麥當勞 (MCD) 2007 Q3 法說會逐字稿

Hello and welcome to McDonald's October 19, 2007, investor conference call.

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

Following the presentation, there will be a question-and-answer session for investors.

(OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Ms.

Mary Kay Shaw, Vice President of Investor Relations for McDonald's Corporation.

Ms.

Shaw, you may begin.

Thank you.

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

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

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

As always, the forward-looking statements, which appear in our earnings release and 8-K filing 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.

Now I'll go ahead and turn it over to Ralph.

Good morning, everyone.

It's a great time to be at McDonalds.

Our business is strong around the world with every area contributing to growth and posting positive comparable sales and transaction counts and we have tremendous opportunity ahead of us.

I'll begin today's comments with the quarterly results and discuss the strategies that are driving momentum.

Then Matt will take you through the earnings per share numbers and provide details about the Boston Market transaction and our capital structure.

Our management team is very pleased with our results and can assure you that performance this quarter is due to McDonald's continued focus on the plan to win.

Our strong, sustained momentum is due to our winning strategy at being better and not just better.

We are running better restaurants and have become more efficient given the evolution of our kitchens to provide consumers with even greater choice and variety.

Operational excellence enables us to capture additional sales from customers who are recognizing our service improvements and rewarding us for it.

Equally important, we have system-wide alignment behind one plan, a compelling benefit for a Company our size.

In addition, our decentralized organization has a competitive advantage because it enables each area of the world to implement aggressive, locally-relevant strategies that ensure our brand will appeal to their customers.

They have the flexibility to emphasize different business drivers for their specific market conditions.

These drivers fit within what we call the common success factors.

They are branded affordability, platforms that offer everyday, predictable prices.

Here in the U.S.

you know that as a $1 menu.

Greater variety on menu choice, building on our strong core menu to provide customers with additional food choices that they didn't expect to get at McDonalds, better operations, creating a more satisfying experience, expanded convenience, which helps our customers access our brand where, when, and how they want to, and our ongoing reinvestment programs making our restaurants the most contemporary and best places for both our customers and for our employees.

As we go through our third quarter results, you will see that all areas of the world are succeeding due to their local employment and execution of the common success factors that apply to their marketplaces.

So now let's talk about operating income and margins.

Driven by strong comparable sales, our revenues increased 3% in constant currencies, in spite of the Latin America transaction and refranchising of restaurants in the U.K.

and Canada.

In the U.S., Europe, and Asia Pacific, Middle East, Africa, the revenues were up 6%, 7%, and 13%, respectively, in constant currencies.

Operating income for the quarter reached $1.5 billion, up 13% in constant currencies.

Our consolidated franchise margins were up 110 basis points to 82.3%.

Now in the face of a more challenging worldwide commodity and labor environment, we are pleased to report consolidated Company operating margins increased 100 basis points to 18.3.

This margin expansion is the result of healthy sales growth and a good balance between traffic and average check increases, and we remain committed to further improving margins as we continue to grow our sales.

Let me now provide details about how each area of the world has contributed to our success.

First Europe, Europe had a strong quarter with comp sales up 6.5%.

Franchise margins increased 80 basis points to 79.4 and Company-operated margins improved 120 basis points to 19.5, the highest level in seven years.

This improvement was driven by strong sales across the segment, ownership changes in the U.K., and supply chain efficiencies.

This was also partially offset by increased labor costs, and to a lesser extent commodity costs.

These are impressive results, especially when compared year-over-year as Europe was up against its best performing quarter from 2006.

Nearly all countries in Europe posted strong numbers.

We are having consistent performance across Europe beyond the big three markets of France, Germany, and the U.K.

Notably, Russia, Italy, and Spain are countries with strong results and the ability to contribute more over time.

The European business has achieved this outstanding results with their continued focus on three core strategies.

Upgrading the customer experience, enhancing local relevance, and building brand transparency.

We continue to attract customers by featuring a variety of premium products, combined with compelling value options.

A good example is Europe's expansion of the Chicken category, including new Chicken products at various price points, such as the Snack Wraps at an entry level in the U.K.

and Germany, Chicken Selects at the core level in Germany, and the Chicken Gourmet and Chicken Mythics sandwiches at premium price points in France and many other countries.

France is also experiencing success in terms of innovating on a fourth tier of menu pricing with their [Petite Faziers], or Small Pleasures offerings.

This strategy is being exported to other markets in southern Europe with comparable success.

Separately, our reimaging work with best in class restaurant designs coming out of our European design studio is also resonating with customers.

In addition to new restaurants opening with these designs, almost a fourth of the European restaurants, 1500 of them over the past five years have been reimaged and are adding to our overall brand experience.

Now let's turn to the U.S.

In the U.S., momentum continues with third quarter comp sales up 5.1%, marking 54 consecutive months of positive increases.

Performance is especially impressive when put into the context of a drop in consumer confidence and the higher gas prices that are impacting the overall industry.

U.S.

franchise margins for the third quarter were up 90 basis points to 83.2%, driven by the strong sales mentioned above.

Company operating margins remain high at 18.4%, but did decline 60 basis points versus the same period last year.

This was primarily due to wage increases and commodities.

We have adjusted prices by approximately 3.5% over the last year, still below the food away from home inflation index, and we will continue to make adjustments, but do so only with the long-term health of the business in mind.

