麥當勞 (MCD) 2010 Q3 法說會逐字稿

Hello and welcome to McDonald's October 21st, 2010, investor conference call.

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

Following today's presentation, there will be a question-and-answer session for investors.

(Operator Instructions).

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

Mary Kay Shaw, Vice President of Investor Relations.

For McDonald's Corporation.

You may begin.

Thank you.

Hello everyone, and thanks for joining us.

With me is Jim Skinner, and Don Thompson will be joining us by phone from Mexico where we are celebrating our 25th anniversary.

Today's conference call is being webcast live and recorded for replay.

Before I turn it over to Jim, I want to remind everyone that as always, the forward-looking statements in our earnings release and [begin edit] 8-K filing also apply to our comments.

Both documents are available on www.investor.mcdonalds.com as are reconciliations of any non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures.

And now I will turn it over to Jim.

Thank you Mary Kay, and good morning everyone.

I am pleased to share McDonald's latest business results that reflect our continued global strength.

For the third quarter global comparable sales were up 6%, operating income increased 11% in constant currencies, and earnings per share reached $1.29, a 15% increase in constant currencies.

Our momentum is continuing into October with global comparable sales expected to increase 5% to 6%.

Our strength remains broad based with each area of the world contributing to our growth.

And we are continuing to grow market share in our major markets.

In an informal eating-out category that varies from markets that are in decline to markets that are just growing slightly.

These results mark our 30th consecutive quarter of comparable sales increases, and this is truly a testament to our ability to perform in any economy.

We continue to deliver what our customers are looking for, great value, outstanding convenience, a modern restaurant experience, and relevant menu offerings with an emphasis on local tastes, and it is all resonating with our customers.

In the United States, comparable sales for the quarter were up 5.3%, and operating income grew 7%.

And most important, we continued to significantly increase traffic into our restaurants.

Now the big menu news this summer was the extension of our beverage platform with the launch of Strawberry Banana and Wild Berry Smoothies, and the rehit of frappes.

Sales from the smoothie launch well exceeded our expectations and both products are being purchased throughout the day.

Both of these high-margin beverages continue to sell at a strong pace.

The US also drove quarterly results with value across the menu, including the continuation of our breakfast Dollar Menu, and on the convenience front we are continuing to be available for more guests more often, with nearly 40% of our US restaurants now open 24 hours, and more than 80% open by 5 AM in the morning.

In August, we launched the Angus snack wrap line with three choices at $1.99.

This new introduction performed very well, and has lifted sales of our entire Angus burger category.

Our new beverage and snack wrap platforms contributed to the trailing 12-month period ending in August, and delivered the highest guest counts in more than 20 years in the US.

Even as the overall industry continued to be stagnant.

We are innovating and we are executing, and it is giving more people more reasons to choose McDonald's.

Our customers continue to give us permission to stretch our brand, and we are delivering at the quality, value, and speed of McDonald's.

This month, we are featuring our core products in McCafe beverages through a Monopoly tie-in with Wal-Mart gift cards, and in November we will advertise the always popular McRib on a national basis for a limited time, something we have not done for years.

Early next year we will be launching oatmeal with maple, brown sugar, raisins, and cranberries, available all day, and in market tests our customers loved the taste, nutrition profile, and the expanded menu choice.

Turning to Europe, we had another strong quarter.

Comparable sales increased 4.1%, and operating income grew 12% in constant currency.

And while the overall informal eating out category in Europe remained in decline, we continued to take share in all of our major markets.

A key driver of growth across Europe continues to be our focus on modernizing and elevating the customer experience.

More than two-thirds of our restaurant interiors in Europe are now reimaged, and provide an ever more contemporary and relevant environment for our guests and the people working in our restaurants.

Meanwhile our customer satisfaction scores improved across the continent as we worked to continually enhance our service, with the biggest gains coming from Drive-Thru times and order accuracy.

Across Europe, we are striking the right blend of variety and choice, broadening our accessibility, and appealing to a wide array of consumer segments.

In Germany, for example, sales benefited from the launch of McWrap, a premium range of chicken and beef wrapped sandwiches.

And of course every day affordable pricing across the menu.

Germany, and many other markets feature a Coca-Cola glass promotion with the purchase of an extra value meal, driving some of our highest extra-value meal sales in history.

We also saw success with the reintroduction of menu favorites, the M-sandwich in the UK, a premium burger with artisan bread, and the popular Double Cheeseburger in France.

The beverage platform while different than the US also contributed to results.

We recently launched frappes, Europe's enhanced milk shakes in several markets including France and Switzerland, where it is contributing to the growth of the snacking day part.

And we are now the largest seller of coffee in the UK, as premium bean to cup and specialty coffees continue to attract a growing number of consumers, especially when a great McDonald's breakfast is available to go along with it.

Looking ahead we know the economic environment remains challenging, with austerity measures continuing to be implemented, in January the VAT will increase in the UK, Poland, and Portugal, and others could follow.

Yet we remain confident that our business model will endure.

We expect our customer focus, menu pipeline, and the ongoing modernization of our restaurants will continue to deliver long-term results.

Now looking to Asia-Pacific, Middle East, and Africa, where we also achieved strong growth.

Comparable sales for the quarter increased 8.1%, and operating income grew 15% in constant currencies.

Results were strong across the segment with nearly half the markets delivering double-digit comparable sales increases.

We are driving results through a focus on convenience, value, and a balance of core and local offerings.

Australia made gains with new menu items including a promotional addition to its extremely popular Angus platform, the new sandwich, Angus III, featured a popular tomato chili relish and scored extremely well with our consumers.

