麥當勞 (MCD) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the McDonald's April 21 investor conference call.

As a reminder, this conference call is being recorded.

I will turn it over to Mary Kay Shaw, Vice President of Investor Relations.

Miss Shaw, you may begin.

Thank you, hello, everyone and thanks for joining us today.

With me are CEO Jim Skinner and CFO Matthew Paull.

Joining us for Q&A from London will be Russ Smyth, President of Europe.

This conference call is being Webcast live and recorded for replay.

As always, the forward-looking statements which appear in today's earnings release and 8K filing also apply to our comments on this call.

Both the earnings release and our 8K, which includes supplemental financial information, are available on investors.mcdonalds.com as well as reconciliations of any non-GAAP financial measures mentioned on the call today to their corresponding GAAP measures.

With that, I'd like turn it over to Jim.

Good morning everyone and thank you for joining us today.

As you may know, last week we celebrated McDonald's 50th anniversary.

Owner/operator, suppliers and employees from around the world gathered together in Chicago to recognize a half century of innovation, opportunity and success.

More important, we also took this opportunity to further calibrate our plan for the future.

While our 50th milestone is significant, we really view it as merely a part of our progress on a journey of continuous improvement.

Our road map to the journey is our Plan to Win.

As long as we're in the food business, we will strategize around the Plan to Win and the five levers that drive our business; people, products, places, prices and promotions.

It is a winning plan that is delivering results.

For the first quarter, systemwide comparable sales for McDonald's restaurants were up 4.6%.

Our eighth consecutive quarter of positive global comparable sales.

Revenues increased 9%.

And operating income was up 6%.

And this is after overcoming a 7 percentage point impact due to the expensing of stock options.

The end result is the EPS was $0.56, a 40% increase over the same period last year.

Our performance in the United States continues to be driven by a holistic approach to the Plan to Win.

Initiatives that are delivering variety, value, convenience and relevance contributed to our ongoing momentum.

The combination of premium products and value as well as Happy Meal choice, extended hours, cashless and reimaging all drove our results.

Chicken Selects and McGriddles continue to sell at strong levels.

While double cheeseburgers and McChicken sandwiches support our customers' for value.

And for the first three months of the year, average weekly Happy Meal sales were up 5.5% when compared to the prior year.

Currently almost 11,000 restaurants offer a cashless option.

Our goal is to have nearly 13,000 restaurants on cashless by mid-year and the addition of gift cards by year end will further increase convenience of the customer's experience.

We're planning to reimage 1300 restaurants this year, as well.

And we expect to see results similar to those in 2004 with comparable sales increases of around 5% over the general market index.

Looking ahead, we will continue this focus on what's most important to our customers.

In Europe, customers are responding to our menu of variety, value and improved service.

In Germany, we continue to mitigate the weak economic environment with our long-term approach to everyday affordability.

And we're encouraged by the market's value menu performance, which features 11 items at EUR 1.

And we've seen steady increases in guest counts since this implementation in January.

And we're beginning to see a shift in how customers are using it as more value purchases are becoming add-ons, average check and profitability will increase.

In addition, customers are responding to three new premium products on the salad-plus menu, Greek salad, chicken flat bread and a fruit smoothie.

In the United Kingdom, we're continuing our work around the McDonald's brand image to increase our relevance and impact public opinion and customer perception.

Initiatives addressing Happy Meal choice, menu variety and balanced lifestyles are some of the tactics we're applying to strengthen our business performance and build a foundation for steady improvement.

Last month we added new menu items to our Happy Meals, including Chicken Grills, delicious portions of chicken pressed meat with 1.27 grams of fat, 0.4 grams of salt and 76 calories for a three-piece serving.

We now offer carrots, which can be chosen as an alternative to either French fries or fruit.

These carrots deliver one of the recommended five a day servings of fruit and vegetables.

And, we're adding two additional no-sugar-added drink choices.

In addition, we're giving parents all the information they need to make the right choices for their children.

The new Happy Meal choices chart communicates the calories, fat and sugar content of every meal combination.

And relates them to the U.K.

Department of Health's estimated average requirements for children.

So that's a brief look at the performance in the United States and Europe.

Globally, McDonald's revitalization is going strong but we're never satisfied with the status quo.

We have our sights set on accelerating momentum in the markets where we're seeing success and gaining traction in others.

We will do this through a combination of operations excellence and leadership marketing and customer-focused innovation.

Some examples of upcoming initiatives include the global rollout of restaurant operations improvement process or ROIP, as we call it.

Which identifies key areas of improvement at the individual restaurant level and brings in resource to enhance performance.

That's one of the reasons, of course, why we've seen increases in comparable sales and customer satisfaction in our U.S. restaurants over the past two years.

