10-K 1 mcd-12312016x10k.htm FORM 10-K Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
 
 
FORM 10-K
 
 
 
 x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                    
Commission File Number 1-5231
 
 
 
McDONALD’S CORPORATION
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
(State or other jurisdiction of
incorporation or organization)
 
36-2361282
(I.R.S. Employer
Identification No.)
 
 
One McDonald’s Plaza
Oak Brook, Illinois
(Address of principal executive offices)
 
60523
(Zip code)
Registrant’s telephone number, including area code: (630) 623-3000
 
 
 
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange
on which registered
Common stock, $.01 par value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
 
None
 
 
(Title of class)
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes x  No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ¨  No x
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer  x         Accelerated filer  ¨
Non-accelerated filer  ¨  (do not check if a smaller reporting company)        Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨  No x
The aggregate market value of common stock held by non-affiliates of the registrant as of June 30, 2016 was $102,676,655,213.
The number of shares outstanding of the registrant’s common stock as of January 31, 2017 was 818,993,182.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates information by reference from the registrant’s 2017 definitive proxy statement, which will be filed no later than 120 days after December 31, 2016.
 



McDONALD’S CORPORATION
INDEX

Page reference
 
 
 
 
Part I.
 
 
 
 
Item 1
 
Item 1A
 
Item 1B
 
Item 2
 
Item 3
 
Item 4
 
Additional Item
 
 
 
 
Part II.
 
 
 
 
Item 5
 
Item 6
 
Item 7
 
Item 7A
 
Item 8
 
Item 9
 
Item 9A
 
Item 9B
 
 
 
 
Part III.
 
 
 
 
Item 10
 
Item 11
 
Item 12
 
Item 13
 
Item 14
 
 
 
 
Part IV.
 
 
 
 
Item 15
 
Item 16
 
 
 
 
Exhibits
 
All trademarks used herein are the property of their respective owners.



PART I
 
ITEM 1. Business
 
McDonald’s Corporation, the registrant, together with its sub-sidiaries, is referred to herein as the “Company.”
a. General
During 2016, there were no material changes to the Company's corporate structure or in its method of conducting business. The business is structured with segments that combine markets with similar characteristics and opportunities for growth. Significant reportable segments include the United States ("U.S."), International Lead Markets and High Growth Markets. In addition, throughout this report we present the Foundational Markets & Corporate segment, which includes markets in over 80 countries, as well as Corporate activities.
b. Financial information about segments
Segment data for the years ended December 31, 2016, 2015, and 2014 are included in Part II, Item 8, page 44 of this Form 10-K.
c. Narrative description of business
General
The Company operates and franchises McDonald’s restaurants, which serve a locally-relevant menu of quality food and beverages sold at various price points in more than 100 countries. McDonald’s global system is comprised of both Company-owned and franchised restaurants. McDonald’s franchised restaurants are owned and operated under one of the following structures - conventional franchise, developmental license or affiliate. The optimal ownership structure for an individual restaurant, trading area or market (country) is based on a variety of factors, including the availability of individuals with the entrepreneurial experience and financial resources, as well as the local legal and regulatory environment in critical areas such as property ownership and franchising. We continually review our mix of Company-owned and franchised restaurants to help optimize overall performance, with a goal to be approximately 95% franchised over the long term. The business relationship between McDonald’s and its independent franchisees is of fundamental importance to overall performance and to the McDonald’s brand. This business relationship is supported by an agreement that requires adherence to standards and policies essential to protecting our brand.
The Company is primarily a franchisor, with approximately 85% of McDonald's restaurants currently owned and operated by independent franchisees. Franchising enables an individual to be their own employer and maintain control over all employment related matters, marketing and pricing decisions, while also benefiting from the strength of McDonald’s global brand, operating system and financial resources. One of the strengths of this model is that the expertise gained from operating Company-owned restaurants allows McDonald’s to improve the operations and success of all restaurants while innovations from franchisees can be tested and, when viable, efficiently implemented across relevant restaurants.
Directly operating McDonald’s restaurants contributes significantly to our ability to act as a credible franchisor. Having Company-owned restaurants provides Company personnel with a venue for restaurant operations training experience. In addition, in our Company-owned and operated restaurants, and in collaboration with franchisees, we are able to further develop and refine operating standards, marketing concepts and product and pricing strategies that will ultimately benefit relevant McDonald’s restaurants.
 
Under a conventional franchise arrangement, the Company generally owns the land and building or secures a long-term lease for the restaurant location and the franchisee pays for equipment, signs, seating and décor. The Company believes that ownership of real estate, combined with the co-investment by franchisees, enables us to achieve restaurant performance levels that are among the highest in the industry.
Franchisees are also responsible for reinvesting capital in their businesses over time. In addition, to accelerate implementation of certain initiatives, the Company frequently co-invests with franchisees to fund improvements to their restaurants or their operating systems. These investments, developed with input from McDonald’s with the aim of improving local business performance, increase the value of our brand through the development of modernized, more attractive and higher revenue generating restaurants.
The Company’s typical franchise term is 20 years. The Company requires franchisees to meet rigorous standards and generally does not work with passive investors. The business relationship with franchisees is designed to assure consistency and high quality at all McDonald’s restaurants. Conventional franchisees contribute to the Company’s revenue through the payment of rent and royalties based upon a percent of sales, with specified minimum rent payments, along with initial fees paid upon the opening of a new restaurant or grant of a new franchise. This structure enables McDonald’s to generate significant levels of cash flow.
Under a developmental license arrangement, licensees provide capital for the entire business, including the real estate interest. The Company does not invest any capital under a developmental license arrangement. The Company receives a royalty based upon a percent of sales as well as initial fees upon the opening of a new restaurant or grant of a new license. We use the developmental license ownership structure in over 80 countries with a total of approximately 6,300 restaurants. The largest developmental licensee operates approximately 2,200 restaurants in 19 countries in Latin America and the Caribbean. In early 2017, the Company announced the sale of its businesses in China and Hong Kong, including more than 1,750 company-operated restaurants, to a developmental licensee. Under the terms of the agreement, the Company will retain a 20% ownership in the business.The Company expects to complete the sale and licensing transaction mid-year 2017.
Finally, the Company also has an equity investment in a limited number of foreign affiliated markets, referred to as “affiliates.” In these markets, the Company receives a royalty based on a percent of sales and records its share of net results in Equity in earnings of unconsolidated affiliates. The largest of these affiliates is Japan, where there are nearly 3,000 restaurants.
Supply Chain and Quality Assurance
The Company and its franchisees purchase food, packaging, equipment and other goods from numerous independent suppliers. The Company has established and enforces high quality standards and product specifications. The Company has quality centers around the world designed to ensure that its high standards are consistently met. The quality assurance process not only involves ongoing product reviews, but also on-site supplier visits. A Food Safety Advisory Council, composed of the Company’s technical, safety and supply chain specialists, as well as suppliers and outside academia, provides strategic global leadership for all aspects of food safety. In addition, the Company works closely with suppliers to encourage innovation, assure best practices and drive continuous improvement. Leveraging scale, supply chain infrastructure and risk management strategies, the Company also collaborates with suppliers toward a goal of

 
McDonald's Corporation 2016 Annual Report 1


achieving competitive, predictable food and paper costs over the long term.
Independently owned and operated distribution centers, approved by the Company, distribute products and supplies to McDonald’s restaurants. In addition, restaurant personnel are trained in the proper storage, handling and preparation of products.
Products
McDonald’s restaurants offer a substantially uniform menu, although there are geographic variations to suit local consumer preferences and tastes. In addition, McDonald’s tests new products on an ongoing basis.
McDonald’s menu includes hamburgers and cheeseburgers, Big Mac, Quarter Pounder with Cheese, Filet-O-Fish, several chicken sandwiches, Chicken McNuggets, wraps, french fries, salads, oatmeal, shakes, McFlurry desserts, sundaes, soft serve cones, pies, soft drinks, coffee, McCafé beverages and other beverages. In addition, the restaurants sell a variety of other products during limited-time promotions.
McDonald’s restaurants in the U.S. and many international markets offer a full or limited breakfast menu. Breakfast offerings may include Egg McMuffin, Sausage McMuffin with Egg, McGriddles, biscuit and bagel sandwiches and hotcakes.
Quality, choice and nutrition are increasingly important to our customers and we are continuously evolving our menu to meet our customers' needs.
Marketing
McDonald’s global brand is well known. Marketing, promotional and public relations activities are designed to promote McDonald’s brand and differentiate the Company from competitors. Marketing and promotional efforts focus on value, quality, food taste, menu choice, nutrition, convenience and the customer experience.
Intellectual property
The Company owns or is licensed to use valuable intellectual property including trademarks, service marks, patents, copyrights, trade secrets and other proprietary information. The Company considers the trademarks “McDonald’s” and “The Golden Arches Logo” to be of material importance to its business. Depending on the jurisdiction, trademarks and service marks generally are valid as long as they are used and/or registered. Patents, copyrights and licenses are of varying durations.
Seasonal operations
The Company does not consider its operations to be seasonal to any material degree.
Working capital practices
Information about the Company’s working capital practices is incorporated herein by reference to Management’s Discussion and Analysis of Financial Condition and Results of Operations for the years ended December 31, 2016, 2015, and 2014 in Part II, Item 7, pages 13 through 27, and the consolidated statement of cash flows for the years ended December 31, 2016, 2015, and 2014 in Part II, Item 8, page 32 of this Form 10-K.
Customers
The Company’s business is not dependent upon either a single customer or small group of customers.
Backlog
Company-operated restaurants have no backlog orders.
Government contracts
No material portion of the business is subject to renegotiation of profits or termination of contracts or subcontracts at government election.
 
Competition
McDonald’s restaurants compete with international, national, regional and local retailers of food products. The Company competes on the basis of price, convenience, service, menu variety and product quality in a highly fragmented global restaurant industry.
In measuring the Company’s competitive position, management reviews data compiled by Euromonitor International, a leading source of market data with respect to the global restaurant industry. The Company’s primary competition, which is referred to as the informal eating out ("IEO") segment, includes the following restaurant categories defined by Euromonitor International: quick-service eating establishments, casual dining full-service restaurants, street stalls or kiosks, cafés,100% home delivery/takeaway providers, specialist coffee shops, self-service cafeterias and juice/smoothie bars. The IEO segment excludes establishments that primarily serve alcohol and full-service restaurants other than casual dining.
Based on data from Euromonitor International, the global IEO segment was composed of approximately 8 million outlets and generated $1.2 trillion in annual sales in 2015, the most recent year for which data is available. McDonald’s Systemwide 2015 restaurant business accounted for 0.4% of those outlets and 7.0% of the sales.
Management also on occasion benchmarks McDonald’s against the entire restaurant industry, including the IEO segment defined above and all other full-service restaurants. Based on data from Euromonitor International, the restaurant industry was composed of approximately 18 million outlets and generated $2.3 trillion in annual sales in 2015. McDonald’s Systemwide restaurant business accounted for 0.2% of those outlets and 3.5% of the sales.
Research and development
The Company operates research and development facilities in the U.S., Europe and Asia. While research and development activities are important to the Company’s business, these expenditures are not material. Independent suppliers also conduct research activities that benefit the Company, its franchisees and suppliers (collectively referred to as the "System").
Environmental matters
The Company continuously endeavors to improve its social responsibility and environmental practices to achieve long-term sustainability, which benefits McDonald’s and the communities it serves.
Increased focus by certain governmental authorities on environmental matters may lead to new governmental initiatives. While we cannot predict the precise nature of these initiatives, we expect that they may impact our business both directly and indirectly. Although the impact would likely vary by world region and/or market, we believe that adoption of new regulations may increase costs for the Company. Also, there is a possibility that governmental initiatives, or actual or perceived effects of changes in weather patterns, climate, or water resources could have a direct impact on the operations of the System in ways which we cannot predict at this time.
The Company monitors developments related to environmental matters and plans to respond to governmental initiatives in a timely and appropriate manner. At this time, the Company has already begun to undertake its own initiatives relating to preservation of the environment, including the implementation of more energy efficient equipment and management of energy use and more sustainable sourcing practices in many of its markets.


