麥當勞 (MCD) 2003 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the McDonald's July 29 conference call.

I would now like to turn the conference over to your host, Ms. Mary Healy, Vice President Investor Relations, Ms. Healey, you may begin.

Hello, everyone, and welcome.

On the call with me today are McDonald's Chairman and CEO Jim Cantalupo, our CFO Matthew Paull, and the President of McDonald's U.S. business, Michael Roberts.

This call is being webcast live and recorded for replay on the web.

The language regarding forward-looking statements included in today's press applies to comments made on this call.

Our release, which includes reconciliation of non-GAAP financial measures, can be found at investors.mcdonalds.com.

As most of you have had an opportunity to review our earnings release by now, we will use our time together to provide additional perspective on the quarter's result, as well as update you on our revitalization plan.

On that note, let's start with Jim.

Thanks, Mary, and good morning, and thank you for joining us all today.

During the past several months we have been refocused on the revitalization plans we laid out in April.

Our focus and discipline is starting to yield results, especially in the United States.

While we are encouraged, we are keenly aware that this is just the starting point.

We still have a long way to go to try to drive sustainable results.

In April we announced that it will take 12 to 18 months to execute our plan.

The early stage of that plan is all about strengthening our foundation.

Strengthening the foundation of our business means returning to the basics that made McDonald's great, operational excellence and marketing leadership.

We need to become more relevant, we need to have the great tasting food that our customers expect, and we need to connect with them in our restaurants and through our marketing.

We intend to accomplish all of this and more with our plan to win.

Our plan to win is all about attracting new customers, encouraging existing customers to visit more often, creating brand loyalty, and creating enduring profitable growth.

The plan is built around five drivers of exceptional customer experiences.

These drivers, or as we call them, the five Ps, are people, product, place, price, and promotion.

Our people will be well trained in hospitality and restaurant operations.

The products we offer will be relevant.

Our restaurants, in other words, our places, will be contemporary, clean and welcoming.

Our brand and affordability and flexible price points will have broad appeal.

That is what we mean by price.

By promotion, we mean marketing and promotional efforts that connect with our customers.

Strengthening the foundation is also about aligning our organization and being more disciplined in how we use our financial resources.

Some of the actions we have taken to date are as follows: To start, we've reduced planned capital spending for 2003 and except cap ex to total approximately $1.2 billion in tax and currencies.

We have made progress on eliminating distractions and focusing the strength of our entire system on our restaurants and our customers.

Our worldwide organization is aligned around our plan to win.

We are developing a new campaign and a new creative approach for brand McDonald's.

We have taken a number of actions to improve food and service, our greatest opportunities.

With regard to food, we have made improvements in the taste of our core menu and introduced a number of new products that are resonating with customers.

We are also getting better at listening to customers especially, those who have left us or don't visit us as often as they used to.

Nutrition and fitness have become top of mind.

Life styles are changing.

Today's customers want additional food choices.

In response, we've added more choices to our Happy Meal offerings around the world, choices that appeal to moms, as well as kids.

We have also established a global advisory council on healthy lifestyles comprised of independent experts in science, nutrition, fitness, and education.

Together we will address the need for a balanced healthy life-style.

Finally, we've taken a leadership role in addressing the important health issue of antibiotic resistance in people.

We are asking our meat suppliers to phase out the use of animal growth antibiotics that are used in human medicine.

On a broader level we are in the early stages of taking a global approach to menu management.

We are creating menu management centers around the world that will use a consistent consumer driven process to develop world class product that leverage our size and scale.

On the service front, our goal is to deliver exceptional customer experiences.

During the coming months, our worldwide system will be rolling out hospitality training for restaurant staffs.

We not only want to serve customers great food, we want to do it quickly and with a smile.

At the same time, we are differentiating McDonald's by creating a more relevant experience.

One example is the hot spot concepts which allows customers to connect to the internet using wireless technology.

We have launched, or have planned to launch hot spot pilot programs in about 25 countries.

Here in the U.S, we are also expanding our WI-FI test.

Marketing leadership is absolutely critical to our revitalization plans, our recent salad ads in the U.S. are examples of marketing that connected with today's consumers.

But the real excitement lies in the new creative brand direction that we'll unveil over the upcoming months.

A direction centered on our new theme line "I Am Loving It".

We believe our new marketing direction will connect with customers around the world, especially young adults, moms, and kids.

It will also serve as the strategic framework for our worldwide marketing and advertising campaigns.

This is a new and different way to present our brand globally.

Great marketing will get people into our restaurants, yet it is great McDonald's experiences that will keep them coming back.

We fully intend to deliver on both counts.

I hope that I have given you a sense of the disciplined customer focus of our company today.

We are several months into our revitalization plan.

We are making progress.

Let me assure you that we will continue to do whatever it takes to position this great company to deliver the growth in sales, operating income, and returns that we are targeting for 2005 and beyond.

Now I would like to turn the call over to Matthew Paull.

Matt.

Thanks, Jim.

I will start by reviewing some of the numbers for the quarter and the factors behind them.

Second quarter EPS was 37 cents, down 2 cents compared with the 39 cents per share we earned last year.

The quarter's result included $50 million in pretax costs associated with our revitalization plan, and $18 million less in gains on sales of restaurant businesses compared with last year.

In addition, our tax rate was 150 basis points higher in the quarter, 33.5 percent versus 32 last year.

Collectively, these items negatively impacted second quarter EPS by more than 4 cents.

On the other hand, foreign currency translation positively impacted reported EPS by 3 cents.

