麥當勞 (MCD) 2002 Q2 法說會逐字稿

Hello and welcome to McDonald's investor relations teleconference.

At the request of McDonald's, today's call is being recorded.

At this time, I would like to turn the conference over to Miss.

Mary Healy, Vice President of Investor Relations.

Miss Healy, you may begin.

Thank you.

Hello, everyone, and welcome.

This conference call is being webcast live.

Earlier today, we issued a press release with our second-quarter results.

The language in that release regarding forward-looking statements also applies to our comments today.

We hold conference calls such as this one to update you on our business and give you a chance to talk with various members of our top management team.

Even though McDonald's is about as straight-forward and simple a business as one could ask for, in today's stock market environment, we think an ongoing dialogue with investors is especially important.

Today, I am joined by a regular on our call, our CFO Matt Paull, as well as a newcomer to our call, but a long-time veteran of McDonald's, Charlie Bell, President of McDonald's Europe.

Matt will begin our commentary by reviewing the quarter and provide details on our U.S. business.

Next Charlie will discuss our European operations.

I will wrap up briefly by reviewing other areas of the world.

Thank you, Mary.

And good morning, everyone.

For the quarter, our system-wide sales increased 2%, both as reported and in constant currencies.

Revenues increased 4%, again, both as reported and in constant currencies.

Operating income increased 9% as reported, and 7% in constant currencies.

Both franchise margin dollars and company operated margin dollars were higher.

G&A expenses were lower and we are on track to achieve our goal of saving $100 million of G&A in 2002.

This was compared with what we otherwise would have spent.

EPS was 39 cents as reported and 38 cents in constant currencies.

The 39 cents is 15% higher than second quarter of 2001, including last year's $24 million asset impairment charge.

Excluding that charge, second quarter 2002 EPS would be 11% higher than second quarter last year.

We expect 2002 annual EPS to improve significantly over that of 2001.

We expect 2002 EPS of $1.47 to $1.53, excluding the $142 million of charges in the first-quarter 2002.

An increase of 8 to 13% over $1.36 last year.

We expect the foreign currency benefit of up to 3 cents for the year.

Our EPS guidance reflects zero at the low end and 3 cents at the high end, thus, excluding impact of foreign currency translation, we continue to expect EPS of $1.47 to $1.50.

With that general overview, I will turn to the U.S. where system-wide sales increased 1% and compairable declined 1.6% for the quarter.

U.S. operating income increased 7% due to higher company operated margin dollars, lower G&A, and higher other operating income.

For the quarter, U.S. company operated margins as a percentage of sale improved 130 basis points.

This was due to lower fluid and paper costs, elimination of good will amortization and lower advertising and promotion costs.

These were partially offset by higher average hourly wage rates.

This year, as previously stated, we expect U.S. sales to increase in the low single digits while we expect core U.S. operating income, which excludes unusual charges in 2001 to increase in the mid single digits.

While we are pleased with the profit growth in the U.S., our top line sales are clearly not where we want them to be.

We have identified strengths in our U.S. business, as well as areas we must improve.

Our next step is accelerating what's working well and fixing what is not.

Our U.S. agenda addresses both of these.

Its key initiatives are to execute our new taste menu to create great taste and variety, create everyday value in the marketplace, deliver outstanding service at the drive-thru and front counter and operate extended hours where appropriate.

Our new taste menu is producing good results.

In the second quarter we scored two hits with Chicken Selects and grilled Chicken Flat Bread.

The success of these products which generated a significantly higher average check demonstrates that customers are willing to pay a higher price for premium products at McDonald's.

We plan to build on this success later this fall with more new taste products supported by food-based advertising.

We are also pleased with customer response to our new desserts, especially the Hot Fudge Brownie Sundae and Triple Thick Shakes.

And while it's to early to gauge long-term success, we are excited about the latest additions, Dannon drinkable yogurt, Gogurt's portable yogurt and Fruit Roll-ups.

These popular treats offer parents additional choices for their kids.

Another way, toys and premiums designed for 8 to 10 years old with selected Mighty Kids' Meals.

In the near future, these meals will feature the radio Disney CD sampler with CD's of popular teen artists and interactive computer games.

Value has always been a key element of who we are, and in today's competitive U.S. marketplace, everyday value is especially important, so we are refreshing our value approach in markets that have had success in the past.

And we are preparing more consistent focused value messages across markets.

Our goal is to give customers good value while increasing restaurant-level cash flows.

We believe the concept of the Mickey D's dollar menu offered in the east can be effective in other markets as well.

We are also intent on delivering a very high standard of QSC, quality, service, and cleanliness that clearly differentiates from our competition.

Achieving this standard in every restaurant with every customer will take time, but we have begun a comprehensive and intense course of action to do this.

This process includes an internal evaluation of each of or more than 13,000 restaurants five times every year.

In addition, each restaurant will receive external evaluations from mystery shoppers three to five times per quarter or an average of 16 times a year.

We have introduced a nationwide toll-free customer feedback number which is printed on all of our cups and bags.

We will work closely with our owner-operators and company store managers to correct the issues identified by this process.

The 800 customer feedback number is now operating in every market across the U.S.

And at this point, we have conducted more than 91,000 mystery shops in restaurants all across the country.

Our initial mystery shop results show very little difference between restaurants run by franchises and those operated by the company.

Both have improved on the whole in overall scores since our first shops began in February.

Our franchise restaurants have also improved service time both at the front counter and in the drive-thru.

The mystery shops measure quality, service and cleanliness.

The results so far indicate that service and specifically, speed and friendliness of service is our biggest opportunity.

So we are increasing capacity and speed through side-by-side drive-thru lanes and remote order takers.

Being faster will allow us to serve more customers during peak hours driving sales.

For example, adding just three transactions every 15 minutes from noon to 1 p.m. can increase comp sales by 1%.

Of course, speed isn't just a drive-thru issue.

To be more efficient at the front counter, we have adopted team service as our national standard.

Under this system, one crew member takes the customer's order and payment, while a second crew member assembles and presents the order.

We believe this system will provide customers with faster, more personalized service.

As I said earlier, we are not pleased with our sales results in the U.S.

We have to more consistently deliver on our strengths and focus and continually improving areas of opportunity.

