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, after-tax return on invested capital from continuing operations, 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 are compared to the same period in the prior year and 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 (including restaurants temporarily closed due to COVID-19 in 2020). Comparable sales exclude the impact of currency translation and the sales of any market considered hyper-inflationary (generally identified as those markets whose cumulative inflation rate over a three-year period exceeds 100%), which management believes more accurately reflects the underlying business trends. Comparable sales are driven by changes in guest counts and average check, which is affected by changes in pricing and product mix. •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 solely of sales by Company-operated restaurants and fees from franchised restaurants operated by conventional franchisees, developmental licensees and affiliates. Changes in Systemwide sales are primarily driven by comparable sales and net restaurant unit expansion. •The Company's after-tax return on invested capital ("ROIC") from continuing operations is a metric that management believes measures our capital-allocation effectiveness over time. Other companies may calculate ROIC differently, limiting the usefulness of the measure for comparisons with other companies. Refer to the reconciliation in Exhibit 12 for further information on the Company's calculation of ROIC. •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. Refer to the reconciliations in Exhibit 12 for further information on the Company's calculations of free cash flow and free cash flow conversion rate. 2020 FINANCIAL PERFORMANCE In 2020, global comparable sales decreased 7.7% primarily as a result of COVID-19. Comparable guest counts were negative across all segments for the year. •Comparable sales in theU.S. increased 0.4% benefiting from strong average check growth and positive comparable sales primarily at the dinner daypart. The Company's strategic marketing investments and promotional activity, along with growth in delivery, had a positive impact on comparable sales in the second half of 2020. •Comparable sales in the International Operated segment decreased 15.0% reflecting negative comparable sales in most markets as a result of COVID-19. The comparable sales decline was primarily driven byFrance , theU.K. ,Germany ,Italy andSpain , partly offset by positive results inAustralia . •Comparable sales in the International Developmental Licensed segment decreased 10.5% reflecting negative comparable sales primarily inLatin America andAsia , partly offset by strong comparable sales inJapan . In addition to the comparable sales results, the Company had the following financial results in 2020: •Consolidated revenues decreased 10% (10% in constant currencies). •Systemwide sales decreased 7% (7% in constant currencies). •Consolidated operating income decreased 19% (20% in constant currencies) and included$268 million of net strategic gains. Excluding these gains, operating income decreased 23% (23% in constant currencies), when also excluding$74 million of net strategic charges from the prior year. Refer to the Operating Income section on page 17 for additional details.McDonald's Corporation 2020 Annual Report 8 -------------------------------------------------------------------------------- •Operating margin, defined as operating income as a percent of total revenues, decreased from 42.5% in 2019 to 38.1% in 2020. Excluding the items referenced in the previous bullet point, operating margin decreased from 42.8% in 2019 to 36.7% in 2020. •Diluted earnings per share of$6.31 decreased 20% (20% in constant currencies). Refer to the Net Income and Diluted Earnings Per Share section on page 12 for additional details. •Cash provided by operations was$6.27 billion . •Capital expenditures of$1.64 billion were allocated mainly to reinvestment in existing restaurants and, to a lesser extent, to new restaurant openings. •Free cash flow was$4.62 billion , a 19% decrease from the prior year. •Across the System, nearly 1,000 restaurants (including those in our developmental licensee and affiliated markets) were opened. •The Company increased its quarterly cash dividend per share by 3% to$1.29 for the fourth quarter, equivalent to an annual dividend of$5.16 per share. STRATEGIC DIRECTION In 2020, the Company announced a new growth strategy, Accelerating theArches (the "Strategy"). The Strategy encompasses all aspects ofMcDonald's business as the leading global omni-channel restaurant brand, and includes a refreshed purpose, updated values, and new growth pillars that build on the Company's competitive advantages. Purpose, Mission, & Values The Company is embracing and prioritizing its role and commitments to the communities in which it operates through our: •Purpose to feed and foster communities, •Mission to create delicious feel-good moments for everyone, and •Core values that define who we are and how we run our business. Growth Pillars The new growth pillars, rooted in the Company's identity, MCD, build on historic strengths and articulate areas of further opportunity. Under the Strategy, the Company will: •Maximize our Marketing by investing in new, culturally relevant approaches to effectively communicate the story of our brand, food and purpose. This will focus on enhanced digital capabilities that provide a more personal connection with customers. The Company is also committed to a marketing strategy that highlights value at every tier of the menu, as affordability remains a cornerstone of theMcDonald's brand. •Commit to the Core by tapping into customer demand for the familiar and focusing on serving delicious burgers, chicken and coffee. The Company will prioritize chicken and beef offerings as we expect they represent the largest growth opportunities. The Company expects there is significant opportunity to expand its chicken offerings by leveraging line extensions of customer favorites. In addition, the Company plans to introduce a new Crispy Chicken Sandwich in theU.S. at the end of February. The Company will also implement a series of operational and formulation changes designed to improve upon the great taste of our burgers. We also see a significant opportunity with coffee, and markets will leverage the McCafe brand, experience, value and quality to drive long-term growth. •Double Down on the 3D's: Digital, Delivery