麥當勞 (MCD) 2006 Q3 法說會逐字稿

Hello and welcome to McDonald's October 19, 2006 investor conference call.

At the request of McDonald's Corporation, this conference is being recorded.

Following today's presentation there will be a question and answer session for investors. [ OPERATOR INSTRUCTIONS ] I would now like to turn the conference over to Miss Mary Kay Shaw, Vice President of Investor Relations for McDonald's Corporation.

Miss Shaw, you may begin.

Hello, everyone, and thank you for joining us today.

With me on our call are Chief Executive Officer Jim Skinner, Chief Financial Officer Matthew Matthew Paull and joining us from Hong Kong is Chief Operating Officer Ralph Alvarez.

This conference call is being webcast live and recorded for replay later today via phone, webcast and podcast.

As always, the forward-looking statements that appear in our earnings release and 8-K filing also apply to our comments.

With the earnings release and our 8-K with supplemental financial information are available on .investor.McDonald's.com as are reconciliations of any non-GAAP financial measures mentioned on today's call with the corresponding GAAP measures.

Now, I would like to go ahead and turn the call over to Jim Skinner.

Thanks, Mary Kay, good morning everybody and thanks for being on the call.

I'm excited to report that our momentum continues with all of our area and world business units contributing both to the top and bottom line.

In the third quarter, systemwide sales increased 8% supported by solid guest count increases.

Margins continue to grow.

Operating income growth was up 12% and earnings per share is $0.68 or 17% increase over the previous year.

It's clear that we're satisfying our customers and as a result, providing value to our shareholders.

And as I see it, the trend is continuing.

There is still substantial upside potential for us to grow our business around the world.

It should come as no surprise that our core business strategy will remain to grow by being better, not just bigger.

We will continue to execute this strategy through our plan to win.

This approach has aligned our system and directed our resources and assets to deliver strong results for the past 3 1/2 years.

As you've heard me say many times, it's all about continuous improvement, getting better at being better is how we will capitalize on the opportunity in the marketplace.

We are intensifying our efforts in a few key areas, most important is evolving the McDonald's experience to achieve even greater customer relevance.

Our pipeline is filled with innovative solutions to customer needs in all areas of our plan to win.

For example, in the areas of food, work is underway to address our customers' desire for additional choices of Happy Meal entrees and beverages that will meet appropriate nutritional guideline.

In service we have a new POS system in 5,000 restaurants, in tests it has improved order accuracy by 33% and allowed us to serve up to 13 additional cars per hour in the drive-thru.

In convenience, we're exploring various ways to increase capacity at the drive-thru and making it easy for our customers to experience grand McDonald's.

There are many more examples, but the point is we have the right focus and resources in place to grow our market share by providing our customers with the most relevant solutions to meet and exceed their needs.

We're also evolving our marketing to further strengthen our connection with customers and build greater trust.

McDonald's is one of the most recognized and respected brands in the world.

The value of this trust is evident in the larger share of customer businesses and higher average annual sales that McDonald's restaurants achieved versus our competitors.

But we can and we will do more.

We believe the opportunity to build greater trust in our brand and the benefit of doing so is significant.

We're focused on two key priorities to fill this greater brand loyalty.

Creating engaging breakthrough communications and enhancing McDonald's brand as it relates to the well-being of children.

Today it's easy for people to opt-out and ignore marketing communications, so we will accelerate our efforts around creating advertising that breaks through the clutter and is engaging.

We've broadened our marketing focus beyond television to include print, billboards mobile communications, such as the UK text message to win World Cup tickets and, of course, the internet.

The internet is an important and effective medium for engaging customers.

For example, our global casting call last spring was entirely internet-based and it was a promotion where customers submitted photos and stories with a chance to be featured on our packaging.

On a shoestring budge with no media support, this promotion drove 13 million hits to our website and received 70 million media impressions.

We've also created advertising targeted toward young adults just for the internet.

One ad that debates the proper pronunciation of Filet-O-Fish has proved popular on Utube, Yahoo! and Google video.

Ad Age and AdCritic recently named this ad pick-- or this ad the pick of the week.