But we are on the right course to bring about meaningful improvement.

With the success we are currently having in controlling costs, we should be pleased with both the top and bottom lines when we achieve these goals.

Now I will ask Charlie to update you on our business in Europe.

Charlie.

Thanks, Matt, and good morning, everyone.

Europe contributed more than one-third of total operating income in the second quarter.

European sales increased 7% in constant currency and comparable sales increased 2.7%.

France reported positive comparable sales in the mid single digits, while Germany and the United Kingdom posted slightly positive comparable sales.

France continued its strong performance due to its focus on the customer experience and menu relevancy.

They introduced several products, including the New 280 with a sweeter sauce.

The Chicken Premiere that began in the United Kingdom and May's Country Chicken promotion that was similar to the Chicken Selects offered in the United States.

Germany's performance was driven by the market's growing breakfast business, a strong McRib 20th anniversary celebration and a Japanese and Korean food promotion tied to the World Cup Soccer.

However, a sluggish economy affected Germany's performance.

In the United Kingdom, the McChoice menu continues to be a popular option for customers.

This branded program let's customers tailor meals to their personal tastes while providing the value of a traditional Extra-Value Meal.

It is also designed to build our snack business as the offering features eight items for 99 PENCE each, including Double Cheeseburger, McRib, large fries and McFlurry.

In addition, the UK's premium sandwich offerings were also successful.

For example, April featured the Chicken McWrap, a roasted breast of chicken, char grilled peppers and onions, lime salsa with sour cream and chive sauce wrapped in a tortilla.

Europe's company operated margins is a percentage of sales decline.

Primarily due to higher labor costs, but partially offset by improvements in the cost of beef and chicken.

Germany had relatively flat company-operated margins, while the UK's and France's margins declined.

Our labor expense in Europe has been increasing due to higher social costs.

This continues to be our biggest challenge to growing margins.

We are intent on offsetting these increases through labor efficiencies, as well as controlling food and other costs and growing comp sales-to improve margins going forward.

The second-quarter 7% sales and 8% operating income constant currency growth rates were not as strong as those of the first quarter.

However, Europe's second quarter comparable sales were negatively impacted by about 1 percentage point because Easter and the related holiday break was in March of of this year versus April in 2001.

We also believe the World Cup soccer games held in June hurt sales somewhat as fans stayed home to watch matches which were often held during peak lunch periods.

Still, we are on track to grow sales in the high single digits and grow core operating income in the high single to low double digits for the year.

With that brief review of the new term, I will turn to our long term vision for Europe.

I will start by giving you a perspective on size of our business.

McDonald's Europe produces 24% of system-wide sales, 32% of total revenues, and 36% of consolidated operating income.

McDonald's European sales are greater than the worldwide sales of each of Wendy's, Arby's, Starbucks, Jack-in-the-Box, and the Hardy's, Carl's Jr. group.

McDonald's European sales equate to 85% of Burger King's worldwide sales, even though we have just under half the number of restaurants Burger King has worldwide.

We also have higher sales per unit than any of these brands and higher total operating income.

Finally, consider the informal eating-out market in Europe.

If you segment that market to include McDonald's and our top three QSR competitors in each country, our share of visits has increased from 51 to 55% over the past 12 months.

Clearly, McDonald's Europe is a large and vibrant business with enormous potential.

So how do we see the future?

Simply put, we will become more things to more people more often more profitably.

What does this mean?

It means attracting more customers, doing it smarter, and leveraging our [pan] European resources to achieve economies of scale.

McDonald's European management team has a strategic plan to achieve our goals.

Key drivers are: to become the best employer, franchisor and developer of people, to continually improve the delivery of QS&C to every customer every time.

To maximize value by out distancing the competition on the experience and price.

To reduce the cost of doing business while enhancing customer and restaurant staff experience, and to invest and maintain our restaurants to achieve the best customer and staff experience and operating efficiency.

And to significantly increase same-store sale, customer counts, and market share by becoming more relevant to people's everyday lives.

And finally, to become the most trusted local business and brand in each community we serve.

Here are a few initiatives that support our strategic growth plan.

We are strengthening our morning day part by giving customers more reasons to visit McDonald's before 11 A.M.

Two ways we are doing this is through breakfast and coffee.

We currently serve breakfast in only a handful of our markets, and we believe it is a huge opportunity for us.

For example, breakfast, which began in the United Kingdom in 1994 is the fastest growing segment in that market.

It has grown over time to almost 9% of sales.

We began serving breakfast in Sweden last November.

And that now produces about 2% of sales.

Clearly, this is an area with continued room for growth.

Germany is another success story.

That market relaunched a breakfast day part in March of this year with bagel sandwiches, muffins and premium coffees.

During the initial launch period, McDonald's share of the out-of-home breakfast market rose to 22%, and today, our breakfast sales are 11% higher than a year ago.

We've added a number of coffee options.

Delicious premium coffee drinks served in McDonald's, as well as gourmet coffee and snacks served in our cafes.

Offerings vary by country to meet local taste preferences.

All in all, we believe we provide a better experience for a better price than our competitors.

To further expand our customer base, some markets are updating their restaurant decors.

France is converted about 40% of its restaurants to one of seven design packages.

The updated look has had a positive impact on both customers and our crews, as evidenced by higher comparable sales and higher adult enjoyment scores.

Service is critical to the customer experience, and we are working hard to make ours the very best it can be.

We continue to make strides in that area as shown by our mystery shop customer service scores which are on the rise year over year in most markets.

Another way enhancing the brand is through menu.

We are sharing successes in that arena and improving menu variety while controlling costs.

For example, the Chicken Premiere sandwich was a big hit in the UK.

We have since introduced it in Belgium and are currently featuring it as a promotional item in France.

We have seen very strong acceptance of this product by our customers.

As you can probably tell, I am very excited about our European business.

The market for McDonald's' products services and experiences is there.

We have the advantage of being a very strong player with plenty of room to grow.

I'm also proud to be leading a team of extraordinary people, dedicated to achieving our goals, which will realize the upside potential of our business in Europe.

With that, I will turn the discussion over to Mary.

Thanks, Charlie.

Moving to Asian Pacific, Middle East and Africa.