and Drive Thru by leveraging competitive strengths and building a powerful digital experience growth engine that provides a fast, easy experience for our customers. To unlock further growth, the Company will accelerate technology innovation so that when customers interact withMcDonald's , they can enjoy a fast, easy experience that meets their needs. •Digital: The Company's new digital experience growth engine, "MyMcDonald's" will transform its digital offerings across drive thru, takeaway, delivery, curbside pick-up and dine-in. Through the digital tools across this platform, customers will receive tailored offers, be able to participate in a new loyalty program and order and receiveMcDonald's food through the channel of their choice. The Company expects to have elements of "MyMcDonald's" across its top six markets by the end of 2021, featuring loyalty programs in several of those markets, including aU.S. loyalty launch later in 2021. Across these top six markets, digital sales exceeded$10 billion or nearly 20% of Systemwide sales in 2020. •Delivery: Over the past three years, the Company has expanded the number ofMcDonald's restaurants offering delivery to nearly 30,000 restaurants, and delivery sales have grown significantly. The Company will build on this progress and enhance the delivery experience for customers by adding the ability to order on theMcDonald's app, which is already available in several markets around the world, and optimizing operations with a focus on speed and accuracy. •Drive Thru: The Company has drive thru locations in over 25,000 restaurants globally, including nearly 95% of the over 13,000 locations in theU.S. During the COVID-19 pandemic, this channel has heightened importance and we expect that it will become even more critical to meet customers' demand for flexibility and choice. The Company will build on its drive thru advantage as the vast majority of new restaurant openings in theU.S. and International Operated Markets will include a drive thru. The Company will test new concepts and technology to enhance the customer experience, including automated order taking; a new drive thru express pick-up lane for customers with a digital order; and a restaurant concept that offers drive thru, delivery and takeaway only to provide a faster, more convenient experience. The Company's Strategy is underpinned by a relentless focus on running great restaurants, including improving speed of service to address customer needs. The Company believes this Strategy will build on our inherent strengths by harnessing our competitive advantages and investing in innovations that will enhance the customer experience and deliver long-term growth.McDonald's Corporation 2020 Annual Report 9 --------------------------------------------------------------------------------
OUTLOOK
2021 Outlook Based on current conditions, the following information is provided to assist in forecasting the Company's future results for 2021. •The Company expects 2021 Systemwide sales growth, in constant currencies, in the low double digits, and expects net restaurant unit expansion to contribute about 1% to 2021 Systemwide sales growth. •The Company expects operating margin percent to be in the low-to-mid 40% range. •The Company expects full year 2021 selling, general and administrative expenses of approximately 2.3% of Systemwide sales, reflecting a decrease of about 2% to 4% in constant currencies. •Based on current interest and foreign currency exchange rates, the Company expects interest expense for the full year 2021 to decrease about 1% to 3% due primarily to lower average debt balances as the Company expects to pay down current debt levels to return to pre-COVID-19 leverage ratios. •The Company expects the effective income tax rate for the full year 2021 to be in the 21% to 23% range. Some volatility may result in a quarterly tax rate outside of the annual range. •The Company expects 2021 capital expenditures to be approximately$2.3 billion , about half of which will be directed towards new unit expansion across theU.S. and International Operated Markets. In 2021, about$1.1 billion will be dedicated to ourU.S. business, about$500 million of which will be allocated to approximately 1,200 restaurant modernization projects. Globally, the Company expects to open over 1,300 restaurants. We will open nearly 500 restaurants in theU.S. and International Operated Markets segments, and our developmental licensee and affiliates will contribute capital towards over 800 restaurant openings in their respective markets. Additionally, theU.S. expects to close roughly 325 restaurants in 2021; a majority of which are lower sales volumeMcDonald's in Walmart locations. The Company expects about 650 net restaurant additions in 2021. •The Company expects to achieve a free cash flow conversion rate greater than 90%. 2022 Outlook The Company has provided a 2022 outlook that is detailed in its Form 10-Q for the quarter endedSeptember 30, 2020 .McDonald's Corporation 2020 Annual Report 10 -------------------------------------------------------------------------------- CONSOLIDATED OPERATING RESULTS The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included on pages 38 through 59 of this Form 10-K. This section generally discusses 2020 and 2019 items and the year-to-year comparisons between the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 . Discussions of 2018 items and the year-to-year comparisons between the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 are not included in this Form 10-K and can be found in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , filed with theSEC onFebruary 26, 2020 .
Operating results
2020 2019
2018
Dollars and shares in millions, except per share data Amount Increase/ (decrease) Amount Increase/ (decrease) Amount
Revenues
Sales by Company-operated restaurants$ 8,139 (14 %)$ 9,421 (6 %)$ 10,013 Revenues from franchised restaurants 10,726 (8) 11,656 6 11,012 Other revenues 343 19 288 24 233 Total revenues 19,208 (10) 21,365 1 21,258 Operating costs and expenses Company-operated restaurant expenses 6,981 (10) 7,761 (6)
8,266
Franchised restaurants-occupancy expenses 2,208 0 2,201 12 1,973 Other restaurant expenses 267 19 224 20 186 Selling, general & administrative expenses Depreciation and amortization 301 14 262 22 215 Other 2,245 14 1,967 (1) 1,985 Other operating (income) expense, net (118) 2 (120) 37
(190)
