Edgar Filing: MCDONALDS CORP

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2018



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from to

Commission File Number 1-5231

McDONALD’S CORPORATION

(Exact Name of Registrant as Specified in Its Charter)



Delaware		36-2361282
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

110 North Carpenter Street Chicago, Illinois		60607
(Address of Principal Executive Offices)		(Zip Code)

(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 has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.



	Large accelerated filer x		Accelerated filer ¨

	Non-accelerated filer ¨		Smaller reporting company ¨

	Emerging growth company ¨

	If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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

775,800,409

(Number of shares of common stock

outstanding as of June 30, 2018)

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McDONALD’S CORPORATION

___________________________

INDEX

_______



	Page Reference
Part I. Financial Information

Item 1 – Financial Statements

Condensed consolidated balance sheet, June 30, 2018 (unaudited) and December 31, 2017	3

Condensed consolidated statement of income (unaudited), quarters and six months ended June 30, 2018 and 2017	4

Condensed consolidated statement of comprehensive income (unaudited), quarters and six months ended June 30, 2018 and 2017	5

Condensed consolidated statement of cash flows (unaudited), quarters and six months ended June 30, 2018 and 2017	6

Condensed consolidated statement of shareholders' equity (unaudited), for the six months ended June 30, 2018	7

Notes to condensed consolidated financial statements (unaudited)	8

Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3 – Quantitative and Qualitative Disclosures About Market Risk	34

Item 4 – Controls and Procedures	34

Part II. Other Information

Item 1 – Legal Proceedings	35

Item 1A – Risk Factors	35

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	35

Item 6 – Exhibits	36

Signature	38

All trademarks used herein are the property of their respective owners and are used with permission.

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements



CONDENSED CONSOLIDATED BALANCE SHEET

	(unaudited)
In millions, except per share data	June 30, 2018			December 31, 2017
Assets
Current assets
Cash and equivalents	$	1,623.5		$	2,463.8
Accounts and notes receivable	2,217.2			1,976.2
Inventories, at cost, not in excess of market	49.6			58.8
Prepaid expenses and other current assets	465.3			828.4
Total current assets	4,355.6			5,327.2
Other assets
Investments in and advances to affiliates	1,127.6			1,085.7
Goodwill	2,347.2			2,379.7
Miscellaneous	2,516.8			2,562.8
Total other assets	5,991.6			6,028.2
Property and equipment
Property and equipment, at cost	36,577.3			36,626.4
Accumulated depreciation and amortization	(14,216.1		)	(14,178.1		)
Net property and equipment	22,361.2			22,448.3
Total assets	$	32,708.4		$	33,803.7
Liabilities and shareholders’ equity
Current liabilities
Accounts payable	$	917.9		$	924.8
Income taxes	211.5			265.8
Other taxes	278.8			275.4
Accrued interest	236.4			278.4
Accrued payroll and other liabilities	1,033.5			1,146.2
Current maturities of long-term debt	292.2			—
Total current liabilities	2,970.3			2,890.6
Long-term debt	30,687.7			29,536.4
Long-term income taxes	1,987.0			2,370.9
Deferred revenues - initial franchise fees	606.7			—
Other long-term liabilities	1,134.6			1,154.4
Deferred income taxes	1,173.1			1,119.4
Shareholders’ equity (deficit)
Preferred stock, no par value; authorized – 165.0 million shares; issued – none	—			—
Common stock, $.01 par value; authorized – 3.5 billion shares; issued – 1,660.6 million shares	16.6			16.6
Additional paid-in capital	7,195.2			7,072.4
Retained earnings	49,106.7			48,325.8
Accumulated other comprehensive income (loss)	(2,435.0		)	(2,178.4		)
Common stock in treasury, at cost; 884.8 and 866.5 million shares	(59,734.5		)	(56,504.4		)
Total shareholders’ equity (deficit)	(5,851.0		)	(3,268.0		)
Total liabilities and shareholders’ equity (deficit)	$	32,708.4		$	33,803.7

See Notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)

	Quarters Ended						Six Months Ended
	June 30,						June 30,
In millions, except per share data	2018			2017			2018			2017
Revenues
Sales by Company-operated restaurants	$	2,594.9		$	3,569.6		$	5,130.5		$	6,981.5
Revenues from franchised restaurants	2,759.0			2,480.1			5,362.3			4,744.1
Total revenues	5,353.9			6,049.7			10,492.8			11,725.6
Operating costs and expenses
Company-operated restaurant expenses	2,130.5			2,903.3			4,261.4			5,719.7
Franchised restaurants-occupancy expenses	483.9			438.0			964.2			868.1
Selling, general & administrative expenses	542.1			525.4			1,075.2			1,046.7
Other operating (income) expense, net	(64.9		)	(112.1		)	(213.4		)	(238.0		)
Total operating costs and expenses	3,091.6			3,754.6			6,087.4			7,396.5
Operating income	2,262.3			2,295.1			4,405.4			4,329.1
Interest expense	240.2			230.9			477.0			449.5
Nonoperating (income) expense, net	4.0			2.8			22.4			10.7
Income before provision for income taxes	2,018.1			2,061.4			3,906.0			3,868.9
Provision for income taxes	521.8			666.3			1,034.3			1,259.0
Net income	$	1,496.3		$	1,395.1		$	2,871.7		$	2,609.9
Earnings per common share-basic	$	1.92		$	1.72		$	3.66		$	3.20
Earnings per common share-diluted	$	1.90		$	1.70		$	3.62		$	3.17
Dividends declared per common share	$	1.01		$	0.94		$	2.02		$	1.88
Weighted-average shares outstanding-basic	780.0			811.6			785.4			815.2
Weighted-average shares outstanding-diluted	787.1			819.2			793.0			822.3

See Notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)

	Quarters Ended						Six Months Ended
	June 30,						June 30,
In millions	2018			2017			2018			2017
Net income	$	1,496.3		$	1,395.1		$	2,871.7		$	2,609.9
Other comprehensive income (loss), net of tax
Foreign currency translation adjustments:
Gain (loss) recognized in accumulated other comprehensive income (AOCI), including net investment hedges	(326.4		)	245.7			(300.7		)	533.3
Reclassification of (gain) loss to net income	—			(4.6		)	—			104.4
Foreign currency translation adjustments-net of tax benefit (expense) of $(143.9), $227.6, $(71.6) and $272.1	(326.4		)	241.1			(300.7		)	637.7
Cash flow hedges:
Gain (loss) recognized in AOCI	32.2			(23.2		)	24.7			(30.3		)
Reclassification of (gain) loss to net income	3.6			(2.0		)	15.6			(5.9		)
Cash flow hedges-net of tax benefit (expense) of $(10.5), $14.3, $(11.7) and $20.5	35.8			(25.2		)	40.3			(36.2		)
Defined benefit pension plans:
Gain (loss) recognized in AOCI	—			—			(1.1		)	(0.3		)
Reclassification of (gain) loss to net income	2.1			2.7			4.9			5.3
Defined benefit pension plans-net of tax benefit (expense) of $0.1, $0.0, $(0.8) and $(0.5)	2.1			2.7			3.8			5.0
Total other comprehensive income (loss), net of tax	(288.5		)	218.6			(256.6		)	606.5
Comprehensive income (loss)	$	1,207.8		$	1,613.7		$	2,615.1		$	3,216.4

See Notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

	Quarters Ended						Six Months Ended
	June 30,						June 30,
In millions	2018			2017			2018			2017
Operating activities
Net income	$	1,496.3		$	1,395.1		$	2,871.7		$	2,609.9
Adjustments to reconcile to cash provided by operations
Charges and credits:
Depreciation and amortization	365.0			339.5			727.9			664.8
Deferred income taxes	54.4			64.6			83.6			150.5
Share-based compensation	23.9			21.3			63.7			44.0
Other	(90.7		)	(76.0		)	(145.6		)	(188.7		)
Changes in working capital items	(510.1		)	(531.1		)	(617.3		)	(523.1		)
Cash provided by operations	1,338.8			1,213.4			2,984.0			2,757.4
Investing activities
Capital expenditures	(611.3		)	(368.7		)	(1,164.1		)	(796.4		)
Purchases of restaurant businesses	(11.6		)	(15.0		)	(35.3		)	(18.1		)
Sales of restaurant businesses	143.2			304.1			329.9			849.9
Sales of property	52.8			28.8			124.5			94.1
Other	(63.9		)	(96.0		)	(104.9		)	(138.2		)
Cash provided by (used for) investing activities	(490.8		)	(146.8		)	(849.9		)	(8.7		)
Financing activities
Net short-term borrowings	239.7			(9.3		)	795.7			(778.5		)
Long-term financing issuances	500.5			537.1			2,000.2			2,530.1
Long-term financing repayments	(1.2		)	(1.4		)	(1,002.8		)	(403.5		)
Treasury stock purchases	(1,607.2		)	(1,107.7		)	(3,240.1		)	(1,855.7		)
Common stock dividends	(786.1		)	(761.5		)	(1,583.6		)	(1,532.1		)
Proceeds from stock option exercises	91.7			174.4			167.0			290.6
Other	(1.6		)	1.9			(6.8		)	(4.6		)
Cash used for financing activities	(1,564.2		)	(1,166.5		)	(2,870.4		)	(1,753.7		)
Effect of exchange rates on cash and cash equivalents	(128.3		)	98.7			(104.0		)	153.4
Cash and equivalents increase (decrease)	(844.5		)	(1.2		)	(840.3		)	1,148.4
Change in cash balances of businesses held for sale	—			(18.6		)	—			20.6
Cash and equivalents at beginning of period	2,468.0			2,412.2			2,463.8			1,223.4
Cash and equivalents at end of period	$	1,623.5		$	2,392.4		$	1,623.5		$	2,392.4

See Notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
	Common stock issued											Accumulated other comprehensive income (loss)											Common stock in treasury					Total shareholders’ equity
					Additional paid-in capital			Retained earnings			Pensions				Cash flow hedges				Foreign currency translation
In millions, except per share data	Shares	Amount																					Shares		Amount
Balance at December 31, 2017	1,660.6		$	16.6		$	7,072.4	$	48,325.8			$	(190.2	)		$	(16.5	)		$	(1,971.7	)	(866.5	)	$	(56,504.4	)		$	(3,268.0	)
Net income								2,871.7																					2,871.7
Other comprehensive income (loss), net of tax												3.8				40.3				(300.7		)							(256.6		)
Comprehensive income																													2,615.1
Adoption of ASC 606 ⁽¹⁾								(450.2		)																			(450.2		)
Adoption of ASU 2016-16 ⁽²⁾								(57.0		)																			(57.0		)
Common stock cash dividends ($2.02 per share)								(1,583.6		)																			(1,583.6		)
Treasury stock purchases																							(20.8	)	(3,336.3		)		(3,336.3		)
Share-based compensation						63.7																							63.7
Stock option exercises and other						59.1																	2.5		106.2				165.3
Balance at June 30, 2018	1,660.6		16.6			7,195.2		49,106.7				(186.4		)		23.8				(2,272.4		)	(884.8	)	(59,734.5		)		(5,851.0		)

(1) Accounting Standards Codification ("ASC") 606, "Revenue Recognition - Revenue from Contracts with Customers." Refer to the Recent Accounting Pronouncements footnote on page 8 for further details.

(2) Accounting Standards Update ("ASU") 2016-16, "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory." Refer to the Recent Accounting Pronouncements footnote on page 8 for further details.

See Notes to condensed consolidated financial statements.

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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, 2017 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 six months ended June 30, 2018, do not necessarily indicate the results that may be expected for the full year.

Restaurant Information

The following table presents restaurant information by ownership type:



Restaurants at June 30,	2018	2017
Conventional franchised	21,535	21,317
Developmental licensed	7,013	7,263
Foreign affiliated	5,973	3,356
Total Franchised	34,521	31,936
Company-operated	2,885	5,075
Systemwide restaurants	37,406	37,011

The results of operations of restaurant businesses purchased and sold in transactions with franchisees were not material either individually or in the aggregate to the condensed consolidated financial statements for the periods prior to purchase and sale.

Per Common Share Information

Diluted earnings 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 compensation, calculated using the treasury stock method, of 7.1 million shares and 7.6 million shares for the quarters 2018 and 2017, respectively, and 7.6 million shares and 7.1 million shares for the six months 2018 and 2017, respectively. Stock options that would have been antidilutive, and therefore were not included in the calculation of diluted weighted-average shares, totaled 2.6 million shares and 0.1 million shares for the quarters 2018 and 2017, respectively, and 2.6 million shares and 4.0 million shares for the six months 2018 and 2017, respectively.

Recent Accounting Pronouncements

Recently Issued Accounting Standards

Measurement Period - Tax Cuts and Jobs Act of 2017

In December 2017, the Securities and Exchange Commission published Staff Accounting Bulletin No. 118 ("SAB 118"), which provides guidance on reporting for accounting impacts of the Tax Cuts and Jobs Act of 2017 (“Tax Act”). SAB 118 allowed the Company to provide reasonable estimates in its 2017 consolidated financial statements for the income tax effects of the Tax Act and to report those effects as provisional amounts in its financial statements through a limited measurement period. Under SAB 118, the measurement period may not extend beyond one year from the enactment of the Tax Act.

The Company has not completed the accounting for the tax effects of the enactment of the Tax Act, although it has made reasonable estimates of the effects on existing deferred tax balances and on the one-time transition tax on earnings of certain foreign subsidiaries. Certain aspects of the Tax Act are expected to be clarified, and as such, could impact these estimates. A net provisional tax cost of approximately $700 million was originally recognized in the Company's 2017 consolidated financial statements, and subsequently increased by $52 million in the first quarter of 2018.

Lease Accounting

In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-02, “Leases (Topic 842),” to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Most prominent among the amendments is the recognition of assets and liabilities by lessees for those leases classified as operating leases under current U.S. GAAP. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The Company will adopt the new standard effective January 1, 2019.

At transition, the Company will recognize and measure leases using the required modified retrospective approach. The Company anticipates ASU 2016-02 will have a material impact on the consolidated balance sheet due to the significance of the Company’s operating lease portfolio. The Company will elect an optional practical expedient to retain the current classification of leases, and, therefore,

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anticipates a minimal initial impact on the consolidated statement of income. The impact of ASU 2016-02 is non-cash in nature; therefore, it will not affect the Company’s cash flows.

Recently Adopted Accounting Standards

Derivatives and Hedging

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” ASU 2017-12 expanded components of fair value hedging, specifies the recognition and presentation of the effects of hedging instruments, and eliminates the separate measurement and presentation of hedge ineffectiveness. The Company elected to early adopt the new standard in the first quarter of 2018 and applied the presentation and disclosure guidance on a prospective basis. The adoption of the standard did not have a material impact on the Company's condensed consolidated financial statements.

Income Taxes

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.” The goal of this update was to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The Company adopted this standard on January 1, 2018 using a modified retrospective method, resulting in a cumulative catch up adjustment of $57 million, the majority of which was recorded within miscellaneous other assets on the condensed consolidated balance sheet. The adoption of this standard did not have a material impact on the condensed consolidated statements of income and cash flows.

