麥當勞 (MCD) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the October 19, McDonald's investor call.

At this time all participants are in a listen-only mode.

Later we will conduct a question-and-answer session, and instructions will follow at that time.

If anyone should require assistance during the conference please press star then zero on your touch-tone telephone.

As a reminder this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Mary Healy, Vice President, Investor Relations.

Ms. Healy, you may begin.

Hello everyone.

Thanks for joining us today.

As usual this conference call is being Webcast live and recorded for replay.

The language in the earnings release we issued this morning regarding forward-looking statements also applies to our comments on this call.

That release is available on investor.McDonalds.com as is our 8(K) filing of the release and supplemental financial information.

Today you will hear from our CFO, Matthew Paull, and the President of McDonald's Europe, Russ Smyth.

In addition in recognition of our first anniversary of the launch of "I'm lovin' it", Larry Light our Global Chief Marketing Officer will join us for Q&A.

Regarding Charlie Bell, our CEO, as you would imagine with these good results Charlie would have loved to be here to discuss them but right now his top priority is his cancer treatment and recovery.

So he won't be participating on the call today.

He appreciates the well wishes many of you have sent.

Now I'd like to turn the call over to Matt.

Thanks Mary, and good morning everybody.

Our strategy of being better, not just bigger, continues to pay off it the third quarter.

Global comp sales were up 5.8 sales, systemwide sales increased 10%, operating income increased 14%, and earnings per share increased 42%.

Because of our systems focus on our customers and the alignment around our Plan to Win we have a business that is vibrant, robust, and profitable.

When we began our revitalization we said the real impact of the Plan to Win would be felt as we improved in all aspects of the customer experience.

Or in McDonald's language, excelling in all five Ps of our plan, people, products, place, price, and promotion.

The power of the combination of these strategic drivers is evident, year to date U.S. comp sales are up 10.4%, better tasting food, greater menu variety choice and value, extended hours, improved service, and the "I'm lovin' it" marketing campaign are all working together to bring more customers to McDonald's more often.

In Europe we have a strong brand and business and we have the right strategic approach to improve the long-term performance of this critical business segment.

We're making progress as evidenced by Europe's year to date comp sales which are up 2.7%.

However, the external economic environment particularly in Germany, one of our three largest markets, is challenging, and our performance is not yet as consistent or as strong as we'd like it to be.

In a few minutes Russ will talk in more detail about the tactics being employed in Europe to drive sustained improvement in sales and profits.

But around the world, there is no doubt that McDonald's is far more relevant today.

Customers are getting a better experience, and they are giving us permission to expand our boundaries.

This has been a key factor in the success of premium salads in the U.S. and salads plus in Australia and Europe.

It is why we are able to test new categories and expand regional ideas like McCafe, we have more brand elasticity to do more things to bring new customers into our restaurant and broaden our appeal.

Now we have to take advantage of this flexibility.

To date we have captured only a small piece of what we believe is possible.

We are pleased with our progress but we are more excited about the opportunity ahead.

We realize that not all markets are performing at an acceptable level.

We are focusing on the areas needing the most attention and continuing to replicate our best products and programs to drive results.

On a consolidated basis results were strong in the third quarter.

I'll review the performance in the U.S. and Asia Pacific, and then you'll hear from Russ on Europe.

The U.S. had another robust quarter growing comp sales 8.5% on top of a 9.5% comp in 2003.

An integrated approach to improving the business drove this strong performance.

On the product front, Chicken Selects, Chicken McNuggets with white meat and a strong Happy Meal lineup were key contributors to the quarters results.

In addition the ongoing popularity of salads and McGriddles, both premium products contributed to strong sales.

On the operations front our mystery shops scores continued to increase over comparable periods in 2003.

That said we certainly recognize that there is still room for improvement.

We are taking steps to do just that, steps such as focus training and service driven equipment enhancements.

In addition we are leveraging our convenient advantage with cashless service and extended hours.

Currently more than 6200 U.S.

McDonald's are speeding service and driving incremental transactions through cashless payments.

It takes about 15 seconds to process cash.

With cashless, it's about 4 seconds.

In time, we will also offer gift cards which provide additional sales and convenience benefits and drive loyalty.

Extended hours is also making McDonald's an easier choice for consumers.

Approximately 19% of our U.S. restaurants were open 24 hours during the third quarter compared to about 12% last year and nearly 80% offered some form of extended hours.

On the value front, our dollar menu continues to bring customers into our restaurants.

Once people know about our every day low price platform they only need an occasional reminder, so we can now focus the vast majority of our marketing resources on brand building.

As a result, today less than 20% of our marketing is focused on price.

At the local level we've shifted significant advertising to products, breakfast, and extended hours.

In Asia Pacific branded affordability programs combined with food relevance and service initiatives drove a 5.4% comp sales increase in the quarter.

China, Japan and Australia all delivered strong sales.

Australia has been able to build on the success of its salads plus menu with the recent introduction of Chicken McNugget with white meat.

In Asia we continue to cater to local tastes increasing our relevance.

Currently we are testing rice and seafood offerings as well as a fresh-plus menu, a local interpretation of salads plus.

Now I'd like to turn to recent margin trends.

Although we haven't specified a time line, we believe that we can return brand McDonald's Company-operated margins to 16.9% of sales, a level last achieved in year 2000.

We are making steady progress against this measure.

Strong performance in the U.S. drove a 40-basis-point improvement in the quarter's consolidated Company-operated margin, at 16.3% of sales it was the highest third quarter margin since 2000.