Total operating costs and expenses 11,884 (3) 12,295 (1) 12,435 Operating income 7,324 (19) 9,070 3 8,823 Interest expense 1,218 9 1,122 14 981 Nonoperating (income) expense, net (35) 50 (70) n/m
26
Income before provision for income taxes 6,141 (23) 8,018 3
7,816
Provision for income taxes 1,410 (29) 1,993 5 1,892 Net income$ 4,731 (21 %)$ 6,025 2 %$ 5,924 Earnings per common share-diluted$ 6.31 (20 %)$ 7.88 5 %$ 7.54 Weighted-average common shares outstanding- diluted 750.1 (2 %) 764.9 (3 %) 785.6 n/m Not meaningful
IMPACT OF FOREIGN CURRENCY TRANSLATION ON REPORTED RESULTS
While changes in foreign currency exchange rates affect reported results,
Impact of foreign currency translation on reported results
Currency translation Reported amount benefit/(cost) In millions, except per share data 2020 2019 2018 2020 2019 2018 Revenues$ 19,208 $ 21,365 $ 21,258 $ (75) $ (610) $ 124 Company-operated margins 1,158 1,660 1,747 (1) (51) 4 Franchised margins 8,519 9,455 9,039 32 (256) 57 Selling, general & administrative expenses 2,546 2,229 2,200 (2) 29 (13) Operating income 7,324 9,070 8,823 35 (280) 56 Net income 4,731 6,025 5,924 26 (165) 33 Earnings per common share-diluted 6.31 7.88 7.54 0.04 (0.21) 0.04 In 2020, results primarily reflected the strengthening of the Euro and British Pound, partly offset by the weakening of the Brazilian Real. In 2019, results reflected the weakening of the Euro and most other major currencies.McDonald's Corporation 2020 Annual Report 11 -------------------------------------------------------------------------------- NET INCOME AND DILUTED EARNINGS PER COMMON SHARE In 2020, net income decreased 21% (22% in constant currencies) to$4.7 billion and diluted earnings per common share decreased 20% (20% in constant currencies) to$6.31 . Foreign currency translation had a positive impact of$0.04 on diluted earnings per share. Results in 2020 reflected sales declines in the International Operated Markets and International Developmental Licensed Markets segments as a result of COVID-19. Results in 2020 also included the following: •Higher Selling, General and Administrative Expenses reflecting: •$100 million for the Company's five year commitment toRonald McDonald House Charities ; •one-time investments in renewed brand communications as part of the "Serving Here" campaign launch that was announced with the new growth strategy, Accelerating theArches ; and •partly offset by lower incentive-based compensation expense. •Over$200 million of incremental franchisee support for the year for marketing to accelerate recovery and drive growth across theU.S. and International Operated Markets, a majority of which was recorded in Selling, General and Administrative Expenses. •About$100 million was recorded in theU.S. and the remaining support was recorded in the International Operated Markets segment. •Higher restaurant closing costs of$68 million in both the International Operated Markets and in theU.S. TheU.S. costs were primarily related to planned closings ofMcDonald's in Walmart locations. •Lower gains on sales of restaurant businesses. •An increase of reserves for bad debts of$58 million related to rent and royalty deferrals. Outlined below is additional information for the full year 2020, 2019, and 2018: Diluted Earnings Per Common Share Reconciliation Increase/(decrease) excluding currency Amount Increase/(decrease) translation 2020 2019 2018 2020 2019 2020 2019 GAAP earnings per share-diluted$ 6.31 $ 7.88 $ 7.54 (20 %) 5 % (20 %) 7 % Strategic (gains) charges (0.26) 0.07
0.26
Income tax (benefit) cost, net - (0.11)
0.10
Non-GAAP earnings per share-diluted$ 6.05 $ 7.84 $ 7.90 (23) % (1) % (23) % 2 % 2020 results included: •net pre-tax strategic gains of$268 million , or$0.26 per share, primarily related to the sale ofMcDonald's Japan stock, which reduced the Company's ownership by about 6%. 2019 results included: •$84 million, or$0.11 per share, of income tax benefit due to regulations issued in the fourth quarter 2019 related to the Tax Act. •net pre-tax strategic charges of$74 million , or$0.07 per share, primarily 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. 2018 results included: •net tax cost of$75 million , or$0.10 per share, associated with the final 2018 adjustments to the provisional amounts recorded inDecember 2017 under the Tax Act. •$234 million, or$0.26 per share, of pre-tax strategic impairment and restructuring charges. Excluding the above 2020 and 2019 items, 2020 net income decreased 24% (25% in constant currencies), and diluted earnings per share decreased 23% (23% in constant currencies). Diluted earnings per share for 2020 and 2019 benefited from a decrease in diluted weighted average shares outstanding. In earlyMarch 2020 , the Company suspended its share repurchase program. The Company repurchased 4.3 million shares of its stock for$874 million in 2020 and 25.0 million shares of its stock for$5 billion in 2019. RESTAURANT UPDATE The Company has continued to follow the guidance of expert health authorities to ensure the appropriate precautionary steps are taken to protect the health and safety of our people and our customers. As a result of COVID-19, throughout 2020, there have been numerous instances of government restrictions on restaurant operating hours, limited dine-in capacity in most countries and, in some cases, mandated dining room closures particularly in the International Operated Markets. These restrictions, which have carried into 2021, are impacting most of the Company's key markets outside of theU.S. , particularly those with fewer drive thru restaurant locations. The Company expects some restrictions in various markets so long as the COVID-19 pandemic continues.McDonald's Corporation 2020 Annual Report 12
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REVENUES