Revenue Recognition

In May 2014, the FASB issued guidance codified in Accounting Standards Codification ("ASC") 606, "Revenue Recognition - Revenue from Contracts with Customers," which amended the guidance in former ASC 605, "Revenue Recognition." The core principle of the standard is to recognize revenue when control of the promised goods or services is transferred to customers in an amount that reflects the consideration expected to be received for those goods or services. The standard also requires additional disclosures around the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

On January 1, 2018, the Company adopted ASC 606 using the modified retrospective method. Refer to the Revenues footnote below for further details.

Revenues

The Company’s revenues consist of sales by Company-operated restaurants and fees from franchised restaurants operated by conventional franchisees, developmental licensees and foreign 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 foreign affiliates and developmental licensees include a royalty based on a percent of sales, and may include initial fees.

ASC 606 provides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the consideration expected to be received for those goods or services. This standard does not impact the Company's recognition of revenue from Company-operated restaurants as those sales are recognized on a cash basis at the time of the underlying sale and are presented net of sales tax and other sales-related taxes. The standard also does not change the recognition of royalties from restaurants operated by franchisees or licensed to affiliates and developmental licensees, which are based on a percent of sales and recognized at the time the underlying sales occur. Rental income from restaurants operated by conventional franchisees is also not impacted by this standard as those revenues are subject to the guidance in ASC 840, "Leases." The standard does change the timing in which the Company recognizes initial fees from franchisees for new restaurant openings and new franchise terms. The Company's accounting policy through December 31, 2017, was to recognize initial franchise fees when received, upon a new restaurant opening and at the start of a new franchise term. Beginning in January 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the franchise term, which is generally 20 years.

The Company adopted ASC 606 as of January 1, 2018, using the modified retrospective method. This method allows the standard to be applied retrospectively through a cumulative catch up adjustment recognized upon adoption. As such, comparative information in the Company’s financial statements has not been restated and continues to be reported under the accounting standards in effect for those periods. The cumulative adjustment recorded upon adoption of ASC 606 consisted of deferred revenue of approximately $600 million within long-term liabilities and approximately $150 million of associated adjustments to the deferred tax balances which are recorded in Deferred income taxes and Miscellaneous other assets on the condensed consolidated balance sheet.

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The following table presents revenue disaggregated by revenue source (in millions):



	Quarters Ended				Six Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
Company-operated sales
U.S.	$	696.8	$	849.5	$	1,405.5	$	1,685.1
International Lead Markets	1,022.7		1,021.4		2,029.8		1,962.6
High Growth Markets	732.6		1,459.3		1,432.9		2,804.6
Foundational Markets & Corporate	142.8		239.4		262.3		529.2
Total	$	2,594.9	$	3,569.6	$	5,130.5	$	6,981.5
Franchised revenues
U.S.	$	1,264.4	$	1,198.9	$	2,422.9	$	2,292.3
International Lead Markets	908.2		791.8		1,778.6		1,494.1
High Growth Markets	281.4		219.9		553.3		411.8
Foundational Markets & Corporate	305.0		269.5		607.5		545.9
Total*	$	2,759.0	$	2,480.1	$	5,362.3	$	4,744.1
Total revenues
U.S.	$	1,961.2	$	2,048.4	$	3,828.4	$	3,977.4
International Lead Markets	1,930.9		1,813.2		3,808.4		3,456.7
High Growth Markets	1,014.0		1,679.2		1,986.2		3,216.4
Foundational Markets & Corporate	447.8		508.9		869.8		1,075.1
Total	$	5,353.9	$	6,049.7	$	10,492.8	$	11,725.6


*	Although the Company expects the application of ASC 606 to negatively impact 2018 annual franchised revenues by approximately $50 million, results for the quarter and six months ended June 30, 2018, only reflected an impact of approximately $10 million and $15 million, respectively, due to the timing of new restaurant openings and new franchise terms.

Fair Value Measurements

The Company measures certain financial assets and liabilities at fair value. Fair value disclosures are reflected in a three-level hierarchy, maximizing the use of observable inputs and minimizing the use of unobservable inputs. The Company did not have any significant changes to the valuation techniques used to measure fair value as described in the Company's December 31, 2017 Annual Report on Form 10-K.

At June 30, 2018, the fair value of the Company’s debt obligations was estimated at $32.1 billion, compared to a carrying amount of $31.0 billion. The fair value was based upon quoted market prices, Level 2 within the valuation hierarchy. The carrying amounts of cash and equivalents, short-term investments and notes receivable approximate fair value.

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Financial Instruments and Hedging Activities

The Company is exposed to global market risks, including the effect of changes in interest rates and foreign currency fluctuations. The Company uses foreign currency denominated debt and derivative instruments to mitigate the impact of these changes. The Company does not hold or issue derivatives for trading purposes.