This was primarily due to the stronger euro and British pound.

When looking at individual line items, please keep in mind that the translation of stronger foreign currencies essentially drove the $8 million increase in interest expense in the quarter and added $18 million to G&A.

The G&A increase also was driven by about $11 million of incremental billboard advertising in the U.S., and $14 million of severance for staff adjustments around the world resulting from the cut back in restaurant openings.

Including these $25 million in G&A costs, we still expect to keep G&A relatively flat for the year in constant currencies.

However, given the weak U.S. dollar, G&A will be up on an as-reported basis.

The remaining $25 million in costs associated with the revitalization plan was recorded in other operating income.

These costs relate to real estate sites we have eliminated from our development plans.

System- wide sales during the second quarter increased 10 percent, or 4 percent in constant currencies.

We recorded our first worldwide comp sales increase for brand McDonald's since the third quarter of 2000.

This was due mainly to our very strong U.S. performance.

In the U.S, brand McDonald's sales grew 8 percent and comp sales increased 4.9 percent.

Company operated restaurant margin dollars were up 18 percent.

As a percent of sales, margins improved 70 basis points.

The benefit to U.S. margins from strong sales was moderated by certain higher costs, some of which are ongoing, and some are not.

For example, costs for rents, utilities and packaging were higher, and we expect this will continue.

However, the increase in promotion costs associated with our Winning Time game and new product coupons and special training costs associated with our recent manager's convention will not be ongoing every quarter.

Now let's turn to Europe.

Favorable currency trends drove a 21 percent quarterly sales increase in Europe.

On a constant currency basis, total sales increased 1 percent.

New units contributed about 3 points to the segment's constant currency sales growth, however, this was currently upset by a decline in sales at existing restaurants.

In terms of our major European markets, both the U.K. and Germany generated mid single digit negative comps during the quarter, compared with slightly positive comps in the same period of 2002.

France recorded a low single digit negative comp against its toughest comparison in 2002.

Despite negative comps overall, Europe's company operated margins as a percent of sales only declined 30 basis points.

U.K. margins, which declined largely due to depressed comp sales and a shift to higher cost products, negatively impacted the segment's margin by 50 basis points.

Excluding the U.K.., Europe's margins would have increased 20 basis points.

We have two key issues in Europe.

One is the depressed economic environment in Germany.

We are convinced that this macro issue is a principal driver of our negative results in Germany.

We believe that when the economy rebounds, our business will bounce back, as well.

In the meantime, we have a number of ongoing initiatives to attract customers through every day branded affordability and innovative premium products.

The other issue is the U.K..

Over the past several years, we have faced increasing competition in this marketplace.

We have struggled to find just the right customer proposition to grow sales and margin simultaneously.

Our challenge is to adapt to customers changes tastes and lifestyles while retaining the core attributes that continue to attract many customers to McDonald's.

Our U.K. team is strategically focused on lifting results with branded affordability, great service, relevant product offerings, compelling restaurant environment, and the successful kickoff of McDonald's new marketing campaign.

These changes may take a little time to resonate with customers, but in a growing marketplace, we are optimistic that we can once again gain our fair share of this growth.

Clearly, we have challenges in Europe.

Nevertheless, there are substantial opportunities to grow our business.

For perspective, McDonald's transactions per capita in Europe are just a small fraction of what we capture in the U.S.

Also, meals away from home are expected to grow significantly, and our breakfast business in Europe is still in its infancy.

Now, let's move on to Asia Pacific.

A large portion of this segment's comp sales and margin declines for the quarter was driven by changes in consumer behavior due to concerns about SARS.

The countries significantly impacted by these concerns include Hong Kong, Taiwan, and China.

We are currently optimistic that SARS concerns will lessen in the second half of the year.

Local residents appear to be resuming their normal lifestyles.

What is still unclear, however, is what, if any, lingering impact SARS will have on the countries' economies and tourism.

Now, before turning the call over to Michael Roberts, I want to remind you of our dividend and share repurchase plans for the year.

When we announced our revitalization plan in April, we told you that we planned on making a decision regarding a dividend increase in the fall.

We still plan to make this announcement in the fall.

We also indicated that we expect the increase to be significant.

Our thinking in this area has not changed.

Paying a higher dividend serves many purposes.

First, it reinforces the message that McDonald's has changed.

Our cap ex and growth targets have changed.

In addition, the change in the tax law has removed the strong bias for share repurchases over dividends.

Finally, our ability to consistently generate substantial amounts of cash supports payment of a higher dividend.

Over the past five years, we have generated an average of $2.8 billion in cash from operations annually.

As indicated in April, we plan to return between $500 million and $1 billion to shareholders this year.

This will take the form of dividends and share repurchases.

We purchased a small amount of our stock in the second quarter and plan to purchase more during the remainder of the year.

Once we make a final decision on the dividend increase in the fall, we will give you more details on our share repurchase plan.

Now, I would like to turn the call over to Michael Roberts.

Mike will tell you about our recent success in the U.S. Mike.

Thanks very much, Matt.

Hello to all of you.

Our cost sales and guest counts are up, driven by a combination of operations, products and marketing.

Company operated margins are up, and owner-operator cash flow is rising.

We have accomplished a lot during the past few months with the partnership of our employees, our owner operators, their leadership and our suppliers.

We intensified our focus on operations, we improved the taste and quality of our existing products, we introduced premium salads and McGriddle breakfast sandwiches to our core menu, and we created exciting relevant marketing, including salad commercials which were successful at reaching moms, and Big Mac creatives which did the same thing with adults.