The market also rolled out a new patty for all-premium chicken sandwiches, driving an increase in sales across the entire premium chicken category.

The addition of a new breakfast roll and breakfast wrap helped grow comp sales and guest counts during the breakfast day part, and Australia continued to focus on running better restaurants, as it achieved some of its best service scores on record with improvements in Drive-Thru speed and accuracy leading the way.

Our other major markets in APMEA, China and Japan also delivered.

Value continues to be a key driver, China's value lunch program remains popular and continues to grow sales and traffic.

The value lunch has now moved into nearly every market in greater Asia, and accounts for more than 10% of the total sales in the region.

Outstanding operations continue to drive growth and differentiate the experience in China, with the market consistently achieving some of our best customer satisfaction scores.

Our strategies in China are resonating with consumers are our fundamentals are strong, as evidenced by China's third quarter 12.7% comparable sales increase.

Meanwhile in Japan we remain competitive to relevant menu offerings and promotions.

We delivered gains from a strong Big Mac campaign, and a new Lemon Chicken sandwich, both of which proved extremely popular.

Japanese consumers also reacted favorably to our recent Food Strap promotion.

which offered miniature models of our iconic products, such as Big Mac and fries for customers, to actually strap to their cell phones.

The program was a huge hit, and helped drive sales profits and new guest visits, as we combined a popular local trend with the popularity of our iconic products.

Japan's other big win was the launch of its value breakfast, featuring McDonald's Sausage McMuffin, and Sausage McGriddle, helping drive sales and revitalize our breakfast business.

So those are a few of the highlights around our continued momentum.

We are delivering the food and beverages our customers want, and the value that they expect.

And an overall dining and brand experience that is modern, relative, and in step with our customers lines.

We are also continuing our commitment to financial discipline.

We have a strong balance sheet and the highest credit rating in the industry, allowing continued access to capital, and it continues to facilitate access to credit for our owner operators to reinvest in their restaurants.

We remain committed to returning all of our free cash flow over the long term to investors through a combination of dividends and share repurchase.

We recently announced an 11% increase in our quarterly cash dividend to $0.61 per share, or the equivalent of $2.44 annually.

Combined with share repurchases, we expect our total cash return to shareholders for 2010 to reach an approximation of $5 billion.

Overall, I am very pleased are our latest quarterly performance, and am confident that we will continue to keep driving our business forward.

While it has been said by economies that the recession has technically ended, and signs of progress are slowly emerging, the global economy remains fragile as consumers continue to be cautious.

But by continuing to innovate and invest and deliver what our customers want, we will continue to gain market share and grow our business.

Thank you, and now I will turn it over to Pete Bensen, our CFO.

Thanks, Jim.

Hello, everyone.

Third quarter marked yet another strong performance for the McDonald's system.

Our alignment behind the Plan to Win again generated significant increases across all of our key measures, comparable sales and guest counts, market share, operating income, and returns.

Combined operating margin, our primary measure of overall profitability, increased 150 basis points to 31.4% for the nine months.

This is a direct result of growth in both our consolidated franchise margins, and our Company-operated margins, along with effective G&A control.

In the US, the successful introduction of McCafe Smoothies in July, and the ongoing demand for our core menu drove gains in both comparable sales and guest counts.

While our pricing remains relatively flat versus a year ago, we are especially encouraged that our traffic growth was about 1.5 times that of our comparable sales growth through September.

Lower food and paper costs along with top line growth contributed to an increase in Company-operated margins of 270 basis points, to 22% in the third quarter.

Equally important our US franchisees are generating significant increases in their annual cash flow per restaurant, now averaging over $350,000, a 15% increase over a year ago.

This speaks to the health of our overall business and contributes significantly to our operator's willingness and ability to reinvest in their restaurants.

On the cost side, our third quarter basket of goods in the US decreased about 6% contributing around 200 basis points to the margin expansion,similar to what we experienced in the first half of the year.

However, the comparisons become unfavorable in the fourth quarter as we face a 1% to 2% increase in commodity costs, compared with fourth quarter 2009.

This still results in our overall food and paper costs being down 3% to 4% for the full year.

In Europe, the grocery bill declined to a more modest 1% in the third quarter.

We now project commodity costs will be down 2% to 3% for the full year.

This means that Europe will experience a slight increase in commodity costs in the fourth quarter, compared with a decline of 3% in fourth quarter last year.

European company-operated margins increased 160 basis points in the third quarter to 22%.

Comparable sales gains in Russia, the UK, Spain, and many other markets, coupled with lower commodity costs were partly offset by higher labor costs.

Menu prices increased an average of 2% to 3% across the segment over the past 12 months, but varied by market.

As we head into the fourth quarter, some of these price increases will roll off, and the current economic environment will impact our pricing power, adding to short-term margin pressure, but nothing we haven't successfully navigated through before.

In Asia Pacific, Middle East, and Africa, Company-operated margins increased 90 basis points to 18.9%.

Positive comparable sales were partly offset by higher labor and other costs around the region.

We have an effective price increase in APMEA of about 1%, and similar to Europe, it varies by market.

Now turning to franchise margins, third quarter franchise margin dollars rose to $1.7 billion, an increase of 9% in constant currencies.

The consolidated franchise margin percent increased 60 basis points to 83.3%, driven by positive global comparable sales.

The third component of combined operating margin is G&A, which we continue to actively manage.

For the third quarter, G&A was up slightly, due in part to increased incentive compensation accruals, based on our strong results.

