Hello and welcome to McDonald's July 23, 2012 Investor Conference Call. At the request of McDonald's Corporation, this conference is being recorded. Following today's presentation, there will be a question-and-answer session for investors. (Operator Instruction) I'd now like to turn the conference over to Ms. Kathy Martin, Vice President of Investor Relations for McDonald's Corporation. Ms. Martin, you may begin.
Thank you, and good morning, everyone. With me on the call are President and Chief Executive Officer, Don Thompson, and Chief Financial Officer, Pete Bensen. Today's conference call is being webcast live and recorded for replay via phone, webcast, and podcast.
And before I turn it over to Don, I want to remind everyone, as always, the forward-looking statements in our earnings release and 8-K filing also apply to our comments. Both of these documents are available on www.investor.mcdonalds.com, as our reconciliation of any non-GAAP financial measures mentioned on today's call with a corresponding GAAP measures. And now I'd like to turn it over to Don.
Thank you, Kathy, and good morning, everyone. It's my pleasure to join you today in my new role as CEO, and I'm honored to lead this great system of first classed owner operators, supplier partners and company employees. And I’m confident that together, we will continue to build this business for all of our stakeholders under the umbrella of our global plan to win. As I said on our last call, we will stay the course; the recent change in management does not mean a change in strategy.
With that, let me provide a perspective on the quarter results and an overview of our plans as we continue to navigate this environment in the short-term and drive the business for the long-term benefit of our system and our shareholders. McDonald’s continued its solid performance in the second quarter. We’ve continued to grow market share despite a slowing global economy.
For the quarter, global comparable sales were up 3.7%, operating income increased 3% in constant currencies, and earnings per share reached $1.32, a 3% increase in constant currencies. And in July, global comparable sales are expected to be positive, but less than second quarter. We’re experiencing stronger headwinds on both the top and bottom lines.
Some of the headwinds are macroeconomic such as declining consumer settlement and higher commodity and labor cost. Other pressures are the result of planned strategic decisions we’ve made to grow the business. these include actions we've taken to enhance our value platforms, our worldwide owner, operator convention; it brings the system together every two years and investments in technology initiatives.
Despite these demands, the system remains aligned around the plan to win in our three global priorities to optimize our menu, modernize the customer experience and broaden accessibility to brand McDonald’s. We’re focused on driving results in this environment by continuing to refine our efforts around these priorities to address local market conditions.
So let's start with the U.S. where comparable sales increased 3.6% for the quarter and operating income rose 2%. The U.S. continues to build sales and guest counts. It is however happening at a slower pace amid an unpredictable economic environment and increased competition. Sales gains during the quarter were driven by everyday value across a variety of price points and new menu news. Breakfast continued the strong momentum with local market emphasis on core breakfast sandwiches and the introduction of Blueberry Banana Nut Oatmeal in May.
Beverages were also a key contributor to growth. The new Cherry Berry Chiller helped to drive beverage sales on top of last year’s strong results, from the launch of Frozen Strawberry Lemonade. Relative to our core products, our 20 piece Chicken McNuggets were highlighted on the new extra value menu, which provides value across multiple price tiers. As a result, total sales of Chicken McNuggets increased nearly 11% during the promotional period when compared to the same time last year.
Now our focus remains on driving guest counts and we are resigning our plans as the environments shift. These plans are balanced across product categories and price tiers. For example, we’re enhancing everyday value with new news and promoting core and premium products for exciting games like the Olympics sign which is starting today.
And to ensure customers have more reasons to visit us in a near-term, we will continue to leverage promotional food events like Spicy Chicken McBites and also additional McCafe flavors. Our new product pipeline also includes several new beef and chicken products and additional innovations around breakfast and beverages was currently testing a number of new products, some of which have been adapted directly from other areas of the world.
Turning to Europe, second-quarter comparable sales were up 3.8% and operating income grew 8% in constant currencies. The UK and Russia delivered strong sales for the quarter, and while France and Germany are also positive. These two markets are feeling a pressure of the ongoing Eurozone difficulties. Europe’s IEO industry is contracted as austerity measures continue to impact consumer purchasing power and confidence. Despite this, however, the UK, France, and Spain have gained market share. And in Germany and Italy, we are maintaining our share. So although year-to-date guest counts are down in several markets, we are faring better than the competition.
Europe is re-energizing its 2012 plans. Those plans are being re-energized to drive traffic in this environment. Markets are also placing an even stronger focus on value offerings across the menu and on promotional food events featuring premium products. The UK’s success is mainly been driven by a balance of popular menu offerings in the second quarter.
The great taste of America food event as an example boosted average check, a focus on daypart expansion also contributed to results, especially at breakfast, with a new wrapped (inaudible) pork sausage, bacon eggs, potatoes and cheese wrapped in a soft flour tortilla.