Our second priority is to further build brand trust by being a recognized leader in the area of children's well-being.

We intend to be an ally of families by offering greater Happy Meal choice, which I talked about earlier, and educating parents about these choices and the relative nutritional value of our food.

As part of this effort, the U.S. now features Chicken McNuggets, apple dippers and milk in most every Happy Meal ad.

In addition, we are recommitting 20% of our children's marketing budget toward communications that inspire kids to be more active, both physically and mentally.

We will pursue these priorities in an effort to build trust which, in turn enables us to grow guest counts in sales and profitability.

In addition to operations through marketing initiatives, we are also focused on ownership structures that provide the best returns for our system and shareholders, this includes our efforts to run franchising more of our restaurants in the UK, to converting more markets to a developmental license structure, and of course Matt's going to talk about this in a few minutes.

And of course, we are always looking at ways to leverage efficiencies and improve effectiveness in those areas we consider competitive advantages, such as supply chain and market.

By focusing on these areas, we will provide even greater value and returns for our shareholders.

Last months dividend and share repurchase announcement is a direct result of our current success and our confidence in our ability to continue to deliver strong results.

As you may recall, we will increase our dividend this year by nearly 50%.

That means since 2002, our shareholders have seen a 325% increase in their dividend, one of the highest increases in the S&P 500.

In addition, we committed to return at least $10 billion to shareholders through dividends and share repurchases this year through 2008.

And earlier this month, we completed our divestiture of Chipotle.

This transaction was the right thing to do for both Chipotle and McDonald's.

Chipotle will benefit from increased flexibility to pursue its own strategic objectives and McDonald's customers and shareholders will benefit from our singular focus on brand McDonald's.

Needless to say I'm excited about our future.

We have tremendous momentum and we are poised to maximize the opportunities in the marketplace.

By intensifying our focus and improving execution of our plan to win, I have no doubt that we will continue to generate strong results.

Helping me lead this charge is our newly-appointed President and Chief Operating Officer, Ralph Alvarez, who is in Hong Kong today.

Ralph is a strong, results-oriented leader who has driven success in our business both inside and outside of the U.S.

His passion for restaurant operations, deep understanding of the competitive landscape, focus on profitability improvement track record make him the perfect person to help take McDonald's revitalization and accelerate our momentum to the next level.

With that, I'll turn the call over to my partner, Ralph Alvarez.

Thank you, Jim, and good morning.

Before I begin, I want to emphasize how proud I am to be partnered with Jim to lead brand McDonald's.

Our plan to win is working.

We have business momentum.

It remains our system's road map and it will continue to drive results to the top and bottom-line.

McDonald's third quarter consolidator results were strong with comparable sales increase a plus 5.8%, that is 41 consecutive months of positive global comp sales growth.

Franchise margins of 81.2%, up 60 basis points.

Company operating margins at 17.3%, an increase of 150 basis points versus the same quarter last year.

We continued that margin expansion as a result of healthy sales growth with a good balance of increases in traffic and average check.

I want to share with you some of what I have been doing recently.

Since assuming my new position, I have been spending time in the field and restaurants in our major markets reviewing our 2007 to 2009 plans and addressing opportunities for growth.

I 'm focused on the incorporation of best practices across the globe and ensuring strong alignment around important brand-defining elements.

Our brand is in different stages of development.

But the right combination of convenience and branded affordability coupled with locally relevant product news has been and is a winning formula.

Now, let me also share with you how Jim and I are looking at the business and what guides our thinking and decision-making.

First, replication and consistency are key to our growth.

Our ability to take an idea, scale it and consistently deliver is a point of differentiation.

We're rigorously reviewing processes and systems that allow our restaurants to handle changes and menu and operations faster and better than ever before.

Simple execution and fast replication are what customers want today from our brand is the key to our success and it is McDonald's strongest core competency.

Second, we are setting up migration paths that enable us to handle the changes both financially and operationally from country leadership all the way down to each restaurant.

Examples of this are restaurant reimaging, operating system, and point of sale changes.

Third, everything we do is filtered through individual restaurant level economics to ensure we balance restaurant enhancements and profitability.

Now, I'd like to highlight what the driving the business around the world.