The following table presents the fair values of derivative instruments included on the condensed consolidated balance sheet:



	Derivative Assets					Derivative Liabilities
In millions	Balance Sheet Classification	June 30, 2018		December 31, 2017		Balance Sheet Classification	June 30, 2018			December 31, 2017
Derivatives designated as hedging instruments
Foreign currency	Prepaid expenses and other current assets	$	20.7	$	0.5	Accrued payroll and other liabilities	$	(5.4	)	$	(31.0	)
Interest Rate						Accrued payroll and other liabilities	(0.8		)	(0.3		)
Foreign currency	Miscellaneous other assets	5.6		0.1		Other long-term liabilities	(0.1		)	(1.4		)
Interest rate	Miscellaneous other assets					Other long-term liabilities	(21.6		)	(5.9		)
Total derivatives designated as hedging instruments		$	26.3	$	0.6		$	(27.9	)	$	(38.6	)
Derivatives not designated as hedging instruments
Equity						Accrued payroll and other liabilities	$	(3.1	)	$	(1.3	)
Foreign currency	Prepaid expenses and other current assets	$	6.5	$	—	Accrued payroll and other liabilities	—			(5.5		)
Equity	Miscellaneous other assets	153.3		167.3
Total derivatives not designated as hedging instruments		$	159.8	$	167.3		$	(3.1	)	$	(6.8	)
Total derivatives		$	186.1	$	167.9		$	(31.0	)	$	(45.4	)

The following table presents the pre-tax amounts from derivative instruments affecting income and other comprehensive income (“OCI”) for the six months ended June 30, 2018 and 2017, respectively:



	Location of Gain or Loss Recognized in Income on Derivative	Gain (Loss) Recognized in Accumulated OCI					Gain (Loss) Reclassified into Income from Accumulated OCI						Gain (Loss) Recognized in Income on Derivative


In millions		2018		2017			2018			2017			2018			2017
Foreign currency	Nonoperating income/expense	$	31.8	$	(47.5	)	$	(19.7	)	$	9.4
Interest rate	Interest expense	—		—			(0.5		)	(0.2		)
Cash flow hedges		$	31.8	$	(47.5	)	$	(20.2	)	$	9.2

Foreign currency denominated debt	Nonoperating income/expense	$	399.7	$	(978.1	)	$	—		$	—
Foreign currency derivatives	Nonoperating income/expense	1.0		(23.0		)	—			8.0
Foreign currency derivatives⁽¹⁾	Interest expense												$	0.2		$	—
Net investment hedges		$	400.7	$	(1,001.1	)	$	—		$	8.0		$	0.2		$	—

Foreign currency	Nonoperating income/expense												$	11.8		$	(18.5	)
Equity	Selling, general & administrative expenses												(8.6		)	50.9
Undesignated derivatives													$	3.2		$	32.4
⁽¹⁾The amount of gain (loss) recognized in income related to components excluded from effectiveness testing.

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Fair Value Hedges

The Company enters into fair value hedges to reduce the exposure to changes in fair values of certain liabilities. The Company enters into fair value hedges that convert a portion of its fixed rate debt into floating rate debt by use of interest rate swaps. At June 30, 2018, the carrying amount of fixed-rate debt that was effectively converted was $727.7 million, which included a decrease of $22.3 million of cumulative hedging adjustments. For the six months ended June 30, 2018, the Company recognized a $16.2 million loss on the fair value of interest rate swaps, and a corresponding gain on the fair value of the related hedged debt instrument to Interest expense.

Cash Flow Hedges

The Company enters into cash flow hedges to reduce the exposure to variability in certain expected future cash flows. To protect against the reduction in value of forecasted foreign currency cash flows (such as royalties denominated in foreign currencies), the Company uses foreign currency forwards to hedge a portion of anticipated exposures. The hedges cover the next 18 months for certain exposures and are denominated in various currencies. As of June 30, 2018, the Company had derivatives outstanding with an equivalent notional amount of $809.5 million that hedged a portion of forecasted foreign currency denominated cash flows.

Based on market conditions at June 30, 2018, the $23.8 million in cumulative cash flow hedging gains, after tax, is not expected to have a significant effect on earnings over the next 12 months.

Net Investment Hedges

The Company primarily uses foreign currency denominated debt (third party and intercompany) to hedge its investments in certain foreign subsidiaries and affiliates. Realized and unrealized translation adjustments from these hedges are included in shareholders' equity in the foreign currency translation component of OCI and offset translation adjustments on the underlying net assets of foreign subsidiaries and affiliates, which also are recorded in OCI. As of June 30, 2018, $11.7 billion of the Company's third party foreign currency denominated debt and $4.0 billion of intercompany foreign currency denominated debt were designated to hedge investments in certain foreign subsidiaries and affiliates.

Undesignated Derivatives

The Company enters into certain derivatives that are not designated for hedge accounting, therefore the changes in the fair value of these derivatives are recognized immediately in earnings together with the gain or loss from the hedged balance sheet position. As an example, the Company enters into equity derivative contracts, including total return swaps, to hedge market-driven changes in certain of its supplemental benefit plan liabilities. Changes in the fair value of these derivatives are recorded in Selling, general & administrative expenses together with the changes in the supplemental benefit plan liabilities. In addition, the Company uses foreign currency forwards to mitigate the change in fair value of certain foreign currency denominated assets and liabilities. The changes in the fair value of these derivatives are recognized in Nonoperating (income) expense, net, along with the currency gain or loss from the hedged balance sheet position.

