麥當勞 (MCD) 2007 Q1 法說會逐字稿

Hello and welcome to McDonald's April 20, 2007 investor relations conference call.

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

[OPERATOR INSTRUCTIONS]

I would 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.

Hello everyone and thank you for joining us today.

With me on our call our Chief Operating Officer, Ralph Alvarez; and Chief Financial Officer, Matthew Paull.

This conference call is being webcast live and recorded for replay via phone, webcast, and pod cast.

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

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

At 11:00 a.m.

we will pause for a moment of silence in remembrance of all those affected by the tragedy at Virginia Tech.

Virginia Governor Tim Kaine has declared today a day of mourning and called for a moment of silence at noon Eastern time.

Our thoughts and prayers go out to the family and friends of the victims and we plan to join in that remembrance at 11:00 a.m.

our time.

Now I'd like to turn it over to Ralph Alvarez.

Thank you and thanks for joining us.

I will begin with comments on the quarter's results and then discuss this morning's announcement regarding our developmental Bison strategy.

Our first quarter results were very strong and I am pleased with the momentum the execution of our plan to win is driving across all geographies.

Our system is aligned, and focused on one plan to create an even more successful future.

And we are confident that being better, not just bigger, is the right strategy.

Although we are proud of our recent business performance, make no mistake that our management team knows there's much more we can and will do to sustain and grow the business in '07 and beyond.

Now, for the quarter.

We delivered earnings per share of $0.62, up 27% over prior year earnings of $0.49 per share.

Separately, if you compared our earnings from continuing operations, they were up 38% over last year's $0.45 per share.

Revenues increased 7% in constant currencies, driven by our strong comparable sales growth.

Operating income for the quarter reached almost $1.2 billion, up 25% in constant currencies.

Reflected in these results is a benefit of 11 points from impairment charges we took in the first quarter of last year.

We condition to drive margin expansion.

As a result of healthy sales growth and a good balance between traffic and average check increases, company operating margins increased 120 basis points, and our franchise margins increased by 30 basis points.

I'll now provide the details by area of the world.

And we'll start with Europe.

Europe had an excellent quarter with comparable sales up 8%.

We are pleased by the sustained momentum we have achieved.

Company operated margins also improved 180 basis points to 15.4% driven primarily by the very strong comparable sales.

The U.K.

contributes 75 of those basis points of the margin improvement due to positive comp sales and last year's strategic closing of restaurants and ownership changes.

During the quarter, beef costs in Europe increased by 2% while chicken decreased about 2%.

We expect beef and chicken costs to be relatively flat for the year.

Results in Europe are being achieved with a focus on three core strategies--Upgrading the customer experience, building brand transparency, and enhancing our local relevance.

Related to upgrading the customer experience, McDonald's Europe continues to attract customers by featuring a variety of premium products along with compelling value options.

These mixed with exciting marketing promotions are driving the results.

Talking about menu offerings, the U.K.

launched Chicken Selects and Snack Wraps and their early results are reflected in the March sales.

Germany will be next to launch these menu items.

Beyond the big three countries of France, Germany, and the U.K., we are also seeing strong consistent performance elsewhere, including Russia and Italy, markets with significant upside for growth and they'll contribute much more on the next few years.

Now, turning to the U.S., our momentum continues with first quarter comp sales up 4.4%.

We are seeing success from breakfast, extended hours, and a menu line extension of the popular Snack Wraps with February's launch of the grilled and honey mustard versions.

We will continue to keep the menu fresh for our customers with this week's rollout of our premium Southwest salad.

Company operating margins for the first quarter remained high at 18%, but declined 30 basis points versus last year.

This was primarily due to state minimum wage increases and group health costs.

Now, regarding commodity costs, beef was down 5% for the quarter, while chicken was up 6%.

For the year, we expect beef costs to be down slightly, and chicken to be up in that 5 to 7% range.

In total, we believe 2007 cost pressures can be managed by our continued business momentum, along with reasonable menu prices, increases which will be spread out throughout the year.

Our U.S.

breakfast business continues to grow and has never been stronger.

In 2007, you will continue to see an emphasis on breakfast with new product introductions like Cinnamelts now available in most of our restaurants and our coffee customization.

In addition we have tests of a bigger breakfast burrito and a southern style chicken biscuit.

We have also built a strong foundation in our brewed coffee business with last year's introduction of the Premium Roast coffee.

The success of our efforts now enables us to further expand in the coffee space by adding ice coffee in many markets.

And then later, down the road, specialty coffees like capuccinos, lattes, and mocha.

Our U.S.

business has a strong plan in place and the best owners/operators in the industry executing against that plan.

In act, during our recent U.S.

owner/operator annual business meetings, Jim Skinner and I were very impressed by the energy and alignment and the commitment to continue to grow the brand.

Now, turning to our Asia Pacific, Middle East, and Africa area of the world.

In Asia Pacific the comps for the quarter were up 8.5% led by Japan, China, and the Middle East.

Asia Pacific's focus on branded affordability, breakfast, combined with convenience extensions, like 24 hours drive-thru and delivery, are producing results.

This segment generated a 260 basis-point improvement in company-operated margins to 14.9%, primarily driven by the strong sales.

