10-K 1 d10k.htm FORM 10-K Form 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 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, 2003

 

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   36-2361282

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

McDonald’s Plaza    
Oak Brook, Illinois   60523
(Address of principal executive offices)   (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                
    Chicago Stock Exchange                

8 7/8%    Debentures due 2011

  New York Stock Exchange                

7.05%    Debentures due 2025

  New York Stock Exchange                

7.31%    Subordinated Deferrable Interest Debentures due 2027

  New York Stock Exchange                

6 3/8%    Debentures due 2028

  New York Stock Exchange                

 

Securities registered pursuant to Section 12(g) of the Act:

 

None

 


 

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 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 registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes  x    No  ¨

 

The aggregate market value of voting common equity held by non-affiliates of the registrant was $28,033,465,369 as of June 30, 2003. The number of shares of common stock outstanding was 1,261,748,725 as of January 31, 2004.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Parts II and III of this Form 10-K incorporate information by reference from the registrant’s 2004 definitive proxy statement which will be filed no later than 120 days after December 31, 2003.

 



Part I

 


Item 1. Business

 

McDonald’s Corporation, the registrant, together with its subsidiaries, is referred to herein as the “Company.”

 

(a) GENERAL DEVELOPMENT OF BUSINESS

 

During 2003, there have been no significant changes to the Company’s corporate structure or material changes in the Company’s method of conducting business.

 

(b) FINANCIAL INFORMATION ABOUT SEGMENTS

 

Segment data for the years ended December 31, 2003, 2002 and 2001 are included in Part II, Item 8, page 35 of this Form 10-K.

 

(c) NARRATIVE DESCRIPTION OF BUSINESS

 

General

 

The Company primarily operates and franchises McDonald’s restaurants in the food service industry. These restaurants serve a varied, yet limited, value-priced menu (see Products) in more than 100 countries around the world.

 

The Company also operates Boston Market and Chipotle Mexican Grill in the U.S. and has a minority ownership interest in U.K.-based Pret A Manger. In December 2003, the Company sold its Donatos Pizzeria business.

 

Since McDonald’s restaurant business comprises virtually all of the Company’s consolidated operating results, this narrative primarily relates to that business, unless otherwise noted.

 

All restaurants are operated either by the Company, by independent entrepreneurs under the terms of franchise arrangements (franchisees), or by affiliates operating under license agreements.

 

The Company’s operations are designed to assure consistency and high quality at every McDonald’s restaurant. When granting franchises and forming joint-ventures, the Company is selective and is not in the practice of franchising to or partnering with investor groups or passive investors.

 

Under the conventional franchise arrangement, franchisees provide capital by initially investing in the equipment, signs, seating and décor of their restaurant businesses, and by reinvesting in the business over time. The Company generally shares the investment by owning or leasing the land and building. Franchisees contribute to the Company’s revenue stream through payment of rent and service fees based upon a percent of sales, with specified minimum rent payments, along with initial fees. The conventional franchise arrangement typically lasts 20 years and franchising practices are generally consistent throughout the world. A discussion regarding site selection is included in Part I, Item 2, page 5 of this Form 10-K.

 

The Company, its franchisees and affiliates purchase food, packaging, equipment and other goods from numerous independent suppliers that have been approved by the Company. The Company has established and strictly enforces high-quality standards. The Company has quality assurance labs around the world to ensure that our high standards are consistently met. The quality assurance process not only involves ongoing product reviews, but also on-site inspections of suppliers’ facilities. Further, a Quality Assurance Board, composed of the Company’s technical, safety and supply chain specialists, provides strategic global leadership for all aspects of food quality and safety. In addition, the Company works closely with suppliers to encourage innovation, assure best practices and drive continuous improvement.

 

Independently owned and operated distribution centers, also approved by the Company, distribute products and supplies to most McDonald’s restaurants. In addition, restaurant personnel are trained in the proper storage, handling and preparation of our products and in the delivery of customer service.

 

McDonald’s global brand is well known. Marketing, promotional and public relations activities are designed to nurture McDonald’s brand image and differentiate the Company from competitors. Marketing and promotional efforts focus on value, food taste and the customer experience. In addition, the Company is focused on being a leader in social responsibility, as the Company believes it is important to give back to the people and communities around the world who are responsible for our success.

 

Products

 

McDonald’s restaurants offer a substantially uniform menu. In addition, McDonald’s tests new products on an ongoing basis.

 

McDonald’s menu includes hamburgers and cheeseburgers, Big Mac, Quarter Pounder with Cheese, Big N’ Tasty, Filet-O-Fish, several chicken sandwiches, Chicken McNuggets, french fries, Premium Salads, milk shakes, McFlurry desserts, sundaes and soft serve cones, pies, cookies, and soft drinks 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 certain international markets are open during breakfast hours and offer a full- or limited-breakfast menu. Breakfast offerings may include Egg McMuffin, Sausage McMuffin with Egg, McGriddle, biscuit and bagel sandwiches, hotcakes and muffins.

 

Chipotle serves gourmet burritos and tacos. Boston Market is a home-meal replacement concept serving chicken, meatloaf and a variety of other main and side dishes. Pret A Manger is a quick-service food concept that serves mainly prepared and packaged cold sandwiches, snacks and drinks during lunchtime.

 

McDonald’s Corporation    3


Intellectual property

 

The Company owns valuable intellectual property including trademarks, service marks, patents, copyrights, trade secrets and other proprietary information, some of which, including “McDonald’s,” “The Golden Arches Logo,” “Ronald McDonald,” “Big Mac” and other related marks, are of material importance to the Company’s business. Depending on the jurisdiction, trademarks generally are valid as long as they are used or registered. Patents and licenses are of varying remaining 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, 2003, 2002 and 2001 in Part II, Item 7, pages 9 through 23, and the Consolidated statement of cash flows for the years ended December 31, 2003, 2002 and 2001 in Part II, Item 8, page 27 of this Form 10-K.

 

Customers

 

The Company’s business is not dependent upon 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 the election of the U.S. government.

 

Competition

 

McDonald’s restaurants compete with international, national, regional and local retailers of food products. The Company competes on the basis of price, convenience and service and by offering quality food products. The Company’s competition in the broadest perspective includes restaurants, quick-service eating establishments, pizza parlors, coffee shops, street vendors, convenience food stores, delicatessens and supermarkets.

 

In the U.S., there were about 527,000 restaurants that generated $340 billion in annual sales in 2003. McDonald’s restaurant business accounts for 2.6% of those restaurants and 6.5% of the sales. No reasonable estimate can be made of the number of competitors outside the U.S.

 

Research and development

 

The Company operates a research and development facility in Illinois. 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 McDonald’s System, which includes franchisees and suppliers as well as the Company, its subsidiaries and joint ventures.

 

Environmental matters

 

The Company is not aware of any federal, state or local environmental laws or regulations that will materially affect its earnings or competitive position or result in material capital expenditures. However, the Company cannot predict the effect on its operations of possible future environmental legislation or regulations. During 2003, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.

 

Number of employees

 

During 2003, the Company’s average number of employees worldwide, including Company-operated restaurant employees, was approximately 418,000. This includes employees at McDonald’s Company-operated restaurants as well as other restaurant concepts operated by the Company.

 


(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 9 through 23 and Segment and geographic information in Part II, Item 8, page 35 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 Securities and Exchange Commission (SEC). Such reports may be obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street NW, Washington, D.C. 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 regarding issuers that file electronically.

 

Financial and other information can be accessed on the investor section of the Company’s website at www.mcdonalds.com. The Company makes available, free of charge, copies of our 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 available free of charge by calling (630) 623-7428 or by sending a request to McDonald’s Corporation Investor Relations Service Center, Department 300, Kroc Drive, Oak Brook, Illinois 60523.

 

Also posted on McDonald’s website are the Company’s Corporate Governance Principles, the charters of McDonald’s Audit Committee, Compensation Committee and Governance Committee, the Company’s Standards of

 

4    McDonald’s Corporation


Business Conduct, the Code of Ethics for the Chief Executive Officer and Financial Officers and the Code of Conduct for the Board of Directors. Copies of these documents are also available free of charge by calling (630) 623-7428 or by sending a request to McDonald’s Investor Relations Service Center, Department 300, Kroc Drive, Oak Brook, IL 60523.

 

Information on our website is not incorporated into this Form 10-K or our other securities filings and is not a part of them.

 


Item 2. Properties

 

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, school enrollments 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 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 9 through 23 and in Financial statements and supplementary data in Part II, Item 8, pages 24 through 41 of this Form 10-K.

 


Item 3. Legal proceedings

 

The Company has pending a number of lawsuits which have been filed from time to time 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 of these categories of lawsuits. In addition, the Company is subject to various federal, state and local regulations that impact various aspects of its business, as discussed below. 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.

 

FRANCHISING

 

A substantial number of McDonald’s restaurants are franchised to independent entrepreneurs operating under contractual arrangements with the Company. In the course of the franchise relationship, occasional disputes arise between the Company and its franchisees relating to a broad range of subjects including, but not limited to, quality, service and cleanliness issues, contentions regarding grants or terminations of franchises, payments of rents, franchisee claims for additional franchises or rewrites of franchises, and delinquent payments. Additionally, occasional disputes arise between the Company and individuals who claim they should have been granted a McDonald’s franchise.

 

SUPPLIERS

 

The Company and its affiliates and subsidiaries do not supply, with minor exceptions outside the U.S., food, paper or related items to any McDonald’s restaurants. The Company relies upon numerous independent suppliers that are required to meet and maintain the Company’s high standards and specifications. On occasion, disputes arise between the Company and its suppliers on a number of issues including, by way of 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

 

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, firing and promotion practices.

 

CUSTOMERS

 

The Company’s restaurants serve a large cross-section of the public. In the course of serving so many people, disputes arise as to products, service, accidents, advertising, nutritional and other disclosures as well as other matters typical of 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 defend and protect the use of its intellectual property.

 

GOVERNMENT REGULATIONS

 

Local, state and federal governments have adopted laws and regulations involving various aspects of the restaurant business including, but not limited to, franchising, health, safety, environment, zoning and employment. 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.

 

McDonald’s Corporation    5



Item 4. Submission of matters to a vote of shareholders

 

None.

 


The following are the Executive Officers of our Company:

 

Claire H. Babrowski, 46, is Corporate Senior Executive Vice President and Chief Restaurant Operations Officer, a position to which she was appointed in December 2003. From June 2001 to December 2003 she was President of McDonald’s Asia/Pacific, Middle East and Africa. From January 2000 to June 2001 she was Executive Vice President, Worldwide Restaurant Systems; from June 1998 to January 2000 she was Executive Vice President, U.S. Restaurant Systems; and from May 1997 to June 1998 she was Senior Vice President, U.S. Restaurant Systems. Ms. Babrowski has been with the Company for 26 years.

 

Charles H. Bell, 43, is President and Chief Operating Officer, a position to which he was appointed effective January 2003. From June 2001 to December 2002 he was President of McDonald’s Europe; from September 1999 to June 2001 he was President of McDonald’s Asia/Pacific, Middle East and Africa; and from 1993 to September 1999 he was Managing Director of McDonald’s Australia. Mr. Bell has been with the Company for 28 years.

 

James R. Cantalupo, 60, is Chairman and Chief Executive Officer, a position to which he was appointed effective January 2003. From January to December 2002 he was Vice Chairman, Emeritus and President, Emeritus. From December 1999 to December 2001 he was Vice Chairman and President. From August 1998 to December 1999 he was Vice Chairman, Chairman and Chief Executive Officer of McDonald’s International. From January 1992 to August 1998 he was President and Chief Executive Officer, McDonald’s International. Mr. Cantalupo has been with the Company for 30 years.

 

M. Lawrence Light, 62, is Corporate Executive Vice President–Global Chief Marketing Officer. He has served in that position since joining the Company in September 2002. Prior to joining McDonald’s he was President and Chief Executive Officer of Arcature, a brand consultancy. Mr. Light has been with the Company for less than two years.

 

Matthew H. Paull, 52, is Corporate Executive Vice President and Chief Financial Officer, a position to which he was elected in July 2001. Prior to that time he served as Senior Vice President, Corporate Tax and Finance from December 2000 to July 2001, Senior Vice President from January 2000 to December 2000 and Vice President from June 1993 to January 2000. Mr. Paull has been with the Company for 10 years.

 

David M. Pojman, 44, is Corporate Senior Vice President–Controller, a position he has held since March 2002. He served as Vice President and Assistant Corporate Controller from January 2000 to March 2002; and from July 1997 to January 2000 he served as Vice President-International Controller. Mr. Pojman has been with the Company for 21 years.

 

Michael J. Roberts, 53, is President–McDonald’s USA, a position he has held since June 2001. From July 1997 to June 2001 he was President, West Division. Mr. Roberts has been with the Company for 26 years.

 

Gloria Santona, 53, is Corporate Executive Vice President, General Counsel and Secretary, a position she has held since July 2003. From June 2001 to July 2003 she was Corporate Senior Vice President, General Counsel and Secretary. From December 2000 to June 2001 she was Vice President, U.S. General Counsel and Secretary. From March 1997 to December 2000 she was Vice President, Deputy General Counsel and Secretary. Ms. Santona has been with the Company for 26 years.

 

James A. Skinner, 59, is Vice Chairman. Mr. Skinner was appointed to his current position effective January 2003. He served as President and Chief Operating Officer of McDonald’s Worldwide Restaurant Group from February 2002 to December 2002. Prior to that, he served as President and Chief Operating Officer of McDonald’s Europe, Asia/Pacific, Middle East and Africa from June 2001 to February 2002; and President of McDonald’s Europe from December 1997 to June 2001. Mr. Skinner has been with the Company for 33 years.

 

Russell P. Smyth, 47, is President–McDonald’s Europe, a position to which he was appointed in January 2003. He served as President of Partner Brands from December 2001 to January 2003; International Relationship Partner for Southeast and Central Asia from May 1999 to December 2001; and Vice President of the Latin America Group from July 1996 to May 1999. Mr. Smyth has been with the Company for 20 years.

 

6    McDonald’s Corporation


Part II

 


Item 5. Market for registrant’s common equity, related shareholder matters and issuer purchases of equity securities

 

The Company’s common stock trades under the symbol MCD and is listed on the New York and Chicago stock exchanges in the U.S.

 

The following table sets forth the common stock price ranges on the New York Stock Exchange composite tape and dividends declared per common share.

