麥當勞 (MCD) 2005 Q4 法說會逐字稿

Hello and welcome to McDonald's January 24, 2006 investor conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Ms. Mary Kay Shaw, Vice President of Investor Relations for McDonald's Corporation.

Ms. Shaw, you may begin.

Thank you.

Hello, everyone and thanks for joining us today.

With me today are Chief Executive Officer Jim Skinner and Chief Financial Officer Matthew Paull.

Also joining us by phone for Q&A is Chief Operating Officer Mike Roberts.

Mike is with our owner/operator leadership at a regularly scheduled off-site meeting to discuss the Plan To Win.

Jim will discuss the progress we have made against our strategies, as well as the priorities he laid out for his tenure as CEO, 2005 highlights and 2006 strategies, and a discussion of plans for our Company-operated restaurants.

Matt will highlight some of the ownership changes we plan to make.

He will also outline steps we will take to provide more information to investors about the performance of our Company-operated restaurants.

I will then comment on our current operating results and look ahead to 2006.

Then we will have time to take your questions.

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

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 of supplemental financial information are available on investor.mcdonalds.com as are as reconciliations of any non-GAAP financial measures mentioned on the call today to their corresponding GAAP measures.

And now, I'd like to turn it over to Jim.

Thanks, Mary Kay and good morning, everyone.

We appreciate your participation and interest in this call.

On this earnings call last year, we reported outstanding results for 2004.

At that time, I committed that we would build on our success in 2005.

We delivered on that commitment. 2005 was a very solid year for McDonald's.

Our performance resulted from an intense focus on our customers, disciplined execution of our Plan to Win, continued brand strength and system alignment.

You'll remember on that same call, I outlined my priorities for my tenure as CEO of this great brand.

Long-term, profitable growth for our system and shareholders, talent management and leadership development to support that growth and balanced, active lifestyles.

We have made excellent progress in each of these areas.

For the third consecutive year, we grew sales and profit.

Comparable sales increased 4.2% for the quarter and 3.9% for the year.

Revenues increased 4.5% in the fourth quarter and reached a record high for the year at more than $20 billion.

EPS was $0.48 for the fourth quarter and $2.04 for the full year.

Our cash flow statement is not yet finalized, but I can tell you that we expect to have another very strong year of cash flow performance.

This financial success enabled us to enhance shareholder value by returning a significant amount of cash to shareholders.

In 2005, we increased our annual dividend by 22%, nearly tripling the payout since 2002.

Additionally, share repurchases were ramped up this year to $1.2 billion.

In 2006 and 2007 combined, we plan to return another $5 to $6 billion to shareholders through dividends and share repurchase.

Bottom line, our actions prove our commitment to building long-term value.

And you can count on this leadership team to continue acting in the best interests of our system and shareholders.

Turning to talent management and leadership development, we focus on having the right people in the right places with the right skills and this continues to pay off for McDonald's.

We have a strong and deep leadership bench.

We continually cultivate and promote talent.

And we have a robust succession planning process for all key leadership positions around the world, enabling us to act quickly when we need to.

Over the past year, we've placed new leadership in Europe, Asia Pacific, Canada and here in Oakland.

Thanks to effective talent management, these dynamic leaders did not miss a beat and are driving the results you see today.

In the area of balanced lifestyles, we are committed to offering menu choice and variety, promoting importance -- the importance of physical activity and providing nutrition information.

This is important to our customers and it's important to us.

Two years of diligent work culminated in 2005 with the announcement that we will now provide nutrition information on our food packaging.

This is a first for the quick service restaurant industry.

Our new packaging will launch at the February Winter Olympics in Italy and by the end of 2006, it will be in 20,000, that's 20,000 restaurants worldwide.

In 2005, we also launched several new menu items around the world, including Premium Chicken Sandwiches in the U.S., new salad varieties in Europe, more Happy Meal choice in Asia, new chicken sandwiches in Latin America and much more.

In terms of the priorities I established as CEO, I believe we made great progress and I am confident we will continue our momentum in all three areas.

In 2006, I intend to focus more of my time on our achievement of long-term profitable growth.

This means keeping our system aligned around our Plan to Win and its five strategic imperatives; people, products, place, price, and promotion.

They are the fundamental drivers of our success and the foundation for long-term, profitable growth.

And there is tremendous room to grow market share and profit under each imperative.

Our play strategy will target convenience in Asia Pacific, the Middle East and Africa.

This includes extended hours in the appropriate markets and an aggressive drive-thru strategy to capitalize on increased automobile usage.

If you just take China, for example, there were more than 2 million new cars on the road in 2004, with 15% more expected each year.

With this increased spending power and mobility comes a faster pace of life and demand for greater convenience.

The McDonald's drive-thru then becomes a perfect dining option.

We opened the first ever drive-thru in China last November and now have a total of three in the marketplace.

These drive-thrus are outperforming the market average in sales and guest counts.

And we'll profit from our first mover advantage by opening 12 more this year.

Our price strategy uses a sustained value platform to bring in more customers.

In Europe we're seeing traction and success with programs that combined everyday value with a strong tradeup strategy.

In Germany, this balanced approach resulted in higher guest counts, comparable sales and margins.

In the United States, our product strategy is aimed at increasing our share of the rapidly growing chicken market, a $22 billion business.