Year to date September, the margin was 15.4%, a full 100 basis points over the same period in 2003.

U.S.

Company operated margins increased 100 basis points in the third quarter to 19.6%.

On a two-year basis they were up 410 basis points versus third quarter of '02, year to date September U.S. margins were 19.1% of sales.

This margin improvement was achieved despite higher commodity costs in the U.S., notably beef and cheese costs were up, but as we've previously communicated, the year-over-year increases moderated compared with the first half.

We expect beef costs in the fourth quarter to be similar to last year's costs while cheese costs are expected to be lower than last year.

Looking toward '05 we currently expect beef and chicken costs to be up modestly and cheese costs to be down.

Our U.S. owner operators also are benefiting from strong sales momentum.

The average cash flow per franchise restaurant continues to be up significantly.

Asia Pacific's third quarter Company-operated margin was 12.3% of sales essentially flat with the same period in '03.

Hong Kong and Australia were strong while South Korea was weak.

In addition, China's margins were affected by a benefit received in '03 from SARS-related sales tax relief.

This benefit added 80 basis points to the segment's margin in '03.

Now let's take a look at franchise restaurant margins which represent about two-thirds of worldwide margin dollars.

As a percent of franchise revenues the consolidated franchise margin increased 40 basis points for the quarter and 100 basis points for the nine months.

These improvements were largely driven by the U.S. business which contributed more than 55% of the margin dollar increases.

On the tax line, we realized a 7-cent per share benefit in the quarter primarily due to a transfer of shares between subsidiaries and a change in assumptions about the utilization of certain loss carry forwards.

As a result the quarter's effective tax rate was 22.6%.

This brought third quarter EPS to 61 cents, an increase of 42%.

Even without the tax benefit growth in earnings per share was robust.

Our current outlook for the fourth quarter tax rate is about 30%.

This tax outlook does not take into account the corporate tax bill currently awaiting the President's signature.

Based on a preliminary review we expect that bill to have limited effect on McDonald's reported results.

We expect next year's tax rate to return to historical levels, as we complete our 2005 planning we'll update our guidance.

Now I'd like to turn the call over to Russ.

Thanks, Matt, and good morning.

As you know our business in Europe ran into some challenges in the third quarter.

Up to that point we had been showing steady momentum, delivering our strongest comp sales growth in more than two years in the second quarter.

Our third quarter comp was up just slightly, and this has slowed our momentum but year to date comp sales are still up almost 3% compared to a 2% decline in this same period last year.

During the third quarter several external factors affected many of our largest markets, most significant was a high unemployment rate across Europe which has resulted in low consumer confidence and a decrease in eating out.

This is not a completely new development, though.

We began to see erosion in consumer confidence and modest shrinkage in the informal eating out market in the first half of the year.

However, we were able to offset these factors and still deliver positive results.

In the third quarter Europe's external issues intensified, particularly in Germany, unemployment is at nearly 11% in this market and consumers are experiencing high uncertainty about labor market reforms planned for next year.

And while I don't want to dwell on Germany the reality is that their results have significantly impacted our overall momentum due to both their size and their positive performance in the first half of this year.

In fact, if you compare our quarter 2 comp of 4.4% to our quarter 3 comp of .3% Germany accounts for almost two-thirds of the difference.

McDonald's is not alone in feeling the effect of stagnant economies in Europe, companies such as Coca-Cola, Cadbury, Schweppes, and Nestle, have all recently reported a significant decline in European sales but our third quarter challenges were not all about external factors.

We failed to execute well with two of our key customer groups.

Kids and young adult males.

Happy Meal sales were down in the third quarter as were the number of young adult males visiting our restaurants.

In both cases neither our offerings nor our marketing resonated compared to previous quarters.

Looking forward we do not anticipate that economic conditions in Europe and particularly Germany will improve dramatically in the short term.

So rather than expending energy on these external factors our focus is on driving sales and taking even more market share from our competition.

The good news is that doing this does not require a change in our strategy.

We have the right plan and strategic priorities in place to grow top-line sales and drive bottom line results.

Our four priorities of service, food, value, and leadership marketing and communications will remain our priorities into 2005.

But to improve results we must concentrate on two things.

First, improving our execution, and second, shifting our emphasis on specific priorities or tactics.

For example, value becomes especially important when the economy is struggling and people, particularly young adults, are less inclined to spend money eating out.

Our approach to value remains a balance of offering every day value platforms like euro saver and pound saver, along with the selection of premium products like salads plus and the the bigger Big Mac.

In response to ongoing economic issues in Germany we are plusing up the McDeals everyday platform, ensuring that the right products are offered at the right price and shifting our advertising spend to provide more TV support.

We will also run a short-term coupon promotion similar to one we used successfully earlier in the year with the goal of getting people out of their homes and back into our restaurants.

In France we're working hard to find the right value offer that will drive transactions in a profitable way.

This month we started testing a new euro saver-type menu called Leprix Gourmal (ph) in 100 restaurants around Paris.

We have carefully chosen the products featured on this menu and to complement this we now have a better selection of premium product to encourage in-store tradeup.

In addition, next year we plan to introduce some new burger choices in all of our French restaurants, priced to be affordable and featuring different sauces and flavors like Asian and Tex-Mex that will have particular appeal to young adults.

In the area of service we have introduced extended hours in 200 restaurants in both France and the UK so that we are even more convenient for our customers and we will continue to look for ways to apply this tactic in other countries where appropriate.

We are also continuing to use incentive programs at all levels of our organization to drive better service performance.