Fourth quarter G&A should be relatively flat, resulting in a full-year increase of about 3%.

On the other operating income line, similar to last quarter, we experienced lower gains on sales of restaurants in the third quarter, compared with the prior year.

More broadly speaking, the components of other operating income often include items such as gains, asset disposition costs, asset write-offs, in part due to re-imaging, and other unique items.

As many of these items are transactional in nature, it makes comparisons between certain quarters difficult.

This was the case in the third quarter, and we also expect comparisons will be challenging in the fourth quarter where our current estimate for total other operating income is less than half of the $67 million recognized in fourth quarter 2009.

Let's now move on to something I know you are all very interested in, the cash generated from our operations.

Our first priority for this cash is to reinvest in our business to build strong sales, profitability, and returns.

We have slightly trimmed our 2010 CapEx estimate from $2.4 billion to $2.3 billion,primarily due to currency translation, and fewer completions of re-imaging projects in the US versus our original budget.

This was a purposeful and strategic reduction, which I will discuss in more detail in a moment.

Approximately half of our capital expenditures are spent on our existing restaurants.

As we expect to re-image approximately 1,800 restaurants around the world this year, I wanted to provide you a brief update on the activities in our three major segments.

In the US, we have completed about 40 sites, and expect another 350 restaurants to be re-imaged within six months.

We are being very deliberate in our approach, testing different designs, closely examining our costs, and making sure that we have adequate sales history post re-imaging to evaluate the returns.

In short, we are focussed on doing this right, versus doing it quickly.

While it is still early, given the relative small sample size and limited time frame, preliminary results are in line with or better than our initial 6% to 7% incremental sales list estimate.

Most importantly, we are encouraged by the support of our owner/operators, who are leading this transformation of our brand in the US.

In Europe, we have re-imaged about 500 restaurants through September, primarily in our largest markets, France, the UK, and Germany.

Europe plans to have about 90% of its interiors remodeled by 2012.

Exterior re-imaging tends to take longer due to permitting time and other regulations.

In APMEA, we are leveraging some of the European designs, and are focused on both interior and exterior remodels, particularly in China and Japan.

Australia is virtually 100% re-imaged.

In addition to reinvestment, we are spending the other half of our capital expenditures to open new restaurants.

We are on track to open 1,000 new restaurants this year.

Approximately half of these openings will be in APMEA, including 150 to 175 in China.

Another 250 new restaurants will be open in Europe, primarily in Russia, France, and Germany.

The US has already opened about 100 restaurants, well on its way to a total of 150 new restaurants this year, and the remaining 100 restaurants will be opened in Latin America and Canada.

Now let's spend a few minutes talking foreign currency.

As you know exchange rates have changed significantly since I last updated you.

At current rates, we now expect currency translation to negatively impact fourth quarter earnings per share by only $0.01, resulting in a full-year benefit from currency translation of about $0.01.

As I said before, current volatility renders any estimate outdated within days, so please take this as directional guidance only.

As most of you know, we believe constant currency results provide a more complete picture of the underlying strength of our business.

In closing, I am proud to say that the focused execution of our system behind the plan to win, the entrepreneurial power of our owner/operators who are widening the gap versus our competition, and our disciplined operational and financial controls continue to drive our business forward.

We will be entering 2011 from a position of strength.

We remain confident in our sales momentum and our system alignment has never been better.

We are currently finalizing 2011 planning.

Visiting markets around the world, and meeting with our local management teams, who are focused on executing against our key business drivers, optimizing our menu, modernizing the McDonald's experience, and broadening our accessibility.

Though the global environment remains challenging, I am confident McDonald's can continue to deliver long-term growth and value for our system and our shareholders.

Thank you.

Now I will turn it over to Mary Kay to begin our Q&A.

Thanks, Pete.

I will now open the call for analysts and investor questions.

(Operator Instructions).

To give as many people as possible the opportunity to ask questions, please limit yourself to one question, and we will come back to you for follow-up questions as time allows.

First question is from David Palmer at UBS.

Hey, guys, congratulations on the quarter, and congratulations and best wishes to you, Mary Kay.

Thanks, David.

Two areas of curiosity for me, ongoing curiosities I suppose, the pricing decisions that you make, and just generally speaking the outlook for Europe.

You gave us some comment there about pricing rolling off, and limited pricing power in some European markets.

I think it was you Pete that said that, perhaps you could talk about pricing power being on the eave of inflation, and obviously there are a lot of markets where it looks like you sure do have pricing power.

How are you thinking about that?

Thanks.

Sure.

You know, what we know is as we look at and we dealt with this in our European business over the years, as VAT increases start to come along, we have to be very smart about how we handle that through the menu board.

We know the wrong answer is to immediately increase prices the full amount of that VAT increase.

So we look at doing it in smaller pieces.

Sometimes we try to get a little bit ahead of the VAT increase, do it in small chunks, but really, if you look across the whole continent as you indicate, the economies are in various forms of recovery.

So we really look at the individual markets.

What is the consumer's appetite to pay a little more?

What is going on with inflation?

So as you point out, as we look at least preliminarily in to Europe next year, we think commodity costs will be up about 3%.

That is not an unreasonable number for us to manage through, and if inflation is a sign that the economies are picking up a little bit, and the consumer will be able to pay a little more, then we certainly ought to be able to handle that through the menu board, but as we sit here today, we are just not exactly sure in which markets and when that will be, but to our business model in total, that type of increase in commodities is not insurmountable.

And David, our business model, this is Jim, will endure there in the European marketplace, particularly when you look at these VAT increases.