Consumption of chicken in the United States has increased nearly 40% over the past five years and we are seizing this opportunity.

For example, with the launch of our premium chicken sandwich line, we are selling about 20% more chicken sandwiches at a premium price, which provides a nice balance with our everyday affordability platform, the dollar menu.

This year, we are adding to our chicken line with new spicy chicken premium sandwiches and Asian chicken premium salads.

All of these diverse strategies are part of a holistic plan incorporating all five pieces of our Plan to Win that will continue to generate growth and deliver shareholder value.

Now, I want to switch gears and talk about our Company-operated restaurants.

As you know, there's a lot of interest in the accountability of our McCopCo restaurants and many opinions about the balance of Company-operated and franchise restaurants.

Let me tell you where we stand.

First, we absolutely believe that every restaurant, McCopCo or otherwise, needs to be accountable for strong financial performance and deliver a great customer experience.

In 2006, we intend to create more transparency around that McCopCo performance.

Second, we are committed to franchising.

McDonald's as you know is a franchising Company and we will always be a franchising Company.

At the same time, we believe it is critical to own and operate a certain number of restaurants.

Restaurants that we hold accountable for delivering strong financial results.

We call it "skin on the game."

We firmly believe that owning restaurants is paramount to being a credible franchisor.

Credible to providing restaurant operations support and culture, in delivering the bottom line as well as the top line.

And credible in shaking -- or sharing the risks and rewards.

In short, we will continue to own and operate restaurants to better the McDonald's system and to deliver shareholder value.

Having said that, it's reasonable to ask the question;

What's the right balance?

This is something we continually manage and will manage in the future.

We believe we have the right balance in the United States, Australia, France, and Russia, for example.

Just a few markets with strong margins and returns.

But as we've said before, we also believe some of the roughly 8,000 McDonald's restaurants we currently own would be better served in the hands of franchisees.

We've talked about this at our analyst meeting last September.

Over the past year, we have identified markets where our customers, system, and shareholders will benefit from the entrepreneurial spirit of franchisees who can optimize the market's potential.

But we will seek a better balance in the right way, by being thoughtful and thorough.

It will not be a wholesale transaction that will not serve anybody's best interests.

Additionally, we're looking at ownership in certain markets.

We have identified about 15 to 20 countries where we will pursue converting ownership to developmental licenses or DL's, as we say.

A DL structure enables a local entrepreneur to use their capital, their real estate and their local knowledge to build the brand and optimize sales and profitability over the long-term.

In a DL arrangement, McDonald's collects a royalty, but invests no capital.

We currently have 32 DL markets around the world and experience great success with this model.

We believe this is the best approach in markets where the pie isn't big enough to support both McCopCo and franchise restaurants.

We are confident these ownership plans will increase value and Matthew Paull will talk about this in detail in a moment.

To close, I want to go back to where I began, by repeating what I said a year ago.

We are firmly focused on our customers and restaurants.

Our system is aligned and committed to growing the business through our Plan to Win and we maintain our commitment to financial discipline in delivering shareholder value.

As a result, I am confident that 2006 will be another strong year for McDonald's.

Thank you.

And now, I'd like to introduce our Chief Financial Officer, Matthew Paull.

Thanks, Jim and good morning, everyone.

In 2005 we delivered against our stated annual targets of system-wide sales and revenue growth of 3% to 5%, operating income growth of 6% to 7% and return on incremental invested capital in the high teens.

These targets continue to be appropriate and achievable for a Company of our size.

Notably, over the past three years, our comp sales margins and returns have all improved.

We've enhanced our financial strength and grown cash flow to even higher levels.

All of this is a direct result of our focus and alignment on growing the business by being better, not just bigger.

But there is clearly more that we can do.

We will get better at being better through continued efforts under the five P's and by evolving our ownership mix to best serve our business needs, our customers and our shareholders.

As Jim said, we are firmly committed to franchising.

It is our historic foundation and the best way to grow our business going forward.

The alignment we have with our operators, for example, contributed to a 150 basis point improvement in franchise margins as a percent of revenues over the past three years.

While we are deeply committed to franchising, we do operate a minority of restaurants as McCopCo because we believe it makes us a more credible and more effective franchisor.

However, as Jim just pointed out just a few minutes ago, that does not give McCopCo a pass on financial performance.

Let's talk about the performance of the 15% of the U.S. restaurant base that we operate as McCopCo.

Profits as a percentage of sales in our U.S. franchise restaurants trend about 1.5 point higher than in our Company-operated restaurants.

We've closely examined our mystery shop scores in the U.S., and the differences are minimal.

So, it's not operations driving the performance difference.

But there are differences that relate to the motivation and skill sets of an independent entrepreneur and others that are inherent in the way our businesses are structured.

First and foremost, the independent entrepreneur who owns an average of three to four restaurants is highly motivated to drive sales and profits.

After all, their livelihood depends on it.

Franchisees, as you all know, are in their restaurants every day.

They make quick changes based on immediate needs.

They know their competition, they know their trading areas, are very close to the day-to-day operations, and are obviously more connected to the local community than any large public Company can possibly be.

Structurally, franchisees, as small businessmen and women have certain cost advantages.

For example, they have a great deal of flexibility in designing their employee benefits.

While large U.S.-based public companies are required by law to provide similar benefits for all employees, whether working in headquarters or restaurants.