And our cross-functional operations improvement team is preparing for an intensive service focus throughout Europe beginning in the first quarter of 2005.

In the area of food, we continue to be pleased with the performance of our salads plus line, which is a key building block for increased consumer relevance and future growth.

Depending on the country, these new products are adding as much as two points to top-line sales and are building average check.

We have also seen increased penetration among our key target groups of women ages 25 to 44 and women visiting with children.

And to maintain consumer interest in salads plus a number of our countries are offering a line of low-calorie dressings, some starting later this month.

Our salads plus markets are also looking for more creative ways to get consumers to taste the new products.

Our research shows that 90% of consumers who try our salads intend to come back for more.

But today only 40% of potential customers have actually tried them.

And we'll add new product toment salads plus menu beginning next year.

Overall our plan is to have new food news in Europe two times a year, balanced by two periods of focus on existing or core menu products.

Chicken McNuggets made with white meet are another new products whose performance is encouraging so far.

They've been offered in the UK since May, were introduced in Germany in mid-September and are rolling out in the Netherlands this month.

In the UK the new nuggets have consistently added a point to monthly comp sales results.

In Germany the results are clearly being complicated by the economic situation but to date we are selling 25% more nuggets than we did before.

Going forward we will continue to monitor success and identify where it makes sense to introduce the new nuggets in 2005.

Beverages are also an important focus for us in the food arena.

In Europe we believe that meal occasions such as breakfast and afternoon snack are driven more by beverage than by food choices.

We've switched to our customer's preferred brands of coffee in most markets and are also adding new offerings such as fruit juice, iced tea, flavored water, and diet drinks.

Again, choosing customers' most preferred brands.

Adding great beverage options is an important component of a UK effort to expand their breakfast business.

Currently accounting for about 10% of sales.

UK restaurants are now featuring improved orange juice and coffee choices plus new breakfast food options such as bagels, porridge and fruit toast.

Breakfast remains an untapped opportunity in many of our other European markets so as we continue to learn more we'll apply learning's from the UK to our other countries.

And our final priority is leadership, marketing, and communications which remains a critical factor in driving sales in Europe.

Consumer perception of our brand tends to be less positive in certain European countries so we are taking a more proactive and coordinated approach to telling our story through marketing and public relations involving third parties where appropriate.

Our work is beginning to pay off in certain markets.

Just last week in the UK there was extensive media coverage about McDonald's positive impact on the community as a franchiser, employer, and training organization.

It stemmed from a research study produced by the UKs Works foundation, an independent think tank concerned with employment issues.

At the same time the UK has been using marketing and public relations to challenge consumers to take another look at what has changed at McDonald's.

They recently announced a new advertising approach related to this change theme, but reports that they are dropping the golden arches logo and the "I'm lovin' it" tag line have been highly exaggerated.

On the contrary, a recent study named "I'm lovin' it" as the advertise -- as the advertising line that has most effectively become a part of everyday British speech.

Our ongoing efforts in the UK are starting to pay dividends.

We're seeing signs of improvement in both the perception of our brand and our business results.

We now need to bring this more proactive approach to bear in Germany to help us tackle our challenges there.

Another key learning this year in the marketing arena has been the importance of speaking more effectively to multiple target audiences at the same time.

Our salads plus advertising has been successful at reaching women, but we can't do this at the exclusion of speaking to young adults and kids.

We need sustaining messages sent consistently across the year to all of our key audiences.

In addition, we must implement proven tactics to grow our Happy Meal business beyond just having an attractive premium.

Before closing I'd like to address our margins which actually held up well this quarter given the only slightly positive sales count.

Franchise margins were down 20 basis points an improvement here will be all about growing top-line sales.

Company operated margins were down 30 basis points for the quarter as strong results in Russia were offset by declines in each of the big three markets.

Last year in the third quarter Europe's margins benefited from a very warm summer that resulted in more sales from higher margin percentage products such as drinks and ice cream.

This summer was significantly cooler and wetter, and this, combined with the introduction of salads plus, resulted in a greater percentage of our sales coming from lower margin percentage products.

This was a factor in each of our big three market declines.

Though Germany's was driven more by their mid single-digit negative comparable sales.

France's margin decline was also influenced by labor costs driven by wage increases.

The UKs margin decline was much lower than previous quarters.

They did a better job of controlling labor costs which were flat as a percentage of sales compared with quarter 3 of last year.

Clearly there is much work ahead but we're very confident that we can grow the business in Europe.

We have the right plan in place, and our focus remains on improving execution and increasing our market share despite the difficult business climate.

Our ultimate goal of sustainable profitable growth and contributing our fair share to McDonald's Company-wide goals for 2005 and beyond.

Thanks.

And now, Matt, I'll turn it back over to you.

Thanks, Russ, before we open the call to your questions let me make a couple of important additional points.

It's clear that our strong earnings will generate significant growth and cash flow.

We will continue to exercise discipline in the use of that cash.

What does that mean?

It means we will invest in markets where we expect good returns or have significant potential relative to risk.

We will invest in existing restaurants as part of our renewed focus on the customer.

We will use some excess cash to pay down debt, about 8 to $900 million in '04, and we will continue to return cash to shareholders, this year more than $1.3 billion.

We have made a lot of progress.

In the U.S. we orchestrated a dramatic turn around and have continued to produce strong results on top of outstanding results last year.

In Europe year-to-date results have improved and we are working to build sustained momentum across the segment.

Our improved operating results along with financial discipline have put us on track to earn a handsome return on incremental invested capital in '04 well above our long-term high teens target.