 

DOLLARS PER

SHARE


   2003

   2002

   High

   Low

   Dividend

   High

   Low

   Dividend

Quarter:

                             

First

   17.38    12.12    —      29.06    25.38    —  

Second

   22.95    13.88    —      30.72    27.00    —  

Third

   24.37    20.40    .400    28.62    17.42    —  

Fourth

   27.01    23.01    —      19.95    15.17    .235
    
  
  
  
  
  

Year

   27.01    12.12    .400    30.72    15.17    .235
    
  
  
  
  
  

 

The approximate number of shareholders of record and beneficial owners of the Company’s common stock as of January 31, 2004 was estimated to be 953,000.

 

Given the Company’s returns on equity and assets, management believes it is prudent to reinvest a significant portion of earnings back into the business and use excess cash flow for debt repayments and returning cash to shareholders either through share repurchases or dividends. The Company has paid dividends on common stock for 28 consecutive years through 2003 and has increased the dividend amount at least once every year. As in the past, future dividends will be considered after reviewing returns to shareholders, profitability expectations and financing needs and will be declared at the discretion of the Company’s Board of Directors.

 

EQUITY COMPENSATION PLAN INFORMATION

 

Information regarding equity compensation plans is incorporated herein by reference from the Company’s definitive proxy statement which will be filed no later than 120 days after December 31, 2003.

 

McDonald’s Corporation    7



Item 6. Selected financial data

 

11-year summary

 

DOLLARS IN MILLIONS,

EXCEPT PER SHARE DATA


  2003

    2002

    2001

    2000

  1999

  1998

    1997

  1996

  1995

  1994

  1993

Company-operated sales

  $ 12,795     11,500     11,041     10,467   9,512   8,895     8,136   7,571   6,863   5,793   5,157

Franchised and affiliated revenues

  $ 4,345     3,906     3,829     3,776   3,747   3,526     3,273   3,116   2,932   2,528   2,251
   


 

 

 
 
 

 
 
 
 
 

Total revenues

  $ 17,140     15,406     14,870     14,243   13,259   12,421     11,409   10,687   9,795   8,321   7,408
   


 

 

 
 
 

 
 
 
 
 

Operating income

  $ 2,832 (1)   2,113 (2)   2,697 (3)   3,330   3,320   2,762 (4)   2,808   2,633   2,601   2,241   1,984

Income before taxes and cumulative effect of accounting changes

  $ 2,346 (1)   1,662 (2)   2,330 (3)   2,882   2,884   2,307 (4)   2,407   2,251   2,169   1,887   1,676

Net income

  $ 1,471 (1,5)   893 (2,6)   1,637 (3)   1,977   1,948   1,550 (4)   1,642   1,573   1,427   1,224   1,083
   


 

 

 
 
 

 
 
 
 
 

Cash provided by operations

  $ 3,269     2,890     2,688     2,751   3,009   2,766     2,442   2,461   2,296   1,926   1,680

Capital expenditures

  $ 1,307     2,004     1,906     1,945   1,868   1,879     2,111   2,375   2,064   1,539   1,317

Treasury stock purchases

  $ 439     687     1,090     2,002   933   1,162     765   605   321   500   628
   


 

 

 
 
 

 
 
 
 
 

Financial position at year end:

                                                     

Total assets

  $ 25,525     23,971     22,535     21,684   20,983   19,784     18,242   17,386   15,415   13,592   12,035

Total debt

  $ 9,731     9,979     8,918     8,474   7,252   7,043     6,463   5,523   4,836   4,351   3,713

Total shareholders’ equity

  $ 11,982     10,281     9,488     9,204   9,639   9,465     8,852   8,718   7,861   6,885   6,274

Shares outstanding

In millions

    1,262     1,268     1,281     1,305   1,351   1,356     1,371   1,389   1,400   1,387   1,415
   


 

 

 
 
 

 
 
 
 
 

Per common share:

                                                     

Net income–basic

  $ 1.16 (1,5)   .70 (2,6)   1.27 (3)   1.49   1.44   1.14 (4)   1.17   1.11   .99   .84   .73

Net income–diluted

  $ 1.15 (1,5)   .70 (2,6)   1.25 (3)   1.46   1.39   1.10 (4)   1.15   1.08   .97   .82   .71

Dividends declared

  $ .40     .24     .23     .22   .20   .18     .16   .15   .13   .12   .11

Market price at year end

  $ 24.83     16.08     26.47     34.00   40.31   38.41     23.88   22.69   22.56   14.63   14.25
   


 

 

 
 
 

 
 
 
 
 

Company-operated restaurants

    8,959     9,000     8,378     7,652   6,059   5,433     4,887   4,294   3,783   3,216   2,733

Franchised restaurants

    18,132     17,864     17,395     16,795   15,949   15,086     14,197   13,374   12,186   10,944   9,918

Affiliated restaurants

    4,038     4,244     4,320     4,260   4,301   3,994     3,844   3,216   2,330   1,739   1,476
   


 

 

 
 
 

 
 
 
 
 

Total Systemwide restaurants

    31,129     31,108     30,093     28,707   26,309   24,513     22,928   20,884   18,299   15,899   14,127
   


 

 

 
 
 

 
 
 
 
 

Franchised and affiliated sales(7)

  $ 33,137     30,026     29,590     29,714   28,979   27,084     25,502   24,241   23,051   20,194   18,430
   


 

 

 
 
 

 
 
 
 
 

(1) Includes pretax charges (substantially all non-cash) of $408 million ($323 million after tax or $0.25 per share) primarily related to the disposition of certain non-McDonald’s brands and asset/goodwill impairment. See other operating expense, net note to the consolidated financial statements for further details.
(2) Includes pretax charges of $853 million ($700 million after tax or $0.55 per share) primarily related to restructuring certain international markets and eliminating positions, restaurant closings/asset impairment and the write-off of technology costs. (The cash portion of these charges was approximately $100 million after tax.) See other operating expense, net note to the consolidated financial statements for further details.
(3) Includes pretax operating charges of $378 million primarily related to the U.S. business reorganization and other global change initiatives, and restaurant closings/asset impairment as well as net pretax nonoperating income of $125 million primarily related to a gain on the initial public offering of McDonald’s Japan, for a total pretax expense of $253 million ($143 million after tax or $0.11 per share). (The cash portion of this net expense was approximately $100 million after tax.) See other operating expense, net note to the consolidated financial statements for further details. Net income also reflects an effective tax rate of 29.8 percent, primarily due to the benefit of tax law changes in certain international markets ($147 million).
(4) Includes pretax charges of $322 million ($219 million after tax or $0.16 per share) consisting of $162 million of Made For You costs and $160 million related to a home office productivity initiative.
(5) Includes a $37 million after-tax charge ($0.03 per share) to reflect the cumulative effect of the adoption of SFAS No. 143 “Accounting for Asset Retirement Obligations,” which requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time the obligations are incurred. See summary of significant accounting policies note to the consolidated financial statements for further details.
(6) Includes a $99 million after-tax charge ($0.08 per share–basic and $0.07 per share–diluted) to reflect the cumulative effect of the adoption of SFAS No. 142 “Goodwill and Other Intangible Assets,” which eliminates the amortization of goodwill and instead subjects it to annual impairment tests. See summary of significant accounting policies note to the consolidated financial statements for further details. Adjusted for the nonamortization provisions of SFAS No. 142, net income per common share would have been $0.02 higher in 2001 and 2000 and $0.01 higher in 1996-1999.
(7) While franchised and affiliated 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 and affiliated revenues and are indicative of the financial health of the franchisee base.

 

8    McDonald’s Corporation



Item 7. Management’s discussion and analysis of financial condition and results of operations

 

OVERVIEW

 

DESCRIPTION OF THE BUSINESS

 

The Company primarily operates and franchises McDonald’s restaurants. In addition, the Company operates certain non-McDonald’s brands that are not material to the Company’s overall results. Of the more than 30,000 McDonald’s restaurants in over 100 countries, more than 8,000 are operated by the Company, approximately 18,000 are operated by franchisees and about 4,000 are operated by affiliates under license agreements. Regardless of who operates the restaurant, the Company generally owns the land and building or secures long-term leases for restaurant sites. This ensures long-term occupancy rights and helps control related costs.

 

Revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees and affiliates. These fees primarily include rent, service fees and/or royalties that are based on a percent of sales, with specified minimum rent payments. Fees vary by type of site, investment by the Company and local business conditions. These fees, along with occupancy and operating rights, are stipulated in franchise agreements that generally have 20-year terms.

 

We manage the business based on geographic segments: United States; Europe; Asia/Pacific, the Middle East and Africa (APMEA); Latin America and Canada. In addition, throughout this report we present a segment entitled “Other” that includes non-McDonald’s brands. The U.S. and Europe segments account for approximately 70% of total revenues. France, Germany and the United Kingdom account for about 65% of Europe’s revenues; Australia, China and Japan (a 50%-owned affiliate accounted for under the equity method) account for about 45% of APMEA’s revenues; and Brazil accounts for about 40% of Latin America’s revenues. These seven markets along with the U.S. and Canada are referred to as “major markets” throughout this report and comprise approximately 70% of total revenues.

 

In analyzing business trends, management considers a variety of performance and financial measures including Systemwide sales growth, comparable sales growth and Company-operated margins. Systemwide sales include sales by all restaurants, whether operated by the Company, by franchisees or by affiliates. While sales by franchisees and affiliates are not recorded as revenues by the Company, management believes the information is important in understanding the Company’s financial performance because they are the basis on which the Company calculates and records franchised and affiliated revenues and are indicative of the financial health of our franchisee base. Comparable sales are a key performance indicator used within the retail industry and are indicative of acceptance of the Company’s initiatives as well as local economic and consumer trends. Increases or decreases in comparable sales represent the percent change in constant currency sales from the same period in the prior year for all Systemwide restaurants in operation at least thirteen months. 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 certain compensation plans on these results because the Company believes they better represent the underlying business trends.

 

STRATEGIC DIRECTION AND 2003 FINANCIAL PERFORMANCE

 

In 2001 and 2002, the Company’s results reflected a focus on growth through adding new restaurants, with associated high levels of capital expenditures and increasing levels of debt financing. This strategy, combined with challenging economic conditions and increased competition in certain key markets, adversely affected results and returns on investment.

 

In 2003, the Company introduced a comprehensive revitalization plan to increase McDonald’s relevance to today’s consumers as well as improve our financial discipline. We redefined our strategy to emphasize growth through adding more customers to existing restaurants. In line with this, we took a more disciplined approach to capital allocation and put a greater emphasis on controlling expenses. We aligned the System around our customer-focused Plan to Win, designed to deliver operational excellence and leadership marketing. This Plan contains aggressive goals and measures for success based on the five drivers of exceptional customer experiences—people, products, place, price and promotion.

 

Our near-term goal was to fortify the foundation of our business. Our long-term goal is to create a differentiated customer experience—one that builds brand loyalty—and enables us to deliver attractive top- and bottom-line growth and returns on a sustained basis. For 2005 and beyond, McDonald’s is targeting annual Systemwide sales and revenue growth of 3 percent to 5 percent, annual operating income growth of 6 percent to 7 percent and annual returns on incremental invested capital in the high teens. (Return on incremental invested capital is the change in operating income plus depreciation divided by the change in gross assets.) These targets exclude the impact of foreign currency translation.

 

We made significant progress in 2003 in operational excellence and leadership marketing. We improved our core menu and added several successful new products. We used more consistent, rigorous measurements such as evaluations by Company personnel, independent mystery shoppers and customer research to evaluate restaurant performance. Using this information, along with enhanced training and other processes, we have strengthened our operations. We have expanded our everyday value offerings, attracting more customer visits. We began to create more relevant

 

McDonald’s Corporation    9


restaurant environments by updating, rebuilding and relocating some of our restaurants. We also introduced our first global marketing strategy, embodied by the “i’m lovin’ it” theme, which emphasizes more contemporary music and images and is connecting with both our customers and our employees.

 

From a financial perspective, our results also improved in 2003. In concert with the Company’s strategic shift to emphasize growth from existing restaurants, management is focusing in particular on comparable sales and Company-operated margin trends, both of which gained momentum during the year. Performance in the U.S. was impressive, with robust annual comparable sales and margin increases. In Europe, while comparable sales were slightly negative for the year, they improved sequentially each quarter, as did Company-operated margins, compared with the prior year. APMEA’s comparable sales and Company-operated margins declined for the year, but both showed significant improvement in the second half.

 

As part of the Company’s revitalization plan, we eliminated projects not directly affecting our customers’ experience and narrowed non-McDonald’s brand activities. These actions along with the write down of a portion of our goodwill and restaurant assets resulted in the Company recording $408 million of pretax charges (primarily noncash) in 2003.

 

Highlights from the year included:

 

Comparable sales increased 2.4%, a significant improvement over the 2.1% decline in 2002.

 

Consolidated revenues increased 11% to a new record high of $17 billion. Excluding the positive impact of currency translation, revenues increased 6%.

 

Systemwide sales increased 11%. Excluding the positive impact of currency translation, Systemwide sales increased 5%.

 

Net income per common share totaled $1.15, compared with $0.70 in 2002.

 

Company-operated margins as a percent of sales improved 10 basis points, progressing toward our goal of increasing margins by 35 basis points per year beginning in 2005.

 

Cash from operations increased $400 million to $3.3 billion, primarily driven by higher sales at existing restaurants and stronger foreign currencies.

 

Capital expenditures were reduced by $700 million to $1.3 billion.

 

Debt pay-down totaled approximately $900 million.

 

The annual dividend increased 70% to more than $500 million.

 

Share repurchases totaled about $440 million.

 

OUTLOOK FOR 2004

 

We expect 2004 to be a year of ongoing progress in operational excellence, leadership marketing and key financial metrics. We will continue to focus our revitalization efforts on improving our customers’ experiences by providing better service, enhancing food taste, menu variety and value offerings, and creating more relevant marketing. While we are confident in our plans for 2004, we also are conscious of the challenges we face. For example, we must continue to deliver solid results in the U.S., a very competitive marketplace, despite sequentially more difficult sales comparisons. We believe that the combination of initiatives that benefited our U.S. business in 2003 will continue to create positive momentum in 2004.

 

Outside the U.S., some key markets must increase customer relevance, while others have economic challenges. We believe that we are in a better position to overcome these issues today than we have been for some time. Our plan is to leverage successes in the U.S. and other markets like Australia—such as more relevant menus, strong value platforms, creative marketing and better restaurant-level execution—to improve results in additional markets around the world.

 

While the Company does not provide specific guidance on earnings per share, the following information is provided to assist in analyzing the Company’s results.