ROIP will be up and running in our top 10 international markets by then end of this year.

And this will be an enhancement to our already strong measurement programs that are in place in those markets.

Last month, we launched a global initiative and partnership with the International Olympic Committee around food energy balance.

This public education awareness campaign will be communicated through marketing, around the theme it's What I Eat and What I Do, I'm Lovin' It.

In the U.S., fruit and walnut salad will launch nationwide in early May.

And three varieties of premium of chicken sandwiches will launch later in the year, following encouraging customer response during testing.

The sandwiches feature tastier grilled or crispy chicken breasts, prepared in classic club or bacon ranch styles on a honey wheat roll.

In the area of service, we continue to align and motivate our restaurant managers and crew.

This summer, we're holding the second U.S.

Manager's Peak Experience and this is a chance for us, with thousand of our managers and owner/operators to strengthen our alignment around the Plan to Win to build on our momentum.

We're expanding our salad plus menu platform in Europe, adding pasta our couscous salads with chicken.

And in addition, later this year selected European markets will launch a new line of sandwiches called Pitamac, featuring vegetables, grilled chicken or spicy beef in a pita pocket.

In the third quarter we will hold the first PanEuropean open doors program.

Where we open the doors of our restaurants and suppliers to give consumers a behind the scenes look at our operations.

It's been successful in delivering messages about food quality and increasing consumer trust in individual countries.

And now we will leverage the opportunity by holding open doors in all of our major European markets at the same time.

In Asia, following a promising test, we're launching in Taiwan a brandable rice platform, including a crispy chicken rice burger and the sliced kalubi beef rice burger.

We're building on the learnings and success of our U.S. and European value menus by expanding our value platforms in every area of the world.

Our investment in reimaging the interiors and exteriors of our restaurants will continue.

This year we will reimage about 700 restaurants outside the United States in addition to the 1300 in the U.S.

New plate place concepts that encourage physical activity and stimulate creativity are being developed in the U.S., Latin American, and France.

And self-service kiosk testing is occurring in the U.S., Australia and Japan.

Moving forward, we will continue to develop new and innovative ways to enhance our customers' experience.

And as we look to our future, we will stay focused on our customers and restaurants.

Organizational alignment around our Plan to Win will drive our progress.

And unwaivering dedication to leadership marketing will continually increase our relevance in the customer experience.

And commitment to financial discipline will continue to pay dividends to our system and our shareholders.

I'm confident in our future.

And as I told the McDonald's system last week at our 50th, our first 50 years have been great, but the next 50 years promise to be even better.

Thank you and now I will turn it over to our CFO, Matthew Paull.

Thank you, Jim.

Good morning, everybody.

I will focus on the financial results for the quarter with an emphasis on margins; one component of our consolidated financial goals.

Overall, we delivered strong results for the quarter.

Consolidated comp sales were up 4.6%.

Revenues were up 6% in constant currencies and combined operating margin dollars increased 6% in constant currencies.

Franchise margins represent 2/3 of combined margin dollars and were $945 million for the quarter, an increase of 58 million in constant currencies over first quarter of last year.

For the quarter, franchise margins as a percent of franchise revenues were 78.6%, up 70 basis points.

Franchise margins increased in most segments but the U.S. and Europe were the biggest contributors, due primarily to positive comp sales.

McDonald's Company operated margin dollars increased approximately $19 million or 4% in constant currencies over first quarter last year.

The related margin percentage decreased 30 basis points, primarily due to higher commodity costs, mainly beef.

More on that in a minute.

Improvement in our margins is an important part of our financial goals.

Yet, strategic decisions in individual markets can sometimes put temporary pressure on margins.

As you will hear, we feel these are the right decisions for the medium to long-term.

And we remain committed to improving annual margins, on average, by 35 basis points.

In the U.S., Company operated margins were down 30 basis points, due to higher commodity costs, labor-related expenses and increased straight-line rent expense.

Higher commodity costs from the U.S., primarily beef and cheese, affected margins in the first quarter.

Beef costs were up 6% and cheese costs were up 15% in the first quarter.

We expect beef costs to be up 5% to 8% for the year.

For a perspective, a 5% increase in U.S. beef costs with no change in mix or menu prices affects margins by about 20 basis points.

We expect cheese prices to be stable for the year in spite of the spike in the first quarter.

The margin affect of the four-day Chicken Select sampling event was minimal for the quarter and it successfully grew sales of additional units.

Since completion of the sampling event, unit movement of Selects is up 30% to 40%.

The U.S. experienced an increase in certain labor related costs during the quarter.

This was due to increased staffing levels and increased compensation and related benefits for our store managers.

The restaurant manager is on the front line and ultimately responsible for the customers' experience.