2 McDonald's Corporation 2016 Annual Report


Number of employees
The Company’s number of employees worldwide, including its corporate office employees and company-owned restaurant employees, was approximately 375,000 as of year-end 2016.
d. Financial information about geographic areas
Financial information about geographic areas is incorporated herein by reference to Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7, pages 13 through 27 and Segment and geographic information in Part II, Item 8, page 44 of this Form 10-K.
e. Available information
The Company is subject to the informational requirements of the Securities Exchange Act of 1934 ("Exchange Act"). The Company therefore files periodic reports, proxy statements and other information with the U.S. Securities and Exchange Commission ("SEC"). Such reports may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, NE, Washington, DC 20549, or by calling the SEC at (800) SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements and other information.
Financial and other information can also be accessed on the investor section of the Company’s website at www.investor.mcdonalds.com. The Company makes available, free of charge, copies of its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC. Copies of financial and other information are also available free of charge by calling (800) 228-9623 or by sending a request to McDonald’s Corporation Shareholder Services, Department 720, One McDonald’s Plaza, Oak Brook, Illinois 60523.
Also posted on McDonald’s website are the Company’s Corporate Governance Principles; the charters for each of the Committees of the Board of Directors, including the Audit and Finance Committee, Compensation Committee, Governance Committee, Public Policy and Strategy Committee and Sustainability and Corporate Responsibility Committee; the Code of Conduct for the Board of Directors; and the Company’s Standards of Business Conduct, which applies to all officers and employees. Copies of these documents are also available free of charge by calling (800) 228-9623 or by sending a request to McDonald’s Corporation Shareholder Services, Department 720, One McDonald’s Plaza, Oak Brook, Illinois 60523.
Information on the Company’s website is not incorporated into this Form 10-K or the Company’s other securities filings and is not a part of them. 
ITEM 1A. Risk Factors and Cautionary Statement Regarding Forward-Looking Statements
 
 
The information in this report includes forward-looking statements about future events and circumstances and their effects upon revenues, expenses and business opportunities. Generally speaking, any statement in this report not based upon historical fact is a forward-looking statement. Forward-looking statements can also be identified by the use of forward-looking words, such as “may,” “will,” “expect,” “believe” and “plan” or similar expressions. In particular, statements regarding our plans, strategies, prospects and expectations regarding our business and industry are forward-looking statements. They reflect our expectations, are not guarantees of performance and
 
speak only as of the date of this report. Except as required by law, 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 results are subject to a variety of risks, including those that are reflected in the following considerations and factors, as well as elsewhere in our filings with the SEC. If any of these considerations or risks materialize, our expectations may change and our performance may be adversely affected.
If we do not successfully design and execute against our new business strategies within our new organization structure, we may not be able to increase operating income or market share.
To drive future results, we must design business strategies that are effective in delivering operating income growth. Whether these strategies are successful depends mainly on our System’s ability to:
Continue to innovate and differentiate the McDonald’s experience in a way that balances value and convenience to our customers with profitability;
Reinvest in our restaurants and identify and develop restaurant sites consistent with our plans for net growth of Systemwide restaurants;
Provide clean and friendly environments that deliver a consistent McDonald's experience and demonstrate high service levels;
Drive restaurant improvements that achieve optimal capacity, particularly during peak mealtime hours; and
Manage the complexity of our restaurant operations.
If we are delayed or unsuccessful in executing our strategies, or if our strategies do not yield the desired results, our business, financial condition and results of operations may suffer.
The implementation of our turnaround plan may intensify the risks we face and may not be successful in achieving improved performance.
Our turnaround plan includes an accelerated pace of refranchising, cost savings initiatives and global restructuring. As we continue to implement our plans, the existing risks we face in our business may be intensified. Our efforts to reduce costs and capital expenditures depend, in part, upon our refranchising efforts, which, in turn, depend upon our ability to select qualified and capable franchisees and licensees. Our cost savings initiatives also depend upon our ability to achieve efficiencies through the consolidation of global, back-office functions. Therefore, if our turnaround-related initiatives are not successful, take longer to complete than initially projected, or are not well executed, or if our cost reduction efforts adversely impact our effectiveness, our business operations, financial results and results of operations could be adversely affected.
Our investments to enhance the customer experience, including through technology, may not generate the expected returns.
We will continue to build upon our investments in Experience of the Future (“EOTF”), which focus on restaurant modernization and technology and digital engagement in order to transform the restaurant experience. As we accelerate our pace of converting restaurants to EOTF, we are placing renewed emphasis on our improving our service model and strengthening relationships with customers, in part through digital channels and loyalty initiatives. We may not fully realize the intended benefits of these significant investments and therefore our business results may suffer.

 
McDonald's Corporation 2016 Annual Report 3


We face intense competition in our markets, which could hurt our business.
We compete primarily in the “informal eating out” (IEO) segment, which is highly competitive. We are facing sluggish restaurant industry trends in several key markets, including the U.S. We also face sustained, intense competition from traditional, fast casual and other competitors, which may include many non-traditional market participants such as convenience stores, grocery stores and coffee shops. We expect our environment to continue to be highly competitive, and our results in any particular reporting period may be impacted by new or continuing actions of our competitors, which may have a short- or long-term impact on our results.
We compete on the basis of product choice, quality, affordability, service and location. In particular, we believe our ability to compete successfully in the current market environment depends on our ability to improve existing products, develop new products, price our products appropriately, deliver a relevant customer experience, manage the complexity of our restaurant operations and respond effectively to our competitors’ actions. Recognizing these dependencies, we have intensified our focus in recent periods on strategies to achieve these goals, including the turnaround plan described above, and we will likely continue to modify our strategies and implement new strategies in the future. There can be no assurance these strategies will be effective, and some strategies may be effective at improving some metrics while adversely affecting other metrics.
If we do not anticipate and address evolving consumer preferences, our business could suffer.
Our continued success depends on our System’s ability to anticipate and respond effectively to continuously shifting consumer demographics, and trends in food sourcing, food preparation and consumer preferences in the IEO segment. In order to deliver a relevant experience for our customers amidst a highly competitive, value-driven operating environment, we must implement initiatives to adapt at an aggressive pace. There is no assurance that these initiatives will be successful and, if they are not, our financial results could be adversely impacted.
If pricing, promotional and marketing plans are not effective, our results may be negatively impacted.
Our results depend on the impact of pricing, promotional and marketing plans across the System, and the ability to adjust these plans to respond quickly and effectively to evolving customer preferences, as well as shifting economic and competitive conditions. Existing or future pricing strategies, and the value proposition they represent, are expected to continue to be important components of our business strategy; however, they may not be successful and could negatively impact sales and margins. Further, the promotion of menu offerings may yield results below the desired levels.
Additionally, we operate in a complex and costly advertising environment. Our marketing and advertising programs may not be successful, and we may fail to attract and retain customers. Our success depends in part on whether the allocation of our advertising and marketing resources across different channels allows us to reach our customers effectively. If the advertising and marketing programs are not successful, or are not as successful as those of our competitors, our sales, guest counts and market share could decrease.
Failure to preserve the value and relevance of our brand could have a negative impact on our financial results.
 
To be successful in the future, we believe we must preserve, enhance and leverage the value of our brand. Brand value is based in part on consumer perceptions. Those perceptions are affected by a variety of factors, including the nutritional content and preparation of our food, the ingredients we use, our business practices and the manner in which we source the commodities we use. Consumer acceptance of our offerings is subject to change for a variety of reasons, and some changes can occur rapidly. For example, nutritional, health and other scientific studies and conclusions, which constantly evolve and may have contradictory implications, drive popular opinion, litigation and regulation (including initiatives intended to drive consumer behavior) in ways that affect the IEO segment or perceptions of our brand generally or relative to available alternatives. Consumer perceptions may also be affected by third parties presenting or promoting adverse commentary or portrayals of the quick-service category of the IEO segment, our brand and/or our operations, our suppliers or our franchisees. If we are unsuccessful in addressing such adverse commentary or portrayals, our brand and our financial results may suffer.
Additionally, the ongoing relevance of our brand may depend on the success of our sustainability initiatives, which require System-wide coordination and alignment. If we are not effective in addressing social responsibility matters or achieving relevant sustainability goals, consumer trust in our brand may suffer. In particular, business incidents that erode consumer trust or confidence, particularly if such incidents receive considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our financial results.
Unfavorable general economic conditions could adversely affect our business and financial results.
Our results of operations are substantially affected by economic conditions, which can vary significantly by market and can impact consumer disposable income levels and spending habits. Economic conditions can also be impacted by a variety of factors including hostilities, epidemics and actions taken by governments to manage national and international economic matters, whether through austerity or stimulus measures or trade measures, and initiatives intended to control wages, unemployment, credit availability, inflation, taxation and other economic drivers. Continued adverse economic conditions or adverse changes in economic conditions in our markets could pressure our operating performance, and our business and financial results may suffer.
Our results of operations are also affected by fluctuations in currency exchange rates, which may adversely affect reported earnings.
Supply chain interruptions may increase costs or reduce revenues.
We depend on the effectiveness of our supply chain management to assure reliable and sufficient product supply, including on favorable terms. Although many of the products we sell are sourced from a wide variety of suppliers in countries around the world, certain products have limited suppliers, which may increase our reliance on those suppliers. Supply chain interruptions, including shortages and transportation issues, and price increases can adversely affect us as well as our suppliers and franchisees whose performance may have a significant impact on our results. Such shortages or disruptions could be caused by factors beyond the control of our suppliers, franchisees or us. If we experience interruptions in our System’s supply chain, our costs could increase and it could limit the availability of products critical to our System’s operations.


4 McDonald's Corporation 2016 Annual Report


Food safety concerns may have an adverse effect on our business.
Our ability to increase sales and profits depends on our System’s ability to meet expectations for safe food and on our ability to manage the potential impact on McDonald’s of food-borne illnesses and food or product safety issues that may arise in the future. Food safety is a top priority, and we dedicate substantial resources to ensure that our customers enjoy safe food products, including as our menu evolves. However, food safety events, including instances of food-borne illness, have occurred in the food industry in the past, and could occur in the future. Instances of food tampering, food contamination or food-borne illness, whether actual or perceived, could adversely affect our brand and reputation as well as our revenues and profits.
Our franchise business model presents a number of risks.
Our success increasingly relies on the financial success and cooperation of our franchisees, yet we have limited influence over their operations. Our restaurant margins arise from two sources: fees from franchised restaurants (e.g., rent and royalties based on a percentage of sales) and, to a lesser degree, sales from Company-operated restaurants. Our franchisees manage their businesses independently, and therefore are responsible for the day-to-day operation of their restaurants. The revenues we realize from franchised restaurants are largely dependent on the ability of our franchisees to grow their sales. If our franchisees do not experience sales growth, our revenues and margins could be negatively affected as a result. Also, if sales trends worsen for franchisees, their financial results may deteriorate, which could result in, among other things, restaurant closures or delayed or reduced payments to us. Our refranchising effort will increase that dependence and the effect of those factors.
Our success also increasingly depends on the willingness and ability of our independent franchisees to implement major initiatives, which may include financial investment, and to remain aligned with us on operating, promotional and capital-intensive reinvestment plans. Franchisees’ ability to contribute to the achievement of our plans is dependent in large part on the availability to them of funding at reasonable interest rates and may be negatively impacted by the financial markets in general or by the creditworthiness of our franchisees or the Company. Our operating performance could also be negatively affected if our franchisees experience food safety or other operational problems or project an image inconsistent with our brand and values, particularly if our contractual and other rights and remedies are limited, costly to exercise or subjected to litigation. If franchisees do not successfully operate restaurants in a manner consistent with our required standards, the brand’s image and reputation could be harmed, which in turn could hurt our business and operating results.
Our ownership mix also affects our results and financial condition. The decision to own restaurants or to operate under franchise or license agreements is driven by many factors whose interrelationship is complex and changing. Our ability to achieve the benefits of our refranchising strategy, which involves a shift to a greater percentage of franchised restaurants, in a timely manner or at all, will depend on various factors, including our ability to timely and effectively select franchisees and/or licensees that meet our rigorous standards and/or to complete transactions on favorable terms and to manage associated risks. It will also depend on the performance of our franchisees, and whether the resulting ownership mix supports our financial objectives.
 