We have compelling locally relevant plans in each of the countries and we are doing a good job executing against those plans.

For example, in China, our management team is having success delivering on what we said we would do, focusing on branded affordability, more choice on the menu, and expanded convenience.

We are beginning to see traction.

In fact, in the first quarter -- excuse me -- China revenues increased 15.9% in constant currencies, company-operated margins were up 380 basis points and our operating income grew by 73.5%.

McDonald's China is actively promoting the variety of proteins we offer, chicken, beef, and fish.

This unique to McDonald's consumer proposition, when coupled with creative advertising, [distrungusha] sauce from the other quick service restaurants there.

With increased spending power and a 15% growth in automobiles comes a greater mobility and demand for convenience.

The McDonald's' drive-thru becomes an ideal choice.

Our development plans for 2007 include opening 100 new restaurants, half of which will be drive-thrus.

New restaurant drive-thru restaurant sales are higher than those restaurants that open without drive-thrus.

In addition, we opened the first drive-thru as part of our Sinopec alliance this year, and we expect to open 10 more by the end of the year.

Sinopec is China's largest petroleum retailer with 30,000 locations, providing us with an important pipeline of sites for the future..

We are very optimistic about our prospects in China.

Our business is strong around the world.

We remain committed to continue to increase customer relevance and are confident in our ability to continue to deliver results.

Now, let me shift focus and discuss strategic activities around maximizing our asset base and our ownership structures.

Franchising remains the backbone of our business.

A recognized business model that helps build and make our brand what it is today.

In fact, more than 70% of our restaurants worldwide are owned and operated by entrepreneurs.

We remain committed to our long-term strategy to add McDonald's restaurants mostly run by strong, independent business women and men.

Who are dedicated to growth in the markets they operate.

While it is important to maintain a certain number of company-operated restaurants to test new concepts, develop talent and to remain a credible franchisor, our goal has been to reduce the overall percentage over time.

As part of this process, we announced a significant transaction under our developmental licensee strategy or DL.

We have committed to franchise nearly 1600 restaurants in Latin America, to a single developmental license organization led by Woods Staton.

Woods is a highly respected businessman and leader and a valued member of the McDonald's system for more than 20 years.

He most recently served as South Latin America Division President.

In that role, he worked closely with McDonald's Latin America President, Jose Amario and the leadership team to help revitalize our business.

In fact, many key leaders there were recruited and developed by Woods and are expected to remain a part of his team.

Woods possesses strong operations and marketing skills to continue the growth of the brand, make effective reinvestment choices, and maximize the potential for this geography.

Woods is committed to a long-term relationship and will be the CEO.

His other partners include Capital International Private Equity Fund, Gavea Investimentos, and DLJ South American Partners, all are prominent groups in Latin America with many years of business experience.

Ultimately, this selection was based on the best overall package of offer price and terms acceptable to McDonald's, as well as Woods and his team's expertise and experience in the marketplace.

Their strength provides additional assurance that our Latin America business will continue to exemplify the highest qualities of our brand.

We want to express our appreciation and the enormous respect we have for our Latin American franchisees, partners and employees who have worked hard to achieve a great business turn around.

Despite external economic challenges the recovery is well underway.

Our brand is extremely popular, and we remain confident in its long-term potential.

In fact, for the past three years, McDonald's Latin America has achieved double-digit comp sales gains driving improvement in both company-operated and franchise margins.

First quarter 2007 marks the 13th consecutive quarter of company-operated margin improvements.

We hope this prospective gives you additional insight into the current health of the business and our confidence that the momentum will continue under Woods' leadership and result in success for all three legs of the McDonald's stool.

It is important to emphasize that this ownership approach is one we have used for many years as we have over 1,000 restaurants currently operating as DL's around the world.

It is a structure similar to a traditional franchise arrangement.

A local entrepreneur uses their capital, real estate, and business knowledge to build the brand, and optimize results.

Now, in terms of McDonald's commitment to building long-term value for our investors, we believe our actions speak louder than words.

You can count on this leadership team to continue to act in the best interests of both the shareholders and the system.

I would now like to turn it over to Matthew Paull who will provide more details on the transaction, our quarterly results and our impact that we've had.

Thank you, Ralph.

And good morning everyone.

Our intense focus on providing solutions for today's busy consumer is driving sustained business momentum.

We're leveraging this momentum with disciplined practices to enhance long-term shareholder value.

Today I'd like to highlight some of these activities, in particular the progress we've made on our developmental license strategy.

In 2006, we outlined our intent to franchise about 2300 restaurants with developmental licensees over a three-year period.

This morning's announcement of the franchising of virtually all of McDonald's Latin America under a developmental license marks a milestone in pursuit of our goal.

When we close the Latin American transaction and complete the conversion of these restaurants, the McDonald's brand will be better positioned from both a customer and a shareholder perspective.

The customer will see us growing faster and becoming even more locally relevant.

Our shareholders will see a less capital intensive business with reduced volatility, a steadily growing stream of royalties, and improved returns.

On our last call, we made reference to getting even better at being better and not just bigger.

One of you on the call asked us to describe just what we meant by that.

Well, this transaction is an example of just that.