Beginning this year we gave all U.S. [McDonald's] restaurant managers an incremental 1% salary increase to make it easier for them to participate in our 401(k) plan.

In addition to the salary increase, our margin was affected by our decision to increase the matching 401(k) contribution to 3% to 7% of salary, most of which is incremental to what was offered last year.

This enhanced benefit substantially increased manager participation in our 401(k) plan.

The restaurant manager position is the critical position for driving execution in our restaurants.

We believe this change in benefits will lead to increased manager commitment, ultimately resulting in higher retention.

We expect it to contribute to improve store operations and result in a better customer experience over the long-term.

Lastly, the higher amounts of straight line rent expense, due to last year's fourth quarter change in accounting for leases, negatively impacted U.S.

Company operated margins by about 20 basis points.

We expect a similar impact each quarter for the remainder of the year.

Turning to Europe, Company operated margins declined 90 basis points, partly due to higher beef costs and brand building efforts in the U.K. and Germany.

These efforts include couponing and an everyday low-price menu.

The U.K. used couponing as part of its brand-building efforts, both in '2004 and again in 2005.

Coupons were included in brand books that describe McDonald's quality and choice offerings.

For example, a recent book highlighted our three new low-fat dressings and included a coupon for a free fruit and yogurt parfait with the purchase of a premium salad.

These books improve public perception of our brand and will continue to be a part of our strategy in the U.K.

Germany introduced its everyday low priced platform in January this year.

The menu features 11 items, including a chicken burger, a garden salad or a cappuccino, all for EUR 1.

We're pleased with the progress of the value menu in Germany.

As a result, we will not go forward with a coupon promotion originally planned for April.

In the first quarter, Europe had an increase in beef costs of about 12%.

The increase in beef costs impacted margins by about 50 basis points in Europe.

We expect beef costs in Europe to lessen slightly in the second half of the year.

Despite commodity cost pressures in the U.S. and Europe, we remain committed to improving margins.

Our Plan to Win is designed to utilize the five P's to create more brand-loyal customers.

Part of the power of a strong differentiated brand is not having to completely absorb increases in commodity costs.

So, while cost increases might explain why margins are down in a particular quarter, they do not diminish our obligation to deliver margin growth over the longer term.

Shifting over to Asia-Pacific, Company operated margins increased 20 basis points.

This was primarily due to improved result in China and Hong Kong, partly offset by South Korea.

Now I'd like to turn to our early adoption of FAS 123R accounting for stock-based compensation.

As a result of implementation, we recorded $57 million of incremental compensation expense, primarily in G&A, which equates to about a $0.03 impact on EPS in had the quarter.

The $57 million is comprised of about 48 million related to share base compensation and about 9 million related to a shift to cash-based compensation.

Last year, stock-based compensation of $0.03 per share was not included in G&A but was described in our footnote disclosure.

Thus, G&A for the quarter was up $53 million or 12% in constant currencies, entirely due to FAS 123R.

For the full year 2005, we expect a $0.10 impact to EPS from FAS 123R and an incremental $190 million of compensation costs primarily in G&A.

Because of the 190 million, for the full year we expect G&A to be up about 10% on a constant currency basis.

Without these costs, G&A is expected to be flat to up slightly for the year.

Nonoperating expense for the quarter reflects a $20 million benefit when compared to last year.

This is primarily due to higher interest income and lower translation losses.

The other unusual item in the quarter was a $179 million tax benefit, primarily resulting from a favorable audit settlement of the Company's U.S. tax examination.

This resulted in a $0.13 benefit to earnings per share for the quarter and an effective tax rate of about 12%.

For full year 2005, we expect the effective tax rate will be about 29% to 30%.

This rate does not take into account any action we might take as a result of the American Jobs Creation Act of 2004.

Like many other companies, we have not yet made our repatriation decisions.

We will do so very soon after the government clarifies certain issues.

In the first quarter, we bought back $437 million of stock.

For the year, we expect to return at least $1.3 billion to shareholders through dividends and share repurchase.

We continue to generate substantial amounts of cash.

I want to assure you that our plans regarding deployment of capital will not change.

We are committed to our better, not bigger strategy.

We continue to expect our net new store growth to fluctuate between 1% and 2% in the near-term.

I'd like to close by reminding you that our longer term financial goals have not changed since we first shared them with you.

Our average annual goals are; to grow system wide sales and revenue 3% to 5%, operating income 6% to 7% and to achieve returns on incremental invested capital in the high teens.

We remain committed to strong financial discipline and to our customers.

And we are encouraged by our results and continue to be very optimistic about our future.

Now I'll turn the call back over the Mary Kay.

Thanks Matt.

