McDonaldโs Corporation is an American operator and franchisor of fast food restaurants represented worldwide and the biggest fast food company in the world.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
For the quarterly period ended September 30, 2005
OR
For the transition period from to
Commission File Number 1-5231
McDONALD’S CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
McDonald’s Plaza
Oak Brook, Illinois
(630) 623-3000
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
1,258,571,503
(Number of shares of common stock
outstanding as of September 30, 2005)
INDEX
Part I.
Part II.
Signature
Exhibits
The following trademarks used herein are the
property of McDonald’s Corporation and its
affiliates or the Company: Boston Market,
Chipotle Mexican Grill and McDonald’s.
2
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEET
(unaudited)
September 30,
2005
December 31,
2004
Assets
Current assets
Cash and equivalents
Accounts and notes receivable
Inventories, at cost, not in excess of market
Prepaid expenses and other current assets
Total current assets
Other assets
Investments in and advances to affiliates
Goodwill, net
Miscellaneous
Total other assets
Property and equipment
Property and equipment, at cost
Accumulated depreciation and amortization
Net property and equipment
Total assets
Liabilities and shareholders’ equity
Current liabilities
Accounts payable
Dividend payable
Income taxes
Other taxes
Accrued interest
Accrued payroll and other liabilities
Current maturities of long-term debt
Total current liabilities
Long-term debt
Other long-term liabilities
Deferred income taxes
Shareholders’ equity
Preferred stock, no par value; authorized – 165.0 million shares; issued – none
Common stock, $.01 par value; authorized – 3.5 billion shares; issued – 1,660.6 million shares
Additional paid-in capital
Unearned ESOP compensation
Retained earnings
Accumulated other comprehensive income (loss)
Common stock in treasury, at cost; 402.1 and 390.7 million shares
Total shareholders’ equity
Total liabilities and shareholders’ equity
See notes to condensed Consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
Quarters Ended
Nine Months Ended
Revenues
Sales by Company-operated restaurants
Revenues from franchised and affiliated restaurants
Total revenues
Operating costs and expenses
Company-operated restaurant expenses
Franchised restaurants – occupancy expenses
Selling, general & administrative expenses
Other operating (income) expense, net
Total operating costs and expenses
Operating income
Interest expense
Nonoperating (income) expense, net
Income before provision for income taxes
Provision for income taxes
Net income
Net income per common share
Net income per common share–diluted
Dividends declared per common share
Weighted average shares
Weighted average shares–diluted
4
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Operating activities
Adjustments to reconcile to cash provided by operations
Noncash charges and credits:
Depreciation and amortization
Income taxes audit benefit
Share-based compensation
Other
Changes in working capital items
Cash provided by operations
Investing activities
Property and equipment expenditures
Purchases and sales of restaurant businesses and sales of property
Cash used for investing activities
Financing activities
Notes payable and long-term financing issuances and repayments
Treasury stock purchases
Proceeds from stock option exercises
Cash used for financing activities
Cash and equivalents increase
Cash and equivalents at beginning of period
Cash and equivalents at end of period
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Basis of Presentation
The accompanying condensed Consolidated financial statements should be read in conjunction with the Consolidated financial statements contained in the Company’s December 31, 2004 Annual Report on Form 10-K. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been included. The results for the quarter and nine months ended September 30, 2005 do not necessarily indicate the results that may be expected for the full year.
The results of operations of restaurant businesses purchased and sold were not material to the condensed Consolidated financial statements for periods prior to purchase and sale.
Comprehensive Income
The following table presents the components of comprehensive income for the quarters and nine months ended September 30, 2005 and 2004:
Other comprehensive income (loss):
Foreign currency translation adjustments
Deferred hedging adjustments
Total other comprehensive income (loss)
Total comprehensive income
Per Common Share Information
Diluted net income per common share is calculated using net income divided by diluted weighted-average shares. Diluted weighted-average shares include weighted-average shares outstanding plus the dilutive effect of share-based employee compensation, calculated using the treasury stock method, of 17.7 million shares and 11.7 million shares for the third quarter 2005 and 2004, respectively, and 17.1 million shares and 12.5 million shares for the nine months ended September 30, 2005 and 2004, respectively. Stock options that were not included in diluted weighted-average shares because they would have been antidilutive were 45.6 million shares and 83.5 million shares for the third quarter 2005 and 2004, respectively, and 45.6 million shares and 90.0 million shares for the nine months ended September 30, 2005 and 2004, respectively.