Similarly, regarding insurance, a large public Company with thousands of restaurants is not as nimble as small entrepreneurs who can pick and choose among carriers, capturing cost advantages.

These three differences explain the vast majority of the small gap between McCopCo and franchise stores in the U.S.

We earn excellent returns in our U.S.

McCopCo business.

Even after imputing a 13% rent and service fee, these returns are well above our cost of capital.

While our U.S. franchisees on average perform slightly better than McCopCo, none of the barriers to improve performance I just described is removed by substituting a new, publicly-owned McCopCo for our current structure.

As you know, there's been a good deal of debate surrounding our McCopCo restaurants.

The idea of a McCopCo IPO has been raised.

Along with the suggestion that such a step would improve transparency, resulting in better performance and increased shareholder value.

As you also know, we have rejected the idea of a McCopCo IPO because we firmly believe it will not deliver the value already being created by our current strategy, the McDonald's Plan to Win.

We put that strategy in place in early 2003.

Since then, we've recorded 32 consecutive months of positive global comparable sales.

Our share price has nearly tripled.

And we've returned more than $4.2 billion to shareholders by dividends and share buy-backs.

To state the obvious, McDonald's is on a bit of a roll.

Having said that, we certainly know there is no resting on the past laurels, which is why we continue to evolve our business to make it stronger.

But the key word here is "evolve."

We do not believe a McCopCo IPO is evolutionary, nor is it necessary.

Are we committed to significantly reducing the number of our Company-owned restaurants?

Certainly, but as Jim said, we intend to do it in the right way and in markets where it makes the most sense to make changes.

An IPO has been served up as a panacea.

Believe me, it is not.

From our own experience with the McDonald's Japan IPO in 2001, we know how much distraction and bureaucracy can be created.

After all, we owned 50% of the largest publicly-traded restaurant franchisee in the world.

McDonald's Japan has 4,000 restaurants.

And their public Company status does not protect them from economic volatility, commodity cost increases or competitive pressures in the marketplace.

And just as importantly, we know that taking a large portion of our Company-owned restaurants public does not eliminate the structural differences or create the entrapreneurial spirit that exists with a franchisee.

It merely creates an additional layer of complications and ultimately, costs.

For all these reasons, we concluded that an IPO of any portion of our Company-operated restaurants will not improve performance in McCopCo.

We believe there are better ways to accomplish this.

We recognize opportunities for improvement exist in many markets.

As part of our regular business review, we evaluate approaches that best promote profitability.

Today, we have more than 9,000 Company-operated restaurants globally, including 1,000 operated by our partner brands, Chipotle and Boston Markets.

I want to focus today on our 8,000 McDonald's Company-owned restaurants. 2,100 of these are in the U.S. with strong margins and returns.

Another 900 are in Germany, France, Russia and Australia, also with strong margins and returns.

These markets, which comprise about 40% of our Company-owned restaurant base, strongly contribute to our results and make us a better franchisor.

No significant changes are currently planned.

In China and Brazil, where we have a combined 1,100 Company-owned restaurants, franchise laws either do not exist or are more or less unenforceable.

So again, franchising opportunities are not currently available.

But we have about 800 Company-operated restaurants in the UK.

Consistent with what we discussed at our analysts meeting in September, we will begin refranchising some McCopCo's in the UK this year.

Currently, the UK is 63% Company operated.

The goal is to get to something less than 50%.

We have not yet determined exactly how far below 50% we will get or how long it might take us to get there.

But remember, we're starting in the UK with a relatively small owner/operator base.

As the base grows and as we gain experience with the refranchising strategies, the pace should accelerate.

Earlier, you heard Jim talk about our developmental license or DL strategy.

This is an excellent opportunity to evolve our ownership structure and capture the structural and motivational advantages I mentioned earlier.

Over the next three years, we plan to convert 15 to 20 additional countries or 1,500 restaurants, representing about 1.5 billion in sales.

These restaurants also represent about 1.6 billion in combined net investment, generate approximately 60 million in net operating losses, and account for nearly 100 million in G&A and $50 million of maintenance CapEx annually.

Significantly, when we convert this group of restaurants to developmental licensees, the results we currently report from these markets will be replaced over time with a royalty based solely on a percentage of sales.

And our capital requirements will be eliminated.

The effect of this DL initiative is to put a significant number of restaurants in the hands of entrepreneurs who can keep them locally relevant, improve returns over time, protect our brand, and continue their growth without any use of McDonald's capital.

Please keep in mind, it takes time to find the right developmental license partner.

In the first three quarters of 2005, we added two countries and 325 restaurants to the list of markets using a developmental license ownership structure, increasing total DL countries from 30 to 32.

Work on establishing DL's in these two additional countries began two years ago.

Over time, we expect to significantly reduce the number of Company-operated restaurants from the current to 27%.

Putting more restaurants in the hands of small, entrepreneurial local businessmen and women.

In this process, markets like China will remain primarily Company-operated in the near-term, while we await the evolution of China's franchising and property laws and continue to develop a pool of talented franchisees.

So, those are the highlights of our plans for refranchising and developmental licensing.

Now, let's return to McCopCo performance.

We believe in accountability and incentives tied to results and in transparency.

Three years ago, as a lot of you know, we've reorganized U.S.

McCopCo to operate as a separate business reporting to one McCopCo Vice President in each U.S. division.

