麥當勞 (MCD) 2005 Q2 法說會逐字稿

Welcome to McDonald's July 2005.

I'll turn that over to Mary Kay Shaw, Vice President of Investor Relations.

Thank you.

Hello everyone and thanks for joining us today.

On the phone today we have our CEO, Jim Skinner who is joining us from a field location.

And with me is CFO, Matthew Paull as well as Ralph Alvarez, the President of North America.

Ralph is joining us for Q&A on the U.S. and Canada which currently represents about 65% of consolidated operating income.

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 8-K filing, also apply to our comments on this call.

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

And now I'd like to turn the call over to Jim.

Well good morning everybody and thanks for joining us as we report on our second quarter earnings.

System-wide comparable sales for McDonald's restaurant were up 2.8% for the second quarter.

Our ninth consecutive quarter of positive global comparable sales.

Revenues increased 8%.

Operating income was up 5 %.

And EPS was $0.42, including $0.09 per share of incremental tax expense related to the Homeland Investment Act.

Now, while we're pleased with our global top line performance we're intent on driving more to our bottom line.

In addition, we're taking steps to generate the same levels of success in all of our business segments.

The most important way we'll do this is by having the right people in the right place to deliver results.

I told you at the beginning of the year that talent management is one of my priorities.

In line with this, we've taken action in several key markets as it relates to leadership.

In February, we appointed Tim Fenton, President of Asia-Pacific, Middle East and Africa.

And I'm confident that Tim's prior experience in this region, as Relationship Partner for the Middle East and Africa, his successful track record as the U.S.

East Division President and the work he's done over the last six months in his new role will yield results.

Guy Russo, a 30 year veteran who delivered impressive results in Australia, as Managing Director, was appointed Relationship Partner for Greater China.

He has moved to Hong Kong to leverage his experience and talent to improve performance in the region.

Jeff [Schwartz] was appointed CEO of McDonalds China.

Jeff has prove. track record in his 37 years at McDonald's.

And he's most recently served as Senior Vice President in charge of Company operated stores in the U.S.

West Division and General Manager of the Southern California region, which he led to great success.

He will provide exceptional leadership to take McDonald's China to the next level.

Tim and Jeff will also reside in Asia to maximize their impact on the business and develop future local talent.

Asia-Pacific, Middle East, Africa reported comparable sales of 1.2 % increase for the quarter.

And driven - - this was driven by strong results in Australia.

Australia's positive momentum continued this quarter with the success of deli sandwiches, McCafe and salads plus.

And despite negative comparable sales, in the last few months, China has progressively improved its comparable sales trend throughout the quarter.

The additional fire power of Guy and Jeff will certainly help accelerate this trend.

In Japan, the value platform launched in April, is beginning to gain traction.

We know from experience that there's a predictable cycle with the introduction of a value program.

Guess counts go up, average check typically dips a bit.

And then customers transition away from purchasing only value products.

And in Japan this is the case.

The next phase of their value strategy is a six month holistic marketing plan that was launched at the end of June.

It's aimed at increasing average check while maintaining guest counts.

And the program focuses on the promotion of EVM's and other meal combinations purchases outside the value menu.

And we plan to see substantial growth from our value platform over time as we do in most markets.

In Europe, we also made changes in leadership.

As you know, Russ Smyth decided to pursue a new direction in his life and career.

And he did a good job in Europe building a strong foundation.

And while we were disappointed with Russ' departure, we took the opportunity to strength our structure and our European leadership team.

Because of our focus on talent management, we have two experienced and talented leaders ready to step up.

Denny Hennequin is President McDonald's Europe and Glen Steeves is Chief Operating Officer.

Denny is a talented executive who forged a brilliant track record in France during his eight years as Managing Director.

Under his leadership, France became one of the most successful, innovative and influential markets for McDonald's around the world.

France's reimaging efforts became our global gold standard.

And the food studio was created to innovate new and existing product venues.

Denny's strategic thinking has already contributed to the traction we're beginning in Europe.

Where throughout the past year and a half he was Russ' number two as Executive Vice President of McDonald's Europe.

Glen is another strong McDonalds executive with deep restaurant operations expertise and an enormous passion for our customers and our brand in Europe.

You'll hear more from Denny and Glen at the analysts' meeting we're hosting in September.

But let me share a few headlines on their priorities.

They've taken action through structure, process and people to improve focus on the three;

France, Germany and the U.K.

Since these markets drive more than 70% of the profits for the region.

Denny and Glen organized Europe operations around four divisions, similar to what we have in the United States.

Each Division President is responsible for the major market in that division and a regional VP oversees all the other markets.

The divisions' Presidents report to Glen.

And notably, Denny appointed 18 year veteran, [Boni Denistovitch] as CEO of Germany and President of the Western Europe Division. [Boni] is qualified for this position.

He most recently oversaw European in training where he consistently demonstrated a passion for delivering great service.