The Company's revenues consist of sales by Company-operated restaurants and fees from restaurants operated by 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. The Company's Other revenues are comprised of fees paid by franchisees to recover a portion of costs incurred by the Company for various technology platforms, revenues from brand licensing arrangements to market and sell consumer packaged goods using theMcDonald's brand, and third party revenues for the Dynamic Yield business. Franchised restaurants represented 93% ofMcDonald's restaurants worldwide atDecember 31, 2020 . The Company's heavily franchised business model is designed to generate stable and predictable revenue, which is largely a function of franchisee sales and resulting cash flow streams. As most revenues are based on a percent of sales, the Company expects that government regulations as a result of COVID-19 resurgences will continue to have a negative impact on revenue in the near term. Revenues Increase/(decrease) excluding currency Amount Increase/(decrease) translation Dollars in millions 2020 2019 2018 2020 2019 2020 2019 Company-operated sales: U.S.$ 2,395 $ 2,490 $ 2,665 (4 %) (7 %) (4 %) (7 %) International Operated Markets 5,114 6,334 6,668 (19) (5) (18) (1) International Developmental Licensed Markets & Corporate 630 597 680 6 (12) 7 (7) Total$ 8,139 $ 9,421 $ 10,013 (14 %) (6 %) (12 %) (3 %) Franchised revenues: U.S.$ 5,261 $ 5,353 $ 5,001 (2 %) 7 % (2 %) 7 % International Operated Markets 4,348 5,064 4,839 (14) 5 (15) 10 International Developmental Licensed Markets & Corporate 1,117 1,239 1,172 (10) 6 (8) 10 Total$ 10,726 $ 11,656 $ 11,012 (8 %) 6 % (8 %) 9 %Total Company -operated sales and Franchised revenues: U.S.$ 7,656 $ 7,843 $ 7,666 (2 %) 2 % (2 %) 2 % International Operated Markets 9,462 11,398 11,507 (17) (1) (17) 4 International Developmental Licensed Markets & Corporate 1,747 1,836 1,852 (5) (1) (3) 4 Total$ 18,865 $ 21,077 $ 21,025 (10 %) 0 % (10 %) 3 % Total Other revenues$ 343 $ 288 $ 233 19 % 24 % 19 % 25 % Total Revenues$ 19,208 $ 21,365 $ 21,258 (10 %) 1 % (10 %) 3 % In 2020, total Company-operated sales and franchised revenues decreased 10% (10% in constant currencies), primarily reflecting sales declines in the International Operated Markets segment as a result of COVID-19. Results also reflected positive sales performance in theU.S. , which was more than offset by support provided for marketing, through incentives to franchisees, to accelerate recovery and drive growth, including the free Thank You Meals served across the country to first responders and health care workers. Revenue declines were more significant in the International Operated Markets segment, driven by the temporary restaurant closures and limited operations. While performance was mixed, the ability of each market to drive sales and revenue growth is also impacted by the number of drive thru restaurant locations. The revenue declines were driven by theU.K. ,France ,Germany ,Italy andSpain . TOTAL REVENUES BY SEGMENT [[Image Removed: mcd-20201231_g2.jpg]][[Image Removed: mcd-20201231_g3.jpg]][[Image Removed: mcd-20201231_g4.jpg]]U.S. International Operated Markets International Developmental Licensed Markets & CorporateMcDonald's Corporation 2020 Annual Report 13 --------------------------------------------------------------------------------
The following tables present comparable sales and Systemwide sales increases/(decreases): Comparable sales increases/(decreases)
2020 2019 2018 U.S. 0.4 % 5.0 % 2.5 % International Operated Markets (15.0) 6.1 6.1
International Developmental Licensed Markets & Corporate (10.5)
7.2 5.6 Total (7.7 %) 5.9 % 4.5 %
Systemwide sales increases/(decreases)*
Increase/(decrease) excluding currency translation 2020 2019 2020 2019 U.S. 0 % 5 % 0 % 5 % International Operated Markets (13) 3 (14) 8 International Developmental Licensed Markets & Corporate (10) 5 (8) 10 Total (7 %) 4 % (7 %) 7 % * Unlike comparable sales, the Company has not excluded hyper-inflationary market results from Systemwide sales as these sales are the basis on which the Company calculates and records revenues. 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 2020 2019 2018 2020 2019 2020 2019 U.S.$ 38,123 $ 37,923 $ 35,860 1 % 6 % 1 % 6 % International Operated Markets 25,446 28,853 27,557 (12) 5 (13) 10 International Developmental Licensed Markets & Corporate 21,609 23,981 22,717 (10) 6 (8) 10 Total$ 85,178 $ 90,757 $ 86,134 (6 %) 5 % (6 %) 8 % Ownership type Conventional franchised$ 63,297 $ 66,415 $ 63,251 (5) 5 % (5) % 7 % Developmental licensed 11,781 14,392 13,519 (18) 6 (14) 13 Foreign affiliated 10,100 9,950 9,364 2 6 0 7 Total$ 85,178 $ 90,757 $ 86,134 (6 %) 5 % (6 %) 8 %McDonald's Corporation 2020 Annual Report 14
-------------------------------------------------------------------------------- RESTAURANT MARGINS Restaurant margins
Increase/(decrease) excluding currency
Amount Increase/(decrease) translation Dollars in millions 2020 2019 2018 2020 2019 2020 2019 Franchised: U.S.$ 4,097 $ 4,227 $ 4,070 (3 %) 4 % (3 %) 4 % International Operated Markets 3,329 4,018 3,829 (17) 5 (19) 10 International Developmental Licensed Markets & 1,093 1,210 1,140 (10) 6 (8) 11 Corporate Total$ 8,519 $ 9,455 $ 9,039 (10 %) 5 % (10 %) 7 % Company-operated: U.S.$ 405 $ 388 $ 397 4 % (2 %) 4 % (2 %) International Operated Markets 748 1,266 1,327 (41) (5) (41) (1) International Developmental Licensed Markets & n/m n/m n/m n/m n/m n/m n/m Corporate Total$ 1,158 $ 1,660 $ 1,747 (30 %) (5 %) (30 %) (2 %) Total restaurant margins: U.S.$ 4,502 $ 4,615 $ 4,467 (2 %) 3 % (2 %) 3 % International Operated Markets 4,077 5,284 5,156 (23) 2 (24) 7 International Developmental Licensed Markets & n/m n/m n/m n/m n/m n/m n/m Corporate Total$ 9,677 $ 11,115 $ 10,786 (13 %) 3 % (13 %) 6 % n/m Not meaningful In 2020, total restaurant margins decreased 13% (13% in constant currencies), which reflected sales declines in the International Operated Markets segment as a result of COVID-19, partly offset by positive sales performance in theU.S. Franchised margins represented over 85% of restaurant margin dollars. Franchised margins in theU.S. reflected higher depreciation costs related to investments in Experience of the Future ("EOTF"), as well as support provided for marketing to accelerate recovery and drive growth, including the free Thank You Meals served across the country to first responders and health care workers. Company-operated margins in theU.S. and International Operated Markets segments reflected incremental COVID-19 expenses incurred for employee related costs, personal protective equipment, and signage and other restaurant costs. Due to the nature of our operating model, franchised margin expenses (primarily comprised of lease expense and depreciation expense) are mainly fixed, whereas Company-operated restaurant expenses have more variable cost components. Total restaurant margins included$1,452 million of depreciation and amortization expenses in 2020. RESTAURANT MARGINS BY TYPE (In millions) [[Image Removed: mcd-20201231_g5.jpg]]McDonald's Corporation 2020 Annual Report 15 -------------------------------------------------------------------------------- SELLING, GENERAL & ADMINISTRATIVE EXPENSES Selling, general & administrative expenses Increase/(decrease) excluding currency Amount Increase/(decrease) translation Dollars in millions 2020 2019 2018 2020 2019 2020 2019 U.S.$ 625 $ 587 $ 591 7 % (1 %) 7 % (1 %) International Operated Markets 700 629 641 11 (2) 11 3 International Developmental Licensed Markets & Corporate(1) 1,221 1,013 968 20 5 20 5 Total Selling, General & Administrative Expenses$ 2,546 $ 2,229 $ 2,200 14 % 1 % 14 % 3 % Less: Incentive-Based Compensation(2) 158 289 284 (45 %) 2 % (45 %) 3 %