As a result we continue to outpace the competition with strong traffic growth, significant market share gains, and growing restaurant cash flow.

While we have more pricing power than ever before, our comprehensive value strategy enables us to achieve results while meeting consumer needs for everyday affordability and convenience.

Our three-tier menu approach provides consumers with a range of menu option.

This starts with our $1 menu value platform, which has now been in place for five years and continues to bring in consumers who are looking for ways to stretch their wallets and encompasses the higher end with premium salads and sandwiches.

Another important part of the value proposition in the U.S.

is the addition of Chicken Snack Wraps.

The August introduction of the Chipotle Barbecue Snack Wrap further extends this product line and it's selling significantly above target.

By staying the course we will continue to build consumer loyalty and grow our customer base.

We will leverage these gains with the future rollout of new products from our strong menu pipeline.

In terms of the drivers behind the quarter's U.S.

results, breakfast and beverages continue to fuel that growth as we provided more choice and variety.

We have continued to capitalize on the strong foundation we built with last year's successful introduction of premium roast coffee.

Overall coffee sales, both premium roast and iced coffees contributed to the sales increases.

The credibility we have established in coffee propels us to further expand our test of specialty coffees, such as cappuccinos, lattes, and mochas.

Also driving U.S.

momentum continues to be the added convenience we offer customers through extended hours.

Late-night, early morning, and 24 hours.

The gains in market share we've had this year have strengthened our competitive position.

Our U.S.

business has a strong plan in place and the best owner/operators in the industry to execute against it.

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

Robust sales growth in all major countries in Asia Pacific, including Japan, Australia, and China resulted in an 11.4% comp for the quarter, the highest in ten years.

Franchise margins for this area of the world are strong at 88.4%.

In the face of increasing labor and commodity costs, Company-operated margins still improved 190 basis points to 15.8%.

This improvement was primarily driven by the strong sales, guest counts, and improved operating performance in South Korea, Hong Kong, and Australia.

APMEA is achieving these results due to their strategy of offering everyday, predictable value, coupled with day part expansion into breakfast and conveniences like extended 24-hours drive-thru, and delivery.

Now let me give you some specifics from our three largest business units there.

Japan has achieved 20 consecutive months of positive comp sales and broke several previous sales records by leveraging the popularity of many line extensions such as EB Filleto, and mega-Teriyaki.

Our team in China has relaunched breakfast, simplified our value pack forum, and continued to promote the range of proteins we offer, chicken, beef, and fish.

No other quick-service restaurant in China offers such as a broad variety.

Australia has recently driven double digit comp sales growth with a focus on big burgers, breakfast, and coffee.

They have also benefited from an expansion into 24 hours and a series of smart price increases.

Now I would like to switch and talk about our worldwide ownership strategies.

McDonald's previously announced plans to reduce a number of Company-operated restaurants by putting more of them into the hands of local owner/operators and qualified entrepreneurs.

As we look to optimize our business under the plan to win, we will continue to evolve our ownership base by making changes in those markets where it makes most sense.

Through either traditional franchise agreements or developmental licensees.

Today I want to take a moment to update you on the progress we are making as part of this strategy to evolve our ownership to best serve our business needs, our shareholders, and our customers.

In the last 12 months, we have reduced a percentage of Company-operated restaurants around the world by 5% or 1200 units from 27% down to 22%.

In the U.K., the percentage of Company-operated restaurants decreased by 3% this quarter, bringing the total to 53% of the restaurants under Company management.

We have also made progress in Canada, with a comparable 3% reduction so that 33% of their restaurants are now Company operated.

Also in the third quarter, we successfully closed a transaction to franchise restaurants in 18 Latin American countries.

We are pleased to report the transition to convert these restaurants was seamless for our customers, employees, suppliers, and franchisees.

Our Latin America business had another impressive quarter with comp sales up 18.3%.

With new capital and local entrepreneurship, McDonald's Latin America has a very bright future.

Now let me turn it over to Matt.

Thank you, Ralph, and good morning, everyone.

Despite a challenging consumer and cost environment, we've strengthened our business, built our momentum, and delivered solid results with operating income up 13% in constant currencies to $1.5 billion.

Third quarter earnings per share were up from $0.68 last year to $0.89 this year.

The $0.89 includes $0.83 per share from continuing operations, an 18% increase in constant currencies over '06, and $0.06 per share, representing an after tax gain of $69 million on the sale of Boston Market which closed in August.

We received proceeds of about $250 million from this sale.

The sale of Boston Market is consistent with our singular focus on driving growth at brand McDonalds.

The capital gain on Boston Market allows us to utilize a greater amount of our capital loss on the Latin America transaction, which also closed in the quarter.

This resulted in a $0.04 per share tax benefit.

However, this tax benefit was offset by additional charges related to the Latin America transaction of $53 million.

Our effective tax rate of 31% in the third quarter reflects this tax benefit.

Without it, or the additional charges, our tax rate would have been 33.3% for the quarter.

The IRS tax audit I mentioned last quarter is nearly complete and we hope to come to a final agreement soon.

Until we do so, we cannot provide tax guidance for the coming quarter or the full year.

Since Ralph addressed the operating results, I'll just touch on a couple of miscellaneous items for the quarter.

Other operating income was higher in the third quarter than in '06, primarily due to higher equity pickup from our Japanese and U.S.

affiliates, higher gains on sales of Company-operated restaurants, primarily in Canada where we franchised 21 restaurants, and lower asset disposition costs and other miscellaneous expenses in '07.