We're excited to have [Boni] lead the - - lead Germany into the future.

In addition to improving focus on the big three by by having them report to Glen, this structure also allows for tighter alignment to accelerate adoption of what's working.

Denny and Glen are also committed to making the McCopCo the gold standard for operations and people practices by focusing on training and accountability, in order to improve leadership and strategic direction across Europe.

Now turning to results in Europe.

France continued to deliver solid performance and we saw improvement in Germany.

However, comparable sales were flat for the quarter due to weak results in the U.K..

Significant challenges still exist in the United Kingdom.

Externally, the QSR market is currently flat.

Internally, we are mitigating issues around perception in the restaurant experience.

Beginning with brand perception, we know from our research, that food quality is the main driver of brand trust in this market.

And our quality message is not getting through.

That's why we're supplementing our existing brand building efforts with a full scale campaign to rebuild consumer confidence and trust in the quality of our food.

The campaign will include multi-media marketing as well as new food news.

The campaign launched at the end of June with distribution of the next phase of brand books to 23 million households.

The book delivers a transparent quality message by featuring the U.K. farmers who supply beef, potatoes, free range eggs, organic milk and produce to our restaurants.

A television and print campaign will follow at the end of this month.

This will be supported in-restaurant with tray liners, posters and brochures. 28% of our total marketing weight will be dedicated to this campaign through September.

We will continue to reinforce our quality storage through the end of the year.

The new food news in the U.K. will come in September, with the launch of toasted deli sandwiches.

This product line will serve as a proof point to our quality food message.

It will also give us an entry into the sandwich market.

A whopping $3.5 billion segment that is driving the recent growth in the informal eating out market.

We are excited about the toasted deli sandwiches based on customer testing.

They are currently in more than 600 restaurants.

And are selling even better than the initial test scores.

Customer feedback shows positive product and taste scores as well as improvement in value and menu variety stores.

In addition to this brand work, we are improving the customer experience in our restaurants.

A dedicated food team is working on enhancing the taste and delivery of our core menu items.

Menu simplification will eliminate 19 SKU's, making it easier for our crew and managers to serve customers.

The restaurants operations improvement process is now in place in this market.

And as you'll remember, this process identifies key areas for improvement at the individual restaurant level and then targets resources to enhance performance.

And a final note on the U.K., they have allocated additional resources to improving operations, including a Vice president of QSC.

Who will a sharper focus to store level operations and execution.

In Germany, the macroeconomic environment continues to be challenging.

Unemployment has hit its highest level since the 1930's and the economy is forecast to grow at just 1% this year.

In spite of this, our business is stabilizing.

In January we implemented a value platform, as you know.

And in the months following we adjusted and added products, for both value and premium, to provide our customers with the choices they wanted.

The value strategy is working.

Germany has delivered six consecutive months of positive guest counts.

And positive comparable sales has been posted in four of the last six months.

Finally, France and Russia are delivering solid results on the top and bottom lines that are positively contributing to the region's overall performance.

Our business in the United States continues to generate strong results with second quarter comparable sales at 4.8%.

Customer focused initiatives across all five keys of our plan to win are driving the sustained performance.

Now, Matt will discuss our U.S. business in more detail.

But I just wanted to say that there is still opportunity for growth in the United States.

And I'm confident that our plans will capture that opportunity and continue our solid momentum.

Overall, we have made progress with our global results to date.

We know we have markets that need to improve.

We are taking action in every area of the world to strengthen our resources processes and people so we deliver quality, long term growth in every business unit.

Thank you and now I turn it over to Matthew Paull.

Thanks Jim.

I'll briefly discuss second quarter results including our decision to repatriate earnings..

I will also review certain guidance for the year.

Overall, we delivered another quarter of positive results.

Our $0.42 reported EPS included a $0.09 impact from incremental tax expense stemming from our decision to repatriate foreign earnings under the Homeland Investment Acts or HIA.

This one time opportunity results in a 3% to 5% tax on these earnings, avoiding significant future tax costs.

During the fourth quarter, we expect certain markets will increase local borrowings to fund the majority of the repatriated earnings.

The result will be a temporary increase in cash and debt levels on our consolidated balance sheet at year end.

The increase is temporary and does not signal any change in our financial policies in 2005 or in the years to come.

The increase in cash, regardless of the source, does not give us license to lessen our financial discipline.

Because the activity will occur in the fourth quarter, we expect interest expense to remain relatively flat in '05.

And increase slightly on a net basis in '06, after considering interested generated by the excess cash.

To receive the lower tax rate on these earnings we are required to bring the cash back in 2005.

However, we have a number of years to spend it.

Our plans are to use this cash for U.S. salaries and planned U.S. capital expenditures over a multi year period.

Therefore, our 2005 plan will not change as a result of HIA.

To clarify, this means that our CapEx, debt pay down, share repurchase and dividend payout plans will not be affected.