We are encouraged by our progress but we know we have opportunities to further strengthen our Company and this is where our focus will continue to be as we move toward achieving the goals we've set for '05 and beyond.

And now we'd love to take your questions.

Thanks, Matt.

So I think everyone knows the procedure.

You can press one if you have a question, and the pound key if you want to take yourself out of the queue.

To give everybody an opportunity to ask a question we ask to you try to limit yourself to one question.

We'll come back to you for follow-up if need be.

I think we'll start our questioning with John Glass from CIBC.

Just trying to reconcile, I guess, your comments on this call, maybe last call about how well received they've been with the customers and pleased to the amount that they are producing in the mix with the relatively low trial rate, maybe if you'd give a comparison to what the trial rate's been in the U.S. versus Europe -- European market.

Thanks.

John you were cut off just at the beginning.

Were you asking about salads plus products?

Salads plus in Europe and trying to reconcile your comments about how well they've been received in Europe and the relatively low trial rate and your comments about lower margin products being more popular.

Okay.

Russ.

Okay.

Relative to the trial rate of salads plus, you know, part of -- a big part of what we're doing with our menu is offering new choice to attract more customers to our restaurants.

Not just expanding frequency of our existing customer base but growing our customer base.

And that is not a task that happens overnight.

It takes time and takes a lot of focus and some sustainable efforts.

So actually 40% trial rate given an overall 40% penetration level in Europe is pretty good and I believe, Larry, it's comparable to what the U.S. is at in terms of salad trial among customers.

So we're happy with where it's been so far and that's why we think it's been received very well.

And, John, I think we've mentioned before we sold more units of salads plus than either the U.S. or Australia during comparable periods of the launch.

So we think it's done really well.

We're not saying it's not doing well.

What I'm trying to say is we think the platform is going to provide us more opportunity for growth for the future but the way to get that growth is to build more trial with consumers that have not had a chance to actually try the product yet and so that's what our challenge is.

We like what it's added but we think it can do a lot more for us in the future.

Thank you.

David Palmer at UBS has a question.

Hey, guys.

When will the everyday low pricing in the way that you're going to be shifting it to and perhaps you can elaborate on what that means, when will that be coming to Germany and how broad will the menu be, how many items will be effectively dropped in price, and when do you -- and how soon thereafter do you expect to see results?

In terms of relative to Germany the McDeals program has been in place since April of 2004.

On the menu board it's been six items.

Between -- offers are between one euro and two euros at those two price points.

The issue there though has been lack of awareness.

Most of the media support behind it has been limited to sporadic radio bursts throughout the year and as a result although we've had the program we have not created enough awareness of the program, especially with young adults, which is the most price sensitive group of all of our consumers in Europe.

So we have starting in mid-October shifted some of our media budgets from other items into putting McDeals on TV and we will continue to make sure that we've got better TV awareness levels for McDeals for the rest of this year and into 2005.

In terms of how quickly does that, you know, turn things around, this is about sustaining profitable growth, and I don't think anyone should expect that just because we go on TV with it we're going to see an automatic uptick in sales.

As we saw from the U.S. results they were on dollar menu for, I think, several months before they started to see the sustaining benefits because customers need to understand this is an everyday affordable menu platform, it is not about a short-term price promotion.

So I don't expect it to have an immediate impact but I do know that it will have a sustainable impact over time.

Thanks, David.

Our next question is from Peter Oakes at Piper Jaffray.

Hi.

Appreciate the opportunity to have Larry actually on the call here.

Larry, if you look at McDonald's domestic comps over the last years, I mean, it's essentially running at a 20% clip, I'd be curious if you could kind of give us a scorecard from your assessment as to how far along we are as far as McDonald's making the strides that view -- you view as both possible and necessary on the relevancy front.

Thanks.

Thank you.

I think we've only just begun.

Our most recent research with consumers indicates that we've just begun to influence the attitudes of some skeptics and maybe some undecideds'.

You can use a political model.

Our experience with the original 13 months of "I'm lovin' it" for example is that it first turned around the attitudes of our customers and made them feel more positive, our employees and made them feel prouder.

But it takes time to start attracting the attention, gaining the interest and persuading those who come to us rarely, are undecided or possibly skeptical, and the good news, I think remarkable news, is that we're starting to see penetration among the unpenetrated.

That has huge potential for us, and I'm convinced -- I don't know how to put a percentage on it -- but that we've only begun to see the impact.

The top spin of increased points of penetration among non-users coming to us will have a huge impact on our business.

Thanks, Peter.

Our next question is from John Ivankoe at JP Morgan.

I have a question on the U.S. product that's currently being tested, the Oven Selects, and if you're prepared to perhaps give us an early indication in terms of how that's going, in terms of speed of service and the pricing and the product selection, and as a conclusion to that question, if it all goes well when could that possibly be seen in the U.S. system and perhaps some implications elsewhere?

Thanks.

John this is Matt.

I'll take that question.

Just for background we're currently testing Oven Selects in 400 stores in five metropolitan areas in the U.S.

As I think you know at any point in time in a market in like the U.S. we're testing anywhere from two to four products and probably fewer than half those product end up with a national rollout.

So this is one of several things that we're testing.

On the other hand it is a very big category and we're trying to see if we can leverage the speed and convenience of McDonald's in a category which is growing very quickly.

I would emphasize that even though unit movement is pretty good so far it is just a test, and we're testing much more than just customer appeal and sales levels.

We're looking carefully at many, many areas one of which is service times, especially in the drive-through.

If we're going to do this we can't slow down service times for all of the other customers.

