MANAGEMENT'S VIEW OF THE BUSINESS In analyzing business trends, management reviews results on a constant currency basis and considers a variety of performance and financial measures which are considered to be non-GAAP, including comparable sales and comparable guest count growth, Systemwide sales growth, return on incremental invested capital ("ROIIC"), free cash flow and free cash flow conversion rate, as described below. Management believes these measures are important in understanding the financial performance of the Company. • 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 excluding
the effect of foreign currency translation, impairment and other strategic
charges and gains, as well as income tax provision adjustments related to the
Tax Cuts and Jobs Act of 2017 ("Tax Act"), and bases incentive compensation
plans on these results, because the Company believes this better represents
underlying business trends.
• Comparable sales represent sales at all restaurants, whether operated by the
Company or by franchisees, in operation at least thirteen months including
those temporarily closed. Some of the reasons restaurants may be temporarily
closed include reimaging or remodeling, rebuilding, road construction and
natural disasters. Comparable sales exclude the impact of currency
translation, and, since 2017, also exclude sales from
hyper-inflation. Management generally identifies hyper-inflationary markets
as those markets whose cumulative inflation rate over a three-year period
exceeds 100%. Comparable sales are driven by changes in guest counts and
average check, which is affected by changes in pricing and product mix. The
goal is to achieve a relatively balanced contribution from both guest counts
and average check.
• Comparable guest counts represent the number of transactions at all
restaurants, whether operated by the Company or by franchisees, in operation
at least thirteen months including those temporarily closed.
• Systemwide sales include sales at all restaurants, whether operated by the
Company or by franchisees. While franchised sales are not recorded as
revenues by the Company, management believes the information is important in
understanding the Company's financial performance because these sales are the
basis on which the Company calculates and records franchised revenues and are
indicative of the financial health of the franchisee base. The Company's
revenues consist of sales by Company-operated restaurants and fees from
franchised restaurants operated by conventional franchisees, developmental
licensees and affiliates.
• ROIIC is a measure reviewed by management over one-year and three-year time
periods to evaluate the overall profitability of the markets, the
effectiveness of capital deployed and the future allocation of capital. The
return is calculated by dividing the change in operating income plus
depreciation and amortization (numerator) by the cash used for investing
activities (denominator), primarily capital expenditures. The calculation
uses a constant average foreign exchange rate over the periods included in
the calculation.
• Free cash flow, defined as cash provided by operations less capital
expenditures, and free cash flow conversion rate, defined as free cash flow
divided by net income, are measures reviewed by management in order to
evaluate the Company's ability to convert net profits into cash resources,
after reinvesting in the core business, that can be used to pursue
opportunities to enhance shareholder value.
2019 FINANCIAL PERFORMANCE In 2019, global comparable sales increased 5.9% and global comparable guest counts increased 1.0%, reflecting the continued execution against the Velocity Growth Plan.
• Comparable sales in the
decreased 1.9%. The increase in comparable sales reflected strong sales of
our iconic core products driven by promotional activity and the continued
positive impact from our Experience of the Future ("EOTF") deployment, as
well as menu price increases.
• Comparable sales in the International Operated segment increased 6.1% and
comparable guest counts increased 3.5%, reflecting positive results across
all markets, primarily driven by the
• Comparable sales in the International Developmental Licensed segment
increased 7.2% and comparable guest counts increased 2.2%, reflecting
positive sales performance across all geographic regions.
In addition to improved comparable sales and guest count performance, the Company achieved the following financial results in 2019: • Consolidated revenues were relatively flat with the prior year (increased 3%
in constant currencies) at
• Systemwide sales increased 4% (7% in constant currencies) to
• Consolidated operating income increased 3% (6% in constant currencies).
Excluding the impact of current year and prior year impairment and strategic
charges, operating income increased 1% (4% in constant currencies). Refer to
the Operating Income section on page 15 for additional details.
• Operating margin, defined as operating income as a percent of total revenues,
increased from 42.0% in 2018 to 43.0% in 2019. Excluding the items referenced
in the previous bullet point, operating margin increased from 43.1% in 2018 to 43.4% in 2019.McDonald's Corporation 2019 Annual Report 6
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• Diluted earnings per share of
Refer to the Net Income and Diluted Earnings Per Share section on page 10 for
additional details.
• Cash provided by operations was
• Capital expenditures of
existing restaurants and, to a lesser extent, to new restaurant openings.
• Free cash flow was
• Across the System, about 1,200 restaurants (including those in our
developmental licensee and affiliated markets) were opened.
• One-year ROIIC was 22.8% and three-year ROIIC was 40.6% for the period ended
the Company's strategic refranchising initiatives, three-year ROIIC was 24.6%
(see reconciliation in Exhibit 12).
• The Company increased its quarterly cash dividend per share by 8% to
for the fourth quarter, equivalent to an annual dividend of
• The Company returned
and dividends for the year, marking successful achievement of the Company's
targeted return of
STRATEGIC DIRECTION The strength of the alignment among the Company, its franchisees and suppliers is key toMcDonald's long-term success. By leveraging the System,McDonald's is able to identify, implement and scale ideas that meet customers' changing needs and preferences.McDonald's continually builds on its competitive advantages of System alignment and geographic diversification to deliver consistent, yet locally-relevant restaurant experiences to customers as an integral part of their communities. CUSTOMER-CENTRIC GROWTH STRATEGY The Velocity Growth Plan, the Company's customer-centric strategy, is rooted in extensive customer research and insights, along with a deep understanding of the key drivers of the business. The Plan is designed to drive sustainable comparable sales and guest count growth, reliable long-term measures of the Company's strength that are vital to growing shareholder value. In 2019, execution of the Plan drove further broad-based growth around the globe. In 2020, the Company will continue to focus on elevating the customer experience through improved restaurant execution and creating excitement around our food and value offerings, while continuing to leverage technology to enable greater convenience and customer personalization. The Company continues to target the opportunity at the core of its business - its food, value and customer experience. The strategy is built on the following three pillars, all focusing on building a betterMcDonald's :
• Retaining existing customers - focusing on areas where it already has a
strong foothold in the IEO category, including family occasions and food-led
breakfast.
• Regaining customers who visit less often - recommitting to areas of historic
strength, namely food taste and quality, convenience and speed, experience
and value.
• Converting casual to committed customers - building stronger relationships
with customers so they visit more often, by elevating and leveraging the
McCafé coffee brand and enhancing snack and treat offerings.