Share-based Compensation
Prior to January 1, 2005, the Company accounted for the plans under the measurement and recognition provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation. Accordingly, share-based compensation was included as a pro forma disclosure in the financial statement footnotes.
Effective January 1, 2005, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-Based Payment (SFAS No. 123(R)), using the modified-prospective transition method. Under this transition method, compensation cost in 2005 includes the portion vesting in the period for (1) all share-based payments granted prior to, but not vested as of January 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of FASB Statement No. 123 and (2) all share-based payments granted subsequent to January 1, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated.
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In 2005, in connection with the adoption of SFAS No. 123(R), the Company adjusted the mix of employee long-term incentive compensation by reducing stock options awarded and increasing certain cash-based compensation (primarily annual incentive-based compensation) and other equity-based awards. Third quarter 2005 results included pretax expense of $44.3 million ($30.0 million after tax or $0.02 per share) of which $35.1 million related to share-based compensation (stock options and restricted stock units (“RSUs”)) and $9.2 million related to the shift of a portion of share-based compensation to primarily cash-based incentive compensation. For the nine months 2005, results included pretax expense of $146.8 million ($98.5 million after tax or $0.08 per share) of which $119.0 million related to share-based compensation and $27.8 million related to the compensation shift. Compensation expense related to share-based awards is generally amortized over the vesting period in selling, general & administrative expenses in the Consolidated statement of income. As of September 30, 2005, there was $211.7 million of total unrecognized compensation cost related to nonvested share-based compensation that is expected to be recognized over a weighted-average period of 2.2 years.
Prior to the adoption of SFAS No. 123(R), the Company presented all benefits of tax deductions resulting from the exercise of share-based compensation as operating cash flows in the Statement of cash flows. SFAS No. 123(R) requires the benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. Results included $8.5 million for third quarter 2005 and $27.4 million for the nine months 2005 of excess tax benefits as a financing cash inflow.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123 to options granted under the Company’s stock options plans in third quarter and nine months ended September 30, 2004.
Net income, as reported
Add: Total share-based employee compensation expense included in reported net income, net of related tax effects
Deduct: Total share-based employee compensation expense determined under fair value method for all rewards, net of related tax effects
Pro forma – net income
Net income per share:
As reported – basic
Pro forma – basic
As reported – diluted
Pro forma – diluted
Income Taxes
In 2005, the effective income tax rate was 32.3% and 30.1% for the quarter and nine months, respectively. The effective income tax rate for the nine months was reduced by a tax benefit of $178.8 million due to a favorable audit settlement of the Company’s 2000 – 2002 U.S. tax returns in the first quarter. This benefit was partially offset by incremental tax expense of $112.0 million as a result of the Company’s decision during the second quarter to take advantage of the one-time opportunity provided under the Homeland Investment Act. The net of both of these items reduced the nine month tax rate by approximately 2 percentage points.
The Homeland Investment Act is a provision within the American Jobs Creation Act that was signed by the President of the United States on October 22, 2004 which creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. In fourth quarter 2005, the Company will repatriate approximately $3.2 billion of historical foreign earnings from our international business.
In 2004, the effective income tax rate was 22.6% and 28.5% for the quarter and nine months, respectively. The income tax rate in both periods benefited primarily from the transfer of shares between subsidiaries and a change in assumptions about the utilization of certain loss carry forwards. These items impacted the third quarter effective tax rate by approximately 10 percentage points and the nine month tax rate by 4 percentage points.
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Debt Financing
Subsequent to September 30, 2005, due to the Company’s decision to repatriate foreign earnings under the Homeland Investment Act, certain wholly-owned subsidiaries outside the U.S. entered into a multicurrency term loan facility totaling $3.0 billion which is currently unused. The loan has a three-year term with the ability to prepay without penalty. The loan agreement stipulates that any unused portion of the facility as of December 31, 2005 will be cancelled and future repayments of borrowings reduce the amount available under the facility.