In 2005 we will continue with our plans to pay down $6 to $800 million of debt.

In 2006 and early 2007, the temporary increase in cash and debt levels will be eliminated as we pay down the incremental debt.

Our CapEx plans for 2005 remain intact.

We expect to spend approximately $1.7 billion. 55% of which is targeted for existing restaurants.

Our tax rate for the quarter was 43%, increased 12 points by the incremental $112 million in tax expense from repatriation.

For the full year, we expect the effective tax rate to be about 30% to 31%, which include the impact of the first quarter favorable audit settlement and the cost of repatriation.

Now I'd like to comment on our operating performance for the quarter.

Since Jim already discussed our strategies in Europe, I'll focus first on the U.S. business and then on overall margins and operating income.

The U.S. business led results with strong same store sales of 4.8%.

We're continuing to build customer visits in the U.S. on top of the strong gains we achieved over the past two years.

Combined initiatives, including new product introductions, extended hours and cashless payment options all contributed to the sustaining results we delivered.

We continue to enhance our product relevance by listening to our customers and responding.

In May we introduced the fruit and walnut salad, which is driving incremental visits and a higher average check.

It's available throughout the day and it's great as a snack or a meal.

In August, we launch our new premium chicken sandwiches.

The latest installment in our chicken strategy.

There will be three varieties; classic, ranch BLT and club.

All are served on a honey wheat and available with grilled or crispy chicken.

We're confident that our premium chicken sandwiches will resonate with customers and contribute to our profit goals.

Even before the introduction of these tasty new sandwiches, our U.S. chicken business has gone from a $2.7 billion business in 2002 to $4.3 billion business in 2004.

Again that's before the introduction of the new sandwiches.

Also, we are making it easier for customers to choose McDonald's with extended hours and cashless payment options.

As of June, about 90% of our restaurants are on some form of extended hours, with almost 40% offering 24 hour service during all or part of each week.

About 30% of restaurants are offering 24 hour service seven days a week, up from about 20% last year at this time.

With more restaurants participating in extended hours, we've been able to advertise locally and build awareness.

Going forward, we expect to increase transactions during extended hours.

Cashless payment is another initiative contributing to results and is now accepted in most U.S. restaurants.

Cashless transactions continue to generate a higher average check than cash and most importantly cashless is a faster payment option.

Given the number of restaurants now accepting cashless payments, we have a large enough base to introduce gift cards nationally and take our fair share of this rapidly growing market.

We expect to have gift cards available systemwide in the U.S. by the holidays.

Now let's turn to operating income and margins.

Consolidated operating income for the quarter increased 3% in constant currencies driven mainly by franchise margins.

This operating income included approximately $45 million of incremental compensation expense due to FAS123-R.

As you know, we did not expense options last year.

This negatively impacted the quarter's operating income growth rate.

Including the 2004 pro forma share base compensation of $57 million, our pro forma growth rate for operations was 9%.

So there is a 6 point spread between the reported and pro forma growth rates.

Franchise margin dollars, which represent about 2/3 of our combined margin dollars, were just over $1 billion in the quarter.

This is a $58 million increase over last year driven by strong sales in the U.S.

Our consolidated franchise margin percentage increased 40 basis points for the quarter reaching 80.2%.

The highest since our revitalization began.

Company operated margin dollars increased $17 million for the quarter.

But as a percent of sales fell 60 basis points.

This was primarily due to the weakness in U.K. and Germany, which I'll cover in a moment.

The U.S.

Company operated margin remains strong at 19.2%, which is still near it's all time high.

The decline of 30 basis points in the second quarter is consistent with first quarter's results and os a result of three items.

One, incremental labor cost due in part to our strategic decision to increase store management salaries and benefits.

Two, higher beef costs.

And three, higher rent expense primarily as a result of the change in lease accounting.

Beef costs in the United States were up 10% in the second quarter, higher than the 6% increase we experienced in the first quarter.

We expect this to taper off in the second half of the year with beef costs being up to about 5% to 8% for the full year in the U.S..

The opening of the Canadian border should have a slight positive impact, which is already built into our projection.

In Europe, Company operated margins declined 120 basis points for the quarter driven by brand billing initiatives and everyday value in the U.K. and Germany, higher labor cost in the U.K. and higher beef costs across Europe.

Beef costs in Europe increased about 19% for the quarter, impacting margins by about 60 basis points.

While beef costs are expected to continue to pressure margins, the level of increase should be slightly lower in the second half of the year.

Compared with last year, we expect beef costs in Europe to increase about 15% for the year.

We know we have work to do on margins.

But we belief our commitment to operations excellence and leadership marketing is the right strategy to achieve our goals.

Now, I'd like to update some expectations for the remainder of the year.

In spite of the recent downward movement in the Euro and British pound, foreign currency added about $0.01 to reported EPS in the second quarter.