The Company continues to scale and optimize the Plan through the following growth accelerators: • Experience of the Future. The Company is building upon its investments in
EOTF, focusing on restaurant modernization in order to transform the
restaurant service experience and enhance our brand in the eyes of our
customers. The modernization efforts are designed to provide a better
customer experience, leading to increased frequency of customer visits and
higher average check. As of the end of 2019, EOTF is deployed in over half of
the restaurants in our global system, with most of the major markets
substantially complete. In 2019, the
to EOTF, resulting in about 70% of the
2020, the Company will further deploy EOTF around the globe, including
converting about 1,800 of the remaining restaurants in the
• Digital. The Company is improving its existing service model with customers
through technology. Digital technology is transforming the retail industry,
and the Company is using it to transform
accelerated pace. By evolving the technology platform, the Company is
expanding choices for how customers order, pay and are served their food. The
added functionality of the Company's global mobile app, self-order kiosks,
and other technologies enable greater convenience for the customer on their
terms. In 2019, the Company built on its digital foundation, acquiring
Dynamic Yield, a leader in personalization and decision logic technology. The
Company has implemented this technology via outdoor digital menu boards in
over 11,000
and producing sales growth through higher average check. This technology is
also deployed in nearly all drive-thrus in
deploy across further international markets beginning in 2020. The Company
continued to expand its technological capabilities via the acquisition of
Apprente, an early-stage leader in conversational interface technology. This
technology is expected to provide more efficient and accurate ordering in the
drive-thru. In 2020, the Company will continue to utilize more personalized
digital initiatives to engage customers, grow awareness and adoption of digital offerings, and support our menu offerings.McDonald's Corporation 2019 Annual Report 7 --------------------------------------------------------------------------------
• Delivery. The Company continues to build momentum with its delivery platform
as a way of expanding the convenience for its customers. In 2019,
continued to add third-party delivery partners in order to maximize the
System's delivery scale and potential. Across the global system, nearly
25,000 restaurants now offer delivery. Customers are responding positively,
as demonstrated by high satisfaction ratings, strong reorder rates, and
average checks that are generally two times higher than average non-delivery
transactions. Further, in some of our top markets, delivery now represents as
much as 10% of sales in those restaurants offering delivery. Consequently,
Systemwide sales in 2019, up from
great runway ahead of us to drive awareness and trial of delivery, and are
focusing on efforts to encourage frequency and retention in 2020 and beyond.
The Plan is a global strategy that is tailored at a market level to allow for the best customer experience and most convenience for our valued customers. While the Plan provides a consistent framework on how to retain, regain, and convert customers, the execution varies across the globe. TheU.S. , for example, remains centered on returning to guest count growth by focusing on running better restaurant operations, introducing new menu items and offering compelling value. In addition, we will continue transforming the customer experience through aggressive execution of the growth accelerators of EOTF, digital and delivery. In 2020, the markets around the world will continue to make progress on the three pillars of the Plan and its growth accelerators, focusing on food, value and customer convenience. Our Plan also includes the Company further embedding actions in response to certain social and environmental issues into the core of our business. As one of the world's largest restaurant companies, our approach highlights our commitment to global actions that are consistent with our strategic priorities and provides an opportunity to collaborate with our franchisees and suppliers to drive meaningful progress. We recognize that our success in advancing these initiatives will be demonstrated as customers continue to feel good about visitingMcDonald's restaurants and eating our food. While we are working to address many challenges facing society today, we are elevating global action where we believe we can make the greatest difference in driving industry-wide change. Our priorities reflect the social and environmental impacts of our food and our business. Highlights include science-based targets for greenhouse gas emissions reductions and climate action, advancing sustainable practices in beef production with suppliers and producers, driving innovative solutions for our packaging and recycling efforts, and ongoing commitments to support families and provide opportunities for youth in our communities. In 2019, for example, we made progress toward our 2030 climate action target with the addition of significant investments in renewable energy projects in theU.S. ; we achieved our goal of 100% sustainably sourced McCafé coffee forU.S. restaurants; and we continued to make a difference for families through innovation in our food offerings, reading programs and support forRonald McDonald House Charities . The Company is confident, that under the Plan, we will continue to improve the taste of our delicious food, enhance convenience and service through running great restaurants, offer compelling value, and heighten the trust consumers place in our brand, which we believe will enable us to deliver long-term sustainable growth.McDonald's Corporation 2019 Annual Report 8
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OUTLOOK
2020 Outlook The following information is provided to assist in forecasting the Company's future results. • Changes in Systemwide sales are driven by comparable sales, net restaurant
unit expansion, and the potential impacts of hyper-inflation. The Company
expects net restaurant additions to add approximately 1.5 percentage points
to 2020 Systemwide sales growth (in constant currencies).
• The Company expects full year 2020 selling, general and administrative
expenses to increase about 5% to 7% in constant currencies as the Company
invests in technology and research & development, and incurs costs related to
the
quarter 2020.
• Based on current interest and foreign currency exchange rates, the Company
expects interest expense for the full year 2020 to increase about 4% to 6%
due primarily to higher average debt balances.
• A significant part of the Company's operating income is generated outside the
Accordingly, earnings are affected by changes in foreign currency exchange
rates, particularly the Euro, British Pound, Australian Dollar and Canadian
Dollar. Collectively, these currencies represent approximately 80% of the
Company's operating income outside the
moved by 10% in the same direction, the Company's annual diluted earnings per
share would change by about
• The Company expects the effective income tax rate for the full year 2020 to
be in the 23% to 25% range. Some volatility may result in a quarterly tax
rate outside of the annual range.
• The Company expects capital expenditures for 2020 to be approximately
billion. About
of which is allocated to approximately 1,800 EOTF projects. Globally, we
expect to open roughly 1,400 restaurants. We will spend approximately
million in the
restaurants and our developmental licensees and affiliates will contribute
capital towards the remaining 1,000 restaurant openings in the International
Developmental Licensed segment. The Company expects about 1,000 net
restaurant additions in 2020.
Long-Term Outlook • Over the long-term, the Company expects to achieve the following average
annual (constant currency) financial targets:
• Systemwide sales growth of 3% to 5%;
• Operating margin in the mid-40% range;
• Earnings per share growth in the high-single digits; and
• Return on incremental invested capital in the mid-20% range.