At this time I'll open up the call for questions. [OPERATOR INSTRUCTIONS] Do we have any questions?

Tom Giovine, Giovine Capital.

Hi, can you tell me whether the Board has recently undertaken a study of the impact of the stock price, if they were to look at spinning out the real estate?

Or have you looked at spinning out the real estate in a while?

Hi, it's Matt.

We have a study that we did four years ago that we update about once a year, where we look at whether the whole is greater than the sum of the parts or whether the sum of the parts would be greater than the whole.

And part of the reason you would ever consider looking at something like this is there used to be a significant tax advantage if you were to separate the real estate.

Suffice it to say while we update this study every year, it's something that we believe would not add value to McDonald's and would be a tremendous distraction.

So, we do look at it periodically, we share it with our Board, but it's very unlikely that we would ever go there.

Thank you.

Our next comes from John Ivankoe at JP Morgan.

Hi, thanks.

Is it possible for you to talk about labor initiatives that may have been going on in Europe?

And whether, you know, labor initiatives may begin to effect '05 and maybe even '06 as perhaps they are in the U.S. are now?

Thanks.

Russ?

Sure, John.

You know, a couple of things, I think first of all, the best way for to us get labor productivity up in our restaurants is to make sure we've got the right crew of people and restaurant managers properly trained.

And keep them happy in terms of their work environment and morale.

Which will help us reduce turnover so we don't have to retrain our folks all the time.

As well as driving top-line sales and guest counts.

And so, our focus, really, for the last 12 to 18 months in Europe has been around the people side of improving the quality of our personnel in the restaurants.

Properly rewarding them and incentivizing them for delivering the right business results.

And then driving top-line sales, which we've been pretty effective at doing over the last 15 months now.

So, those are, we think, the biggest ways that we can impact the labor percentage over the next several years.

Because we realize that across Europe we're going to have to deal with minimum wage or labor - - mandatory labor wage rate increases.

That will not go away.

We have also looked at the possibility to use technology and innovation to continue to find more effective ways to help have that reduce our labor costs, like an automated beverage system and our higher European drive through restaurants.

So, we will do that, as well.

But I think the bigger benefit will come out of the first several points that I mentioned.

And John, this is Matt.

I wanted to follow-up, I agree with everything that Russ said.

But I want to take kind of a global perspective to talk a little bit more about technology and the effect it could have on service and cost.

Our system grew very large over a long period of time.

And frankly, we grew large in a lot of countries before we understood how important it would be to be on a common technology platform.

This is especially important in the area of POS.

So, on a global basis, we're on a three to four year migration path to get to a common POS solution.

When we get there, and we will get there over the next three to four years, we will find that getting to a common POS solution will make existing crew people with the same skill set much more productive than they are today.

And they will be better able to deliver the kind of experience our customers expect.

You know, a good example is when you go into a U.S. restaurant today, if you're ordering multiple items, the crew person is so busy trying to find the right key to press and sometimes you have to drill down several layers to get to the right key, that it's hard for them to focus on the customer and what the customer is saying when they're ordering the second item.

That will improve as we migrate our POS systems.

In addition, when we get to a common POS platform, and we will it get there, it enables so many other things, cashless and gift cards are an example.

Self-order kiosks, that Jim mentioned, are an example.

Call centers for taking orders on a remote basis and there's all kinds of other possibilities.

So, I think the longer term answer is what Russ said.

It is we need to use technology more effectively and the POS solution we're working on is a huge part of that.

Thank you.

Okay, our next question comes from Rachel Rothman at Merrill Lynch.

Guys, can you just talk briefly about your capital allocation plans going forward?

I think based on our calculation you still had about $3 billion left on your repurchase authorization?

And I think previously you'd talked about 2005 kind of being philosophically your last year for major debt reduction.

Can you talk about how you're thinking about allocating all of your free cash going forward?

Sure, Rachel, this is Jim.

As we've said, we're staying the course in our financial discipline because it's been so important to us in the revitalization and the momentum that we have today.

We're going to allocate it very judiciously, relative to the CapEx in the markets and new store growth.

And as you know, we're going to allocate about 35% to new store growth, 55% to reimaging.

And of course, that's - - we still have the same expectations around that as we go into '05.

And Rachel, I'm sure you're focusing on all the cash we're generating and, you know there, was more than a normal amount of cash on our balance sheet.

And we want to assure you we're sticking with better, not bigger.

We said at least $1.3 billion return to share - - I remind you that last year we said at least 1 billion.

We ended up returning a lot more.

So, we want to assure you we're not changing course.

What we're doing is working and the discipline will remain.

Thank you.

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

Hi, can you give us kind of a - - just a quick overview update on the product launch up in Canada, the sandwich product?