At that time, Ralph Alvarez led a team that determined which McCopCo's we could run well and which should be refranchised.

Since that time, compensation and incentives for all non-store level employees in U.S.

McCopCo are directly tied to McCopCo's operating income.

U.S.

McCopCo store managers earn bonuses, again, tied directly to the profitability of their individual restaurants.

We have seen the benefit of these simple, organizational changes in improved McCopCo profitability, margins and returns in the U.S.

Ralph Alvarez, who is now President of McDonald's North America has begun a similar process in Canada.

We will look at which of Canada's 500 McCopCo restaurants we can run well and which should be franchised.

We'll organize personnel around the revised structure and implement incentives tied directly to the operating income of McCopCo in Canada.

We will consider similar changes in other countries where appropriate.

On a separate but related topic, we believe we will find a way to supplement our disclosures regarding Company-operated restaurant performance.

Of course, any information provided must be allowed by disclosure guidelines and must not be misleading.

Meaning there should be a solid foundation for any imputed data we give you.

Let me be clear.

The way we report McCopCo results today is consistent with generally accepted accounting principles and with how the rest of the industry reports results, allowing for comparisons across our industry.

Our intent is to provide more information so investors can better understand the results of Company-operated restaurants as if they were operated on a stand-alone basis.

Because these contemplated disclosures could be considered pro forma, we will probably provide you with the components and let all of you in the investment community do the math.

We are targeting disclosure of this additional information in our 10-K, which will be filed in about six weeks.

The bottom line is more information, which we welcome.

We will let you, our investors, decide how best to value our cash flows.

So to conclude, our objective over the next several years is to lower the number of our Company-owned restaurants and provide more information in the process.

Rest assured, we will do this in the right way, when and where it makes the best sense for our system and our shareholders.

Now, I'd like to turn the call back over to Mary Kay, who will comment on our current operating results and look ahead to '06.

Thanks, Matt.

Overall, we delivered a strong quarter of positive results.

Our focus on the Plan to Win and our alignment generated guest count increases and solid comparable sales growth for both the quarter and the year.

Fourth quarter franchise margins as a percent of revenues continued to be strong, increasing 100 basis points to 80.3%.

The U.S. business drove much of this improvement.

Consolidated Company-operated margins, although a smaller contributor to overall margin dollars, are an indicator of the restaurant level health of the business.

Company-operated margin dollars increased 7% in constant currencies for the quarter and were flat as a percent of sales.

U.S.

Company-operated margins as a percent of sales remained strong at 19.1% for the quarter.

These margins were positively impacted by an adjustment to our current year estimates of profit-sharing and store manager incentives.

This was partly offset by higher beef costs, higher labor, and higher occupancy costs, including utilities.

In the U.S., beef was up about 8% in the fourth quarter and 9% for the year, up slightly from last quarter's expectations.

We are expecting costs for beef, as well as chicken and cheese, to be flat in 2006.

Utility costs, which represent about 3% of sales for the average, traditional restaurant, rose approximately 9% this year.

We are anticipating increases again in 2006 and have plans in place to address utility cost increases and to improve energy efficiency in the restaurant over time.

To continue our U.S. momentum in 2006, we will introduce two new chicken products and reimage approximately 1,400 restaurants.

We will continue our focus on improving service and providing a great customer experience in the restaurant.

Turning to Europe's Company-operated margins for the quarter.

Strong sales in Germany and Russia were offset by weak performance in the UK and higher beef costs across Europe.

Beef costs across Europe increased about 6% in the fourth quarter, impacting margins by about 30 basis points.

For the year, European beef prices were up 14% over last year.

Looking forward, we expect beef costs to be up slightly in the first quarter of '06 and basically flat for the year.

The issues faced by the UK are longer term and will take time to resolve.

We have plans in place to drive improvement, including; refranchising Company-operated restaurants, wide-ranging consumer communications to further build trust, and enhancing the customer experience through promotions like "Monopoly" and tie-ins to the World Cup.

In September, we successfully launched Toasted Deli Sandwiches in the UK.

We have opportunities for greater frequency and awareness with our customers.

And therefore, we are planning some advertising rehits to remind customers in the UK they have more reasons to visit McDonald's, as we now offer more variety.

Moving to Asia Pacific, this segment has generated another quarter of positive comparable sales, primarily driven by Australia and Japan.

Company-operated margins declined 30 basis points for the quarter, primarily due to negative comp sales in China and weak results in South Korea.

We remain excited about the opportunities in China, a growing market with 1.3 billion people.

We've tested value over the past year and are confident we are on the right track with the balance of premium products and value menus.

We've also added real estate expertise to improve our site selection process and our global supply chain is working on efficiency initiatives to help reduce costs, all of which should lead to improved margins.

In 2005, we opened about 100 restaurants in China and we'll open approximately 125 in 2006.

Worldwide, we will continue our emphasis on remaining relevant for our customers, strengthening operations, and maintaining capital discipline.

In '06, we plan to reinvest about $1.8 billion, 50% allocated to existing restaurants and 40% to open new restaurants.

Including approximately 800 new McDonald's restaurants, primarily in the U.S., China, France, and Russia.

Jim mentioned our significant share repurchases.

On this topic, I know many of you have been disappointed, as we have been, that our share count has not declined despite all the stock we've purchased.

I'd like to explain why this happened.

We began 2005 with a higher share base for several reasons.