In fact, Big Mac sales are up 40 percent in July.

This shows what happens when we focus on our core.

Comp sales for the second quarter were up 4.9 percent, largely driven by increased traffic.

This was the first quarterly increase for the U.S. business since the fourth quarter of 2001, and our highest comp since the Teeny Beany Baby promotion in 1998.

The big difference this time, we are selling food.

While we don't share specific guest count information, I can tell you it was the fourth straight month of significant guest count increases.

This is no accident, but part of a well thought out plan that is focused on better tasting food, improved service, rewarding and recognizing our people, and creating marketing that motivates our customers.

Clearly, it is the combination of all of this that is driving our U.S. results.

Let me explain.

The core of our turn around is being driven by operations, and our restaurant operations improvement process.

After hundreds of thousands of mystery shops and operation visits, we are collectively doing a much better job looking at our business from the customer's perspective.

As a result, our restaurants are staffing accordingly, opening more registers during peak periods, and smiling.

These improvements are being noticed.

Customers are giving us higher marks for fast and efficient drive through, good value, and they feel like they are being treated like a valued customer.

With that said, however, we know we still have significant opportunities to improve in this area.

The dollar menu also is contributing to our results by bringing more customers into our restaurants.

What is significant is the way the dollar menu, our new products, and strong Happy Meals promotions are working together to produce higher average checks.

For example, 25 percent of our premium salads and their purchases included the purchase of an item from the dollar menu.

Also, premium salads are bringing back moms.

Since April, we have seen a 6 percent or more increase in Happy Meal transactions, accompanied by a salad purchase.

We have seen significant improvement in the percentages of salads sold after 4 p.m.

Our salads are positively impacting premium chicken sandwich sales, which are up 26 percent since the salads were launched.

McGriddle Breakfast sandwiches are also resonating with our customers.

Breakfast sales, in fact, were up double digits in June, largely because of this new product.

Extended hours played a role in the quarter's results too.

We expect this to continue as more restaurants extend their hours, and either open later, open earlier, or remain open 24 hours.

Looking forward, our emphasis will be on maintaining the baseline momentum we have created and initiating more changes to speed up service, providing hospitality training for our restaurant staffs, continuing to improve the taste of our food, adding to the fun of a McDonald's visit with an exciting game, and popular Happy Meal premiums, and talking to customers in new ways with a launch of the "I Am Loving It" campaign.

Just a minute to explain each of these.

First, we will continue our heavy emphasis on improving restaurant performance through ROIP.

Based on mystery shops year-to-date, we know more stores need to consistently perform at a top level, and that speed of service remains our number one priority.

To improve speed, we are adding a bun buffer, as well as other equipment enhancements to improve our production system.

In addition, our restaurant optimization initiative will speed up service by simplifying the restaurant environment for our crew and our guests.

More visual menu boards with simpler pricing strategies will make it easier for our guests to order, and the elimination of some product sizes and slow-selling items will improve the efficiency of our crew.

Restaurants that have been on the restaurant optimization program the longest have seen service times improve by 30 seconds.

They are also posting better mystery shop scores and better margins compared to other restaurants in the market.

Recently, for the first time ever, 8500 of our restaurant managers came to Las Vegas for the peak managers experience.

These managers received training on taste of quality, optimizing service, and on hospitality.

The managers left fired up and better trained to deliver a great McDonald's experience.

To ensure our crew focuses on being friendly as well as fast, all restaurants will participate in hospitality training this fall.

The centerpiece of this training will be a new relevant hospitality video that will help the crew understand the kind of experience our customers expect.

We are confident this focus on speed, hospitality, and restaurant optimization will culminate in an improved experience for our guests.

We will also continue enhancing our food.

In addition to supporting our new products with ongoing advertising, we will introduce before year end chicken nuggets made with white meat.

We are very encouraged with results from markets that already have the new nuggets.

We know menu choices for kids are important, too.

In addition to offering milk, water, Hi-C's, parfaits, and apple juice, we will also be testing apple dippers and a low-fat, fun-to-drink milk option, as well.

And we have an exciting Happy Meal lineup for kids over the next six months, and we will create the same enthusiasm for our older kids, as well.

We are joining forces with electronics retailer, Best Buy, to update an old classic, Best Monopoly, which will reward winning customers with traditional food and cash prices, as well as $50 million in Best Buy merchandise and discount offers.

Finally, as Jim mentioned, our new creative direction, "I'm Loving It", will be unveiled this fall.

I am excited about the creative being lined up for the U.S. and the accompanying entertainment tie-ins, which will be announced soon.

So, I am energized by the improvements we are making in operations, and at the same time, I know this remains our biggest opportunity.

I am energized by our value proposition which remains very motivating to many of our customers.

I am energized by our customers' response to our new products, salads and McGriddles, both of which are exceeding our expectations and improving our baseline momentum.

I am energized by the taste and quality improvements we are making to our existing menu, but really, most importantly, I am energized that all of these things are collectively creating a better McDonald's experience for our customers and positively impacting our brand.

As I said, although we are pleased with our recent performance, we know we have a lot of work to do.

We know our past is a history of ups and downs, and we know our biggest internal enemy is complacency.

We are determined to stay the course, to intensify our focus, to continually improve execution in all of our restaurants, to continue pleasing our guests, and to drive sales and profits in all we do.

Now, let me turn this back to Mary.

Thanks, Mike.

We would like to open the call for your questions.

I think you know the drill.

Please press one if you have a question.

And you can press the pound key to remove yourself from the queue.