In the U.S., momentum continues with third quarter comp sales up 4.1%.

Company operating margins continue to be strong at 19% for the quarter, an increase of 30 basis points despite higher average hourly rates, utility increases, and depreciation as a result of our reimaging investments.

We are seeing specific success from breakfast, branded affordability and chicken.

Consumers love the new chicken snack wrap, with a suggested price of $1.29, it's a great value and has exceeded our projections by 20%.

Our profitable breakfast business had increases of 7% for the quarter, led by the leverage of this year's launch of premium roast coffee.

In addition to the significant growth from our existing restaurants, we will open about 200 new units in the U.S. this year.

I am confident the strength of the U.S. business and the leadership of Don Thompson and Jan Fields.

We have an experienced management team, strong order operators and a momentum of growing guest counts.

Now moving on to Europe.

We continue to be pleased with our progress.

We delivered strong third quarter comp sales of 7.6% up.

September was the 8th month of consecutive positive comp sales for Europe.

This resulted in company operating margins increasing 220 basis points to 18.3%, the highest quarter in five years.

The improvement occurred in all big three markets, UK, Germany and France and was partially offset by labor pressures.

The momentum in Europe is building, due to a focus on three key plan-to-win strategies: Improving our customer experience, building brand transparency, and increasing consumer relevance.

In Germany, we're seeing success through the right balance of branded affordability and recurring seasonal events like Asian and Mexican-themed promotions.

In France, we continue to see outstanding results.

We're growing in a shrinking and formulating out market.

The French team is focused on brand relevance and building a strong connection with their customers.

They, along with other European markets, saw excellent results from this summer's promotion that focused on our extra value meals and feature special Coca-Cola glasses.

In the UK, we're starting to gain traction.

We have now posted positive comps for the last six months and the improvements are benefiting Europe's margins.

The UK contributed almost 100 basis points to Europe's third quarter '06 company-operating margin improvement.

Now the big three are not the only countries contributing to Europe's results.

We continue to deliver strong consistent performance in other parts of Europe, including Russia, Spain, and Italy.

Now, let's turn to Asia, Pacific Middle East and Africa.

Their third quarter comp sales growth was plus 6.1% led by Japan.

We also generated a 150 basis-point increase in company operating margins, primarily driven by China.

Our team in China is focused on executing the basics of the business and growing our brand equity.

We are laying a strong foundation for the continued growth of our convenient strategy there.

This means a movement to almost 50% of our new restaurant is being built with drive-thrus.

While building a drive-thru restaurant in China, it's costing us about $200,000 more U.S., we're achieving opening volumes that are tracking at at least 250,000 higher than before.

Clearly a good investment.

We are confident in the leadership of our China team and the opportunities that we will capture in this market.

Bottom line, our plan is working.

All major geographies are growing sales and returns.

As I mentioned earlier, I have spent the last few weeks with our global teams as they finalize their 2007 through '09 plans.

I can tell you that it will be more of what is already working well.

It's a combination of a strong pipeline of innovative new menu items, combined with everyday branded affordability and increased consumer conveniences like extended and 24 hours, delivery, cashless and gift cards.

We continue to invest in our facilities, our operating systems, and our people so we truly can be better at being better.

Our teams are motivated to continue to build in the foundations of the plan to win.

And now, I would like to turn it over to our CFO Matt Paull.

Thank you, Ralph and good morning, everyone.

At the risk of sounding a bit like a broken record, our strategic focus on being better, not just bigger, continues to deliver strong results.

Jim and Ralph already discussed the quarter's performance, so I will update you on our efforts to optimize our restaurant ownership mix, explain how we will account for the Chipotle splitoff and describe our plans to reduce share counts.

Last January, we outlined our intent to transfer ownership in 15 to 20 countries with about 1,500 restaurants to develop our licensees over the next three years.

As a reminder, we have successfully used the developmental license, or DL structure, for more than 15 years now and currently have it in place in about 35 countries.

The DL structure aligns us with local entrepreneurs who know the local culture, business and legal environment.

They use their capital and local expertise to build the brand.

Under this arrangement, McDonald's collects a royalty and invests no capital for new stores or for reinvestment.

