex and changing. Our plan to reduce our ownership of restaurants may be difficult to achieve for many reasons, and the change in ownership mix may not affect our results as we now expect. Regulatory and similar initiatives around the world have also become more wide-ranging and prescriptive and affect how we operate, as well as our results. In particular, increasing consumer focus on food “from field to front counter” presents challenges for our Brand and may adversely affect our sales and costs of doing business.
These risks can have an impact both in the near- and long-term and are reflected in the following considerations and factors that we believe are most likely to affect our performance.
Our ability to remain a relevant and trusted brand and to increase sales depends largely on how well we execute the Plan to Win.
We developed the Plan to Win to address the key drivers of our business and results—people, products, place, price and promotion. The quality of our execution depends mainly on the following:
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Our results and financial condition are affected by our ownership mix and whether we can achieve a mix that optimizes margins and returns, while meeting our business needs and customer expectations.
Our plans call for a reduction in Company-operated restaurants in the U.K. by re-franchising them to third parties, as well as the pursuit of a developmental license model in 15 to 20 additional markets and organizational changes to improve the performance of Company-operated restaurants in other markets, notably Canada. Whether and when we can achieve these plans, as well as their success, is uncertain and depends mainly on the following:
Our results and financial condition are affected by global and local market conditions, which can adversely affect our sales, margins and net income.
Our results of operations are substantially affected not only by global economic conditions, but also by local operating and economic conditions, which can vary substantially by market. Unfavorable conditions can depress sales in a given market and may prompt promotional or other actions that adversely affect our margins, constrain our operating flexibility or result in charges, restaurant closings or sales of Company-operated restaurants. Whether we can manage this risk effectively depends mainly on the following:
Increasing regulatory complexity will continue to affect our operations and results in material ways.
Our legal and regulatory environment worldwide exposes us to complex compliance, litigation and similar risks that affect our operations and results in material ways. In many of our markets, including the United States and Europe, we are subject to increasing regulation, which has significantly increased our cost of doing business. In developing markets, we face the risks associated with new and untested laws and judicial systems. Among the more important regulatory and litigation risks we face are the following:
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Our results can be adversely affected by disruptions or events, such as the impact of severe weather conditions and natural disasters.
Severe weather conditions (such as hurricanes), terrorist activities, health epidemics or pandemics or the prospect of these events (such as the potential spread of avian flu) can have an adverse impact on consumer spending and confidence levels and in turn the McDonald’s System and our results and prospects in the affected markets. Our receipt of proceeds under any insurance we maintain for these purposes may be delayed or the proceeds may be insufficient to offset our losses fully.
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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, 2005 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, 2006. 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, 2006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 1. Legal Proceedings
On April 2, 2004, a class action lawsuit was filed in the United States District Court for the Northern District of Illinois (Case No. 04C-2422)(Allan Selbst v. McDonald’s Corporation, Jack M. Greenberg, Matthew H. Paull and Michael J. Roberts), alleging violation of federal securities laws. Two nearly identical actions were subsequently filed in the same court. On October 19, 2004, the lead plaintiff filed its amended and consolidated class action complaint, alleging, among other things, that the Company and individual defendants misled investors by issuing false and misleading financial reports and earnings projections in a series of press releases and other public statements between December 14, 2001 and January 22, 2003, thereby overstating the Company’s current and anticipated earnings. The amended complaint seeks class action certification, unspecified compensatory damages, and attorneys’ fees and costs. On May 17, 2006, the court granted the defendants’ motion to dismiss the amended complaint without prejudice, giving the plaintiffs another chance to state a claim. On June 16, 2006, the plaintiffs filed their third amended complaint. On July 17, 2006, the defendants filed their motion to dismiss this complaint.
On January 30, 2006, the following shareholder derivative action was filed in the Circuit Court of Cook County, Illinois, Chancery Division, (Case No. 06CH01950) (Philip Bufithis and Thomas Bauernfeind v. Hall Adams, Jr., Edward A. Brennan, Robert A. Eckert, Jack M. Greenberg, Enrique Hernandez, Jr., Jeanne P. Jackson, Walter E. Massey, Andrew J. McKenna, Cary D. McMillan, Matthew H. Paull, Michael J. Roberts, John W. Rogers, Jr., James A. Skinner, Anne-Marie Slaughter, and Roger W. Stone). This suit is purportedly brought on behalf of McDonald’s Corporation against several of its directors, officers and a former officer (collectively Individual Defendants), and the Corporation as a nominal defendant. Bufithis contains allegations similar to the lawsuit described above, claiming that from 2001 to 2003 the Individual Defendants participated in or acquiesced to improper undisclosed accounting practices, in alleged violation of federal securities law. Bufithis alleges that these acts or omissions by the Individual Defendants constitute breaches of fiduciary duty, and seeks judgment in favor of McDonald’s for unspecified damages sustained by the Corporation and unspecified equitable relief, as well as attorneys’ fees and costs. On May 3, 2006, Individual Defendants filed their motions to dismiss the complaint. On July 13, 2006, the court dismissed the plaintiffs’ complaint without prejudice pursuant to the parties’ agreed motion for voluntary dismissal.
Item 1A. Risk Factors
This report contains certain forward-looking statements which reflect management’s expectations regarding future events and operating performance and speak only as of the date hereof. These forward-looking statements involve a number of risks and uncertainties. These and other risks are noted in the Risk Factors and Cautionary Statement Regarding Forward-Looking Statements following Management’s Discussion and Analysis.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table presents information related to repurchases of common stock the Company made during the three months ended June 30, 2006:
Issuer Purchases of Equity Securities
Period
April 1-30, 2006
May 1-31, 2006
June 1-30, 2006
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:
Additional directors, whose terms of office as Directors continued after the Annual Meeting of Shareholders, are as follows:
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(2) The proposal to approve the appointment of an independent public accounting firm for 2006 was approved by shareholders as follows:
(3) The shareholder proposal relating to shareholder approval of future severance agreements was approved by shareholders as follows:
BROKER
NON-VOTE
(4) The shareholder proposal relating to labeling of genetically engineered products was not approved by shareholders as follows:
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Item 6. Exhibits
Exhibit Number
Description
(3)
(4)
(i)
(10)
(ii)
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(12)
(31.1)
(31.2)
(32.1)
(32.2)
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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)
August 4, 2006
/s/ Matthew H. Paull
Matthew H. Paull
Corporate Senior Executive Vice President and Chief Financial Officer
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