We expect to franchise almost 1600, mostly McOpCo restaurants to Woods Staton and his organization when the transaction closes sometime in the next few months.

The benefit of licensing substantially all of our Latin American markets to this one group is the increased opportunity for the long-term success of the licensee.

Owning a portfolio of markets balances the risk so that if one market experiences volatility, it is likely to be mitigated by the success of other markets.

Now, let's get into some of the details.

With the approval of this transaction earlier this week by our Board of Directors, we crossed the threshold to account for these trends for these restaurants as held for sale for impairment-testing purposes.

As such, in the second quarter, we can now write down the assets to their estimated realizable value.

Cash proceeds from the transaction are expected to be about $700 million.

In line with previous guidance, the expected proceeds represent slightly less than half of the $1.5 billion net book value of the assets in these markets.

This results in a substantially all non-cash second quarter impairment charge of approximately $800 million.

Our noncash second quarter impairment charge will also include about $825 million to recognize accumulated translation losses, losses currently carried in the shareholders' equity section of our balance sheet.

Moving forward under this arrangement, we will collect a royalty starting at 5% of sales and escalating after 10 years.

Woods Staton and his partners have committed to invest about $100 million annually to reimage existing restaurants and to open new restaurants and McDonald's overall G&A will decline in excess of $125 million, as our licensee assumes responsibility for most of the activities we previously funded in Latin America.

Based on 2006 results for these restaurants, the anticipated annualized impact of this transaction is a decrease in revenues of about $1.5 billion, increased franchise and company-operated margin percentages, no significant initial impact on operating income as the incremental net royalty income will approximate the operating income earned in this segment in 2006.

In addition, CapEx requirements will be reduced by about $90 million and finally, we anticipate the benefits of this structure in Latin America will improve our consolidated return on assets by about 90 basis points.

You may have noticed that we did not include guidance this morning for our full-year tax rate in the filing we made this morning.

We expect a minimal tax benefit from the Latin American transaction and we are nearing the end of an IRS tax audit which could impact the tax rate.

Once we have resolution of these items, we will update our guidance.

This Latin American transaction combined with other markets franchised to developmental licensees in 2006 results in about 600 restaurants remaining in the DL pipeline.

These mostly McOpCo restaurants represent $500 million in net book value.

We continue to expect completion of these conversions by the end of 2008.

We believe today's developmental licensing announcement is a positive for our customers, our shareholders and our system, and is another step in the direction of moving to a more franchised business model.

Woods and his team will optimize the McDonald's brand and experience better than we could and faster.

This relationship gives us an opportunity to participate in Latin America's considerable growth potential via a more stable, more investor-friendly royalty stream.

The growth and stability of our licensing strategy also supports our commitment to return more cash to shareholders.

We will use the $700 million in proceeds from this transaction to increase cash returned to shareholders.

We now expect to return at least $5.7 billion to shareholders through dividends and share repurchase in '07 and '08 combined.

In the first quarter, we repurchased about $1 billion or 22.4 million shares of our stock.

So we are off to a good start on this commitment.

Going forward, we remain committed to further reducing shares outstanding through buybacks and disciplined compensation mixed practices.

This disciplined approach also extends to our G&A.

In the first quarter, G&A increased 4%, about one-third of the quarter's revenue growth rate.

For the year, we expect G&A as a percent of revenues to decline, continuing a four-year trend.

In closing, I am pleased with our strong first quarter results and with the significant progress we've made in franchising more of our restaurants.

The Latin America transaction is one more step in the process and will reduce our worldwide McOpCo percentage from 26 to 23%.

I echo Ralph's confidence in Woods' team and believe that these strategic actions further solidify our commitment to continue to enhance shareholder value.

Thank you and now I'd like to turn things back over to Mary Kay.

Thanks, Matt.

I will open the call up for questions.

[OPERATOR INSTRUCTIONS] The first question is from Glen Petraglia.

Good morning.

Ralph, I was hoping you could just maybe repeat your comment about the U.S.

margins being down in the first quarter, and what your expectations are going forward regarding pricing.

My understanding was that wage pressures -- the plan was to be able to price for the wage increases throughout the states and I'm curious to know maybe why that wasn't the case in the first quarter.

Thanks.

Sure, Glen.

Margin were down 40 basis points, yes, they were at 18%, which is close to our all-time high.

Really, this is the winter quarter.

It is not when we normally take many of our pricing.

We spread them out throughout the year.

But not at the time when customers are tighter in the wallets.

And so we're comfortable that throughout the year that the -- both the minimum wage increases, some of the group health costs, and the commodity costs are reasonable and that our business momentum will, along with the fact that we have brand strength and price sensitivity, we'll cover that throughout the year.

But this was not unexpected for us.

Thank you.

The next question comes from Larry Miller at RBC.

Thank you.

I just want to ask you a question on the U.S.

breakfast.

A lot of competitors coming in, maybe over the next 12 months and clearly McDonald's has the biggest share.

Can you guys talk about how you think about defending market share and defending margin to balance between those two things?

Thank you.

Sure.

Larry, first on the margin side, breakfast has very strong margins.

Our growth in coffee has only made those stronger.

And it's not an area that we do much discounting.

The growth is exceeding demand.