In addition to the financial benefits from reduced capital intensity, improved return and a growing stream of royalties, this strategy enables our management team to focus most of its time and energy on the markets that can make the greatest difference.

This is an essential component of the being better not just bigger strategy.

We are tailoring the ownership structures we use to the unique aspects and risk reward relationships in each of these markets.

In fact, we now believe that the DL structure is appropriate for an even larger number of countries and restaurants than originally contemplated.

In aggregate, the markets now on our DL list account for about 2,300 restaurants and in 2005, represented 2.5 billion dollars in sales, that's just under 5% of systemwide sales, $150 million in G&A, about 20 million in operating income, excluding impairments of 21 million, 100 million in capital expenditures and slightly combined negative free cash flow.

These 2,300 mostly [macaco] restaurants represent about $3 billion in combined net investments, this includes some $800 million in accumulated currency translation losses, reflected as negative shareholders' equity on our balance sheet.

We do not expect any potential licensee to compensate us for these historical currency losses.

In addition, if we are able to complete these transactions, we do not anticipate that sales proceeds will allow us to recover most of the remaining $2.2 billion in net book value.

Remember, these markets generated negative free cash flow in 2005, and that's before considering the royalty we will collect from potential licensees and any additional capital commitments we will expect from these licensees.

Though we are aggressively pursuing the DL strategy, accounting rules do not allow us to record potential losses to bring asset-carrying values down to likely value at sale until we conclude we're likely to complete a sale within 12 months and we have a reasonable sales price estimate.

Both of these criteria must be satisfied in order to apply what we call held-for-sale accounting to our impairment testing.

The amount of any loss recorded if and when we cross the held-for-sale threshold could be significant.

Until then, we will continue to test these assets for impairments in accordance with the help-for-use accounting policies described in our 10-K.

Separately, in the United Kingdom, we're making progress toward our goal of reducing the company owned store count to about 50% by the end of '07.

Our ultimate goal is to get this number below 50%.

Through the third quarter, we have franchised or entered into joint venture arrangements for 100 company-operated restaurants in the UK, this brings company-operated restaurant ownership down to 56% from 63% at the beginning of the year.

As Jim mentioned, we completed the Chipotle splitoff earlier this month.

The gain from the exchange offer is about $500 million.

This gain and all Chipotle results will be recorded as discontinued operations in the fourth quarter.

All prior year Chipotle results will be presented in this manner as well.

As a result of the Chipotle exchange, we reduced shares outstanding by almost 19 million shares.

This amount plus year-to-date repurchases of 53 million shares brings total shares acquired so far this year to nearly 72 million.

Now that the Chipotle exchange is over, we plan to resume buying back stock in the fourth quarter, and consistent with our previous guidance, we anticipate total shares outstanding at the end of '06, the total, not average, to decline by about 5% from year-end 2005.

It's important to remember that the timing of when shares are acquired during the year and when options are exercised affects the weighed average shares outstanding calculations.

For example, the McDonald's shares acquired in the Chipotle exchange offer were still outstanding for more than nine months of calendar year 2006.

Therefore, we do not expect a reduction of 5% in diluted weighed average shares for the full-year '06 or the fourth quarter.

Much of the activity taking place in 2006 will affect the diluted weighed average share calculation more significantly in 2007.

We remain strongly committed to further reducing shares outstanding through share repurchase and disciplined compensation mix practices.

Last year, we implemented changes to our compensation mix that resulted in just 7 million options and about 1 million restricted stock units being granted in both 2005 and 2006.

This is substantially less than the average of 27 million options granted per year from 2000 through 2004.

As a result of reduced grant levels and abnormally heavy option exercise activity, total options outstanding declined 18% in 2005 and are down another 16% since the beginning of 2006.

The reduced amounts of outstanding options coupled with a significantly reduced option grant run rate are a big part of the reason we're confident that share repurchase activity will yield a meaningful reduction in share count in the years ahead.

Stated more simply, we will no longer be bucking strong head winds as we attempt to reduce share count.

In closing, we are confident that our focus on being better in all aspects of our business, from delivering great customer experiences to our financial management practices, will drive our business forward and help create even greater value for share holders and our system.