Segment Information
The Company primarily operates and franchises McDonald’s restaurants in the food service industry. In addition, the Company operates certain non-McDonald’s brands that are not material to the Company’s overall results.
The following table presents the Company’s revenues and operating income by geographic segment. The APMEA segment represents McDonald’s restaurant operations in Asia/Pacific, Middle East and Africa. The Other segment represents non-McDonald’s brands.
U.S.
Europe
APMEA
Latin America
Canada
Operating income (loss) (1)
Corporate
Total operating income
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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Description of the Business
The Company primarily operates and franchises McDonald’s restaurants. In addition, the Company operates certain non-McDonald’s brands that are not material to the Company’s overall results. Of the more than 30,000 McDonald’s restaurants in over 100 countries, about 8,000 are operated by the Company, more than 18,000 are operated by franchisees/licensees and about 4,000 are operated by affiliates. In general, the Company owns the land and building or secures long-term leases for restaurant sites regardless of who operates the restaurant. This ensures long-term occupancy rights and helps control related costs.
Revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees and affiliates. These fees primarily include rent, service fees and/or royalties that are based on a percent of sales, with specified minimum rent payments. Fees vary by type of site, amount of Company investment and local business conditions. These fees, along with occupancy and operating rights, are stipulated in franchise/license agreements that generally have 20-year terms.
The business is managed as distinct geographic segments: United States; Europe; Asia/Pacific, Middle East and Africa (APMEA); Latin America and Canada. In addition, throughout this report we present a segment entitled “Other” that includes non-McDonald’s brands (e.g., Boston Market and Chipotle Mexican Grill). The U.S. and Europe segments account for approximately 70% of total revenues.
Strategic Direction and Financial Performance
In 2003, the Company introduced a comprehensive revitalization plan to increase McDonald’s relevance to today’s consumers as well as improve our financial discipline. We redefined our strategy to emphasize growth through adding more customers to existing restaurants and aligned the System around our customer-focused Plan to Win. The near-term goal of our revitalization plan was to fortify the foundation of our business. This was substantially achieved by year-end 2004.
Over the past two years, we have also exercised increased financial discipline; we paid down debt, reduced capital expenditures and reduced selling, general & administrative expenses as a percent of revenues. In addition, we returned a significant amount of excess cash to shareholders in the form of dividends and share repurchases.
For the nine months of 2005, the Company reported solid revenue and operating income growth, on top of last year’s strong results. This performance was driven by positive global comparable sales and the continued strength of our U.S. business.
For the third quarter and nine months of 2005, the U.S. achieved positive comparable sales every month and revenues continue to increase. These results reflect the effectiveness of our “better, not just bigger” strategy as we continue to deliver a relevant restaurant experience that is resonating with our customers and building brand loyalty.
In Europe, we are focused on gaining traction and building momentum across the entire segment. In 2005, the positive comparable sales performance and increased customer traffic was driven by France, Germany, and Russia, partly offset by negative comparable sales in the U.K. We are encouraged by our progress and confident that our strategies to enhance our customers’ experience through menu, marketing and value initiatives will continue to generate improvements over the long term.
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During 2005, APMEA’s performance was driven primarily by strong results in Australia. We expect our continued focus on combined initiatives such as branded everyday affordability and new premium menu offerings to broaden customer relevance and drive improved results for the region.
During the second quarter 2005, the Company decided to take advantage of the one-time opportunity under the Homeland Investment Act to repatriate in 2005 approximately $3.2 billion of historical foreign earnings. This resulted in $112 million of tax expense that was recognized in the second quarter. During the fourth quarter of 2005, we expect certain markets will increase local borrowings to fund the majority of the repatriation. This will result in a temporary increase in cash and debt levels on our Consolidated balance sheet at year end. The increase is temporary and does not signal any change in our focus on financial discipline.
McDonald’s global operations generate a significant amount of cash, and we remain committed to returning a meaningful percent of cash from operations to our shareholders through dividends and share repurchase. We increased our annual dividend for 2005 by 22% to $0.67 per share, on top of last year’s 38% increase, reflecting our continued confidence in the strength of our business and reliability of our cash flow. For the full year 2005, we expect to return at least $2 billion to shareholders, and return an additional $5 billion to $6 billion during 2006 and 2007 combined.