They are not robust increases.

They are incremental increases, and the population there wouldn't be able to absorb enormous increases, and so I think as we operate throughout the year, as Pete indicated, we will be able to mitigate the impact of those increases and our business model will be able to perform well in that environment.

Thank you.

The next question is from Jeff Omohundro at Wells Fargo.

Thank you Mary Kay, and also best wishes to you in the future.

Thank you very much.

I was just wondering if you could elaborate on the impressive domestic sales momentum that was reported throughout the quarter, and in particular in the September period?

And also, particularly interested in the mix sustainability of the frappes and Smoothies into the fall and into the cooler weather, and if you consider continuing the market support of those items out of their traditional season?

Thanks.

Jeff, this is Jim.

Don, of course, very close to that combined beverage initiative in the US, and he is in Mexico.

Don, can you take Jeff's questions?

Yes, Jim.

Hi Jeff, how are you?

A couple of things.

One is Frappes and Smoothies are performing very well, and again as we have mentioned, they are exceeding expectations that we had.

You asked about the seasonality.

The products do have some seasonality to them.

Having said that though, that has all been baked into our model as we look at the overall sales contribution.

It is important to note that everyone kind of grabs hold to frappes and Smoothies, keeping in mind, breakfast is a strong contributor in the US.

We still have a tremendous amount of sales coming in from Angus.

Angus is still performing well.

Jim talked about the Angus snack wraps.

There will be additional media, and a continuous wake of media relative to frappes and Smoothies in the US, but also even broader, we still have an opportunity relative to the broader McCafe coffees.

So I know the US team is going to be marketing those products as well, so there are quite a few things that will be coming up.

Jim talked about the McRib, which is something we haven't done nationally.

We have done it in spot markets but not nationally.

So ongoing strength wise, the US plan is solid, and we are looking forward to also a very strong 2011.

Thank you.

The next question from David Terantino, Robert Baird.

Good morning, and congratulations on another great quarter.

Pete, I have a question maybe following on to the first question about the cost outlook, and how you might manage that heading into 2011?I know you mentioned European commodities are expected to be up 3%, but if you could maybe give a broader picture of what that might look like globally including in the US, and also talk about labor trends and with that, are there any efficiency opportunities, maybe that you could use to offset some of that pressure?

Thanks.

Sure, David.

Yes, I don't have a global commodity number, but in the US, we think the number is closer to a 2% increase.

And, again, that is a very manageable number for us, and nothing that we are terribly concerned about, so all-in-all from an input cost side, we feel pretty good about heading into 2011.

Labor, virtually all markets around the world are seeing increases in labor, but nothing that is, again, out of the ordinary, or something that is so extreme that we would have to do something dramatic in our pricing or suffer some dramatic hit to margins, so book commodities and labor, while going up are in line with kind of, what I would go back to kind of some more normal trends for our business, and historically we have said, in the US we needed 2% to 3% comp in normal times, and in Europe probably a 3-plus comp in normal times to grow margins, so I consider this more normal times from the input cost side.

The question will be exactly at what point will we be able to take some of that pricing, but our early look at some of the 2011 plans, markets are anticipating they are be able to take some pricing next year.

From an efficiency standpoint to offset some of that, we are constantly looking at operations within the restaurants, and one of the big enhancements, we are in the process of rolling out through the US is our new POS system, which makes it easier for the crew to take the orders, easier to get the order right, they can do it faster and basically what that means is increased through-put, especially during our peak hours, which makes us more efficient per labor hour.

Thank you.

The next question is from John Glass, Morgan Stanley.

On the US remodeling program, you talked about, Pete, just remind us where you thought you would be at year end, and where you are coming out, and again the specific reasons, was there something about delaying getting the construction projects, or not getting enough data to read, and you talk about a 6% to 7% lift, though, can you talk about over time if you have a greater expectation, what the sort of 3 to 5-year expectation is in terms of sales lift to those remodels?

Yes, John, I will give you a perspective, and certainly if Don or Jim want to jump in, they can do that.

I think we started out with an aggressive goal this year.

We thought we would do 400 to 500 starting out, and it looks like we will probably end up doing 200 by the end of the year, maybe 225.

And really as I said in my comments, as we started the initial wave of this, we wanted to make sure that as we really have one chance to get this right, and while we realize there is an opportunity to strike right now, because we have the financial strength and the momentum, that is still not a reason just to go quickly if you don't have everything exactly nailed down, so we are making sure we have got the designs right, that we have got the quality of the materials right, that we have got the pricing right, and like I said, it is because we really have one chance to do this right, and we are going to do it.

I would see that 200 number this year, probably go up to 600 in 2011, based on the plans, so there is momentum, and something that we are very encouraged about the operator participation in.

When we talked about the sales lift, the 6 to 7 was our initial estimate, and that lift, just to remind you is incremental to what is happening in the marketplace, and that we know over time that sales halo continues in that restaurant.

We don't have a five-year track record of these things in the US to tell you over five years what is going to happen, but our instincts tell us that those sales will continue to be positive, primarily because of the opportunity it gives us to introduce new menu items, introduce new customers back to that restaurant, et cetera, so we are very bullish on the opportunity it provides, not only in year one, but sustaining.

Hey, John, I think it is really important too to note, and Pete mentioned this, in the US one of the things we have been able to benefit from is the fact that we have seen France and Australia move forward, and particularly Australia move forward even more aggressively relative to re-imaging.

So we have been able to take some of those ideas and the things that did work very well from those markets and really employ them in the US designs as we move forward.