First, we were not in the market buying shares at the end of 2004.

In addition, option exercises were much higher in the past two years, at a combined 5% of the outstanding share base, as the stock prices improved.

As a result, we did not offset the dilutive impact of option exercises on share counts.

This is expected to taper off over time as we have significantly reduced the number of options granted from about 2% of outstanding shares per year to about 0.7% of outstanding shares per year.

We plan to be aggressive with share repurchase this year, buying back $1 billion worth in the first quarter of 2006 and have a portion already completed.

So, we do expect a decrease in share count for 2006.

In closing, 2005 has been a good year and we have much to look forward to in 2006.

We have additional opportunities for future growth and are confident we have the right plans in place.

At this time, I'll open up the call for questions.

[OPERATOR INSTRUCTIONS] The first question is from Joe Buckley at Bear Stearns.

Thank you.

Matt, a couple of questions, I'll combine them into one.

On the Company-operated McCopCo information that you shared with us, curious if your studies show that pricing is different in the McCopCo stores versus franchise stores across the board?

And could you walk through again the margin differential?

I think you indicated that your studies show franchise margins are about 1.5 points better than the Company margins?

And is that on a fully-allocated basis for the rent and royalty?

Just fill that out for us as much as you can, please.

Joe, that is -- that would be on a fully-allocated basis.

What we're saying is, if you give a franchisee and McCopCo the same opportunity, in general, on average, the franchisee, for all the reasons we cited, will 1.5 point better profitability as a percentage of sales.

That's why we're a franchising Company, we recognize this.

However, considering that, and whatever it is you want to do with rents and service fees, we're still earning a terrific return on U.S. McCopCo.

And it's making us a much more effective, more credible franchiser.

On the issue of pricing, over time our McCopCo prices are probably on average 3% or 4% below where franchisees set prices.

Bear in mind, we are required by law to set our prices independently of where our franchisees set their prices and we never ever try to influence their pricing.

Thank you.

Thank you.

The next question is from Jeff Bernstein at Lehman.

Thanks very much.

Just a question on competitive U.S. landscape.

It seems that most of your competitors have been following the same approach of the higher quality, healthier eating options.

You've seen strength by a lot of these peers.

Just wondering if you could talk about just the strength in the overall QSR segment, whether you think this category momentum is sustainable?

Also, just wondering if you see the overall category growing or do you think quick-serve is taking share from the segments?

And then if you could size up the promotional environment, that would be great.

Well Jeff, this is Jim Skinner.

I'll start with the headline and then Mike Roberts may want to contribute from his off-site location.

First of all, we are so excited about our opportunities in the quick service marketplace and the informal eating out marketplace and we continue to grow share.

I think that's important.

As to whether that share is high growth or whether that share comes from our competitors, I can only reflect upon what appears to be a rather stagnant performance in the overall marketplace relative to quick service.

But informal eating out marketplace, an opportunity continues to grow.

And our focus on the customers and restaurants in our Plan to Win and our tactics seem to be driving share growth for us.

Mike, did you want to -- ?

Yes, thanks, Jim.

Jeff, this is Mike.

QSR at U.S. is planning to grow in the neighborhood of 3% to 5%, which is robust.

The three year comp now for the U.S., '03 at 96, '04 at 64, and now at '05, a 44 comp for the year, so we continue to grow market share.

The marketplace is growing but we're growing faster than the market.

It's a combination of all of the initiatives we've spoken about from late-night to breakfast to chicken to the new fruit and walnut salad and of course the dollar menu.

So, progress continues.

Thanks, Mike.

The next question is from John Glass at CIBC.

Thanks.

Can you comment a little on the European margins?

It looks like the year-over-year decline is starting to abate.

Maybe it sounds like beef got better in the fourth quarter?

Is there -- could you maybe decompose it by market?

Is there anything that's moved significantly?

And also, I guess as your comments relating to the difference in the McCopCo versus franchise, is that global or is that just the U.S.?

And maybe if it is the U.S., could you talk about, is that difference the same as in Europe?

Hi, John, this is Mary Kay.

I'll cover the Europe margins.

Beef costs did abate.

For the year, beef costs were up 14% in Europe and only 6% in the fourth quarter, so it's about 20 or 30 basis points difference.

So, 50 basis points for the year and only about 30 basis points for the quarter.

That was really the primary reason.

I think UK was the main market that was pulling the margins down.

Without the UK the margins would have been up in a pretty good way.

And the UK is beginning to make some progress too but the biggest challenges for them are labor.

So, the beef costs have helped the margins there.

Matt, did you want to comment on the second part?

Sure.

John, on the second part of your question about if we did a comparison of McCopCo and franchise results.

We have not done an exactly similar study in Europe.

But if we did, we think we'd see a slightly larger gap on average, slightly larger gap, but it is, as you know, 51 different countries with 51 different stories.

I would be quick to point out that that gap would be heavily influenced by what's going on in the UK right now, where we have probably the biggest gap in Europe.

We've already indicated we're going to be doing refranchising there.

I also want to point out that probably our best performing margin market in all of Europe is Russia, which is entirely Company-operated.

It's somewhere near 25%.

And on the pricing relationship, John, I would say that it's probably similar in Europe.

It's important to know, though, that we all use the same pricing tools -- or encourage the use of the same pricing tools, because the balance between affordability and driving opportunity for customers to experience McDonald's through price is so very important.