Demand is exceeding supply here and so we continue to grow breakfast comps higher than our regular menu.

We've got a strong pipeline of new products and so what we have done is we've accelerated the amount of media that we spend against this segment in order to be able to communicate the new products and the pipelines that we have, and make sure that we stay top of mind.

So we believe breakfast will continue.

Breakfast away from home grew 10% last year.

And so not for us, that's for the category group.

And so we're very bullish on it and not concerned about the competition coming in.

Larry, just some perspective, I think meals eaten outside the home for breakfast is at about 11% in the Unite States, for lunch, it's probably in the mid to highway 20s.

For dinner, it's also much much higher.

As Ralph mentioned, it's growing very quickly.

If we only hold onto our sure of this growth, we're going to do very well.

We think we'll do better in this this.

Remember that this is a habit developed over long period of time.

People have been jumping in and out of breakfast for some time.

We would agree these days because they see what we see, there happen to be more people jumping in, but that's been going on for many months now and we have been doing just fine, but we will take nothing for granted.

One last item there is, that I would say, we've been making real safe decisions for the last 30 years with breakfast side of the road being a key component of that.

And I would not underestimate the value of convenience, as you know, when people are going to work, they will not make a left-hand turn and get out of the traffic pattern.

Thank you.

The next question comes from David Palmer at UBS.

Good morning.

Congratulations on the quarter.

Question for you on Europe and the operations changes that you're making there.

The kitchen changes, the bridge operating platform, you put that out in the U.K.

recently.

Could you talk about how you might be phasing that in throughout Europe and what sort of schedule we can think about that?

And was that an expense lately -- as you deploy that, is that something that we should consider on the margin line?

And lastly, if there's other things like credit cards and other point of sale systems that we should be thinking about particularly in Europe.

Thanks very much.

Yes, hi David.

The bridge operating platform will be mostly complete with rolling out bridge operating platform by 2008 throughout the major countries of Europe.

And so it's not just the U.K., we're very far along in France and in Germany, and this is a critical component to allow us to extend our chicken strategy and continue some of the menu momentum.

That's why you're now seeing the Chicken Selects and those type of products, because we're able to handle them at a much higher level of quality and a more varied menu.

So as far as margins, they're not significant investments, and so not an impact on margins.

You saw the level of margins we had first quarter.

It's more the reason we have not done it faster is the operational take and the retraining that needs to occur on how we call production and how we schedule labor.

And so we've been very careful on doing that.

Relative to credit cards, in general, in Europe, the majority of our business is debit card, not credit card.

That's what's a big part of it, and in most markets other than the U.K., we already have been taking cashless for a long, long time.

The U.K.

is something that, because of the POS systems and where we were, we were not able to do that.

That's going to happen here over the next year.

Thank you.

Thank you.

The next question is from Jim Baker at Neuburger Berman.

Yes, I had a couple quick ones.

One on China.

Can you give us some sense as to what percentage of the Asia profit growth might have been just attributable to the turnaround you're seeing in China?

That was my first question.

Secondly, I noticed in Canada, you had no revenue growth to speak of but a lot of profit growth, a lot of margin improvement, so if you could talk about that.

And finally, to which geography was the impairment charge of $2.6 million in '07 attributed to?

Okay.

First on China, I can tell you relative to the margins, the Company-operated margins, of the 270 basis points, China was 100 of those basis points improvement.

They improved 380 on their base, but that represented 100 basis points to the Asia Pacific area of the world improvement.

Relative to Canada, Canada sales were just slightly up on a comp sales basis.

We were not satisfied with that.

We could say weather and everything else, but the reality is, we were not.

But we've stabilized our Canadian business, our branded affordability, and our margins have been growing there.

So that's why you saw decent margins.

We also had a few gains from some of the refranchising that we're doing there of company restaurants that are part of our operating results, but are not necessarily going to be a recurring gain that continues going forward to the long term.

But we are -- we just rolled out Snack Wraps in Canada, and we've got a strong plan.

So we believe their plan is solid for the rest of the year.

And Jim, that impairment of $2.6 million that's Moldova, that's one more thing, to give you a perspective on Asia, the most profitable two markets are Australia and Japan in that order, and then gaining quickly on them is China.

So China would be number three in Asia.

Okay.

Thank you.

That's very helpful, thank you.

Okay.

Thank you.

As we said earlier, we would like to pause for a moment of silence for the victims of Virginia Tech at this time.

[Moment of silence]

Okay.

We can go ahead with the next question now.

Thank you for that.

The next question is from John Glass at CIBC.

One clarification and then a question.

The clarification is on the remaining 600 DL units if you could just talk about their sales and profit contribution.

My question Matthew is for you, I guess on leverage.

Can you remind us on the rationale of why 35 to 40% debt-to-capital is the right level?

I guess in particular I'm interested if your thinking has changed on that, as others in the restaurant space, particularly the quick service space have used leverage more recently and more aggressively to increase returns, and has that changed the way you look at leverage?

Thanks.

Thanks, John.

Mary Kay will, when I'm done answering the leverage question, she'll update you on the remaining 600 restaurants in our DL pipeline.

The -- we get a lot of questions about our capital structure.

I want to give you some background.

We review our capital structure with our Board at least once a year.