Thank you and now I'll turn the call back over to Mary Kay.

Thanks, Matt, I will now open the call open for questions.

[ OPERATOR INSTRUCTIONS ] The first question is from Jeff Bernstein at Lehman Brothers.

Great.

Thank you very much.

Just a question on the company operating margins you spoke of earlier for both the U.S. and Europe.

In the U.S. it seems we're seeing stability in the very high teens.

Just wondering whether there is something structural that will keep them from reaching 20% plus?

And as well, what comps are needed to sustain them at the current levels?

And simply on Europe, obviously we have seen very strong margin improvement over the past few quarters.

I am just wondering if European margins can reach and maintain a level similar to the U.S. or are there, obviously, some structural differences that would limit achieving those U.S. levels?

Thanks.

Hi, Jeff.

This is Ralph Alvarez.

I'll take that.

On the U.S. side, there has been a leveling at around that level.

Under -- the type of inflationary times that we have now, we probably need something around 2% comp in the U.S. to maintain the [inaudible] comp margins.

In Europe, that number is more like 3% because the market rents.

Rents aren't as fixed as they are in the U.S.

Those are the two items that are there and it's really based on our leverage off of comparable sales on our existing restaurants.

Thank you.

The next question is from David Palmer at UBS.

Hi, congratulations on the quarter and [inaudible] the cashing of the dividends in particular.

The question I have as limited to one.

Really on the U.S., and I wonder if it's fair to say that your growth initiatives, while your main varies are really kind of shifting in terms[inaudible], in the past might have been a little bit more in the menu class 1 list, the menu [innovations] in big class 1, credit card, extended hours.

Now it seems like it's a little more better advertising, better throughput and a focus on [really] keeping the number of menu items a little more [flat].

Could you, perhaps, comment on the sources of growth going forward?

Thanks very much.

Ralph, did you want to respond to that relative to the U.S. growth and the initiatives?

Sure.

Yes.

Hi, David.

On the -- I would tell you that what we're really focused on is the improvements-- or the initiatives that we have add to the base of our business versus just being promotional spikes, and so you're seeing items that do add capacity that extend our value platform.

That's what chicken snack wraps does.

It's an item that is a permanent menu item.

It incorporates all products that we already have that allow us to be able to execute it well and it's not a burden on the restaurant, and so in the convenience items that we have added of extra hours, 24 hours, cashless and and debit cards, all continue to show growth year to year as people get more used that we have those and we're open those hours.

So, truly, those are the things we're focused on.

We do have some very innovative menu items we're working on for the long-term that will also play a part in the next year or two years.

Thank you.

The next question is from Laurie Hahn from Deutsche Bank.

Hi, everyone.

I was wondering if you could comment on commodity costs and the outlook in 2007 across your segments, particularly U.S. and Europe?

This is Matt.

I will give you a look at '06 and how we see it, and I'll ask Mary Kay to jump in on '07.

First the U.S., beef, down in the third quarter, expected to be slightly down for the full year in the U.S.

Chicken, a relatively flat in the third quarter and we expect it to be relatively flat for the full year, and cheese down in the third quarter, we expect it to be down for the full-year.

Europe, again, for '06, beef, down in the third quarter, expected to be relatively flat for the full-year, remembered that, in '05 our biggest spikes that we saw in beef in Europe were in the second and third quarters.

Chicken for Europe in '06, the third quarter was down, and we expect chicken to be down for the full year.

And cheese, relatively flat in the third quarter, and expect it to be relatively flat for the full year.

And those are the primary commodity cost drivers, but there are other things that obviously are a factor, there's paper and orange juice and eggs, all kinds of other commodities.

Those are the big three.

I'll ask Mary Kay to comment for '07.

For '07 in the U.S., chicken costs are expected to be up slightly and beef flat to down slightly.

In Europe, beef and chicken are both expected to be up 2 to 3%.

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

Can you talk a little bit about your unit growth plans as you think about '07 to '09?

And maybe if you could comment globally on it if there is a change to it?

And then, specifically in the U.S. where you have had outstanding results and this may be an opportunity to accelerate growths.