For the remainder of '05, if rates stay where they are today, we expect currency to have a slightly negative impact on EPS.

As a reminder, if the British pound and Euro move in the same direction by 10%, as compared to the prior year's average rate, the impact on our annual EPS is between $0.06 and $0.07.

Given our strong cash flow, we have updated our guidance on cash we expect to return to shareholders, in the form of share repurchase and dividends, to about $2 billion for 2005.

Year for date through June, we bought back approximately $1 billion in stock and plan to buy back up to another 300 million in the second half of the year.

Over the next few years we expect diluted shares outstanding to decrease gradually.

But keep in mind that in the short term, we cannot control all the variables that go into this calculation.

Variables such as option exercises and share price.

Finally, in the fall, we expect to announce the annual dividend.

Although we expect the dividend to increase, we do not expect the increase to be as much in 2004.

In summary, our financial performance for the quarter and year has been solid.

We remain committed to the financial discipline and the goals we established over two years ago.

We are acutely aware of the challenges before us and confident that we have the right plans in place to overcome them.

We know that running better restaurants is the right strategy for McDonald's.

We're focused on the customer and on delivery long term sustainable growth in sales and operating income.

And high teens return on incremental invested capital.

Now I'd like to turn the call back to Mary Kay.

Thanks Mat.

At this time I'll open up the call for question. [OPERATOR INSTRUCTIONS]

Our first question today is from David Palmer at UBS.

David.

Hey guys, hi.

Thank you.

I guess I just want to hammer on the U.K. market.

You did a very good intro there.

So, I really just wanted to see if we could dive into it just a little bit more.

And that is, is there any evidence that you see thus far that you're kind of on the right track as to what you're pursuing?

You're talking about the quality message.

You're going to be adding an important new platform in September there with the sandwiches.

Which might be more important given the fact that you have a lot of greater London presence and that means you're competing more head to head with these fast casual guys.

But I'm just curious to know your confidence that you're kind of on the right track with the initiatives that you are pursuing and that seem fairly similar to what you've done already.

Thank you.

David it's Jim Skinner.

I think we are seeing progress in the United Kingdom.

First of all, we've got some segments of our business that continue to do well.

Like breakfast, for example, which has always been a mainstay there for us.

And we see evidence that that continues to perform well for us.

Our June comparable sales were better than the May comps.

Actually going up against some difficult numbers and so we sort of like the trend that we see there.

Although we're certainly not where we want to be.

And I believe that on the operating side and the focus on the restaurants and what we're trying to get done there, will serve us well.

And then on the new product news, you're exactly right.

The opportunity for us to get into the sandwich market, which is a very strong informal eating out segment in the United Kingdom and has been.

The toasted deli sandwiches will play very very well there for us, we believe, and it's being demonstrated in the test markets.

And so when you combine all of that with our efforts around quality of food and communication in the marketplace, and most importantly, focusing on the customer experience and the delivery there, I think we are doing the right things and certainly we'll see progress in the future.

Thanks.

Our next question is from John Glass at CIBC.

Thanks.

Earlier there have been some discussion in Europe about changing the cooking platform as one of the ways to improve the quality of food or diversity of menu.

Have you made any decision on that?

And I guess just more broadly, what's the logic behind doing that at a time when you're also trying to drive sales and improve service levels?

Is there a risk that you actually slow service down or somehow impede that progress?

Thanks.

John, Jim Skinner again.

The bridge operating platform is a platform that will actually help us provide a better experience for our customers with the variety of products.

And it's a combination of grill direct and a combination then of same time delivery as you see with the "made for you".

And it's a combination that gives us the flexibility to deliver that better experience and it's being tested there in a couple of markets.

And the way we've done that this time around through the innovation center in Oak Brook Illinois is the teams from Europe and other parts of the world have actually come in and worked with the - - our expertise there together to decide what's the best approach to delivering the menu and the products at the speed of McDonald's at the various markets.

And it will be an enhancement and it certainly will not be a distraction from our progress at the moment relative to service to our customers.

And John, for perspective, this is Matt.

We have the bridge operating platform in about 250 restaurants today.

It will be in a few hundred by year end.

But it's not an expense undertaking on a per restaurants basis.

It's nothing like the conversion to "made for you."

And we don't want to create too much excitement or imply that it's going to be very expensive to get this done.

Thanks.

Our next question is from Jeff Bernstein at Lehman Brothers.

Thank you very much.

In the press release and in your commentary you mentioned returning about 2 billion to shareholders through the combination of dividend and share repurchase.

It seems to an increase from the prior 1.3 billion.

And I think you mentioned share purchase of about 300 million in the back half, obviously 1 billion in the first half.

I was wondering why not be more aggressive in terms of the repurchase in the back half of the year?

Thanks Jeff.

This is Matt, I'll take it.

In you look at the increase versus the prior year, significant increase in share repurchase.