Another point is that the US designs are both internal and external at the same time, so we are not just doing the internals of the restaurants.

Some of those have been done a while ago, we are refreshing those.

But this is a full re-image process that we are going through.

So we wanted to make sure that we got it right.

We consciously slowed down, and went back and revisited the design.

Some of them we didn't think actually were aggressive enough in designs, and the franchisees have been a major, major part of how we have looked at that.

When we looked at the results at Australia and in Europe, across Europe, the second and the third years have been very positive as we continue to move forward, largely because of the reasons that Pete mentioned around menu, as well as the awareness from customers, and the last point is that we know as we get more and more of these done in the marketplace, there is a broader synergy that takes place from a consumer awareness perspective, and that allows us to be able to reap the benefits of that and even stronger sales.

So we feel real confident about where we are in the US, and I know as we move into next year, the franchisees are ready to be more aggressive, as well as our teams are ready to be more aggressive as we move forward.

We have got the right designs now, so we feel pretty good about it.

Thank you.

The next question is from Andy Barish at Jefferies.

Thanks.

Just a question on kind of European-brand relevance.

I mean, do you think you have made a kind of a sea change in your European business over the years, and does that show up in terms of more brass on the day parts, less kind of weekend, special occasion business, and how does that make you feel just going forward with maybe some economic bumps in the road?

Are you better prepared to ride those out than maybe in the past?

Andy, this is Jim.

I don't know that we could point to a sea change in Europe in specific.

I think we have seen a sea change and a relevance for our consumers across the globe.

So Europe, of course, is pursuing the same plan to win that we are pursuing in Asia-Pacific, Middle East, Africa, the United States.

We are very aligned around the consumer relevance issues, and what we are doing around re-imaging menu, and all of the every day affordability access and improvement in the Drive-Thru, which is a big one for Europe, because they are adding more and more Drive-Thrus now, and as you heard from my comments, the improvement on customer satisfaction, particularly in the Drive-Thru accuracy and speed of service in markets outside of the United States, and including the United States, is paying dividends.

But I don't think that there is anything there in the brand that would differentiate Europe relative to a sea change that changes the visit mix, or the opportunity for our customers that visit McDonald's.

Okay.

Thank you.

If that is what you are asking.

Maybe I didn't understand the question, but I think that is it.

Thank you, the next question is from Jason West at Deutsche Bank.

Yes, thanks.

I just wanted to touch back on the margin outlook for next year, and I guess focus a bit on the US.

You mentioned you think you had some room to take price in some markets.

I am wondering if you guys are still looking at the CPI away from home as kind of an indicator on where you would like to focus the pricing, and if you would talk about the overall competitive environment in the US, if you feel like things have started to flatten out, or even get a little better?

Jason, it is Pete, as we have said before, you touched on it, one of the things we look at is what is going on in the food away from home index, and that is actually up a little bit on a trailing 12-month basis ended September.

But also during the last economic downturn if you will, we started to look also at food at home.

What is going on at the grocery stores, because as Don likes to say, the refrigerator has started to become a big competitor of ours.

So food at home is still flat to down slightly as we look at the period, so we will be keeping an eye on what is going on, both at the grocery stores and in the competitive market as we look at our pricing, but obviously the momentum that we have, some of these premium beverages, while they don't necessarily qualify as a price increase, but introducing these premium beverages with high margins is definitely helping and accretive to cash flow, as maybe we aren't able to take price on some other items, but we will definitely be actively looking at the opportunities, and again, with some optimism the economy is going to start to get a little bit stronger next year, and we will get some price increase.

The next question from Matt DeFrisco at Oppenheimer.

I guess following on that, the question about the premium beverages, with some of these new products, as we look at it leaving the US moreso and going global, with some of these new products that have been very successful in the US, on a gross profit dollar basis, and I guess overall on a regional margin basis, should we expect then, factoring in everything that you highlighted as far as commodity costs and labor pressure?

Would Europe then potentially be going back to the days of actually maybe even potentially having higher margins again than the US, if you look on a store level if I am looking at your branded Company-owned basis, as we bring in these higher gross profit margin terms and higher margin items, to the stores?

This is Don, and a couple of things on that.

One is the other areas of the world, clearly Europe has looked at some of the other premium beverages, is looking at that, and particularly looking at frappes and Smoothies, they have done one offering of those type of beverages, but they are looking at the US execution.

APMEA is looking at the same thing.

From a margin perspective, keep in mind, that as we implement some of the higher-margin products, we are also looking at our tiered-value offerings.

So we are also looking at what we do in terms of breakfast offerings to stimulate that day part, which is a huge opportunity for us across the big four in Europe.

We are looking at the same things relative to the regular value menu, they brought back in Europe the Double Cheeseburger in France, and the question is relative to what happens economically, to Jim's point earlier, our model allows us to be able to flex the price in and out of that, relative to what the economy will yield and what the discretionary spending will look like.

So keep in mind, it is not just about the implementation of beverages, that is one part, but it is also what we do with the rest of the menu.

What beverages and higher margin products allow us to do is to be able to afford to execute our value platforms, so that we can continue to gain market share and grow guest counts.

That is really the biggest goal that we have in economic downturns, protect and grow the guest counts, which then yield us high levels of profitability.

Thank you.

The next question is from Joe Buckley, Bank of America Merrill Lynch.

Thank you, good morning.

One statistical question.

You shared with us the China same-store sales number for the third quarter of the year of 12.7.

Could you share with us what that was up against in third quarter of 2009?