Challenges with respect to talent management could harm our business.
Effective succession planning is important to our long-term success. Failure effectively to identify, develop and retain key personnel, recruit high-quality candidates and ensure smooth management and personnel transitions could disrupt our business and adversely affect our results.
Our success depends in part on our System’s ability to recruit, motivate and retain a qualified workforce to work in our restaurants in an intensely competitive environment. Increased costs associated with recruiting, motivating and retaining qualified employees to work in our Company-operated restaurants could have a negative impact on our Company-operated margins. Similar concerns apply to our franchisees.
We are also impacted by the costs and other effects of compliance with U.S. and international regulations affecting our workforce, which includes our staff and employees working in our Company-operated restaurants. These regulations are increasingly focused on employment issues, including wage and hour, healthcare, immigration, retirement and other employee benefits and workplace practices. Our potential exposure to reputational and other harm regarding our workplace practices or conditions or those of our independent franchisees or suppliers (or perceptions thereof) could have a negative impact on consumer perceptions of us and our business. Additionally, economic action, such as boycotts, protests, work stoppages or campaigns by labor organizations, could adversely affect us (including our ability to recruit and retain talent) or the franchisees and suppliers that are also part of the McDonald's System and whose performance may have a material impact on our results.
Changes in commodity and other operating costs could adversely affect our results of operations.
The profitability of our Company-operated restaurants depends in part on our ability to anticipate and react to changes in commodity costs, including food, paper, supply, fuel, utilities, distribution and other operating costs. Any volatility in certain commodity prices could adversely affect our operating results by impacting restaurant profitability. The commodity markets for some of the ingredients we use, such as beef and chicken, are particularly volatile due to factors such as seasonal shifts, climate conditions, industry demand, international commodity markets, food safety concerns, product recalls and government regulation, all of which are beyond our control and, in many instances, unpredictable. We can only partially address future price risk through hedging and other activities, and therefore increases in commodity costs could have an adverse impact on our profitability.
The global scope of our business subjects us to risks that could negatively affect our business.
We encounter differing cultural, regulatory and economic environments within and among the more than 100 countries where McDonald’s restaurants operate, and our ability to achieve our business objectives depends on the System's success in these environments. Meeting customer expectations is complicated by the risks inherent in our global operating environment, and our global success is partially dependent on our System’s ability to leverage operating successes across markets. Planned initiatives may not have appeal across multiple markets with McDonald's customers and could drive unanticipated changes in customer perceptions and guest counts.
Disruptions in operations or price volatility in a market can also result from governmental actions, such as price,

 
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foreign exchange or changes in trade-related tariffs or controls, government-mandated closure of our, our franchisees' or our suppliers’ operations, and asset seizures. The cost and disruption of responding to governmental investigations or inquiries, whether or not they have merit, may impact our results and could cause reputational or other harm. Our international success depends in part on the effectiveness of our strategies and brand-building initiatives to reduce our exposure to such governmental investigations or inquiries.
Additionally, challenges and uncertainties are associated with operating in developing markets, which may entail a relatively higher risk of political instability, economic volatility, crime, corruption and social and ethnic unrest. Such challenges may be exacerbated in many cases by a lack of an independent and experienced judiciary and uncertainties in how local law is applied and enforced, including in areas most relevant to commercial transactions and foreign investment. An inability to manage effectively the risks associated with our international operations could have a material adverse effect on our business and financial condition.
We may also face challenges and uncertainties in developed markets. For example, as a result of the U.K.'s decision to leave the European Union through a negotiated exit over a period of time, it is possible that there will be increased regulatory complexities, as well as potential referenda in the U.K. and/or other European countries, that could cause uncertainty in European or worldwide economic conditions. In the short term, the decision created volatility in certain foreign currency exchange rates, and the resulting depression in those exchange rates may continue. Any of these effects, and others we cannot anticipate, could adversely affect our business, results of operations, financial condition and cash flows.
Changes in tax laws and unanticipated tax liabilities could adversely affect the taxes we pay and our profitability.
We are subject to income and other taxes in the United States and foreign jurisdictions, and our operations, plans and results are affected by tax and other initiatives around the world. In particular, we are affected by the impact of changes to tax laws or policy or related authoritative interpretations, including to the extent that corporate tax reform becomes a key component of budgetary initiatives in the United States or elsewhere. We are also impacted by settlements of pending or any future adjustments proposed by taxing authorities outside of the U.S. or the IRS in connection with our tax audits, all of which will depend on their timing, nature and scope. Any increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results.
Information technology system failures or interruptions or breaches of network security may interrupt our operations.
We are increasingly reliant on technological systems, such as point-of-sale and other in-store systems or platforms, as well as technologies that facilitate communication and collaboration internally, with affiliated entities, or with independent third parties to conduct our business, including technology-enabled solutions provided to us by third parties. Any failure of these systems could significantly impact our operations and customer perceptions.
Despite the implementation of security measures, those technology systems and solutions could become vulnerable to damage, disability or failures due to theft, fire, power loss, telecommunications failure or other catastrophic events. The third party solutions also present the risks faced by the third party’s business. If those systems or solutions were to fail or otherwise be unavailable, and we were unable to recover in a
 
timely way, we could experience an interruption in our operations.
Furthermore, security breaches involving our systems, the systems of the parties we communicate or collaborate with, or those of third party providers may occur, such as unauthorized access, denial of service, computer viruses and other disruptive problems caused by hackers. Our information technology systems contain personal, financial and other information that is entrusted to us by our customers and employees as well as financial, proprietary and other confidential information related to our business. An actual or alleged security breach could result in system disruptions, shutdowns, theft or unauthorized disclosure of confidential information. The occurrence of any of these incidents could result in adverse publicity, loss of consumer confidence, reduced sales and profits, and criminal penalties or civil liabilities.
Increasing regulatory complexity may adversely affect restaurant operations and our financial results.
Our regulatory environment worldwide exposes us to complex compliance and similar risks that could affect our operations and results in material ways. In many of our markets, we are subject to increasing regulation, which has increased our cost of doing business. We are affected by the cost, compliance and other risks associated with the often conflicting and highly prescriptive regulations we face, including where inconsistent standards imposed by multiple governmental authorities can adversely affect our business and increase our exposure to litigation or governmental investigations or proceedings.
Our success depends in part on our ability to manage the impact of new, potential or changing regulations that can affect our business plans and operations. These regulations include product packaging, marketing, the nutritional content and safety of our food and other products, labeling and other disclosure practices; and compliance efforts may be affected by ordinary variations in food preparation among our own restaurants and the need to rely on the accuracy and completeness of information from third-party suppliers (particularly given varying requirements and practices for testing and disclosure).
Additionally, we are working to manage the risks and costs to us, our franchisees and our supply chain of the effects of climate change, greenhouse gases, and diminishing energy and water resources. These risks include the increased public focus, including by governmental and nongovernmental organizations, on these and other environmental sustainability matters, such as packaging and waste, animal health and welfare, deforestation and land use. These risks also include the increased pressure to make commitments, set targets or establish additional goals and take actions to meet them. These risks could expose us to market, operational and execution costs or risks. If we are unable to effectively manage the risks associated with our complex regulatory environment, it could have a material adverse effect on our business and financial condition.
We are subject to increasing legal complexity and could be party to litigation that could adversely affect us.
Increasing legal complexity will continue to affect our operations and results in material ways. We could be subject to legal proceedings that may adversely affect our business, including class actions, administrative proceedings, government investigations, employment and personal injury claims, landlord/tenant disputes, disputes with current or former suppliers, claims by current or former franchisees and intellectual property claims (including claims that we infringed another party’s trademarks, copyrights or patents).


6 McDonald's Corporation 2016 Annual Report


Inconsistent standards imposed by governmental authorities can adversely affect our business and increase our exposure to regulatory proceedings or litigation.
Litigation involving our relationship with franchisees and the legal distinction between our franchisees and us for employment law purposes, if determined adversely, could increase costs, negatively impact the business prospects of our franchisees and subject us to incremental liability for their actions. Similarly, although our commercial relationships with our suppliers remain independent, there may be attempts to challenge that independence, which, if determined adversely, could also increase costs, negatively impact the business prospects of our suppliers, and subject us to incremental liability for their actions. We are also subject to legal and compliance risks and associated liability, such as in the areas of privacy and data collection, protection and management, as it relates to information we collect and share when we provide optional technology-related services and platforms to third parties.
Our operating results could also be affected by the following:
The relative level of our defense costs, which vary from period to period depending on the number, nature and procedural status of pending proceedings;
The cost and other effects of settlements, judgments or consent decrees, which may require us to make disclosures or take other actions that may affect perceptions of our brand and products;
Adverse results of pending or future litigation, including litigation challenging the composition and preparation of our products, or the appropriateness or accuracy of our marketing or other communication practices; and
The scope and terms of insurance or indemnification protections that we may have.
A judgment significantly in excess of any applicable insurance coverage or third party indemnity could materially adversely affect our financial condition or results of operations. Further, adverse publicity resulting from these claims may hurt our business.
We may not be able to adequately protect our intellectual property or adequately ensure that we are not infringing the intellectual property of others, which could harm the value of the McDonald’s brand and our business.
The success of our business depends on our continued ability to use our existing trademarks and service marks in order to increase brand awareness and further develop our branded products in both domestic and international markets. We rely on a combination of trademarks, copyrights, service marks, trade secrets, patents and other intellectual property rights to protect our brand and branded products.
We have registered certain trademarks and have other trademark registrations pending in the United States and certain foreign jurisdictions. The trademarks that we currently use have not been registered in all of the countries outside of the United States in which we do business or may do business in the future and may never be registered in all of these countries. The steps we have taken to protect our intellectual property in the United States and foreign countries may not be adequate. In addition, the steps we have taken may not adequately ensure that we do not infringe the intellectual property of others, and third parties may claim infringement by us in the future. In particular, we may be involved in intellectual property claims, including often aggressive or opportunistic attempts to enforce patents used in information technology systems, which might affect our operations and results. Any claim of infringement, whether or
 
not it has merit, could be time-consuming, result in costly litigation and harm our business.
We cannot ensure that franchisees and other third parties who hold licenses to our intellectual property will not take actions that hurt the value of our intellectual property.
Changes in accounting standards or the recognition of impairment or other charges may adversely affect our future operations and results.
New accounting standards or changes in financial reporting requirements, accounting principles or practices, including with respect to our critical accounting estimates, could adversely affect our future results. We may also be affected by the nature and timing of decisions about underperforming markets or assets, including decisions that result in impairment or other charges that reduce our earnings. In assessing the recoverability of our long-lived assets, we consider changes in economic conditions and make assumptions regarding estimated future cash flows and other factors. These estimates are highly subjective and can be significantly impacted by many factors such as global and local business and economic conditions, operating costs, inflation, competition, consumer and demographic trends, and our restructuring activities. If our estimates or underlying assumptions change in the future, we may be required to record impairment charges. If we experience any such changes, they could have a significant adverse effect on our reported results for the affected periods.
A decrease in our credit ratings or an increase in our funding costs could adversely affect our profitability.
Our credit ratings may be negatively affected by our results of operations or changes in our debt levels.  As a result, our interest expense, the availability of acceptable counterparties, our ability to obtain funding on favorable terms, collateral requirements and our operating or financial flexibility could all be negatively affected, especially if lenders impose new operating or financial covenants.
Our operations may also be impacted by regulations affecting capital flows, financial markets or financial institutions, which can limit our ability to manage and deploy our liquidity or increase our funding costs. If any of these events were to occur, they could have a material adverse effect on our business and financial condition.
Trading volatility and price of our common stock may be adversely affected by many factors.
Many factors affect the volatility and price of our common stock in addition to our operating results and prospects. The most important of these factors, some of which are outside our control, are the following:
The continuing unpredictable global economic and market conditions;
Governmental action or inaction in light of key indicators of economic activity or events that can significantly influence financial markets, particularly in the United States, which is the principal trading market for our common stock, and media reports and commentary about economic or other matters, even when the matter in question does not directly relate to our business;
Trading activity in our common stock or trading activity in derivative instruments with respect to our common stock or debt securities, which can be affected by market commentary (including commentary that may be unreliable or incomplete); unauthorized disclosures about our performance, plans or expectations about our business; our actual performance and creditworthiness; investor confidence, driven in part by expectations about our

 
McDonald's Corporation 2016 Annual Report 7


performance; actions by shareholders and others seeking to influence our business strategies; portfolio transactions in our stock by significant shareholders; or trading activity that results from the ordinary course rebalancing of stock indices in which McDonald’s may be included, such as the S&P 500 Index and the Dow Jones Industrial Average;
The impact of our stock repurchase program or dividend rate; and
The impact on our results of corporate actions and market and third-party perceptions and assessments of such actions, such as those we may take from time to time as we implement our strategies in light of changing business, legal and tax considerations and evolve our corporate structure.
Our results and prospects can be adversely affected by events such as severe weather conditions, natural disasters, hostilities and social unrest, among others.
Severe weather conditions, natural disasters, hostilities and social unrest, terrorist activities, health epidemics or pandemics (or expectations about them) can adversely affect consumer spending and confidence levels and supply availability and costs, as well as the local operations in impacted markets, all of which can affect our results and prospects. Our receipt of proceeds under any insurance we maintain with respect to some of these risks may be delayed or the proceeds may be insufficient to cover our losses fully.
ITEM 1B. Unresolved Staff Comments
 
None.
ITEM 2. Properties
 
The Company owns and leases real estate primarily in connection with its restaurant business. The Company identifies and develops sites that offer convenience to customers and long-term sales and profit potential to the Company. To assess potential, the Company analyzes traffic and walking patterns, census data and other relevant data. The Company’s experience and access to advanced technology aid in evaluating this information. The Company generally owns the land and building or secures long-term leases for conventional franchised and Company-operated restaurant sites, which ensures long-term occupancy rights and helps control related costs. Restaurant profitability for both the Company and franchisees is important; therefore, ongoing efforts are made to control average development costs through construction and design efficiencies, standardization and by leveraging the Company’s global sourcing network. Additional information about the Company’s properties is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7, pages 13 through 27 and in Financial statements and supplementary data in Part II, Item 8, pages 28 through 47 of this Form 10-K.
ITEM 3. Legal Proceedings
 