If you just look at where the cash is coming from, what we've already told you, we've said basically about 2 billion will go back to shareholders this year.

We've said between 6 and 800 million of debt paydown.

And we've set our CapEx target as 1.7 billion.

If you add that all up, that's about 4.4 billion.

So given what we've said we want to do with our debt levels and the amount of cash we're going to generate for you; we've probably accounted for most of the cash and what we've told you.

Thanks very much.

The next question is from Joe Buckley at Bear Stearns.

Thank you.

Why don't you explore the repatriation of earnings a little bit more?

You mentioned, obviously I guess that debt and cash go up at year end.

You mentioned paying down the debt pretty quickly.

Maybe by early 2007.

How do you envision this playing out?

You'll be borrowing in foreign currencies.

Will you be paying down foreign debt or will you been paying down U.S debt?

And I know you know you said that none of your plans are changing as a result of this.

But doesn't it give you a lot more flexibility in the U.S. as you use these monies for money that you would have spent on other projects in the U.S.?

Joe, we're going to pay down a combination of foreign currency denominated and dollar denominated debts.

It will occur in 2006 and part of '07.

It's complicated because there are prepayment penalties on paying down some of our fixed rate debt.

We don't want to incur those penalties if we can avoid it.

As far as; does it give us more flexibility?

Yes.

Will it change our spending plans on CapEx, share repurchase, dividends, G&A?

The answer to that is, no.

Simply having the ability to borrow against earnings and restaurants that exist overseas doesn't change our attitude on how we ought to be spending the money.

Thanks very much.

The next question is from Carl Sibilski at MorningStar.

Hi, good morning.

I have a question about the how fast consumers respond to the extended and 24 hour schedule.

I know that you have to increase your labor expense.

How fast - - do you see instance responses or does it take a couple of months to get a pay back?

Hi, this is Ralph Alvarez.

The response is pretty immediate.

Because obviously, these are late night hours, so they see you're open and it's pretty immediate but it does build.

And what we see our second and third year of restaurants that are open now, either late night or 24 hours, is that the business keeps on growing as a habit gets made.

That is why we also what you wanted to get to where we could advertise in some of the markets because we felt we could accelerate what we see in year two or three earlier.

And that's what we hope to do this summer.

Thanks.

Our next question is from Steven Kron at Goldman Sachs.

Thanks a lot.

I had a quick question on China.

I would have thought that with a competitor like KFC seeing some significant demands pressure in the first part of this year that may be you would see some benefits from that and some better results.

So, I guess the question is what's going on in that market for you and why aren't you seeing - - I know you mentioned improvement throughout the quarter, but why aren't you seeing profits at the level that you're happy with at this time?

Steven, this Jim Skinner.

I think the impact that KFC felt, we sort of felt some of that as well.

Particularly this dye issue that they had reflected negatively on all quick service restaurants, including McDonald's.

Although it had nothing to do with us.

And they're still suffering some from that.

And as we are, just in terms of the general marketplace.

But you we, as you know, have made substantial changes in China relative to the focus of our talent.

The capability of scaling in that marketplace, we're opening 100 restaurants a year now.

We expect have more than a 1,000 by 2008.

And the strategic nature of our behavior there regarding the everyday affordability has also been ramped up and we're getting the proper products in position to be successful.

At one time that everyday affordable menu was very successful for us.

And then we took a couple of products off the menu, which was not very smart.

And we now have them back on.

And just at the end of last month and we're seeing things moving back in the right direction for that very important segment of our business.

And we believe that we're moving in the right direction there.

Thank you.

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

Thanks.

Hi.

As toasted deli sandwiches get rolled out across the world I guess, in Canada, in the UK and Australia, what has that taught you in terms of potential U.S. experience perhaps over the next six or twelve months?

And is it just a function of the drive-thru that's constraining or are there other things that we should consider as well?

Thanks.

Yes.

Hi.

This is Ralph responding to that.

The - - we have them in 500 restaurants here in the U.S. and in four separate markets where we've been getting the experience.

These sandwiches and what the customers want are slightly different around the world.

And so part of what we needed to learn was what was the different appeals, the exact price points.

And then how we operationally need to set ourselves up so that we deliver them at McDonald's speed.

And that's the learning that we've been getting in Australia, for sure in Canada and here in the U.S.

The U.S. decision will not happen this year, relative to the deli sandwiches.

We have a robust pipeline of all the other products that we're rolling out.

And we will continue to evaluate that and then make the decision appropriately as it fits within the other items that we're testing.

But we've gotten very good learning and good sales results out of what we're doing right now.

Thanks.

The next question is from Mark Wiltamuth at Morgan Stanley.

Hi.

Yes.

On your U.S.

Company operated margins being down 30 basis point, I'm just curious if your franchisees are doing a little better than you are?

Because it seems like some of this margin compression was due to your decision to take up compensation and staffing levels.

The 20 basis points, actually, of that is the lease accounting change.