I think you're all aware that we have another, depending how you would measure it, 7 to $10 billion of debt that the rating agencies add back to our balance sheets due to leases.

You've seen us be very serious and committed to reducing share count and returning large amounts of cash to shareholders.

With that in mind, each year in our outlook we try to give you an idea of what will happen with debt levels.

I think we've targeted 35 to 40%, a simple debt to cap ratio, we're probably running much closer to the 35 than 40.

Even within the guidance we gave you, which is in not written in stone, we've given ourselves 5 points of flexibility, that's probably a little over $1 billion.

We look at how we want to run our system, we do consider the effect it would have on our suppliers and franchisees, then we give you some guidance as to how much we expect to return to shareholders at a minimum over a period of time.

I think you've seen that every time we put out a minimum, we've exceeded it, and that is -- we're fully aware that we're evolving our business model in a direction where we're going to be less capital-intense and more money will be finding its way into the pockets of our shareholders, what we'd like to reserve is the flexibility to say exactly what form it will take dividend or share repurchase and exactly which year.

And anybody who has invested in the stock and we welcome everybody, but anybody who has invested in the stock thinking in a month there's going to be some big leverage events, it's just not likely to happen, but it is something we look at regularly.

We certainly understand we could run our system with something less than a stable A credit rating, but for now, that's what we're targeting.

And to update you on the 600 restaurants, they're primarily located in Asia Pacific, Middle East, Africa, and some small markets in Europe.

They have a net book value of less than $500 million.

These 600 restaurants in 2006 had sales of about $800 million, had an operating loss of about $10 million, but that was before impairment charges of about $30 million, G&A of about $45 million, and CapEx of about $25 million.

And John I wanted to come back to one last item relating to the leverage issue.

You know, we are not people who think like we have all the answers.

We monitor trends very carefully, we certainly have watched what's happened at Dominos, it seems to have worked nicely for them, but it's a different company, a different brand, a different set of franchisees than we have.

Just because it worked for one company in our industry doesn't necessarily mean that we would do it.

The next question is from Scott Carroll at Goldman Sachs.

Hi, thanks, just along those lines, maybe you could talk about the dividend, it looks like the payout ratio is around 37.5% or so on consensus '07 earnings, and I'm just wondering if maybe you could frame where you would like that payout ratio to go over time.

Thanks, Scott, we don't target a particular payout ratio.

However, I want to make it clear that we love dividends.

Before, if became popular, we made a significant move with our dividend, and for those of you who weren't following us back then we said it reinforces, paying a larger dividend reinforces our overall strategy of better not just bigger.

We had this history of opening a lot of units as the only way of growing.

When we decided to transition to better not bigger, we wanted the way we use our capital, to reinforce our strategy.

So we went to a bigger dividend, our Board meets once a year usually in the fall to consider the dividend and I would expect that would happen this year.

Other than signaling how much total cash at a minimum we expect to return to shareholders over the next two years, we're not in a position to talk about a specific dividend recommendation today.

Thank you.

Next question is from Jeff Bernstein at Lehman Brothers.

Great, thank you.

Actually a question on your long-term growth targets you established a few years ago, specifically related to system sales and revenues, profits, returns.

Obviously the past two years have been very strong, on all measures, I was just wondering if that out performance is something you can sustain over the next few years, I guess this is directed more towards Matt, the serving of an increase perhaps in those long-term targets or whether you see those as appropriate in the near term.

Separately what you see as more your normalized long-term EPS growth, just wondering whether high-single digits you would view as appropriate as you look out over the next few years, or whether you think the momentum continues above that?

Thanks.

Jeff, thanks for your question.

We learned three or four years ago that we're better at running a business than at predicting what the business will do.

And so we picked targets that we thought were healthy for our system.

We've been fortunate enough to exceed them every year.

I expect that we can continue to exceed them, but by exactly how much, we don't want to say.

We know that focusing on the 32,000 locations we have today has been very, very healthy for us.

We fully understand that in places like Russia and China it's bigger and better, but for a lot of the rest of the world, it's better, not just bigger.

And so we're going to stick with the strategy we have, we're not going to predict what our long-term growth rate would be other than to say we're going to stick with these targets and we expect to continue to exceed them.

Thanks.

Thank you.

The next question is from Steven Kron at Goldman Sachs.

Great, thanks.

I just want to go back to Europe if I could, a couple of questions there.

Just, I guess first on the sales line, can you just talk to us about the makeup of price, mix, and traffic in the 8% comp and how that might compare to the trends you were seeing a year ago, if there's any changes?

And then secondly, and related, if I think about the source of the margin gains there, if you bucketed them into kind of the mix of product versus the absence of discounting or just leveraging the fixed costs, can you give us some color as to how you think that margin expansion, that 180 basis points shook out?

Sure, Steven.

First in Europe, Europe is an area, stable inflation.

So our price increases which we normally try to keep right at or slightly below inflation is something that as far as into sales, you can pretty much count on those being in that 2 to 3% range.

Now, what we have had, when you look at that 8% comp is we've had some very successful new products that are priced at higher than our average products.

So if you look at the -- our results, it's a healthy blend of traffic, price increases, somewhere below 3%, we've had a little bit of an average check growth also from the new products.