We're looking at whether or not this product line will bring in customers we're not currently reaching with brand McDonald's, we're closely monitoring trade off of other products, and we're looking at whether or not it's going to add to the dinner day times and then, you know, I have to tell you it's pretty clear that if we were to roll this out nationally it would probably take 12 to 18 months from when we made the decision to roll it out because it requires changing out pieces of the kitchen and there's also a 20 to $30,000 investment per store and for us and our franchisees we want to be sure it's profitable and provides an adequate return.

It's something we're watching very carefully.

We're also rolling it into more than 1,000 stores in Canada and rolling it into a piece of Australia.

Thank you.

Our next question is from Andy Barish at Banc of America.

Yes, on the U.S. comp numbers could you give us at least a little bit of kind of broad-brush strokes on the check average versus traffic components most recently and if there's been any change in those two areas?

It obviously doesn't look that way, but as you start to lap some of the premium priced products that you've been very successful with do you expect check average increases to maybe start slowing down a little bit?

Andy this is Matt.

I'll address that question.

Throughout this year, it's been a fairly steady composition of our sales growth in the U.S., about half of the comp is coming from average check and about half is coming from increased guest count.

That's a very healthy relationship and it's one we hope to continue.

Thank you, Andy.

Next question is from Joe Buckley at Bear Stearns.

Thank you.

I want to ask you a question about the U.S. margins.

When you talk about the calendar year 2000 targets, I know you're talking about specific regions, you're talking about the overall margin but the current U.S. margin is well above those levels and I'm curious what you think about the sustainability of the current level of U.S. profitability.

Joe, on the -- the current levels are well above year 2000 for the U.S.

By no means do I think we've hit a peak, but it's clear when you've come up as quickly as we have future increases won't come quite as easily.

So I think we have an ability to push it higher but we have greater opportunities elsewhere in the McDonald's world.

Thank you.

Our next question is from Larry Miller at Prudential.

Said another way you've talked about a 1% increase in U.S. comp store sales adding about 2 cents to the year.

Can you give us an idea how much margin growth that might be in the U.S. on a consolidated basis?

Larry, you still there?

Yeah.

Can you guys hear me?

Yeah.

Can you say that again?

I missed some part of it. 1% comp is worth 2 cents.

1% comp is worth 2 cents at the end of the year, is that correct?

Yeah.

Well, to give you some idea in a normal inflationary environment we need a 1 or 2% comp in the U.S. to hold our own on the margin percentage to cover cost increases, in a normal inflationary environment.

I would say 2004, when you look at commodity costs, was an abnormal year, abnormal amounts of inflation and commodity costs in the U.S. so we probably needed a little bit more than 1 or 2% to cover our costs.

So once you get to that let's say, 2% comp level, above that you're probably adding something to the margin percentage.

Thanks, Larry.

Our next question is from Matt Difrisco at Harris Nesbitt.

Hi.

I wonder if you could talk about the experience that you're seeing in Europe with the salads.

It sounds kind of strange that you have such -- it sounds like you're having good success hitting the key market that you wanted, female audience with the salads yet the Happy Meals you cited as one of the weaker parts.

Is that something that was -- could be paralleled with your experience in the U.S.?

Should we expect the Happy Meals to follow-on the salad success?

Or are you going to look at that for as part of marketing maybe positioning and trying to bring attention to getting that salad person to bring in someone who might want a Happy Meal as well?

Matt, I think -- well, I think -- I know in the early part of the launch of salads plus in quarter two we did see, just like the U.S. did, an increase in Happy Meal sales.

So there was something else for mom to have at McDonald's now and that helped us build our Happy Meal business at the same time.

We haven't seen anything that indicates that that phenomenon changed in quarter three.

More of it I think in quarter three is first of all the premiums that we had this year in Europe during the summer months, you know, turned out to be not as attractive as the ones that we ran last year.

Number two, Burger King had the Shrek 2 property which was a big success across Europe in the summer so that took some of our family business away as well.

And, third, the economic issues, the reality is the family visits are more sensitive to economic fluctuations, you know, than other visits.

And so those three things we believe are what drove the decline in Happy Meal sales in the third quarter.

Not that we still haven't seen the same benefit from the synergies between salads plus and Happy Meals.

That still seems to exist.

Our next question is from Rob Schwartz at U.S. Steel.

Hi, it's Rob Schwartz from JL Advisors.

Congratulations guys, just had a quick question on the promotional environment, can you talk a little bit about what you're seeing in the U.S. around you and expectations into the next quarter?

Rob this is Matt.

I'll answer.

We look very carefully at the competition but we don't reset our game plan based on what we see them doing, so we see a reasonably healthy environment for QSR in the U.S.

We certainly see Burger King making some noises like, you know, they're showing strong signs of life, something we watch very carefully but I want to emphasize that our Plan to Win and our revitalization plan are built on playing to our strengths and we're not going to overreact to anything any single competitor does.

Thank you.

Thanks.

The next question is from Dean Haskell at JMP Securities.

Good morning.

Congratulations everyone.

The Happy Meal advertising in the third quarter about buying a salad and getting a Happy Meal at a reduced price is that an ongoing or was that just in specific mark?

That was a local regional promotion, so we have 21 regions in the United States and one of the regions was doing this.

So it was local, I believe it was in New York only.

Thank you.

September was a local window.

So you saw a lot of different advertising around the country.

The next question is from Janice Meyer of CSFB.

Thanks, Mary.