So it's really just an accounting change.

Our margins are basically at parity with some - - the highest commodity cost increases we've seen in years.

We mentioned beef earlier but chicken and cheese also.

Our operated margins are comparable to our Company margins.

And on a dollar basis, both are growing at a healthy rate on top of two record years.

And so we're very happy with the cash flow results that are current in our restaurants.

And store level cash flow for our operators up about 30% from where it was two years ago, that's a healthy number.

And as Ralph said, when we talked about what hits our margin, obviously, the lease accounting, that's about 20 basis points, it has no affect on our operators' cash flow.

It's not a cash flow problem.

The store management salary and 401K benefits we chose to give our restaurant managers doesn't affect that.

That's another 20 basis points.

The beef cost issues affects all of us.

That was in the neighborhood of 40 basis points.

So some of what we described hit them, some of it did not.

Thanks.

Thanks.

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

Two - - actually just one quick question on Europe and sort of the promotional spending, couponing et cetera in the first half to try to jump start the business.

Do you anticipate a similar level of promotional spending in the back half of the year?

Or could that actually be a little bit less and a little bit more helpful to margins?

Andy, Jim Skinner.

You know that couponing in Europe has been a mainstay of our success.

Much of that driven by the fact that the way you're able to communicate through media, is somewhat restrictive, particularly in Germany.

And so it is not unusual in any year to have them have two or three couponing events.

And I don't think it's any more aggressive this year than it has been.

And they've added some and then taken some away.

So I think it's fairly balanced in terms of expectation over the year.

And certainly is fairly balanced relative to the expectation and the impact that it would have on our margins.

So I don't think there's anything unusual there.

Okay.

Thank you.

Our next question is from Rachael Rothman at Merrill Lynch.

Hi good morning.

Would you mind just updating us on what your thought process is behind the potential for any refranchising in Europe given the better relationships with your franchisees and how they're performing better these days.

Is there any opportunity there?

Yes, this is Matt.

It's something that we look at but I don't want to get our investors excited that there will be any kind of massive change.

We are very heavily franchised in France if you counts joint venture arrangements and traditional franchises.

I think it's 83% franchised in France.

We are not as much franchised in U.K..

We're probably 30% to 40% franchised in U.K.

And Germany is again mostly franchised.

We're looking at it because frankly, when we saw improvement in margins in the U.S., part of the improvement we saw starting two years ago, was the effort that Ralph undertook, to say we only ought to operate McCopCo where we're qualified to do so.

Instead of always being the buyer of a store that an operator wanted to sell, we decided to be more thoughtful and strategic about it.

It improved our results in the U.S.

So we're looking at it but I don't want you - - I don't want to get you excited that you're going to see a massive number of stores of McCopCo stores become franchised any time soon.

We're probably looking a little bit more carefully at in the U.K.

Thank you.

Rachel, this is Jim Skinner.

I'm sorry your question broke up and otherwise I would have chimed in it.

I've asked - - we review this on a regular basis, the mix between the franchise restaurants and the Company owned restaurants.

If you look at the United States, for example, over the several years, the level was always around 25% and then it was 20% and then 15 and then 18.

And so I've asked Matthew and the geographic presidents to take a look at this in these markets where the margin is under stress, if you will, and particularly the United Kingdom.

But as Matthew said, I don't see - - I don't think the outcome of that is going to be any sort of aggressive play relative to the number of Company owned restaurants.

But we are taking a look at it.

Thank you.

Our next question is from Jerry [Bakes] at Sharp Investments.

Yes, my question is about the FAS123 expense recognized in this quarter versus the year ago.

And our understanding is that for this quarter, the options expense was $0.03, versus in the year ago quarter there was 0 expense.

And first of all is that correct?

And also we want to know about the fact that you had bought back $600 million worth of stock in the quarter but the weighted average shares outstanding was actually higher than the year ago shares outstanding.

And we're wondering why was that?

And was the end of quarter shares outstanding lower than the year ago?

I'll address first the FAS123-R issues.

The number - - for stock option expense it was a part of this quarter's results was $0.02 Jerry.

And last year the number was 0 but had we had we been on the same accounting, the pro forma number for last year would have been $0.03.

If you were comparing apples to apples.

As to weighted average shares, it's a very confusing computation.

You're right, for the quarter, we were about flat as compared to last year.

In spite of the fact that we bought back a lot of shares.

Part of the reason for that, that is it's a function of the amount of option exercises by employees, how many options are in the money, and how many shares of stock we bought back.

We were somewhat inactive in the second half of last year, as we've mentioned on a prior call, because of Charlie's medical situation.

And so some of that contributed to the fact that we fell behind a little on buying back shares.

Our share count grew in the first quarter and now we're beginning to catch up but it takes a little bit of time.

And again, there are many variables involved besides the number of shares we're buying back.

If you looked at the number for the quarter versus the six months, you see a big difference.