The long-term goal of our revitalization plan is to create a differentiated customer experience – one that builds brand loyalty and delivers sustainable, profitable growth for shareholders. Looking forward, consistent with that goal, we are targeting average annual Systemwide sales and revenue growth of 3% to 5%, average annual operating income growth of 6% to 7%, and annual returns on incremental invested capital in the high teens. These targets exclude the impact of foreign currency translation.
Operating Highlights Included:
Outlook
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The Following Definitions Apply to These Terms as Used Throughout This Form 10-Q:
Forward-Looking Statements
A number of factors can affect our business, including the effectiveness of operating initiatives and changes in global and local business and economic conditions. These and other risks are noted in the Forward-Looking Statements at the end of the Management’s Discussion and Analysis.
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CONSOLIDATED OPERATING RESULTS
Quarter Ended
September 30, 2005
% Increase /
(Decrease)
Nonoperating (income), net
n/m Not meaningful
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Accounting Change
Effective January 1, 2005, the Company adopted SFAS No. 123(R), Share-Based Payment. This new accounting standard requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. The Company adopted this accounting treatment prospectively. Prior to the adoption of SFAS No. 123(R), the Company, like most other U.S. companies, accounted for share-based payments to employees under APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, share-based compensation was included as pro forma disclosure in the financial statement footnotes. The Company’s third quarter and nine months 2004 pro forma earnings, as reported in its Form 10-Q for the period ended September 30, 2004, included $0.02 and $0.08 per share of share-based compensation expense, respectively.
In 2005, in connection with its adoption of SFAS No. 123(R), the Company adjusted the mix of employee long-term incentive compensation by reducing stock options awarded and increasing cash-based incentives and other equity based awards. Third quarter 2005 results included pretax expense of $44.3 million (or $0.02 per share) of which $35.1 million related to share-based compensation, stock options and RSUs, and $9.2 million related to the shift of a portion of share-based compensation to primarily cash-based incentive compensation. For the nine months 2005, results included pretax expense of $146.8 million (or $0.08 per share) of which $119.0 million related to share-based compensation and $27.8 million related to the compensation shift.
Net Income and Diluted Net Income per Common Share
For the third quarter 2005, net income and diluted net income per common share were $735.4 million and $0.58, respectively. Third quarter 2004 diluted net income per common share was $0.61, excluding a pro forma expense of $0.02 per share related to share-based compensation as discussed in the section above. The 2004 results included a $0.07 per share tax benefit primarily due to the transfer of shares between subsidiaries and a change in assumptions about the utilization of certain loss carry forwards.
For the nine months 2005, net income and diluted net income per common share were $1,993.7 million and $1.56, respectively. The 2005 results included $178.8 million or $0.13 per share tax benefit primarily due to a favorable audit settlement of the Company’s 2000-2002 U.S. tax returns and $112.0 million or $0.09 per share of incremental tax expense resulting from the decision to repatriate foreign earnings under the Homeland Investment Act. Diluted net income per common share for the nine months 2004 was $1.48, excluding a pro forma expense of $0.08 per share related to share-based compensation as discussed in the section above. The 2004 results included the $0.07 per share tax benefit discussed above.
Diluted weighted average shares outstanding increased for the third quarter and nine months. Shares outstanding at the beginning of the year were higher than the prior year due to stock options exercised exceeding treasury stock purchased in 2004. In addition, the dilutive effect of stock options outstanding was higher in 2005, primarily due to a higher average stock price. For the nine months 2005, treasury stock purchased of 37.3 million shares exceeded stock options exercised of 26.0 million, which nearly offset the increases noted above. As a result of our adjustment to the mix of employee long-term incentive compensation implemented in 2005, the Company granted 8.1 million stock options and RSUs in 2005 compared with 20.3 million in 2004. We expect future grants to be at similar levels to those in 2005.
During the nine months 2005, the Company repurchased nearly $1.2 billion or 37.3 million shares of its common stock.