And just kind of give us a sense of what that product is and operationally how it's fitting into the restaurants up there?

Well sure, Andy.

I think - - first of all, the product is the Deli Selects, as you know them.

And they're fitting in very well operationally in the marketplace and they're doing well.

And so we have optimism around that particular product and the impact it's going to have with the customer relevance around new product news and more to come.

Okay.

Our next question comes from Joe Buckley at Bear Stearns.

Thank you.

One question, just on share counts, you bought back more stock than we expected but the share counts keep going up.

And also, talk about the supply chain write-off or expense in Europe, what that's related to and what it means going forward?

I will take the share count issue.

Joe, what's happening here, there are two things that work.

One is; we did buy back more than $400 million worth of stock in the quarter.

But what happens is because there's a much greater number of options that have been granted that are now in the money, because their stock price is higher, that number rose faster than we would buy back.

The other thing at work here is we were not active in the stock in the last two quarters of last year, in part because of what was going on with Charlie Bell.

And so you're seeing the effects of that.

You know, we do think that at the end of the year, our shareholders will be happy with our share buyback program but we don't want to commit to any specific number.

And on the supply chain issue, and Russ can jump in if he wants to, but basically we had a termination of a supply chain arrangement in Europe that caused about $24 million of expense to hit the quarter's results.

We did not feel like we should call it out and treat it like an extraordinary item.

On the other hand, we don't think that this is recurring in nature, we feel it's very unusual for McDonald's.

Okay, thank you.

The next question comes from Howard Penney at FBR.

My question is on the - - similar to on the stock option -- or the stock options and why your share count is going down, is the change in the more cash base compensation going to improve the options issued and therefore we should see the share count come down more as you buy back more stock?

There's - - Howard, there's two parts to that question.

We're certainly granting many fewer options than we have historically, so, you're right, over the long-term it will come down.

There's also a feature of the way you do the share count that will help us.

Basically the unamortized piece of the compensation expense gets counted in your favor, so that will help us a little bit in the future.

But I do expect that the share count will be coming down over the long-term.

Thank you.

Thank you.

The next question comes from Jeff Bernstein at Lehman Brothers.

Yes, thank you very much.

My question, I guess, is for Russ on Europe.

On the recent Company operated margin pressure, can you talk in some more detail about your efforts to balance value offerings to drive traffic, versus premium products offerings, in order to drive more consistent margins and returns in the region?

Sure, Jeff, it is a balancing act, you hit the nail on the head.

And it's finding the right balance between everyday affordable price offers that bring in new guest counts as well as offering premium products and our core menu favorites to protect average check and margins.

The issue is part of the premium product from a percentage of margin basis.

Even though they are premium-priced, they're also typically either larger in size or cost more.

So they may not actually help the margin on a percentage basis, but they certainly contribute, as much or usually more on a Euro profit or a penny profit basis, than our regular menu sandwiches or our everyday low price points.

So, it's a matter of getting the balance right.

You may not see the percentage margins go up.

But frankly we're not managing the business on margins, we're trying to drive more bottom line profitability.

And so, I think in the environment we've got with this year rising beef costs, as well as the ongoing labor issues, we're focusing on driving bottom line profitability.

I wouldn't expect a lot of short-term margin benefit, even if we get the balance right between those two products.

But as I said earlier, I think if we get 2.5% to 3% comp in Europe, that's enough to help us maintain our margins.

And if we can drive topline sales and guest counts at a faster count than that, then I think you should see some margin improvement as a result. result.

Thank you.

Our next question comes from David Palmer at UBS.

Hi.

This question is for Matt.

Matt, you covered a lot on that -- on the margin front.

But it seems like, to me, that the occupancy and other expenses line rose a lot.

I think it was a 9% increase or about 7% per Company unit on a currency neutral basis.

And that looks like the fastest rate in years.

Could you, perhaps, explain why there might have been such a big increase per restaurant?

And maybe what we can be expecting from restaurant expenses in the future?

Hi, David, it's Matt.

I have to admit, I don't have the answer to your question about occupancy.

I will give you a little bit more background, though.

It sounds like you're asking mostly about the U.S.

Just to try to quantify some of the forces at work; we mentioned what happened with beef and cheese costs, the effect that had was 20 basis points.

I think we mentioned lease accounting was 20 basis points.

We mentioned that we're trying to do more for our restaurant managers.

And when you add that piece to it, that's another 15 to 20 basis points.

Those were the biggest effects that we saw.

We will look into it and one of Mary Kay's people will get back to you on the occupancy cost issue.

Because I don't have that data with me at the moment.

And David, I think it's certainly percentage of revenue, if you look at quarter-to-quarter relationship and sales, it probably explains some of it.