 

Changes in constant currency Systemwide sales are driven by restaurant unit expansion and changes in comparable sales. The Company expects net restaurant additions to add approximately one percentage point to sales and operating income growth in 2004 (in constant currencies). Most of this anticipated growth will result from restaurants opened in 2003. The Company does not provide specific guidance on changes in comparable sales. However, as a perspective, assuming no change in cost structure a one percentage point increase in U.S. comparable sales would impact annual earnings per share by about 2 cents. Similarly, an increase of one percentage point in Europe’s comparable sales would impact annual earnings per share by about 1.5 cents.

 

The Company expects full year 2004 selling, general & administrative expenses to be relatively flat to up slightly in constant currencies and to decline as a percent of revenues and Systemwide sales, compared with 2003. However, due to the timing of certain expenses, the Company expects selling, general & administrative expenses to increase in the first half of 2004 and to decline in the second half, compared with 2003.

 

A significant part of the Company’s operating income is from outside the U.S., and more than 70% of its total debt is denominated in foreign currencies. Accordingly, earnings are affected by changes in foreign currency exchange rates, particularly the Euro and the British Pound. If the Euro and the British Pound both move 10% in the same direction (compared with 2003 average rates),

 

10    McDonald’s Corporation


  the Company’s annual earnings per share would change by about 5 cents to 6 cents. In 2003, foreign currency translation benefited earnings per share by 7 cents.

 

For 2004, the Company expects its net debt principal repayments to be approximately $400 million to $700 million. However, despite lower average debt balances, the Company expects interest expense to be relatively flat compared with 2003 due to stronger foreign currencies.

 

The Company expects the effective income tax rate for 2004 to be between 32.5% and 33.5%.

 

The Company expects capital expenditures for 2004 to be approximately $1.5 billion to $1.6 billion.

 

The Company expects to return about $1 billion to shareholders through dividends and share repurchases in 2004.

 

A number of factors can affect our business, including effectiveness of operating initiatives and changes in global and local business and economic conditions. These and other risks are noted in the Forward-looking statements at the end of Management’s discussion and analysis.

 


CONSOLIDATED OPERATING RESULTS

 

Operating results

 

     2003

    2002

    2001

 

DOLLARS IN MILLIONS,

EXCEPT PER SHARE DATA


   Amount

    Increase/
(decrease)


    Amount

    Increase/
(decrease)


    Amount

 

Revenues

                                    

Sales by Company-operated restaurants

   $ 12,795     11 %   $ 11,500     4 %   $ 11,041  

Revenues from franchised and affiliated restaurants

     4,345     11       3,906     2       3,829  
    


 

 


 

 


Total revenues

     17,140     11       15,406     4       14,870  
    


 

 


 

 


Operating costs and expenses

                                    

Company-operated restaurants

     11,006     11       9,907     5       9,454  

Franchised restaurants

     938     12       840     5       800  

Selling, general & administrative expenses

     1,833     7       1,713     3       1,662  

Other operating expense, net

     531     (36 )     833     nm       257  
    


 

 


 

 


Total operating costs and expenses

     14,308     8       13,293     9       12,173  
    


 

 


 

 


Operating income

     2,832     34       2,113     (22 )     2,697  
    


 

 


 

 


Interest expense

     388     4       374     (17 )     452  

McDonald’s Japan IPO gain

                         nm       (137 )

Nonoperating expense, net

     98     27       77     48       52  
    


 

 


 

 


Income before provision for income taxes and cumulative effect of accounting changes

     2,346     41       1,662     (29 )     2,330  
    


 

 


 

 


Provision for income taxes

     838     25       670     (3 )     693  
    


 

 


 

 


Income before cumulative effect of accounting changes

     1,508     52       992     (39 )     1,637  

Cumulative effect of accounting changes, net of tax

     (37 )   nm       (99 )   nm          
    


 

 


 

 


Net income

   $ 1,471     65 %   $ 893     (45 )%   $ 1,637  
    


 

 


 

 


Per common share–diluted:

                                    

Income before cumulative effect of accounting changes

   $ 1.18     53 %   $ .77     (38 )%   $ 1.25  

Cumulative effect of accounting changes

     (.03 )   nm       (.07 )   nm          

Net income

   $ 1.15     64 %   $ .70     (44 )%   $ 1.25  
    


 

 


 

 



nm Not meaningful.

 

STRATEGIC ACTIONS

 

In 2003, the Company eliminated projects not directly impacting its customers’ experience, narrowed its non-McDonald’s brand activities, aligned its System around a single action plan (Plan to Win), and re-established McDonald’s marketing leadership through the introduction of its first ever global brand strategy embodied by the “i’m lovin’ it” theme. These actions were consistent with management’s strategy of concentrating the Company’s capital and resources on the best near-term opportunities and avoiding those that distract from restaurant-level execution.

 

In 2002, the Company initiated actions designed to optimize restaurant operations and improve the business. They included the restructuring of certain international markets, the closing of a significant number of underperforming restaurants, the decision to terminate a long-term technology project, and the consolidation of certain home office facilities and elimination of positions to control costs, streamline operations and reallocate resources.

 

McDonald’s Corporation    11


In 2001, the Company also implemented structural changes and restaurant initiatives, primarily in the U.S. The changes included streamlining operations by reducing the number of U.S. regions and divisions, enabling the Company to combine staff functions and improve efficiency.

 

The Company recorded charges associated with certain of the above actions as “special items.” Special items generally represent actions or transactions related to the implementation of strategic initiatives of the Company, items that are unusual or infrequent in nature (such as the dispositions of certain non-McDonald’s brands in 2003 and the Japan IPO gain in 2001), and charges resulting from annual goodwill and asset impairment testing. McDonald’s management does not include these items when reviewing business performance trends because they do not believe these items are indicative of expected ongoing results.

 

On a pretax basis, the Company recorded $408 million of special charges in 2003, $853 million of special charges in 2002 and $253 million of special items in 2001. All special items were recorded in other operating expense, except as noted in the discussion that follows.

 

Special items–expense/(income)

 

    

Pretax


   

After tax(2)


   

Per common

share–diluted


 

IN MILLIONS, EXCEPT PER SHARE DATA


   2003

   2002

   2001

    2003

   2002

   2001

    2003

   2002

   2001

 

Restructuring

   $ 272    $ 267    $ 200     $ 183    $ 244    $ 136     $ .14    $ .19    $ .11  

Restaurant closings/asset impairment

     136      402      135       140      336      107       .11      .26      .08  

Other

            184      55              120      37              .10      .03  

McDonald’s Japan IPO gain

                   (137 )                   (137 )                   (.11 )
    

  

  


 

  

  


 

  

  


Total special items(1)

   $ 408    $ 853    $ 253     $ 323    $ 700    $ 143     $ .25    $ .55    $ .11  
    

  

  


 

  

  


 

  

  



(1) See other operating expense, net note to the consolidated financial statements for a summary of the activity in the related liabilities. The Company expects to use cash provided by operations to fund the remaining employee severance and lease obligations associated with the special charges.
(2) Certain special items were not tax-effected.

 

Restructuring

 

In 2003, the Company recorded $272 million of pretax charges consisting of: $237 million related to the loss on the sale of Donatos Pizzeria, the closing of all Donatos and Boston Market restaurants outside the U.S. and the exit of a domestic joint venture with Fazoli’s; and $35 million related to revitalization plan actions of McDonald’s Japan, including headcount reductions, the closing of Pret A Manger stores in Japan, and the early termination of a long-term management services agreement.

 

In 2002, the Company recorded $267 million of net pretax charges consisting of: $201 million related to the anticipated transfer of ownership in five countries in the Middle East and Latin America to developmental licensees and ceasing operations in two countries in Latin America; $81 million primarily related to eliminating approximately 600 positions (about half of which were in the U.S. and half of which were in international markets), reallocating resources and consolidating certain home office facilities to control costs; and a $15 million favorable adjustment to the 2001 restructuring charge due to lower employee-related costs than originally anticipated. Under the developmental license business structure, which the Company successfully employs in about 30 markets outside the U.S. (approximately 400 restaurants), the licensee owns the business, including the real estate interest. While the Company generally does not have any capital invested in these markets, it receives a royalty based on a percent of sales.

 

In 2001, the Company recorded $200 million of pretax restructuring charges related to initiatives designed to improve the restaurant experience, primarily in the U.S. These initiatives included streamlining operations by reducing the number of regions and divisions, enabling the Company to combine staff functions and improve efficiency. In connection with these initiatives, the Company eliminated approximately 850 positions (700 in the U.S., primarily in the divisions and regions, and 150 in international markets).

 

Restaurant closings/asset impairment

 

In 2003, the Company recorded $136 million of net pretax charges consisting of: $148 million primarily related to asset/goodwill impairment, mainly in Latin America; $30 million for about 50 restaurant closings associated with strategic actions in Latin America; and a $42 million favorable adjustment to the 2002 charge for restaurant closings, primarily due to about 85 fewer closings than originally anticipated. The lower closings were primarily due to management’s reassessment of the plans as a result of the new strategic direction of the Company.

 

In 2002, the Company recorded $402 million of pretax charges consisting of: $302 million related to management’s decision to close 751 underperforming restaurants primarily in the U.S. and Japan; and $100 million primarily related to the impairment of assets for certain existing restaurants in Europe and Latin America. Most of the restaurants identified for closing had negative cash flows and/or very low annual sales volumes. Also, in many cases they would have required significant capital investment to remain financially viable.

 

12    McDonald’s Corporation


In 2001, the Company recorded $135 million of pretax charges consisting of: $91 million related to the closing of 163 underperforming restaurants in international markets; a $24 million asset impairment charge in Turkey; and $20 million related to the disposition of Aroma Café in the U.K.

 

Although restaurant closings occur each year, these restaurant closing charges in each year were identified as “special charges” because they were the result of separate intensive reviews by management in conjunction with other strategic actions.

 

Other

 

In 2002, the Company recorded $184 million of pretax charges consisting of: $170 million primarily related to the write-off of software development costs as a result of management’s decision to terminate a long-term technology project; and $14 million primarily related to the write-off of receivables and inventory in Venezuela as a result of the temporary closure of all McDonald’s restaurants due to a national strike. Although the terminated technology project was expected to deliver long-term benefits, it was no longer viewed as the best use of capital, as the anticipated Systemwide cost over several years was expected to be more than $1 billion.

 

In 2001, the Company recorded $55 million of pretax charges consisting of: $18 million primarily related to the write-off of certain technology costs; $12 million (recorded in nonoperating expense) primarily related to the write-off of a corporate investment; and $25 million primarily related to the unrecoverable costs incurred in connection with the theft of winning game pieces from the Company’s Monopoly and certain other promotional games over an extended period of time, and the related termination of the supplier of the game pieces. Fifty individuals (none of whom were Company employees) were convicted of conspiracy and/or mail fraud charges.

 

McDonald’s Japan IPO gain

 

In 2001, McDonald’s Japan, the Company’s 50%-owned affiliate, completed an IPO of 12 million shares. The Company recorded a $137 million gain (pre and after tax) in nonoperating income to reflect an increase in the carrying value of its investment as a result of the cash proceeds from the IPO received by McDonald’s Japan.

 

IMPACT OF FOREIGN CURRENCIES ON REPORTED RESULTS

 

While changing foreign currencies affect reported results, McDonald’s lessens exposures, where practical, by financing in local currencies, hedging certain foreign-denominated cash flows, and by purchasing goods and services in local currencies.

 

In 2003, foreign currency translation had a positive impact on consolidated revenues, operating income and earnings per share due to the strengthening of several major currencies, primarily the Euro. In 2002, foreign currency translation had a minimal impact on revenues as the stronger Euro and British Pound were offset by weaker Latin American currencies (primarily the Argentine Peso, Brazilian Real and Venezuelan Bolivar). Operating income in 2002 was positively impacted by foreign currency translation primarily due to the stronger Euro and British Pound.

 

Impact of foreign currency translation on reported results

 

    

Reported amount


  

Currency translation
benefit (loss)


 

IN MILLIONS, EXCEPT PER SHARE DATA


   2003

   2002

   2001

   2003

    2002

   2001

 

Revenues

   $ 17,140    $ 15,406    $ 14,870    $ 886     $ 15    $ (457 )

Company-operated margins(1)

     1,695      1,513      1,525      101       29      (49 )

Franchised margins(1)

     3,405      3,064      3,028      195       39      (65 )

Selling, general & administrative expenses

     1,833      1,713      1,662      (68 )     8      35  

Operating income

     2,832      2,113      2,697      189       90      (78 )

Income before cumulative effect of accounting changes

     1,508      992      1,637      89       42      (50 )

Net income

     1,471      893      1,637      89       42      (50 )

Per common share–diluted:

                                            

Income before cumulative effect of accounting changes

     1.18      .77      1.25      .07       .03      (.04 )

Net income

     1.15      .70      1.25      .07       .04      (.04 )
    

  

  

  


 

  



(1) Includes McDonald’s restaurants only.

 

McDonald’s Corporation    13


REVENUES

 

Consolidated revenue growth in 2003 was driven by stronger foreign currencies and a strong performance in the U.S. In 2002, consolidated revenue growth was driven by expansion and a higher percentage of Company-operated restaurants compared with 2001.

 

Revenues

 

     Amount

   Increase (decrease)

   

Increase (decrease)

excluding currency

translation


 

DOLLARS IN MILLIONS


   2003

   2002

   2001

   2003

    2002

    2003

    2002

 

Company-operated sales:

                                             

U.S.

   $ 3,594    $ 3,172    $ 3,139    13 %   1 %   13 %   1 %

Europe

     4,498      3,982      3,727    13     7     —       2  

APMEA

     2,158      2,115      1,938    2     9     (3 )   8  

Latin America

     774      696      821    11     (15 )   20     12  

Canada

     632      505      478    25     6     11     7  

Other

     1,139      1,030      938    11     10     10     10  
    

  

  

  

 

 

 

Total

   $ 12,795    $ 11,500    $ 11,041    11 %   4 %   6 %   4 %
    

  

  

  

 

 

 

Franchised and affiliated revenues:

                                             

U.S.

   $ 2,445    $ 2,251    $ 2,257    9 %   —       9 %   —    

Europe

     1,377      1,154      1,025    19     13 %   1     6 %

APMEA

     289      253      265    14     (5 )   —       (6 )

Latin America

     85      118      150    (28 )   (21 )   (20 )   (8 )

Canada

     146      128      130    14     (2 )   1     —    

Other

     3      2      2    33     —       33     —    
    

  

  

  

 

 

 

Total

   $ 4,345    $ 3,906    $ 3,829    11 %   2 %   5 %   1 %
    

  

  

  

 

 

 

Total revenues:

                                             

U.S.