It has to be balanced against the profitability of the restaurant on each individual item.

And so we spend a lot of time learning and using the tools around this.

But I would say that the pricing relationship is probably about the same there as it is here.

Thanks.

The next question is from Larry Miller at Prudential.

Thank you, hi.

Nice year, guys.

And one of the areas that was raised was higher G&A per store.

And I was wondering if you could explain why is at is and if there is any opportunity there to bring that down?

And then I was also curious, with the Company-operated stores, the McCopCo stores, do they tend to run higher unit volumes?

And if so, did you adjust for that in your analysis?

And is that mainly because they may be in better locations that have more expensive retail real estate so there is that offset?

Larry, this is Jim skinner and then Mike, you might want to comment on the McCopCo volumes.

But three years ago or 3.5 years ago when we set out and the revitalization in the financial discipline around that revitalization, G&A reduction and discipline around the G&A spend of the organization was a critical piece of that.

But the focus on that G&A reduction was at the center and not in the field.

Because the relationship that we have with our franchisees and our Company restaurants relative to focus on our customers in our restaurants causes us to believe that it's important for us to have the support in the field relative to the day-to-day operations in that moment of truth at the front counter and drive-thru for our customers and the best experience possible.

So, we did not reduce the spend relative to the field.

But we focused more on the reduction here at the center.

And we do have higher volume because of that in my mind.

We have a better customer experience because of that.

And we're able to deliver on the Plan to Win in that expectation.

And Larry, this is Matt.

I just want to ask you to recall that at our Analysts Day meeting, we made quite a point of this.

We recognize that on a per-store basis, our G&A spend is higher than most of the rest of the industry.

But the way we run the business, as Jim was saying, is very different than others.

There is much more collaboration and engagement with our operators and probably more provision of field support than you see with other brands.

We think the collaboration and engagement process results in us making, as a system, much better decisions because of all the valuable input we get from our franchisees.

Very few other franchise systems operate that way.

It is clearly a more expensive way to operate if you're just looking at the G&A line.

But when you look at the average unit volumes, our system drives probably double the average of the competitors.

When you look at store-level cash flow, maybe almost triple the level of the competitors, we think it's worth it.

And also, we showed everybody at Analysts Day on September 21, what the trend has been in G&A.

We committed three years ago to reduce G&A as a percentage of system-wide sales by about 10 basis points a year.

We've delivered on at least that every year in the last three years and dramatically brought down our G&A's percentage of sales.

And the only thing that got in the way this year was having to expense options.

Mike, did you want to comment on the average volumes of the McCopCo versus franchise?

Jim, the only thing I'd add is the average sales in the U.S. now are over $2 million. 3.5 years ago they averaged about 1.6 million, so a significant increase.

And there's very little difference between an average McCopCo annual sale and the average operator sale.

So, they're roughly the same.

And Larry, when we cited that 1.5 point, we did it using -- adjusting for differences in volumes.

Hopefully, that answers your question.

Thank you.

The next question is from Mark Wiltamuth at Morgan Stanley.

Could you please comment on the sales trends in chicken in your China market?

And if you could also just talk about how the returns have changed over the last year there in your China unit, if they're getting better or worse?

Mike, did you want to talk about the chicken --?

Yes.

I would say the notion here is that obviously, we've got a full menu there made up of beef and chicken.

We're promoting beef at the moment and doing quite well, I would add.

Obviously, with Avian influenza, there are significant concerns there, as you've heard from our competitors.

But our chicken sales remain strong in China.

And chicken and beef and pork are an important part of the Chinese diet and we offer all three.

Thank you.

And Mark, this is Matt.

On the returns issue, as you know, we've had a negative comp a large part of 2005 in China.

The whole industry has and our comps probably aren't as negative as some others, that has driven our returns down slightly.

We are still very optimistic.

We're not changing our opening plans.

And returns aren't just problematic there because the up-front investment to open a restaurant is maybe 0.25 of what it is in the U.S.

So, we're still very optimistic and we are proceeding with our opening plans.

Thank you.

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

Hi.

Question on kind of first quarter European promotional activity.

Last year you guys were a little bit more aggressive on the couponing and the brand books.

Is there anything you see out there promotionally that would either be positive or negative to margins in the European business here for the next few months?

Yes, this is Matt, Andy.

In Germany, last year we had heavy couponing in January that we did not run this year.

You could expect that to have a small negative effect on sales but probably a small positive effect on margins, on a stand-alone basis for January, in Germany.

And we did the same thing in Europe.

The brand coupon books have been pulled back this year.

So the end result of that, Andy, is less discounting in this first quarter.

Our goal there, as Mike Roberts has said many times, is a holistic plan around all the things that we know that will drive the business and give our customers a better experience around the five P's.

That includes everyday affordability.

That includes the balance between the affordability menu and premium sandwiches and premium items on the menu.

And we know what works; it's now just a matter of time and execution, I think, relative to those marketplaces and the consumer expectation being delivered.

Jim, I would just add for Andy, it's much more of a focus on the premium products, which is a tactic that we've now used around the world very successfully, continuing here in the U.S.

We've got a Big N' Tasty rehit in France.

We've got the double QPC in Europe as well.

The Pound Saver in the UK.

Much more activity related to Cheese Saga in Germany.