Although I - - we haven't looked at the line item specifically.

And, Jim and Matt, if I could just add David, for Europe, occupancy and other combined only contributed to about 1/10 of the margin impact in the first quarter.

The rest of it was really food and labor.

Thank you, the next question comes from John Glass at CIBC.

Hi, thanks.

I just wanted to revisit theat issue on the couponing in Europe.

And I guess ask was it successful in your minds?

Did the benefits outweigh the costs, given that you got to that 3% comp that you had thought you needed to leverage expenses?

What was the basis impacting of just the couponing?

And forgive me if you said that earlier.

And why again are you discontinuing couponing in April?

Yes, John, it's Russ.

I will break it up between the U.K.

Because I think the answer is very different between the two markets.

In the U.K., I think their approach to the couponing, that it is combined with a brand book, as Matt described.

Which is part of an ongoing way of changing our customers' minds in the U.K. about McDonald's and what we stand for.

It has been very effective, both in terms of the impact on moving the needle on the brand as well as driving more guest counts into our U.K. restaurants.

So, their approach is working very effectively for us.

And that is going to be a continued part of our business plan here in 2005 and possibly even into 2006.

In Germany, it's a different situation because of the success and launch of our everyday value platform called Einmaleins, in January.

And we're very happy of the launch of that program.

It's driving in a lot of extra guess counts into our restaurants.

And it's for that reason that we've decided to not do a coupon book in April as they had originally planned.

Because we're getting enough discount traffic increase because of the everyday value proposition, we don't think right now we need the coupons on top of it in April.

Now, we did have a coupon drop last April in Germany.

So we're going to be comping up against that.

But we're very happy that from a profitability standpoint, even if we don't match the sales from a year ago, relative to not being comped on couponing; that from a profitability standpoint we'll be much better.

And the German coupon drop wasn't as effective profitability wise as the U.K. one, is the other point I would add.

Thank you.

The next question comes from Peter Oakes at Piper Jaffray.

Hi, actually I was hoping to go back to U.S. margins if we could for a moment.

U.S. had another great comp performance, up fivish.

And Matt, as you mentioned, there were some contributors to the U.S., Company operated margin pressure.

But when you take a step back, when Russ mentioned that on a run rate basis, when you get past some of those first quarter hurdles, Europe needs about a 2.5%, 3% comp, in theory, to get a flat margin.

How do you think about that for the U.S.?

Because there is going to be a recurring nature of some of those items you talked about.

Thanks Peter.

In the U.S., I would say the number is about one comp point less to get to the same points as Europe.

And - - but I want to point out that the U.S. is certainly starting from a much higher margin percentage than the rest of the world.

And that does make it not impossible, but more difficult to lift the margin percentage, than you might see in other parts of the world.

And then I want to re-emphasize what Russ said about Europe.

It's true about the whole world.

Even though we set a margin percentage improvement target, it's not the way we run the business.

We run the business to be customer-focused, to differentiate the brand, along the five P's.

We believe if we do that well, our comps will improve.

Eventually we will get better margins and good things will happen.

Peter, this is Jim.

We made a conscious decision to really invest some of that margin with our managers and crew, relative to what we've done there.

To continue to be sure we have the linchpin well taken care of and incentivizing McDonald's for the long term, and that's the store managers.

So, some of that was conscious.

And certainly as Matt said, from where we started we had a higher threshold.

But at the same time decided to take some of that money and certainly to enhance our management tenure.

Thank you.

The next question comes from Steven Krone at Goldman Sachs.

Great, thanks a lot.

I just have a quick question on the U.K.

You guys talked a couple of times about the brand books being successful and improving public perception.

And I was wondering if you can just share with us a little bit what you do to track public perception?

And maybe share some of the results of late?

Sure Steven, we track all articles about us, TV shows, press articles, print articles, on a regular basis.

And so as we measure - - and we track them as either positive, neutral or negative.

And what you see over the last 12 months is a significant move - - we were in the negative category, primarily negative, a year ago.

We've moved it to what I would consider to be pretty much neutral ground right now.

So, we still have some - - a lot of opportunity move it into a positive territory.

But it's certainly been a shift from where we've been a year ago at this time.

The other things we do; is we have a measure we have called Fast Track, which measures both customers' perceptions about their last restaurant visits, as well as just regular brands image questions with our customers.

And when we look across Fast Track for the first quarter in particular, I was just going through this yesterday, we've seen some very nice improvements in some of the key categories for the U.K..

Particularly about the taste of our food and the nutritional offerings at McDonald's, are both up significantly in the first quarter of 2005.

Thanks, Russ.

The next question comes from Joe Buckley at Bear Stearns.