And then a broader question, again on margins, curious on the 2% commodity inflation outlook in the US, how visible that is to you?

How much of that you might have contracted or hedged?

And just in general on the margins, if I am not mistaken the 22% level, in both the US and Europe is probably an all-time record, and I realize there is some seasonality around that.

But we talk about the sustainability of the 2009 margin performance, if you do have even just slight headwinds in food costs, are these levels sustainable?

Alright.

Joe.

The 2% increase in the fourth quarter in the US, we have a pretty fair amount of visibility in, so a fair amount of that is contracted, locked in, and so that number feels pretty solid to me, and even heading in to 2011, I am not going to give specific percentages, but we are probably more contracted at this point in time versus any other year previous, so while it is still early, our 2011 estimate feels pretty good too.

The quarterly margins, the third quarter margins are actually kind of just off of their all-time highs for both Europe and the US, but as I think about 2011 more broadly, and think about some of the comments I made earlier, in an environment with about 2% inflation, and normal wage increases, in that environment, really a 2% to 3% comp is what we need to grow the annual margin, and so with the momentum that we have, and the outlook of being able to take some price to keep driving the guest counts with these beverages and the breakfast value, et cetera, we feel pretty confident that is doable.

I think Joe, we get this question often, obviously we get it externally and internally, and our answer is always the same.

We focus on the top-line growth and ensuring the traffic into our restaurants, and the rest has to take care of itself.

It doesn't mean that we are not smart about how we price on the menu and how we introduce new products, but we play it as it lies, if you will, relative to the commodity costs, other than what we are able to hedge as Pete mentioned, and so the concern that I have with the segments around the world and the planning process, is what are we doing about continuing to drive top line and preserving the increases in traffic into our restaurants?

When we take care of that, as Pete mentioned, certainly at the 2% to 3% level, all else falls into line.

And Joe you asked the question about last year's comp in China.

Last year, the quarterly comp was our easiest comparison.

It was a negative 10.7, but still this year's number and the momentum going on there, we are extremely proud of the team in China and what is going on there.

Pete, I think for Joe too and for everyone else on the call, one thing that is really impressive about China now is they are being able to benefit from not only the historical regular menu, but also breakfast now is becoming a stronger and stronger day part for China, the value lunch program that they have in place, they did some very aggressive things with summer drinks this year.

Jim mentioned Drive-Thru expansions earlier.

We are confident in the development plan.

China has a very good strategic plan, both now and again as we move in to 2011, so it is not just about whether or not you are comped on a weaker number last year, the way that we are comping now and the opportunity for continued growth is pretty strong.

Thank you, the next question is from Larry Miller at RBC.

Yes, thanks.

I had a two-part question on the US.

Can you guys give us any sense of how the business in the US breakfast is trending since BK rolled out their new menu, and then the second part of that is, you guys had a nice acceleration in September in same store sales, it looks like the fast-food market overall is getting better?Any thoughts you could share relative to that, that would be great.

And then also best of luck Mary Kay.

Thanks, Larry.

First of all relative to the overall segment and the improvement, we continue to look at the same things that Pete mentioned, the consumer spending, the consumer confidence, consumer confidence went down in September.

Unemployment is still at 9.6%, and the recovery, we think is going to be elongated in America, and so if you look over the next 12 months, I think people are still talking about maybe getting to 8.5% or 9% unemployment, when we know that normalized unemployment rates in a robust economy are 4% or 5% at the most, and so we have got a long way to go there relative to consumer confidence, and that confidence of people being able to put food on the table at home or away from home, and I think jobs have a lot to do with that, so the improvement in the overall segment in September I don't think is necessarily an earmark of, or a bellwether of things to come relative to the overall recovery, except to say that we are certainly pleased with our performance and the fact that the rest of the industry is starting to come around is good for them, but I think in an overall indicator, that is probably not something that we would look at to say, well, we are in the middle of a recovery.

And we continue to outperform the industry, so our gap with the industry continues to be significant, and we are proud of that, and regarding the breakfast question, we haven't seen any impact from the Burger King rollout.

Thank you.

The next question is from Jeff Bernstein at Barclays.

Great.

Thank you very much.

And best of luck, Mary Kay.

Two things, one just a follow-up on the European results.

I know there is a lot of speculation around the acceleration in August, including a very strong reacceleration in September.

Just wondering if you can offer incremental thoughts, it is going to be tough to pass along all of the VAT increases on the menu board, but in terms of the austerity measures, perhaps McDonald's positioning versus where you are in the US, are you perhaps lower end, or maybe which markets you might think are most or least vulnerable with the big changes coming up in Europe, and then separately on the shareholder value front that you guys mentioned earlier, is there any potential to increase leverage perhaps to return more capital to holders, either through additional repo or dividend?

I think you guys have talked about the potential willingness to move in that direction.

Thanks very much.

I will let Pete respond to most of that, but let me respond to the big ballyhoo over August in Europe.

Europe had a little bit of glitch in August, mostly around France.

Everybody got all concerned.

It is because France did not run the promotion that many of the other markets ran in August have which was the Coca-Cola glass promotion.

And they did not perform as well as the other markets, and yet, it was not a trend.

It was a one-month occurrence and we are still optimistic and they are back on track, and things are moving along well there.

Can I just add something, Jeff, you mentioned lower end in the US.

And just as a point of clarity,Smoothies, frappes, Angus, salads, those aren't lower end, and we have had a good mix across the menu board, and it is really important to note thatValue still only represents 10% to 11% if you look at the regular menu value offerings and platform.