Credit Risk

The Company is exposed to credit-related losses in the event of non-performance by its derivative counterparties. The Company did not have significant exposure to any individual counterparty at June 30, 2018 and has master agreements that contain netting arrangements. For financial reporting purposes, the Company presents gross derivative balances in the financial statements and supplementary data, including for counterparties subject to netting arrangements. Some of these agreements also require each party to post collateral if credit ratings fall below, or aggregate exposures exceed, certain contractual limits. At June 30, 2018, 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 certain hedges of the Company’s supplemental benefit plan liabilities where the counterparties were required to post collateral on their liability positions.

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Segment Information

The Company franchises and operates McDonald’s restaurants in the global restaurant industry. The following reporting segments reflect how management reviews and evaluates operating performance.


•	U.S. - the Company's largest segment


•	International Lead Markets - established markets including Australia, Canada, France, Germany, the U.K. and related markets


•	High Growth Markets - markets the Company believes have relatively higher restaurant expansion and franchising potential including China, Italy, South Korea, Poland, Russia, Spain, Switzerland, the Netherlands and related markets


•	Foundational Markets & Corporate - the remaining markets in the McDonald's system, most of which operate under a largely franchised model. Corporate activities are also reported within this segment

The following table presents the Company’s revenues and operating income by segment:



	Quarters Ended				Six Months Ended
	June 30,				June 30,
In millions	2018		2017		2018		2017
Revenues
U.S.	$	1,961.2	$	2,048.4	$	3,828.4	$	3,977.4
International Lead Markets	1,930.9		1,813.2		3,808.4		3,456.7
High Growth Markets	1,014.0		1,679.2		1,986.2		3,216.4
Foundational Markets & Corporate	447.8		508.9		869.8		1,075.1
Total revenues	$	5,353.9	$	6,049.7	$	10,492.8	$	11,725.6
Operating Income
U.S.	$	999.2	$	1,072.9	$	1,997.2	$	2,020.8
International Lead Markets	889.9		776.0		1,699.6		1,442.6
High Growth Markets	282.7		349.5		517.0		650.2
Foundational Markets & Corporate	90.5		96.7		191.6		215.5
Total operating income	$	2,262.3	$	2,295.1	$	4,405.4	$	4,329.1

Subsequent Events

The Company evaluated subsequent events through the date the financial statements were issued and filed with the Securities and Exchange Commission. There were no subsequent events that required recognition or disclosure.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The Company franchises and operates McDonald’s restaurants. Of the 37,406 restaurants in 120 countries at June 30, 2018, 34,521 were licensed to franchisees (comprised of 21,535 franchised to conventional franchisees, 7,013 licensed to developmental licensees and 5,973 licensed to foreign affiliates (“affiliates”) – primarily in Japan and China) and 2,885 were operated by the Company.

Under McDonald's conventional franchise arrangement, franchisees provide a portion of the capital required by initially investing in the equipment, signs, seating and décor of their restaurant business, and by reinvesting in the business over time. The Company generally owns the land and building or secures long-term leases for both Company-operated and conventional franchised restaurant sites. This maintains long-term occupancy rights, helps control related costs and assists in alignment with franchisees enabling restaurant performance levels that are among the highest in the industry. In certain circumstances, the Company participates in the reinvestment for conventional franchised restaurants in an effort to accelerate implementation of certain initiatives.

Under McDonald's developmental license arrangement, licensees provide capital for the entire business, including the real estate interest, and the Company generally has no capital invested. In addition, the Company has an equity investment in a limited number of affiliates that invest in real estate and operate or franchise restaurants within a market.

McDonald's is primarily a franchisor and believes franchising is paramount to delivering great-tasting food, locally-relevant customer experiences and driving profitability. Franchising enables an individual to be his or her own employer and maintain control over all employment-related matters, marketing and pricing decisions, while also benefiting from the financial strength and global experience of McDonald's. However, directly operating restaurants is important to being a credible franchisor and provides Company personnel with restaurant operations experience. In Company-operated restaurants, and in collaboration with franchisees, McDonald's further develops and refines operating standards, marketing concepts and product and pricing strategies, so that only those that the Company believes are most beneficial are introduced in the restaurants. McDonald's continually reviews its mix of Company-operated and franchised restaurants to help optimize overall performance, with a goal to be approximately 95% franchised over the long term.

The strength of the alignment among the Company, its franchisees and suppliers (collectively referred to as the "System") is key to McDonald's long-term success. By leveraging the System, McDonald’s is able to identify, implement and scale ideas that meet customers' changing needs and preferences. McDonald's continually builds on its competitive advantages of System alignment and geographic diversification to deliver consistent, yet locally-relevant restaurant experiences to customers as an integral part of their communities.

The Company’s revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees. Revenues from conventional franchised restaurants include rent and royalties based on a percent of sales with minimum rent payments, and initial fees. Revenues from restaurants licensed to affiliates and developmental licensees include a royalty based on a percent of sales, and generally include initial fees. Fees vary by type of site, amount of Company investment, if any, and local business conditions. These fees, along with occupancy and operating rights, are stipulated in franchise/license agreements that generally have 20-year terms.