Sales in this segment declined 6% in constant currency for the quarter.

The segment's operating income defined 25% in constant currency if you exclude the 2001 asset impairment charge.

Including this charge, the segment's operating income was flat on a constant currency basis.

Comparable sales for the segment declined 11.7% for the quarter primarily driven by Japan's high teen comparable sales decline.

This segment continues to be hurt by Japan's weak economic conditions and lingering consumer concerns about food safety.

We continue to share food safety and quality messages in Japan, and we have launched a new value and taste initiative, which we expect will drive incremental customers visits and improve results.

In May and June, Japan expanded the availability of new food tastes to a much broader group of restaurants.

These new tastes include premium coffees, soups, salads, and desserts.

In mid-July, Japan introduced value pricing on Happy Meals.

Over the next two months, Japan will roll out new, every-day low prices for hamburgers, cheeseburgers, frankfurters and featured extra-value meals as well as McChoice menu.

Australia continued to perform well during the quarter with mid-single digit positive comparable sales.

The continuation of a strong marketing campaign, exciting new taste menu choices, and a focus on reducing costs drove Australia's second-quarter sales and profits.

The last segment I'll discuss is Canada, which posted a 2% total sales increase but a comparable sales decline of 2.1% for the quarter.

In June, Canada launched the Canadian Lighter Choices menu, part of our commitment to innovation and value.

The menu includes two sandwiches, the fruit and yogurt parfait and salads.

While it is a little early to evaluate results, we are excited about the program's potential.

With that, we would like to open up the call for your questions.

The operator is going to explain the polling process.

At this time we will start the question and answer session.

If you have a question, simply press star 1 on your telephone touch pad.

If you are using speaker equipment, you may need to lift your equipment before pressing star 1.

If you wish to cancel your question or if your question has already been answered, simply press star 2.

Once again, if you have a question, press star 1 and to cancel a question, press star 2.

One moment while the questions register.

Okay, our first question from Coralee Whitter from Goldman Sachs.

Hi, Coralee.

Hi.

I have questions on the U.S. federal related.

With your new taste menu, can you describe the research process that is behind rolling those out?

It seemed like the success of Chicken Flat Bread was a little bit of a surprise.

I want to understand the process behind that.

Second, have you seen service times go down at the counter since you have introduced the split counter service?

And third, how receptive are franchisees to returning to the original ad contribution that you had taken down this year and what would be the impact to U.S. restaurant margins?

Okay, Coralee.

Matt, do you want me to touch on the --

Why don't you take the first one and I will take the second two.

In terms of the new taste menu research process and specifically as it relates to Chicken Flat Bread, you know, we do a lot of consumer testing with any of our new products, including all of those that are appearing on the new taste menu.

That testing is done from a couple of perspectives.

One, it is just to find out what the -- you know, how favorable the customers' impression is on these products as well as what the repurchase intent is.

But I will say that despite that pretty thorough testing, we hadn't had a lot of experience with a product like chicken -- the grilled Chicken Flat Bread, which was a higher-priced premium sandwich offering for us.

And somewhat different than many of the other offerings we had had.

So it did take us a little bit by surprise we got the volumes that we did with that product in the first ten days of the new taste menu offerings.

As you know, just to avoid disappointing customers, we did decide to pull the advertising for short period of time toward the end of June into about mid-July before we began advertising it again.

So I think that with this particular product, it did take us by surprise.

Whereas, with the Chicken Select, the new taste menu offering just before that, we had a little more experience with that type of a product, and so the level of unit sales there, which was -- ended up being very similar to the grilled Chicken Flat Bread was not as much of a surprise to us.

You know, with any consumer testing and even a market test, it is a limited-size test.

So there is no way to know that that is necessarily going to be exactly what you are going to replicate across the country.

We actually built in some cushion of over and above what we thought the grilled Chicken Flat Bread would do and it did even better than that.

In terms of the team service --

Coralee, I will cover the ad question and then the team service.

The ad question, the contribution to the national co-op prior to last year had been -- last year had been 1.85%.

It was reduced for 2002 to 1.5%.

You then have to make some assumption about whether or not the local store was -- the local was choosing to increase the local rate or keep it where it was.

If they didn't adjust the local rate, then 35 basis points, you know, went to our margin line in terms of improvement in 2002.

In terms of what's going to happen for 2003, we are right in the middle of the process as I speak, and it will be voted on by our franchisees.

I think it is likely that we will decide to increase the national spent.

The exact amount hasn't yet been determined, and obviously, if all that happened is that we increase the national spend and we didn't get additional sales out of that, that wouldn't help our margins.

But the reason we are going to spend more nationally is because we expect it will boost our sales.

The issue of service times at the counter.

I think that we don't have all the data we would like on this, but what we have seen is when team service is properly staffed, people are trained, and we execute it well, it is significantly helps our service times, but I can't say that we are seeing evidence of that across our entire U.S. system yet.

I think when we get it installed in all of our restaurants, and the people execute it well, we are confident it will bring down our service times.

We haven't seen that data yet.

Thank you.

Our next question comes from Mark Kowlinouski from Solomon Smith Barney.

Hi.

Two things to ask about, on the Chicken Flat Bread sandwich.

I've heard that some franchisees are lobbying for it to become a permanent menu item.

What are the chances of that happening?

And just in general, what is the decision process like in determining whether any product from the new taste menu would become a permanent menu item?

Second question is related to France, if I am not mistaken, I heard that France's company operated margins were down despite the mid-single-digit top growth if Charlie could touch on what part of top growth is needed for the environment going forward for France to see flat to up margins.

I will take the issue about the flat bread and decision making process regarding whether or not the item becomes permanent or not, Mark.

It's a difficult process.

The product as you've mentioned, has been very popular with our customers and with our franchisees.

Part of the reason it's so popular with our franchisees because the average check has been at very, very high levels.

The reason for introducing the Chicken Flat Bread and Chicken Selects, we wanted to add variety to our menu.

If we make something like that permanent, you lose some of the credit you are hoping to get with consumers on the variety issue.

And so, If you were to make products like that permanent, then you would have a reduced ability to introduce other new products in the future because too many things at once in the kitchen creates confusion and that's something we are trying to get away from.