In constant currencies, G&A declined 1% in the quarter, partly due to a $25 million decrease in Latin America as a result of the DL transaction.

This morning I also want to discuss our commodity outlook and share some of our thinking related to our capital structure.

Given our menu variety, there are many different commodities that we carefully monitor.

In the U.S., dairy and to a lesser extent chicken were the primary drivers of increased commodity costs in the quarter.

Dairy, including cheese, was up 20 to 30% in the quarter.

Chicken was up 3%, and beef was relatively flat.

For the year, we expect dairy to be up 14 to 20%, chicken to be up between 4 and 5%, and beef to be relatively flat.

In Europe, third quarter beef costs were down 4% while chicken was relatively flat.

We continue to expect beef and chicken costs to be flat in Europe for the year.

We are evaluating the current commodity cost environment.

In general most commodities are cyclical in nature.

Historically, those cycles have been somewhat predictable.

Today, however, we are seeing the beginning of a shift in the demand/supply balance in many areas of the world that could change these cycles and our ability to predict longer-term commodity costs.

This shift, as most of you know, is driven in part by growing interest in biofuels, which is increasing the demand for corn and soy and is likely to exert upward pressure on other commodities including beef, dairy, and poultry.

Higher demand for dairy and protein in China is also contributing to this pressure.

We will continue to leverage our scale, global supply infrastructure, and effective risk management practices to help deliver predictable, competitive prices for our restaurants in a rapidly-changing environment.

We believe we can continue to manage consolidated Company-operated margins while driving customer visits and sales given our diversity of products, day parts in countries, the value our menu offers, our pipeline of premium and higher margin products, the convenience of our restaurants, and our enhanced pricing power and improved consumer relevance.

We will update you further on our '08 outlook at the analyst meeting in November.

Now turning to our capital structure, in September we announced our intent to return 15 billion to $17 billion to shareholders by a dividend and share repurchase in 2007 through 2009.

This is about double the $8 billion we returned from '04 through '06.

When we set this target, we considered all of our sources of cash, including cash from operations, cash on our balance sheet, our ability to increase leverage, and the proceeds of the Boston Market sale.

Most importantly, this announcement reflects our confidence in our continued business momentum and the strength and reliability of our cash flow as we continue to evolve to a more heavily-franchised, less capital-intensive business model.

We expect to take on some incremental debt to reach this target.

The actual amount and timing of incremental debt will depend on business and market conditions and our intent to retain a strong credit rating.

We are not giving specific guidance as we want to retain maximum flexibility.

As most of you know, when making capital structure decisions, we consider how the rating agencies look at leverage, which is different than what appears on our balance sheet.

The biggest difference, as most of you know, is that credit rating agencies view operating leases as a future cash commitment and therefore consider it a part of total adjusted debt.

Typically, the rating agencies use a factor of 6 to 8 times rent when converting leases to debt.

Accordingly, they arrive at a total adjusted debt figure that's much higher than what is on our balance sheet.

Regardless of whether we agree or disagree with this perspective, it's something we need to consider in managing our global business and making capital structure decisions.

The real headline here is that our actions to strengthen and build our business by being better, not just bigger, have combined to strengthen our free cash flow, a substantial amount of which will be returned to shareholders.

In closing we are confident that our plan to win will continue to drive McDonalds forward and deliver even greater value for our customers, our systems, and our shareholders.

Thank you.

And now I'll turn things over to Mary Kay to begin the Q&A session.

Thanks, Matt.

I will now open the call up for questions.

(OPERATOR INSTRUCTIONS) To give as many people as possible the opportunity to ask questions, please limit yourself to one question.

We'll come back to you for follow-up questions as time allows.

The first question is from Steven Kron at Goldman Sachs.

Hey.

Thanks, good morning, everyone.

A question on the U.S.

margins.

I guess I'm just trying to reconcile the 60-basis point decline.

I recognize there's a bunch of different buckets here, mainly the commodity and the labor side of things, but if I look at the commodities, beef being flat and that's the guidance for the year, chicken up for the quarter and expected to be up for the year, but not an unreasonable amount, and I know cheese was the big outlier here, but I would have expected, given the increasing mix of what I would expect to be higher margin product and around a 3, 3.5% price increase that we could maybe defend the margins a little bit more.

Can you speak to it a little bit more specifically and do you think going forward this 3.5% that you now have in the menu can protect margins a little bit better?

Yes.

Hi, Steven.

Getting back to you on that, in the third quarter, on the U.S.

business, we were very aggressive on our marketing.

Concern going into the summer, both the drop in consumer confidence and what was going on with gas prices and took a strategy to protect and grow traffic during that time.

So if you look at our marketing calendar, the amount of weight we put on $1 menu advertising, the aggressive launch or extension of Snack Wraps, attractively priced drinks, sweet iced tea, soft drinks, and iced coffee, we did that on purpose to build traffic at a time that we felt there was going to be some risk.

Those items also have a small effect in being dilutive on the margins, beside the items that we mentioned.

The labor had a little bit more impact than the food because there was a minimum wage increase and some of that ripples through.

We're much higher than minimum wage on a price point of view, but all the states moved theirs up also, and so we had a little bit of that ripple, and that takes over time.