The business is structured into segments that combine markets with similar characteristics and opportunities for growth, and reflect how management reviews and evaluates operating performance. Significant reportable segments include the United States ("U.S."), International Lead Markets and High Growth Markets. In addition, throughout this report we present the Foundational Markets & Corporate segment which includes markets in over 80 countries, as well as Corporate activities. For the six months ended June 30, 2018, the U.S., the International Lead Markets and the High Growth Markets accounted for 36%, 36% and 19% of total revenues, respectively.

Strategic Direction

The Company is focused on delivering long-term growth through systemwide execution of its customer-centric growth strategy - the Velocity Growth Plan. The plan is designed to drive sustainable guest count growth, a reliable long-term measure of the Company's strength that is vital to growing sales and shareholder value.

The Company continues to focus on restaurant execution and elevating the overall customer experience, including convenience, value and food offerings. These actions will enable the Company to deliver on the plan’s key pillars of retaining existing customers, regaining lost customers and converting casual customers to committed customers. In each of these pillars, McDonald’s has established platforms that enable each market to engage with franchisees to execute the plan. Markets are focused on acting with speed, efficiency and impact, as evidenced by a recent business reorganization in the U.S. designed to better support franchisees and create a more nimble organization.

Additionally, the Company continues to scale the following growth accelerators:

•Experience of the Future ("EOTF"). Focuses on restaurant modernization and technology, in order to transform the restaurant service experience and enhance the brand in the eyes of the customer. The modernization efforts are designed to drive incremental customer visits and higher average check. McDonald’s currently has EOTF deployed in about one-third of the restaurants globally, with half of the U.S. restaurants expected to be deployed by the end of 2018.

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•Digital. Emphasizes improving the Company's existing service model (i.e., eat in, take out, or drive-thru) and strengthens its relationships with customers through technology. By evolving the technology platform, the Company is expanding choices for how customers order, pay and are served through additional functionality on its global mobile app, self-order kiosks and technology driven models that enable table service and curb-side pick-up.

•Delivery. Offers a platform of added convenience, bringing McDonald's food to customers on their terms. Delivery is now available from over 13,000 McDonald's restaurants. In addition to added convenience, delivery transactions tend to realize a higher average check and a high customer satisfaction rating. While the Company will continue to expand the number of restaurants offering delivery, the current priority is to optimize the delivery business through growing awareness and demand in the areas where delivery is already offered.

The Company remains confident in the Velocity Growth Plan as a result of good performance across our business and is aggressively focused on unlocking more of the plan’s potential to drive long-term sustainable growth.

Financial Performance

Management reviews and analyzes business results excluding the effect of foreign currency translation, impairment and other strategic charges and gains, as well as adjustments to the provisional amounts recorded in December 2017 under the Tax Cuts and Jobs Act of 2017 (“Tax Act”), and generally bases incentive compensation plans on these results, because the Company believes this better represents underlying business trends.

Global comparable sales increased 4.0% for the quarter and 4.7% for the six months. The refranchising strategy has been a key part of transforming McDonald's into a more stable and more efficient organization focused on continuing to grow top-line sales.

U.S. comparable sales increased 2.6% for the quarter and 2.7% for the six months, driven by growth in average check resulting from both product mix shifts and menu price increases.

Comparable sales for the International Lead segment increased 4.9% for the quarter and 6.3% for the six months, reflecting positive results across all markets, primarily driven by the U.K.

In the High Growth segment, comparable sales increased 2.4% for the quarter and 3.5% for the six months, led by strong performance in Italy and positive results across most of the segment, partly offset by continued challenges in South Korea.

Results for the quarter and six months benefited from an increase in sales-driven franchised margin dollars and a lower effective tax rate, partly offset by lower Company-operated margin dollars driven by refranchising. Net income was $1,496.3 million, an

increase of 7% (4% in constant currencies) for the quarter and $2,871.7 million, an increase of 10% (6% in constant currencies) for the six months. Diluted earnings per share was $1.90, an increase of 12% (9% in constant currencies) for the quarter and $3.62, an increase of 14% (10% in constant currencies) for the six months.

Results for the quarter included $92 million, or $0.09 per share, of pre-tax strategic restructuring charges, primarily related to the previously disclosed restructuring of the U.S. business. Excluding these charges, net income was $1,565.0 million, an increase of 10% (8% in constant currencies) and diluted earnings per share was $1.99, an increase of 15% (12% in constant currencies), over prior year earnings per share (excluding $0.03 per share of strategic charges).

Results for the six months also included additional income tax expense of approximately $52 million, or $0.07 per share, associated with adjustments to the provisional amounts recorded in December 2017 under the Tax Act. Excluding these adjustments as well as the strategic restructuring charges, net income was $2,993.9 million, an increase of 14% (10% in constant currencies) and diluted earnings per share was $3.78, an increase of 18% (14% in constant currencies), over prior year earnings per share (excluding $0.03 per share of strategic charges).