We would like to give everyone an opportunity to ask a question, so we are asking you for you to limit yourself to one question, and get back in the queue by pressing 1 again if you have a second question.

Our first question comes from Coralie Witter at Goldman Sachs.

Hi.

I had a multipart question for Mike on operations, specifically.

You mentioned that the restaurants are, some of them, are open more hours a day.

Could you help us understand how many have moved to that?

How many hours are we talking about?

How long until the rest of the system is there?

Secondly, what are you doing to remove the bottleneck in the kitchen, specifically, that the made-for-use system has to contend with beyond simplifying the menu and the bun buffers to get those products out quicker during the peak hours?

Coralie, we currently have thousands of U.S. restaurants on extended hours.

For us, that includes 24 hours, as well.

The evening/day part between 11 pm and 4 am is a significant opportunity for us.

As the word is getting across America about the possibilities for us, more restaurants are extending their hours, either staying open a few hours later or opening earlier, we think it is a huge opportunity for us.

Men and women all over America are working late.

There have different responsibilities.

Moms are working later.

Dads are working all night, et cetera.

It is a great opportunity for us.

Related to -- with some significant sales increases, as a part of it.

Related to the production system, I think you know, we continue to refine our production system.

We have added a lot of efficiencies to the kitchen, the automated beverage system.

We are making our POS simpler, so our crew people can order.

We have added a bun buffer which will anticipate orders and make it easier for our restaurant managers to produce, and crew to produce product more quickly.

We have added our new packaging, which is easier to produce than the wraps.

It takes us about 3 to 4 seconds less to use a carton than it does to wrap.

All of this, combined with the optimization initiative, which is fewer products, fewer EDMs, fewer sizes, as well as opening more registers, is all contributing to the success we are having, and the optimism that we have that we're going to improve our service.

Thanks, Mike.

Our next question is from Jeff Omohundro at Wachovia.

Thanks.

I wonder if you could elaborate a little bit on Latin America, in particular the divergence between comparable sales and operating income?

Thanks.

Hello,Jeff, this is Matt.

In Latin America, comp sales are going up, not necessarily driven in every case by transactions, but by the fact that prices are going up, rapidly.

Our issue there is that costs are also going up rapidly.

In some of our key markets in Latin America, certain products are dollar-based.

So when you are importing some items that are dollar-based in costs, and you are collecting sales revenues in local currency, that doesn't lead to good margins.

Jeff, this is Jim.

A couple of other perspectives on Latin America.

Latin America has a history of cycles.

You go through the cycles that are generally created by devaluations, as you are probably aware.

It takes a while for the dislocation to work themselves out so you get back on a level playing field.

My analogy is the last couple of years have been impacted by the double whammy of Brazil and Argentina in terms of the devaluations, and that interlocking thing.

Because the southern cone is where our issues are at.

Northern Latin America is actually doing pretty well in terms of Mexico and some of the other markets.

So to me, it is an issue of dislocations in the economy and the actions we are taking to deal with them.

Obviously, what we have been doing hasn't been working.

But I feel pretty good that we are getting on top of the issues, particularly like Brazil.

It will see better results as we move forward.

This is not, to me, something that is unusual or different than some of the things that we have experienced in the past, except for the duration, and as I said, the double whammy of the two devaluations in the southern cone.

Thanks, Jeff.

Our next question is from John Glass at CIBC.

Hi, John.

Good morning.

A question for you on the U. K. In your commentary you did not mention the possibility of refranchising that market.

I was under the impression you might be considering that.

If you are, are there any details on that plan, and maybe a reasonable time frame?

John, I don't know what you mean by refranchising, but we have always realigned markets there.

But there is no major plan to do a wholesale franchising of the U.K. market.

We make a lot of money in a lot of stores in the U.K..

Now the profits are down, same thing in Germany.

In Germany, we still have very good returns, they just aren't what they used to be for the last several years.

So there is no plan to refranchise on a wholesale basis.

We will continue top deal with, on a restaurant by restaurant basis, whether it makes sense to operate them as company stores, or would they be better off having a franchise.

I will add that over the past several years, the U.K. has increased their percentage of franchise restaurants, and today, about 62 percent of the restaurants are company operated, which is lower than it was three to five years ago.

And that was a planned strategy they had.

But I think they are about where they would like to be.

It's also somewhat dictated as we expanded into the outer markets and away from the big metro areas.

It's always made more sense to operators to franchise restaurants.

The percentage of franchised restaurants increased for that reason, also.

Thanks.

Howard Penney from SunTrust has the next question.

Hi, thanks very much.

Relative to when you set out your guidance, you put out this 2005 number as to when you thought you would see improvements in operations, or when you thought you would resume growth.

I think we have all been somewhat surprised about the current trends.

I mean, your commentary of Big Mac sales are up, moms are in, Happy Meal sales are up, and yet, you're kind of sticking with this 2005 turn around, yet it looks like the business has already turned.

Maybe the turn around will have come and gone by the time 2005 comes.

Can you speak to that guidance?

And also, if I can throw it in, the $500 million to $1 billion, does that include the current dividend, or is that in addition?

So you've got your dividend and then another 500 million to $1 billion?

Howard, let me talk about the 12 to 18 months, which I talked about in April.

To me, you know, I defined success as a pretty sustained performance of improving margins, comparable sales, and returns.

We aren't there yet.

Certainly, we have certain areas of the world that are still struggling a bit.

But that is what I would define as, in effect, a foundation that will allow the sustainable performance we talked about after 2005.

I'm very happy with a lot of things that have occurred to date.