The Company has pending a number of lawsuits that have been filed in various jurisdictions. These lawsuits cover a broad variety of allegations spanning the Company’s entire business. The following is a brief description of the more significant types of claims and lawsuits. In addition, the Company is subject to various national and local laws and regulations that impact various aspects of its business, as discussed below. While the Company does not believe that any such claims, lawsuits or regulations will have a material adverse effect on its financial condition or results of operations, unfavorable rulings could occur. Were an unfavorable ruling to occur, there exists the possibility of a material
 
adverse impact on net income for the period in which the ruling occurs or for future periods.
Franchising
A substantial number of McDonald’s restaurants are franchised to independent owner/operators under contractual arrangements with the Company. In the course of the franchise relationship, occasional disputes arise between the Company and its current or former franchisees relating to a broad range of subjects including, but not limited to, quality, service and cleanliness issues, menu pricing, contentions regarding grants or terminations of franchises, delinquent payments of rents and fees, and franchisee claims for additional franchises or rewrites of franchises. Additionally, occasional disputes arise between the Company and individuals who claim they should have been granted a McDonald’s franchise or who challenge the legal distinction between the Company and its franchisees for employment law purposes.
Suppliers
The Company and its affiliates and subsidiaries generally do not supply food, paper or related items to any McDonald’s restaurants. The Company relies upon numerous independent suppliers, including service providers, that are required to meet and maintain the Company’s high standards and specifications. On occasion, disputes arise between the Company and its suppliers (or former suppliers) which include, for example, compliance with product specifications and the Company’s business relationship with suppliers. In addition, disputes occasionally arise on a number of issues between the Company and individuals or entities who claim that they should be (or should have been) granted the opportunity to supply products or services to the Company’s restaurants.
Employees
Hundreds of thousands of people are employed by the Company and in restaurants owned and operated by subsidiaries of the Company. In addition, thousands of people from time to time seek employment in such restaurants. In the ordinary course of business, disputes arise regarding hiring, termination, promotion and pay practices, including wage and hour disputes, alleged discrimination and compliance with labor and employment laws.
Customers
Restaurants owned by subsidiaries of the Company regularly serve a broad segment of the public. In so doing, disputes arise as to products, service, incidents, advertising, nutritional and other disclosures, as well as other matters common to an extensive restaurant business such as that of the Company.
Intellectual Property
The Company has registered trademarks and service marks, patents and copyrights, some of which are of material importance to the Company’s business. From time to time, the Company may become involved in litigation to protect its intellectual property and defend against the alleged use of third party intellectual property. 
Government Regulations
Local and national governments have adopted laws and regulations involving various aspects of the restaurant business including, but not limited to, advertising, franchising, health, safety, environment, zoning, employment and taxation. The Company strives to comply with all applicable existing statutory and administrative rules and cannot predict the effect on its operations from the issuance of additional requirements in the future.
ITEM 4. Mine Safety Disclosures
 
Not applicable.


8 McDonald's Corporation 2016 Annual Report


Executive Officers of the Registrant
The following are the Executive Officers of our Company (as of the date of this filing, unless otherwise noted):
Ian F. Borden, 48, is President - Foundational Markets, a position he has held since July 2015. From January 2014 through June 2015, Mr. Borden served as Vice President and Chief Financial Officer - McDonald’s Asia/Pacific, Middle East and Africa. Prior to that time, Mr. Borden served as Regional Vice President of Europe’s East Division from April 2011 to December 2013 and as Managing Director - McDonald’s Ukraine from December 2007 to December 2013. He has served the Company for 22 years.
Stephen J. Easterbrook, 49, is President and Chief Executive Officer, a position he has held since March 2015. Mr. Easterbrook was also elected a Director of the Company effective March 2015. From May 2014 through February 2015, Mr. Easterbrook served as Corporate Senior Executive Vice President and Global Chief Brand Officer.  From June 2013 through April 2014, Mr. Easterbrook served as Corporate Executive Vice President and Global Chief Brand Officer. From September 2012 through May 2013, Mr. Easterbrook served as the Chief Executive Officer of Wagamama Limited, a pan-Asian restaurant chain, and from September 2011 to September 2012, he served as the Chief Executive Officer of PizzaExpress Limited, an Italian restaurant brand. From December 2010 to September 2011, he held the position of President, McDonald’s Europe. Prior to that, Mr. Easterbrook served in a number of roles with the Company. Except for the period he was with PizzaExpress and Wagamama, Mr. Easterbrook has served the Company for 23 years.
Joseph Erlinger, 43, is President - High Growth Markets, a position he has held since September 2016.   Prior to that, Mr. Erlinger served as Vice President and Chief Financial Officer - High Growth Markets from March 2015 to January 2017 (serving in dual roles from September 2016 through January 2017), as Managing Director of McDonald’s Korea from April 2013 to January 2016 (serving in dual roles from March 2015 through January 2016), and US Vice President - GM for the Indianapolis region from December 2010 to March 2013.  He has served the Company for 15 years.
David O. Fairhurst, 48, is Corporate Executive Vice President & Chief People Officer, a position he has held since October 2015. Mr. Fairhurst served as Corporate Senior Vice President, International Human Resources and Strategy from April 2015 to September 2015. Prior to that time, he served as Europe Vice President - Chief People Officer from January 2011 to March 2015. Mr. Fairhurst has served the Company for 11 years.
Robert L. Gibbs, 45, is Corporate Executive Vice President - Corporate Relations and Chief Communications Officer, a position he has held since June 2015. Mr. Gibbs joined the Company from The Incite Agency, a strategic communications advisory firm that he co-founded in 2013. Prior to that, Mr. Gibbs held several senior advisory roles in the White House, serving as the White House Press Secretary beginning in 2009, then as Senior Advisor in the 2012 re-election campaign.
Douglas M. Goare, 64, is President, International Lead Markets and Chief Restaurant Officer, a position he has held since July 2015. From October 2011 through June 2015, Mr. Goare served as President, McDonald’s Europe. Prior to that time, Mr. Goare served as Corporate Executive Vice President of Supply Chain and Development from February 2011 through September 2011.  In addition, Mr. Goare assumed responsibility for Development in December 2010 and served as Corporate Senior Vice President of Supply Chain and Development through January 2011.  Mr. Goare has served the Company for 38 years.


 
Catherine Hoovel, 46, is Corporate Vice President - Chief Accounting Officer, a position she has held since October 2016.  Ms. Hoovel served as Controller for the McDonald's restaurants owned and operated by McDonald's USA from April 2014 to September 2016. Prior to that time, Ms. Hoovel served as a Senior Director of Finance from February 2012 to April 2014 and was a Divisional Director from August 2010 to February 2012. Ms. Hoovel has served the Company for 21 years.
Christopher Kempczinski, 48, is President, McDonald’s USA, a position he has held since January 1, 2017. Prior to that, Mr. Kempczinski served as Corporate Executive Vice President - Strategy, Business Development and Innovation, from October 2015 through December 2016. Mr. Kempczinski joined the Company from Kraft Heinz, a manufacturer and marketer of food and beverage products, where he most recently served as Executive Vice President of Growth Initiatives and President of Kraft International from December 2014 to September 2015. Prior to that, Mr. Kempczinski served as President of Kraft Canada from July 2012 through December 2014 and as Senior Vice President - U.S. Grocery from December 2008 to July 2012.
Jerome Krulewitch, 52, was promoted, effective March 4, 2017, to Corporate Executive Vice President, General Counsel and Secretary.  Mr. Krulewitch is currently the Corporate Senior Vice President - Chief Counsel, Global Operations, a position he has held since 2011.  Prior to that, Mr. Krulewitch was Corporate Senior Vice President - General Counsel, The Americas from 2010 to 2011.  Mr. Krulewitch has served the Company for 15 years. 
Silvia Lagnado, 53, is Corporate Executive Vice President, Global Chief Marketing Officer, a position she has held since August 2015. Ms. Lagnado served as Chief Marketing Officer of Bacardi Limited, a spirits company, from September 2010 to October 2012. Prior to that, Ms. Lagnado served more than twenty years in positions of increased responsibility at Unilever.
Kevin M. Ozan, 53, is Corporate Executive Vice President and Chief Financial Officer, a position he has held since March 2015. From February 2008 through February 2015, Mr. Ozan served as Corporate Senior Vice President - Controller. Mr. Ozan has served the Company for 19 years.
Gloria Santona, 66, is Corporate Executive Vice President, General Counsel and Secretary, a position she has held since July 2003. Ms. Santona has been with the Company for 39 years and will retire effective March 3, 2017.
Jim R. Sappington, 58, is Corporate Executive Vice President, Operations, Digital and Technology Systems, a position he has held since March 2015. From January 2013 through February 2015, Mr. Sappington served as Corporate Senior Vice President-Chief Information Officer. Prior to that time, Mr. Sappington served as U.S. Vice President - General Manager for the Northwest Region from September 2010 to December 2012. Mr. Sappington has been with the Company for 29 years.


 
McDonald's Corporation 2016 Annual Report 9


PART II
 
 
ITEM 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
 
MARKET INFORMATION AND DIVIDEND POLICY
The Company’s common stock trades under the symbol MCD and is listed on the New York Stock Exchange in the U.S. The following table sets forth the common stock price ranges on the New York Stock Exchange and dividends declared per common share:
 
 
2016
 
 
2015
 
 
Dollars per share
High

 
Low

 
Dividend

 
High

 
Low

 
Dividend

 
Quarter:
 
 
 
 
 
 
 
 
 
 
 
 
First
126.96

 
112.71

 
0.89

 
101.09

 
88.77

 
0.85

 
Second
131.96

 
116.08

 
0.89

 
101.08

 
94.02

 
0.85

 
Third
128.60

 
113.96

 
1.83

*
101.88

 
87.50

 
0.85

 
Fourth
124.00

 
110.33

 

 
120.23

 
97.13

 
0.89

 
Year
131.96

 
110.33

 
3.61

 
120.23

 
87.50

 
3.44

 
*
Includes an $0.89 per share dividend declared and paid in third quarter, and a $0.94 per share dividend declared in third quarter and paid in fourth quarter.
The number of shareholders of record and beneficial owners of the Company’s common stock as of January 31, 2017 was estimated to be 1,658,000.
Given the Company’s returns on incremental invested capital and assets, management believes it is prudent to reinvest in the business in markets with acceptable returns and/or opportunity for long-term growth and use excess cash flow to return cash to shareholders through dividends and share repurchases. The Company has paid dividends on common stock for 41 consecutive years through 2016 and has increased the dividend amount at least once every year. As in the past, future dividend amounts will be considered after reviewing profitability expectations and financing needs, and will be declared at the discretion of the Company’s Board of Directors.
ISSUER PURCHASES OF EQUITY SECURITIES
The following table presents information related to repurchases of common stock the Company made during the quarter ended December 31, 2016*:
Period
Total Number of
Shares Purchased

 
Average Price
Paid per Share

 
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs(1)

 
Approximate Dollar
Value of Shares
that May Yet
Be Purchased Under
the Plans or Programs(1)
 
October 1-31, 2016
5,902,572

 
113.43

 
5,902,572

 
 
$
4,571,138,206

November 1-30, 2016
3,076,425

 
116.25

 
3,076,425

 
 
4,213,514,184

December 1-31, 2016
2,915,083

 
121.76

 
2,915,083

 
 
3,858,569,963

   Total
11,894,080

 
116.20

 
11,894,080

 
 

*
Subject to applicable law, the Company may repurchase shares directly in the open market, in privately negotiated transactions, or pursuant to derivative instruments and plans complying with Rule 10b5-1, among other types of transactions and arrangements.
(1)
On December 3, 2015, the Company's Board of Directors approved a share repurchase program, effective January 1, 2016, that authorized the purchase of up to $15 billion of the Company's outstanding common stock with no specified expiration date.