We have listened to our franchises and customers carefully and likely we will be bringing Flat Bread back.

I don't think we havemade a decision to make it permanent, but you are correct in assuming that we are being lobbied on that issue.

Mark, I would just add, the great thing about the new taste menu that gives us flexibility on a local level.

And there are many markets that are planning to continue offering the grilled Chicken Flat Bread beyond the end date for the national advertising.

So that one's already in place.

They have that flexability to keep it on the menu during August and perhaps support it with some local advertising as well.

The other thing I would point out is with any new product, you go through a normal kind of new product curve.

And I think this is -- I'm sure standard across the industry.

So it really takes a little while to see what the sustainability of any product will be over the long term.

McRib is a great example of a product that has always been very popular for us in the U.S. on a promotional basis.

Where we bring it in and get a lot of business for a limited period of time, but what we have found with that particular product is it just doesn't seem to have the sustainability that we would need for a permanent menu item.

That's another factor that we will consider.

Mark, one last item on Flat Bread.

One other reasons why our franchises are excited is.

In terms of our new product offerings, it has had the highest success rate with female customers of any other New Taste Menu items than we offered.

That's another reason people are trying to find ways to keep it in the stores.

Answer his question, with respect to company-operated margins in France, and they are primarily down and driven by government regulations and certainly our labor costs.

But I want to point out that our margins in France are still some of the highest in all of Europe and, indeed, the McDonald's world.

With respect to what we need to do going forward.

Our biggest opportunity is in productivity and we are working on that.

We have a variance -- the simple measure that we use at McDonald's for transactions per labor hour.

And they range across Europe from about a high of about 13 to a low of about 4 or 5.

And so a number of our markets have an opportunity to go after that.

France is one of those.

And they are working on their training and development of their people, reducing their turnover, and we think that will ehance the productivity rate.

Thanks for the question.

Next question comes from Michael Sherck from Morgan Stanley.

Thanks.

Really, just two pieces.

You talked of the success of the New Taste Menu, the Flat Bread, the chicken product, and noticed in the mystery shops you have seen improvement, you didn't quantify the magnitude, but you've seen some improvement in the shop, but clearly they haven't seen it reflected in Same-Store sales per performance.

I guess my question is, what will it take to begin to drive Same-Store sales in the U.S.?

Is advertising one of the issues and that's one of the reasons you are looking at moving that back up?

Or is it, you know, merely a saturation issue.

As we look at the overall growth of the industry, it is very difficult to conceive McDonald's growing in excess of that.

If you can touch on that and one other which is, what was the debt level at the end of the quarter?

This is Matt.

You can probably tell my my lack of an accent, but I will deal with the debt level right now is right around $9.3 billion dollars, a little bit under that.

And on the New Taste Menu success, we certainly are talking about the very same issues you asked in your question.

And I think it is two things.

First of all, I think there is terrific room for improvement.

I don't think that the industry and its growth rate is limiting our ability to grow our comps.

That is not our issue.

I think the issue is a combination of things.

It's QSC and marketing.

On the QSC side, and I think that we all suspect it had would take a while to turn around perceptions.

People form perceptions about a brand and about the level of service you provide over a period of time.

And so we are in the process of changing what's happening inside our stores, and we recognize it will take some time for customers to notice the difference and give us credit for it and reward us with more visits, but the other side of this is the marketing.

You know, we all concede that with the power we have in the marketing dollars that we have at our disposal, we have not delivered very effective, very consistent, very aligned messages and we're going to be doing a much better job of that, part of that will be we are going to have a higher national spend next year, hopefully that addresses your question.

Thanks.

Our next question comes from Timothy McCallister from UBS PaineWebber.

Hello, Mr. Paull, one very important question for you to follow up, actually this is following up on what the previous caller had mentioned about the debt.

Basically, your long-term debt has doubled over the past five years while years while your net assets certainly have not.

I know you still enjoy a high credit rating and strong cash flow, but I'm wondering if you could give more explanation of what your strategy is toward the use of leverage.

Thank you.

Certainly.

Thanks, Timothy.

Our debt levels have gone up principally as a means of buying back more stock.

And we have announced back in October that when we targeted the stock purchase program for the next few years, first of all, we weren't putting a time line on when we expected to complete the $5 billion share repurchase, because we are very sensitive to protecting our credit rating.

And so we said then and continue to operate this way, that we are going to look at the free cash flow being generated by our business and we will adjust our stock repurchase activity to be consistent with the amount of free cash flow we are throwing off.

We don't have plans to take on huge amounts of incremental debt soley for the purpose of buying back our stock.

So we are trying to leave ourselves with some cushion against the credit rating category that we are in today.

I think if you look at the U.S.-based industrial companies, our credit rating is still in the top 30 or 40 of all U.S.-based industrials.

Thank you.

Next question comes from John Glass from CIBC World Markets.

Thanks.

It's two related questions on European profit margins.

Do you think - Can European profit margins go back before pre Mad Cow levels or has there been something that's structurally changed in the cost structure in Europe?

So, if can kind of, give us a time frame if you think margins get back.

Is it just a function of volumes or is there something else?

And then, related to that, have you revisited the question of perhaps refranchising some of the more heavily company-owned markets in Europe as a way to take advantage of the rebound in sales and perhaps higher cost pressures?

Thanks.

Thank you for your question, John.

I mean, obviously, we would hope that at some point in time, we will get back to the margin levels that we had in the past.

But there is a whole lot of things that affect margins as I talked about. [INAUDIBLE] costs and regulatory costs and insurance costs and so forth.

And we are focused on increasing same-store sales and gaining more customers into our average store.

This will also help us regain margin over time.

But, you know, I can't sort of predict a time line for it other than to say the team is working very hard to get the efficiencies that we need to -- to make that enhancement.

The beef cost has certainly helped us this year so far, but hadn't been enough to offset some of the other cost increases.

But basically, there are no structural reasons that we can't get there.

Relative to the mix of company-operated versus franchise stores, this varies dramatically by country.

Some of our markets are 100% company-operated, others are 100% franchised.

We look at this from time to time, but at this point in time, there won't be any dramatic shift in the mix as we go forward.

But thank you for your question.

Our next question comes from Howard Penny from Suntrust.