Just a clarification on the tax rate.

Matt, you mentioned 29%, 30% for the full year.

Does that include the 12% first quarter run rate?

Joe, the 29 to 30 for the year does include - - it does include 12% in the first quarter.

So you do the math and you probably conclude that the rate for the last three quarters is above the rate we're targeting for the next three years.

That's true.

I want to reiterate, though, what we said in January, that the rate for all companies, McDonald's specifically, will be choppier than it's been in the past.

We believe our long-term rate will be in the low 30's.

That's somewhere between 30 and 33.

And it will be choppy quarter-to-quarter, and maybe even year-to-year, but it will average in the low 30s.

Thank you.

Thanks.

Next question from John Ivankoe at J.P. Morgan.

Hi, Matt, just a few model clarifications if I may.

At first, in terms of G&A, I know there was a one-time reversal in corporate G&A relating to '01 and '02 charges.

Could you talk about that?

And secondly, normally we've seen the other nonoperating expense, should we expect that to nonoperating income going forward for some reasons?

Thanks.

Okay.

John, the reversal just has to do with - - you're all familiar with the charges we took in 2001 and 2002.

Totaled to hundreds and hundreds of millions of dollars.

Something I'd prefer to forget, but there is a trueing up process that takes place.

And so $18 million of that reserve was not needed and it was trued up and reversed.

That's the first thing that you're talking about.

The second is try to get a sense of where non-Op is going.

And a big factor in that was that we had a lot of cash on our balance sheet in the first quarter, that generated interest income.

I can't really tell you or not whether that's recurring.

Because we will have a dividend payment coming up.

We're not publicly committing to what our share repurchase strategy will be.

But I'd say that in general, we've been carrying more cash on average over the last two quarters than I would expect to over the long run.

Probably by a few hundred million dollars.

Thank you.

Next question comes from Howard Penney at FBR.

I'm glad I could follow that up with back to the capital allocation question that you got before.

You know, you're spending a lot of money on paying down debt, you don't have to do that, or at least from what your commentary is and where your feel comfortable with your debt levels in 2006.

Which, again, is going to free up a lot more cash flow.

And I guess what I wanted to hear is that you're not going to leave that on the balance sheet and that you're actually going to do something with it?

Well, we're certainly not going to end up with, you know, billions of dollars on our balance sheet.

But I don't want to leave you with the impression that anytime we get to over $400 million of cash we have to instantly do something with it.

There are many companies, besides McDonald's, that carry some cash.

Our strategy will not change.

We're not going to go back to building units at a rate of 4% to 5%.

We know it's important to our shareholders that we return a sizeable amount of cash to shareholders in one form or another.

And we're committed to doing that.

We're just not yet prepared to be very specific about exactly how much.

So, I do not expect that the cash balance will grow from where it is today on average over the next couple of years.

Thanks.

We have another question from Joe Buckley, Bear Stearns.

Thank you, I wanted to circle back to the European supply chain question.

Matt, you kind of described what was the in text, but you didn't put it in any context.

What exactly was it?

And strategically, does it have any implications?

Does it imply any potential restructuring in Europe on a grander scale?

We're not going to be specific, but I will let Russ address that.

We're not going to talk about which country or exactly why.

But Russ, could you just comment about whether or not it has implications for the longer term, do we exact more of this?

Sure.

Joe, I think you from the conversations we've had before, it's been several years now that we've continued to consolidate supply chain and re-evaluate strategic sourcing decisions across Europe.

And that's the way we've been able to save on average 35 to 40 million a year in supply chain each year.

You know, as we continue to re-evaluate these things, we had to make a decision to terminate a supplier.

And the write-off of 24 million is a direct result of that decision to terminate a supplier.

This is, as Matt said earlier, just a one-time thing.

We do not expect any other such write-offs as we continue to monitor our strategic sourcing supply chain decisions to position us well for the long term.

It was just a very unusual circumstance.

And not something that we think is going to recur as part of a normal supply chain consolidation or strategic sourcing decisions.

Does that help?

Thanks Russ.

Our next question comes from Larry Miller at Prudential.

Hi, I was wondering if you could give us a little color on why the franchise margins were up in Europe?

I would have thought with sales being a little bit light that they might have been down?

And also just to follow up on that, Russ, can you kind of discuss the franchisee relationships in your major markets in Europe and where you think they're at today?

Sure, in terms of the franchising margins, most of our costs on the franchise side of the equation are fixed.

Either in terms of rents to landlords, although they do escalate on owned properties they're really fixed.

And we have depreciation and amortization on our buildings and other assets.

So typically, as long as we're driving top line sales comps, we will see some improvement our franchise margins, which is what you saw in the first quarter.