McDonald's Corporation 2019 Annual Report 9
-------------------------------------------------------------------------------- CONSOLIDATED OPERATING RESULTS Operating results 2019 2018 2017 Dollars and shares in millions, Increase/ Increase/ except per share data Amount (decrease) Amount (decrease) Amount Revenues Sales by Company-operated restaurants$ 9,421 (6 %)$ 10,013 (21 %)$ 12,719 Revenues from franchised restaurants 11,656 6 11,012 9 10,101 Total revenues 21,077 0 21,025 (8 ) 22,820 Operating costs and expenses Company-operated restaurant expenses 7,761 (6 ) 8,266 (21 ) 10,410 Franchised restaurants-occupancy expenses 2,201 12 1,973 10 1,789 Selling, general & administrative expenses 2,229 1 2,200 (1 ) 2,231 Other operating (income) expense, net (184 ) 22 (237 ) 80 (1,163 ) Total operating costs and expenses 12,007 (2 ) 12,202 (8 ) 13,267 Operating income 9,070 3 8,823 (8 ) 9,553 Interest expense 1,122 14 981 7 922 Nonoperating (income) expense, net (70 ) n/m 26 (56 ) 58 Income before provision for income taxes 8,018 3 7,816 (9 ) 8,573 Provision for income taxes 1,993 5 1,892 (44 ) 3,381 Net income$ 6,025 2 %$ 5,924 14 %$ 5,192 Earnings per common share-diluted$ 7.88 5 %$ 7.54 18 %$ 6.37 Weighted-average common shares outstanding- diluted 764.9 (3 %) 785.6 (4 %) 815.5 n/m Not meaningful IMPACT OF FOREIGN CURRENCY TRANSLATION ON REPORTED RESULTS While changes in foreign currency exchange rates affect reported results,McDonald's mitigates exposures, where practical, by purchasing goods and services in local currencies, financing in local currencies and hedging certain foreign-denominated cash flows. In 2019, results reflected the weakening of the Euro and most other major currencies. In 2018, results reflected the stronger Euro and British Pound. In 2017, results reflected the stronger Euro, offset by the weaker British Pound. Impact of foreign currency translation on reported results Currency translation Reported amount benefit/(cost) In millions, except per share data 2019 2018 2017 2019 2018 2017 Revenues$ 21,077 $ 21,025 $ 22,820 $ (606 ) $ 123 $ 186 Company-operated margins 1,660 1,747 2,309 (51 ) 4 17 Franchised margins 9,455 9,039 8,312 (256 ) 57 25 Selling, general & administrative expenses 2,229 2,200 2,231 29 (13 ) (10 ) Operating income 9,070 8,823 9,553 (280 ) 56 28 Net income 6,025 5,924 5,192 (165 ) 33 2
Earnings per common share-diluted 7.88 7.54 6.37
(0.21 ) 0.04 - NET INCOME AND DILUTED EARNINGS PER COMMON SHARE In 2019, net income increased 2% (4% in constant currencies) to$6.0 billion and diluted earnings per common share increased 5% (7% in constant currencies) to$7.88 . Foreign currency translation had a negative impact of$0.21 on diluted earnings per share. In 2018, net income increased 14% (13% in constant currencies) to$5.9 billion and diluted earnings per common share increased 18% (18% in constant currencies) to$7.54 . Foreign currency translation had a positive impact of$0.04 on diluted earnings per share. Results in 2019 reflected stronger operating performance primarily due to an increase in sales-driven franchised margin dollars, partly offset by lower gains on sales of restaurant businesses (mostly in theU.S. ) and higher G&A spend. Results in 2018 reflected a lower effective tax rate, and stronger operating performance due to an increase in sales-driven franchised margin dollars, partly offset by lower Company-operated margin dollars due to the impact of refranchising.McDonald's Corporation 2019 Annual Report 10
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Outlined below is additional information for the full year 2019, 2018, and 2017: Diluted Earnings Per Common Share Reconciliation
Increase/(decrease) excluding currency Amount Increase/(decrease) translation 2019 2018 2017 2019 2018 2019 2018 GAAP earnings per share-diluted$ 7.88 $ 7.54 $ 6.37 5 % 18 % 7 % 18 % Income tax (benefit) cost, net (0.11 ) 0.10 0.82 Strategic charges 0.07 0.26 (0.53 )
Non-GAAP earnings per share-diluted
(1 )% 19 % 2 % 18 % Included in the 2019 results were: •$84 million , or$0.11 per share, of income tax benefit due to new regulations issued in the fourth quarter 2019 related to the Tax Act; and
•
related to impairment associated with the purchase of our joint venture
partner's interest in the India Delhi market, partly offset by gains on
the sales of property at the former Corporate headquarters.
Included in the 2018 results were:
•
final 2018 adjustments to the provisional amounts recorded in December
2017 under the Tax Act;
•
•
Included in the 2017 results were:
•
share; and
• a pre-tax gain of
in
and impairment charges in connection with the Company's global G&A and refranchising initiatives, for a net benefit of$0.53 per share. Excluding the above 2019 and 2018 items, 2019 net income decreased 3% (1% in constant currencies), and diluted earnings per share decreased 1% (increased 2% in constant currencies). Excluding items impacting 2018 and 2017, 2018 net income increased 14% (14% in constant currencies), and diluted earnings per share increased 19% (18% in constant currencies). The Company repurchased 25.0 million shares of its stock for$5.0 billion in 2019 and 32.2 million shares of its stock for$5.2 billion in 2018, driving reductions in weighted-average shares outstanding on a diluted basis in both periods, which positively benefited earnings per share.
REVENUES
The Company's revenues consist of sales by Company-operated restaurants and fees from franchised restaurants operated by conventional franchisees, developmental licensees and affiliates. Revenues from conventional franchised restaurants include rent and royalties based on a percent of sales with minimum rent payments, and initial fees. Revenues from restaurants licensed to developmental licensees and affiliates include a royalty based on a percent of sales, and generally include initial fees. Initial fees are recognized evenly over the franchise term. Franchised restaurants represent 93% ofMcDonald's restaurants worldwide atDecember 31, 2019 . The Company's current mix of Company-owned and franchised restaurants enables the Company to generate stable and predictable revenue and cash flow streams. Refranchising to a greater percentage of franchised restaurants may negatively impact consolidated revenues as Company-operated sales are replaced by franchised revenues, where the Company receives rent and/or royalty revenue based on a percent of sales. In 2019, revenues were relatively flat with the prior year (increased 3% in constant currencies). The constant currency increase was primarily due to strong comparable sales, partly offset by the impact of refranchising. In 2018, revenues decreased 8% (8% in constant currencies), reflecting the Company's strategic refranchising initiatives, partly offset by positive comparable sales.McDonald's Corporation 2019 Annual Report 11
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Revenues Increase/(decrease) excluding currency Amount Increase/(decrease) translation Dollars in millions 2019 2018 2017 2019 2018 2019 2018 Company-operated sales: U.S.$ 2,490 $ 2,665 $ 3,260
(7 %) (18 %) (7 %) (18 %) International Operated Markets
6,334 6,668 6,845 (5 ) (3 ) (1 ) (3 ) International Developmental Licensed Markets & Corporate 597 680 2,614 (12 ) (74 ) * (7 ) (75 ) * Total$ 9,421 $ 10,013 $ 12,719 (6 %) (21 %) (3 %) (22 %) Franchised revenues: U.S.$ 5,353 $ 5,001 $ 4,746 7 % 5 % 7 % 5 % International Operated Markets 5,064 4,839 4,271 5 13 10 11 International Developmental Licensed Markets & Corporate 1,239 1,172 1,084 6 8 10 11 Total$ 11,656 $ 11,012 $ 10,101 6 % 9 % 9 % 8 % Total revenues: U.S.$ 7,843 $ 7,666 $ 8,006 2 % (4 %) 2 % (4 %) International Operated Markets 11,398 11,507 11,116 (1 ) 4 4 2 International Developmental Licensed Markets & Corporate 1,836 1,852 3,698 (1 ) (50 ) * 4 (50 ) * Total$ 21,077 $ 21,025 $ 22,820 0 % (8 %) 3 % (8 %) * Reflects the impact of refranchising the Company's businesses inChina andHong Kong in 2017. •U.S. : Revenues in 2019 and 2018 reflected positive comparable sales. The
impact of refranchising partly offset these benefits in 2019 and more than
offset these benefits in 2018.