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Impact of Foreign Currency Translation on Reported Results
IMPACT OF FOREIGN CURRENCY TRANSLATION ON REPORTED RESULTS
Dollars in millions, except per common share data
Combined operating margins*
Net income per common share – diluted
Nine Months Ended September 30,
Foreign currency translation had a positive impact on the growth rates of consolidated revenues, operating income and net income in both periods and on earnings per share for the nine months only. For the nine months, the positive impact was primarily driven by the Euro, the Canadian Dollar and the Australian Dollar. For the quarter, the impact of translation lessened significantly primarily due to the weaker Euro relative to the U.S. Dollar.
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Revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees and affiliates. These fees primarily include rent, service fees and/or royalties that are based on a percent of sales, with specified minimum rent payments.
REVENUES
Dollars in millions
Company-operated sales
Total
Franchised and affiliated revenues
15
Consolidated revenues increased 8% (7% in constant currencies) for the quarter and 8% (6% in constant currencies) for the nine months, primarily due to positive comparable sales in each month of 2005.
In the U.S., the increase in revenues for the quarter and nine months was driven by multiple initiatives that are delivering variety, value and convenience to our customers.
Europe’s increase in revenues for both periods was due to strong comparable sales in Russia, which is entirely Company-operated, and positive comparable sales in France and Germany, partly offset by negative comparable sales in the U.K.
In APMEA, revenues for the quarter and nine months benefited from strong comparable sales in Australia, and were negatively impacted by the transfer of certain subsidiaries to developmental licensees during 2005. Under this structure, the Company receives a royalty based on a percent of sales. In addition, for both periods, revenues benefited from expansion in China, partly offset by that market’s negative comparable sales.
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The following table presents the percent change in comparable sales for the quarters and nine months ended September 30, 2005 and 2004:
McDonald’s Restaurants
The following table presents the percent change in Systemwide sales for the quarter and nine months ended September 30, 2005:
Total sales
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Operating Margins
COMPANY-OPERATED AND FRANCHISED RESTAURANT MARGINS –
McDONALD’S RESTAURANTS
Quarters Ended September 30,
Company-operated
Franchised
Combined operating margin dollars increased $89.8 million or 6% for the quarter (5% in constant currencies) and $271.2 million or 6% for the nine months (5% in constant currencies). The U.S. and Europe segments accounted for almost 85% of the combined margin dollars in both periods.
In the U.S., the Company-operated margin percent decreased for the quarter and nine months due to higher labor-related costs, partly due to increased compensation for store managers and crew as well as increased staffing levels, higher commodity costs and increased occupancy expenses. This was partly offset by positive comparable sales. Commodity cost pressures are expected to lessen during the fourth quarter.
In Europe, the Company-operated margin percent for both periods of 2005 decreased due to the U.K., primarily as a result of negative comparable sales, brand building marketing initiatives and higher labor-related costs, partly offset by strong performance in Russia. For the quarter, results also benefited from positive performance in Germany. In addition, higher commodity costs, primarily beef, had a negative impact across the segment for both periods. Beef cost pressures are expected to lessen in the fourth quarter.
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In APMEA, the Company-operated margin percent in both periods of 2005 was negatively impacted by weak results in South Korea. For the nine months, the margin percent benefited from improvements in China and Hong Kong.
The following table presents margin components as a percent of sales:
COMPANY-OPERATED EXPENSES AND MARGINS AS A PERCENT OF SALES –
Food & paper
Payroll & employee benefits
Occupancy & other operating expenses
Total expenses
Company-operated margins
The consolidated Franchised margin percent increased for the quarter and nine months primarily due to positive comparable sales in the U.S., but reflected higher occupancy costs, due in part to an increased proportion of leased sites. In addition, the quarter benefited from improved results in Europe.
Selling, General & Administrative Expenses
Selling, general & administrative expenses increased 15% for the quarter (14% in constant currencies) and 12% for the nine months (11% in constant currencies). The share-based and related incremental compensation expense due to the adoption of SFAS No. 123(R) accounted for a majority of the constant currency increase in both periods. Selling, general & administrative expenses as a percent of revenues for the nine months of 2005 were 10.5% compared with 10.2% for the nine months of 2004 and as a percent of Systemwide sales were 4.0% for 2005 compared with 3.8% for 2004. The share-based and related incremental compensation expense increased these ratios 0.9 percentage points and 0.4 percentage points, respectively, in 2005.