   $ 6,039    $ 5,423    $ 5,396    11 %   1 %   11 %   1 %

Europe

     5,875      5,136      4,752    14     8     —       3  

APMEA

     2,447      2,368      2,203    3     7     (3 )   7  

Latin America

     859      814      971    6     (16 )   14     9  

Canada

     778      633      608    23     4     9     6  

Other

     1,142      1,032      940    11     10     11     10  
    

  

  

  

 

 

 

Total

   $ 17,140    $ 15,406    $ 14,870    11 %   4 %   6 %   4 %
    

  

  

  

 

 

 

 

In the U.S., ongoing menu, service and value initiatives drove the increase in revenues in 2003 as the U.S. achieved its highest annual comparable sales increase since 1987. These initiatives included the introduction of Premium Salads and McGriddles breakfast sandwiches, the Dollar Menu, extended hours, a heightened focus on operations, more disciplined measurements and a new marketing direction. Results also reflected improvement in the U.S. economy in 2003. In 2002, revenues increased slightly due to restaurant expansion. Results in 2002, in part, reflected the overall slowdown in the restaurant industry and increased competition.

 

In 2003 and 2002, Europe’s revenues reflected strong performance in Russia driven by expansion and positive comparable sales, along with expansion in France. These results were partly offset by weak results in the U.K. and Germany, although Germany’s performance improved in the second half of 2003.

 

In 2003 and 2002, APMEA’s revenues benefited from positive comparable sales in Australia and expansion in China. Revenues were negatively affected in 2003 by weak results in Hong Kong, South Korea and Taiwan, compounded by consumer concerns about Severe Acute Respiratory Syndrome (SARS) in several markets in the first half of the year. In addition, Japan had negative comparable sales for 2003 and 2002, although the market’s performance improved in the fourth quarter of 2003. In 2002, revenues reflected a benefit from the restructuring of our ownership in the Philippines, effective July 2001, that resulted in the reclassification of franchised restaurants to Company-operated.

 

In Latin America, revenues in 2003 increased in constant currencies primarily due to a higher percentage of Company-operated restaurants. The increase in revenues in 2002 was primarily due to positive comparable sales in Brazil and expansion in Mexico.

 

14    McDonald’s Corporation


The following tables present Systemwide sales growth rates and the increase or decrease in comparable sales.

 

Systemwide sales

 

     Increase (decrease)

   

Increase (decrease)
excluding currency

translation


 
     2003

    2002

    2001

    2003

    2002

    2001

 

U.S.

   9 %   1 %   2 %   9 %   1 %   2 %

Europe

   18     11     1     2     5     5  

APMEA

   6     (3 )   (6 )   (2 )   (3 )   3  

Latin America

   (4 )   (17 )   (3 )   4     4     6  

Canada

   17     1     —       4     2     5  

Other

   10     9     61     10     9     62  
    

 

 

 

 

 

Total

   11 %   2 %   1 %   5 %   2 %   4 %
    

 

 

 

 

 

 

Comparable sales–McDonald’s restaurants

 

    

Increase (decrease)


 
     2003

    2002

    2001

 

U.S.

   6.4 %   (1.5 )%   0.1 %

Europe

   (0.9 )   1.0     (1.4 )

APMEA

   (4.2 )   (8.5 )   (4.8 )

Latin America

   2.3     1.0     (3.9 )

Canada

   —       (2.5 )   1.3  
    

 

 

Total

   2.4 %   (2.1 )%   (1.3 )%
    

 

 

 

OPERATING INCOME

 

Consolidated operating income in 2003 included higher combined operating margin dollars, higher selling, general & administrative expenses and lower gains on sales of restaurant businesses compared with 2002. Operating income in 2002 included higher combined operating margin dollars, higher selling, general & administrative expenses and a net loss from our Japanese affiliate compared with earnings in 2001. In all three years, the Company recorded special charges that are included in these results.

 

Operating income

 

     Amount

    Increase
(decrease)


    Increase (decrease)
excluding currency
translation


 

DOLLARS IN MILLIONS


   2003

    2002

    2001

    2003

    2002

    2003

    2002

 

U.S.

   $ 1,982     $ 1,673     $ 1,622     18 %   3 %   18 %   3 %

Europe

     1,339       1,022       1,063     31     (4 )   13     (8 )

APMEA

     226       64       325     nm     (80 )   nm     (81 )

Latin America

     (171 )     (133 )     11     (28 )   nm     (7 )   nm  

Canada

     163       125       124     30     1     15     3  

Other

     (295 )     (66 )     (66 )   nm     —       nm     —    

Corporate

     (412 )     (572 )     (382 )   28     (50 )   28     (50 )
    


 


 


 

 

 

 

Total

   $ 2,832     $ 2,113     $ 2,697     34 %   (22 )%   25 %   (25 )%
    


 


 


 

 

 

 


nm Not meaningful.

 

McDonald’s Corporation    15


The following table presents the special charges included in operating income by segment for 2003, 2002 and 2001.

 

Special charges

 

IN MILLIONS


   U.S.

    Europe

    APMEA

    Latin
America


    Canada

    Other

    Corporate

   Consolidated

 

2003

                                                               

Restructuring

                   $ 35                     $ 237            $ 272  

Restaurant closings/asset impairment(1)

   $ (11 )   $ (20 )     20     $ 109     $ (1 )     29     $ 10      136  
    


 


 


 


 


 


 

  


Total

     (11 )     (20 )     55       109       (1 )     266       10      408  

Currency translation benefit (loss)

             3       (5 )     (20 )             (11 )            (33 )
    


 


 


 


 


 


 

  


Total excluding currency translation

   $ (11 )   $ (17 )   $ 50     $ 89     $ (1 )   $ 255     $ 10    $ 375  
    


 


 


 


 


 


 

  


2002

                                                               

Restructuring

   $ 25     $ 9     $ 141     $ 66     $ 2     $ 3     $ 21    $ 267  

Restaurant closings/asset impairment

     74       135       81       62       4       31       15      402  

Other

             4               14       4               162      184  
    


 


 


 


 


 


 

  


Total

     99       148       222       142       10       34       198      853  

Currency translation benefit (loss)

             (17 )     (3 )     23                              3  
    


 


 


 


 


 


 

  


Total excluding currency translation

   $ 99     $ 131     $ 219     $ 165     $ 10     $ 34     $ 198    $ 856  
    


 


 


 


 


 


 

  


2001

                                                               

Restructuring

   $ 156     $ 7     $ 3     $ 3     $ 6     $ 5     $ 20    $ 200  

Restaurant closings/asset impairment

             39       35       37       4       20              135  

Other

     25               4                               14      43  
    


 


 


 


 


 


 

  


Total

     181       46       42       40       10       25       34      378  

Currency translation benefit (loss)

             (1 )     1       6                              6  
    


 


 


 


 


 


 

  


Total excluding currency translation

   $ 181     $ 45     $ 43     $ 46     $ 10     $ 25     $ 34    $ 384  
    


 


 


 


 


 


 

  



(1) Bracketed amounts resulted from favorable adjustments to 2002 charges primarily due to fewer than anticipated restaurant closings.

 

In 2003, U.S. operating income included higher combined operating margin dollars, higher selling, general & administrative expenses and higher other operating expenses (excluding special charges). U.S. operating income in 2002 included lower combined operating margin dollars, lower selling, general & administrative expenses and lower other operating income (excluding special charges).

 

Europe’s constant currency results in 2003 and 2002 benefited from strong performances in France and Russia. However, difficult economic conditions in Germany and weak results in the U.K. negatively impacted results in both years. Despite the difficult economic conditions, Germany’s performance improved in the second half of 2003.

 

APMEA’s constant currency results in 2003 reflected strong results in Australia. However, weak results in most other markets, compounded by concerns about SARS in certain markets, negatively impacted the segment. In 2002, strong results in Australia were more than offset by weak results in Japan and Hong Kong.

 

Latin America’s operating income in constant currencies significantly declined in both 2003 and 2002 due to the continuing difficult economic conditions experienced by several key markets in the segment. In addition, Latin America’s results for both years were negatively impacted by higher provisions for uncollectible receivables. The Company is currently in litigation with about one-third of the franchisees in Brazil, which is negatively impacting the Company’s results in Latin America. We expect this to continue in the near term.

 

16    McDonald’s Corporation


OPERATING MARGINS

 

Operating margin information and discussions relate to McDonald’s restaurants only and exclude non-McDonald’s brands.

 

Company-operated margins

 

Company-operated margin dollars represent sales by Company-operated restaurants less the operating costs of these restaurants. Company-operated margin dollars increased $182 million or 12% (5% in constant currencies) in 2003 and declined $12 million or 1% (3% in constant currencies) in 2002. The constant currency increase in 2003 was primarily due to strong comparable sales in the U.S. The constant currency decrease in 2002 was primarily due to negative comparable sales and higher labor rates, partly offset by restaurant expansion.

 

Company-operated margins–McDonald’s restaurants

 

IN MILLIONS


   2003

    2002

    2001

 

U.S.

   $ 635     $ 507     $ 501  

Europe

     708       631       626  

APMEA

     213       239       240  

Latin America

     47       66       83  

Canada

     92       70       75  
    


 


 


Total

   $ 1,695     $ 1,513     $ 1,525  
    


 


 


PERCENT OF SALES


                  

U.S.

     17.7 %     16.0 %     16.0 %

Europe

     15.7       15.9       16.8  

APMEA

     9.9       11.3       12.4  

Latin America

     6.1       9.4       10.1  

Canada

     14.6       13.7       15.6  
    


 


 


Total

     14.5 %     14.4 %     15.1 %
    


 


 


 

Operating cost trends as a percent of sales were as follows: food & paper costs decreased in 2003 and 2002, payroll costs were flat in 2003 and increased in 2002, and occupancy & other operating expenses increased in both years.

 

The U.S. Company-operated margin percent increased in 2003 primarily due to positive comparable sales and lower payroll as a percent of sales due to improved productivity and lower wage inflation. Higher commodity costs partly offset these trends. In 2002, the U.S. Company-operated margin percent benefited from the elimination of goodwill amortization and a lower advertising contribution rate, while weak comparable sales and higher labor costs negatively impacted the margin.

 

In 2003, Europe’s Company-operated margin percent reflected weak performance in the U.K. (which has the largest number of Company-operated restaurants in Europe), partly offset by improved margin performance in Germany and France. In 2002, Europe’s Company-operated margin percent reflected higher labor costs and an increase in occupancy & other operating expenses.

 

Franchised margins

 

Franchised margin dollars represent revenues from franchised and affiliated restaurants less the Company’s occupancy costs (rent and depreciation) associated with those sites. Franchised margin dollars represented more than 65% of the combined operating margins in 2003, 2002 and 2001. Franchised margin dollars increased $341 million or 11% (5% in constant currencies) in 2003 and $36 million or 1% (flat in constant currencies) in 2002.

 

Franchised margins–McDonald’s restaurants

 

IN MILLIONS


   2003

    2002

    2001

 

U.S.

   $ 1,945     $ 1,781     $ 1,799  

Europe

     1,044       885       792  

APMEA

     248       217       229  

Latin America

     54       79       103  

Canada

     114       102       105  
    


 


 


Total

   $ 3,405     $ 3,064     $ 3,028  
    


 


 


PERCENT OF REVENUES


                  

U.S.

     79.5 %     79.1 %     79.7 %

Europe

     75.8       76.7       77.2  

APMEA

     85.6       85.8       86.2  

Latin America

     64.3       66.9       68.4  

Canada

     78.2       79.2       80.4  
    


 


 


Total

     78.4 %     78.5 %     79.1 %
    


 


 


 

The consolidated franchised margin percent declined slightly in 2003 as positive comparable sales were offset by higher occupancy costs, due in part to an increased proportion of leased sites. The decline in the consolidated franchised margin percent in 2002 reflected negative comparable sales, higher rent assistance to franchisees primarily in the U.S. and Europe, and higher occupancy costs, due in part to an increased proportion of leased sites.

 

SELLING, GENERAL & ADMINISTRATIVE EXPENSES

 

Consolidated selling, general & administrative expenses increased 7% in 2003 and 3% in 2002 (3% and 4% in constant currencies). The constant currency increase in 2003 was primarily due to higher performance-based incentive compensation, as well as severance and other costs associated with the strategic decision to reduce restaurant openings. The constant currency increase in 2002 was primarily due to higher spending on technology in the Corporate segment, higher advertising expenses in the U.S. primarily related to the introduction of the Dollar Menu, and higher expenses for non-McDonald’s brands.

 

McDonald’s Corporation    17


Selling, general & administrative expenses as a percent of revenues declined to 10.7% in 2003 compared with 11.1% in 2002 and 11.2% in 2001, and selling, general & administrative expenses as a percent of Systemwide sales declined to 4.0% in 2003 compared with 4.1% in 2002 and 2001. Management believes that analyzing selling, general & administrative expenses as a percent of Systemwide sales as well as revenues is meaningful because these costs are incurred to support Systemwide restaurants.

 

Selling, general & administrative expenses

 

     Amount

   Increase
(decrease)


   

Increase (decrease)

excluding currency
translation


 

DOLLARS IN MILLIONS


   2003

     2002

     2001

   2003

    2002

    2003

    2002

 

U.S.

   $ 567      $ 558      $ 563    2 %   (1 )%   2 %   (1 )%

Europe

     424        359        328    18     9     2     4  

APMEA

     173        158        152    10     4     2     3  

Latin America

     102        102        126    —       (19 )   8     3  

Canada

     54        49        51    9     (3 )   (3 )   (2 )

Other

     115        114        102    1     13     —       12  

Corporate(1)

     398        373        340    7     10     7     10  
    

    

    

  

 

 

 

Total

   $ 1,833      $ 1,713      $ 1,662    7 %   3 %   3 %   4 %
    

    

    

  

 

 

 


(1) Corporate expenses consist of home office support costs in areas such as facilities, finance, human resources, information technology, legal, marketing, supply chain management and training.

 

OTHER OPERATING EXPENSE, NET

 

Other operating (income) expense, net

 

DOLLARS IN MILLIONS


   2003

    2002

    2001

 

Gains on sales of restaurant businesses

   $ (55 )   $ (114 )   $ (112 )

Equity in earnings of unconsolidated affiliates

     (37 )     (24 )     (63 )

Special charges(1)

     408       853       378  

Other expense

     215       118       54  
    


 


 


Total

   $ 531     $ 833     $ 257  
    


 


 



(1) See other operating expense, net note to the consolidated financial statements for a discussion of the special charges and a summary of the activity in the related liabilities.