But I am not at the point where I am declaring any victory in terms of a turn around, because it really is to me a more holistic thing in terms of the foundation of our company, and how we want to move forward.

So that is how--so, you know, sustained margin improvements, sustained capital sales increases, and sustained returns, and I might add, maybe some sustained good headlines.

Howard, this is Matt.

On the issue of the dividend, the $50 million to $1 billion range includes the current dividends.

Thank you.

Thanks, Howard.

Our next question is from Mitch Speiser at Lehman Brothers.

Hi, Mitch.

Good morning, Mary.

Just a question, probably a two-part question on the U.S. business.

First, the number of franchises in the U.S, I believe you have been pruning down.

In the past, you have thrown numbers out here and there as to how many franchises have left the system.

I just--if you can give us an update on the number of franchisees that have, perhaps, not performed and have been asked to leave.

Do you expect that number to accelerate?

And then just, you know, going back to your April 7 release, you did talk about a one - letter grade improvement, increases, sales by about $100,000.

I was wondering, you know, collectively for the U.S. system, where do you stand on improving the whole system by one letter grade?

Thank you.

Mitch, in terms of our restaurant performance, as I said, we have significant opportunities, yet, to improve.

We are all pleased by the movement we had, we have had in the last year on mystery shops, and that work continues to improve, and some of the things I I.D.ed, I think are going to help our restaurants execute.

Related to our operator's support for our U.S. agenda, it is very strong, we continue to work with all of our operators and all of our [INAUDIBLE] leaders around the country to improve our restaurant performance.

Our guest scores, as I mentioned to you, are improving, which gives us, you know, great optimism that with our continued intensified focus, we will continue to improve.

All of our operators and all of our restaurant managers in [INAUDIBLE] want to improve.

ROIP is about improvement.

For those restaurants that continue to underperform, we have programs in place now to support them.

Where we don't find the improvement, and where we are not getting the kind of results we want, we will seek, you know, new ownership for that particular restaurant.

We are moving fast in terms of our ability to collect the data.

We are sharing that with all of our teammates, our division President Ralph Alvarez, all of the operator leadership.

We continue to work hard to improve our performance at each and every restaurant.

We have systems in place we didn't have a year ago.

As you know, the goal is to raise the bar here, improve our performance, and we are doing that.

I have the support of our operator leadership to continue this focus.

Mitch, I would also add, this is Jim.

You know, grading is not about taking operators out of the system.

The majority of our operators are terrific people that want to do the right job.

To me the grading ROIP and all the other things Mike is doing and accomplishing in the U.S. business is really a recalibration of standards, talking about what we expect in terms of operating standards today versus, maybe, where we have been in the last two years.

That is really -- generally, everybody wants to do them, because they see the results of that.

Thanks, Jim.

Janice Meyer from Credit Suisse is our next questioner.

Thank you.

Comments on Europe.

Your business there has been awfully weak for a long time.

If we look specifically at Germany, you have been blaming the economy for many, many years.

You have already done value, you have done new products, it hasn't worked.

Now you are talking about branded affordability, which sounds like value to me, as well as new products, which sounds like new products.

What is different about the approach this time?

Specifically, what are you talking about value?

How much are you considering lowering prices overall?

And why isn't it finally time to just, maybe, rebase your pricing in that market, based on a weak economy persisting as it has, then just move forward from there.

But just finally making your product more affordable to the German consumer?

Janice, this is Matt.

I would disagree with the notion that its been years and years in Germany.

Unemployment is a little over 10 percent, retail spending is way down, consumer confidence is way down.

Those aren't an excuse, it is an environment in which we have to try to succeed.

When we say branded affordability, we did something in Ireland called Euro Saver, where we had one, two, and three euro price points.

Germany is going to do something like that with more price points.

Our intention is not to sell all our products at one euro, but to have price points that provide a reasonable margin.

I think we are doing the right things.

I don't think that we are just throwing out pablum, which is what you are implying.

I think we have to stay the course.

We have to remember we are a very big player in the German economy, in the eating out market.

To some extent our results are effective of what is going on in the broader economy.

I would be more concerned if we saw their economy bouncing back and we weren't picking up our fair share.

I'm confidence that we will.

And Janice, let me just add this.

This is Jim.

I have been at it for a few years out there, and, you know, what motivates consumers?

I would like to say, we can just determine that, but we can't.

Sometimes a tactic will work during a particular economic environment.

Other times it won't.

So it is a matter of sometimes going back at it several times.

The program they are at now, I was just over in Germany I think two months ago.

It is very clear to me that the economy is where our biggest issue is.

Our market share, which is very, very significant in terms of western QSR, and what we take out of the retail environment.

So, you know, I think, as Matt said, it's not been, you know, many years.

It's been a few months, I guess, or a real few years, in terms of our difficulties there.

This has been a market that has been terrific for us.

It still has today, pretty significant returns for us.

They were once the highest in Europe.

I think they still are today.

So, it's a great market for us.

I think we were tracking share visits versus our competitors there, we are up, you know.

So our market share is going up.

This is about that economy there.

It is about psychology of the German consumer, which they behave differently there, country by country.

So finding a tactic that really ignites a response is what is going on there.

I think this branded affordability thing which is on the neighborhood of Euro Saver, it's called McDeals, is certainly going to, I think, produce a rush.

And if the last couple of weeks are any indication, a little bit encouraged.

Janice it is Matt.

I've calmed down, I want to add one more thing.

We have to succeed in whatever environment we are operating.