You've been work on improving service in the U.S. for, I don't know, a good two years now, and while you tell us that your internal measures continue to show improvement, despite great same-store sales, it doesn't seem like you're really seeing as much improvement on external, you know, service-specific measures.

I mean we look at the drive-through survey.

I'm sure you have your own measures.

But you don't seem to be making the kind of progress there.

Can you talk about why you think you are not seeing the kind of service improvements you think you should and how long is too long to wait, you know, between internal measures improving and external measures not and finally, for Russ, you talked about an intensity on service for Europe for 2005.

Are you going to be using the same platform that they use in the U.S., or are you doing something different?

Janice, I'll take the U.S. question and Russ will deal with Europe.

I want to kind of challenge the premise.

We've seen some progress.

We've focused probably most of our institutional effort on speed of service, and in terms of the seconds it takes to serve a customer we've made progress there.

Now, some people in the industry have also made progress but we see steady progress against our internal measures.

What we've done as a Company is we've recommitted to fundamental training.

We went away from it for quite a few years and it doesn't show instant results, we're making a lot of progress.

We've rolled out E learning by the end of the year to all of our U.S. stores, we're using a seed store training which is a method where we show something to a key group of operators and they train the rest of the system.

There's a lot more buy in there.

But I want to make it clear that some of the fixes to our service issues are more long-term and more technology dependent and it will take more than a few months to see progress.

I'll mention a couple of things we're working on.

Our cash register systems that we call our POS systems, need to be simplified and standardized and better integrated with our customer order displays which feeds back information to the customer at the drive-through.

We will have something in place by the end of '05 that gives us a much better chance to get that right at 10,000 of our stores.

It's not in place today.

We're also working on something longer term involving call centers where a call center employees with very strong communication skills would be taking orders from drive-throughs operating on a call center basis, it's a chance to allow people to play to their strengths, people with really good communication skills would be taking orders.

We're going to have it in 40 or 50 stores within a month or two and it has a lot of long-term potential but I want to make it clear that it isn't about changing our crews.

It's really trying to find a way to make the crew we have today more productive.

We think some of the training and technology tools that will become available will allow us to make strides in that area and we look at the QSR study very carefully and we're a little disappointed especially in the area of order accuracy and I want you to know it has our attention.

Russ, do you want to--

Janice, on the Europe piece I would say that Mike Roberts and I keep in pretty close contact and whenever either one of us finds something that's working from a service standpoint, whether it's speed or hospitality we are sharing that information back and forth across the ocean.

So whenever anybody finds out something that works in service we're all ears and figuring out a way to get it into it the system faster.

Having said that I think there are some business differences between where the U.S. is at and where Europe is at.

I'll touch on the two biggest ones.

The first is operating platform.

All of you know the U.S. has been on "made for you" for a long time.

One of the challenges that we have going forward is as we add more choice to the menu and as we balance giving consumer more choice with making sure we can still improve our quality service and cleanliness scores in the restaurants we've got to make some adjustments to our operating platform.

It does not mean we're going to "made for you."

In fact, we're going to stay on the elements of grow direct as it -- because it serves our business volume patterns very well but we've got to do some tweaking of that.

And we've had -- our three largest markets UK, Germany, and France into the innovation lab to play with what changes would need to be required to give us the capability of expanding the menu a little bit more over the next few years and still helping us improve service levels and food quality levels.

So we're doing work there that is unique to Europe.

The second big area of difference is in the drive-through.

In the U.S. drive-through is a much bigger percentage of the business than it is in Europe.

As we look at consumer trends in Europe convenience and food in the car is becoming a bigger and bigger opportunity, and so we've got to focus specifically on improving drive-through service in Europe which the U.S.

I think has done a pretty good job of over the last few years.

So I think that's a bigger opportunity for us in the future than it is for the U.S.

Thanks Russ.

Jeff Omohundro from Wachovia is our next question.

Hi.

I wanted to dig in a bit more on the "I'm lovin' it" campaign.

And in particular it seems like over the past year or so the campaign has been used initially as a branded McDonald's campaign and it's transitioned it seems likes as an umbrella for some of the the product campaigns you've been using.

I guess my question is where are we on the evolution of "I'm lovin' it" and what do we have to look forward to in the future?

"I'm lovin' it" is more than just a slogan and you are correct that it is more than just a component of our brand launch, or what you call their branded McDonald's.

We have three strategic objectives with "I'm lovin' it."

One, it is a brand statement, a verbal expression of the spirit of our brand.

Two, we view every product advertisement and communication as also a brand communication.

So "I'm lovin' it" will be integrated and will continue to be integrated into our product and promotional advertising.

Because that is another reason people love coming to McDonald's.

And it is also an internal message, an internal rallying cry, and we are using that to communicate internally.

For example, next week we will have our first ever -- first ever global HR meeting, and one of the messages will be to improve employee prides. "I'm lovin' it" as a rallying cry because people who love what they do, do a better job.

So there will be internal communications, external communications, and you'll see both branded messages, McDonald's brand messages continuing, you'll also see it integrated at product and promotional messaging.

Larry, I'd like to ask you to follow up on two things relating to "I'm lovin' it".

Number one are we edgy enough now with "I'm lovin' it"?

Number two, you shared some data with me about how memorable it is.

Would you mind sharing that.

The first question, are we edgy enough now, the answer is no.

We moved the edge of our brand and people were shocked.

It's only 13 months, only 13 months ago that we launched "I'm lovin' it" and today's consumer looking at the same advertising is now saying, well, you moved the edge, will you continue to move the edge.

Now, the good news is we've changed from a brand that's cold to a brand that's cool, and that has had an impact on the consumer.