As far as the margin growth, biggest factor was sales, but a stable branded affordability, especially in the U.K.

where we were doing a lot more discounting before and had not established a solid consumer-strong everyday value, is helping margins.

We already had that in Germany, we have had it for the last almost two years, and we've got a pretty good base also in France.

So in our big markets that's where we're at.

So I would tell you it's mostly sales, some definitely with the predictable branded affordability, and we had a slight benefit in the U.K.

as we mentioned earlier from the store closings and the refranchisings.

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

Yes, just quickly following up that, in the U.K.

assets, can you give us an update, any significant actions early this year, kind of sort of what you're expecting for the remainder of '07?

Yes, Andy, not anything of significance in the first quarter, we did have, I think we had 12 refranchisings and we closed a few like five or six restaurants.

We do have leases that come up, if it's not in our best situation to go ahead and renew those, we get out of some of those.

But we continue to be committed to get below that 30%.

We have said that that will be at a pace and I would tell you that pace is more in that 50-store range because we need our franchisees to be healthy, both from a capital and a management and training point of view to be able to absorb the restaurants as we transfer those over.

We have a franchising plan, we've worked with them, our best franchisees are the ones that are going to grow, they're developing that talent, they're putting themselves in an economic situation to be able to do it and we're executing against that plan.

Thank you.

The next question is from Rachael Rothman at Merrill Lynch.

Hi, thanks, good morning.

Could we talk a little bit about your CapEx?

I know you guys have been doing a great job with the refranchising, I think the remodels are, at least the interior remodels complete in the U.S.

Can you talk a little bit about the remodel program within the context of, I guess your forecast is for CapEx to be up again in '07 versus '06 and versus '05, at what point should we expect you to begin to trail off in your capital expenditures?

Thanks, Rachael.

We have been trending up a little bit but I have to mention that the euro itself has been going up so fast that if you did this on a constant currency basis it wouldn't look like much of an increase.

I think that when you look at the opportunities we have around the world, the only thing that I can see changing significantly for us is that you heard Ralph describe how excited we are about our progress in China.

Well, if we decided to hope 200 restaurants a year instead of 100 in China, it would only take maybe another 50 million of capital.

So it's not going to be a significant factor, a significant change.

We've signaled this morning that as a result of this licensing transaction, the CapEx requirements which used to be ours will transition to the licensee over the course of this year, it depends when we close the transaction.

So some piece of that 90 million won't be our responsibility this year, and none of it will be next year.

And I might point out that the licensee Wood is going to grow units probably at a rate that's twice as fast as we've grown them in the last three or four years but that will not be our capital.

I would say you ought to expect our CapEx to run in about the same range, please remember when the euro is up, it not only raises our operating income but some of our CapEx requirements go up because we're also investing in euros in some of these markets.

The next question is from Matt DiFrisco at Thomas Weisel Partners.

Thank you.

Matthew, can you update us as far as is there a franchise mix goal that you're looking for in the more mature western European countries right now, where you stand and where you look to go to on a desired basis?

Matt, we have signaled pretty clearly that we believe in franchising.

We kind of invented the category as applied to the restaurant industry, and we have to admit, we got distracted over a period of years and in some of the major Western markets we ended up with a company-owned percentage that was higher than we thought made sense.

So we've signaled, for instance, in Canada and the U.K., that our long-term goal is to have no more than 30% McOpCo in each of those countries.

We've looked at all of the other countries, France is way below that, the U.S.

is way below that, Australia might be very slightly above that, and then there are several other large markets where franchising isn't available to us because local law doesn't allow it or our rights as a franchisor and landlord aren't enforcible.

We believe in franchising, we're going to continue to reduce the Company-owned percentage but other than the U.K.

and Canada we have not set a firm target.

Thanks.

Thank you.

The next question is from John Ivankoe at JPMorgan.

Thanks.

Obviously in the U.S.

you have a few major market tests going on of what I think are some pretty exciting premium products, the Southern Chicken sandwich and what we've seen, the one-third pound Angus burger in the West Coast.

Could you help us understand how those products are doing in individual markets and assuming that it is going well when they might be ready for national rollout?

Sure.

John, we don't signal how well they're doing, but if we're mentioning them to you on this call, they're in general, obviously we believe to have the ability to be scaled.

We had not talked about the Angus burger test, in Southern Cal, it's early, we started that in the first quarter.

We know there's a market out there.

What we said is our greatest success is when we give our customers what they are already getting in the marketplace that we have not offered them, and if we can deliver those at McDonald's price and McDonald's speed.

So if you look at in general, the type of products that we're testing, they are products that are already in the marketplace, already have consumer appeal and what we've got to figure out is can we deliver it within our operating system.

And also, does a customer believe that brand McDonald's has credibility in order to sell those.

And so that's where we're at.

But we believe we have a strong pipeline here for the next three years.

And John, I want to reinforce what Ralph just said.

We used to have two issues, one was can we do the operationally and will the customer accept it from McDonald's.

Well, on that latter issue, we've discovered that we've got a lot more freedom of movement from a customer's point of view because of of the way the brand has evolved.

And we are very, very positive about that.