Part of that is because the average share price was higher for the six months than it's been for the last quarter.

So it's a complex computation.

We are committed to reducing that share count gradually over time.

Thank you.

Our next question is from Mark Kalinowski at Buckingham Research.

I just wanted to ask about the coffee roll out.

Could you bring us up to date with the latest thinking there and timing?

Thanks.

Yes.

Hi Mark, it's Ralph.

On the coffee, we've made conversions through the blends as we wanted to do around the U.S.

Upgraded all the equipment.

We are in process now for our suppliers producing the cups that we need and at our volume that's a lot of cups.

And we will have the coffee as part of a breakfast advertising campaign, so we wouldn't do coffee on its own.

We'd do it as part of our normal advertisement that we do at breakfast.

And that'll happen some time during the beginning of '06 when we always do a strong effort on breakfast.

It is not, and was never going to be, one of the two major product introductions this year.

Those are going to be fruit and walnut and the premium chicken sandwiches.

And so it'll be part of what you'll see in next year's equation.

Thank you.

Our next question is from Peter Oakes at Piper Jaffray.

Hi good morning.

I was hoping you could update us as far as the trend for the U.S.

The trend in average check gain today versus where it was a year or two years ago and obviously the role that that's playing in the comp?

Thanks.

Yes, Peter, it's Actually, we've had a very - - for the last three years a very healthy blend of growing our customer counts, growing average checks due to premium priced products, and being able to also have some pricing movement just below the inflation rate that we measure ourselves against, which is food away from home.

And that continues to happen this year where we have that nice blend of all three of those contributing to the overall sales growth.

And Peter, we would say, though, that in the last six months, we've seen a little bit more reliance on average check than guest count growth but both are positive.

Our next question is from Larry Miller at Prudential.

Thank you very much.

My question is about Europe and the cost structure there.

The way I recall it, you probably need about a 2.5% comp store sales gain broadly speaking across those markets to leverage the cost structure there.

Are there any initiatives that you can speak to that you have to lower the cost structure?

And also can you talk about the PanEuropean synergies that were a big part of the plan given the changes in the management team over there?

Yes, Larry, it's Jim.

We think all of our initiatives really relative to top line will give us the opportunity to deliver that 2.5% to 3% that you're talking about relative to sort of maintenance of margin and maintenance of cost in the market place.

And then relative to the synergies and the efficiencies, it's always been an issue as you look at 51 countries that have a lot of moving parts as I like to say.

And one of the things that Mike and I and others have been strategizing about is; first of all, having the leadership for these major segments of the business in the marketplace.

We did that in Asia obviously, which was our first move.

And now the opportunity to do that in Europe since the team is in Europe.

And then the structure that we've created so that the focus on the big three and the leveraging of the synergies between the big three, which trickle down, if you will, are certainly - - elevate our opportunity to be successful in the surrounding markets and the associated markets with the VP's of the region.

And we think that's going to help in terms of our ability to provide the leadership around what's working and more importantly eliminate what's not working.

And at the same time, the synergies around supply chain, synergies around marketing, we think that all of those things under this new structure and process that we're using will give us a better opportunities to achieve that.

And Larry, the 2% to 3% that you described is about right in a normal inflationary environment.

If these comps kept going up at 19% we might have to adjust that number but for the long run that's the number.

But I think you also have to talk about where the sales come from.

We're assuming that we'll get a reasonable balance of sales movement off of everyday value and premium products blended.

If it was all driven by everyday value, the number would probably need to be a bit higher.

But we don't expect it will all be driven by everyday value.

Larry, I might just add to that.

This is Jim again.

That this is not a new thing for us.

This is the operating environment we've had in Europe from the time we got into the market place.

Because it's a little more expensive to operate there in some of the markets than others.

But at the same time, across Europe, it's an issue we've had to deal with and we know how to deal with it and we will.

Thanks.

Our next question is from Dean Haskell at JPM Securities.

That's JMP Securities.

Congratulations on a great second quarter.

My first question is you had net negative franchise growth in the second quarter of '05 from the first quarter of '04.

But you had great franchise operating margins.

Do you see that continuing?

Well, there's's probably a few things in operation there.

We had some adjustment to our franchise base in Brazil that might have affected some of the numbers you're citing.

We mentioned in the fourth quarter of last year that we bought back some franchises in Brazil.

That affected some of the numbers you're describing.

I do think that our franchise margin number is strong and can get stronger.

I might ask Ralph to comment on the same thing.

Because the U.S. franchise margin drives most of that.

The U.S. franchise margin was up 60 basis points.

And really driven by the continued growth of sales.

We have a large fixed cost basis on our historical properties in the U.S.

And when we drive comp sales growth, you get the flow-through on that margin becomes pretty significant and that's what we've seen.

We also have some depreciation that is fallen off or amortization, both fallen off, that is helping that some.

And then there's one other factor in play here.