• International Operated Markets: In 2019 and 2018, the constant currency
increase in revenues reflected positive comparable sales across all markets,
partly offset by the impact of refranchising.
The following tables present comparable sales, comparable guest counts and Systemwide sales increases/(decreases): Comparable sales and guest count increases/(decreases)
2019 2018 2017 Guest Guest Guest Sales Counts Sales Counts Sales Counts U.S. 5.0 % (1.9 %) 2.5 % (2.2 %) 3.6 % 1.0 % International Operated Markets 6.1 3.5 6.1 2.8 5.6 2.7 International Developmental Licensed Markets & Corporate** 7.2 2.2 5.6 1.0 8.0 2.5 Total** 5.9 % 1.0 % 4.5 % 0.2 % 5.3 % 1.9 %
** The Company excludes sales from markets identified as hyper-inflationary
(currently, only
Systemwide sales increases/(decreases)***
Increase/(decrease) excluding currency translation 2019 2018 2019 2018 U.S. 5 % 2 % 5 % 2 % International Operated Markets 3 10 8 8
International Developmental Licensed Markets & Corporate 5 6
10 9 Total 4 % 6 % 7 % 6 % *** Unlike comparable sales, the Company has not excluded hyper-inflationary market results (currently, onlyVenezuela ) from Systemwide sales as these sales are the basis on which the Company calculates and records revenues. The difference between comparable sales growth rates and Systemwide sales growth rates are due to both restaurant expansion and the hyper-inflationary impact.McDonald's Corporation 2019 Annual Report 12
-------------------------------------------------------------------------------- Franchised sales are not recorded as revenues by the Company, but are the basis on which the Company calculates and records franchised revenues and are indicative of the financial health of the franchisee base. The following table presents franchised sales and the related increases/(decreases): Franchised sales Increase/(decrease) excluding currency Amount Increase/(decrease) translation Dollars in millions 2019 2018 2017 2019 2018 2019 2018 U.S.$ 37,923 $ 35,860 $ 34,379 6 % 4 % 6 % 4 % International Operated Markets 28,853 27,557 24,386 5 13 10 11 International Developmental Licensed Markets & Corporate 23,981 22,717 19,426 6 17 * 10 20 * Total$ 90,757 $ 86,134 $ 78,191 5 % 10 % 8 % 10 % Ownership type Conventional franchised$ 66,415 $ 63,251 $ 59,151 5 % 7 % 7 % 6 % Developmental licensed 14,392 13,519 12,546 6 8 13 13 Foreign affiliated 9,950 9,364 6,494 6 44 * 7 42 * Total$ 90,757 $ 86,134 $ 78,191 5 % 10 % 8 % 10 %
* Reflects the impact of refranchising the Company's businesses in
FRANCHISED MARGINS Franchised margin dollars represent revenues from franchised restaurants less the Company's costs associated with those restaurants, primarily occupancy costs (rent and depreciation). Franchised margin dollars represented about 85% of the combined restaurant margins in 2019 and 2018, and about 80% in 2017. In 2019, franchised margin dollars increased$416 million or 5% (7% in constant currencies). In 2018, franchised margin dollars increased$727 million or 9% (8% in constant currencies). For both 2019 and 2018, the increases were due to positive comparable sales performance across all segments, as well as expansion and the impact of refranchising. Franchised margins Increase/(decrease) excluding Amount % of Revenue Amount % of Revenue Amount % of Revenue Increase/(decrease) currency translation Dollars in millions 2019 2018 2017 2019 2018 2019 2018 U.S.$ 4,227 79.0 %$ 4,070 81.4 %$ 3,913 82.4 % 4 % 4 % 4 % 4 % International Operated Markets 4,018 79.3 3,829 79.1 3,365 78.8 5 14 10 11 International Developmental 1,210 97.7 1,140 97.3 1,034 95.4 6 10 11 13 Licensed Markets & Corporate Total$ 9,455 81.1 %$ 9,039 82.1 %$ 8,312 82.3 % 5 % 9 % 7 % 8 % The adoption of Accounting Standard Codification ("ASC") Topic 842, "Leases" ("ASC 842") had no impact on franchised margin dollars, but had a negative impact on the Company's franchised margin percent for 2019 of approximately 1.3% in theU.S. and 0.7% on a consolidated basis. ASC 842 clarified the presentation of sub-lease income and lease expense, requiring the straight-line impact of fixed rent escalations to be presented on a gross basis in lease income and lease expense. •U.S. : In 2019 and 2018, the decreases in the franchised margin percents were
primarily due to higher depreciation costs related to investments in EOTF,
partly offset by the benefit from positive comparable sales. 2019 also
reflected the impact of the new lease standard.
• International Operated Markets: In 2019 and 2018, the increases in the
franchised margin percent primarily reflected the benefit from strong comparable sales.McDonald's Corporation 2019 Annual Report 13 -------------------------------------------------------------------------------- COMPANY-OPERATED MARGINS Company-operated margin dollars represent sales by Company-operated restaurants less the operating costs of these restaurants. In 2019, Company-operated margin dollars decreased$87 million or 5% (2% in constant currencies). In 2018, Company-operated margin dollars decreased$562 million or 24% (25% in constant currencies) primarily reflecting the Company's sale of its businesses inChina andHong Kong in 2017. Company-operated margins Increase/(decrease) excluding currency Amount % of Revenue Amount % of Revenue Amount % of Revenue Increase/(decrease) translation Dollars in millions 2019 2018 2017 2019 2018 2019 2018 U.S.$ 388 15.6 %$ 397 14.9 %$ 523 16.0 % (2 %) (24 %) (2 %) (24 %) International Operated Markets 1,266 20.0 1,327 19.9 1,336 19.5 (5 ) (1 ) (1 ) (1 ) International Developmental n/m n/m n/m n/m n/m n/m n/m n/m n/m n/m Licensed Markets & Corporate Total$ 1,660 17.6 %$ 1,747 17.4 %$ 2,309 18.2 % (5 %) (24 %) (2 %) (25 %)
n/m Not meaningful
•
reflected the benefit from positive comparable sales, partly offset by higher
commodity costs, wages and depreciation expense associated with EOTF
deployment. In 2018, the Company-operated margin percent decreased,
reflecting the impact of accelerated deployment of EOTF (including the
related decrease in labor productivity and higher depreciation expense), and
higher wages and commodity costs, which more than offset the benefit from
positive comparable sales and refranchising.