All full-priced products that historically have done very well for us, not only profitability-wise, but sales-wise.

Thank you.

Thank you.

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

Actually, I wanted to have a lot of clarification, actually, on the DL strategy.

I think Mary Kay, you kind of threw out some numbers. 1,500 restaurants at $1.5 billion in sales in 15 to 20 countries.

Is that all Company-operated?

That is for all practical purposes, it's all Company operated.

Okay.

And I think the numbers that you use -- it's losing 60 million pre-tax or net a year?

$60 million at the operating income line of losses.

Okay, so that's pre-tax.

And that 100 million of G&A, that's --?

But that would be included in that loss.

Okay.

Do you have any sense what that G&A would go to if it was DL market?

G&A would be cut dramatically.

I can't give you an exact number but it would be well, well under half of what it is today.

And just one final one.

Hopefully, this counts as one question.

Do you think you can -- just again, round numbers, think you can sell your net investment at at least a break-even or perhaps gain or should we expect losses from that?

John, this is a very long and careful process.

The first thing is to find the right partner, somebody who believes in the brand, has a long-term view, and can make the brand and keep the brand locally relevant.

We're not focusing on what the proceeds of selling might be.

But you have to bear in mind the information I gave you in deciding what you think we might be able to raise.

We're not going to comment on individual markets or what we expect to raise in proceeds.

Thank you.

The next question is from David Kolpak at Victory Capital.

Hi, everybody.

Recently, several of your competitors have boosted their marketing focus on value menus in the U.S.

And I'm just wondering if you've seen any kind of a trend from consumer demand towards more value-priced items recently?

And are you assuming a slowdown in average ticket growth in the U.S. in '06?

Mike, do you want to -- ?

Yes, David, I would tell you that the dollar menu in the U.S. remains an important part of our portfolio.

In terms of our advertising spend, it represents in the neighborhood of 10% to 15% of the total.

We have a very robust calendar here with new food news like spicy chicken and then the new coffee initiative, followed by the Asian salad in the spring.

So, the combination of everyday low price, the dollar menu, as well as new food news and great promotional activity like Monopoly, and "I'm Lovin' It" is the plan for the '06 calendar.

We would tell you that with the higher energy costs and what have you, related to consumers' pocketbooks, the dollar menu is a really important part of our portfolio and we intend to continue to communicate to our consumers what great value is available at McDonald's.

And David, I would just have to say, this is Jim Skinner.

I think that the customer relationship with our restaurants proves that they understand good value and everyday affordability and the balance between that and other options they have on the menu.

And if our competitors pay attention to our customers, they understand that formula and it makes sense for them to pursue that.

Thank you.

Our next question is from Howard Penney at FBR.

Thanks so much.

Can you just walk through the process on how you decided on using the developmental license as a strategy of refranchising the stores?

And will this provide you the best return versus other potential forms of franchising?

Well, I can start, Howard.

Thanks for the question.

We, of course, have had a number of developmental licenses for a number of years now.

And the reason for that is because some markets we didn't have the opportunity to own Company restaurants.

We didn't have the opportunity to have enough pie in the marketplace and enough growth and the size of the marketplace for us to make that kind of investment.

And we didn't have enough opportunity really to have conventional franchising.

And therefore, we chose the DL route, where you find a person who has some passion for the brand.

They still have to train and develop to be good restauranteurs, this is important for people to remember.

But they also have the willingness to invest the capital, represent the brand and run the business effectively in those marketplaces.

But it's a size-related issue in terms of the marketplace.

And then secondly, the size of the pie.

And of course, we make investments and bets in marketplaces.

And sometimes we go in there as a Company operation and find out that we don't get the same kind of results on an overall basis that we might want to get.

And then it becomes better for that marketplace to be a developmental license, as we talked about the parameters of that earlier.

Thank you.

Thank you.

The next question is from Peter Oakes at Piper Jaffray.

Hi, good morning.

I was actually hoping to follow up on Howard's developmental license question.

In the past, you've utilized joint ventures and obviously outright franchising.

Can you articulate a little bit better on the developmental license program?

How much capital's involved, the royalty stream that we might think of versus the alternatives?

And even the current unit count, where it stands here at the end of the year?

Thank you.

Peter, it's Matt.

To give you some perspective, when we go to a developmental license structure, we're focusing a lot on;

What is the upside potential in the market versus the risk?

And if we decide that that doesn't work to our favor and that having a local developmental licensee gives us an advantage in the marketplace, we go the developmental license route.

We've made the most extensive use of it in the Middle East.

Jim Skinner actually launched that program.

Probably, we have 15 or 20 markets in the Mideast on a developmental license program.

And when you look there, none of our capital is at risk.

We don't put any capital into the entity that's running the restaurants.

We get a pure royalty.

And using the Mideast as an example, we probably collect royalties anywhere from 2% to 7%.

And the G&A we spend to make sure that the brand is being presented in the right way and that standards are being met might run 20% to 30% of the royalty that we collect.

So, that's the way we think about it.

Now, we're going to be using developmental license structures in other parts of the world, we have already.

But we're going to be going to new parts of the world and we can't predict exactly what royalty stream we will get.

We're going to focus, first and foremost, on finding the right developmental licensee.

And frankly, we would accept a lower royalty to get the right person into the market running that business.

Thank you.

Next question is from Joe Buckley at Bear Stearns.