And one of the studies, an external study, not a study of our own, asked American consumers to identify which companies were associated with which slogans.

The average was 19% for major slogans in the United States, some that have been around for years, like "You're in good hands with All State."

So the average was 19%.

Some major brands with budgets much bigger than ours, with campaigns that have been around for a few years, actually scored less than 10%, and we were delighted to see that "I'm lovin' it" on that survey scored 33%, nearly twice the average, and it's only been 13 months.

Other research confirms that "I'm lovin' it" is resonating with consumers, we're very pleased with our progress over the first year, we're excited about the future.

In Japan on a similar survey of corporate brand slogans, we increased in rank position from being in the 80s to being in the top 20.

In fact, I think we moved from 85 to 17 or 16.

And this is -- pattern is continuing around the world.

So we're thrilled with the impact it's had, the feedback from the consumer, but I wouldn't underestimate.

We've had a terrific feedback even from our own employees, feeling better about how our brand is represented in the marketplace.

Thanks, Jeff.

Next question is from Paul Westra at SG Cowen.

Great.

Thank you good afternoon.

Just wonder if you could give us a little bit more detailed update on China.

You noted in the release you had improved performance there.

I was wondering if you could give us a little more color about what's going on there.

And I think you noted earlier in the year, you're looking to do a little bit accelerated development, I was wondering where you stood on that front as well?

Thanks, Paul.

Russ and I were just in China together two weeks ago.

Incredibly exciting market.

We cannot stand that we're not number one there and so we've put together a ten-year plan that we're sharing with management and all our top talent is working on it and we're going to be very aggressive in China and you will see higher unit openings than you've seen in the past but nothing that's outside of the capital budgets we've already shared with you.

So we think it has incredible potential, we expect that we'll have a thousand restaurants there by the Olympics in -- coming up in a couple of years and I think that our returns will be good and our customers there, our crews over there are incredibly excited.

Thanks, Paul.

Our next question is from Joe Buckley at Bear Stearns.

Thank you.

I wanted to go back to Russ's comments about the young adult males in Europe.

Just kind of curious what you think you -- how you think you sort of missed connecting with them through the summer months, and also would you comment, do you see a minimum wage increase coming here in the fourth quarter?

Yeah.

I don't know anything about a UK minimum wage increase so I believe the answer is no but we can follow up and get back to you.

In terms of the young adult males, Joe, what did we miss?

A couple of things.

First of all in Germany and France we didn't have, you know, either, a value program, which is the case in France, or one that young adult males were aware of, which is the case in Germany in place in the summer.

And I think when the economic uncertainty hit and we already know that young adults are the most price sensitive of our consumers, that we kind of got a double impact in those two large markets.

So that's part of what hurt us with the young adult male group.

The second thing I would say is, you know, with no disrespect to Larry, Sony connect didn't connect, and that was a big part of what our calendars were in July.

Part of it was because we ran a euro 2004 promotion that was tied to the Big Mac sandwich that we were committed to and then the Sony connect was also a global Big Mac piece so we had a double dose of Big Mac back to back and I'm sure that was a big piece of why it wasn't as effective.

And then the third area I would say Joe, is Larry talked a little bit about our "I'm lovin' it" marketing not being edgy enough and Europe is very guilty of that.

And frankly, in Europe, our customers give us permission to be a lot edgier than we would get in the U.S., and so we've got permission to be hipper and edgier and we need to get there, because we're far away from that and I think that not sustaining the "I'm lovin' it" tonality and relevance also hurt us with the young adult group, males in particular.

So those would be the three big reasons why I would say that our results in that category in the third quarter showed a decline.

Thanks, Joe.

Howard Penney from FBR has a question.

Matt, I was going to paraphrase your closing comments when you said the return on incremental capital in '04 was well above your high teens target which I assume was set back prior to the turn around.

Why is that high teens target still appropriate today, especially given the business model that you have and the significant improvement still to come, why isn't it 20 to 25% and somehow can you justify the 16% or not justify it but maybe break that down on how you get to 16%?

Why it isn't more today?

Sure, Howard.

Let me first make it clear that when we measure that, we're ignoring currency effect.

So if you look at the as reported number it would have been higher.

We take out any wind at our backs from stronger currencies when we do that computation.

And as to why it's not higher we set goals back in April of '03 that we thought were very realistic and attainable.

We didn't want to overreach.

Part of what's helping us now is very clear is not just the returns we're getting on new stores and remodels but we're improving the base.

We've got a $25 billion base that is looking a lot healthier than did it two years ago.

That makes more things possible.

And there are certain market where I expect that we will do better than high teens but there are other markets where we might not.

So on a blended basis that's still what we're going to target to deliver.

When I look at McDonald's at its peak, our overall Company-wide return was in the high teens.

We're trying to get back there, and the way to do that is to be sure that our incremental return is at least at that level.

So I don't think we're going to reset a higher target because we're not certain that a higher target would be sustainable.

Thanks, Howard.

Thanks, Howard.

Your next is Mark Kalinowski at Smith Barney.

You're seeing in general the relations between the parent corporation and franchisees in the U.S. improving as part of that wondering if you're getting any push-back from the franchisees as you roll out cashless throughout the U.S.?

Mark, we always have a give and take with our franchisees.

I want to make it very clear that relationships will never be entirely harmonious, nor should they be.

They're a very good check and balance on our excesses, because if we had our way they'd be investing forever and not reaping any of the rewards of their efforts.

So I'd say our relationships are certainly better than they were two years ago.