The coffee beverages, McCafe beverages are definitely not lower end, and consumers tell us that, and they prefer the beverages and there are a tremendous amount of those beverages sold during the morning day part, as well as across the afternoon.

All day parts are up in the US business.

So just a point of clarity.

I think that when you look at the US business, it may appear that it is value driven.

Value helps, but we have got good mix across the board, just as we have in Europe.

And specifically about which markets will be hit harder with the austerity, et cetera.

Jeff, as we look at the continent I would just look at the last couple of years performance, that is what gives us the confidence.

We know that while we prefer a more robust environment to operate in, that if times get a little tougher, that we have got the ability to continue to attract customers, and to continue to perform well.

Regarding additional leverage, our debt balances are up this year a little bit compared to last year, and that is consistent with our plans, is that every year that the business performs well and grows bigger, that we have an opportunity to add some incremental leverage to the balance sheet to return cash to shareholders, but we are not planning to do any significant leverage event.

Okay.

Thank you.

The next question is from Mitch Speiser, Buckingham Research.

Great.

Thanks.

My question is on Europe.

In particular, Germany, UK, France, can you update us on what the Drive-Thru mix is in those markets?

And what the opportunity is over the next couple of years in terms of increasing that mix?

And on the frappes, do you think it can have the impact that it has had in the US?

And if these Drive-Thru mix and frappes growth could, should we view it as perhaps an offset to what is happening in Europe with VAT taxes and weak economy, and austerity plans, and just as a side note to that, can you let us know the experience you have had when VAT taxes have gone up in Europe?

And how comp trends have changed?

Thanks.

Alright.

Mitch, in Europe, our Drive-Thru percentage is about 60%, a little over 60%, and that is probably about the same in those big markets.

So that is the number, that is not the percentage of sales through the Drive-Thru.

That is the percentage of restaurants that have Drive-Thru, and the percentage of sales in those restaurants is closer to 45%, and so you think about the US being 67% Drive-Thru, that is a huge opportunity for us to increase that, and that is why Jim had referenced this.

It is a focus area for Europe.

They know there are opportunities not only to add more Drive-Thrus to satisfy that demand, but also to improve those Drive-Thru operations to attract more customers.

Historically, as Jim mentioned, these VAT tax increases are probably going to be more incremental than they are substantial, and in the past you have had VAT increases that have tended to be more substantial, so you had to take a little longer period to get those bled into the menu board, if you will.

So again, I am not sure there is a historical comparison for us to make, especially considering the economic environment and all else that is going on, but again, I get back to the confidence we have that our ability to manage through this with our business model, and new products, the beverages certainly will help.

I don't know that they will have, at least as of now, as you look in to 2011, they probably won't be as impactful in Europe as they are in the US, but certainly over time all of the markets have beverages in their plans, and on their plates to take a look at.

The other thing that I would say is that if you look at Europe, these populations are very much supported by social programs.

So when you talk about austerity in these countries, it is much about the benefits, if you look at France now, they are talking about raising the retirement age to 62 years old.

Everybody is in a big flap.

But what does that do to discretionary income for customers who could visit McDonald's?

It is de minimis.

And so the impact around a number of these austerity programs will not have a severe impact on discretionary spending of our consumers, because they are supported at a very high level already, relative to Social Services and the other support they get from the government, so we have been able to absorb that over the years, and as Pete said, we will be able to do this as well during the coming months.

Thank you.

The next question is from Keith Siegner, Credit Suisse.

Thanks, and I might turn around that answer from that question a little bit.

Looking at the US business with the free Wi-Fi, with the McCafe, with the snacking, and now most importantly, with this new remodel program, does this change at all the mix in Drive-Thru versus eat-in, let's say sit and stay?

Or could it potentially increase that mix a little bit?

And if that were to happen, does this change or open up maybe some of the new product development over the next couple of years if that happens?

Well, I think it could.

Possibly change the mix over time.

That is not why we have pursued those strategies.

We have pursued those strategies because we want to offer our customers those opportunities for convenience, and they are relevant to their lifestyles today, and I think when I look at the population and their lifestyles today, I couldn't make an argument, I think for a change in their behaviors relative to the use of the Drive-Thru.

The convenience and how people are on the move all of the time now, I don't know that we would see a substantial change there, having said that though, it doesn't mean that we won't pursue other menu opportunities over time to enhance the opportunity for people to come into the restaurant as compared to going through the Drive-Thru.

Thank you.

The next question is from John Ivankoe, JPMorgan.

Thanks.

Just a couple of quick follow-ups.

What kind of benefit are you seeing for the new Point Of Sales system whether in costs, and I guess that includes cost of training and speed of service with the new hardware platform, and secondly Pete, you have kind of mentioned it regarding a leverage event, but your profitability per store, your debt to EBITDA, your debt to free cash flow seems to be so conservative right now, and the cost of debt being at extremely, extremely low levels, especially for a company like yours, even on a 10, or perhaps even a 30 year basis.

So could you kind of walk through, I mean, just a little bit more in terms of why it doesn't make sense for McDonald's to pursue a leverage event at this point?

Hey, Pete, I can take the first one.

New POS benefit, and we call the system New POS, what we are seeing, John, is first a benefit in terms of the ordering ease for the crew in the restaurants, which does give us some benefit in order-taking time.

So we do see some benefit there, which as you know, seconds mean additional capacity, so we are happy about that.

One of the broader benefits of the new technology system is that it opens up additional applications, such as hand-held order taking within the restaurant, and as well outside of the restaurant.