And you look at what's in the tests that Ralph named, we've got Southern Style chicken, Angus burger, specialty coffees, iced coffees, all premium-priced products and customers, it's still early, customers have told us this makes sense at McDonald's.

It doesn't mean everyone of these tests will become national, but the reception on the part of the customer and what our brand stands for has never been stronger.

And so we're very excited about all the things that are in test and all of the possibilities.

Thank you.

The next question is from Joe Buckley at Bear Stearns.

Thank you.

I just wanted to go back to U.S.

margins for a moment.

The labor pressure you mentioned, minimum wage increases and a couple other things, but is it also related to raises that you may have given independently, changes in schedules, or even some of the extended hours and the labor percentages you might run in those extended hours?

Joe, on the -- we give out increases on a regular basis.

They're based on both seniority and levels of training achieved in the restaurants.

And so those don't necessarily happen in one month.

And we do that on purpose so that they're spread out.

We had 22 states raise minimum wage, have minimum wage increases here in the last few months and so, this piled on a little bit more at one time.

Normally it something that's spread out and then they match how we also move our prices and thus it's more predictable on a month-to-month basis.

We made the decision not to mess with our price value equation just because we had a slightly higher bundle.

Our productivity on a per-transaction basis, which is how we measure it, including our extended hours, is strong and has not declined.

So it isn't because of that.

Thank you.

The next question is from Howard Penney at Prudential.

Thanks very much.

I guess technically, my question was asked, but I wanted to frame it a different way.

You've -- the pendulum has swung dramatically from sort of the low points in '02, '03, to where the rating agencies were sort of breathing down your necks to improve profitability, now the pendulum has swung so far in the other direction that, yes, you've sort of mentioned before what your target is for debt-to-cap and you're giving 5.7 billion to shareholders over the next few years, you gave 5 billion in '06.

It almost seems like you are significantly underlevered today.

And the $5.7 billion while it is a huge number, it is grossly low to what you could really give especially given what you did last year, what your cash flow looks like, what your CapEx is and if you could maybe go through how you come up with the $5.7 billion, I understand you've got the $700 million additional increase with the assets, but given the sort of development and license strategy, and you're moving towards a more franchise system with more stable royalties and all that, can you maybe go into sort of why $5.7 is the right number and why it shouldn't be 10 or $15 billion even?

Sure, Howard.

I want to reemphasize, we keep saying at least.

And we have a pretty good history of exceeding our minimums.

So I don't want you to fixate on $5.7, that's the minimum.

What we do, and I agree that the landscape is changing in the capital markets generally, but also we've got a more stable business model that I agree would support more debt if we decide that's where we want to go.

And what we do is we go through an internal analysis that we're certainly not going to share on the call.

We have our own view of what that borrowing would do for the stock price, and we look at that and we look at, okay, what does it mean to our system that we're financially strong.

And we weigh those things every year.

Once a year.

And again, this is not in cement but for now it's where we are and for now that outlook is what it is until we decide to change it.

I'm not guaranteeing you that next year we'll say 35 to 40 is right, it could be something different.

But for now, that's where we are.

And I think by the time we end the year you'll be happy with what we've returned to shareholders and I certainly agree that we could run this system and run it well at something less than a stable A rating but for now that's where we are.

Thanks, Howard.

Thank you.

The next question is from Paul Westra at SG Cowen.

Great, thank you and good afternoon.

I have a question going back to the transaction with Woods.

I think I've got it but I just wanted a little clarity.

You mentioned the 1600 units.

I just want to be clear, those are the 1100 plus company and inclusive of 500 or so franchise units, is that the case?

And if so, just walk us through the new development licensee would be the master franchise, development licensee with franchisees underneath them and how would those contracts perhaps change or anything change from the local franchisee's perspective?

Sure, Paul.

You're right, we have over 1100 McOpCo's there, so those transfer and our company-owned restaurants of Woods and his company.

The franchisees become franchisees of that new company.

And so the contracts that are in place transfer to Woods.

The responsibility for servicing those restaurants transfer along.

In fact, we had -- we've had conversations with our franchisees in Latin America over the last few months, I personally, Jose Amario and I have been out in the marketplaces, the word of potentially doing a deal has been out there, we had a conference call before this, we had a webcast where Woods and Jose addressed the different issues.

So we are confident on the serviceability, the capital strength of Woods and his investment group and their commitment to growth, and from our point of view, it is a master franchisee, is what -- we call it a DL but he is a master franchisee for those other franchises, and we will provide the brand guidance, support, and sharing of best practices from around the world is what our responsibility will be to that area of the world.

Thank you.

The next question is from Rachael Rothman at Merrill.

I may have missed it, but can you give us a breakdown of the consolidated company operated margins with labor and occupancy to the quarter?

You didn't miss it.

It's usually in the 8-K.

I didn't hear the question.

The breakdown of food and labor.

Food was 33.3%, labor was 26.2%, and occupancy and other was 24.6%.

Was that your question?

Yes, I guess we were anticipating that question.

Thank you.

The next one is from Joe Buckley at Bear Stearns.

Just a follow-up to that, Mary Kay, those are worldwide numbers, I assume?

Would the U.S.

numbers be available?

No.

Nice try, though.