• International Operated Markets: In 2019 and 2018, the increase in the
Company-operated margin percent was primarily due to strong comparable sales
partly offset by higher labor and occupancy & other costs.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES Consolidated selling, general and administrative expenses increased 1% (3% in constant currencies) in 2019 and decreased 1% (2% in constant currencies) in 2018. The results for 2019 and 2018 reflected investments in technology and research & development. The decrease in 2018 also reflected lower employee-related costs, partly offset by costs related to the 2018Worldwide Owner/Operator Convention and sponsorship of the 2018 Winter Olympics. Selling, general & administrative expenses Increase/(decrease) excluding currency Amount Increase/(decrease) translation Dollars in millions 2019 2018 2017 2019 2018 2019 2018 U.S.$ 587 $ 591 $ 624 (1 %) (5 %) (1 %) (5 %)
International Operated Markets 629 641 654
(2 ) (2 ) 3 (4 ) International Developmental Licensed Markets & Corporate(1) 1,013 968 953 5 2 5 2 Total Selling, General & Administrative Expenses$ 2,229 $ 2,200 $ 2,231 1 % (1 %) 3 % (2 %) Less: Incentive-Based Compensation(2) 289 284 336 2 % (16 %) 3 % (16 %) Total Excluding Incentive-Based Compensation$ 1,940 $ 1,916 $ 1,895 1 % 1 % 3 % 1 %
(1) Included in International Developmental Licensed Markets & Corporate are home
office support costs in areas such as facilities, finance, human resources,
information technology and R&D, legal, marketing, restaurant operations,
supply chain and training.
(2) Includes all cash incentives and share-based compensation expense.
Selling, general and administrative expenses as a percent of Systemwide sales was 2.2% in 2019, 2.3% in 2018 and 2.5% in 2017. Management believes that analyzing selling, general and administrative expenses as a percent of Systemwide sales is meaningful because these costs are incurred to support the overallMcDonald's business.McDonald's Corporation 2019 Annual Report 14
-------------------------------------------------------------------------------- OTHER OPERATING (INCOME) EXPENSE, NET Other operating (income) expense, net In millions 2019 2018
2017
Gains on sales of restaurant businesses$ (127 ) $ (304 ) $ (295 ) Equity in earnings of unconsolidated affiliates (154 ) (152 ) (184 ) Asset dispositions and other (income) expense, net 23 (13 )
19
Impairment and other charges (gains), net 74 232 (703 ) Total$ (184 ) $ (237 ) $ (1,163 )
• Gains on sales of restaurant businesses
In 2019, gains on sales of restaurant businesses decreased primarily due to
fewer restaurant sales in the
In 2019, impairment and other charges (gains), net primarily reflected$99.4 million of impairment associated with the purchase of our joint venture partner's interest in the India Delhi market. Impairment was recorded to reflect the write-down of net assets to fair value in accordance with accounting rules. This was partly offset by$20.3 million of gains on the sales of property at the former Corporate headquarters which were impaired in 2015 based on estimated fair values. The results in 2018 reflected$140 million of impairment charges due to the Company's assessment of the recoverability of long-lived assets as well as the strategic restructuring charge in theU.S. of$85.0 million . The results in 2017 reflected a gain on the Company's sale of its businesses inChina andHong Kong of$850 million , partly offset by$150 million of restructuring and impairment charges. OPERATING INCOME Operating income Increase/(decrease) excluding Amount Increase/(decrease) currency translation Dollars in millions 2019 2018 2017 2019 2018 2019 2018 U.S.$ 4,069 $ 4,016 $ 4,023 1 % 0 % 1 % 0 %
International Operated Markets 4,789 4,643 4,173
3 11 8 9 International Developmental Licensed Markets & Corporate 212 164 1,357 29 (88 ) 59 (86 ) Total$ 9,070 $ 8,823 $ 9,553 3 % (8 %) 6 % (8 %)
• Operating Income: Results for 2019 included
strategic charges. Results for 2018 included
charges and
included a gain on the Company's sale of its businesses in
Kong of
impairment charges. Excluding these current year and prior year items, operating income increased 1% (4% in constant currencies) for 2019 and increased 2% (2% in constant currencies) for 2018.
•
operating income decreased 1% for 2019 and increased 2% for 2018. 2019 results reflected lower gains on sales of restaurant businesses, partly
offset by higher franchised margin dollars. 2018 results reflected
higher franchised margin dollars and lower G&A costs, partly offset by
lower Company-operated margin dollars.
• International Operated Markets: In 2019 and 2018, the constant currency
operating income increase was primarily due to sales-driven
improvements in franchised margin dollars. 2018 results also reflected
higher gains on sales of restaurant businesses in theU.K. andAustralia compared to 2017.
• Operating margin: Operating margin was 43.0% in 2019, 42.0% in 2018 and 41.9%
in 2017. Excluding the impact of the current and prior year impairment and
strategic charges, as well as the 2017 refranchising gain, operating margin
was 43.4%, 43.1% and 38.8% for the years ended 2019, 2018 and 2017,
respectively.
INTEREST EXPENSE Interest expense increased 14% (16% in constant currencies) and 7% (6% in constant currencies) in 2019 and 2018, respectively. Both periods reflected higher average debt balances. Interest expense in 2019 also reflected the impact of interest incurred on certain Euro denominated deposits due to the current interest rate environment, while 2018 results reflected lower average interest rates.McDonald's Corporation 2019 Annual Report 15
-------------------------------------------------------------------------------- NONOPERATING (INCOME) EXPENSE, NET Nonoperating (income) expense, net In millions 2019 2018 2017 Interest income$ (37 ) $ (4 ) $ (7 )
Foreign currency and hedging activity (48 ) 5 26 Other expense
15 25 39 Total$ (70 ) $ 26 $ 58 Foreign currency and hedging activity includes net gains or losses on certain hedges that reduce the exposure to variability on certain intercompany foreign currency cash flow streams. PROVISION FOR INCOME TAXES In 2019, 2018 and 2017, the reported effective income tax rates were 24.9%, 24.2% and 39.4%, respectively. The effective income tax rate for 2019 reflected$84 million of income tax benefit due to new regulations issued in the fourth quarter 2019 related to the Tax Act. Excluding the income tax benefit, the effective income tax rate was 25.9% for the year 2019. The effective income tax rate for 2018 reflected the final 2018 adjustments to the provisional amounts recorded in 2017 under the Tax Act of$75 million net tax cost. Excluding the 2018 impact of the Tax Act and impairment charges, the effective income tax rate was 22.9% for the year 2018. Excluding these current year and prior year items, the lower effective income tax rate for 2018 primarily reflected a benefit from a change in tax reserves as a result of global audit progression, as well as lower tax costs in 2018 related to ongoing taxes under the Tax Act. Consolidated net deferred tax liabilities included tax assets, net of valuation allowance, of$5.3 billion in 2019 and$2.0 billion in 2018. Substantially all of the net tax assets are expected to be realized in theU.S. and other profitable markets. RECENTLY ISSUED ACCOUNTING STANDARDS Recently issued accounting standards are included on page 39 of this Form 10-K. CASH FLOWS The Company generates significant cash from its operations and has substantial credit availability and capacity to fund operating and discretionary spending such as capital expenditures, debt repayments, dividends and share repurchases. Cash