 

Gains on sales of restaurant businesses

 

Gains on sales of restaurant businesses include gains from sales of Company-operated restaurants as well as gains from exercises of purchase options by franchisees with business facilities lease arrangements (arrangements where the Company leases the businesses, including equipment, to franchisees who have options to purchase the businesses). The Company’s purchases and sales of businesses with its franchisees and affiliates are aimed at achieving an optimal ownership mix in each market. Resulting gains or losses are recorded in operating income because the transactions are a recurring part of our business. The Company expects lower gains on sales of restaurant businesses in 2004 compared with 2003.

 

Equity in earnings of unconsolidated affiliates

 

Equity in earnings of unconsolidated affiliates—businesses in which the Company actively participates but does not control—is reported after interest expense and income taxes, except for U.S. restaurant partnerships, which are reported before income taxes. The increase in 2003 was primarily due to strong results in the U.S. The decrease in 2002 was due to a net loss from our Japanese affiliate compared with earnings in 2001.

 

Other expense

 

Other expense in 2003 reflected higher losses on asset dispositions, higher provisions for uncollectible receivables (primarily in Latin America), and costs in the U.S. related to sites that will no longer be developed as a result of management’s decision to significantly reduce capital expenditures. Other expense in 2002 reflected payments to U.S. owner/operators to facilitate the introduction of a new front counter service system and higher provisions for uncollectible receivables (primarily in Europe and Latin America), partly offset by a benefit from the elimination of goodwill amortization. The Company expects lower other expense in 2004 compared with 2003.

 

INTEREST EXPENSE

 

Interest expense increased in 2003 due to stronger foreign currencies, partly offset by lower average debt levels and interest rates. Interest expense decreased in 2002 due to lower average interest rates, partly offset by higher average debt levels and stronger foreign currencies.

 

NONOPERATING EXPENSE, NET

 

Nonoperating expense includes miscellaneous income and expense items such as interest income, minority interests, and gains and losses related to other investments, financings and foreign currency translation. Nonoperating expense in 2003 reflected an $11 million loss on the early extinguishment of $200 million of debt as well as higher foreign currency translation losses compared with 2002. Nonoperating expense in 2002 reflected higher minority interest expense and foreign currency translation losses in 2002 compared with foreign currency translation gains

 

18    McDonald’s Corporation


in 2001. In addition, nonoperating expense in 2001 included $12 million primarily related to the write-off of a corporate investment as well as minority interest expense related to the sale of real estate in Singapore.

 

PROVISION FOR INCOME TAXES

 

The following table presents the reported effective income tax rates as well as the effective income tax rates before special items.

 

     2003

    2002

    2001

 

Reported effective income tax rates

   35.7 %   40.3 %   29.8 %

Impact of special items(1)

   (2.2 )   (7.6 )   1.3  
    

 

 

Effective income tax rates before special items

   33.5 %   32.7 %   31.1 %
    

 

 


(1) Certain special items were not tax-effected.

 

The 2001 effective income tax rate reflected a benefit from the impact of tax law changes in certain international markets.

 

Consolidated net deferred tax liabilities included tax assets, net of valuation allowance, of $1,032 million in 2003 and $867 million in 2002. Substantially all of the net tax assets arose in the U.S. and other profitable markets.

 

CUMULATIVE EFFECT OF ACCOUNTING CHANGES

 

Effective January 1, 2003, the Company adopted SFAS No. 143, Accounting for Asset Retirement Obligations, which requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which eliminates the amortization of goodwill and instead subjects it to annual impairment tests. See summary of significant accounting policies note to the consolidated financial statements for further discussion.

 


CASH FLOWS

 

The Company generates significant cash from operations and has substantial credit capacity to fund operating and discretionary spending. Cash from operations totaled $3.3 billion and exceeded capital expenditures by $2.0 billion in 2003, while cash from operations totaled $2.9 billion and exceeded capital expenditures by $0.9 billion in 2002. Cash provided by operations, along with borrowings and other sources of cash, is used for capital expenditures, debt repayments, dividends and share repurchases.

 

Cash provided by operations

 

DOLLARS IN MILLIONS


   2003

    2002

    2001

 

Cash provided by operations

   $ 3,269     $ 2,890     $ 2,688  

Cash provided by operations as a percent of capital expenditures

     250 %     144 %     141 %

 

In addition to its cash provided by operations, the Company can meet short-term funding needs through commercial paper borrowings and line of credit agreements. Accordingly, the Company purposefully maintains a relatively low current ratio, which was .76 at year-end 2003.

 

RESTAURANT DEVELOPMENT AND CAPITAL EXPENDITURES

 

As a result of the Company strategically shifting its focus from adding new restaurants to building sales at existing restaurants, the Company significantly reduced capital expenditures and restaurant openings in 2003 compared with 2002 and 2001.

 

In 2003, the Company opened 513 traditional McDonald’s restaurants and 319 satellite restaurants (small, limited-menu restaurants for which the land and building are generally leased), and closed 486 traditional restaurants and 184 satellite restaurants. In 2002, the Company opened 1,247 traditional McDonald’s restaurants and 392 satellite restaurants, and closed 474 traditional restaurants and 158 satellite restaurants. About 65% of McDonald’s restaurant additions occurred in the major markets in 2003.

 

Systemwide restaurants at year end(1)

 

     2003

   2002

   2001

U.S.

   13,609    13,491    13,099

Europe

   6,186    6,070    5,794

APMEA

   7,475    7,555    7,321

Latin America

   1,578    1,605    1,581

Canada

   1,339    1,304    1,223

Other

   942    1,083    1,075
    
  
  

Total

   31,129    31,108    30,093
    
  
  

(1) Includes satellite units at December 31, 2003, 2002 and 2001 as follows: U.S.–1,307, 1,159, 1,004; Europe–150, 102, 63; APMEA (primarily Japan)–1,841, 1,923, 1,879; Latin America–20, 19, 46; and Canada–350, 330, 307.

 

In 2004, the Company expects to open about 550 traditional McDonald’s restaurants and 300 satellite restaurants and close about 300 traditional restaurants and 100 satellite restaurants.

 

Approximately 60% of Company-operated restaurants and more than 85% of franchised restaurants were located in the major markets at the end of 2003. Franchisees and affiliates operated 73% of McDonald’s restaurants at year-end 2003. Non-McDonald’s brand restaurants are primarily Company-operated.

 

Capital expenditures decreased $697 million or 35% in 2003 and increased $98 million or 5% in 2002. The decrease in capital expenditures in 2003 was primarily due to lower restaurant openings, consistent with our shift in strategic focus, partly offset by stronger foreign currencies (foreign currency translation increased capital expenditures by $73 million). The increase in 2002 was primarily due to higher spending in the U.S. and Canada, partly offset by lower capital expenditures for new restaurants in Latin America. Capital expenditures for McDonald’s restaurants

 

McDonald’s Corporation    19


in 2003, 2002 and 2001 reflected the leasing of a higher proportion of new sites and a program that gave U.S. franchisees the option to purchase new restaurant buildings.

 

During 2003, the Company began to phase out the option for U.S. franchisees to purchase new restaurant buildings. Consequently, the Company is currently purchasing most buildings and, as a result, collects additional rent from the franchisees.

 

Capital expenditures invested in major markets excluding Japan represented approximately 70% of the total in 2003 and 2002 and 60% in 2001. Japan is accounted for under the equity method, and accordingly its capital expenditures are not included in consolidated amounts.

 

Capital expenditures

 

IN MILLIONS


   2003

   2002

   2001

New restaurants

   $ 617    $ 1,161    $ 1,198

Existing restaurants(1)

     564      659      571

Other properties(2)

     126      184      137
    

  

  

Total

   $ 1,307    $ 2,004    $ 1,906
    

  

  

Total assets

   $ 25,525    $ 23,971    $ 22,535
    

  

  


(1) Includes technology to improve service and food quality and enhancements to facilities to achieve higher levels of customer satisfaction.
(2) Primarily computer equipment and furnishings for office buildings.

 

Capital expenditures for new restaurants decreased $544 million or 47% in 2003 because the Company opened fewer restaurants and concentrated new restaurant investments in markets with acceptable returns or opportunities for long-term growth. While capital expenditures for existing restaurants decreased in 2003, they increased as a percentage of total capital spending. This is due to the Company’s focus on growing sales at existing restaurants including reinvestment initiatives such as restaurant reimaging in several markets around the world, including the U.S.

 

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 owned by the Company, are managed through the use of optimally sized restaurants, construction and design efficiencies, standardization and global sourcing. In addition, foreign currency fluctuations affect average development costs. In 2004, the Company is targeting eleven consolidated markets, including the U.S., for opening ten or more restaurants. Although the Company is not responsible for all costs on every restaurant opened, in 2003 total development costs (consisting of land, buildings and equipment) for new traditional McDonald’s restaurants averaged approximately $1.8 million in the U.S. and approximately $1.7 million in the ten markets outside the U.S.

 

The Company and its affiliates owned about 37% of the land and 60% of the buildings for its restaurants at year-end 2003 and 2002.

 

SHARE REPURCHASES AND DIVIDENDS

 

During 2003, the Company acquired 18.9 million shares of McDonald’s stock for approximately $439 million under a $5.0 billion share repurchase program authorized in 2001. Through 2003, 39.0 million shares for $975 million have been repurchased under this program.

 

The Company has paid dividends on its common stock for 28 consecutive years and has increased the dividend amount every year. In 2003, the Company declared a 70% increase in the annual dividend to $504 million, reflecting the Company’s confidence in the ongoing strength and reliability of its cash flow, the positive results from its revitalization efforts and favorable changes in the U.S. tax law. As in the past, future dividends will be considered after reviewing returns to shareholders, profitability expectations and financing needs and will be declared at the discretion of the Board of Directors. Cash dividends are declared and paid on an annual basis.

 


FINANCIAL POSITION AND CAPITAL RESOURCES

 

TOTAL ASSETS AND RETURNS

 

Total assets grew by $1.6 billion or 6% in 2003 and $1.4 billion or 6% in 2002. Changes in foreign currency exchange rates increased total assets by approximately $1.9 billion in 2003 and $785 million in 2002. At year-end 2003 and 2002, approximately 65% of consolidated assets was located in the major markets excluding Japan. Net property and equipment rose $1.3 billion in 2003 and represented 78% of total assets at year end.

 

Operating income is used to compute return on average assets, while income before the cumulative effect of accounting changes is used to calculate return on average common equity. Month-end balances are used to compute both average assets and average common equity.

 

Returns on assets and equity

 

     2003

    2002

    2001

 

Return on average assets

   11.4 %   9.2 %   12.3 %

Return on average common equity

   13.3     9.8     17.5  

 

Special charges reduced return on average assets by 1.4% points in 2003, 3.6% points in 2002 and 1.8% points in 2001. In addition, these charges reduced return on average common equity by 2.8% points in 2003, 7.0% points in 2002 and 1.6% points in 2001. In 2003, return on average assets and return on average common equity both began to stabilize due to strong operating results in the U.S., partly offset by continued weak operating results in most markets in APMEA and Latin America. In 2002, return on average assets and return on average common equity both declined, primarily due to weak operating results in APMEA and Latin America. During 2004, the Company will continue to concentrate McDonald’s restaurant openings and new capital invested in markets with acceptable returns or opportunities for long-term growth.

 

20    McDonald’s Corporation


FINANCINGS AND MARKET RISK

 

The Company generally borrows on a long-term basis and is exposed to the impact of interest rate changes and foreign currency fluctuations. Debt obligations at December 31, 2003 totaled $9.7 billion compared with $10.0 billion at December 31, 2002. The net decrease in 2003 was due to net payments ($892 million) and SFAS No. 133 noncash fair value adjustments ($44 million), partly offset by the impact of changes in exchange rates on foreign currency denominated debt ($686 million).

 

Debt highlights(1)

 

     2003

    2002

    2001

 

Fixed-rate debt as a percent of total debt(2,3)

   62 %   62 %   45 %

Weighted-average annual interest rate of total debt

   4.1     4.1     5.4  

Foreign currency-denominated debt as a percent of total debt(2,3)

   71     64     57  

Total debt as a percent of total capitalization (total debt and total shareholders’ equity)(2)

   44     48     48  

Cash provided by operations as a percent of total debt(2)

   35     30     30  

(1) All percentages are as of December 31, except for the weighted-average annual interest rate, which is for the year.
(2) Based on debt obligations before the effect of SFAS No. 133 fair value adjustments.
(3) Includes the effect of interest rate and foreign currency exchange agreements.

 

Moody’s, Standard & Poor’s and Fitch currently rate McDonald’s commercial paper P-1, A-1 and F1; and its long-term debt A2, A and A, respectively. Historically the Company has not experienced difficulty in obtaining financing or refinancing existing debt. The Company’s key metrics for monitoring its credit structure are shown in the preceding table. While the Company targets these metrics for ease of focus, it also looks at similar credit ratios that incorporate capitalized operating leases to estimate total adjusted debt using a multiple of eight times rent expense after considering certain adjustments to more accurately reflect its total aggregate lease commitments. These adjustments include: excluding percent rents in excess of minimum rents; excluding certain Company-operated restaurant lease agreements outside the U.S. that are cancelable with minimal penalties (representing approximately 20% of Company-operated restaurant leases outside the U.S., based on the Company’s estimate); capitalizing non-restaurant leases using a multiple of three times rent expense; and reducing total rent expense by approximately half of the annual minimum rent payments due to the Company from franchisees operating on leased sites.

 

Certain of the Company’s debt obligations contain cross-acceleration provisions and restrictions on Company and subsidiary mortgages and the long-term debt of certain subsidiaries. There are no provisions in the Company’s debt obligations that would accelerate repayment of debt as a result of a change in credit ratings or a material adverse change in the Company’s business. The Company has $1.3 billion available under committed line of credit agreements (see debt financing note to the consolidated financial statements) as well as $1.6 billion under a U.S. shelf registration and $607 million under a Euro Medium-Term Notes program for future debt issuance.

 

The Company uses major capital markets, bank financings and derivatives to meet its financing requirements and reduce interest expense. The Company manages its debt portfolio in response to changes in interest rates and foreign currency rates by periodically retiring, redeeming and repurchasing debt, terminating exchange agreements and using derivatives. The Company does not use derivatives with a level of complexity or with a risk higher than the exposures to be hedged and does not hold or issue derivatives for trading purposes. All exchange agreements are over-the-counter instruments.

 

In managing the impact of interest rate changes and foreign currency fluctuations, the Company uses interest rate exchange agreements and finances in the currencies in which assets are denominated. All derivatives were recorded at fair value in the Company’s Consolidated balance sheet at December 31, 2003 and 2002 as follows: miscellaneous other assets–$102 million and $134 million; other long-term liabilities (excluding interest)–$136 million and $39 million; and accrued payroll and other liabilities–$29 million and $24 million. See summary of significant accounting policies note to the consolidated financial statements related to financial instruments for additional information regarding their use and the impact of SFAS No.133 regarding derivatives.