Total Excluding Incentive-Based Compensation
$ 1,916 23 % 1 % 23 % 3 % (1)Included in International Developmental Licensed Markets & Corporate are home office support costs in areas such as facilities, finance, human resources, investments in strategic technology initiatives, legal, marketing, restaurant operations, supply chain and training. (2)Includes all cash incentives and share-based compensation expense. In 2020, consolidated selling, general and administrative expenses increased 14% (14% in constant currencies). The results reflected about$175 million of incremental marketing contributions by the Company to the System's advertising cooperative arrangements across theU.S. and International Operated Markets to accelerate recovery and drive growth; the Company's five year commitment totaling$100 million to RMHC; one-time investments in renewed brand communications as part of the "Serving Here" campaign launch that was announced with the new growth strategy, Accelerating theArches ; and higher investments in strategic technology initiatives. These results were partly offset by lower incentive-based compensation expense and travel costs. Selling, general and administrative expenses as a percent of Systemwide sales was 2.7% in 2020, 2.2% in 2019 and 2.3% in 2018. Management believes that analyzing selling, general and administrative expenses as a percent of Systemwide sales is meaningful because these costs are incurred to support the overallMcDonald's business. OTHER OPERATING (INCOME) EXPENSE, NET Other operating (income) expense, net In millions 2020 2019
2018
Gains on sales of restaurant businesses$ (23) $ (127) $ (304) Equity in earnings of unconsolidated affiliates (117) (154)
(152)
Asset dispositions and other (income) expense, net 290 87
34
Impairment and other charges (gains), net (268) 74 232 Total$ (118) $ (120) $ (190) •Gains on sales of restaurant businesses In 2020, gains on sales of restaurant businesses decreased primarily due to fewer restaurant sales primarily in theU.K. and theU.S. •Equity in earnings of unconsolidated affiliates In 2020, equity in earnings of unconsolidated affiliates declined primarily due to sales declines as a result of COVID-19 in both the International Operated Markets and International Developmental Licensed Markets. •Asset dispositions and other (income) expense, net Asset dispositions and other expense, net reflected$68 million of restaurant closing costs in both the International Operated Markets and in theU.S. TheU.S. costs were primarily related to planned closings ofMcDonald's in Walmart locations. Results also reflected an increase of reserves for bad debts of$58 million , related to rent and royalty deferrals;$31 million of payments to distribution centers for obsolete inventory to support franchisee liquidity; and litigation settlements. •Impairment and other charges (gains), net In 2020, impairment and other charges (gains), net reflected$274 million of pre-tax strategic gains related to the sale ofMcDonald's Japan stock, which reduced the Company's ownership by about 6% for the year. Results also reflected the write-off of impaired software that was no longer being used of$26 million , partly offset by$13 million of income primarily comprised of a reversal of a reserve associated with the Company's sale of its business in the India Delhi market inJanuary 2020 . The results in 2019 reflected$99 million of impairment associated with the purchase of our joint venture partner's interest in the India Delhi market, partly offset by$20 million of gains on the sales of property at the former Corporate headquarters. The results in 2018 reflected$140 million of impairment charges and$85 million of strategic restructuring charges in theU.S. McDonald's Corporation 2020 Annual Report 16 -------------------------------------------------------------------------------- OPERATING INCOME Operating income
Increase/(decrease) excluding currency
Amount Increase/(decrease) translation Dollars in millions 2020 2019 2018 2020 2019 2020 2019 U.S.$ 3,789 $ 4,069 $ 4,016 (7 %) 1 % (7 %) 1 % International Operated Markets 3,315 4,789 4,643 (31) 3 (32) 8 International Developmental Licensed Markets & Corporate 220 212 164 4 29 12 59 Total$ 7,324 $ 9,070 $ 8,823 (19 %) 3 % (20 %) 6 % Operating margin 38.1 % 42.5 % 41.5 % Non-GAAP operating margin 36.7 % 42.8 % 42.6 % •Operating Income: Operating income decreased 19% (20% in constant currencies). Results for 2020 included$268 million of net strategic gains primarily related to the sale ofMcDonald's Japan stock, and results for 2019 included$74 million of net strategic charges. Excluding these current year and prior year items, operating income decreased 23% (23% in constant currencies) for 2020. •U.S.: The operating income decrease reflected positive sales performance, which was more than offset by about$100 million of support for marketing to accelerate recovery and drive growth; EOTF depreciation; a comparison to a prior year gain on the sale of real estate; lower gains on sales of restaurant businesses; and higher restaurant closing costs, primarily related to planned closings ofMcDonald's in Walmart locations. •International Operated Markets: The operating income decrease reflected sales declines as a result of COVID-19; over$100 million of support for marketing to accelerate recovery and drive growth; incrementalCOVID-19 Company -operated expenses primarily for employee related costs; lower gains on sales of restaurant businesses primarily in theU.K. ; higher restaurant closing costs; lower equity in earnings from unconsolidated affiliates; and$23 million of payments to distribution centers for obsolete inventory. •International Developmental Licensed Markets & Corporate: Excluding the current year and prior year strategic gains and charges described above, the results primarily reflected higher G&A due to the Company's five year commitment totaling$100 million to RMHC as well as one-time investments in renewed brand communications.