Hi, thanks very much.

I have two or three questions, if you don't mind.

First, what was the averagecheck up in the quarter?

And second, given your rate of share repurchase program if I am doing the math right by the end of the decade, you will have shrunk the equity value of the company to zero effectively bringing the company private.

Is that what you still intend to do?

The third question is, one of your competitors talked about corporate governance issues and I was wondering if the management team of McDonald's is gonna certify their financial statements.

Thanks, Howard.

On the average check -- we actually don't disclose the average check, and to be quite honest, I don't even know exactly what it was in the quarter.

I haven't looked at that.

The average check for the grilled Chicken Flat Bread was -- near -- about double, I'd say what our overall average check is.

So I'm sure -- you know, it had some positive impact on the check for the quarter.

And on the share repurchase activity, you know, we have no intentions to take the company private.

I would like to, you know, correct an impression from an earlier question.

I think there was a question earlier that implied that we had doubled our debt load from five years ago.

I have the numbers in front of me now.

And the debt level in '97 was roughly 6.5 billion.

And so the increase over that five-year period is about a 43% increase, and, again, we have no plans to take the company private.

Lastly on the corporate governance issue, we will follow the SEC order.

We will be certifying our financial statements on August 14th.

And just a quick reminder, as Mary mentioned in the beginning, our business model isn't all that complicated.

We don't have revenue recognition issues because we are a cash business.

We have virtually no inventories so we don't have inventory evaluation issues and we have just about no receivables so we don't have any bad debt reserves to worry about.

Thank you.

Our next question comes from Joe Buckley from Bear Stearns.

Thank you, I have a couple of questions.

First, a couple for Charlie.

Looking at the June numbers.

The system wide sales numbers given at the mid quarter update versus the full quarter numbers.

Looks like June softened considerably in Europe, by my calculation accounts, it looked like they were flat for the month.

I am curious if you would attribute that to World Cup or if there are other issues that might have you affected the June comps?

And then secondly, just curious your thoughts on the long-term unit growth potential in Europe.

Just what kind of rate of unit expansion you expect to maintain over the next three to five years in Europe?

Okay, Joe.

Thanks for the question.

Look, we primarily believe the business softened due to the World Cup.

Initially, it was planned that most of the matches would take place at breakfast time, which we thought would benefit us, but a number of the matches, particularly in the big countries like Germany and so forth took place over the lunch-time period, which significantly hurt our lunch-time business.

So that was primarily the reason that affected the June results across much of Europe.

In terms of unit growth, we are still saying that the range between 400 and 450 a year is about the right rate for us to grow.

It's off the peak of three or four years ago where we were growing about 600, 680 a year but we believe that's a sustainable rate us to to add incemental profit and do it the right way across Europe.

Thank you.

Our next question comes from Brett Levy from UBS Warburg

I guess it is still good afternoon for me.

A couple of little questions.

Hello, Charlie.

How are you?

First question for Charlie is on VAT.

Is there anything that you expect to see the lowering?

I know there has been some speculation on that.

Secondly, following on the share repurchase question.

An option-related question, do you have any -- can you quantify what the effect would be of options in - to your P & L?

And third, deals with U.S. and QSC, how many of your units have had the comprehensive first run of the full grading, the two-day grading.

What's the initial feel, consistency and are there any complaints?

Thank you.

Well, I'll take the first question, Brett, nice to hear from you.

Well, as you know the VAT rate varies across Europe.

The whole -- throughout our industry has been lobbying governments hard on this issue.

This is primarily driven by Brussels and Brussels needs to act first and then it needs to be enacted at the local country level.

We are optimistic, but we have not planned for it.

Is my -- would be the best way I could answer that -- that question.

And we -- we really are in the hands of the politicians quite frankly and very much a political issue in Europe today.

And with that, I will hand it over to Matthew with our -- without the accent.

Hi, Brett, on share repurchase and effective options.

I think I understand your question, and if you looked over a five- or ten-year period and you're trying to figure out what is the net effect of granting options which get exercised versus share repurchase, we have roughly 30% more shares repurchased than options granted and exercised over the last ten years.

That's probably the best indication.

If you look at any one, three, or six-month period, you will get a crazy answer because obviously when our stock is up, people are exercising them.

When our stock is not, people are not.

And I will and this over to Mary for that last question.

Brett, just as a reminder, the first step in the process is really the system training days which is a full day in each restaurant, working with the operator and their management team to go through a thorough review of every system in the restaurant and make sure that we're all on the same page in terms of what our expectations are, as well as to identify the low-hanging fruit that might exist in that restaurant in order to improve the customers' experience.

As first step, we are still completing those training visits for all restaurants because rather than just zipping through all of them and kind of a checklist mentality, we are taking enough time in the market to work with the management team so we can effect some improvement and some change right away.

But I think your question was really about the second step, which is the full two-day visit, which is a graded visit.

How many restaurants have completed that.

We are roughly -- at the end of June, we had about 20% of the restaurants had received that visit.

Now that we are toward the end of the July, I expect that percentage is up a little bit.

You know, it will probably be another, you know -- I don't know, I'm guessing it will be another few months before every restaurant would have gotten that visit, maybe as much as through the end of the year.

Thank you.

Our next question comes from Andrew Barish from Bank of America.

Good morning, Andy.

Good morning.

A couple of cost-related questions.

If you can give us a sense in Europe, maybe an average wage rate increase for the big three markets or something like that.

I know it obviously varies across countries or try to match that up against what is going on in the U.S. business and then how have you quantified sort of cross border economies of scale in terms of purchasing and things.

Any goals on that over the next year in terms of dollar saved or purchasing in the European business?

And then finally just one traslation question.

On the G&A numbers, am I correct in that when the dollar actually weakens, you know, some of your local G&A numbers actually get reported back on a higher basis?

Am I thinking about that in the right way?

Sure.

Let me take that -- that last one first because that's an easy one, yes, you are correct in thinking about that in the right way.

In other words, as the dollar weakens, and as it has weakened significantly against the euro in particular and the pound over the last month plus, all of the local currency numbers are reported as a higher number in U.S. dollars, including all the expenses.

So the G&A expenses would look a little higher just because of the currency translation change for those markets.