10 McDonald's Corporation 2016 Annual Report


Stock Performance Graph
 
At least annually, we consider which companies comprise a readily identifiable investment peer group. McDonald's is included in published restaurant indices; however, unlike most other companies included in these indices, which have no or limited international operations, McDonald's does business in more than 100 countries and a substantial portion of our revenues and income is generated outside the U.S. In addition, because of our size, McDonald's inclusion in those indices tends to skew the results. Therefore, we believe that such a comparison is not meaningful.
Our market capitalization, trading volume and importance in an industry that is vital to the U.S. economy have resulted in McDonald's inclusion in the Dow Jones Industrial Average (DJIA) since 1985. Like McDonald's, many DJIA companies generate meaningful revenues and income outside the U.S. and some manage global brands. Thus, we believe that the use of the DJIA companies as the group for comparison purposes is appropriate.
The following performance graph shows McDonald's cumulative total shareholder returns (i.e., price appreciation and reinvestment of dividends) relative to the Standard & Poor's 500 Stock Index (S&P 500 Index) and to the DJIA companies for the five-year period ended December 31, 2016. The graph assumes that the value of an investment in McDonald's common stock, the S&P 500 Index and the DJIA companies (including McDonald's) was $100 at December 31, 2011. For the DJIA companies, returns are weighted for market capitalization as of the beginning of each period indicated. These returns may vary from those of the Dow Jones Industrial Average Index, which is not weighted by market capitalization, and may be composed of different companies during the period under consideration.
mcd-1231201_chartx51936.jpg
Company/Index
12/31/2011
12/31/2012
12/31/2013
12/31/2014
12/31/2015
12/31/2016
McDonald's Corporation
$100
$91
$103
$103
$134
$143
S&P 500 Index
100
116
154
175
177
198
Dow Jones Industrials
100
110
143
157
158
184
Source: S&P Capital IQ

 
McDonald's Corporation 2016 Annual Report 11


ITEM 6. Selected Financial Data
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
6-Year Summary
Years ended December 31,

 
 
 
 
 
 
 
 
 
 
 
 
In millions, except per share and unit amounts
2016

 
2015

 
2014

 
2013

 
2012

 
2011

Consolidated Statement of Income Data
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
 
 
 
   Sales by Company-operated restaurants
$
15,295

 
$
16,488

 
$
18,169

 
$
18,875

 
$
18,603

 
$
18,293

   Revenues from franchised restaurants
9,327

 
8,925

 
9,272

 
9,231

 
8,964

 
8,713

Total revenues
24,622

 
25,413

 
27,441

  
28,106

 
27,567

 
27,006

Operating income
7,745

 
7,146

 
7,949

 
8,764

 
8,605

 
8,530

Net income
4,687

 
4,529

 
4,758

 
5,586

 
5,465

 
5,503

Consolidated Statement of Cash Flows Data
 
 
 
 
 
 
 
 
 
 
 
Cash provided by operations
$
6,060

 
$
6,539

 
$
6,730

 
$
7,121

 
$
6,966

  
$
7,150

Cash used for investing activities
982

 
1,420

 
2,305

 
2,674

 
3,167

  
2,571

Capital expenditures
1,821

 
1,814

 
2,583

 
2,825

 
3,049

  
2,730

Cash used for (provided by) financing activities
11,262

 
(735
)
 
4,618

 
4,043

 
3,850

  
4,533

Treasury stock purchases(1)
11,142

 
6,182

 
3,175

 
1,810

 
2,605

  
3,373

Common stock dividends
3,058

 
3,230

 
3,216

 
3,115

 
2,897

  
2,610

Financial Position
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
31,024

 
$
37,939

 
$
34,227

 
$
36,626

 
$
35,386

  
$
32,990

Total debt
25,956

 
24,122

 
14,936

 
14,130

 
13,633

  
12,500

Total shareholders’ equity (deficit)
(2,204
)
 
7,088

 
12,853

 
16,010

 
15,294

  
14,390

Shares outstanding
819

 
907

 
963

 
990

 
1,003

  
1,021

Per Common Share Data
 
 
 
 
 
 
 
 
 
 
 
Earnings-diluted
$
5.44

 
$
4.80

 
$
4.82

 
$
5.55

 
$
5.36

 
$
5.27

Dividends declared
3.61

 
3.44

 
3.28

  
3.12

 
2.87

 
2.53

Market price at year end
121.72

 
118.44

 
93.70

  
97.03

 
88.21

 
100.33

Restaurant Information and Other Data
 
 
 
 
 
 
 
 
 
 
 
Restaurants at year end
 
 
 
 
 
 
 
 
 
 
 
   Company-operated restaurants
5,669

 
6,444

 
6,714

 
6,738

 
6,598

 
6,435

   Franchised restaurants
31,230

 
30,081

 
29,544

 
28,691

 
27,882

 
27,075

Total Systemwide restaurants
36,899

 
36,525

 
36,258

 
35,429

 
34,480

 
33,510

Franchised sales(2)
$
69,707

 
$
66,226

 
$
69,617

 
$
70,251

 
$
69,687

 
$
67,648

(1)
Represents treasury stock purchases as reflected in Shareholders' equity.
(2)
While franchised sales are not recorded as revenues by the Company, management believes they are important in understanding the Company's financial performance because these sales are the basis on which the Company calculates and records franchised revenues and are indicative of the financial health of the franchisee base. Franchised restaurants represent approximately 85% of McDonald's restaurants worldwide at December 31, 2016.


12 McDonald's Corporation 2016 Annual Report


ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
DESCRIPTION OF THE BUSINESS
The Company franchises and operates McDonald’s restaurants. Of the 36,899 restaurants in 120 countries at year-end 2016, 31,230 were franchised (reflects 21,559 franchised to conventional franchisees, 6,300 licensed to developmental licensees and 3,371 licensed to foreign affiliates ("affiliates")—primarily Japan) and 5,669 were operated by the Company.
Under McDonald's conventional franchise arrangement, franchisees provide a portion of the capital required by initially investing in the equipment, signs, seating and décor of their restaurant business, and by reinvesting in the business over time. The Company generally owns the land and building or secures long-term leases for both Company-operated and conventional franchised restaurant sites. This maintains long-term occupancy rights, helps control related costs and assists in alignment with franchisees enabling restaurant performance levels that are among the highest in the industry. In certain circumstances, the Company participates in the reinvestment for conventional franchised restaurants in an effort to accelerate implementation of certain initiatives.
Under McDonald's developmental license arrangement, licensees provide capital for the entire business, including the real estate interest, and the Company generally has no capital invested. In addition, the Company has an equity investment in a limited number of affiliates that invest in real estate and operate or franchise restaurants within a market.
McDonald's is primarily a franchisor and believes franchising is paramount to delivering great-tasting food, locally-relevant customer experiences and driving profitability. Franchising enables an individual to be his or her own employer and maintain control over all employment-related matters, marketing and pricing decisions, while also benefiting from the financial strength and global experience of McDonald's. However, directly operating restaurants is important to being a credible franchisor and provides Company personnel with restaurant operations experience. In Company-operated restaurants, and in collaboration with franchisees, McDonald's further develops and refines operating standards, marketing concepts and product and pricing strategies, so that only those that the Company believes are most beneficial are introduced in the restaurants. McDonald's continually reviews its mix of Company-operated and franchised restaurants to help optimize overall performance, with a goal to be approximately 95% franchised over the long term.
The Company’s revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees. Revenues from conventional franchised restaurants include rent and royalties based on a percent of sales along with minimum rent payments, and initial fees. Revenues from restaurants licensed to affiliates and developmental licensees include a royalty based on a percent of sales, and generally include initial fees. Fees vary by type of site, amount of Company investment, if any, and local business conditions. These fees, along with occupancy and operating rights, are stipulated in franchise/license agreements that generally have 20-year terms.
The business is structured into the following segments that combine markets with similar characteristics and opportunities for growth, and reflect how management reviews and evaluates operating performance:
 
U.S. - the Company's largest segment.
International Lead Markets - established markets including Australia, Canada, France, Germany, the U.K. and related markets.
High Growth Markets - markets that the Company believes have relatively higher restaurant expansion and franchising potential including China, Italy, Korea, the Netherlands, Poland, Russia, Spain, Switzerland and related markets.
Foundational Markets & Corporate - the remaining markets in the McDonald's system, each of which the Company believes have the potential to operate under a largely franchised model. Corporate activities are also reported within this segment.
For the year ended December 31, 2016, the U.S., International Lead Markets and High Growth Markets accounted for 34%, 29% and 25% of total revenues, respectively.
In analyzing business trends, management reviews results on a constant currency basis and considers a variety of performance and financial measures which are considered to be non-GAAP, including comparable sales and comparable guest count growth, Systemwide sales growth, return on incremental invested capital ("ROIIC"), free cash flow and free cash flow conversion rate, as described below.
Constant currency results exclude the effects of foreign currency translation and are calculated by translating current year results at prior year average exchange rates. Management reviews and analyzes business results in constant currencies and bases most incentive compensation plans on these results because the Company believes this better represents its underlying business trends.
Comparable sales and comparable guest counts are key performance indicators used within the retail industry and are indicative of the impact of the Company’s initiatives as well as local economic and consumer trends. Increases or decreases in comparable sales and comparable guest counts represent the percent change in sales and transactions, respectively, from the same period in the prior year for all restaurants, whether operated by the Company or franchisees, in operation at least thirteen months, including those temporarily closed. Some of the reasons restaurants may be temporarily closed include reimaging or remodeling, rebuilding, road construction and natural disasters. Comparable sales exclude the impact of currency translation. Comparable sales are driven by changes in guest counts and average check, which is affected by changes in pricing and product mix. Typically, pricing has a greater impact on average check than product mix. The goal is to achieve a relatively balanced contribution from both guest counts and average check.
Systemwide sales include sales at all restaurants. While franchised sales are not recorded as revenues by the Company, management believes the information is important in understanding the Company’s financial performance because these sales are the basis on which the Company calculates and records franchised revenues and are indicative of the financial health of the franchisee base.
ROIIC is a measure reviewed by management over one-year and three-year time periods to evaluate the overall profitability of the markets, the effectiveness of capital deployed and the future allocation of capital. The return is calculated by dividing the change in operating income plus depreciation and amortization (numerator) by the cash used for investing activities (denominator), primarily capital expenditures. The calculation uses a constant average

 
McDonald's Corporation 2016 Annual Report 13


foreign exchange rate over the periods included in the calculation.
Free cash flow, defined as cash provided by operations less capital expenditures, and free cash flow conversion rate, defined as free cash flow divided by net income, are measures reviewed by management in order to evaluate the Company’s ability to convert net profits into cash resources, after reinvesting in the core business, that can be used to pursue opportunities to enhance shareholder value.
STRATEGIC DIRECTION AND FINANCIAL PERFORMANCE
The strength of the alignment among the Company, its franchisees and suppliers (collectively referred to as the "System") is key to McDonald's long-term success. By leveraging the System, McDonald’s is able to identify, implement and scale ideas that meet customers' changing needs and preferences. McDonald's continually builds on its competitive advantages of System alignment and geographic diversification to deliver consistent, yet locally-relevant restaurant experiences to customers as an integral part of their communities.
PROGRESS ON THE COMPANY'S TURNAROUND
The turnaround plan, introduced in 2015, represented a significant step change in how McDonald's operates and a recommitment to putting customers first. With an aspiration of being recognized by customers as a modern and progressive burger company, the Company prioritized fewer, more strategic initiatives that focused on running better restaurants, driving operational growth, returning excitement to the brand and enhancing financial value.
Building on these initial steps, the Company made purposeful changes in 2016. The Company continued to right-size the organization and put the appropriate talent in place by blending executives with deep McDonald’s experience with new executives to generate fresh energy and innovative ideas, while successfully executing against the key elements of its turnaround plan. As reflected by improved customer satisfaction measures across most of the major markets, customers have taken notice.
In addition to the customer-relevant changes in the restaurants, the Company has enhanced financial value through its refranchising efforts, cost savings initiatives and cash return to shareholders, as follows:
Refranchising - the Company expects to achieve its refranchising target of 4,000 restaurants by the end of 2017, a full year ahead of the original target date, with a long-term goal to become approximately 95% franchised. Since 2015, the Company has pursued its refranchising goal through the expansion of its conventional franchisee base and the addition of new developmental licensees that bring strong strategic capabilities and financial resources that will enable accelerated expansion and innovation.
Moving to a more heavily franchised business model will benefit the Company’s performance over the long term, as the rent and royalty income received from franchisees will provide a more predictable and stable revenue stream with significantly lower operating costs and risks. This model is less capital intensive as franchisees are responsible for reinvesting capital in their businesses.
Cost Savings - the Company made meaningful progress towards its goal of reducing net G&A levels by $500 million by the end of 2018 from the Company’s G&A base of $2.6 billion at the beginning of 2015. Actions taken in 2015 and 2016, including the redesign of the organization to eliminate layers and increase spans of control, more centralization of non-customer facing business processes and execution
 
against its refranchising targets, have resulted in savings of more than $200 million.
Cash Return to Shareholders - The strength and reliability of the Company's significant and growing free cash flow, strong investment grade credit rating and continued access to credit provide the flexibility to fund capital expenditures as well as return cash to shareholders. By the end of 2016, the Company achieved its three-year target of $30 billion cash return to shareholders. Optimization of the Company's capital structure by adding a meaningful amount of additional debt was instrumental in meeting this target.
2016 FINANCIAL PERFORMANCE
The Company's progress in executing the turnaround plan is evident by its stronger business results, including the highest comparable sales growth since 2011. In McDonald’s heavily franchised business model, growing comparable sales is key to increasing operating income and returns. In 2016, global comparable sales increased 3.8%, including positive comparable sales across all segments. Comparable guest counts were negative 0.3%, as positive guest traffic in the Foundational Markets and International Lead Markets was more than offset by negative guest traffic in the U.S. and High Growth Markets.
Comparable sales in the U.S. increased 1.7%, due in part to a higher average check, while comparable guest counts declined 2.1% amidst continued industry softness. The growth in comparable sales was supported by All-Day Breakfast and everyday value under the McPick 2 platform.
Comparable sales in the International Lead Markets increased 3.4% and comparable guest counts increased 1.5%, reflecting solid comparable sales performance across most of the segment, led by the U.K.
In the High Growth Markets, comparable sales increased 2.8%, while comparable guest counts declined 0.8%. The increase in comparable sales reflected positive results across most of the segment, led by China.
Comparable sales in the Foundational Markets increased 10.0% and comparable guest counts increased 1.9%, led by very strong performance in Japan and certain markets in Latin America, as well as solid results across the remainder of the segment.
In addition to improved comparable sales performance, the Company achieved the following financial results in 2016:
Consolidated revenues decreased 3% (flat in constant currencies) due to the impact of refranchising, partly offset by positive comparable sales.
Systemwide sales increased 3% (5% in constant currencies).
Consolidated operating income increased 8% (11% in constant currencies).
Operating margin, defined as operating income as a percent of total revenues, increased from 28.1% in 2015 to 31.5% in 2016.
Diluted earnings per share of $5.44 increased 13% (16% in constant currencies).
Cash provided by operations was $6.1 billion.
Capital expenditures of $1.8 billion were allocated mainly to reinvestment in existing restaurants and, to a lesser extent, to new restaurant openings. Across the System, about 900