OPERATING INCOME BY SEGMENT* [[Image Removed: mcd-20201231_g6.jpg]][[Image Removed: mcd-20201231_g7.jpg]][[Image Removed: mcd-20201231_g8.jpg]]
U.S. International Operated Markets International Developmental Licensed Markets & Corporate*
*The IDL segment excludes Corporate activities, which is a Non-GAAP metric.
McDonald's Corporation 2020 Annual Report 17 -------------------------------------------------------------------------------- •Operating margin: Operating margin is defined as operating income as a percent of total revenues. The contributions to operating margin differ by segment due to each segment's ownership structure, primarily due to the relative percentage of franchised versus Company-operated restaurants. Additionally, the number of temporary restaurant closures, which varies by segment, as a result of COVID-19, also impacts the contribution of each segment to the consolidated operating margin. The decrease in operating margin percent for 2020 was driven by a decline in sales, higher other operating expenses and higher G&A. While the sales-driven franchised margin decline had a dilutive effect on operating margin percent, franchised margin dollars represented over 85% of overall margin dollars and were a key component of operating income.
OPERATING MARGIN PERCENT ROLL-FORWARD*
[[Image Removed: mcd-20201231_g9.jpg]] Operating margin Increase Decrease
*The operating margin roll-forward excludes the strategic gains and charges previously described.
INTEREST EXPENSE Interest expense increased 9% (8% in constant currencies) and 14% (16% in constant currencies) in 2020 and 2019, respectively. Results in 2020 reflected higher average debt balances, partly offset by a decrease in the amount of Euro denominated deposits incurring interest expense as a result of the Company's cash management strategies. NONOPERATING (INCOME) EXPENSE, NET Nonoperating (income) expense, net In millions 2020 2019 2018 Interest income$ (18) $ (37) $ (4) Foreign currency and hedging activity (3) (48) 5 Other expense (14) 15 25 Total$ (35) $ (70) $ 26 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.McDonald's Corporation 2020 Annual Report 18
-------------------------------------------------------------------------------- PROVISION FOR INCOME TAXES In 2020, 2019 and 2018 the reported effective income tax rates were 23.0%, 24.9% and 24.2%, respectively. Results for 2020 included$50 million of income tax benefits due to newU.S. tax regulations and$48 million of income tax benefits related to the impact of a tax rate change in theU.K. The effective income tax rate for 2019 reflected$84 million of income tax benefit due to 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 impact of the Tax Act and impairment charges, the effective income tax rate was 22.9% for the year 2018. Consolidated net deferred tax liabilities included tax assets, net of valuation allowance, of$6.5 billion in 2020 and$5.3 billion in 2019. 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 43 of this Form 10-K.