Russia also continues to perform quite well with a strong focus on breakfast, lunch and beverages. Second quarter marks the seven consecutive quarter of double-digit comparable sales growth in Russia.
In France, we’re increasing our media spend to further strengthen our share of voice and increasing the focus on our popular Petit Plaisir line up of smaller premium sandwiches that are priced at a mid-tier value. Germany consumers remain deal conscious in an increasingly competitive environment. We stepped up our value messaging to consistently remain customers of the great everyday value that they can get at McDonald’s.
The market recently implemented mid-deal of value meal that offers a chicken classic or McChicken classic or a hamburger, Royale with Cheese along with a fry and a drink for €3.79. This contributed to strong sales and guest counts in the month of June.
Germany is also leveraging its nearly 800 McCafes with new [news] including bubble tea. This is helping strengthen multiple dayparts including breakfast and afternoon snack. From value and variety on our menu including the McRib, which is now available in 24 markets, to our ability to offer more convenience options like cashless payment in 85% of our restaurants. We are providing European customers with what they want. And our commitment and ability to execute a great relevant experience for the customer is evident in our improving customer satisfaction scores as well.
Now shifting to Asia Pacific, Middle East and Africa or APMIA, comp sales were up 0.9% for the quarter and operating income increased 1% in constant currencies. Across this region, we are seeing fragile consumer confidence in Australia, Japan’s uneven recovery, and an economic slow down in China.
We are positioning our markets appropriately in this environment with strong value platforms to build traffic. And we will complement these platforms with average check builders that include new food news and brand extensions.
Australia’s second quarter comparable sales growth was due in part to strong breakfast results, as well as the successful launch of its Olympics promotion. Additionally, the Loose Change Menu introduced in late March has helped drive guest count and sales. And as expected, once customers realize that this value offering is not going away, the use of the menu has leveled out and they are beginning to trade up to other items like extra value meals.
Japan continues to grapple with a difficult economy coupled with ongoing disaster recovery and anticipation of energy restrictions. This is taking a toll on consumers who are now eating more meals at home. Despite a significantly contracting IEO market, we continue to grow share this quarter. We responded to customers needs by rolling out a new multicare platform the 100 yen, 250 yen and 500 yen menu. We are feeling to even more customers with this new branded affordability platform. Unlike any market that implements value, our strategy is to drive sales and profitability by trading these visits up to extra value meals and other premium offers.
Utilizing our philosophy to learn, share, and scale, Japan is growing its beverage business by promoting trail of ice coffee from the U.S. through sampling events. Turning to China, in China, consumers are reacting with greater caution as the economy has slowed. We’ve seen this particularly in our tier 1 cities where we are more heavily concentrated. We're also seeing high competitive activity focused on value.
In China, branded affordability has been a key part of our strategy over the last few years and we are staying to course. Value lunch and the recently launched value dinner are driving sales and guest counts that contributed to second quarter’s comparable sales increase of 2.2% and market share gains in our top five cities.
China spent this growing daypart continues to be breakfast. Our ability to bundle convenience with uniquely McDonald's products is resonating with customers, not only this is daypart now represent more than 9% of sales in China, it continues to grow. We're also making sure that the brand is accessible. We remain on track to open 225 to 250 restaurants this year and also continue to focus on conveniences like make delivery and dessert kiosks.
As you can clearly see, we are operating at a more difficult global environment. And this environment requires us to be even more flexible and aggressive, particularly as economic and consumer volatility persists. And although we’ve continued to deliver positive results, let me be very clear, we’re not satisfied. We remain focused on appealing to customers more than anyone else as we run the business for the long-term.
The headline is this, we have a resilient business model, a talented and aligned system, and experience in every type of operating environment. We’re staying focused on the things that will continue to differentiate us like our new restaurant designs. We’ve already reimaged 1,000 restaurants around the world this year and remain on target to meet our goal of more than 2,400 reimages in 2012.
And, we are on course to build over 1,300 new restaurants this year in emerging markets like China, Brazil, India, and Russia, and also in more established markets including the U.S., France, Germany and Australia. We will continue to go after these new store development opportunities when and where appropriate. We have the discipline, the capital and resources to continue to do this successfully.
Now as our business grows and continues to generate significant levels of cash, our philosophy for its use remains the same. We will reinvest in the business first, and after that we’ll return all free cash flow to shareholders. In fact, in the second quarter, we returned $1.6 billion to shareholders through a combination of dividends and share repurchases.