But the headline is, we're comfortable with margins over the long-term, we're not going to manage it over the short-term, especially the pricing side of the equation.

We believe that's an important one to spread out over time and we'll continue to do so.

Steven, as you'll hear probably on November 13, at the analyst day meeting, we're very excited about some of the premium products in the U.S.

pipeline and it's very important to keep guest counts up when you have those kinds of products in the pipeline.

Thanks.

for notification, we've talked about having about 50, 55% of our sales growth coming also in guest -- in guest counts versus average check.

It was closer to 70% this quarter.

In the United States.

Thank you.

The next question is from Jeff Bernstein at Lehman.

Jeff, are you there?

Yes, I am.

Can you hear me?

Yes.

A question, you guys mentioned the labor costs which obviously impacting you worldwide.

Just looking for your thoughts by region.

I know in the U.S.

it would seem to be minimum-wage driven, and I would think the pressure would begin to ease as we look into '08 based on the lapping of the state increases, but I guess the Federal won't be lapping until midyear.

Just wonder if you can talk about the impact in the U.S.

as we look to '08 and perhaps separately how you see labor pressures playing out in Europe and APMEA in coming quarters?

I know it was mentioned as limiting profitability in each region.

Thanks.

Labor and managing the labor pressures, is something we have on a regular basis.

It's been a little bit more intense in the U.S.

as the minimum wage, the national minimum wage finally got adjusted.

We think we're in a cycle where those increases now in the U.S.

will be fairly normal.

There were some states that took big increases.

Michigan is an example.

They went up $1.80 overnight.

So we've cycled on those now where it's -- it won't be where you're going to have flat increase -- you're not going to be flat, you're going to have to have increases, but they'll be at the inflation rate.

So if we have that, then we're fine on margins.

In Europe, Europe has always had, managing wages there is a big issue.

Things like what we've done with our operating platform make us more productive.

Some of the investments we're doing in drive-thru over there right now also have not just customer benefits, but productivity benefits.

So we see them as -- there are headwinds and we talk about it because it doesn't let you benefit completely from the price increase he took, but they're at a fairly normal rate of growth at this point.

Thanks.

Asia, I'm sorry.

On Asia Pacific, we're having some higher increases in places like China in the geographies that have great GDP happening.

That middle class is growing fast.

We have that in our models and so labor's a much lower percent of our cost of doing business in those marketplaces.

So when you get a large increase there in the wages, it's on a very low base.

So on an overall basis, as long as we continue to drive the comp sales, we'll grow margins.

Thank you.

The next question is from Larry Miller at RBC.

Yes.

Thanks, guys.

Ralph, you guys have added a lot new products over the past few years and I think you're planning on adding a lot more over the next couple years, the beverages, the angus, the seven style chicken sandwiches, and to my recollection I can't recall that you've really removed anything.

So I'm just curious, can you help me understand what you're doing from an operations perspective to handle the increased complexity and not jeopardize any kind of speed of service?

Yes.

I'm going to go to Europe and Asia, the other places, putting in either made more you or bought?

Made for you is what we're putting in in all of Asia.

British operating platforms is what we're putting in in Europe.

We'll be mostly complete if not by the end of '08, by mid-'09.

It gives us the operation and the ability to handle more menu complexion.

That combined with the POS improvements that'll allow us to take the orders up and more complex menu easier and then have those pop-up in the back for our kitchens to get ahead of the game, it absolutely opens up the possibilities for us to handle more product.

The other piece we did all around the world is we removed -- we did remove low-selling items.

They're not important, because that's why they were low-selling.

But we have been very careful to not -- we used to have five sizes of fries, five sizes of drinks, we're down to three on each of those.

A significant benefit on the operating side.

In Europe things like the Big Tasty, Chicken Mythics that have helped sales a lot, rotate in and out.

We don't keep them in.

We bring them in for 8 to 12 weeks, get a big benefit, and then bring them back the next year and the customers look forward to it, but if we kept that on the menu under the bridge operating platform on an everyday basis, it would have -- it would be a challenge.

We monitor this closely through our operations metrics and we are running better restaurants.

We're faster, we have better accuracy than we did last year, significantly more than we did two years ago, and that's the check and balance.

Thank you.

The next question is from David Palmer at UBS.

Thanks.

On Europe, you mentioned the bridge operating platform.

I was just wondering, just given the fact that I think you're going to be done in the big three markets there this quarter, the fourth quarter, is that a big deal for '08?

Is that a real big enabler?

I guess two more smaller questions, could you update us on the reimaging floor that's going on in the U.K.

and where you're going with that and how far you are along?

And third and last is Russia, that's been such a fantastic market for you guys, really great returns, might be the best in the world.

Is there any chance that you can meaningfully accelerate your unit growth there and how might you think of that?

Thanks.

Sounds like you read that Wall Street Journal article.

First on BOP, getting completed on BOP will make a big difference in Europe in the big three markets.

As I mentioned, some of the product promotions we've done, we literally cannot -- we can't overlap them.

In some cases we would like to have beef and chicken promoted at the same time for balance on the menu, but we can't because we wouldn't execute it well.

So it does open up the possibilities, we invested in our European Food Studio, we moved it to Munich and made a big investment in both people and facility in order to strengthen our future food pipeline and so we've done that in anticipation of being able to have BOP, to be able to execute against it.

I wouldn't say -- I think '08 will be good.