 

The Company uses foreign currency debt and derivatives to hedge the foreign currency risk associated with certain royalties, intercompany financings and long-term investments in foreign subsidiaries and affiliates. This reduces the impact of fluctuating foreign currencies on cash flows and shareholders’ equity. Total foreign currency denominated debt, including the effects of foreign currency exchange agreements, was $6.8 billion at year-end 2003 and $6.2 billion at year-end 2002. In addition, where practical, McDonald’s restaurants purchase goods and services in local currencies resulting in natural hedges.

 

The Company does not have significant exposure to any individual counterparty and has master agreements that contain netting arrangements. Certain of these agreements also require each party to post collateral if credit ratings fall below, or aggregate exposures exceed, certain contractual limits. At December 31, 2003, the Company was required to post collateral of $11.6 million, and at December 31, 2002, collateral of $2.2 million was posted by a counterparty.

 

The Company’s net asset exposure is diversified among a broad basket of currencies. The Company’s largest net asset exposures (defined as foreign currency assets less foreign currency liabilities) at year end were as follows:

 

Foreign currency net asset exposures

 

IN MILLIONS OF U.S. DOLLARS


   2003

   2002

Euro

   $ 1,922    $ 1,536

Canadian Dollars

     1,086      808

Australian Dollars

     781      620

British Pounds Sterling

     741      700

Brazilian Reais

     365      385
    

  

 

McDonald’s Corporation    21


The Company prepared sensitivity analyses of its financial instruments to determine the impact of hypothetical changes in interest rates and foreign currency exchange rates on the Company’s results of operations, cash flows and the fair value of its financial instruments. The interest rate analysis assumed a one percentage point adverse change in interest rates on all financial instruments but did not consider the effects of the reduced level of economic activity that could exist in such an environment. The foreign currency rate analysis assumed that each foreign currency rate would change by 10% in the same direction relative to the U.S. Dollar on all financial instruments; however, the analysis did not include the potential impact on sales levels or local currency prices or the effect of fluctuating currencies on the Company’s anticipated foreign currency royalties and other payments received in the U.S. Based on the results of these analyses of the Company’s financial instruments, neither a one percentage point adverse change in interest rates from 2003 levels nor a 10% adverse change in foreign currency rates from 2003 levels would materially affect the Company’s results of operations, cash flows or the fair value of its financial instruments.

 

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

 

The Company has long-term contractual obligations primarily in the form of lease obligations (related to both Company-operated and franchised restaurants) and debt obligations. In addition, the Company has long-term revenue and cash flow streams that relate to its franchise arrangements. Cash provided by operations (including cash provided by these franchise arrangements) along with the Company’s borrowing capacity and other sources of cash will be used to satisfy the obligations. The following table summarizes the Company’s contractual obligations and their aggregate maturities as well as future minimum rent payments due to the Company under existing franchise arrangements as of December 31, 2003. (See discussions of cash flows, financial position and capital resources as well as the Notes to the December 31, 2003 consolidated financial statements for further details.)

 

    

Contractual cash

outflows


  

Contractual cash

inflows


IN MILLIONS


   Operating
leases


   Debt
obligations
(1)


   Minimum rent
under franchise
arrangements


2004

   $ 998    $ 388    $ 1,804

2005

     939      1,371      1,761

2006

     877      1,941      1,715

2007

     815      667      1,663

2008

     758      851      1,611

Thereafter

     6,531      4,191      12,987
    

  

  

Total

   $ 10,918    $ 9,409    $ 21,541
    

  

  


(1) The maturities reflect reclassifications of short-term obligations to long-term obligations of $750 million in 2006 and $500 million thereafter, as they are supported by long-term line of credit agreements. Debt obligations do not include $321 million of SFAS No.133 noncash fair value adjustments.

 

The Company maintains a nonqualified, unfunded Supplemental Plan that allows participants to make tax-deferred contributions and receive Company-provided allocations that cannot be made under the Profit Sharing and Savings Plan because of Internal Revenue Service limitations. The investment alternatives and returns in the Supplemental Plan are based on certain market-rate investment alternatives under the Profit Sharing and Savings Plan. Total liabilities under the Supplemental Plan were $329 million at December 31, 2003 and $297 million at December 31, 2002, and were included in other long-term liabilities in the Consolidated balance sheet.

 

In addition to long-term obligations, the Company had guaranteed certain affiliate and other loans totaling $89 million at December 31, 2003.

 


OTHER MATTERS

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Management’s discussion and analysis of financial condition and results of operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses as well as related disclosures. On an ongoing basis, the Company evaluates its estimates and judgments based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

The Company reviews its financial reporting and disclosure practices and accounting policies quarterly to ensure that they provide accurate and transparent information relative to the current economic and business environment. The Company believes that of its significant accounting policies the following involve a higher degree of judgment and/or complexity.

 

Property and Equipment

 

Property and equipment are depreciated or amortized on a straight-line basis over their useful lives based on management’s estimates of the period over which the assets will generate revenue. The useful lives are estimated based on historical experience with similar assets, taking into account anticipated technological or other changes. The Company periodically reviews these lives relative to physical factors, economic factors and industry trends. If there are changes in the planned use of property and equipment or if technological changes occur more rapidly than anticipated, the useful lives assigned to these assets may need to be shortened, resulting in the recognition of increased depreciation and amortization expense in future periods.

 

22    McDonald’s Corporation


Long-Lived Assets

 

Long-lived assets (including goodwill) are reviewed for impairment annually in the fourth quarter and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In assessing the recoverability of the Company’s long-lived assets, the Company considers changes in economic conditions and makes assumptions regarding estimated future cash flows and other factors. (The biggest assumption impacting estimated future cash flows is the estimated change in comparable sales.) Estimates of future cash flows are highly subjective judgments based on the Company’s experience and knowledge of operations. These estimates can be significantly impacted by many factors including changes in global and local business and economic conditions, operating costs, inflation, competition, and consumer and demographic trends. If the Company’s estimates or underlying assumptions change in the future, the Company may be required to record impairment charges.

 

Restructuring and Litigation Accruals

 

The Company has recorded charges related to restructuring markets, closing restaurants, eliminating positions and other strategic changes. The accruals recorded included estimates pertaining to employee termination costs, number of restaurants to be closed and remaining lease obligations for closed facilities. Although the Company does not anticipate significant changes, the actual costs may differ from these estimates.

 

From time to time, the Company is subject to proceedings, lawsuits and other claims related to franchisees, suppliers, employees, customers, competitors and intellectual property. The Company is required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of accrual required, if any, for these contingencies is made after careful analysis of each matter. The required accrual may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters. The Company does not believe that any such matter will have a material adverse effect on its financial condition or results of operations.

 

Income Taxes

 

The Company records a valuation allowance to reduce its deferred tax assets if it is more likely than not that some portion or all of the deferred assets will not be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax strategies in assessing the need for the valuation allowance, if these estimates and assumptions change in the future, the Company may be required to adjust its valuation allowance. This could result in a charge to, or an increase in, income in the period such determination is made.

 

Deferred U.S. income taxes have not been recorded for basis differences totaling $4.2 billion related to investments in certain foreign subsidiaries or affiliates. The basis differences consist primarily of undistributed earnings considered permanently invested in the businesses. If management’s intentions change in the future, deferred taxes may need to be provided.

 

In addition, the Company operates within multiple taxing jurisdictions and is subject to audit in these jurisdictions. The Company records accruals for the estimated outcomes of these audits, and the accruals may change in the future due to new developments in each matter.

 

EFFECTS OF CHANGING PRICES – INFLATION

 

The Company has demonstrated an ability to manage inflationary cost increases effectively. This is because of rapid inventory turnover, the ability to adjust menu prices, cost controls and substantial property holdings—many of which are at fixed costs and partly financed by debt made less expensive by inflation.

 

FORWARD-LOOKING STATEMENTS

 

Certain forward-looking statements are included in this report. They use such words as “may,” “will,” “expect,” “believe,” “plan” and other similar terminology. These statements reflect management’s current expectations regarding future events and operating performance and speak only as of the date of this report. These forward-looking statements involve a number of risks and uncertainties. The following are some of the factors that could cause actual results to differ materially from those expressed in or underlying our forward-looking statements: effectiveness of operating initiatives; success in advertising and promotional efforts; changes in global and local business and economic conditions, including their impact on consumer confidence; fluctuations in currency exchange and interest rates; food, labor and other operating costs; political or economic instability in local markets, including the effects of war and terrorist activities; competition, including pricing and marketing initiatives and new product offerings by the Company’s competitors; consumer preferences or perceptions concerning the Company’s product offerings; spending patterns and demographic trends; availability of qualified restaurant personnel; severe weather conditions; existence of positive or negative publicity regarding the Company or its industry generally; effects of legal claims; cost and deployment of capital; changes in future effective tax rates; changes in governmental regulations; and changes in applicable accounting policies and practices. The foregoing list of important factors is not all-inclusive.

 

The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

McDonald’s Corporation    23



Item 7A. Quantitative and qualitative disclosures about market risk

 

Quantitative and qualitative disclosures about market risk are included in Part II, Item 7, page 21 of this Form 10-K.

 


Item 8. Financial statements and supplementary data

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page reference

Consolidated statement of income for each of the three years in the period ended December 31, 2003

   25

Consolidated balance sheet at December 31, 2003 and 2002

   26

Consolidated statement of cash flows for each of the three years in the period ended December 31, 2003

   27

Consolidated statement of shareholders’ equity for each of the three years in the period ended December 31, 2003

   28

Notes to consolidated financial statements

   29

Quarterly results (unaudited)

   40

Management’s report

   41

Report of independent auditors

   41

 

24    McDonald’s Corporation



Consolidated statement of income

 

     Years ended December 31,

 

IN MILLIONS, EXCEPT PER SHARE DATA


   2003

    2002

    2001

 

REVENUES

                        

Sales by Company-operated restaurants

   $ 12,795.4     $ 11,499.6     $ 11,040.7  

Revenues from franchised and affiliated restaurants

     4,345.1       3,906.1       3,829.3  
    


 


 


Total revenues

     17,140.5       15,405.7       14,870.0  
    


 


 


OPERATING COSTS AND EXPENSES

                        

Company-operated restaurant expenses

                        

Food & paper

     4,314.8       3,917.4       3,802.1  

Payroll & employee benefits

     3,411.4       3,078.2       2,901.2  

Occupancy & other operating expenses

     3,279.8       2,911.0       2,750.4  

Franchised restaurants–occupancy expenses

     937.7       840.1       800.2  

Selling, general & administrative expenses

     1,833.0       1,712.8       1,661.7  

Other operating expense, net

     531.6       833.3       257.4  
    


 


 


Total operating costs and expenses

     14,308.3       13,292.8       12,173.0  
    


 


 


Operating income

     2,832.2       2,112.9       2,697.0  
    


 


 


Interest expense–net of capitalized interest of $7.8, $14.3 and $15.2

     388.0       374.1       452.4  

McDonald’s Japan IPO gain

                     (137.1 )

Nonoperating expense, net

     97.8       76.7       52.0  
    


 


 


Income before provision for income taxes and cumulative effect of accounting changes

     2,346.4       1,662.1       2,329.7  
    


 


 


Provision for income taxes

     838.2       670.0       693.1  
    


 


 


Income before cumulative effect of accounting changes

     1,508.2       992.1       1,636.6  
    


 


 


Cumulative effect of accounting changes, net of tax benefits of $9.4 and $17.6

     (36.8 )     (98.6 )        
    


 


 


Net income

   $ 1,471.4     $ 893.5     $ 1,636.6  
    


 


 


Per common share–basic:

                        

Income before cumulative effect of accounting changes

   $ 1.19     $ .78     $ 1.27  

Cumulative effect of accounting changes

     (.03 )     (.08 )        

Net income

   $ 1.16     $ .70     $ 1.27  
    


 


 


Per common share–diluted:

                        

Income before cumulative effect of accounting changes

   $ 1.18     $ .77     $ 1.25  

Cumulative effect of accounting changes

     (.03 )     (.07 )        

Net income

   $ 1.15     $ .70     $ 1.25  
    


 


 


Dividends per common share

   $ .40     $ .24     $ .23  
    


 


 


Weighted-average shares outstanding–basic

     1,269.8       1,273.1       1,289.7  

Weighted-average shares outstanding–diluted

     1,276.5       1,281.5       1,309.3  
    


 


 


 

See notes to consolidated financial statements.

 

McDonald’s Corporation    25



Consolidated balance sheet

 

     December 31,

 

IN MILLIONS, EXCEPT PER SHARE DATA


   2003

    2002

 

ASSETS

                

Current assets

                

Cash and equivalents

   $ 492.8     $ 330.4  

Accounts and notes receivable

     734.5       855.3  

Inventories, at cost, not in excess of market

     129.4       111.7  

Prepaid expenses and other current assets

     528.7       418.0  
    


 


Total current assets

     1,885.4       1,715.4  
    


 


Other assets

                

Investments in and advances to affiliates

     1,089.6       1,037.7  

Goodwill, net

     1,665.1       1,558.5  

Miscellaneous

     960.3       1,075.5  
    


 


Total other assets

     3,715.0       3,671.7  
    


 


Property and equipment

                

Property and equipment, at cost

     28,740.2       26,218.6  

Accumulated depreciation and amortization

     (8,815.5 )     (7,635.2 )
    


 


Net property and equipment

     19,924.7       18,583.4  
    


 


Total assets

   $ 25,525.1     $ 23,970.5  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                

Current liabilities

                

Accounts payable

   $ 577.4     $ 635.8  

Income taxes

     71.5       16.3  

Other taxes

     222.0       191.8  

Accrued interest

     193.1       199.4  

Accrued restructuring and restaurant closing costs

     115.7       328.5  

Accrued payroll and other liabilities

     918.1       774.7  

Current maturities of long-term debt

     388.0       275.8  
    


 


Total current liabilities

     2,485.8       2,422.3  
    


 


Long-term debt

     9,342.5       9,703.6  

Other long-term liabilities and minority interests

     699.8       560.0  

Deferred income taxes

     1,015.1       1,003.7  

Shareholders’ equity

                

Preferred stock, no par value; authorized–165.0 million shares; issued–none

                

Common stock, $.01 par value; authorized–3.5 billion shares; issued–1,660.6 million shares

     16.6       16.6  

Additional paid-in capital

     1,837.5       1,747.3  

Unearned ESOP compensation

     (90.5 )     (98.4 )

Retained earnings

     20,172.3       19,204.4  

Accumulated other comprehensive income (loss)

     (635.5 )     (1,601.3 )

Common stock in treasury, at cost; 398.7 and 392.4 million shares

     (9,318.5 )     (8,987.7 )
    


 


Total shareholders’ equity

     11,981.9       10,280.9  
    


 


Total liabilities and shareholders’ equity

   $ 25,525.1     $ 23,970.5  
    


 


 

See notes to consolidated financial statements.