14 McDonald's Corporation 2016 Annual Report


restaurants were opened and over 1,700 existing locations were reimaged.
Free cash flow was $4.2 billion and the Company's free cash flow conversion rate was 90% (see reconciliation in Exhibit 12).
One-year ROIIC was 62.7% and three-year ROIIC was 5.1% for the period ended December 31, 2016 (see reconciliation in Exhibit 12).
The Company increased its quarterly cash dividend per share by 6% to $0.94 for the fourth quarter, equivalent to an annual dividend of $3.76 per share.
The Company returned $14.2 billion to shareholders through dividends and share repurchases for the year, achieving the Company's targeted return of $30 billion for the three-year period ended 2016.
STRATEGIC DIRECTION
Building on the momentum established in 2016, the Company is beginning to shift focus from revitalizing the business to longer-term growth. The Company will move with increased velocity to drive sustainable guest count growth, a reliable long-term measure of the Company's strength that is vital to growing the Company’s sales and shareholder value.
In order to drive guest count growth in an ever-changing customer environment, the Company developed a customer-centric growth strategy for 2017 and beyond, informed by deep customer research across multiple markets. The Company's greatest opportunities are at the heart of the brand - in its food, value and customer experience - and within defined customer groups. This strategy is built on the following three pillars, which will position McDonald's as a modern and progressive burger company that "makes delicious, feel good moments easy for everyone."
Retaining existing customers. The Company will renew its focus on areas where the Company already has a strong foothold in the IEO, including family occasions and food-led breakfast.
Regaining lost customers. The Company plans to regain customers by recommitting to areas of historic strength, namely quality, convenience and value.
Converting casual to committed customers. The Company will focus on building stronger relationships with customers so they visit more often, by elevating and leveraging the McCafé coffee brand and enhancing snack and treat offerings.
The Company will continue to build upon its investments in Experience of the Future ("EOTF"), which focuses on restaurant modernization and technology, in order to transform the restaurant service experience. The Company is also accelerating its pursuit of the following two initiatives designed to further drive growth.
Digital. As the Company accelerates its pace of converting restaurants to EOTF, it is placing renewed emphasis on improving its existing service model (i.e., eat in, take out, or drive-thru) and strengthening its relationships with customers through technology. By evolving the technology platform, the Company will simplify how customers order, pay and are served through additional functionality on its global mobile app, self-order kiosks and technology-driven models that enable table service and curb-side pick-up.
Delivery. The Company is accelerating its focus and investment on its delivery platform as a way to expand the convenience customers expect from McDonald's. The
 
Company is conducting various pilot tests in the U.S., Europe and Asia and plans to scale quickly based on results of these pilots.
AREAS OF FOCUS BY SEGMENT
U.S.
While the U.S. has begun to build sales momentum, its greatest opportunity is guest count growth, by focusing on actions that collectively transform the customer experience.
A focus on food taste and quality will remain a key priority, including offering the Company's best tasting burger. In 2017, the U.S. is planning to introduce its Signature Crafted offering, a premium platform focused on authentic ingredients that allows customers to customize their sandwiches. In addition, the U.S. will remain focused on strengthening its customer-relevant value proposition.
The U.S. expects to launch its mobile order and pay functionality as well as curbside pick-up across all traditional restaurants in the fourth quarter 2017. Further, most of the System's traditional restaurants are expected to be converted to EOTF by 2020. In addition, the U.S. will continue to test its delivery platform.
International Lead Markets
The International Lead Markets are deepening their connection with customers and meeting their changing needs with meaningful enhancements in menu, accessibility and experience.
The segment is focused on providing quality, great taste, value and choice across the entire menu. Entry-level value programs appeal to teens and young adults, while other platforms provide budget-conscious customers affordable meal bundles. Programs across the segment are energizing the core menu, and every market has successfully extended into premium chicken and beef with locally relevant offerings. All of this is supported by modernized cooking and service platforms that expand capacity and enable hotter, fresher products. The segment will also remain focused on enhancing and expanding the McCafé coffee brand and pastry offerings.
The International Lead Markets continues to lead the McDonald’s System in the development and deployment of EOTF.
High Growth Markets
McDonald’s High Growth Markets have leveraged learnings from the International Lead Markets to enhance the customer experience through design, digital, people, menu innovation and value.
In addition to driving operational growth in existing restaurants, targeted new restaurant development and refranchising initiatives are top priorities. In early 2017, the Company announced the planned sale of its businesses in China and Hong Kong to a developmental licensee.
Foundational Markets
The Foundational Markets is a diverse group of markets that share common goals of enhancing the critical elements that differentiate McDonald’s - the menu and the customer experience. The segment is committed to running great restaurants and increasing convenience to customers, including through drive-thru and delivery. The Foundational Markets continue to pursue refranchising opportunities, including the sale of certain markets to developmental licensees. In early 2017, the Company announced the planned sale of its businesses in the Nordic markets (Denmark, Finland, Norway and Sweden) to a developmental licensee.

 
McDonald's Corporation 2016 Annual Report 15


OUTLOOK
2017 Outlook
The following global and certain segment-specific information is provided to assist in forecasting the Company’s future results.
Changes in Systemwide sales are driven by comparable sales and net restaurant unit expansion. The Company expects net restaurant additions to add approximately 1 percentage point to 2017 Systemwide sales growth (in constant currencies).
The Company does not generally provide specific guidance on changes in comparable sales. However, as a perspective, assuming no change in cost structure, a 1 percentage point change in comparable sales for either the U.S. or the International Lead segment would change annual diluted earnings per share by about 4 to 5 cents.
With about 75% of McDonald's grocery bill comprised of 10 different commodities, a basket of goods approach is the most comprehensive way to look at the Company's commodity costs. For the full-year 2017, costs for the total basket of goods are expected to increase about 0.5-1.5% in the U.S. and increase about 2.0% in the International Lead segment.
The Company expects full-year 2017 selling, general and administrative expenses to decrease about 7-8%, in constant currencies with fluctuations expected between the quarters. This includes incentive-based compensation costs of less than $300 million.
Based on current interest and foreign currency exchange rates, the Company expects interest expense for the full-year 2017 to increase about 5-10% compared with 2016 due to higher average debt balances.
A significant part of the Company's operating income is generated outside the U.S., and about 35% of its total debt is denominated in foreign currencies. Accordingly, earnings are affected by changes in foreign currency exchange rates, particularly the Euro, British Pound, Australian Dollar and Canadian Dollar. Collectively, these currencies represent approximately 70% of the Company's operating income outside the U.S. If all four of these currencies moved by 10% in the same direction, the Company's annual diluted earnings per share would change by about 25 cents.
The Company expects the effective income tax rate for the full-year 2017 to be in the 31-33% range. Some volatility may result in a quarterly tax rate outside of the annual range.
The Company expects capital expenditures for 2017 to be approximately $1.7 billion, about one-third of which will be used to open new restaurants. The Company expects to open about 900 restaurants, including about 500 restaurants in affiliated and developmental licensee markets where the Company generally does not fund any capital expenditures. The Company expects net additions of about 400 restaurants. The remaining two-thirds of capital will be used to reinvest in existing locations, including about 650 reimages in the U.S. When combined with previously modernized restaurants that will be updated with EOTF elements in 2017, we expect to have about 2,500 EOTF restaurants in the U.S. by the end of 2017.
 
Long-Term Outlook
The Company expects to refranchise about 4,000 restaurants in the three-year period ending 2017, with a long-term goal to become approximately 95% franchised.
The Company expects to realize net annual G&A savings of about $500 million from its G&A base of $2.6 billion at the beginning of 2015. Through the end of 2016, the Company realized cumulative savings of more than $200 million and expects to realize the majority of its savings target by the end of 2017. Beyond its $500 million reduction, the Company expects to further reduce G&A by 5-10% from the remaining G&A base by the end of 2019. These targets exclude the impact of foreign currency changes.
The Company expects capital expenditures to decline by approximately $500 million from the 2017 level of $1.7 billion, once the U.S. restaurant modernization work is substantially completed.
The Company expects to return between $22 and $24 billion to shareholders for the three-year period ending 2019. This new target contemplates proceeds from future restaurant sales expected under its ongoing refranchising initiative. As the business grows, the Company also expects to modestly increase its debt levels, while maintaining its credit metrics within current ranges.

Long-Term Financial Targets
The Company has established the following long-term, average annual (constant currency) financial targets, beginning in 2019, with variability expected during 2017 and 2018 due to the impact of refranchising:
Systemwide sales growth of 3-5%;
Operating margin in the mid-40% range;
Earnings per share growth in the high-single digits; and
ROIIC in the mid-20% range.




16 McDonald's Corporation 2016 Annual Report


Consolidated Operating Results
Operating results
 
 
 
 
2016

 
 
 
 
2015

 
 
2014

Dollars and shares in millions, except per share data
 
Amount

 
Increase/ (decrease)

 
 
Amount

 
Increase/ (decrease)

 
 
Amount

Revenues
 
 
 
 
 
 
 
 
 
 
 
 
Sales by Company-operated restaurants
 
$
15,295

 
(7
%)
 
 
$
16,488

 
(9
%)
 
 
$
18,169

Revenues from franchised restaurants
 
9,327

 
5

 
 
8,925

 
(4
)
 
 
9,272

Total revenues
 
24,622

 
(3
)
 
 
25,413

 
(7
)
 
 
27,441

Operating costs and expenses
 
 
 
 
 
 
 
 
 
 
 
 
Company-operated restaurant expenses
 
12,699

 
(9
)
 
 
13,977

 
(9
)
 
 
15,288

Franchised restaurants-occupancy expenses
 
1,718

 
4

 
 
1,647

 
(3
)
 
 
1,697

Selling, general & administrative expenses
 
2,384

 
(2
)
 
 
2,434

 
(2
)
 
 
2,488

Other operating (income) expense, net
 
76

 
(64
)
 
 
209

 
n/m

 
 
19

Total operating costs and expenses
 
16,877


(8
)
 
 
18,267

 
(6
)
 
 
19,492

Operating income
 
7,745

 
8

 
 
7,146

 
(10
)
 
 
7,949

Interest expense
 
885

 
39

 
 
638

 
11

 
 
576

Nonoperating (income) expense, net
 
(6
)
 
87

 
 
(48
)
 
n/m

 
 
1

Income before provision for income taxes
 
6,866

 
5

 
 
6,556

 
(11
)
 
 
7,372

Provision for income taxes
 
2,180

 
8

 
 
2,027

 
(22
)
 
 
2,614

Net income
 
$
4,686

 
3
%
 
 
$
4,529

 
(5
%)
 
 
$
4,758

Earnings per common share—diluted
 
$
5.44

 
13
%
 
 
$
4.80

 
0
%
 
 
$
4.82

Weighted-average common shares outstanding—
diluted
 
861.2

 
(9
%)
 
 
944.6

 
(4
%)
 
 
986.3

n/m Not meaningful
IMPACT OF FOREIGN CURRENCY TRANSLATION ON REPORTED RESULTS
While changes in foreign currency exchange rates affect reported results, McDonald’s mitigates exposures, where practical, by purchasing goods and services in local currencies, financing in local currencies and hedging certain foreign-denominated cash flows.
Foreign currency translation had a negative impact on consolidated operating results in each of the last three years. In 2016, results were negatively impacted by the weaker British Pound as well as many other currencies. In 2015, results were negatively impacted by the weaker Euro, Australian Dollar, Russian Ruble and most other currencies. In 2014, results were negatively impacted by the weaker Russian Ruble, Australian Dollar and certain other currencies, partly offset by the stronger British Pound.
Impact of foreign currency translation on reported results
 
 
  
 
Reported amount
 
 
 
 
 
Currency translation benefit/(cost)
 
In millions, except per share data
 
2016

 
2015

 
2014

 
 
2016

 
2015

 
2014

Revenues
 
$
24,622

 
$
25,413

 
$
27,441

 
 
$
(692
)
 
$
(2,829
)
 
$
(570
)
Company-operated margins
 
2,596

 
2,511

 
2,881

 
 
(89
)
 
(331
)
 
(60
)
Franchised margins
 
7,609

 
7,278

 
7,575

 
 
(118
)
 
(626
)
 
(119
)
Selling, general & administrative expenses
 
2,384

 
2,434

 
2,488

 
 
28

 
158

 
21

Operating income
 
7,745

 
7,146

 
7,949

 
 
(173
)
 
(771
)
 
(152
)
Net income
 
4,686

 
4,529

 
4,758

 
 
(97
)
 
(473
)
 
(114
)
Earnings per common share—diluted
 
5.44

 
4.80

 
4.82

 
 
(0.11
)
 
(0.50
)
 
(0.12
)
 
NET INCOME AND DILUTED EARNINGS PER COMMON SHARE
In 2016, net income increased 3% (6% in constant currencies) to $4.7 billion and diluted earnings per common share increased 13% (16% in constant currencies) to $5.44. Foreign currency translation had a negative impact of $0.11 on diluted earnings per share.
In 2015, net income decreased 5% (increased 5% in constant currencies) to $4.5 billion and diluted earnings per common share was relatively flat (increased 10% in constant currencies) at $4.80. Foreign currency translation had a negative impact of $0.50 on diluted earnings per share.
Results in 2016 benefited from stronger operating performance and higher gains on sales of restaurant businesses, mostly in the U.S., while results in 2015 benefited from higher franchised margins and a gain on the strategic sale of a unique restaurant property in the U.S.
 