I think it will really reap more benefits for that towards the end of '08 and into '09 as we get through the testing of the products and get them out there.

Relative to the U.K., we're going to do 130 reimages this year in the U.K.

I was just there yesterday.

And with a significant impact on our high street locations, which have a -- they're not our highest-volume locations, but because it's all inside -- obviously, they don't have drive-thrus and because of the amount of foot traffic that go in front of those restaurants, there's significant brand implications and we're seeing that traction.

So we will do a comparable number next year -- actually, we're going to accelerate a little bit more next year in the U.K., try to get close to 200 is what we think we can execute well within both the capital budgets that we've allocated and just the contractors on our people.

So at that point we'll start getting close to where you start getting critical mass and the brand has a different look.

When we've seen that in other countries, whether it's been the U.S., or France, or Germany, we've seen our brand scores accelerate.

That gives us pricing flexibility and menu flexibility.

We're pretty encouraged by that.

In Russia we have a great business with really strong management.

It's [Paul McCockill].

When it looks like we could grow faster, we're adding 30 to 40% to our business every year right now in number of restaurants and we have got to grow all that management internally.

So we will grow as fast as we can do restaurants well.

We've pushed them, but we're not going to get ahead of ourselves there.

We have a strong pipeline of real estate.

It takes in some cases three years to get our real estate done there, especially for our drive-thru locations.

Right now we think the pace that we have of 30 to 40% growth a year is a good number to be able to manage it from a talent point of view.

Interesting enough is as we're growing at that pace, our comparable guest count growth in our existing restaurants and what new restaurants are averaging at both continue to go up.

And so the marketplace is absorbing it very, very well.

That's definitely encouragement.

And when it comes to the financial picture in Russia, on a per-restaurant basis, it's the most profitable market we have in the world.

And when you look at our returns, you're right, David, it is also the highest-returning market in the world.

So we are doing everything we can to move our growth along in Russia.

Thanks.

Next question is from Glen Petraglia at Citigroup.

Good morning.

Just as a quick follow-up to that, I was hoping you could maybe comment on what sort of sales lift you're getting in the U.K.

when you remodel a restaurant?

And then just secondly, with the commodity environment and with the labor environment as it is here in the U.S., is there any thought or is there any perceived need to maybe change the price points on the $1 menu?

I know, obviously, one of your competitors had done it several years ago and was unhappy with the result, but I was hoping you could maybe comment on the result?

Glen, on the U.K., above 5%.

We get a slightly higher increase in our high street locations because it's all customers that are inside, you walk by the restaurant and it's 5% in the drive-thru location.

So we're very happy with the impact and know that the brand implications are even more important over time.

The $1 menu, we believe we need to hold the line on the $1 menu.

It's a -- it's really from a consumer point of view, we have great equity, it's less than 14% of our sales.

Some of our other competitors have 25, 28% of their sales on their value menu.

They were much more dependent on it and it had much higher impact to their margins from it.

So maintaining it is something we believe is still important.

We can continue to test alternatives, not just in the U.S., but around the world where, especially in more inflationary places, how to move off of a set price menu, but for the time being, we have the room in our business, we have a rich product pipeline for the U.S.

for the next two to three years, and we believe having traffic in the restaurants that get to see that pipeline is a winning combination.

Then, Glen, from time to time, we're opportunistic in hedging some of the commodity costs that go into making a double cheeseburger, which is the number one item on the dollar menu.

So in many years we will lock in those costs ahead of time so we can tell our operators exactly what the food and paper costs will be.

Also, we've been very successful with the Snack Wrap, which has clearly taken some margin pressure off the $1 menu.

Over time we've kept the $1 menu, but we did move the majority of the U.S.

-- and we do this on a local market-by-market basis based on the needs of the customers, but when we first started, it was medium fry, medium drink, in most cases now, those are small fry, small drink.

So items like that actually have a big difference in being able to sustain it.

Thank you.

The next question is from Jason West at Deutsche Bank.

Thank you, everyone.

I was wondering -- you mentioned a couple of times a challenging consumer environment.

First, I just want to clarify if that's just the U.S.

that you're referring to?

And secondly, if you could just talk about, have you seen any change recently -- we've seen some pretty weak numbers in September from some competitors in the U.S.

Have you seen any change recently in the U.S.

consumer environment?

And then in Europe, kind of the same question?

Are things stronger there relative to the U.S.

and how do you continue the comps in Europe, they've been very strong now for over a year?

In the U.S., consumer confidence is slightly down and -- but we have not seen an impact.

You've seen the numbers in our business.

As we did mention, we did adjust some of our marketing and make sure we counteract what are perceptions out there.

We do believe that today, with our convenience play in the U.S., we're much more of a visit that people need to have than it is a variable visit that they can decide to have or not to have.

So destination -- when you're a destination business, it's a different scenario.

When you're much -- have a bigger piece of your business being driven by convenience, you're part of people's everyday solutions.

And if we are the best value for that everyday solution, we believe we'll win.

So that's the piece in the U.S.

In Europe, the economy's strong in Europe.

The only place where we had some impact was in Germany because of the VAT increase that they needed to do based on the rules of European community to balance their deficits and that had an impact on retail sales and we felt some of that, even though we've managed pretty well through it this year.

But the rest of Europe, the economies are strong.

And regarding the challenging consumer environment, that was only a U.S.-based comment that we were making.