I mentioned Brazil briefly.

We - - it's been publicly reported starting a year or two ago that we had some litigation in Brazil.

And when that began - - its was litigation with franchisees, we became very conservative in the way we account for franchise revenue in Brazil.

Our franchise margins down there, starting a couple of years ago took a fairly significant hit.

When things get back to normal down there, there's the potential for that franchise margin to improve dramatically.

That is the Latin America franchise margin.

Thank you.

The next question is from Joe Buckley at Bear Stearns.

Just a couple of questions on U.K..

You mentioned the distribution of another brand book.

I was curious if that included coupons?

And then also as you roast out - - or roll out the toasted deli sandwiches, are there some capital expenditures associated with that in terms of equipment needs and things of that sort?

Yes, there are, Joe.

Jim Skinner.

There are some coupons in the book as there always are.

And then secondly, I think Matthew, you can help me with this but I think it's 25 or $30,000 - -

Correct.

per store to facilitate the deli product.

And of course we have it in 600 restaurants now.

And we're getting ready to go here in a couple of months so, we're well on our way with that investment.

And again, for perspective, any equipment investment we have to make for toasted deli is already in the number we've given you for the year.

The 1.7 we projected.

And then our franchisees in the UK would pay their own way on this equipment.

Thank you.

And it looks like we have another question from Dean Haskell at JMP Securities.

I had to ask another question to get the name right.

Thanks, Dean.

Two questions, just housekeeping for Matthew.

Tax rate for the next two quarters, what do you expect that to be, given the changes in the first quarter and second quarter?

And then the '05 total year option, the stock option expense estimate.

Dean, on the tax rate, we've indicated 30% to 31% about for the whole year.

We now know the first two quarters, so the math would come out as somewhere in the mid too high 30's.

To make all of that happen.

That's what the second two quarters will look like.

I want to broaden the question a little bit though and talk about the next few years.

We've mentioned on a prior call that how you account for income taxes is an involving area and it's going to be harder and harder to predict quarter by quarter and year by year what the rate will be.

We think we'll be between 30% and 33% over the next few years.

But you'll see more volatility than we've seen in the past.

There was another question.

The stock option expense for the year, I'm going to get back to you.

I know for the quarter it was 45 million.

For the year I thought it was roughly four times that but I think it's actually a little bit less than that.

We'll have - - Mary Kay is writing me a note.

It's about 190 million for the year.

But that includes not just the stock option expense but shifting some of our compensation from equity base to cash base.

Thank you.

Thank you.

Looks like we have another question from Peter Oakes.

Hi.

You've had toasted deli sandwiches in Canada for the last couple of quarters but the comps continue soft there at least compared to the U.S.

Can you help reconcile a little bit of what else is going on?

If you're pretty pleased with how the products rolled out there?

Sure, Peter.

It's Ralph.

On the - - Canada had a soft first quarter and the sales have been getting progressively better as we've gone through.

Many different things affected that but one of the items, as we both talked, toasted deli.

We actually are getting a very good movement on the sandwiches.

The reaction in Canada from the competitors was to try to create a significant price war, which we did not want to jump into.

Both Subway and Quiznos did unprecedented discounting.

And we let that continue because to jump in it during a new roll out and jump into that fray would have been the wrong thing to do.

We're now seeing - - we're getting what we expected on the average check movement.

We've made some changes so that we have some staggered pricing on sandwiches and are rehitting that.

But we believe that what we have in Canada, along with a stronger everyday value that we have to put in, will create the results that need to happen.

Canada had a great year last year and they just didn't sustain it during the first three or four months of this year.

Thanks.

The next question is from John Glass at CIBC.

Thanks.

I wanted to follow-up on the repatriation of the foreign profits.

Is the primary benefit to shareholders going to be just a lower future tax rate?

It sounds like in other words, you borrowed the money, you could have borrowed money anyway and you're not going to change the way you look at repurchase or debt pay down.

So it is simply just a lower future tax rate that would benefit us?

John, it's Matt.

Yes.

The primary benefit is a little bit of financial flexibility and a significant future tax cost avoided.

So, if you look at our business, we're generating a lot of cash overseas.

Our ability to reinvest that cash and avoid the residual the U.S. tax would have come to a limit someday and we would have had a very significant tax cost to pay in the future.

Which was not something that had been provided for because we were more or less permanently invested.

And so this allows us to avoid a very significant future tax cost.

A number that would have been in the hundreds of millions of dollars.

Thanks.

I think we are out of questions so I'll go ahead and turn it over to Jim to make some concluding comments.

Jim.

I'm here.

Okay.

Go ahead.

I want to thank everyone for their interest in McDonald's.

And we are positioned well for the future and confident with the changes that we have made and the focus on our customers and restaurants that will continue to be successful.

And thanks for your interest.

Thanks.

Bye.

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

This does conclude the program.

You may all disconnect.

Have a great day.