Thank you.

Can you talk about -- just update us on the plans to refranchise units in the UK.

I think you mentioned 50 restaurants for this year.

And Matt, you mentioned that the DL deals done last year took a couple of years to finally come to fruition.

Where are you in the pipeline on additional DL deals?

Are we likely to see any this year?

Joe, on the UK refranchising, I think we said at our September analyst day meeting around 50.

I think there's a chance we'll end up getting more done but we don't want to say exactly how many.

Part of this is trying to determine how quickly and how well our franchisees in the UK can absorb additional restaurants.

The franchisee base there is not as big as in the U.S.

And the proportion of restaurants that are McCopCo to the number of franchisees we have is not exactly what we want it to be.

But if we see it working, we will move it along more quickly.

On the pipeline issue, with respect to developmental licenses, I want to say a few things.

Sometimes these things happen quickly, and sometimes they take years.

I do want to say that we have two officers working just about full-time on this project.

But remember, we've got 15 to 20 different countries on our list.

We can not predict whether this will be one a quarter or none for the first six quarter and then we'll complete eight of them all at once.

It's just not something we can predict but we wanted to let you know what things will look like when we're done.

We will not have capital invested in these markets.

We'll be collecting a royalty and we'll be applying a small amount of G&A against that.

Thank you.

Thank you.

The next question is from David Palmer at UBS.

Thank you.

This is a great call.

I guess one last -- I have two last ones, if I could just fit in here.

On the dividend, perhaps you could give us a thought or two as to what you'll be thinking in the coming years about the key factors that would drive decisions on increasing a dividend, perhaps faster than your earnings per share growth.

And secondly, on coffee, I see that gourmet coffee chains and donut chains are driving about 1/3 of the U.S. industry unit growth.

And you have the upcoming reformulation and relaunch and possibly you'll do some more things in coffee down the road.

Nationally, you're not doing a co-branding of your coffee and I was wondering what your thought was there?

Why not co-brand?

And of course, I realize that in New England you've recently rolled out Newman's Own Green Mountain Coffee.

How are coffee and breakfast sales doing up there?

Is there any learnings to project nationwide?

Thanks.

This is Jim Skinner.

I'll just make comment on the dividend and then Matt may want to chime in and Mike, I'm sure you'll want to talk about your pet project on coffee.

Thanks, Jim.

But as you know, we already committed to $5 to $6 billion over the next two years of return to our shareholders over the dividends and stock repurchase.

And we take the dividend decision, as you know, somewhat later in the year and we'll take all that under advisement.

And relative to the ratios of the payout, that gets determined at that particular time relative to the nature of our share repurchase and dividend and return to shareholders.

Matt, do you want to say something else?

Sure.

David, I want to point out a couple of things.

The payout that will take place in '06 and '07 will probably end up being, 100% of our net income when you think about it the way Jim just described it.

Dividend and share repurchase combined.

When you look;

At how do you break that between the dividend piece and share buyback?

Here are the factors that we consider.

We absolutely consider how the market values dividends versus share buybacks.

That's a big factor.

We consider flexibility.

Obviously, a dividend is a quasi-long-term commitment.

We look at strength of the business.

And finally, it's a minor factor but it is a consideration, what's going on with the tax law, treatment of dividends versus share repurchase.

And Mike, were you going to cover coffee?

Yes, thanks, Matt.

David, as you mentioned, premium coffee and speciality coffees are really an important part of the American breakfast experience now.

We'll be launching, as I said, the new premium roast coffee in the U.S.

And we're beginning to -- it's rolling out as we speak with new cup, new lid and new graphics, et cetera.

We'll start promoting the end of February.

The objective, obviously, is to increase both coffee and breakfast sales.

We promoted coffee with McGriddles in April of '05 and improved our coffee sales and improved breakfast sales.

As you mentioned, we have some locally relevant brands that are part of our test sales with Green Mountain in Boston and Seattle's Best in Seattle.

They're part of our advertising plans beginning in February here in the U.S. as well.

And then we have another 50 or so restaurants that have begun a test sell on speciality coffees.

And we know what an important play speciality coffees are.

So, a lot of activity related to coffee and we're optimistic about February's launch here in the U.S.

Thank you.

Thanks.

Our next question is from Larry Miller at Prudential.

Yes, ,y follow-up question was answered, but could you give us a sense, Mike, what the coffee percent of sales is right now in the U.S.?

Larry, it's a small percentage overall.

Our goal is to increase it.

We promoted coffee with McGriddles, as I said, in April of '05.

And my recollection is that's the first time we advertised our coffee in over 10 years.

And so we're getting more active here and getting a lot of, a lot of expertise built up in our menu management teams.

And look for more from us on coffee.

Okay.

It looks like we are out of questions.

So thanks, everyone.

I'm going turn it over to Jim for a closing comment.

Well, in closing, let me just say thanks again everybody for your participation today.

I want to reinforce our commitment to providing value for our customers, the McDonald's system and our shareholders.

Our strategy of being better, not just bigger is paying off.

For three consecutive years, our Plan to Win has delivered results and that momentum continues.

We will continue to generate growth by executing our proven Plan to Win and optimizing our ownership in structuring relevant markets around the world.

And I am confident that 2006 will be another strong year for McDonald's.

Thank you.

Thank you.

Thank you for attending today's conference call.

You may now disconnect.