One of the things that Ralph and I were talking about before the call was the importance of the $1 menu in terms of the value perception our brand enjoys.

When you go into a grocery store these days to buy the ingredients to make a meal at home, I think most consumers have the impression that inflation is higher than the government is admitting.

But when those same consumers come into our restaurants and they see the $1 menu that's been there for four or five years now, it gives us great credit for providing everyday value.

Also, I think Jason, one of your questions had to do with, are we seeing any impact from the challenging consumer environment and the higher gas prices?

We have some stores, a small number, in highway locations and in lower-income neighborhoods and we tend to see a little bit more reliance on the $1 menu in those stores, but it's a fairly small percentage of the U.S.

space.

Next question is from Andy Barish at Banc of America.

Just digging into the U.S.

business a little bit more, industry data on QSR, traditional lunch/dinner has not been a robust day part.

In fact, maybe flat to down.

Your commentary on your U.S.

sales, I think over the last year or so, has really focused on kind of breakfast and nontraditional day parts.

What do you attribute that to and are you concerned about it continuing, or is it really just lifestyle changes of Americans that is kind of driving people into the restaurants at different hours than the traditional lunch at noon and dinner at 6:00?

I do think it's lifetime changes is a part of it, and we've adjusted.

That's why you seen us focusing on some of the snack businesses, beverages as destination versus just complementary to a sandwich purchase, and increasing our product pipeline for breakfast.

But our lunch and dinner business is up also.

Just breakfast is up more.

Late night is up more, but the other two are healthy both on sales and on traffic.

But there is no doubt, when you do the cross section and you look at all the industry data that the higher growth is coming in the off-hours and there's a business to be had there and we're going to capitalize on it.

Thank you.

The next question is from Rachael Rothman at Merrill Lynch.

Good morning, guys.

It's actually [Mike Sang] in for Rachael.

A couple of questions.

First on BLAs, could you talk about -- you have some language in the outlook section in the 8-K that says the Company will continue to pursue the sale of certain existing markets to developmental licenses over the next several years.

The original planned BLA converts were for [2300] stores, which would be roughly 600 by the end of '08.

Is that still your plan, or do you plan to do more more stores but over a longer period of time?

Secondly, could you talk about the kind of feedback you're getting from franchisees about the margin pressures and the pricing increases by competitors given that some QSRs are taking much greater pricing?

Thanks.

Mike, this is Matt, I'll deal with the developmental licensing issue.

The biggest transaction we needed to get done we completed in this quarter, which was Latin America.

There are still quite a few markets on our list, but we wanted to give ourselves more time to do this the right way, to be sure the market is in shape where we can get a decent price for any restaurants we might license and to be certain that we end up with a partner who believes in the business, has a rather deep pocket, and is patient.

So we, a couple of quarters ago, we said this will take us a little bit more time to get it done the right way, but all those stores and countries are still on our list.

On the franchisees and margin pressures, they're feeling.

You see our [McCofko] margins are a reflection of what the franchisees have in their P&Ls, but the overall cash flow is still up.

Not at the rate, obviously, that we had the last two or three years, and so it's a constant debate around -- and it's one of the most important things we do, to decide how do you price to the consumer to still have traffic growth, but to grow margins?

And we're in active debate.

We have great -- it used to be this was only an art.

You kind of guessed at it based on your experiences.

We've got a lot of science around this now on sophisticated pricing tools that let us know what happens when you move prices on one item, where do customers trade to, what's the impact on margin, what's the impact on traffic, and we have that data down to the individual restaurant.

And that's why if you go into marketplaces, you'll see every restaurant is priced differently and it's getting to that perfection on pricing.

So that's what we use and we'll continue to manage it, but it's a long-term strategy, not a monthly or quarterly strategy.

Thank you.

The next question is from John Ivankoe -- sorry, John -- at JPMorgan.

Thank you very much.

There have obviously been some articles recently, not only about beverages, but also McDonald's thinking about doing some reworking of its drive-thrus in the U.S.

Certainly as lunch is obviously very business and breakfast is very busy, do you think it's necessary to actually redesign the physical plan at some point, to push through more capacity, and is that something that may become a system-wide effort in the relatively near-term?

First, I do think it's necessary.

We're doing over 60% of our business through drive-thru and the average is closer to 65% for those restaurants that have drive-thrus.

And in many cases, those booths are 5 foot wide.

And we've got a lot of products.

And those -- customers who drive through are less forgiving on problems, because they can't come back to the problem and fix them.

So we're very concerned with what are accuracy issues, wrong orders, or slowing down the drive-thru -- which in most cases have a single point of ordering.

We're working through those pieces.

These aren't -- it's -- I've read all the articles that are out there too.

That's the reason we're doing extensive testing.

We're in 1500 restaurants with some form of this beverage initiative with different variations in the drive-thru, with 85% of those restaurants in test being franchisees and we'll get to the solution, but it's an investment not just in a beverage strategy, it's really -- eventually, it's a long-term investment, no different than reimaging the dining room in the business where it's growing.

Thank you.

The next question is from John Glass at CIBC.

Thanks.

Part of the answer -- you may have answered this in part, but Ralph, you mentioned you're compelled to continue to expand the coffee test.

What are you waiting for?

Is it just that bottleneck at the drive-thru, and is it reasonable at this point to expect an impact from coffee, specialty coffees, in '08?

And if you could also talk about other constraining factors.