What your thoughts there?

John, this is Jim.

We basically are staying the course in our growth profile over the next few years.

And we have talked very specifically about growing at that 1.2 or 1.3 or 1.5% rate.

We may move more toward the 2% over the next few years, with the focus on China and Russia, Italy, markets around the world that have demonstrated the opportunity for growth both in terms of returns and future potential.

Relative to the United States, we may pick up a few units here and there.

But, overall, the growth profile, I think, is going to stay about the same.

Thank you.

The next question is from Larry Miller at RBC.

Thanks very much, I had a question on the franchise margin in Europe.

I saw the Company margins up over 220 basis points, but the franchise margin wasn't up quite as much, I hope can you give me a little color on that?

And I'm guessing you're going to talk about the mix in the UK being company-- more company-owned.

My question again would be as a followup, why wouldn't you see a similar kind of increase, given that you should get leverage on the increase in franchise in-store sales?

Thanks.

Yes, Larry, hi, this is Ralph.

I'll take that.

In Europe the -- first, we always get a higher leverage on the Company restaurants because our contribution margin on every dollar of sales is higher when we're operating the restaurants than the lower percent of contribution margin that we have off of just the rent and royalties.

But for Europe, our 50 basis points growth was driven primarily by Germany and France and the UK because we were doing some of the ownership mix changes, some of those restaurants that now become part of the mix on the franchise side may have slightly lower franchise margins.

But we still had the growth of 50 basis points in Europe.

Thank you.

The next question is from Joe Buckley at Bear Stearns.

Thank you, a question on the UK.

I think you mentioned the was 6th-- September was the 6th month in the row of positive comps.

I guess I wonder if you could just talk about what is driving the business, why you think you finally gained traction from the many changes you have implemented over the past few years in the UK?

I can start, Joe.

Thanks for the question.

This is Jim.

We had a leadership change there, Steven Easterbrook now is running the marketplace, and the connect with our customers there and the results are on execution in almost every aspect of the business has improved.

Of course, much of this work had been done over the last year and a half or so, Peter [Barrister] was there now, Steven Easterbrook is the continuation of the initiatives that had served us well there and it's the fundamentals.

Better delivery in the restaurants, better delivery around new food news, better delivery in terms of the overall communication with our customers and the brand and all of those things added up have given us the results that we're looking at today.

And, Joe, you have known me awhile.

This is Matt.

I don't like to talk about anecdotes, but there is an anecdotal story that re-enforces what Jim said about Steve Easterbrook and the style and the approach he's taken to running the UK for us.

It's about brand transparencies.

There is a movie coming out that talks about our industry, and in the past, our approach in the UK was to not dignify some of the charges that were leveled against us.

But the BBC and the UK offered to share a debate between the guy who authored that movie and Steve Easterbrook.

And instead of backing away, when Steve was only about a month on into his job, he said sure, I'll go on network television and the BBC and talk to this gentleman about our brand.

The very fact that we showed up, in our view, made us a winner because it showed that we had nothing to hide and we're willing to be transparent as a company and a brand, and Steve has taken that signal to the enth degree and I think it sends a very strong message about how proud we are of our food and our brand and that is a big part of the reason we're beginning seeing some turn in the UK.

Thank you, our next question is from Andy Barish, Banc of America.

Hi, the question is for Matt on the update of the DLs, previously, the developmental licensee stores you were talking about were actually, had operating losses of about 50 million.

Now, you're talking about an additional 800 stores that in total now you're looking at operating profits that you're looking at moving aside to licensees, so I guess a little bit of background in terms of what the strategy is there would seem you're going to some bigger markets that are actually making money and why is that sort of shifted a little bit here as you have been a year into kind of renewing the program?

Andy, I agree with your analysis.

We have put some markets on the list that are making money.

But we have taken a look at each market and said what does the risk reward relationships look like and what is going to take to realize our potential for the brand in each of the markets.

And in many cases, we have room to grow but we think it isn't the best use of our capital and we think we need to emphasize local relevance more than we have.