Both 2016 and 2015 results were partly offset by net pre-tax impairment and other charges of $342 million and $307 million, respectively, primarily related to goodwill impairment and other asset write-offs in conjunction with the Company's refranchising initiatives, restructuring and incremental restaurant closings. The 2015 charges combined with the gain on the strategic sale of a unique restaurant property in the U.S. had a net negative impact on diluted earnings per share of $0.18 in 2015, while the 2016 charges had a net negative impact on diluted earnings per share of $0.28 in 2016.
The Company repurchased 92.3 million shares of its stock for $11.1 billion in 2016 and 61.8 million shares of its stock for $6.2 billion in 2015, driving reductions in weighted-average shares outstanding on a diluted basis in both periods, which positively benefited earnings per share.

 
McDonald's Corporation 2016 Annual Report 17


REVENUES
The Company’s revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees. Revenues from conventional franchised restaurants include rent and royalties based on a percent of sales, minimum rent payments and initial fees. Revenues from franchised restaurants that are licensed to foreign affiliates and developmental licensees include a royalty based on a percent of sales, and generally include initial fees.
The Company continues to accelerate the pace of refranchising to optimize its restaurant ownership mix, generate more stable and predictable revenue and cash flow streams, and operate with a less resource-intensive structure. The shift to a greater percentage of franchised restaurants negatively impacts consolidated revenues as Company-operated sales are replaced by franchised sales, where the Company receives rent and/or royalty revenue based on a percentage of sales.
In 2016, revenues decreased 3% (flat in constant currencies) due to the impact of refranchising, partly offset by positive comparable sales. In 2015, revenues decreased 7% (increased 3% in constant currencies), partly due to foreign currency translation. In constant currencies, revenue growth was driven by positive comparable sales and the benefit from expansion.
Revenues
 
 
Amount
 
 
Increase/(decrease)
 
 
Increase/(decrease)
excluding currency
translation
 
Dollars in millions
 
2016

 
2015

 
2014

 
2016

 
2015

 
2016

 
2015

Company-operated sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S.
 
$
3,743

 
$
4,198

 
$
4,351

 
(11
%)
 
(4
%)
 
(11
%)
 
(4
%)
International Lead Markets
 
4,278

 
4,798

 
5,443

 
(11
)
 
(12
)
 
(6
)
 
1

High Growth Markets
 
5,378

 
5,442

 
6,071

 
(1
)
 
(10
)
 
4

 
6

Foundational Markets & Corporate
 
1,896

 
2,050

 
2,304

 
(8
)
 
(11
)
 
(5
)
 
5

Total
 
$
15,295

 
$
16,488

 
$
18,169

 
(7
%)
 
(9
%)
 
(4
%)
 
2
%
Franchised revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S.
 
$
4,510

 
$
4,361

 
$
4,300

 
3
%
 
1
%
 
3
%
 
1
%
International Lead Markets
 
2,945

 
2,817

 
3,101

 
5

 
(9
)
 
8

 
6

High Growth Markets
 
783

 
731

 
774

 
7

 
(5
)
 
9

 
9

Foundational Markets & Corporate
 
1,089

 
1,016

 
1,097

 
7

 
(7
)
 
11

 
10

Total
 
$
9,327

 
$
8,925

 
$
9,272

 
5
%
 
(4
%)
 
6
%
 
5
%
Total revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S.
 
$
8,253

 
$
8,559

 
$
8,651

 
(4
%)
 
(1
%)
 
(4
%)
 
(1
%)
International Lead Markets
 
7,223

 
7,615

 
8,544

 
(5
)
 
(11
)
 
(1
)
 
3

High Growth Markets
 
6,161

 
6,173

 
6,845

 
0

 
(10
)
 
4

 
6

Foundational Markets & Corporate
 
2,985

 
3,066

 
3,401

 
(3
)
 
(10
)
 
1

 
7

Total
 
$
24,622

 
$
25,413

 
$
27,441

 
(3
%)
 
(7
%)
 
0
%
 
3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
US: In 2016, the decrease in revenues reflected the impact of refranchising, partly offset by modestly positive comparable sales. In 2015, the decrease reflected the impact of refranchising.
International Lead Markets: In 2016, the decrease in revenues was due to the impact of refranchising, partly offset by strong comparable sales growth across most of the segment. In 2015, revenues decreased due to foreign currency translation. In constant currencies, revenues increased due to positive comparable sales performance, primarily in the U.K., Australia and Canada, partly offset by the impact of refranchising.
 
High Growth Markets: In 2016 and 2015, revenue growth was negatively impacted by foreign currency translation. In constant currencies, 2016 revenues increased due to positive comparable sales growth in China and most other markets, and continued expansion in Russia. In constant currencies, 2015 revenues increased due to expansion and positive comparable sales, primarily driven by Russia and China.


18 McDonald's Corporation 2016 Annual Report


The following tables present comparable sales, comparable guest counts and Systemwide sales increases/(decreases):
Comparable sales and guest count increases/(decreases)
 
 
 
 
 
 
 
 
 
2016
 
 
2015
 
 
2014
 
  
 
Sales

 
Guest
Counts

 
Sales

 
Guest
Counts

 
Sales

 
Guest
Counts

U.S.
 
1.7
%
 
(2.1
%)
 
0.5
%
 
(3.0
%)
 
(2.1
%)
 
(4.1
%)
International Lead Markets
 
3.4

 
1.5

 
3.4

 
1.0

 
0.8

 
(1.2
)
High Growth Markets
 
2.8

 
(0.8
)
 
1.8

 
(2.2
)
 
(2.8
)
 
(2.9
)
Foundational Markets & Corporate
 
10.0

 
1.9

 
0.7

 
(3.7
)
 
(0.1
)
 
(4.8
)
Total
 
3.8
%
 
(0.3
%)
 
1.5
%
 
(2.3
%)
 
(1.0
%)
 
(3.6
%)

Systemwide sales increases/(decreases)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Increase/(decrease)
excluding currency
translation
 
 
 
2016

 
2015

 
2016

 
2015

U.S.
 
2
%
 
1
%
 
2
%
 
1
%
International Lead Markets
 
1

 
(10
)
 
5

 
5

High Growth Markets
 
3

 
(7
)
 
6

 
8

Foundational Markets & Corporate
 
8

 
(13
)
 
11

 
3

Total
 
3
%
 
(6
%)
 
5
%
 
3
%
Franchised sales are not recorded as revenues by the Company, but are the basis on which the Company calculates and records franchised revenues and are indicative of the financial health of the franchisee base. The following table presents franchised sales and the related increases/(decreases):
Franchised sales
 
 
Amount
 
 
Increase/(decrease)
 
 
Increase/(decrease)
excluding currency
translation
 
Dollars in millions
 
2016

 
2015

 
2014

 
2016

 
2015

 
2016

 
2015

U.S.
 
$
32,646

 
$
31,639

 
$
31,096

 
3
%
 
2
%
 
3
%
 
2
%
International Lead Markets
 
17,049

 
16,313

 
17,921

 
5

 
(9
)
 
8

 
6

High Growth Markets
 
4,858

 
4,525

 
4,678

 
7

 
(3
)
 
10

 
10

Foundational Markets & Corporate
 
15,154

 
13,749

 
15,922

 
10

 
(14
)
 
14

 
3

Total
 
$
69,707

 
$
66,226

 
$
69,617

 
5
%
 
(5
%)
 
7
%
 
4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
McDonald's Corporation 2016 Annual Report 19


FRANCHISED MARGINS
Franchised margin dollars represent revenues from franchised restaurants less the Company’s occupancy costs (rent and depreciation) associated with those sites. Franchised margin dollars represented about 75% of the combined restaurant margins in 2016, 2015 and 2014.
In 2016, franchised margin dollars increased $331 million or 5% (6% in constant currencies). In 2015, franchised margin dollars decreased $297 million or 4% (increased 4% in constant currencies), due to foreign currency translation. For both 2016 and 2015, the constant currency increases were due to positive comparable sales performance, expansion and refranchising.
In connection with the Company's refranchising initiatives, the Company expects to refranchise about 4,000 restaurants for the three-year period ending 2017. While this refranchising activity may have a dilutive effect on the franchised margin percent, it typically results in higher franchised margin dollars.
Franchised margins
 
Amount

% of Revenue

 
Amount

% of Revenue

 
Amount

% of Revenue

 
Increase/(decrease)
 
 
Increase/(decrease) excluding currency translation
 
Dollars in millions
2016
 
2015
 
2014
 
2016

 
2015

 
2016

 
2015

U.S.
$
3,726

82.6
%
 
$
3,606

82.7
%
 
$
3,572

83.1
%
 
3
%
 
1
%
 
3
%
 
1
%
International Lead Markets
2,363

80.2

 
2,254

80.0

 
2,486

80.1

 
5

 
(9
)
 
8

 
6

High Growth Markets
550

70.2

 
520

71.1

 
555

71.7

 
6

 
(6
)
 
8

 
7

Foundational Markets & Corporate
970

89.1

 
898

88.3

 
962

87.7

 
8

 
(7
)
 
12

 
11

Total
$
7,609

81.6
%
 
$
7,278

81.5
%
 
$
7,575

81.7
%
 
5
%
 
(4
%)
 
6
%
 
4
%
U.S.: In 2016 and 2015, the decreases in the franchised margin percent were due to higher occupancy costs, partly offset by positive comparable sales.
International Lead Markets: In 2016, the increase in the franchised margin percent reflected the benefit from positive comparable sales performance, partly offset by higher occupancy costs and the impact of refranchising. In 2015, the slight decrease reflected the benefit from positive comparable sales performance and the negative impact from higher occupancy costs and refranchising.
 
High Growth Markets: In 2016, the decrease in the franchised margin percent was primarily due to the impact of refranchising and higher occupancy costs, partly offset by the benefit of positive comparable sales performance. In 2015, the decrease was primarily due to the impact of refranchising.
The franchised margin percent in Foundational Markets & Corporate is higher relative to the other segments due to a larger proportion of developmental licensed and/or affiliated restaurants where the Company receives royalty income with no corresponding occupancy costs.

COMPANY-OPERATED MARGINS
Company-operated margin dollars represent sales by Company-operated restaurants less the operating costs of these restaurants. In 2016, Company-operated margin dollars increased $85 million or 3% (7% in constant currencies). In 2015, Company-operated margin dollars decreased $370 million or 13% (1% in constant currencies).
Company-operated margins
 
Amount

% of Revenue

 
Amount

% of Revenue

 
Amount

% of Revenue

 
Increase/(decrease)
 
 
Increase/(decrease) excluding currency translation
 
Dollars in millions
2016
 
2015
 
2014
 
2016

 
2015

 
2016

 
2015

U.S.
$
618

16.5
%
 
$
632

15.1
%
 
$
756

17.4
%
 
(2
%)
 
(16
%)
 
(2
%)
 
(16
%)
International Lead Markets
886

20.7

 
961

20.0

 
1,080

19.8

 
(8
)
 
(11
)
 
(3
)
 
2

High Growth Markets
796

14.8

 
659

12.1

 
780

12.9

 
21

 
(16
)
 
26

 
3

Foundational Markets & Corporate
296

15.6

 
259

12.7

 
265

11.5

 
14

 
(2
)
 
17

 
15

Total
$
2,596

17.0
%
 
$
2,511

15.2
%
 
$
2,881

15.9
%
 
3
%
 
(13
%)
 
7
%
 
(1
%)
U.S.: In 2016, the increase in the Company-operated margin percent was due to a higher average check and lower commodity costs, partly offset by the impact of negative guest counts and higher labor costs. In 2015, the decrease was primarily due to the incremental investment in wages and benefits for eligible Company-operated restaurant employees, effective July 1, 2015, designed to improve restaurant performance and enhance our employment proposition.
International Lead Markets: In 2016 and 2015, the increases in the Company-operated margin percent were primarily due to positive comparable sales, partly offset by higher labor and occupancy costs. In 2015, the margin percent also benefited from refranchising efforts.
 