Second Quarter and Six Months 2018 Highlights:


•	Global comparable sales increased 4.0% for the quarter and 4.7% for the six months, reflecting positive comparable sales in all segments


•	Due to the impact of the Company's strategic refranchising initiative, consolidated revenues decreased 12% (14% in constant currencies) for the quarter and 11% (14% in constant currencies) for the six months


•	Systemwide sales increased 5% in constant currencies for the quarter and 6% in constant currencies for the six months

•

Consolidated operating income decreased 1% (4% in constant currencies) for the quarter and increased 2% (decreased 2% in constant currencies) for the six months. Both periods were negatively impacted by $92 million of strategic restructuring charges incurred in the current quarter. Excluding the impact of these charges, as well as strategic charges in the prior year, operating income increased 2% (decreased 1% in constant currencies) for the quarter and increased 3% (decreased 1% in constant currencies) for the six months


•	Diluted earnings per share of $1.90 increased 12% (9% in constant currencies) for the quarter and $3.62 for the six months increased 14% (10% in constant currencies), reflecting $0.09 per share of strategic restructuring charges incurred in the quarter. The six months also included $0.07 per share of additional income tax expense related to an adjustment to the

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provisional amount recorded in December 2017 under the Tax Act. Excluding these items, as well as $0.03 per share of prior year strategic charges, diluted earnings per share was $1.99, an increase of 15% (12% in constant currencies) for the quarter and $3.78, an increase of 18% (14% in constant currencies) for the six months


•	Returned $2.5 billion to shareholders through share repurchases and dividends for the quarter. This brings the six months return to shareholders to $4.9 billion

Outlook

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


•	Changes in Systemwide sales are driven by comparable sales, net restaurant unit expansion, and the potential impacts of hyper-inflation. The Company expects net restaurant additions to add approximately 1 percentage point to 2018 Systemwide sales growth (in constant currencies).


•	The Company does not generally provide specific guidance on changes in comparable sales. However, as a perspective, assuming no change in cost structure, a 1 percentage point change in comparable sales for either the U.S. or the International Lead segment would change annual diluted earnings per share by about 5 to 6 cents.

•

Effective January 1, 2018, the Company adopted the guidance issued in Accounting Standards Codification 606, "Revenue Recognition - Revenue from Contracts with Customers." This standard changed the way initial fees from franchisees for new restaurant openings and new franchise terms are recognized. Under the new guidance, initial franchise fees will be recognized evenly over the franchise term. The Company expects the adoption of this guidance to negatively impact 2018 Consolidated franchised revenues and franchised margins by approximately $50 million.


•	With about 75% of McDonald's grocery bill comprised of 10 different commodities, a basket of goods approach is the most comprehensive way to look at the Company's commodity costs. For the full-year 2018, costs for the total basket of goods are expected to increase about 1% to 2% in the U.S. and increase about 2% in the International Lead segment.


•	The Company expects full-year 2018 selling, general and administrative expenses to decrease about 1% in constant currencies.


•	Based on current interest and foreign currency exchange rates, the Company expects interest expense for the full-year 2018 to increase about 5% to 7% compared with 2017 due primarily to higher average debt balances.

•

A significant part of the Company's operating income is generated outside the U.S., and about 40% of its total debt is denominated in foreign currencies. Accordingly, earnings are affected by changes in foreign currency exchange rates, particularly the Euro, British Pound, Australian Dollar and Canadian Dollar. Collectively, these currencies represent approximately 70% of the Company's operating income outside the U.S. If all four of these currencies moved by 10% in the same direction, the Company's annual diluted earnings per share would change by about 30 cents.


•	The Company expects the effective income tax rate for the full-year 2018 to be in the 25-27% range, with volatility between the quarters. Certain aspects of the Tax Act are expected to be clarified, and as such, could impact the Company's tax rate.

•

The Company expects capital expenditures for 2018 to be approximately $2.4 billion. About $1.5 billion will be dedicated to our U.S. business, primarily focused on accelerating the pace of EOTF. We expect to complete EOTF at nearly 4,000 additional U.S. restaurants in 2018, and, as a result, about half of the total U.S. restaurants will have EOTF by the end of 2018. Of the remaining capital, about half will be dedicated to new restaurant openings and the remainder will be allocated to reinvestment in continued expansion of EOTF around the world. The Company will contribute capital towards about 250 restaurant openings, while developmental licensees and affiliates will contribute capital towards the opening of approximately 750 restaurants, for a total of about 1,000 expected restaurant openings in 2018. The Company expects net additions of about 600 restaurants in 2018.

In addition, the Company has other long-term targets that are detailed in its Form 10-K for the year ended December 31, 2017.

The Following Definitions Apply to these Terms as Used Throughout this Form 10-Q:

•

Information in constant currency is 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 adjustments to the provisional amounts recorded in December 2017 under the Tax Act, and bases incentive compensation plans on these results, because the Company believes this better represents underlying business trends.

•

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.

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•

Comparable sales represent sales at all restaurants and 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. Some of the reasons restaurants may be temporarily closed include reimaging or remodeling, rebuilding, road construction and natural disasters. Comparable sales exclude the impact of currency translation and sales from hyper-inflationary markets (currently only Venezuela). Management generally identifies hyper-inflationary markets as those markets whose cumulative inflation rate over a three-year period exceeds 100%. Management believes that these exclusions more accurately reflect 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. Typically, pricing has a greater impact on average check than product mix. Management reviews the increase or decrease in comparable sales and comparable guest counts compared with the same period in the prior year to assess business trends.

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CONSOLIDATED OPERATING RESULTS