And when those circumstances come together, we think it's an ideal candidate for developmental licensing because in many of these places, the returns may take a long time to harvest, and some of the competition that we're up against is using somebody else's capital, but most importantly, we want to be able to focus our management teams on the markets that have the greatest opportunity and Jim wants to comment as well.

I just want to make a comment.

I know we talked a little about this in San Francisco.

Our opportunity to grow McDonald's brand presence in these markets around the world while improving returns is really where we're headed.

And when we looked at these markets, then, as Matt mentioned, the risk reward, it's been a successful structure for us.

When we put the matrix of this structure to these additional markets, we were able to see where we could grow brand presence, local entrepreneurs and deliver a better return.

That's why it has methods [inaudible].

And on the return side of this, the math is pretty easy.

We would be removing from the denominator of the return computation, over $2 billion in assets, and then the numerator is going to increase and the issue is where will the royalty rates be set and how much G&A will it take for us to earn that royalty and how fast will it grow.

It's clearly going help our return by a minimum of 100 basis points once we're completed the project.

Thanks.

Next question is from Jeff Omohundro from Wachovia.

Yes, I wonder if you'd elaborate a bit more on the higher costs associated with the drive-thru initiative in China?

During the recent analyst meeting in Shanghai this touched on, I was wondering if you could elaborate perhaps on the opportunities over time to reduce those costs?

Thanks.

Ralph, did you want to talk about the drive-thru concept there?

Sure; the higher cost is, obviously, we're buying property that is freehold versus going in line, and we have slightly higher construction costs that also play a part there.

So, these are the 200,000 additional costs is really a reasonable amount relative to what we have there.

We will, as we start building some of these restaurants that we're doing with the deal that we signed with SINPOEC, some of those costs may be different, it may be lower because we're sharing property with the gas station, and our experience with that is that we're going to lower some of our fixed costs.

And then, Jeff, also we tend to, when we do something for the first time, we usually do it in a bigger way.

As we build more drive-thrus, they'll be as big as the ones that we're currently building.

They're more flagship right now.

Thank you, the next question is from Rachael Rothman of Merrill Lynch.

Hi, guys.

Can you talk about, a little bit earlier in the year when gas prices were up so much, a lot of the casual diners were talking about their consumers trading down to QSR.

Now that the gas prices have come down considerably, are you seeing any tradeaway or trade back up to casual or do you feel like it was not trade down owing to gas it was just better execution on the part of the quick-service operators?

Thanks.

Rachael, this is Jim.

I think right at the moment, it's a little too early to tell to see whether there is any trade changes regarding fuel costs.

We're all happy, of course, that the fuel costs are going down, and yet it has not indicated any change relative to our traffic in the restaurants, and earlier, of course, we were able to operate above that noise because I think of our convenience and execution, as you mentioned, and so we were very pleased with that.

But certainly, like everybody, pleased at the moment that the prices are going down.

Thank you, the next question is from from John Ivankoe, J.P. Morgan.

Thanks.

Jim earlier in your prepared remarks, you talked about the point of sale system in the U.S., I think in 5,000 stores, that led to at least some tests, 13 more cars an hour, can you quantify that in terms of comps, discuss when that might be systemwide?

And also talk about some implications outside of the United States in terms of driving traffic?

Thanks.

Well, Ralph might be better to talk about this, John, but the fact is it's 5,000 around the world.

It's not all in the United States.

And we have a number of these new POS systems in the United States but we're not ready for primetime there yet relative to the execution implementation of that, and able to quantify that really in terms of comparable sales growth except to say that we all know that serving our customers at the speed of McDonald's and improving the efficiencies in the drive-thrus will certainly lead to top-line growth and bottom line growth.

We have not quantified it yet and we're in a migration path today, relative to this new POS system and yet it won't be worldwide for probably a couple of years yet.

Ralph, did you want to talk about the U.S. migration?

Sure.

And, again, this is not hardware.

This is mostly software and -- but the changes are significant and so we do migrate them into the restaurants at the same time that we may be doing some of the new food news or some of the other items so that the changes can be handled appropriately.

What this, what it does is basically the benefit is significantly reduced key strokes, less greens to go through and that's where the speed comes in.