I would say there was very strong push-back on cashless, a lot of discussion, but we've moved beyond that.

And I have to say when you look at everything good that's happened in the U.S., we've said many things working together have delivered a much stronger healthier business.

The alignment with franchisee leadership is way up on the list, maybe at the top, and a better and improving brand image is probably right behind that.

Thanks, Mark.

Thanks.

Our next question is from Warren Davis at Tribune Capital.

Warren, do you still after question?

We'll move to Matt Difrisco at Harris Nesbitt.

Hi.

Just following on your comments regarding the beverages in Europe.

How about the beverages in the U.S.?

I mean, we obviously have one large coffee brand here that's developed over the last decade.

Is there any looking into improving or sooner than later improving the coffee product and highlighting it maybe through advertising to try and draw in some incremental traffic into the breakfast day part?

Matt, we would agree with your premise that there's huge opportunity in hot and cold beverages and over the last few years we've not attacked that opportunity properly.

We're looking at a new blend of coffee, we're testing it in a few dozen stores.

We're also, you know, looking at specialty coffees and the issue is will we do that through McDonalds or through McCafe.

But we would agree that snack, dinner time, and hot and cold beverages are where our biggest opportunities, untapped opportunities, lie in the United States.

Thanks, Matt.

Okay.

We have time for a couple more questions.

Larry Miller at Prudential has a question.

Thanks, Mary.

I was wondering on your current thoughts on acquisitions, it's been awhile, you've been divesting businesses, clearly the U.S. business is improving, cash flow is improving.

What are your thoughts?

Yeah.

Well, our cash flow improving, but, you know, we study history very carefully.

Our system gets distracted very easily.

I'm not talking about the franchisees, I'm talking about our management gets distracted very easily.

What we're doing now is looking.

When we were acquiring small business we weren't doing very well.

We've got tremendous focus and discipline now and I cannot imagine in the next 18 months we'd be looking at any serious acquisition.

We're going to stick to what's working.

The only exception that I see on the horizon, and it wouldn't be in the next 18 months, if there was some product out there that we thought was a killer product for 20,000 or 30,000 stores and the only way for us to access that product was through acquiring something, maybe we would consider something like that, but that would be out there a couple of years.

Okay.

Our last question is from David Palmer at UBS.

Follow-up question on Germany and the everyday low pricing there.

You mentioned that you'll be increasing the marketing emphasis behind every day low pricing there, namely the McDeal menu.

Is it -- so just -- from that can I infer that you believe that it's an awareness issue and that really it's not a price point issue, not a true perceived value issue, in other words, here in the U.S. the dollar menu seemed to really ring the bell for consumers and you haven't really had to emphasize that with advertising to a large degree.

And I'm wondering if you feel like that value is at the same level in Germany in particular?

David, we've done consumer research to test what we call price sensitivity and the good value ratings of the items that are on the McDeals menu and they're off the charts.

So we're very confident that it's not a matter of are these the right products at the right price.

It's clearly an awareness issue because when we went to the marketplace to find out who was aware of it, it was very, very low.

So we're confident that we've got the facts that it's more about awareness rather than products and price.

Our experience in the United States and other places is that when we -- to establish something like the dollar menu, does take substantial media weight.

In the United States, for 90 days, it was by far the majority of the messaging, the whole system was aligned nearly single mindedly behind establishing the dollar menu.

You are correct that today it's less than 15% of the national messaging to the consumer.

But that's because it was well seeded in the customers' minds, and now only needs reminding.

We didn't do that in Germany.

David, one other add-on is part of increasing awareness is using the exterior of our restaurants to better communicate great value offers and so increasing awareness is just not about shifting TV media support.

There's a lot of other merchandising tactic things that can be improved that will also help increase awareness at a relatively low cost.

Thanks.

We do have one more question from Peter Oakes at Piper Jaffray.

Hi.

Russ, thanks, I want to follow up on Germany.

The way you're describing the macro environment it's tenuous at -- if we go back a couple of years ago I think the entire in promo eating out market was down as much as high-single digits, are we seeing anything close to that currently and are you starting to see any follow-up as far as a supply shake-out occurring throughout the informal eating out market?

In terms of the shrinkage and the IEO in Germany, Peter, it is similar to what it was now a couple of years ago.

It was not as bad as that in the first half of this year but what we've seen in the third quarter is further slippage.

In terms of implications for supply chain do you mean do we think that some restaurants are going to close?

Is that what your question is?

Exactly

From what we're aware of you see lot of small mom and pop type single store closings.

We haven't seen or heard of any signs of major chains closing.

But in fact one of our biggest competitors now in informally eating out in Germany is these little kabob stands.

People that set up on a street corner with a little cart and give a lot of food at a very low price and they are taking a lot of share from everybody in the IEO because it's bulk food very inexpensively.

So whatever benefit we might see from add-on mom and pop closings we're seeing these kind of kabob stands pick that up very quickly.

Thanks, Peter.

With that I'd like to ask Matt to close our call with a couple of comments.

Thanks, Mary.

I'd like to close with a longer term view of our future.

With the exception of a few countries the global informal eating out category is expanding at a very healthy rate and the experts tell us that this will continue over the next five years at least.

As our brand continues to gain relevance we are well positioned to capture this opportunity.

The trajectory of our business indicates we are heading in the right direction and I am confident we will continue to deliver for our customers, our system, and our shareholders.

Thank you all for joining us today.

Good-bye.

Ladies and gentlemen, thank you for participating in today's conference this concludes the program.

You may all disconnect.

Everyone have a great day!