provided by operations totaled$8.1 billion in 2019, an increase of$1.1 billion or 17%. Free cash flow was$5.7 billion in 2019, an increase of$1.5 billion or 36%. The Company's free cash flow conversion rate was 95% in 2019 and 71% in 2018 (see reconciliation in Exhibit 12). Cash provided by operations increased in 2019 compared to 2018 primarily due to a decrease in accounts receivable and lower income tax payments. In 2018, cash provided by operations totaled$7.0 billion , an increase of$1.4 billion or 25% compared with 2017, primarily due to lower tax payments. Cash used for investing activities totaled$3.1 billion in 2019, an increase of$616 million compared with 2018. The increase was primarily due to the Company's strategic acquisitions of a real estate entity, Dynamic Yield and Apprente, partly offset by lower capital expenditures. Cash used for investing activities totaled$2.5 billion in 2018, an increase of$3.0 billion compared with 2017. The increase was primarily due to lower proceeds from the sale of restaurant businesses in 2018 including the comparison to the proceeds received in 2017 associated with the sale of the Company's businesses inChina andHong Kong , as well as higher capital expenditures. Cash used for financing activities totaled$5.0 billion in 2019, a decrease of$955 million compared with 2018, primarily due to net debt activity. Cash used for financing activities totaled$5.9 billion in 2018, an increase of$639 million compared with 2017, primarily due to higher treasury stock purchases. The Company's cash and equivalents balance was$899 million and$866 million at year end 2019 and 2018, respectively. In addition to cash and equivalents on hand and cash provided by operations, the Company can meet short-term funding needs through its continued access to commercial paper borrowings and line of credit agreements. RESTAURANT DEVELOPMENT AND CAPITAL EXPENDITURES In 2019, the Company opened 1,231 restaurants and closed 391 restaurants. In 2018, the Company opened 1,081 restaurants and closed 467 restaurants. Systemwide restaurants at year end 2019 2018
2017
U.S. 13,846 13,914
14,036
International Operated Markets 10,465 10,263
10,098
International Developmental Licensed Markets & Corporate 14,384 13,678
13,107 Total 38,695 37,855 37,241 Approximately 93% of the restaurants at year-end 2019 were franchised, including 95% in theU.S. , 84% in International Operated Markets and 98% in the International Developmental Licensed Markets. Capital expenditures decreased$348 million or 13% in 2019 primarily due to lower reinvestment in existing restaurants, partly offset by an increase in new restaurant openings that required the Company's capital. Capital expenditures increased$888 million or 48% in 2018, primarily due to reinvestment in existing restaurants (including investment in EOTF).McDonald's Corporation 2019 Annual Report 16 --------------------------------------------------------------------------------
Capital expenditures In millions 2019 2018 2017 New restaurants$ 605 $ 488 $ 537 Existing restaurants 1,702 2,111 1,236 Other(1) 87 143 81
Total capital expenditures
$ 47,511 $ 32,811 $ 33,804
(1) Primarily corporate equipment and other office-related expenditures
New restaurant investments in all years were concentrated in markets with strong returns and/or opportunities for long-term growth. Average development costs vary widely by market depending on the types of restaurants built and the real estate and construction costs within each market. These costs, which include land, buildings and equipment, are managed through the use of optimally-sized restaurants, construction and design efficiencies, as well as leveraging the Company's global sourcing network and best practices. Although the Company is not responsible for all costs for every restaurant opened, total development costs for new traditionalMcDonald's restaurants in theU.S. averaged approximately$4.0 million in 2019. The Company owned approximately 55% and 50% of the land for restaurants in its consolidated markets at year-end 2019 and 2018, respectively, and approximately 80% of the buildings for restaurants in its consolidated markets at year-end 2019 and 2018. SHARE REPURCHASES AND DIVIDENDS In 2019, the Company returned approximately$8.6 billion to shareholders through a combination of shares repurchased and dividends paid, marking the achievement of the Company's targeted return of$25 billion for the three-year period ended 2019. Shares repurchased and dividends In millions, except per share data 2019 2018
2017
Number of shares repurchased 25.0 32.2
31.4
Shares outstanding at year end 746 767
794
Dividends declared per share$ 4.73 $ 4.19 $
3.83
3,582 3,256
3,089
Total returned to shareholders$ 8,562 $ 8,503 $
7,740
InJuly 2017 , the Company's Board of Directors authorized the purchase of up to$15 billion of the Company's outstanding stock, with no specified expiration date. In 2019, approximately 25.0 million shares were repurchased for$5.0 billion , bringing total purchases under the program to approximately 74.5 million shares or$12.9 billion . InDecember 2019 , the Company's Board of Directors terminated the 2017 program and replaced it with a new share repurchase program, effectiveJanuary 1, 2020 , that authorized the purchase of up to$15 billion of the Company's outstanding common stock with no specified expiration date. The Company has paid dividends on its common stock for 44 consecutive years and has increased the dividend amount every year. The 2019 full year dividend of$4.73 per share reflects the quarterly dividend paid for each of the first three quarters of$1.16 per share, with an increase to$1.25 per share paid in the fourth quarter. This 8% increase in the quarterly dividend equates to a$5.00 per share annual dividend and reflects the Company's confidence in the ongoing strength and reliability of its cash flow. As in the past, future dividend amounts will be considered after reviewing profitability expectations and financing needs, and will be declared at the discretion of the Company's Board of Directors. FINANCIAL POSITION AND CAPITAL RESOURCES TOTAL ASSETS Total assets increased$14.7 billion or 45% in 2019, primarily due to the addition of the Lease Right-of-Use Asset, Net, which was recorded upon adoption of ASC 842 effectiveJanuary 1, 2019 . Refer to the Lease Accounting section under Recent Accounting Pronouncements on page 39 for additional information on ASC 842. Net property and equipment increased$1.3 billion in 2019, primarily due to capital expenditures, partly offset by depreciation. Net property and equipment and the Lease Right-of-Use Asset, Net represented over 50% and approximately 30%, respectively, of total assets at year-end. Approximately 93% of total assets were in theU.S. and International Operated Markets at year-end 2019. FINANCING 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 atDecember 31, 2019 totaled$34.2 billion , compared with$31.1 billion atDecember 31, 2018 . The net increase in 2019 was primarily due to net long-term issuances of$2.5 billion .McDonald's Corporation 2019 Annual Report 17
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Debt highlights(1)
2019 2018 2017 Fixed-rate debt as a percent of total debt(2,3) 92 % 91 % 89 % Weighted-average annual interest rate of total debt(3) 3.2 3.2 3.3 Foreign currency-denominated debt as a percent of total debt(2) 38 38 42 Total debt as a percent of total capitalization (total debt and total Shareholders' equity)(2) 131
125 112 Cash provided by operations as a percent of total debt(2) 24 22 19
(1) All percentages are as of
interest rate, which is for the year. See reconciliation in Exhibit 12.