For example, I understand there's equipment that's needed.

Is that a bottleneck, is franchisee buy-in a bottleneck, is there anything else that we should be aware of?

John, those are all the pieces, we're literally in the middle of this.

As you know, we put in a very, four years ago now, rigid, new product testing protocol, where we go to different markets, get diversity of geography, diversity of customer base, and of the type of restaurants we have, how they get affect in these areas.

We do believe that all these issues are -- have solutions.

So we're not hitting anything that you would sit there and say, the equipment can't keep up from a service point of view.

That would have been the case with espresso machine equipment four years ago.

Today they can deliver at the speed and recovery rates that can make it happen.

It's making sure that when we put this in, how it ties into our POS, what customers really want as an offering.

We're not going to offer if we get into this business the breadth of products that a Starbucks offer, but you have to offer enough of a breadth that you're a destination for it.

So what is that breadth, what's our pricing?

Those are the pieces that we're working through.

We've got the product quality consumer acceptance piece figured out.

Now it's the operational pricing, how does it fit into our restaurants and what are the overall economics that come out of that that we're working on very closely with our franchisee body and we won't go until we're ready to do it the right way.

John, this is a -- in the United States alone, it's a $60 billion marketplace and if we can find a way to do this at the speed and convenience and value you expect from McDonalds and do it through the drive-thru as well as the front counter, we have a duty to our customers, our operators, and our shareholders to pursue it, so we're going to look at it very carefully.

Thanks.

Thank you.

The next question is Joe Buckley, Bear Stearns.

Thank you.

First, a follow-up to Ralph.

You mentioned 1500 restaurants that you're testing some form of beverages in.

Could you elaborate a little bit more on that and talk about the different things that may be in test there?

And then a question for Matt on the comments on the commodity cycles.

McDonald's has always had a very unique supply system.

You ever see any changes in the way you source food and -- elaborate a little bit more on your comments, because I found them interesting, but I'm not quite sure where you were headed.

Okay.

Joe, on the 1300, what we're trying to do is get a variety of areas.

So espresso-based drinks have significantly different volume per capita today across the U.S.

Obviously, you know what number one would be, Seattle, but yo go into some of, in middle America, it's a newer phenomenon, newer meaning the last three, four, five years.

So part of what we wanted to do is get a breadth of testing that allow us to understand both how consumers will use the drinks, because they use it differently.

Their knowledge of the variety you've got to have, and then the other piece is, our buildings.

We have a lot of different buildings, a lot of different kitchen layouts and business comes at different rates in different areas, so we wanted high volume, lunch-driven businesses or breakfasts and so -- and then be able to advertise.

So you've got to have enough scale in a market that you can get on TV and put in enough -- that's why the number is 1300, it's between 1300 and 1500.

We're in some stage of rollout of those restaurants right now.

And all markets don't have the same test.

Because they're not -- it's just an early rollout.

Joe, regarding my cryptic comments on commodities, let me first start by passing along my sympathies on Joe Torre, I know you're a big Yankees fan, but back to commodities, what I was referring to is in the normal course of things, when the price of a commodity goes up, supply reacts to produce more supply and the price adjusts and we have not seen that happening in some areas.

It's probably because some of the governments of the world have jumped in and created subsidies, and eventually this will work its way out.

But while the markets are in the process of working things out, all we know is that our unique supply chain approach and our unique suppliers give us a competitive advantage that nobody else has in the industry.

We will get through it.

We've got to let the government stay out of all this and let markets figure it out for themselves, but we're very confident we'll be able to manage through it.

Thanks.

Next question is from Paul Westra at Cowen.

Thanks.

There may be a question or two left.

I think you mentioned the G&A savings, I have a question about on Latin America, I think you may have mentioned $25 million for this quarter.

Is that a good run rate for the year, $100 million of ultimate savings?

I think you had $160 million last year.

I was wondering what you would expect that number to spend down to on an annual basis?

Paul, when you look at at Latin, we licensed the market on August 1, so one-third of the quarter, we still had that G&A, two-thirds we did not.

So you should not multiply that $25 million number by 4 because you would come up short what the number should be.

The guidance weve given in the past that we continue to stand by is that we'll save about $125 million of the G&A in Latin America.

We still have an organization serving Latin America, so we'll have some G&A, but we expect our savings versus that $160 to be about $125 million on an annualized basis.

Thanks.

The next question is from Jeff Omohundro at Wachovia.

Thanks.

Just a question about marketing, as you look out into 2008 with the Olympics coming, just wondering how you're integrating that into the plans?

Maybe just a general overview on that.

Thanks.

Sure.

We've been out, actually, looking at plans the last two weeks.

From a China point of view, we're making a significant bet.

We believe that we can leverage our involvement with the Olympics in a big way for our emerging business in China.

And it's everything we're doing there is all about allowing for our crew or our customers to access the Olympics, literally to be able to go to the Olympics and we have some creative ways that we've done with our crew.

It's just selecting the best crew from each restaurant and those are the ones that will work.

We'll have four restaurants at the actual Olympic village and they're the ones that will work at the village and then we have some customer type programs that we're doing.

The rest of our advertising around the Olympics in China , we will use to communicate in a way that we believe will be -- that will make us more locally relevant and basically it will be a -- when China wins, you win, type promotion that ties us to the Chinese Olympic team.