Other Operating (Income) Expense, Net
OTHER OPERATING (INCOME) EXPENSE, NET
Gains on sales of restaurant businesses
Equity in earnings of unconsolidated affiliates
Impairment and other charges (credits)
Other expense
Equity in earnings of unconsolidated affiliates was impacted in both periods of 2005 by weak results from our Japanese affiliate.
Impairment and other charges (credits) for the third quarter 2005 included a $25.4 million benefit due to the completion of the transfer of the Company’s ownership interest in an international market to a developmental licensee in APMEA. In addition, the nine months included a favorable adjustment of $18.7 million related to certain liabilities established in 2001 and 2002 due to lower than originally anticipated employee-related and lease termination costs. The nine months 2004 reflected a $12.6 million write-off of goodwill in Thailand.
Other expense generally consists of gains or losses on excess property and other asset dispositions as well as provisions for uncollectible receivables. Other expense for the nine months 2005 included a $24.1 million charge related to a supply chain arrangement in Europe.
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Operating Income
OPERATING INCOME
20
The following discussion on Operating Income relates to Pro Forma % Inc / (Dec) Excluding Currency Translation in the table above.
In the U.S., results increased for the quarter and nine months primarily due to higher combined operating margin dollars, partly offset by higher selling, general & administrative expenses, including certain information technology expenses previously recorded in the Corporate segment.
In Europe, results for both periods of 2005 reflected strong performance in France and Russia, improved performance in Germany and weak results in the U.K. In addition, results for the nine months 2005 included the supply chain charge of $24.1 million, which negatively impacted the operating income growth rate by approximately 3 percentage points.
In APMEA, results for both periods of 2005 benefited significantly from the completion of the transfer of the Company’s ownership interest in an international market to a developmental licensee. Results were also positively impacted by performance in Australia and were negatively impacted by weak performance in Japan and South Korea.
Corporate results for the quarter and nine months 2005 benefited from lower incentive-based compensation as well as certain information technology expenses that are now reflected in the U.S. segment. In addition, results for the nine months included the $18.7 million favorable adjustment to certain liabilities previously discussed in the “Other Operating (Income) Expense, Net” section.
Interest, Nonoperating (Income) Expense and Income Taxes
Interest expense for the quarter and nine months decreased due to lower average debt levels, partly offset by higher interest rates for both periods and stronger foreign currencies for the nine months.
For the quarter and nine months 2005, nonoperating (income) reflected higher interest income and lower translation losses.
The effective income tax rate was 32.3% for third quarter 2005 compared with 22.6% in 2004. The lower income tax rate in 2004 was primarily due to the transfer of shares between subsidiaries and a change in assumptions about the utilization of certain loss carry forwards.
The effective income tax rate was 30.1% for the nine months 2005 compared with 28.5% in 2004. The tax rate in 2005 includes a benefit of $178.8 million due to a favorable audit settlement of the Company’s 2000-2002 U.S. tax returns, partly offset by additional expense of approximately $112.0 million related to the Company’s decision to take advantage of the one-time opportunity provided under the Homeland Investment Act. The net of both items benefited the nine month tax rate by about 2 percentage points. The tax rate in 2004 benefited by approximately 4 percentage points primarily due to the transfer of shares between subsidiaries and a change in assumptions about the utilization of certain loss carry forwards.
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Cash Flows and Financial Position
The Company generates significant cash from operations and has substantial credit capacity to fund operating and discretionary spending such as capital expenditures, debt repayments, dividends and share repurchases.
Cash provided by operations totaled $3,208.8 million and exceeded capital expenditures by $2,233.9 million for the nine months. Cash provided by operations increased $252.6 million compared to the nine months 2004 driven by changes in working capital items and strong operating results, primarily in the U.S.
Cash used for investing activities totaled $1,130.9 million for the nine months, an increase of $386.2 million primarily due to higher capital spending and increased purchases of restaurant businesses. Capital expenditures increased $179.4 million for the nine months consistent with the Company’s strategy to increase investment in existing restaurants, primarily in the U.S.