Because the conversation with the customer is we don't interrupt the customer with questions as much as we have to under the current system.

And so, it's a capacity enhancer, how much of that translates to sales, too early to tell, of course, we don't always have capacity constraints but it also, it truly does, not just improve capacity, obviously it improves the quality of service.

This is Matt.

I agree with everything Ralph said.

Building sales is about providing capacity and having demand as well.

But on the capacity side, you heard us say for many years that saving 6 seconds off of the drive-thru experience is worth about a point of comp.

This has the ability to do that.

But, again, there is the capacity side of this and the demand side as well.

Thank you.

Next question is from Joe Buckley from Bear Stearns.

Thanks.

I'm going to sneak two in here because they're both followups.

Matt, would you be willing to comment on the developmental licensing deals, what kind of royalty rates you're getting?

And then secondly, just a little more elaboration on the POS system, how many countries is it in and if you'd be willing to share with us how many of the 5,000 units are in the U.S.?

That would be helpful.

A small number in the U.S. out of the 5,000.

Very small, which is why we're excited about the potential.

And on the issue of the DL, I will give you sort of an order of magnitude idea, Joe.

We said that this year we've converted four countries to DL and we're working on quite a few more.

In general, when we have been able to DL a market, you should think of the royalty as ranging somewhere between 2 and 7%.

If you look at the 35 countries we already have out there, the low is at 2 and the high is probably somewhere 7 or a tiny bit higher, and this is going to be somewhere in the middle of that.

If you have a market that is very challenging in terms of profitability, you have to start at the low end of the range.

If you have a more profitable market, you can start more toward the middle.

And the G&A, to earn that royalty ought to be well less than half of the royalties.

Thank you, we have a followup from David Palmer at UBS.

Hey, guys, a quick followup on Europe and in particular, the UK, is there any sense that can you give us, any data point that can give us confidence that this turnaround there, obviously you're getting a lot of momentum now, but the fact that we continue on a multiyear bases or at least through '07, anything with regard to customer perceptions or anything in particular to the UK?

Thanks.

This is Matt.

I will throw in a comment.

We don't like to predict years ahead of time.

We have trouble sometimes quarter-to-quarter.

As you know, we don't even predict comps or earnings, but we like what we see in terms of mystery shop results and brand trust scores.

The trends are improving and that has to happen for us to sustain what we've got.

So we like the trends but we're not going to make any promises or commitments.

Jim, do you have -- .

David, I would say that, just like our results in every other part of the world today and by the individual country, the focus on our customers in our restaurant and the diligence that we have had around execution and delivering a better experience for our customers and trying to do a better job today than yesterday has served us so very well.

The -- and it's the same in the UK.

The discipline that that team is showing regarding staying the course, delivering around the plan to win, showing the great results that Matthew's talked about and it is sustainable.

When, in fact, we stay focussed and it's our flywheel, if you will, relative to customer relevance is some important for us.

Just to add to that.

Jim and I were there two weeks ago and spent two days in the restaurants and looking at the UK plans and so we're pretty familiar with what is going on.

The one thing that we looked at is, are we getting promotional spikes or are we starting to stabilize the base line?

We're stabilizing the base line, continued improvement in our operations and our relevance, will then move the baseline, and that's really what's the help of future comps, and so that is why I stated the six months, because six months doesn't make a long-term trend, but what we see is encouraging.

Thank you.

It looks like we're out of questions.

So, I will go ahead and turn it back to Jim for a couple of closing remarks.

Thanks again, everybody, for participating in the call.

We appreciate your interest in McDonald's, as always.

To sum up everything you heard today, McDonald's business is strong and getting stronger every day.

The future holds tremendous opportunity for growth, and under our velocity of continuous improvement, we will seize that potential by achieving greater relevance to our customers with a robust pipeline of initiatives and each of the five keys of our plan to win.

We will further strengthen our connection with customers by building brand trust, we will leverage our strongest core competency, simple execution and fast replication to ensure our top-line initiatives drive our bottom-line, and we will optimize our restaurant ownership mix to realize further financial benefits and optimize returns.

Together, these actions will allow us to continue to build systems and shareholder value.

Thank you.

Thanks, everyone.