Two questions, if I can.

One, Matt, on your comments you talked about or made reference to your ratings and how they affect the franchisees and suppliers.

Could you elaborate a little bit on that, if they are really affected and then how so?

And then a follow-up question on the SG&A, it was very, very well controlled in this quarter.

Should we expect that to continue or was there anything usual in that year-over-year comparison that will maybe make the SG&A grow a little bit more even though revenues in following quarters?

Joe, I'll take the question about how our credit rating does or does not affect our franchisees.

I'd say it has a couple effects.

Our franchisees admittedly are very strong compared to the rest of the industry.

Their equity compared to debt levels is extremely healthy and getting healthier year by year.

But still we believe that they enjoy a bit of a halo from the strength of our brand, not that we provide any guarantees but our banking system and the banks that participate in our lending programs, we think make credit available more inexpensively because of our financial strength.

In addition, you know what franchisees pay other franchisors in terms of fees and we get a very generous franchise fee payment from our U.S.

franchisees, for example, same thing for our franchisees all over the world.

And if you got them collectively in a room they would say one of the things they get from McDonald's is our financial strength.

If we decided to take a down rate of a couple of notches to make a big return of cash to shareholders, one of the things we would examine is okay what does it do to that relationship?

Does it change the expectations of our franchisees, will they come to us and say maybe we shouldn't pay you as much because you're not giving us the halo from your financial strength anymore.

We don't know all the answers to all those questions, but that's the sum of what we think about.

On the SG&A, Joe, the rate that you saw for the first quarter is a fairly normal rate of growth.

We've got tight controls on G&A.

It's one of the commitments that we made to our shareholders.

There will be savings in excess of $125 million a year from the Latin America transaction that will come off of that once that transaction closes.

And so that will be a benefit towards later on in the year.

And then just one other comment on G&A, so the 4% we talked about was an as-reported number.

If you did it constant currency it was 1.6 or 1.7%, and then because Europe had a really good quarter, they accrued some incentive compensation that was probably above their 100% target.

That's in there as well.

If you factored that out, it would be below a 1% growth.

Thank you.

The next question from Larry Miller at RBC.

Yes, hi, thanks.

Can you hear me?

Yes.

Just two questions.

Can you update us on where the U.S.

and European business stand in terms of reimaging, how many stores have been done and what kind of sales increases you guys are seeing and plans to get the rest done timing-wise?

And also just in terms of U.S.

average unit volumes, I think roughly around $2 million.

Can you give us an idea where the variance is around there?

Is it pretty tight around that $2 million range or do you have some laggards in the group that could really catch up to that volume?

Thanks.

The reimagings done through the end of '06, about 4500 U.S., about 1100 Europe.

There are still some more being done but the formal program in the U.S.

stopped at the end of '06.

That doesn't mean we won't find things where we choose to coinvest with our franchisees in the U.S.

That's always a possibility.

We really like what the reimaging program did and there are several effects, not all of which we can measure.

One is the store that we reimage has a sales lift and that varies all over the place.

But a second effect is the employees and operators who work in that store get a lot more excited.

And the third effect is reimaging a significant percentage of our base of stores to bring them into this century sends a strong message about our brand.

Ralph talked about all the premium products that are in test.

You can't sell a premium product in a dining room that looks like it hasn't been touched for 20 years and we're fully aware of that.

And this is one of the ways we tap into our competitive financial strength as a franchisor and also among our franchisees, we know the rest of the industry can't match what we're doing in this area.

But we're going to be very careful, we've generally been touching something just under 10% of the store base per year.

I don't ever think it will get greater than that, probably for this year it might be a tiny bit less.

One other item on that, Larry, is in the U.S.

because of the older -- the much older restaurants, we will do between 200 and 250 rebuilds this year.

So while they're not, quote, reimaging, they're major rebuilds.

It's a tear down and set up and so you will see some of that as the system continues to age.

That's the best thing we can do for brand.

Some where we already know how successful we are, and in most cases, our rebuilds, because we can also improve drive-thru layouts and most of those buildings back then were built way back from the street, get better visibility, et cetera.

They're very strong.

On the $2 million amount, we're over $2.1 million in the U.S.

on our traditional restaurants.

So if you say which ones -- we have about a thousand Wal-Marts, we don't put that in that equation, because they're not a full service type, whatever, quite honestly, the distribution is pretty tight around that 2 million because our brand is so strong and our real estate selection process over the years has been pretty solid, the way we spread out those restaurants.

So, yes, obviously we have some very high volume ones but we don't have a lot of very low volume ones in that equation.

Okay.

Thank you.

We are out of questions and about out of time.

So go ahead and turn it over to Ralph for a few closing comments.

Well, thank you.

In closing, 2006 was an outstanding year, and that resulted in returns on incremental invested capital, one of our key measures, far exceeding our high teen's target at 35% for both one and three-year periods.

And we're off to an excellent start in 2007.

The road map to our future remains a plan to win, supported by continued focus on our customers and importantly, alignment with our owner/operators, our suppliers and our employees, we are getting better at being better and we are confident that we'll continue to bill the top and bottom lines.

Thank you for your time.

Thank you, bye.

This concludes today's teleconference.

You may now disconnect.