You know, one of the things they have done in Germany, which we are very proud of, they have produced significant increases in company operated margins in environments where sales are challenged.

They have done that by going to more part-time labor.

It helped a lot with our overall European margin.

And our German margins are up significantly for the quarter.

It is something we are very proud of.

It is not all gloom and doom.

Thanks.

Our next question is from John Ivankoe with J.P. Morgan.

Actually, it is a followup directly on that question.

I'm sorry, can you hear me now?

Yes, thanks.

It is a followup directly on that question.

It does have to do with the European margins, and I guess, specifically, the margins in Germany.

How much of this is structural and when was this put in place?

How much should we expect going forward?

Or is it just basic, you know, cost controls?

Is there anything else that we, particularly, should be aware of, both in Germany and the other European markets?

Thanks.

John, this is Matt.

The shift in our use of labor occurred on January 1.

I think part of it may be related to what German labor laws allowed.

They allowed more flexibility and we took advantage of it beginning January 1, and we expect it to continue for some time.

Lumping Europe together probably doesn't necessarily give you the right picture.

I think our biggest challenge in Europe is the U.K.

The economy hasn't been that bad, but our performance is underperformance.

We really have to get on that one.

It is impacting the entire European picture.

Outside of the majors, the rest of Europe actually looks pretty good.

The other, you know, 40 or so countries outside of the big three.

Thanks.

Our next question is from Mark Kalinowski of Smith Barney.

Hi, Mark.

Hi.

It looks like there was only a net opening of four restaurants in mainland China during the second quarter versus 35 last year.

Just wondering to what extent the slowdown reflects SARS and to what extent it might reflect other factors, particularly if this indicates any slow down in the rate of openings in general for mainland China?

Well, I think at the beginning of the year we talked about China being one of the markets that was getting capital allocated to it in growth.

This year, though, you know, SARS did have an impact on construction activity in China.

Our plan was down over the previous year.

So we are targeting somewhere around 40 to 50 restaurants in China this year compared to, I think it was 100 last year.

So, you know, it is down.

But I will tell you this, I feel very bullish about China.

This year in terms of our revitalization efforts, having less moving parts, more focus and discipline about our capital, probably impacted our opening schedule in China a little more than it should have.

But to me it is not a concern.

We are a significant player in the marketplace, great business there.

I expect to be opening the appropriate level of restaurants again as we move forward.

Thanks.

If you have another question you can press one to queue up again.

But we do have another question from Coralie Witter at Goldman Sachs.

Hi, I had a question on this move towards healthier products that you mentioned on the call.

You have moved in that direction certainly in the U.K. with some of these Happy Meal options, in the U.S. with the salads.

What is the impact to your margins?

These are, I would imagine, higher-cost products.

What does that mean for your outlook on where you can get your margins back to?

Coralie, this is Matt --

Before you start, this is just a comment.

All of our products are healthy.

This initiative is about choice.

It is about having the choices to fit into a balanced diet.

I just wanted to make that point.

A couple of things.

First of all, just looking at the numbers, the food and paper percentage on salads might be a tad bit higher than our old salad, but that ignores the penny profit, which is substantially greater than our old salad, I think it is probably 30 to 35 percent higher on a penny profit basis.

The other thing I want to mention is that our average check for salads has been over $8, and our average check for salad with a Happy Meal has been over $12.

The last thing we need to say about this, it is not just about the profitability on any one product, it is about the perception of the McDonald's brand.

We think that this initiative, which will be a long-standing initiative, is having a very healthy effect on our brand perception.

So it is something we are going to stick with, we are not going to focus on product-by-product profitability in every case.

Thanks, Coralie.

We have another question from Mitch Speiser at Lehman Brothers.

Great.

Thank you.

Matt, can you have a sense, with foreign exchange being beneficial now for a while, if that has had any impact on your margins in Europe?

And just going back to the U.S. business, Mike, I think you mentioned that it is food that is driving sales, yet you do have some new video game toys, which have been great, really strong movie tie-ins.

I was wondering how you really get like a grip as to how the base business is going, given that you have product news, new toys, new movies, you know, just how you go about sifting out this somewhat noise or good noise, to really see how the base business is doing?

Thank you.

Mitch, on the issue of margins in Europe, and what effect foreign exchange and the strengthening of those currencies have had.

I would say that most of our markets in Europe probably pull 80 to 90 percent of their product from within Europe.

Some of those products might be dollar-based cost, but it is pretty small.

I would expect that the overall effect is not very significant on our margins.

Mike, will you take the U.S. question?

Mitch, related to the movement, it really began last October when we introduced the dollar menu, but as I tried to lay out here, it is a combination of the operational improvements we have made, the dollar menu, new product news, salads and McGriddles, the improvements we made to the taste and quality of our core products, Happy Meal premiums, and extended hours all carrying enormous weight to move the business.

From our standpoint, you know, Big Mac sales are up, as I said, since we began advertising.

The brand is healthier today, chicken sandwich sales are up, as I said.

Breakfast sales were up without the benefit of McGriddles.

The brand is lifting.

It is clear to all of us the momentum has begun.

It is our job now to sustain it.

Any attempt to make this one product, or one initiative, would not be right.

The consumer is responding to all of these initiatives.

They are responding well.

Thanks, Mike.

Our next question is from Joe Buckley at Bear, Stearns.

Hi, Joe.

Thank you.

Two questions.

Matt, I was wondering if you could give us an update on the free cash flow ranges you talked about in April?

If anything's changed in your '03 thoughts, any preliminary thoughts for '04?