(2) Based on debt obligations before the effects of fair value hedging
adjustments and deferred debt costs. These effects are excluded as they have
no impact on the obligation at maturity. See Debt Financing note to the
consolidated financial statements.
(3) Includes the effect of interest rate swaps used to hedge debt.
Standard & Poor's and Moody's currently rate, with a stable outlook, the Company's commercial paper A-2 and P-2, respectively; and its long-term debt BBB+ and Baa1, respectively. To access the debt capital markets, the Company relies on credit-rating agencies to assign short-term and long-term credit ratings. 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. InOctober 2016 , the Company's Board of Directors authorized the borrowing of up to$15.0 billion of funds, of which$1.9 billion remained outstanding as ofDecember 31, 2019 . InDecember 2019 , the Company's Board of Directors terminated the 2016 borrowing authority and authorized a new$15 billion of borrowing capacity with no specified expiration date. These borrowings may include (i) public or private offering of debt securities; (ii) direct borrowing from banks or other financial institutions; and (iii) other forms of indebtedness. In addition to debt securities available through a medium-term notes program registered with theSEC and a Global Medium-Term Notes program, the Company has$3.5 billion available under a committed line of credit agreement as well as authority to issue commercial paper in theU.S. and global markets (see Debt Financing note to the consolidated financial statements). In 2020, the Company plans to issue long-term debt to refinance$2.4 billion of maturing corporate debt. As ofDecember 31, 2019 , the Company's subsidiaries also had$242 million of borrowings outstanding, primarily under uncommitted foreign currency line of credit agreements. The Company uses major capital markets, bank financings and derivatives to meet its financing requirements. 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 swaps and using derivatives. The Company does not hold or issue derivatives for trading purposes. All swaps are over-the-counter instruments. In managing the impact of interest rate changes and foreign currency fluctuations, the Company uses interest rate swaps and finances in the currencies in which assets are denominated. 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 was$12.9 billion and$11.8 billion for the years endedDecember 31, 2019 and 2018, respectively. In addition, where practical, the Company's restaurants purchase goods and services in local currencies resulting in natural hedges. See the Summary of significant accounting policies note to the consolidated financial statements related to financial instruments and hedging activities for additional information regarding the accounting impact and use of derivatives. The Company does not have significant exposure to any individual counterparty and has master agreements that contain netting arrangements. Certain of these agreements also require each party to post collateral if credit ratings fall below, or aggregate exposures exceed, certain contractual limits. AtDecember 31, 2019 , the Company was required to post an immaterial amount of collateral due to negative fair value of certain derivative positions. The Company's counterparties were not required to post collateral on any derivative position, other than on hedges of certain of the Company's supplemental benefit plan liabilities where the counterparties were required to post collateral on their liability positions. The Company's net asset exposure is diversified among a broad basket of currencies. The Company's largest net asset exposures (defined as foreign currency assets less foreign currency liabilities) at year end were as follows: Foreign currency net asset exposures In millions of U.S. Dollars 2019 2018 British Pounds Sterling$ 811 $ 1,840 Canadian Dollars 699684 Russian Ruble 577631 Australian Dollars 5601,499 Polish Zloty 396 340McDonald's Corporation 2019 Annual Report 18
-------------------------------------------------------------------------------- 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 theU.S. Dollar on all financial instruments; however, the analysis did not include the potential impact on revenues, local currency prices or the effect of fluctuating currencies on the Company's anticipated foreign currency royalties and other payments received from the markets. Based on the results of these analyses of the Company's financial instruments, neither a one percentage point adverse change in interest rates from 2019 levels nor a 10% adverse change in foreign currency rates from 2019 levels would materially affect the Company's results of operations, cash flows or the fair value of its financial instruments. LIQUIDITY The Company has significant operations outside theU.S. where we earn approximately 65% of our operating income. A significant portion of these historical earnings have been reinvested in foreign jurisdictions where the Company has made, and will continue to make, substantial investments to support the ongoing development and growth of our international operations. The Company's cash and equivalents held by our foreign subsidiaries totaled approximately$425 million as ofDecember 31, 2019 . Consistent with prior years, we expect existing domestic cash and equivalents, domestic cash flows from operations, issuance of domestic debt, and repatriation of a portion of foreign earnings to continue to be sufficient to fund our domestic operating, investing, and financing activities. We also continue to expect existing foreign cash and equivalents and foreign cash flows from operations to be sufficient to fund our foreign operating, investing and financing activities. In the future, should we require more capital to fund activities in theU.S. than is generated by our domestic operations and is available through the issuance of domestic debt, we could elect to repatriate a greater portion of future periods' earnings from foreign jurisdictions. 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. Minimum rent under franchise arrangements are based on the Company's underlying investment in owned sites and parallel the Company's underlying lease obligations and escalations on properties that are leased. The Company believes that control over the real estate enables it to achieve restaurant performance levels that are amongst the highest in the industry. 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 ofDecember 31, 2019 . Contractual cash outflows Contractual cash inflows Minimum rent under In millions Operating leases (1) Debt obligations (2) franchise arrangements 2020 $ 1,147 $ 59 $ 3,008 2021 1,096 2,132 2,884 2022 1,014 2,250 2,750 2023 933 6,007 2,631 2024 854 2,819 2,541 Thereafter 7,090 21,038 20,510 Total $ 12,134 $ 34,305 $ 34,324
(1) For sites that have lease escalations tied to an index, future minimum
payments reflect the current index adjustments through
addition, future minimum payments exclude option periods that have not yet
been exercised.
(2) The maturities include reclassifications of short-term obligations to
long-term obligations of
line of credit agreement expiring in
include the impact of non-cash fair value hedging adjustments, deferred debt
costs and accrued interest.