 

26    McDonald’s Corporation



Consolidated statement of cash flows

 

     Years ended December 31,

 

IN MILLIONS


   2003

    2002

    2001

 

Operating activities

                        

Net income

   $ 1,471.4     $ 893.5     $ 1,636.6  

Adjustments to reconcile to cash provided by operations

                        

Cumulative effect of accounting changes

     36.8       98.6          

Depreciation and amortization

     1,148.2       1,050.8       1,086.3  

Deferred income taxes

     181.4       (44.6 )     (87.6 )

Changes in working capital items

                        

Accounts receivable

     64.0       1.6       (104.7 )

Inventories, prepaid expenses and other current assets

     (30.2 )     (38.1 )     (62.9 )

Accounts payable

     (77.6 )     (11.2 )     10.2  

Taxes and other accrued liabilities

     (147.2 )     448.0       270.4  

Other (including noncash portion of special items)

     622.0       491.5       (60.0 )
    


 


 


Cash provided by operations

     3,268.8       2,890.1       2,688.3  
    


 


 


Investing activities

                        

Property and equipment expenditures

     (1,307.4 )     (2,003.8 )     (1,906.2 )

Purchases of restaurant businesses

     (375.8 )     (548.4 )     (331.6 )

Sales of restaurant businesses and property

     390.6       369.5       375.9  

Other

     (77.0 )     (283.9 )     (206.3 )
    


 


 


Cash used for investing activities

     (1,369.6 )     (2,466.6 )     (2,068.2 )
    


 


 


Financing activities

                        

Net short-term repayments

     (533.5 )     (606.8 )     (248.0 )

Long-term financing issuances

     398.1       1,502.6       1,694.7  

Long-term financing repayments

     (756.2 )     (750.3 )     (919.4 )

Treasury stock purchases

     (391.0 )     (670.2 )     (1,068.1 )

Common stock dividends

     (503.5 )     (297.4 )     (287.7 )

Other

     49.3       310.9       204.8  
    


 


 


Cash used for financing activities

     (1,736.8 )     (511.2 )     (623.7 )
    


 


 


Cash and equivalents increase (decrease)

     162.4       (87.7 )     (3.6 )
    


 


 


Cash and equivalents at beginning of year

     330.4       418.1       421.7  
    


 


 


Cash and equivalents at end of year

   $ 492.8     $ 330.4     $ 418.1  
    


 


 


Supplemental cash flow disclosures

                        

Interest paid

   $ 426.9     $ 359.7     $ 446.9  

Income taxes paid

     608.5       572.2       773.8  
    


 


 


 

See notes to consolidated financial statements.

 

McDonald’s Corporation    27



Consolidated statement of shareholders’ equity

 

IN MILLIONS,
EXCEPT PER
SHARE DATA


 

Common stock

issued


 

Additional

paid-in

Capital


 

Unearned

ESOP

compensation


   

Retained

earnings


   

Accumulated other

comprehensive income
(loss)


   

Common stock in

treasury


   

Total
shareholders’

equity


 
         

Deferred

hedging

adjustment


   

Foreign

currency

translation


     
  Shares

  Amount

            Shares

    Amount

   

Balance at December 31, 2000

  1,660.6   $ 16.6   $ 1,441.8   $ (115.0 )   $ 17,259.4     $ —       $ (1,287.3 )   (355.7 )   $ (8,111.1 )   $ 9,204.4  

Net income

                            1,636.6                                     1,636.6  

Translation adjustments (including taxes of $65.7)

                                            (412.2 )                   (412.2 )

SFAS No.133 transition adjustment (including tax benefits of $9.2)

                                    (17.0 )                           (17.0 )

Fair value adjustments–cash flow hedges (including taxes of $1.4)

                                    7.7                             7.7  

Comprehensive income

                                                                  1,215.1  

Common stock cash dividends ($.23 per share)

                            (287.7 )                                   (287.7 )

ESOP loan payment

                    8.0                                             8.0  

Treasury stock purchases

                                                  (36.1 )     (1,090.2 )     (1,090.2 )

Common equity put option issuances and expirations, net and forward contracts

                                                          199.2       199.2  

Stock option exercises and other (including tax benefits of $70.0)

              149.4     0.3                             11.9       89.9       239.6  
   
 

 

 


 


 


 


 

 


 


Balance at December 31, 2001

  1,660.6     16.6     1,591.2     (106.7 )     18,608.3       (9.3 )     (1,699.5 )   (379.9 )     (8,912.2 )     9,488.4  
   
 

 

 


 


 


 


 

 


 


Net income

                            893.5                                     893.5  

Translation adjustments (including tax benefits of $150.5)

                                            106.7                     106.7  

Fair value adjustments–cash flow hedges (including tax benefits of $3.5)

                                    0.8                             0.8  

Comprehensive income

                                                                  1,001.0  

Common stock cash dividends ($.24 per share)

                            (297.4 )                                   (297.4 )

ESOP loan payment

                    7.4                                             7.4  

Treasury stock purchases

                                                  (25.6 )     (686.9 )     (686.9 )

Common equity put option expirations and forward contracts settled

                                                          500.8       500.8  

Stock option exercises and other (including tax benefits of $61.3)

              156.1     0.9                             13.1       110.6       267.6  
   
 

 

 


 


 


 


 

 


 


Balance at December 31, 2002

  1,660.6     16.6     1,747.3     (98.4 )     19,204.4       (8.5 )     (1,592.8 )   (392.4 )     (8,987.7 )     10,280.9  
   
 

 

 


 


 


 


 

 


 


Net income

                            1,471.4                                     1,471.4  

Translation adjustments (including tax benefits of $203.2)

                                            957.8                     957.8  

Fair value adjustments–cash flow hedges (including taxes of $1.6)

                                    8.0                             8.0  

Comprehensive income

                                                                  2,437.2  

Common stock cash dividends ($.40 per share)

                            (503.5 )                                   (503.5 )

ESOP loan payment

                    7.2                                             7.2  

Treasury stock purchases

                                                  (18.9 )     (438.7 )     (438.7 )

Stock option exercises and other (including tax benefits of $20.5)

              90.2     0.7                             12.6       107.9       198.8  
   
 

 

 


 


 


 


 

 


 


Balance at December 31, 2003

  1,660.6   $ 16.6   $ 1,837.5   $ (90.5 )   $ 20,172.3     $ (0.5 )   $ (635.0 )   (398.7 )   $ (9,318.5 )   $ 11,981.9  
   
 

 

 


 


 


 


 

 


 


 

See notes to consolidated financial Statements.

 

28    McDonald’s Corporation



Notes to consolidated financial statements

 


SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

NATURE OF BUSINESS

 

The Company primarily operates and franchises McDonald’s restaurants in the food service industry. The Company also operates Boston Market and Chipotle Mexican Grill in the U.S. and has a minority ownership in U.K.-based Pret A Manger. In December 2003, the Company sold its Donatos Pizzeria business.

 

All restaurants are operated either by the Company, by independent entrepreneurs under the terms of franchise arrangements (franchisees), or by affiliates operating under license agreements.

 

CONSOLIDATION

 

The consolidated financial statements include the accounts of the Company and its subsidiaries. Substantially all investments in affiliates owned 50% or less (primarily McDonald’s Japan) are accounted for by the equity method.

 

ESTIMATES IN FINANCIAL STATEMENTS

 

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

REVENUE RECOGNITION

 

The Company’s revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees and affiliates. Sales by Company-operated restaurants are recognized on a cash basis. Fees from franchised and affiliated restaurants include continuing rent and service fees, initial fees and royalties received from foreign affiliates and developmental licensees. Continuing fees and royalties are recognized in the period earned. Initial fees are recognized upon opening of a restaurant, which is when the Company has performed substantially all initial services required by the franchise arrangement.

 

FOREIGN CURRENCY TRANSLATION

 

The functional currency of substantially all operations outside the U.S. is the respective local currency, except for a small number of countries with hyperinflationary economies, where the functional currency is the U.S. Dollar.

 

ADVERTISING COSTS

 

Advertising costs included in costs of Company-operated restaurants primarily consist of contributions to advertising cooperatives and were (in millions): 2003–$596.7; 2002–$532.3; 2001–$521.5. Production costs for radio and television advertising, primarily in the U.S., are expensed when the commercials are initially aired. These production costs as well as other marketing-related expenses included in selling, general & administrative expenses were (in millions): 2003–$113.1; 2002–$115.3; 2001–$79.4. In addition, significant advertising costs are incurred by franchisees through advertising cooperatives in individual markets.

 

STOCK-BASED COMPENSATION

 

The Company accounts for all stock-based compensation as prescribed by Accounting Principles Board Opinion No. 25. The Company discloses pro forma net income and net income per common share, as provided by Statement of Financial Accounting Standards (SFAS) No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation.

 

The pro forma information was determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value of these options was estimated at the date of grant using an option pricing model. The model was designed to estimate the fair value of exchange-traded options that, unlike employee stock options, can be traded at any time and are fully transferable. In addition, such models require the input of highly subjective assumptions including the expected volatility of the stock price. For pro forma disclosures, the options’ estimated fair value was amortized over their vesting period. The following tables present the pro forma disclosures and the weighted-average assumptions used to estimate the fair value of these options.

 

Pro forma disclosures

 

IN MILLIONS,

EXCEPT PER SHARE DATA


   2003

    2002

    2001

 

As reported–net income

   $ 1,471.4     $ 893.5     $ 1,636.6  

Add: Total stock-based employee compensation included in reported net income, net of related tax effects

     4.4       —         —    

Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects

     (224.1 )     (251.7 )     (210.0 )
    


 


 


Pro forma–net income

   $ 1,251.7     $ 641.8     $ 1,426.6  
    


 


 


Net income per share:

                        

As reported–basic

   $ 1.16     $ .70     $ 1.27  

Pro forma–basic

   $ .99     $ .50     $ 1.11  

As reported–diluted

   $ 1.15     $ .70     $ 1.25  

Pro forma–diluted

   $ .98     $ .50     $ 1.10  
    


 


 


 

Weighted-average assumptions

 

     2003

    2002

    2001

 

Expected dividend yield

     .75 %     .75 %     .65 %

Expected stock price volatility

     28.1 %     27.5 %     25.7 %

Risk-free interest rate

     3.46 %     5.25 %     5.03 %

Expected life of options IN YEARS

     7       7       7  
    


 


 


Fair value per option granted

   $ 5.09     $ 10.88     $ 9.93  
    


 


 


 

McDonald’s Corporation    29


PROPERTY AND EQUIPMENT

 

Property and equipment are stated at cost, with depreciation and amortization provided using the straight-line method over the following estimated useful lives: buildings–up to 40 years; leasehold improvements–the lesser of useful lives of assets or lease terms including option periods; and equipment–three to 12 years.

 

GOODWILL

 

Goodwill represents the excess of cost over the net tangible assets of acquired restaurant businesses. The Company’s goodwill primarily consists of amounts paid in excess of net tangible assets for purchases of McDonald’s restaurants from franchisees and ownership increases in international subsidiaries or affiliates.

 

In 2001, the Financial Accounting Standards Board issued SFAS No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 and includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations. SFAS No. 142, effective January 1, 2002, eliminates the amortization of goodwill (and intangible assets deemed to have indefinite lives) and instead subjects it to annual impairment tests. Other intangible assets continue to be amortized over their useful lives. Application of the nonamortization provisions of SFAS No. 142 in 2001 would have increased net income by approximately $30 million ($0.02 per share).

 

Under SFAS No. 142, goodwill is generally assigned to the reporting units expected to benefit from the synergies of the combination. If a Company-operated restaurant is sold within 24 months of acquisition, the goodwill associated with the acquisition is written off in its entirety. If a restaurant is sold beyond 24 months from the acquisition, the amount of goodwill written off is based on the relative fair value of the business sold compared to the portion of the reporting unit (defined as each individual country for McDonald’s restaurant business as well as each individual non-McDonald’s brand) that will be retained.

 

The annual goodwill impairment test compares the fair value of a reporting unit, generally based on discounted future cash flows, with its carrying amount including goodwill. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is measured as the difference between the fair value of the reporting unit’s goodwill and the carrying amount of goodwill.

 

The Company performed the initial required goodwill impairment test as of January 1, 2002 and recorded a noncash charge of $98.6 million after tax ($0.07 per diluted share) for the cumulative effect of this accounting change. The impaired goodwill resulted primarily from businesses in Argentina, Uruguay and other markets in Latin America and the Middle East, where economies had weakened significantly in recent years.

 

The following table presents the 2003 activity in goodwill by segment.

 

IN MILLIONS


   U.S.

   Europe

   APMEA(1)

    Latin
America


    Canada

   Other(2)

    Consolidated

 

Balance at December 31, 2002

   $ 676.3    $ 406.3    $ 178.1     $ 97.3     $ 56.3    $ 144.2     $ 1,558.5  

Net restaurant purchases (sales)

     56.7      19.6      16.7       24.6       21.4      (0.4 )     138.6  

Ownership increases in subsidiaries/affiliates

            9.7      11.1                      2.9       23.7  

Impairment charges

                   (23.3 )     (74.9 )                    (98.2 )

Sale of business

                                          (95.8 )     (95.8 )

Currency translation

            75.1      29.0       15.3       18.9              138.3  
    

  

  


 


 

  


 


Balance at December 31, 2003

   $ 733.0    $ 510.7    $ 211.6     $ 62.3     $ 96.6    $ 50.9     $ 1,665.1  
    

  

  


 


 

  


 



(1) APMEA represents Asia/Pacific, the Middle East and Africa.
(2) Other represents non-McDonald’s brands.

 

LONG-LIVED ASSETS

 

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, long-lived assets are reviewed for impairment annually in the fourth quarter and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For purposes of annually reviewing McDonald’s restaurant assets for potential impairment, assets are initially grouped together at a television market level in the U.S. and at a country level for each of the international markets. If an indicator of impairment (e.g., negative operating cash flows for the most recent trailing twelve-month period) exists for any grouping of assets, an estimate of undiscounted future cash flows produced by each individual restaurant within the asset grouping is compared to its carrying value. If an asset is determined to be impaired, the loss is measured by the excess of the carrying amount of the asset over its fair value as determined by an estimate of discounted future cash flows.