And as long as we are on that topic, that would extend over to our other -- other numbers like capital expenditures, debt balances, and so on, since a pretty significant amount of our debt is foreign currency debt, as much as 60%, as you are looking at debt balances going forward, if the dollar stays at these rates, you would expect just because the translation again, that would look a little higher than it otherwise would have.

Andrew where are regards to the wage rates of some of the markets, I don't have the specific numbers in front of me.

We can certainly get back to you.

But -- they have ranged from around, you know, 4 to 5%, up as high as 8%.

The big thing to take into account is the biggest multiplier here is the social costs that go on top of that.

So then you've got -- and that varies by market up to about 45% of wage increases applied to that number for social costs.

So one of our people can certainly get back to you with the detail on that.

As far as cross-border work, we are working together better than we have ever done before in Europe and the supply chain is the key area of opportunity that our people have been mining out in recent years.

They have done great job in the past and they continue to do a great job today.

We have some aggressive goals over the next couple of years of around 50 million euro savings in recurring costs over the next couple of years, and we also intend to save on capital expenditure for new stores by a substantial amount of money over the next two years.

So we are working together better than ever before.

Andy, I'd just like to clarify that that targeted savings is system wide across both franchise and company-operated restaurants.

That's a systems savings target.

Our next question comes from Janice Meyer from Credit Suisse First Boston.

Hi.

Thank you.

Two questions, first, the marketing issue and raising the advertising contribution.

Why do you want to raise the contribution when you are still looking for global head of marketing? -- you have already significantly outspend your competition, so why spend more before you really have the right message.

And, you know, maybe you can update us on the status of that search.

The second thing is, if the average check is up and traffic is obviously down more than Same-Store sales, at least in the U.S., could you talk about where you think the customer is going?

Do you have any research or anecdotal evidence.

Can't imagine Wendy's salads had a big impact on you but do you think that Burger King's new burger products are hurting you?

Janice-- I'll deal with the marketing question first.

The vote taking place now and in the next few weeks, what the national ad rate will be, this is for 2003.

Hopefully, by then, we will have all of our marketing positions at the highest level filled.

And when you look at what our strengths are, you know, I personally believe strongly that we need to be spending more on a national basis for two reasons.

One is, it's much more efficient.

Secondly, I think that we have confused consumers with all of the different messages we send at different levels.

We are in a day and age where somebody can sit in front of a television set and they are watching broadcast some of which are national, some of which are local from other parts of the country, and we need to remember that.

And so to the extent we send more of a national message I think we will be more aligned and we will confuse consumers less about what our messages are.

I think we are doing the right thing.

It would be nice to figure out exactly, you know, who will be heading marketing before we put all our plans in place, but the way our system works is you have to schedule the spending decision for votes well in advance of -- of when the year will come about.

I think we are doing the right thing.

In terms of -- you know, where customer traffic is going, we certainly spend a lot of time looking at that.

There is no evidence that it's going to any one particular competitor.

I think one of the things that's happening today is that customers have more choices than they have ever had before.

One of the reasons for introducing everyday variety into our U.S. menu through the New Taste Menu is to give people more choices at McDonald's.

Mary, do you have anything to add?

I think I would just say also, Janice, that given some of the numbers we have seen our competitors release over the last couple of months in terms of their comparable sales, it would be hard to believe that some of that might not have come from McDonald's.

And in addition, I think when anyone is introducing new products as I kind of commented on earlier and we know that Burger King has introduced a slew of new products, they will get a fair amount of trial.

It remains to be seen how sustainable all that will be, but I have got to believe that with the news surrounding that, that we probably had some impact from the Burger King new product introductions.

I would add to what Matt said, where we are strong, we are strong.

So we are doing very well, we think, with the New Taste Menu offerings.

We have been pleased with what we have seen, as Matt mention, in terms of our dessert menu offerings in the U.S. that is driving incremental transactions.

Where we may need to focus on, you know, our communities a little bit more, again, the effective use of everyday value.

We are doing a great job in some markets, but not a great job in all markets, and we think that's an opportunity.

And then as well we think that -- you know, we've always had a very strong equity with kids, and we want to continue to strengthen that, and so that's where we are putting some effort behind the products that we talked about, as well as just ensuring we have the, you know, very high premium properties and attractive properties to continue driving a high level of kids' business and Happy Meal sales.

Thanks.

Our next question comes from Mark [INAUDIBLE] from John Lebanon Company.

Hi, Mark.

How are you doing?

This question really comes from an investors point of view.

I wanted to go back to the Chicken Flat Bread sandwich not so much because it is a particular product, but more so, a couple of things that ring through to me from your discussion.

I would have thought the correct answer would be we're going to keep the Chicken Flat Bread sandwich because the average check has gone up, and we are bringing in a demographic client that our franchisees tell us- the female, whether the worker or the mom with the kids that are buying kids' meals.

We are capturing a demographic group where we have lacked before.

Why is that not a correct answer?

I am a little confused why there is even a question that this product might not stick around on a national basis.

Mark, I will try to answer.

And one of the issues here is, as Mary mentioned earlier, you look at the sales per week when you run a promotion and you look to see what's happening.

If we run a promotion like this six or seven weeks and we see sales continuing to build toward the end, I think it is likely we would either bring it back or that we would consider making it permanent.

We are not there yet.

Let me give you an example from our past.

We ran McRib, and it was very successful in the past, but it would always trail off at about the fourth or fifth week.

And McRib has been successful for us over the years, bringing it back for a few weeks at a time, maybe once -- once in a while, twice a year.

I agree with you that the demographic that we have appealed to here is important to us and for that reason alone, we will consider all of this, but our operations people tell us how many products we can carry at a given point in time and do a good job with, and this product isn't that difficult, and as you said, the average check is higher.

So there is a chance that we will extend it or that individual comps will choose to extend it, but to make something a permanent menu item and we got the same question, by the way, with Chicken Selects, a lot of pressure to make that a permanent item.

We decided instead to bring it back again in the second half of the year.

It may happen with one of these chicken products.

There is a pattern here when you look at Chicken Parmesan in February, Chicken Selects in April, Chicken Flat Bread in June and July, the chicken products to the new taste menu have all done well.