And then going back to the U.K. again, in terms of worldwide revitalization plan, could you talk about some of the details in the U.K.?

And it does sound like it is more of a competitive issue, I am curious, has this been, in your view, a shift away from the hamburger sector there that's perhaps hurting you, or what has caused the weakness in the U.K.?

I will take the first one, Joe, on free cash flow, and talking about what the balance of the year looks like.

We talked to you in April about a range of free cash flows.

A few things have changed there.

Currencies are a little stronger than expected.

That might help a little bit.

One thing I want to mention is, when you looking at this year versus last year, based on what we see today, when you look at the last six months of 2003, I think our gains from selling stores, we currently expect will be about 2 cents less than what you saw in the last six months of 2002.

That is probably evenly divided between the third and fourth quarter.

Regarding '04 I think it is premature to be talking about free cash flow for '04.

Joe, this is Jim.

As I said, I just returned from Europe a couple of weeks ago.

My analysis of the U.K. situation, basically, had to do with price increase.

We took some price increases last year that had an impact on guest counts, moving through the store.

When this happens in a relatively flat QSR market, it's going to impact you, and that's what it did.

We took increases both on Happy Meals and we got off a pretty branded price point on EBMs.

It took its toll in our traffic.

Now, you know, they've made a move back on the Happy Meals, a couple of months ago.

They are in the process of doing some branded affordability things with our EBMs.

I expect, I think, they are on the right track.

It is a matter of coming up with, at least, the right tactics that match the strategy, of getting back to a value position.

Thanks, Joe.

Our next question is from Laura Starr at Equinox Capital.

Hi, Laura.

Hi.

Congratulations, a good quarter.

I just have two questions.

One's an easy one, beef costs, I know they are going up, can you make some comments on the why you think that will happen in the third quarter and going on?

The other question, I wanted to go back to the person who asked the questions about the things that, the promotions you had in Q2, like the Nemo and other successful movie promotions, maybe turning it around to be more positive, do you have better people in place that are just doing a better job on designing these programs and getting these tie-ins?

Because I think some of these things you have been doing lately have been very, very successful.

Thanks, Laura.

In terms of the cost question, our expectations is that the second half of the year our costs will be higher than they were last year, partly that's due to the fact that last year, costs were down in the second half of the year, particularly in the U.S., so I think that's true in Europe, as well.

So, overall, we expect that for the full year, beef costs will be up around 5 percent for the full year, year-over-year.

Now that's a little bit less than what we thought they would be up at the beginning of the year in the U.S.

We had expected more of an 8 percent increase when we first gave guidance.

We think things look a little bit better now, but still up for the year.

Most people do know that beef is a long cycle.

So we are in a--in the beginning of a cycle that will probably see beef costs continue to rise.

We are doing a lot of things on supply chain side to try and improve efficiencies and to help offset some of those cost increases we might see in commodities.

I think we have a number of plans in place that we believe will help us get to our margin targets in terms of improvement, and company operator margins over the next several years, including efficiencies in supply chain.

In terms of your second question, I will ask Mike to comment on that.

Yes, Laura, related to marketing, it is all about our focus and our discipline.

You know, it is about the customer, and creating a more relevant experience.

We have been planning this for well over a year now.

Our team with Bill Lamar, and his operator/partner Jonah Kaufman, (phonetics) who is the head of op net have been planning this.

Our people have been doing the research appropriately, and Nemo, Brat, Spy Kids, now are all a product of a year's worth of work, focused on relevant messaging to our customer.

That's going to continue.

Bill Lamar and his marketing team are focused on this.

Larry Light says it well, the customer's the boss.

We're focused on the targets, young adult males, moms, moms with kids.

We intend to make their experience something terrific at McDonald's.

These Happy Meal properties and the alliances that we have created will help our customers realize that with our exciting new campaign coming there will be more reasons to come to McDonald's.

Thanks, Mike.

We have time for a couple of more questions.

Our next question is from Joe [INAUDIBLE] at [INAUDIBLE].

Hi, thanks, my question was on free cash flow and it was answered.

Thank you.

And finally, David Kowalczyk (phonetic) at Nordea Securities.

Dave.

Hi, thanks.

I had a question for Jim on management incentives.

Jim, a lot of your shareholders were offended by the massive payout that the board awarded your predecessor after a tenure in which the stock underperformed the S&P by about 30 percentage points.

I was wondering if you could talk about how the board has or has not revised senior management incentives so that we don't see this kind of a payout again for under performance?

In terms of just general philosophy, our bonus program has always been tied to performance, maybe not as much as it should have been.

But going forward, we have a program in place to come up with revised compensation programs starting next year.

I didn't have time to get into that this year, so I basically carried forward our old bonus programs, but they are tied to performance.

The new ones, I will tell you this, will be much more tied to performance than the past ones have.

I will say a good chunk of our performance, or compensation, was based on stock options, which obviously took a hit like everything, like our stock did.

We are all accountable for the results, you know.

I could say, all I could say is that the board, as well as myself and our top management team, accepts the fact that our compensation should be based on the performance of the company.

Thanks.

I think we have time for one more question.

A question from Bob Coleman at Gardner.

Yes, thank you.

I am just curious about the subsidization that occurred in the U.S., especially regarding promotional spend and couponing for the second quarter.

Could you, Mike or Matt, give some color on how much couponing had an influence in the second quarter and how that will go or how the rest of the year will follow through with any additional promotional needs that will be needed to drive sales in the U.S?

This is Matt, Bob, hello.

I will try to quantify it.

The couponing was related to new product launches.