In the rest of the world, we are just putting different plans together and it will be based on what they do and make it look irrelevant.

We do know it's going to be one of the biggest Olympics ever, because viewership projections are high.

And so the -- Europe just presented to us this week and they've got some unique ways they're going to leverage the Olympics.

Mostly, supporting core food, so it's not promotional, it's supporting core food and using the Olympics to tell a

Thank you.

The next question is from Larry Miller at RBC.

Yes.

Hi, I just had two quick follow-ups.

Matt, I think you guys are in A-3 or single-A rated company.

Are you guys targeting an optimal credit rating or an optimal capital structure?

How do you think about that?

Then secondly, maybe you guys can talk about this.

It sounded like you reacted really quickly on a change in marketing as the consumer took a dip in September.

How quick can you guys react in terms of changing marketing plan?

Larry, on the capital structure issues, when we went through the announcement we made in September, I'll just share our thinking with you and hopefully that will address your question.

We wanted to try to find a way to reinforce that we believe in better, not just bigger, that it's working.

That we're going to be a Company that relies more on franchising and relies less on capital to grow and we saw us bumping the dividend and saying, we're in a position to generate a lot of cash and return, an awful lot of that to shareholders.

We thought that's what we wanted to do, but we wanted to do it in a way that didn't financially weaken our system as compared to our competition.

We have the best franchisees in the world at McDonald's.

One of the reasons, they like our brand.

We think there's many.

But one of them is that we're financially stronger than anybody else we compete with.

We wanted to maintain that difference between us and the rest of the competition.

So when we put together analysis, we weren't focusing on a specific credit rating.

We were willing to take our rating down a little bit.

In fact, one of the agencies did adjust us down one notch, but we wanted to stay much stronger than our competition because we want to have flexibility to deal with the opportunities that might come.

I'll let Ralph deal with the marketing issues.

On the marketing issues, Larry, we can move pretty fast if it's a product -- if it's a new product, then we won't because we've learned that being disciplined on the rollout and the training at the rest level and ensuring that we have that in place because we're such a distributed system, we can't move as fast, but if it's a product that we already have or if it's some other promotion, we can move pretty fast.

Our operators -- as you know, our marketing fund is a separate entity that we all contribute into.

Our sales for our Company restaurants and operators for theirs, but we have an empowered Board of operators that can make decisions very fast.

Thank you.

The next question is from Matt DiFrisco at Thomas Weisel.

Hi.

This is [Jake Bartlett] in for Matt.

I just had a quick question on drive-thrus in the U.K.

Could you tell us what percentage of the U.K.

stores total system have drive-thrus?

It's between 50 and 60%.

And it's -- it's where our growth has -- the reality is the first 400 locations were all in line, though.

And so when we have 1300 restaurants there, we still have a significant amount of high street, which is the way people shopped in the U.K.

But as society there has changed to more of the big box type retailers, we've moved our business that way.

And as they've moved to having concessions on highways, we're also doing that.

So you'll see that percentage grow over time to be more drive-thru.

Interesting enough, it is our highest drive-thru percent for those restaurants that have drive-thrus.

So we're at 55% and growing.

For those restaurants that have drive-thru and what percentage comes through drive-thru.

So the consumer uses it, we just need to make -- we've got to wait for retail establishments to catch up and that's how we'll grow our business there.

Looks like we have one final question from Joe Buckley at Bear Stearns.

Thank you.

First, Matt, thanks for your thoughts on Joe Torre.

A question on the international coffee initiatives and the McCafes.

We talk a lot about the U.S.

and what you're doing, but what's going on in Europe and Asia, I guess primarily with coffee?

This is a -- coffee is a big part of one of our common success factors, but we are leveraging it different in different places.

We don't have one set formula.

So if you go from -- I would say the extreme is Australia and Germany, where you had strong coffee cultures without any strong players and we've decided to be very aggressive in our McCafe development.

To a certain extent, we're putting McCafes everywhere we have the ability to physically put in our restaurants and have a full coffee experience, the whole gamut there and are being very successful.

So Australia is pretty much there.

Germany will be at 400 McCafes by the end of this year and another 100 next year.

And the rest of the world we have some McCafes also, but we are definitely leveraging the coffee strategy starting with strong drift coffee first, premium roast, and then where it's accessible, the different espresso-based drinks.

With a high focus on convenience in the U.S.

and in APMEA.

So the U.S.

the convenience is drive-thru.

Our customers believe a product that we offer needs to be offered both in drive-thru and from counter in the U.S.

It's a critical part of our brand.

In APMEA, we do a lot of kiosks and on the go, especially where you have high density, so we're leveraging it there with convenience being a very big driver.

Thank you.

We're out of time and questions, so I'll turn it over to Ralph for a few closing remarks.

Okay.

In closing, we are pleased with our performance for the third quarter and believe we're on track to achieve a record year, both for our system and our shareholders.

While we're proud of our recent business performance, I can assure you we will not allow success to make us complacent.

Our management team is determined to get even better at executing against our plan to win.

We are in a great business with tons of opportunity and we are confident in our ability to continue to deliver results by leveraging successful initiatives from one market and replicating and scaling them to other areas of the world.

Doing so will enable us to deliver solid results for the remainder of the year and accelerate momentum into 2008.

Thank you and have a great weekend.

Thank you.

Thank you.

This does conclude today's conference.

We thank you for your participation.

At this time you may disconnect your lines.