It also opens up additional visibility relative to how we can get the orders back in to the kitchen, and again, increase the speed with which we have the food prepared.

So we do see those operational benefits relative to the new technology system, and also some additional platforms that we could benefit from.

And regarding the conservative position of our balance sheet, John, that is kind of our profile, our strong credit rating is important to us.

It is important to us as a company, but also to the system.

So even though we don't guarantee or do anything like that with our loans for suppliers and owner/operators, the strong credit rating of the corporation provides a halo for them, and they are able to borrow at rates inside of that of our competitors, and so that is important to us, and we are going to return at least $5 billion to shareholders this year, and we plan to grow free cash flow and return all of that next year to shareholders, and incrementally increase the debt, so we think that is a very successful model for us, and one we are very comfortable both from the way we operate the business, the way the system is financed, and the value we are providing to shareholders.

Thank you.

The next question is from Nicole Miller Regan, Piper Jaffray.

Thank you.

This is Josh on for Nicole.

I want to circle back to your gap to the overall QSR industry.

I think previously we had quantified that, and any commentary has that continued to accelerate of late, as it has in 2Q?

Josh, the gap relative to competition has continued.

And I think you are primarily talking about the US, which is where we normally talk about the gap.

However, I will say that we are growing market share in all of the major markets around the world, so we are continuing to grow share, even in cases where some of our competitors may be growing a few more units.

That part of the business is strong.

In the US, that gap again does maintain, and we are continuing to gap the competition, and I would also offer.

Our numbers last year were still positive numbers, so we are gapping the competition at a time when their comp numbers are in some cases going up against much softer comps than we had.

Again, business is pretty strong in the US right now.

And that gap for the quarter was about 5% in the US.

Thank you.

The next question is from Sara Senatore at Sanford Bernstein.

thank you.

Just two follow-up questions.

One was on China, and one on the US.

The first on China, you gave us the comparisons year-over-year, and some of the initiatives that sound like they have been very successful, but we are hearing that at least in some of the bigger cities there has been a decent amount of price being taken in at least some of the menu items, and so I am just trying to get a sense of A) are you taking more price there, in let's say other emerging markets than you might in developed markets?

And B) does it vary depending on what geographic region we are talking about, big cities versus the smaller cities inside the country, and then I will throw in my question on the US before I get cut off, which is can you just update us on some of healthcare legislation?

I know your Company has been in the news with talks about waivers and that kind of thing, so I just wanted to see if you had any incremental data?

Sara, this is Jim.

I'll talk about the healthcare, while these guys figure out what to tell you about the pricing in China.

First of all, the Act wassigned into law in March of 2010, and now they are going through a lot of sorting out of the details relative to the full implementation which doesn't happen until 2014, and so the administration continues to work very hard with companies like McDonald's to sort this out, to make sure that we are implementing this the appropriate way, so that most people that have access to healthcare are going to be covered appropriately.

The flap that I am sure that you are referring to had to do with the limited benefit plans, the mini meds as they were called, that cover some 30,000 people in McDonald's.

But 1.4 million people across America, which is interesting to know, and there was a headline saying that we were going to drop coverage.

Well, we were never ever going to drop coverage.

We are always going to provide coverage, but the regulations around the insurance companies, and their obligations to cover these mini med plans was in jeopardy without a waiver.

Now we think Health and Human Services is going to be very good about giving waivers to companies that are going to be able to continue to cover these very important people on these smaller plans.

Other than that, there is not a lot more to say about healthcare.

Certainly there is a lot of pushback on the one side of the aisle relative to the Republicans, and the mid-term elections and everything going on here, but for us the diligent work around proper implementation of this plan, both with our franchisees through the Administration, and working closely with them to make sure we get it right is where we are spending our time.

And that is really all we have to say at the moment, and it is work in progress.

And in terms of pricing, Sara, in China, I would characterize any price increase that we have had over the last 12 months as modest.

We said the APMEA had averaged about 1%, and China was probably in line with that.

In other emerging markets, I mean Russia is probably the one where we have had the greatest input inflation and the highest amount of price increase.

Thank you.

The next question is from Rachael Rothman, Susquehanna.

Rachael, are you still there?

I know we are almost out of time, but we had a couple of people in queue so we kept going, I am guessing that Rachael dropped off.

We had one other one, Peter Saleh from Telsey Advisory Group.

Great, thanks for taking my question.

I was wondering if you could give an update on coffee as a percentage of sales, and how that compares to last year at this time, and just where do you think that could go to over the next year?

Coffee percentages, in the US as you all know several years we were about, I think in 2004 at about 2%.

Total coffee has grown to over 6%, and that really includes the whole McCafe lineup.

So really positive growth there.

Jim mentioned UK.

In the UK we sell now the most coffee of any of the purveyors that are there.

We see opportunities in many of our other markets, whether that be in Europe or across the other markets like France.

Germany we have 600 McCafes that are there, so we are continuing to grow our coffee business there.

So we do see coffee as a point of leverage and growth for us as we move forward.

Okay.

I think we are out of time now, and out of questions, so I will go ahead and turn it over to Jim for a few closing remarks.

Thank you, Mary Kay.

Thanks for joining us this morning, and in closing I want to reiterate that McDonald's global business is strong.

The system alignment behind our plan to win, and its focus on the customer, we will continue to deliver results.

We will further strengthen our leadership position through collective efforts around our menu, restaurants, and the entire brand experience, and working together I am confident that we will continue to drive long-term growth and become our customers favorite place and way to eat and drink.

Thank you all.

Have a great day.

Thanks.