CASH FLOWS The Company has a long history of generating significant cash from operations and has substantial credit capacity to fund operating and discretionary spending such as capital expenditures, debt repayments, dividends and share repurchases. As our operations have been impacted due to COVID-19, we have taken actions to preserve financial flexibility, primarily during the peak of the pandemic. Cash provided by operations totaled$6.3 billion in 2020, a decrease of$1.9 billion or 23%. Free cash flow was$4.6 billion in 2020, a decrease of$1.1 billion or 19%. The Company's free cash flow conversion rate was 98% in 2020 and 95% in 2019. Cash provided by operations decreased in 2020 compared to 2019 primarily due to a reduction in operating earnings due to COVID-19. In 2019, cash provided by operations totaled$8.1 billion , an increase of$1.1 billion or 17% compared with 2018, primarily due to a decrease in accounts receivable and lower income tax payments. During 2020, the Company deferred collection of rent and royalties earned from franchisees. In total, the Company deferred collection of approximately$1 billion , and has collected over 80% of these total deferrals as ofDecember 31, 2020 . The remaining deferrals are expected to be collected in the first half of 2021. Cash used for investing activities totaled$1.5 billion in 2020, a decrease of$1.5 billion compared with 2019. The decrease was primarily due to lower capital expenditures, fewer strategic acquisitions, and proceeds received from the sale ofMcDonald's Japan stock in 2020. 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 financing activities totaled$2.2 billion in 2020, a decrease of$2.7 billion compared with 2019. The decrease was primarily due to$4.1 billion of lower treasury stock purchases in 2020 as the Company suspended its share repurchase program in earlyMarch 2020 . In addition, the Company had$2.2 billion in net debt issuances in 2020, as compared to$3.2 billion in net debt issuances in 2019. The decrease in net debt issuances was primarily due to the timing of short-term commercial paper issuances and repayments. 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. The Company's cash and equivalents balance was$3.4 billion and$899 million at year end 2020 and 2019, 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.McDonald's Corporation 2020 Annual Report 19 -------------------------------------------------------------------------------- RESTAURANT DEVELOPMENT AND CAPITAL EXPENDITURES In 2020, the Company opened 977 restaurants and closed 643 restaurants. In 2019, the Company opened 1,231 restaurants and closed 391 restaurants. The decrease in openings during the year compared to 2019 was due to COVID-19. The closures in 2020 include approximately 200 closures in theU.S. ; over half of which are lower sales volumeMcDonald's in Walmart locations. Systemwide restaurants at year end 2020 2019 2018 U.S. 13,682 13,846 13,914 International Operated Markets 10,560 10,465 10,263 International Developmental Licensed Markets & Corporate 14,956 14,384 13,678 Total 39,198 38,695 37,855
RESTAURANTS BY OWNERSHIP TYPE [[Image Removed: mcd-20201231_g10.jpg]][[Image Removed: mcd-20201231_g11.jpg]][[Image Removed: mcd-20201231_g12.jpg]]
Franchised restaurants Company-operated restaurants
Approximately 93% of the restaurants at year-end 2020 were franchised, including 95% in theU.S. , 84% in International Operated Markets and 98% in the International Developmental Licensed Markets. Capital expenditures decreased$753 million or 31% in 2020 primarily due to lower reinvestment in existing restaurants as a result of COVID-19. 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.McDonald's Corporation 2020 Annual Report 20 -------------------------------------------------------------------------------- CAPITAL EXPENDITURES BY TYPE (In millions) [[Image Removed: mcd-20201231_g13.jpg]] * 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$4.4 million in 2020. As ofDecember 31, 2020 andDecember 31, 2019 , the Company owned approximately 55% of the land and 80% of the buildings for restaurants in its consolidated markets. SHARE REPURCHASES AND DIVIDENDS In 2020, the Company returned approximately$4.6 billion to shareholders, primarily through dividends paid. Shares repurchased and dividends In millions, except per share data 2020 2019 2018 Number of shares repurchased 4.3 25.0
32.2
Shares outstanding at year end 745 746
767
Dividends declared per share$ 5.04 $ 4.73 $ 4.19 Treasury stock purchases (in Shareholders' equity)$ 874 $ 4,980 $ 5,247 Dividends paid 3,753 3,582
3,256
Total returned to shareholders$ 4,627 $ 8,562
InDecember 2019 , 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 2020, approximately 4.3 million shares were repurchased for$874.1 million under the program. In earlyMarch 2020 , the Company voluntarily suspended share repurchases from the open market. The Company has paid dividends on its common stock for 45 consecutive years and has increased the dividend amount every year. The 2020 full year dividend of$5.04 per share reflects the quarterly dividend paid for each of the first three quarters of$1.25 per share, with an increase to$1.29 per share paid in the fourth quarter. This 3% increase in the quarterly dividend equates to a$5.16 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.McDonald's Corporation 2020 Annual Report 21
-------------------------------------------------------------------------------- FINANCIAL POSITION AND CAPITAL RESOURCES TOTAL ASSETS AND RETURN Total assets increased$5.1 billion or 11% in 2020, primarily due to an increase in Cash and equivalents driven by lower capital expenditures and fewer treasury stock purchases compared to the prior year, as well as proceeds received from the sale ofMcDonald's Japan stock. Net property and equipment increased$0.8 billion in 2020, primarily due to fixed asset additions and the impact of foreign exchange rates, partly offset by depreciation. Net property and equipment and the Lease right-of-use asset, net represented approximately 50% and approximately 25%, respectively, of total assets at year-end. Approximately 86% of total assets were in theU.S. and International Operated Markets at year-end 2020. The Company's after-tax ROIC from continuing operations is a metric that management believes measures our capital-allocation effectiveness over time and was 14.9%, 19.2% and 20.0% as ofDecember 31, 2020 , 2019 and 2018, respectively. The decrease from 2019 to 2020 was primarily due to the decrease in operating performance as a result of COVID-19 and higher average debt balances compared to the prior year. Refer to the reconciliation in Exhibit 12. 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, 2020 totaled$37.4 billion , compared with$34.2 billion atDecember 31, 2019 . The net increase in 2020 was primarily due to net long-term issuances of$3.1 billion , which were used to bolster our cash position in anticipation of the adverse macroeconomic and business conditions associated with COVID-19. Debt highlights(1) 2020 2019 2018 Fixed-rate debt as a percent of total debt(2,3) 95 % 92 % 91 % Weighted-average annual interest rate of total debt(3) 3.2 3.2 3.2 Foreign currency-denominated debt as a percent of total debt(2) 36 38 38
Total debt as a percent of total capitalization (total debt and total Shareholders' equity)(2)