Cash used for financing activities totaled $1,160.6 million for the nine months, an increase of $13.2 million primarily due to higher share repurchases, partly offset by higher proceeds from stock options exercised and lower net debt repayments.
As a result of the above activity, the Company’s cash balance increased $917.3 million from December 31, 2004 to $2,297.1 million at September 30, 2005. For the full year, the Company expects capital expenditures to be approximately $1.7 billion, debt repayments to be about $800 million and to return at least $2 billion to shareholders through dividends and share repurchases in 2005. The guidance related to debt repayments does not take into account the actions that will be taken due to our decision to repatriate $3.2 billion under the Homeland Investment Act.
Debt obligations at September 30, 2005 totaled $8,064.9 million compared with $9,219.5 million at December 31, 2004. The decrease in 2005 was due to net repayments of $607.0 million, the impact of changes in exchange rates on foreign currency-denominated debt of $479.6 million and SFAS No. 133 noncash fair value adjustments of $68.0 million.
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Restaurant Information
The following table presents restaurant information by ownership type:
Restaurants at September 30,
Operated by franchisees
Operated by the Company
Operated by affiliates
Systemwide restaurants
This report includes forward-looking statements about our operating plans and future performance, including those under Outlook. These statements use such words as “may,” “will,” “expect,” “believe,” “plan” and other similar terminology. They reflect management’s current expectations about future events and speak only as of the date of this report. We undertake no obligation to publicly update or revise them. Management’s expectations may change or not be realized and, in any event, they are subject to risks, uncertainties and changes in circumstances that are difficult to predict and often beyond our control. For these reasons, you should not place undue reliance on forward-looking statements. The following are some of the considerations and factors that could change our expectations (or the underlying assumptions) or affect our ability to realize them:
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Additional Statement Regarding Chipotle
This report does not constitute an offer to sell, nor a solicitation of an offer to buy, any securities of Chipotle, which will be made only by prospectus.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There were no material changes to the disclosure made in the Annual Report on Form 10-K for the year ended December 31, 2004 regarding this matter.
Item 4. Controls and Procedures
An evaluation was conducted under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of September 30, 2005. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of such date to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Such officers also confirm that there was no change in the Company’s internal control over financial reporting during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 1. Legal Proceedings
On April 2, 2004, a class action lawsuit was filed in the United States District Court for the Northern District of Illinois (Case No. 04C-2422) (Allan Selbst v. McDonald’s Corporation, Jack M. Greenberg, Matthew H. Paull and Michael J. Roberts), alleging violation of federal securities laws. Two nearly identical actions were subsequently filed in the same court. On October 19, 2004, the lead plaintiff filed its amended and consolidated class action complaint, alleging, among other things, that the Company and individual defendants misled investors by issuing false and misleading financial reports and earnings projections in a series of press releases and other public statements between December 14, 2001 and January 22, 2003, thereby overstating the Company’s current and anticipated earnings. The amended complaint seeks class action certification, unspecified compensatory damages, and attorneys’ fees and costs. On January 18, 2005, the defendants filed a motion to dismiss the amended complaint. On September 21, 2005, the Court denied this motion. The lead plaintiff then filed its First Amended Complaint on October 7, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table presents information related to repurchases of common stock the Company made during the three months ended September 30, 2005.
Issuer Purchases of Equity Securities
Total Number of
Shares Purchased
Average Price Paid
per Share
Under the Program *
Maximum Dollar
Amount that May Yet
Be Purchased Under
the Program
July 1-31, 2005
August 1-31, 2005
September 1-30, 2005
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Item 6. Exhibits
Exhibit Number
Description
(3)
(a)
(b)
(4)
(i)
(ii)
(iii)
(iv)
(c)
(d)
27
(10)
(e)
(f)
(g)
(h)
(j)
(k)
(l)
(m)
(n)
28
(12)
(31.1)
(31.2)
(32.1)
(32.2)
(99)
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
November 4, 2005
/s/ Matthew H. Paull
Matthew H. Paull
Corporate Senior Executive Vice President andChief Financial Officer
30