It is not an ongoing thing.

The first two weeks of salads there was some couponing.

I think, you know, it is not a significant impact on our company operated margins.

If you combine, you know, couponing, with the training, the managers convention, you put that all together, couponing of the salads and McGriddle combined effect was something less than 50 basis points in our company operating margins.

You don't expect any impact going into the third or fourth quarter?

I don't think we presently have any plans to do any couponing.

Thank you.

Jim says we have time for a couple more questions.

A lot of people in line.

We are going to move to Anthony Andrea -- or not.

Howard Penney of SunTrust.

Howard, do you still have followup?

Yes, thanks.

Jim, you said in the beginning you were, part of your turnaround plan was eliminating distractions, are the partners brands a distraction?

And one of your competitors also talked about heavy couponing, by Chipotle, in the quarter.

I was wondering why you would feel the need to coupon in that segment of the market, given the supposed great growth characteristics.

Thanks very much.

Just a comment on Chiptole's couponing, they didn't coupon on a system-wide or chain basis.

They always do coupons when they open stores.

That must be what somebody is referring to.

I can tell you, Chipotle had a comp of about 24 percent I think it was, for the quarter, and it is a terrific, terrific brand and company and going to be a very successful concept.

On the partner brands, to be very honest with you, that has not been a priority for me.

I have been exclusively focused on our McDonald's brand, and that itself has created less distractions by the partner brands.

Now, having said that, I think all the brands are terrific.

I just haven't quite come to a strategic solution for how they fit into either McDonald Corporation's future growth, and/or the strategic direction we are taking for McDonald's, as well as those brands.

So I hope to be able to talk about some specifics by the end of this year in terms of all of them, and where we are going with them.

Thanks, Howard.

Our next question is from Jeff Omohundro at Wachovia.

Yes, my question relates to happy meals.

It sounds like you are planning to expand the consumer choice with the introduction of this apple dippers product.

I wonder if you could elaborate a little bit on that?

I think it is in a test, were are you testing it and what are the plans for that product?

Jeff, I can't tell you where we're going to test it, but I know it starts next month.

It will be in hundreds of U.S. restaurants.

It is not a product that we developed.

It's part of what Jim and Charlie brought from Europe for us to look at.

It was a product in the U.K..

It's apple slices, and they are terrific with grapes, in a packet, and you can dip them in a low-fat caramel topping, which is really fun.

We had it here and the taste panel work is very strong.

We know that Mom's want options for their children.

We've got 8500 restaurants now signed up with the Coca-Cola Company, with Fruitopia, and PowerAide, non carbonated drinks, as you know.

Lowfat milk is already available.

We are looking for more alternatives.

We are rolling out apple juice now in all 13,000 U.S. restaurants, as another item of choice for moms and kids, so this is an important, important piece of our business.

We intend to be relevant there.

These are just the first couple of phases of being more relevant.

And on that point, I think when the results are in, there is early indications it is having an impact on increasing our Happy Meal sales.

Because choice is an important aspect for mom when she makes a decision to take kids out to eat.

The other important thing, this is Matt.

We can't say it enough.

The combination of a Happy Meal and a salad, and that average check and that gross profit is an extraordinary opportunity for McDonald's to continue to maximize.

Okay, Janice, you won the prize.

Janice Meyer from Credit Suisse First Boston.

Do you have a question?

Thank you.

I thought after the last one you might mute my line.

We thought about it.

If I look at, still a U.S. question, if I look at the fourth quarter, even into the first quarter, if I am not mistaken, last year with the Dollar Menu, is it fair to assume that the average check, you know, came down in the U.S.

Traffic might have been boosted, obviously, not enough to turn comps to positive.

If we look this year, assuming not as much focus on the Dollar Menu, might you see continued strength in the average check as we move again to the end of the year, early next year.

Do you think that would be enough to cover potentially your increase in beef costs?

Janice, you are right in terms of the fourth quarter of last year, and the initial launch of Dollar Menu, the average check did drop.

You know, that was part of our plan.

We knew that by itself it would not be enough to drive the business.

It was always laid out with all of our operators in terms of its part of the base, and with salads and McGriddles and Happy Meal choice and new premiums, that the notion was that the combination of all of these would raise average check, and it has.

You know we changed from the Big N Tasty to the double cheeseburger.

The double cheeseburger sales are very, very strong.

As I said, the business has been lifted by all of the initiatives that we have been working on, and salads, and that average check, as we've talked about, are an important reason why we are optimistic.

The Dollar Menu in terms of marketing will be a small part of our 2004 calendar, it will be steady, it will be a low level, but the new news will be about food.

It will be about relevancy for our customers.

Janice, this is Matt.

I will try to cover off on the issue about whether or not the higher average check will offset the higher beef cost.

Based on what we see today, if we can maintain anywhere near these levels of average checks, it will more than offset the anticipated increase in beef cost.

Thank you.

Jim, would you like to make a --

I just want to sum up where we stand today.

If you haven't gotten the picture it's back to basics for brand McDonald's.

Good food, terrific service, and clean, inviting restaurants.

In the coming months you will see our owner/operators, suppliers, and employees continue to take the strategic focused and disciplined steps that I firmly believe will strengthen McDonald's leadership position.

We are encouraged by our progress.

We still have a lot of work to do.

It is all about consistency, about grinding it out each and every day.

It won't be easy, but we are up to the challenge.

I thank you for your interest in McDonald's.

Goodbye.

Ladies and gentlemen.

Thank you for your participation in today's conference.

This concludes the program.

You may disconnect.

Good day.