So, the 50 basis point improvement in the franchise margins is a result of driving top line sales.

The relationship with the franchisees in Europe is extremely strong right now.

In fact, even in a country like Germany that's going through very difficult economic circumstances, as I continue to talk with our franchisees there, they're happy that their franchisees have a brand like McDonald's because many of their friends who have their own businesses are going out of business.

And while the business isn't performing as well as they or we would like, they're still very financially strong.

And we're doing a lot of work across other markets, too, to make sure they're actively involved in the Plan to Win.

In helping us define the local tactics and playing a lead role in execution, even on some them, across Europe.

And we met with our European franchisee leadership group just a couple of days ago in Switzerland.

And I think relations, according to them, are probably at an all-time high.

So.

Great, thanks, Russ.

The next question is from David Palmer at UBS.

Hi.

Matt, in your comments you said something to the effect that your brand equity allows for some pricing or pricing power.

It seemed to me like the Company might be mulling over a near-term price increase in the U.S. or Europe or perhaps both, to cover some of these costs.

Would you maybe comment on that?

Sure, David.

You know, the issue I referenced is; our Plan to Win says we want to attract more customers more often, more brand loyal.

Brand loyalty means that is some commodity costs goes up over the long run, we shouldn't have to absorb all of it.

We should have some pricing power.

We did in the U.S. take a very modest price increase in the first part of year.

But it was very modest, probably a tiny bit less than the inflation rate.

So, it's very important to us to have a strong brand and part of what that means is we do have some pricing power.

There is some price in elasticity, in demand for our products.

Thank you.

Our next question is from Steven Krone at Goldman Sachs.

Yes, just one more question going back to kind of cash or potential cash and capital.

I was wondering if you can give us an update on the potential monetization of Chipotle?

Is that something that you guys are still exploring?

Yes, we are still exploring, it's a work in progress.

We haven't decided what we're going to do yet.

But the big issue there, as you know, is that it's about focus for us and it's a very important Company for us and it's a profitable Company.

And we want to maximize the potential of that brand.

At the same time, though, making sure that our system is focused on our 31,000 restaurants around the world at McDonald's.

And the only decision we've made so far is we've hired two advisors to advise us on what our alternatives might be.

Thank you.

Next question is from Larry Miller at Prudential.

Yes, hi.

I was just wondering on the labor cost line, given that you've increased the compensation, two things, should we kind of plan for that going forward, to be sort of at that same rate?

And also, just back to your comments about leveraging the business in the U.S., does that change the comp store sales that you need to leverage that business at all?

It sounds like it might not have.

I will take a crack at this.

The reference I made to an increase in the salary that was incremental to normal increases and the change in our 401(k) plan, you ought to assume that will be there to stay.

Now, I think I mentioned that that by itself was 15 to 20 basis points.

It's a very important strategic decision, as Jim said.

The people who are getting this money and these benefits are the linchpin of the customer experience.

And we want them committed and motivated to deliver a great restaurant experience.

So, we're going to do it no matter what it does to costs.

But we're not too concerned that that by itself is going to be a problem in terms of our margins going forward.

Larry, you didn't ask about this, but I want to throw something out there, that I was hoping one of you would ask about.

But since you didn't I want to talk about it anyway.

There was a lot of publicity in the last month or two about what's going on in the breakfast business in the U.S.

There was an article in a financial publication that talked about we've somehow lost traffic growth at the breakfast business.

That article was referencing a tiny blip in share of traffic over a very short period of time.

I've got to give you a perspective.

If you look at our U.S. breakfast business, it has never been healthier, from January of '03 to today, the average store has seen a 22% increase in the breakfast business.

Now, the reason it's receiving attention is we had a meeting with our franchisees, trying to get them to understand and get us to understand what the opportunity would be to do more in coffee.

So, in it that context, we talked about traffic count with them.

Coffee is a very small piece of our total sales today.

It could be a lot bigger and that's the context in which that article was written.

I just wanted to get that straight.

Thank you.

Thanks.

Looks like we are out of questions.

So, with that, I'd like to turn it over to Jim to make his concluding remarks.

Well, thanks, everybody, for your participation.

As we look forward to our future, we do so with confidence and optimism.

We know there is strength in staying the course as we've communicated.

We will continue to execute our Plan to Win with a relentless focus on our customers and restaurants, unwaivering dedication to operations excellence and leadership marketing and, of course, financial discipline.

But ours is a journey of continuous improvement.

We know that and we will accelerate momentum in markets where we're seeing success and certainly gain traction in others through even tighter alignment, sharper focus and renewed energy.

Thanks.

Ladies and gentlemen, thank you for participating in today's conference.

This concludes the program.

You may all disconnect.

Everyone have a great day.