126 131 125 Cash provided by operations as a percent of total debt(2) 17 24 22 (1)All percentages are as ofDecember 31 , except for the weighted-average annual 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. In connection with the increased funding activity during the first quarter of 2020, bothStandard & Poor's (S&P) and Moody's affirmed our ratings, although S&P putMcDonald's on negative outlook. S&P and Moody's currently rate 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. InDecember 2019 , the Company's Board of Directors authorized$15 billion of borrowing capacity with no specified expiration date, of which$9.5 billion remains outstanding as ofDecember 31, 2020 . 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. InApril 2020 , the Company's Board of Directors provided additional authorization to issue commercial paper and draw on lines of credit agreements up to$8 billion in addition to the$15 billion authorized as referenced above. 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$4.5 billion available under committed line of credit agreements (see Debt Financing note to the consolidated financial statements). As ofDecember 31, 2020 , the Company's subsidiaries also had$274 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$13.7 billion and$12.9 billion for the years endedDecember 31, 2020 and 2019, respectively. In addition, where practical, the Company's restaurants purchase goods and services in local currencies resulting in natural hedges. See the Summary of significant accounting policies note to the consolidated financial statements related to financial instruments and hedging activities for additional information regarding the accounting impact and use of derivatives.McDonald's Corporation 2020 Annual Report 22 -------------------------------------------------------------------------------- The Company does not have significant exposure to any individual counterparty and has master agreements that contain netting arrangements. Certain of these agreements also require each party to post collateral if credit ratings fall below, or aggregate exposures exceed, certain contractual limits. AtDecember 31, 2020 , the Company was required to post an immaterial amount of collateral due to the negative fair value of certain derivative positions. The Company's counterparties were not required to post collateral on any derivative position, other than on hedges of certain of the Company's supplemental benefit plan liabilities where the counterparties were required to post collateral on their liability positions. The Company's net asset exposure is diversified among a broad basket of currencies. The Company's largest net asset exposures (defined as foreign currency assets less foreign currency liabilities) at year end were as follows: Foreign currency net asset exposures In millions of U.S. Dollars 2020 2019 British Pounds Sterling$ 1,374 $ 811 Australian Dollars 913560 Canadian Dollars 878699 Russian Ruble 533577 Polish Zloty 393 396 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 2020 levels nor a 10% adverse change in foreign currency rates from 2020 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. During the first quarter of 2020, the Company secured$6.5 billion of new financing, including$5.5 billion of debt issuances at various maturities and a new$1.0 billion line of credit that was drawn upon immediately. In the third quarter of 2020, the Company repaid the total$1.0 billion on its line of credit. The$1.0 billion line of credit agreement remains in place and the amount remains available to be borrowed. The Company also has$3.5 billion available under a committed line of credit, which has not been drawn upon, as well as continuing authority to issue commercial paper in theU.S. and global markets. In 2021, the Company intends to reduce current debt levels to return to pre-COVID-19 leverage ratios. Consistent with prior years, we expect existing domestic cash and equivalents, domestic cash flows from operations, the ability to issue 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.McDonald's Corporation 2020 Annual Report 23 -------------------------------------------------------------------------------- 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 payments 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, 2020 . Contractual cash outflows Contractual cash inflows Minimum rent under In millions Leases (1) Debt obligations (2) franchise arrangements 2021$ 1,216 $ 2,244 $ 3,073 2022 1,150 2,332 2,954 2023 1,068 2,644 2,835 2024 989 3,301 2,743 2025 899 3,159 2,642 Thereafter 7,358 23,881 20,175 Total$ 12,680 $ 37,561 $ 34,422 (1)For sites that have lease escalations tied to an index, future minimum payments reflect the current index adjustments throughDecember 31, 2020 . In 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$269 million , as they are supported by a long-term line of credit agreement expiring inDecember 2024 . Debt obligations do not 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, 2020 , total liabilities for the supplemental plans were$431 million . AtDecember 31, 2020 , total liabilities for gross unrecognized tax benefits were$1.5 billion . On a recurring basis, the Company contracts with vendors and suppliers in the normal course of business. These contracts may include items related to construction projects, inventory, energy, marketing, technology and other services. Generally, these items are shorter term in nature and have no minimum payment requirements. They are funded from operating cash flows and reflected in other areas of the Form 10-K (e.g., franchised margins, Company-operated margins and selling, general and administrative expenses that are reflected in the Consolidated Statement of Income and capital expenditures that are reflected on the Consolidated Statement of Cash Flows). The Company has guaranteed certain loans totaling approximately$95 million atDecember 31, 2020 . These guarantees are contingent commitments generally issued by the Company to support borrowing arrangements of the System. AtDecember 31, 2020 , there was no carrying value for obligations under these guarantees in the Consolidated Balance Sheet. 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. Refer to the Property and Equipment section in the Summary of Significant Accounting Policies footnote on page 44 and the Property and Equipment footnote on page 51 for additional information. •Leasing Arrangements The Lease right-of-use asset and Lease liability include an assumption on renewal options that have not yet been exercised by the Company. The Company also uses an incremental borrowing rate in calculating 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. Refer to the Leasing section in the Summary of Significant Accounting Policies footnote on page 44 and the Leasing Arrangements footnote on page 52 for additional information.McDonald's Corporation 2020 Annual Report 24 -------------------------------------------------------------------------------- •Long-lived assets impairment review Long-lived assets (including goodwill) are reviewed for impairment annually. If qualitative indicators of impairment are present, such as changes in global and local business and economic conditions, operating costs, inflation, competition, and consumer and demographic trends, the Company will use these and other factors in estimating future cash flows when testing for the recoverability of its long-lived assets. Estimates of future cash flows are highly subjective judgements based on the Company's experience and knowledge of its operations. 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. Refer to the Long-lived Assets andGoodwill sections in the Summary of Significant Accounting Policies footnote on page 45 for additional information. •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. Refer to the Contingencies footnote on page 53 for additional information. •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. 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. Refer to the Income Taxes sections in the Summary of Significant Accounting Policies footnote on page 46 and the Income Taxes footnote on page 53 for additional information. 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 2020 Annual Report 25
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