High Growth Markets: In 2016, the increase in the Company-operated margin percent was primarily due to positive comparable sales and improved restaurant profitability in China, which benefited from recent value-added tax ("VAT") reform, partly offset by higher labor costs across the segment. In 2015, the decrease was primarily due to the negative impact from currency and inflationary pressures in Russia, and higher labor and occupancy costs across the segment. This was partly offset by the benefit from recovery in China from a 2014 supplier issue.


20 McDonald's Corporation 2016 Annual Report


SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Consolidated selling, general and administrative expenses decreased 2% (1% in constant currencies) in 2016 and decreased 2% (increased 4% in constant currencies) in 2015. The decrease in 2016 was due to lower employee-related costs resulting from the Company's recent restructuring and other cost-saving initiatives, mostly offset by higher incentive-based compensation expenses reflecting improved Company performance. The decrease in 2015 benefited from foreign currency translation. In constant currencies, selling, general and administrative expenses increased due to higher incentive-based compensation costs reflecting improved performance, partly offset by lower employee-related costs resulting from the Company's restructuring initiatives.
Selling, general & administrative expenses
 
Amount
 
 
Increase/(decrease)
 
 
Increase/(decrease)
excluding currency
translation
 
 
Dollars in millions
2016

 
2015

 
2014

 
2016

 
2015

 
2016

 
2015

 
U.S.
$
741

 
$
766

 
$
772

 
(3
%)
 
(1
%)
 
(3
%)
 
(1
%)
 
International Lead Markets
464

 
534

 
621

 
(13
)
 
(14
)
 
(10
)
 
(1
)
 
High Growth Markets
294

 
326

 
389

 
(10
)
 
(16
)
 
(6
)
 
(5
)
 
Foundational Markets & Corporate(1)
885

 
808

 
706

 
10

 
15

 
10

 
20

 
Total (Selling, General & Administrative Expenses)
$
2,384

 
$
2,434

 
$
2,488

 
(2
%)
 
(2
%)
 
(1
%)
 
4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Less: Incentive-Based Compensation(2)
418

 
317

 
171

 
32
%
 
85
%
 
33
%
 
95
%
 
Total (Excluding Incentive-Based Compensation)
$
1,966

 
$
2,117

 
$
2,317

 
(7
%)
 
(9
%)
 
(6
%)
(3) 
(2
%)
(4) 
(1)
Included in Foundational Markets & Corporate are home office support costs in areas such as facilities, finance, human resources, information technology, legal, marketing, restaurant operations, supply chain and training.
(2)
Includes all cash incentives and share-based compensation expense.
(3)
Excludes $24.8 million of foreign currency benefit.
(4)
Excludes $142.1 million of foreign currency benefit.
Selling, general and administrative expenses as a percent of Systemwide sales was 2.8% in 2016, 2.9% in 2015 and 2.8% in 2014. Management believes that analyzing selling, general and administrative expenses as a percent of Systemwide sales is meaningful because these costs are incurred to support the overall McDonald's business.
In connection with our turnaround plan, the Company established a net selling, general and administrative savings target of $500 million to be achieved by the end of 2018, excluding the effects of any foreign currency changes. These savings represent a reduction of about 20% from our selling, general and administrative base of $2.6 billion at the beginning of 2015. This base included incentive-based compensation of approximately $330 million, which assumed achievement of planned operating performance. In 2014, the lower incentive-based compensation reflected nominal payouts for the Company's short-term cash bonus program.
 
OTHER OPERATING (INCOME) EXPENSE, NET
Other operating (income) expense, net
In millions
2016

 
2015

 
2014

Gains on sales of restaurant businesses
$
(283
)
 
$
(146
)
 
$
(137
)
Equity in (earnings) losses of unconsolidated affiliates
(55
)
 
147

 
9

Asset dispositions and other (income) expense, net
72

 
(27
)
 
108

Impairment and other charges (gains), net
342

 
235

 
39

Total
$
76

 
$
209

 
$
19

Gains on sales of restaurant businesses
In 2016, the Company realized higher gains on sales of restaurant businesses, primarily in the U.S.
Equity in (earnings) losses of unconsolidated affiliates
Equity in earnings of unconsolidated affiliates increased in 2016 mainly due to improved performance in Japan. In 2015, the decrease was primarily due to weaker results in Japan, including the decision to close under-performing restaurants.
 
Asset dispositions and other (income) expense, net
In 2015, results included a gain of $135 million on the strategic sale of a unique restaurant property in the U.S., mostly offset by asset write-offs of $72 million resulting from the decision to close under-performing restaurants, primarily in the U.S. and China.
Impairment and other charges (gains), net
Impairment and other charges (gains), net included pre-tax impairment charges incurred primarily in Foundational Markets and Corporate, and charges incurred in connection with global restructuring activities.

 
McDonald's Corporation 2016 Annual Report 21


OPERATING INCOME
Operating income
 
Amount
 
 
Increase/(decrease)
 
 
Increase/(decrease) excluding currency translation
 
Dollars in millions
2016

 
2015

 
2014

 
2016

 
2015

 
2016

 
2015

U.S.
$
3,769

 
$
3,612

 
$
3,523

 
4
%
 
3
%
 
4
%
 
3
%
International Lead Markets
2,838

 
2,713

 
3,034

 
5

 
(11
)
 
9

 
4

High Growth Markets
1,049

 
841

 
934

 
25

 
(10
)
 
29

 
9

Foundational Markets & Corporate
89

 
(20
)
 
458

 
n/m

 
n/m

 
n/m

 
(74
)
Total
$
7,745

 
$
7,146

 
$
7,949

 
8
%
 
(10
%)
 
11
%
 
0
%

U.S.: In 2016, the increase in operating income reflected higher sales-driven franchised margin dollars and higher gains from sales of restaurant businesses, partly offset by the negative impact from lapping the 2015 gain on the strategic sale of a unique restaurant property. In 2015, the increase was primarily due to the aforementioned gain on sale of property and higher franchised margin dollars, partly offset by lower Company-operated margin dollars reflecting higher costs associated with the incremental investment in wages and benefits for eligible Company-operated restaurant employees, effective July 1, 2015. In addition, 2015 results were negatively impacted by restructuring and restaurant closing charges.
International Lead Markets: In 2016, the constant currency operating income increase was primarily due to sales-driven improvements in franchised margin dollars across most markets. In 2015, the operating income decrease was due to foreign currency translation. In constant currencies, the operating income increase was primarily due to higher franchised margin dollars, benefiting from positive comparable sales performance.
High Growth Markets: In 2016, the constant currency operating income increase was driven primarily by improved restaurant profitability in China. In 2015, the operating income decrease was due to foreign currency translation. In constant currencies, the operating income increase reflected recovery from a 2014 supplier issue in China and higher franchised margin dollars, partly offset by restaurant closing charges.
Foundational Markets and Corporate: In 2016, the constant currency operating income increase reflected Japan's strong performance, partly offset by the net impact of the current and prior year impairment and restructuring charges from the Company's global refranchising and restructuring initiatives. In 2015, the constant currency decrease was due to strategic charges across the segment and weaker results in Japan, as well as higher Corporate selling, general and administrative expenses, including the centralization of certain costs.
Operating margin
Operating margin was 31.5% in 2016, 28.1% in 2015 and 29.0% in 2014.
 
INTEREST EXPENSE
Interest expense increased 39% and 11% in 2016 and 2015, respectively, primarily due to higher average debt balances in connection with the Company's strategy to optimize its capital structure, partly offset by lower average interest rates.
NONOPERATING (INCOME) EXPENSE, NET
Nonoperating (income) expense, net
In millions
2016
 
2015
 
2014
 
Interest income
 
$
(4
)
 
$
(9
)
 
$
(20
)
Foreign currency and hedging activity
 
(24
)
 
(56
)
 
20

Other expense
 
22

 
17

 
1

Total
 
$
(6
)
 
$
(48
)
 
$
1

Foreign currency and hedging activity includes net gains or losses on certain hedges that reduce the exposure to variability on certain intercompany foreign currency cash flow streams.


22 McDonald's Corporation 2016 Annual Report


PROVISION FOR INCOME TAXES
In 2016, 2015 and 2014, the reported effective income tax rates were 31.7%, 30.9% and 35.5%, respectively.
In 2014, the higher effective income tax rate was primarily due to a change in tax reserves for 2003-2010 resulting from an unfavorable lower tax court ruling in a foreign tax jurisdiction, as well as the impact of changes in tax reserves related to audit progression in multiple foreign tax jurisdictions. These items had a negative impact of 4.1% on the effective tax rate.
Consolidated net deferred tax liabilities included tax assets, net of valuation allowance, of $2.0 billion in 2016 and $1.8 billion in 2015. Substantially all of the net tax assets are expected to be realized in the U.S. and other profitable markets.
RECENTLY ISSUED ACCOUNTING STANDARDS
Recently issued accounting standards are included in Part II, Item 8, page 34 of this Form 10-K.
Cash Flows
 
The Company generates significant cash from its operations and has substantial credit availability and capacity to fund operating and discretionary spending such as capital expenditures, debt repayments, dividends and share repurchases.
Cash provided by operations totaled $6.1 billion and free cash flow was $4.2 billion in 2016, while cash provided by operations totaled $6.5 billion and free cash flow was $4.7 billion in 2015. In 2016, cash provided by operations decreased $480 million or 7% compared with 2015, primarily due to higher income tax payments primarily outside the U.S. and other working capital changes, partly offset by higher net income. In 2015, cash provided by operations decreased $191 million or 3% compared with 2014 primarily due to lower operating results, including the impact from weaker foreign currencies, and other operating activity, partly offset by changes in working capital.
Cash used for investing activities totaled $982 million in 2016, a decrease of $438 million compared with 2015. The decrease primarily reflected higher proceeds from sales of restaurant businesses. Cash used for investing activities totaled $1.4 billion in 2015, a decrease of $885 million compared with 2014. The decrease primarily reflected lower capital expenditures.
Cash used for financing activities totaled $11.3 billion in 2016, an increase of $12.0 billion compared with 2015, primarily due to a decrease in net borrowings and higher treasury stock purchases. Cash provided by financing activities totaled $735 million in 2015, an increase of $5.4 billion compared with 2014, primarily due to an increase in net borrowings, partly offset by higher treasury stock purchases.
The Company’s cash and equivalents balance was $1.2 billion and $7.7 billion at year end 2016 and 2015, respectively. The decrease was mostly due to higher net borrowings in 2015 that were used for share repurchases in 2016. In addition to cash and equivalents on hand and cash provided by operations, the Company can meet short-term funding needs through its continued access to commercial paper borrowings and line of credit agreements.
RESTAURANT DEVELOPMENT AND CAPITAL EXPENDITURES
In 2016, the Company opened 896 restaurants and closed 522 restaurants. In 2015, the Company opened 989 restaurants and closed 722 restaurants. The increase in restaurant closings in 2015 reflected a strategic review that resulted in additional closures of under-performing restaurants. The Company closes restaurants for a variety of reasons, such as existing sales and profit performance or loss of real estate tenure.
 
Systemwide restaurants at year end
 
2016

 
2015

 
2014

U.S.
14,155

 
14,259

 
14,350

International Lead Markets
6,851

 
6,802

 
6,717

High Growth Markets
5,552

 
5,266

 
5,031

Foundational Markets & Corporate
10,341

 
10,198

 
10,160

Total
36,899

 
36,525

 
36,258

Approximately 85% of the restaurants at year-end 2016 were franchised, including 92% in the U.S., 84% in International Lead Markets, 48% in High Growth Markets and 94% in Foundational Markets.
Capital expenditures in 2016 were essentially flat with 2015, primarily due to higher reinvestment related to reimages, offset by fewer new restaurant openings. Capital expenditures decreased $769 million or 30% in 2015, primarily due to fewer new restaurant openings and lower reinvestment at existing restaurants.
Capital expenditures invested in the U.S., International Lead markets and High Growth markets represented over 90% of the total in 2016, 2015 and 2014.
Capital expenditures  
In millions
2016

 
2015

 
2014

New restaurants
$
674

 
$
892

 
$
1,435

Existing restaurants
1,108

 
842

 
1,044

Other(1)
39

 
80

 
104

Total capital expenditures
$
1,821

 
$
1,814

 
$
2,583

Total assets
$
31,024

 
$
37,939

 
$
34,227

(1)
Primarily corporate equipment and other office-related expenditures
New restaurant investments in all years were concentrated in markets with strong returns or opportunities for long-term growth. Average development costs vary widely by market depending on the types of restaurants built and the real estate and construction costs within each market. These costs, which include land, buildings and equipment, are managed through the use of optimally-sized restaurants, construction and design efficiencies, and leveraging best practices. Although the Company is not responsible for all costs for every restaurant opened, total development costs (consisting of land, buildings and equipment) for new traditional McDonald’s restaurants in the U.S. averaged approximately $3.4 million in 2016.
The Company owned approximately 45% of the land and about 70%&