Each probably exceeded our expectations and could be that the customer is sending us a message here and it is something we are looking at but not ready to make a decision to announce if any of these things would become permanent.

If we can figure out a way to do all of this while still offering variety that rotates every six or seven weeks, we will we'd try to do that Thank you.

Our next question comes from Karen Willmark from Evergreen.

Hi.

More questions on the U.S. comps, with Mick's positive contributor to the comps.

Can you talk about the price and traffic components relative to the first quarter?

Also with respect to QSC, quantify us to the contribution we can expect to see in Q3 or Q4 or what you guys are maybe just planning for.

Thanks.

Karen, you know, we do not comment on transactions or customer traffic.

And price is really difficult for us to judge, because in the U.S., 85% of our restaurants are franchise.

We do not control the pricing for those franchise restaurants.

So, you know, the difference between price and mix is -- you know, pretty challenging.

I think that there have been markets and there have been restaurants that have taken price increases over the last 12 months, but we don't have a number that we can point to to say that price is up X percent.

As -- as you visit McDonald's restaurants around the country, as you may, you will also see that -- I think we are trying to be aggressive in offering every-day value to our customers as well.

It is probably a little bit more of a question of mix and how much of our product sales are Value price sales versus what's on the new menu versus like our New Taste Menu offerings.

On the QSC issue, Karen, I think you were asking, what kind of a sales lift would you expect to see in the second half of the year from QSC?

It's hard to be real specific.

I can tell you that we expect to see a comp that is better than what we had in the first six months and we expect it to be some positive number, but we don't expect to see all the actions we are taking show up only in the next six months.

It is going to take some time, we said we expect to begin to see some lift in our sales starting with the second half of 2002.

We said that six months ago and it's still what we believe will happen.

But the QSC efforts we are undertaking, the full effects from those probably won't show up in 2003, but I expect it to begin showing up in 2002.

Karen, I guess I would just add to clarify, a lot of moving parts here in terms of what is moving our comps, and one of the issues is always, what was going on last year.

And, you know, as we look at the second half of this year, in total, we know that last year, in the U.S., our third-quarter comparisons are actually, you know, a lot tougher than they were in the second quarter, and particularly in July, we are facing some strong sales from last year and the U.S. which was running the Monopoly promotion last year in July which did pretty well for us.

Thanks.

Our next question comes from Mitch Speezer from Lehman Brothers.

Thanks very much and a couple more guess on the U.S. business.

It sounds like, Matthew, that you are expecting positive comps from the second half of the year even with difficult comparrisons and less advertising and with QSC [INAUDIBLE].

I am just trying to understand really why you think you can drive positive Same-Store sales in the second half of the year.

And secondly, and a separate question.

On royalty relief.

It looked like in Europe, your franchise margins were down a bit, even with comps up.

I was wondering if royalty relief has increased, I believe, in the McTrip to Europe you said about 20% of your franchisees or so were getting relief.

Has that increased since then?

I will deal with the first question on the U.S. business and why we have confidence we can generate positive comps in the U.S. business in the second half.

It has to do with a few things.

First of all, I think that our customers will begin noticing what's going on in our stores and will reward us with more visits.

We are not going to turn around 100% of them, but I think they will notice a different environment, better service, quicker service, and I think that will result in higher sales.

I also think we'll see probably a more aligned national message on everyday value.

I am not saying 100% of the market on some kind of dollar menu but we'll have a very significant percentage and a chance we will begin promoting that nationally in the second half of the year.

Mitch, in terms of the franchise mergence in Europe, they were down slightly, down 10 basis points.

I think the biggest issue there was probably occupancy costs.

We saw higher occupancy costs during the quarter across the number of markets, and particularly in the U.K., which, as you may know, goes through a normal process of rent reviews every five years on their leases.

So, I think, is putting some pressure on our margins, as well as as in some other markets.

But in terms of the franchisee rent assistance or rent relief, specifically to the comment you made, I think we are talking about Germany which had gone through a very tough environment certainly with the issues coming from the BSC.

So they had talked about they had given their franchisees more rent assistance.

And right now as Charlie pointed out in his remarks, Germany's economy is pretty sluggish as well.

So I think they are -- they were kind of anticipating that they might have to continue with some level of rent assistance to franchisees this year.

And when we were there, we talked about that.

But I don't believe it is up in any significant way year over year across Europe.

In fact, that would surprise me.

I don't think that's the case.

It is probably mostly driven by occupancy expenses.

And as we pointed out, Europe's comps were -- were not quite as strong as first quarter.

So, you know, it is just a question of the comps not quite keeping up with the increase expenses on that side.

Thank you.

Our next question comes from Peter Oaks from Merrill Lynch.

Hi, good morning out there.

I guess good afternoon now.

Actually, I have a couple for Charlie in Europe and Mary in the U.S.

Charlie, Europe has actually had a nice headstart using the mystery shopper versus when it was implemented here in the U.S. and you even have more experience with it from Australia.

Can you kind of give us your impressions as to how it's -- how it is actually translated into the consumer experience and ultimately how they recognize it and just from your own educated view, how that might translate here in the U.S.

And the other one on Europe is, if you look back over the last 18 months, we've seen a theme of offerings, some higher-quality and even higher-priced fifth flavors.

And obviously there has been pretty receptive consumer response.

How is this entering into your thought process going forward?

And then for Mary, you mentioned the game promotion we gonna be looking at as far as impacting July.

There was a game promotion in second quarter.

Do you have a sense as to how much that impacted the comparisons for the comp?

And then lastly, if I may, breakfast, can you give us an update of how that is performing relative to the rest of business?

Thanks, a lot.

Okay.

Thanks for those questions.

I will head off with the first -- the first two.

You know, I have been around McDonald's a long time.

About 26 years, and can remember being a young person in our stores in Australia and being told during the training -- this is the training and there will be somebody coming in checking that you won't know who they are, and will be a report writen about how well you do and it will be posted for all the other employees in the store, and depending upon your performance on how you do, you'll determine whether that store gets a bonus or not for that particular month.

So from my personal point of view, it certainly kept me on my toes as a young crew member.

As you know, we do a lot of research at McDonald's monitoring our QS&C attributes.