 

Losses on assets held for disposal are recognized when management has approved and committed to a plan to dispose of the assets, and the assets are available for disposal. Generally, such losses relate to either restaurants that have closed and ceased operations or businesses or restaurants that are available for sale.

 

30    McDonald’s Corporation


FINANCIAL INSTRUMENTS

 

The Company generally borrows on a long-term basis and is exposed to the impact of interest rate changes and foreign currency fluctuations. The Company uses foreign currency denominated debt and derivative instruments to manage the impact of these changes. The Company does not use derivatives with a level of complexity or with a risk higher than the exposures to be hedged and does not hold or issue derivatives for trading purposes.

 

The counterparties to these agreements consist of a diverse group of financial institutions. The Company continually monitors its positions and the credit ratings of its counter-parties and adjusts positions as appropriate. The Company did not have significant exposure to any individual counter-party at December 31, 2003 and has master agreements that contain netting arrangements. Certain of these agreements also require each party to post collateral if credit ratings fall below or aggregate exposures exceed certain contractual limits. At December 31, 2003, the Company was required to post collateral of $11.6 million, and at December 31, 2002, collateral of $2.2 million was posted by a counterparty.

 

Effective January 1, 2001, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. SFAS No. 133 requires companies to recognize all derivatives as either assets or liabilities in the balance sheet at fair value. SFAS No. 133 also requires companies to designate all derivatives that qualify as hedging instruments as either fair value hedges, cash flow hedges or hedges of net investments in foreign operations. This designation is based upon the exposure being hedged.

 

The Company recorded a transition adjustment at January 1, 2001 related to cash flow hedges, which reduced accumulated other comprehensive income in shareholders’ equity by $17.0 million, after tax. This adjustment was primarily related to interest rate exchange agreements used to lock in long-term borrowing rates. The cumulative effect of adopting SFAS No. 133 at January 1, 2001 was not material to the Company’s Consolidated statement of income.

 

All derivatives, primarily interest rate exchange agreements and foreign currency exchange agreements, were classified in the Company’s Consolidated balance sheet at December 31, 2003 and 2002 respectively, as follows: miscellaneous other assets–$102.4 million and $133.9 million; other long-term liabilities (excluding accrued interest)–$135.5 million and $39.2 million; and accrued payroll and other liabilities–$29.2 million and $23.8 million.

 

There was no significant impact to the Company’s earnings related to the ineffective portion of any hedging instruments for the three years ended December 31, 2003.

 

Fair value hedges

 

The Company enters into fair value hedges to reduce the exposure to changes in the fair values of certain assets or liabilities. The types of fair value hedges the Company enters into include: (1) interest rate exchange agreements to convert a portion of its fixed-rate debt to floating-rate debt and (2) foreign currency exchange agreements for the exchange of various currencies and interest rates. The foreign currency exchange agreements are entered into to hedge the currency risk associated with debt and inter-company loans denominated in foreign currencies, and essentially result in floating-rate assets or liabilities denominated in U.S. Dollars or appropriate functional currencies.

 

For fair value hedges, the gains or losses on derivatives as well as the offsetting gains or losses on the related hedged items are recognized in current earnings.

 

Cash flow hedges

 

The Company enters into cash flow hedges to reduce the exposure to variability in certain expected future cash flows. The types of cash flow hedges the Company enters into include: (1) interest rate exchange agreements that effectively convert a portion of floating-rate debt to fixed-rate debt and are designed to reduce the impact of interest rate changes on future interest expense, (2) forward foreign exchange contracts and foreign currency options that are designed to protect against the reduction in value of forecasted foreign currency cash flows such as royalties and other payments denominated in foreign currencies, and (3) foreign currency exchange agreements for the exchange of various currencies and interest rates. The foreign currency exchange agreements hedge the currency risk associated with debt and intercompany loans denominated in foreign currencies, and essentially result in fixed-rate assets or liabilities denominated in U.S. Dollars or appropriate functional currencies.

 

For cash flow hedges, the effective portion of the gains or losses on derivatives is reported in the deferred hedging adjustment component of accumulated other comprehensive income in shareholders’ equity and reclassified into earnings in the same period or periods in which the hedged transaction affects earnings. The remaining gain or loss in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in earnings during the period of change.

 

The Company recorded net increases to the deferred hedging adjustment component of accumulated other comprehensive income in shareholders’ equity of $8.0 million, $0.8 million and $7.7 million, after tax, related to cash flow hedges during the years ended December 31, 2003, 2002 and 2001, respectively. Based on interest rates and foreign currency exchange rates at December 31, 2003, no significant amount of deferred hedging adjustments, after tax, included in accumulated other comprehensive income in shareholders’ equity at December 31, 2003 will be recognized in earnings in 2004 as the underlying hedged transactions are realized. The maximum maturity date of any cash flow hedge of forecasted transactions at December 31, 2003 was 24 months, excluding instruments hedging forecasted payments of variable interest on existing financial instruments that have various maturity dates through 2015.

 

McDonald’s Corporation    31


Hedges of net investments in foreign operations

 

The Company uses forward foreign exchange contracts and foreign currency denominated debt to hedge its investments in certain foreign subsidiaries and affiliates. Realized and unrealized translation adjustments from these hedges are included in shareholders’ equity in the foreign currency translation component of accumulated other comprehensive income and offset translation adjustments on the underlying net assets of foreign subsidiaries and affiliates, which also are recorded in accumulated other comprehensive income.

 

During the year ended December 31, 2003, the Company recorded a decrease in translation adjustments in accumulated other comprehensive income of $378.1 million after tax (included in the net increase of $957.8 million of translation adjustments in the Consolidated statement of shareholders’ equity), related primarily to foreign currency denominated debt designated as hedges of net investments. During the year ended December 31, 2002, the Company recorded a decrease in translation adjustments in accumulated other comprehensive income of $312.0 million after tax related to hedges of net investments, while during the year ended December 31, 2001, the Company recorded an increase in translation adjustments of $168.5 million after tax related to hedges of net investments.

 

ASSET RETIREMENT OBLIGATIONS

 

In 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, effective January 1, 2003. The Statement requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, the cost is capitalized as part of the related long-lived asset and allocated to expense over the useful life of the asset. In first quarter 2003, the Company recorded a noncash charge of $36.8 million after tax ($0.03 per diluted share) related to lease obligations in certain international markets to reflect the cumulative effect of this accounting change. There is not a material effect to the Company’s ongoing results of operations or financial position.

 

COMMON EQUITY PUT OPTIONS AND FORWARD CONTRACTS

 

During 2001, the Company sold 12.2 million common equity put options in connection with its share repurchase program. Premiums received of $31.8 million were recorded in shareholders’ equity as a reduction of the cost of treasury stock purchased. In 2002, 10.1 million common equity put options were exercised and 2.1 million options expired unexercised, while 21.0 million options were exercised in 2001. The total amount paid to acquire these shares as a result of the options being exercised was $286 million in 2002 and $700 million in 2001. No common equity put options were sold in either 2003 or 2002; therefore, at December 31, 2003 and 2002, there were no common equity put options outstanding.

 

During 2001, the Company also entered into equity forward contracts in connection with its share repurchase program. The forward contracts for 5.5 million shares settled in March 2002. No additional equity forward contracts were entered into subsequent to March 2002.

 

SALES OF STOCK BY SUBSIDIARIES AND AFFILIATES

 

As permitted by Staff Accounting Bulletin No. 51 issued by the Securities and Exchange Commission, when a subsidiary or affiliate sells unissued shares in a public offering, the Company records an adjustment to reflect an increase or decrease in the carrying value of its investment and a resulting nonoperating gain or loss.

 

PER COMMON SHARE INFORMATION

 

Diluted net income per common share is calculated using net income divided by diluted weighted-average shares. Diluted weighted-average shares include weighted-average shares outstanding plus the dilutive effect of stock options, calculated using the treasury stock method. The dilutive effect of stock options was (in millions of shares): 2003 – 6.7; 2002 – 8.4; 2001 – 19.6. Stock options that were not included in diluted weighted-average shares because they would have been antidilutive were (in millions of shares): 2003 – 159.1; 2002 – 148.0; 2001 – 83.1. The dilutive effect of common equity put options and forward contracts in 2001 was not significant.

 

STATEMENT OF CASH FLOWS

 

The Company considers short-term, highly liquid investments to be cash equivalents. The impact of fluctuating foreign currencies on cash and equivalents was not material.

 


OTHER OPERATING EXPENSE, NET

 

IN MILLIONS


   2003

    2002

    2001

 

Gains on sales of restaurant businesses

   $ (54.5 )   $ (113.6 )   $ (112.4 )

Equity in earnings of unconsolidated affiliates

     (36.9 )     (24.1 )     (62.7 )

Other expense

     215.4       117.8       54.9  

Special charges:

                        

Restructuring

     272.1       266.9       200.0  

Restaurant closings/asset impairment

     135.5       402.4       135.2  

Other

             183.9       42.4  
    


 


 


Total special charges

     407.6       853.2       377.6  
    


 


 


Other operating expense, net

   $ 531.6     $ 833.3     $ 257.4  
    


 


 


 

OTHER EXPENSE

 

Other expense primarily consists of gains or losses on excess property dispositions and provisions for uncollectible receivables.

 

RESTRUCTURING

 

In 2003, the $272.1 million of charges consisted of: $237.0 million related to the loss on the sale of Donatos Pizzeria, the closing of Donatos and Boston Market restaurants outside the U.S. and the exit of a domestic joint venture with Fazoli’s; and $35.1 million related to the revitalization plan actions of McDonald’s Japan, including head-count reductions, the closing of Pret A Manger stores in Japan, and the early termination of a long-term management services agreement.

 

32    McDonald’s Corporation


In 2002, the $266.9 million of net charges consisted of: $201.4 million related to the anticipated transfer of ownership in five countries in the Middle East and Latin America to developmental licensees and ceasing operations in two countries in Latin America; $80.5 million primarily related to eliminating approximately 600 positions (about half of which were in the U.S. and half of which were in international markets), reallocating resources and consolidating certain home office facilities to control costs; and a $15.0 million favorable adjustment to the 2001 restructuring charge due to lower employee-related costs than originally anticipated.

 

In 2001, the $200.0 million of restructuring charges related to initiatives designed to improve the restaurant experience, primarily in the U.S. These initiatives included streamlining operations by reducing the number of regions and divisions, enabling the Company to combine staff functions and improve efficiency. In connection with these initiatives, the Company eliminated approximately 850 positions (700 in the U.S., primarily in the divisions and regions, and 150 in international markets).

 

RESTAURANT CLOSINGS/ASSET IMPAIRMENT

 

In 2003, the $135.5 million of net charges consisted of: $147.7 million primarily related to asset/goodwill impairment, mainly in Latin America; $29.6 million for about 50 restaurant closings associated with strategic actions in Latin America; and a $41.8 million favorable adjustment to the 2002 charge for restaurant closings, primarily due to about 85 fewer closings than originally anticipated.

 

In 2002, the $402.4 million of charges consisted of: $302.3 million related to management’s decision to close 751 underperforming restaurants primarily in the U.S. and Japan; and $100.1 million primarily related to the impairment of assets for certain existing restaurants in Europe and Latin America.

 

In 2001, the $135.2 million of charges consisted of: $91.2 million related to the closing of 163 underperforming restaurants in international markets; a $24.0 million asset impairment charge in Turkey; and $20.0 million related to the disposition of Aroma Café in the U.K.

 

OTHER

 

In 2002, the $183.9 million of charges consisted of: $170.0 million primarily related to the write-off of software development costs as a result of management’s decision to terminate a long-term technology project; and $13.9 million related to the write-off of receivables and inventory in Venezuela as a result of the temporary closure of all McDonald’s restaurants due to a national strike.

 

In 2001, the $42.4 million of charges consisted of: $17.4 million primarily related to the write-off of certain technology costs; and $25.0 million primarily related to the unrecoverable costs incurred in connection with the theft of winning game pieces from the Company’s Monopoly and certain other promotional games over an extended period of time, and the related termination of the supplier of the game pieces. Fifty individuals (none of whom were Company employees) were convicted of conspiracy and/or mail fraud charges.

 

The following table presents the activity included in accrued restructuring and restaurant closing costs in the Consolidated balance sheet.

 

    2001 activity

    Liability at
Dec 31,
2001


  2002 activity

    Liability at
Dec 31,
2002


  2003 activity

    Liability at
Dec 31,
2003


IN MILLIONS


  Provision

  Cash

    Noncash

      Provision

  Cash

    Noncash

      Provision

    Cash

    Noncash

   

Restructuring:

                                                                                     

Asset write-offs

  $ 10.0           $ (10.0 )     —     $ 141.7           $ (141.7 )     —     $ 249.5             $ (249.5 )     —  

Employee-related costs

    114.4   $ (34.6 )           $ 79.8     40.9   $ (48.4 )           $ 72.3           $ (34.0 )           $ 38.3

Lease termination and other

    75.6     (29.4 )             46.2     84.3     (27.2 )             103.3     22.6       (47.1 )     (35.1 )     43.7
   

 


 


 

 

 


 


 

 


 


 


 

      200.0     (64.0 )     (10.0 )     126.0     266.9     (75.6 )     (141.7 )     175.6     272.1       (81.1 )     (284.6 )     82.0
   

 


 


 

 

 


 


 

 


 


 


 

Restaurant closings/asset impairment:

                                                                                     

Asset write-offs

    119.0             (119.0 )     —       282.3             (282.3 )     —       144.4               (144.4 )     —  

Lease termination and other

    16.2     (5.1 )             11.1     120.1     (2.8 )             128.4     (8.9 )     (85.8 )             33.7
   

 


 


 

 

 


 


 

 


 


 


 

      135.2     (5.1 )     (119.0 )     11.1     402.4     (2.8 )     (282.3 )     128.4     135.5       (85.8 )     (144.4 )     33.7
   

 


 


 

 

 


 


 

 


 


 


 

Other:

                                                                                     

Asset write-offs

    17.4             (17.4 )     —       164.4             (164.4 )     —                               —  

Other

    25.0     (17.9 )             7.1     19.5     (2.1 )             24.5             (24.5 )             —  
   

 


 


 

 

 


 


 

 


 


 


 

      42.4     (17.9 )     (17.4 )     7.1     183.9     (2.1 )     (164.4 )     24.5             (24.5 )             —  
   

 


 


 

 

 


 


 

 


 


 


 

Total accrued restructuring and restaurant closing costs

  $ 377.6   $ (87.0 )   $ (146.4 )   $ 144.2   $ 853.2   $ (80.5 )   $ (588.4 )   $ 328.5   $ 407.6     $ (191.4 )   $ (429.0 )   $ 115.7