In theU.S. , the Company maintains certain supplemental benefit plans that allow participants to (i) make tax-deferred contributions and (ii) receive Company-provided allocations that cannot be made under the qualified benefit plans because of Internal Revenue Service ("IRS") limitations. AtDecember 31, 2019 , total liabilities for the supplemental plans were$435 million . AtDecember 31, 2019 , total liabilities for gross unrecognized tax benefits were$1.4 billion . There are certain purchase commitments that are not recognized in the consolidated financial statements and are primarily related to construction, inventory, energy, marketing and other service related arrangements that occur in the normal course of business. Such commitments are generally shorter term in nature, will be funded from operating cash flows, and are not significant to the Company's overall financial position. The Company also has guaranteed certain other loans totaling approximately$75 million atDecember 31, 2019 . These guarantees are contingent commitments generally issued by the Company to support borrowing arrangements of the System. AtDecember 31, 2019 , there was no carrying value for obligations under these guarantees in the Consolidated Balance Sheet.McDonald's Corporation 2019 Annual Report 19 -------------------------------------------------------------------------------- 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 theU.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. The Company reviews its financial reporting and disclosure practices and accounting policies quarterly to confirm 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 (not to exceed lease term plus options for leased property). 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 accelerated recognition of depreciation and amortization expense or write-offs in future periods. • Leasing Arrangements The Company is the lessee in a significant real estate portfolio, primarily through ground leases (the Company leases the land and generally owns the building) and through improved leases (the Company leases the land and buildings). The Right of Use Asset and Lease Liability reflect the present value of the Company's estimated future minimum lease payments over the lease term, which includes options that are reasonably assured of being exercised, discounted using a collateralized incremental borrowing rate. Typically, renewal options are considered reasonably assured of being exercised if the associated asset lives of the building or leasehold improvements exceed that of the initial lease term, and the sales performance of the restaurant remains strong. Therefore, the Right of Use Asset and Lease Liability include an assumption on renewal options that have not yet been exercised by the Company. As the rate implicit in each lease is not readily determinable, the Company uses an incremental borrowing rate to calculate the lease liability that represents an estimate of the interest rate the Company would incur to borrow on a collateralized basis over the term of a lease within a particular currency environment. • Share-based compensation The Company has a share-based compensation plan which authorizes the granting of various equity-based incentives including stock options and restricted stock units ("RSUs") to employees and nonemployee directors. The expense for these equity-based incentives is based on their fair value at date of grant and generally amortized over their vesting period. The Company estimates forfeitures when determining the amount of compensation costs to be recognized in each period. The fair value of each stock option granted is estimated on the date of grant using a closed-form pricing model. The pricing model requires assumptions, which impact the assumed fair value, including the expected life of the stock option, the risk-free interest rate, expected volatility of the Company's stock over the expected life and the expected dividend yield. The Company uses historical data to determine these assumptions and if these assumptions change significantly for future grants, share-based compensation expense will fluctuate in future years. The fair value of each RSU granted is equal to the market price of the Company's stock at date of grant, and prior to 2018 included a reduction for the present value of expected dividends over the vesting period. For performance-based RSUs, the Company includes a relative Total Shareholder Return ("TSR") modifier to determine the number of shares earned at the end of the performance period. The fair value of performance-based RSUs that include the TSR modifier is determined using aMonte Carlo valuation model. • Long-lived assets impairment review 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. Estimates of future cash flows are highly subjective judgments based on the Company's experience and knowledge of its 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. A key assumption impacting estimated future cash flows is the estimated change in comparable sales. If the Company's estimates or underlying assumptions change in the future, the Company may be required to record impairment charges. Based on the annual goodwill impairment test, conducted in the fourth quarter, the Company does not have any reporting units (defined as each individual market) with risk of material goodwill impairment. • Litigation accruals In the ordinary course of business, the Company is subject to proceedings, lawsuits and other claims primarily related to competitors, customers, employees, franchisees, government agencies, intellectual property, shareholders and suppliers. 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 a particular 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 currently being reviewed will have a material adverse effect on its financial condition or results of operations.McDonald's Corporation 2019 Annual Report 20
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• Income taxes
The Company records a valuation allowance to reduce its deferred tax assets if it is considered more likely than not that some portion or all of the deferred tax assets will not be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax strategies, including the sale of appreciated assets, 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. 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. The most significant new developments in 2019 and 2018 are described below. In 2019 and 2018, the Company increased the balance of unrecognized tax benefits by$96 million and$162 million , respectively. In both 2019 and 2018, there was audit progression in theU.S. federal and state audits, as well as multiple foreign tax jurisdictions. The Company has considered this new information in evaluating the unrecognized tax benefits and in certain situations, the Company changed its judgment on the measurement of the related unrecognized tax benefits. These changes have been reflected in the Unrecognized Tax Benefits table that is included in the Income Taxes footnote on page 50. In 2015, the Internal Revenue Service ("IRS") issued a Revenue Agent Report ("RAR") that included certain disagreed transfer pricing adjustments related to the Company'sU.S. Federal income tax returns for 2009 and 2010. Also in 2015, the Company filed a protest with theIRS related to these disagreed transfer pricing matters. During 2017, the Company received a response to its protest. InDecember 2018 , the Company met with theIRS Appeals team and during 2019, the Company and theIRS Appeals team continued to have a dialogue regarding these disagreed transfer pricing matters. As ofDecember 31, 2019 , the Company does not yet have a signed closing agreement with theIRS related to the settlement of these issues. The Company expects resolution on these issues in 2020. In 2017, theIRS completed its examination of the Company'sU.S. Federal income tax returns for 2011 and 2012. In 2018, theIRS issued a RAR for these years. As expected, the RAR included the same disagreed transfer pricing matters as the 2009 and 2010 RAR. Also in 2018, the Company filed a protest with theIRS related to these disagreed transfer pricing matters. The transfer pricing matters for 2011 and 2012 are being addressed along with the 2009 and 2010 transfer pricing matters as part of the 2009-2010 appeals process, such that resolution is expected in 2020. While the Company cannot predict the ultimate resolution of the aforementioned tax matters, we believe that the liabilities recorded are appropriate and adequate as determined in accordance with Topic 740 - Income Taxes of the ASC. The Tax Act was enacted in theU.S. onDecember 22, 2017 . The Tax Act reduced theU.S. federal corporate income tax rate to 21% from 35% and required companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred. In 2017, the Company recorded provisional amounts for certain enactment-date effects of the Tax Act by applying the guidance in Staff Accounting Bulletin ("SAB") 118. In 2018, the Company recorded adjustments to the provisional amounts and completed its accounting for all of the enactment-date income tax effects of the Tax Act.SAB 118 measurement period AtDecember 31, 2017 , the Company had not completed its accounting for all of the enactment-date income tax effects of the Tax Act under ASC 740, Income Taxes, primarily for the following aspects: remeasurement of deferred tax assets and liabilities, one-time transition tax, and its accounting position related to indefinite reinvestment of unremitted foreign earnings. One-time transition tax: The one-time transition tax is based on the Company's total post-1986 earnings and profits ("E&P"), the tax on which it previously deferred fromU.S. income taxes underU.S. law. The Company recorded a provisional amount for its one-time transition tax liability for each of its foreign subsidiaries, resulting in a transition tax liability of approximately$1.2 billion atDecember 31, 2017 . Upon further analysis of the Tax Act and notices and regulations issued and proposed by theIRS and theU.S. Department of the Treasury , the Company finalized its calculations of the transition tax liability during 2018 and increased itsDecember 31, 2017 provisional amount by approximately$75 million . The Company has elected to pay its transition tax over the eight-year period provided in the Tax Act. Deferred tax assets and liabilities: As ofDecember 31, 2017 , the Company remeasured certain deferred tax assets and liabilities based on the rates at which they were expected to reverse in the future (generally 21%), by recording a provisional amount of approximately$500 million . No adjustment to the provisional amount was made in 2018. EFFECTS OF CHANGING PRICES-INFLATION The Company has demonstrated an ability to manage inflationary cost increases effectively. This ability 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.McDonald's Corporation 2019 Annual Report 21
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