But the mystery shopper program is the only one that gives store-specific data to us that is actionable by the store and actually by the regional office or the country office.

And so, keeping some -- it also adds a bit of compliance out there, which helps us monitor which are the stores that need more help versus others.

In fact, most stores have a competitive spirit because they want to beat the store down the road and gain more customers.

So I think customers certainly see this over time, and generally speaking, we have higher levels of QS & C in markets that have had mystery shops long term versus markets that haven't.

And it certainly is something that you can see in our attribute scores and so forth.

Specifically in Europe, as I said, year-on-year, our mystery shop customer service scores are up in the majority of markets because we have added some additional incentives.

All of this plays a role, and certainly enhances the customers' experience.

With regard to the higher-priced fifth flavors as you called them, the premium products we have had in a number of our markets, we have been very pleasantly surprised with their performance.

They have exceeded our expectations, and they will probably be more of those over the next 12 to 24 months in Europe as we work out most effective way to do that.

The one I talked about in my openings remarks, the Chicken Premiere products is now served in three of our major markets and we are using exactly the same advertising with a different language in those three countries.

So again, we are getting cost efficiencies there in the use of our advertising.

They will certainly play a stronger role as we move forward, as will some other products.

To answer that question, we did run a game last year in the U.S., a Millionaire game, and it did drive incremental transaction and visits into our restaurants and drive comp sales.

We don't try to quantify exactly what impact that had then on this year's comp, the fact that we didn't have that game, but I would say we target these games, we are looking for it to drive incremental sales of, you know, somewhere probably in the mid single digits, again, incremental, doesn't necessarily mean that's the comp but you want to increase on the base for the prior year.

So, it clearly had some impact.

And last year, in the -- in the -- in the second quarter, we have to also remember that kind of over time, we are going against a higher sales level in the U.S. and second quarter because of our success with Teeny Beany Babies over the last -- over the prior four years.

The second quarter just continues to be one of our -- one of our tougher comparisons not only because of last year's gain, but because of prior year's Teeny Beany Babies.

Peter, on breakfast.

It sounds like it was a U.S. question.

Our breakfast day part runs across the country about 24 to 25%.

I recently looked at the central division where the low to the high was around 20% up to as high as 28 or 29.

It's an interesting question because you contrast that with Europe.

Europe on breakfast is where the U.S. was 15 or 20 years ago.

In the U.S., it built over many, many years.

It was changing habits, and Europe is just sort of beginning to go through that and I think Charlie shared with you how low those numbers are, but there is tremendous potential to increase it, and I am sure we will get there.

Thank you

Our next question comes from John Ivancoe from JP Morgan.

Oh, hi, thanks.

Again, two questions if I may.

The first is on the other operating income in the U.S., if you could just give us some color and clarification of how much that is and what that was.

And secondly, if we could think about the U.S. business and obviously, you know, transactions I guess by definition were negative in the second quarter, why -- is there any kind of feedback from -- you know, like a core consumer or perhaps a latch consumer why they may be visiting McDonald's less this year versus last year that may be surprising you relative to what you thought that was?

Thanks.

John, this is Matt.

Yeah.

On the other operating income, I thought that was a U.S. question.

There is -- it is not a big number, but only unusual item in there that I remember was a gain on disposing of some excess real estate, and I don't remember what all the other deals -- the details were.

But also, there was elimination of goodwill amortization that affected that number.

In our equity in affiliates in the U.S. was also up during the quarter, John, in terms of driving that overall, whereas gains on sales of restaurants in the U.S. were actually down for the quarter.

Yeah, on the -- on the issue of where is the -- I think you are asking, do we know exactly where it is the customer is going if transactions are down.

And obviously if our comps are negative, and our -- our average check is not going down, then that means transactions are going down.

We've looked long and hard at this, and, you know, what's happening is we are not right now meeting expectations of all of our customers, some of them are turning to other alternatives, and if we can lift our QSC the way we think we are capable of, we will bring a lot of them back.

We have time for about one more question.

Our last question comes from Paul Westra from S.G. Cohen.

Hi, everybody.

Question on the sustainability of U.S. margin improvement, half came from food.

Can you talk about where that was driven by commodity versus mix and then if I could just get your closing comments on the report card of the restructuring.

We know that the consumers quite haven't shown up yet with their feet, but if you can talk a little bit about the soft results, specifically GM satisfaction, turnover rates and how they are responding to the more of the focus and getting rid of some of the tasks that were associated with the restructuring.

Thank you.

Well there are terms of sustainability.

As far as commodity costs I guess are anyone's guess, I guess, looking good for the U.S. for the rest of the year.

We're not really expecting any significant changes in trends.

Beef costs are down right now year over year, as well as chicken costs, so that bodes well for U.S. margins.

We are, as we discussed earlier, discussing with our franchisees an increase in contribution rate for national advertising and that would affect our company-operated restaurants as well.

That is a piece of the savings that we are seeing this year.

I will say, though, on the restructuring and Matt, I am sure you will want to touch on this, but one of the changes we made was putting responsibility and accountability for the company-operated organization and the organization under separate leadership teams.

We think that over time, and we are starting to see some signs that, that this focus and accountability will help us run those restaurants better and more efficiently.

Overall, you know, better results both in terms of top-line and controlling costs.

So the good will amortization is a little piece of light.

The margins are up and that clearly will -- will continue as well.

But I think the key here is can we drive top-line sales which is always, of course, the main question.

And, you know, I agree with Mary.

If we would have given ourselves a grade on the restructuring, the comp-co side of it.

We are pleased with what we're seeing.

The other side, it is too early to say but we're not going to make the mistake of switching strategies mid course.

We have to stay the course on this one.

We believe if we stay the course, we keep measuring, we hold people accountable, we will eventually see the results we want.

Thank you.

Okay, I think that's about -- about concludes our time today.

I think Matt's gonna close with a couple of comments.

Thank you.

Today we have outlined some of the steps we are taking to increase customer satisfaction, sales, and profits around the world.

While we still face challenges, we are confident we are working on the right things to improve results for our customers, our employees, suppliers, and our shareholders.

Charlie, Mary and I thank you for your interest in McDonald's and goodbye.

This concludes today's McDonald's teleconference.

Thanks for attending.

Have a great day.