In closing, we understand what we are facing. From a macro economic environment to an increasingly competitive landscape, we’ve been in situations like these before and we’re drawing on net knowledge and experience to manage through these times. By remaining committed to our long-term strategies to optimize our menu, modernize the customer experience and broaden accessibility to brand McDonald’s while continuing to fortify our shot-term plans, I’m confident we will continue to grow the business for the system and our shareholders.
And with that, I’ll turn it over to Pete.
Peter J. Bensen
Thanks, Don, and hello, everyone. Our focus on the plan to win and the three global priorities of optimizing the menu, modernizing the customer experience and broadening accessibility continue to fuel solid top line performance. I’d like to start with a few higher level comments about the quarter and then get into more detail on the results.
As you know, the macro economic environment for the past several years has been challenging and unpredictable. Our global diversification has been an advantage, as pressures felt in certain markets were often balanced with stronger performance in others.
In second quarter 2012, this wasn’t necessarily the case. While we face significant cost pressures as expected, we also experienced slower sales growth in most of our major markets. Persistent unfavorable economic conditions are weighing on consumer sentiment and spending. And in many markets, we are continuing to experience flat to declining IEO traffic along with a heightened competitive landscape.
We are employing different tactics in each market to address this with the common theme being increasing the emphasis on value in the short-term to drive traffic, which is a critical element of long-term sustainable growth. These tactics are likely to take hold beginning later this year.
Relative to cost pressures, company operated margins are negatively impacted by higher commodity and labor costs. In many markets, this was on top of mid-single digit commodity cost increases last year.
Higher G&A expenses were also a headwind. As previously communicated, the $100 million of incremental G&A investments this year are negatively impacting operating income growth, especially in second and third quarters. We believe these investments in technology enhancements, Olympic sponsorship and our world-wide convention are foundational to future growth, and the long-term health of our business and brand. While we’re not satisfied with these second quarter results, they are not entirely unexpected. We previously communicated that second quarter operating income growth would be affected by the volatile global economy and related headwinds along with our near-term investments.
In keeping with our historical practice, we will not be updating or providing earnings guidance going forward. While earlier this year we disclosed that we expected to meet our long-term average annual constant currency financial targets, based on what we know today considering recent trends along with the heightened global economic challenges, it appears likely that we will end 2012 at or somewhat below the 6% to 7% constant currency operating income growth target.
Now turning to results, in second quarter, system wide sales increased 6% in constant currencies. We continue to grow both global comparable sales and guest counts and are now serving 69 million customers per day, 3 million more than a year ago. This contribute to a 6% constant currency growth in franchise margin dollars and at $1.9 billion they represent approximately 70% of total restaurant margin dollars. The franchised margin percent was up 10 basis points to 83.2%.
Global company operating margin dollars for the quarter totaled [$815 million] and we’re up 1% in constant currencies. The margin percent decreased 80 basis points to 18.2%, as a result of softer top line results coupled with increased cost pressures. To put that 18.2% into perspective, it is our third highest second-quarter margin since the year 2000.
In the U.S., second quarter company operating margins declined 90 basis points to 19.8% as positive comparable sales were more than offset by 5% higher commodity costs and to a lesser extent, higher labor and occupancy costs. As a result of risk management efforts and supplier production efficiencies, the full-year outlook for the increase in our U.S. grocery basket has been lowered to 3.5% to 4.5%. This implies the second half increase of approximately 2%, which should be fairly balanced between third and fourth quarters.
In terms of pricing, the U.S. is running about 3% for the trailing 12 months. The food-away-from-home inflation index is projected to be up 2% to 3% in 2012. If it ends the year closer to the bottom end of the range, we may have a little less room to take pricing in the back half of the year. As always though, we will be thoughtful with future price increases speaking to maintain positive guest counts.
In Europe, second quarter company operated margins decreased 30 basis points to 19.3%, primarily impacted by higher labor expenses, 4% higher commodity costs and to a lesser extent, higher occupancy costs. Europe’s projected full year commodity cost increase remains at 2.5% to 3.5%, which implies a second half increase of approximately 2% to 3%. As noted earlier this year, we have less pricing power in Europe than in the U.S. primarily due to the austerity measures. Our price increases vary by market with Russia at the high-end due to a significant inflation and all other markets averaging about 2% year-over-year. As [we’ll have] prior year increases during the second half of this year, we will likely replace them with more increases.
Turning to Asia-Pacific, Middle East and Africa, company operated margins for the quarter decreased 170 basis points to 15.3% as modestly positive comparable sales were more than offset by higher labor, commodity and occupancy cost. In addition, new restaurant openings in China negatively impacted the segments margin percent. EMEA’s guest count increases significantly out paid comparable sales increases for the quarter. So we are encouraged by the efforts of our franchisees and company employees that resulted in increased demand for brand McDonald’s throughout the region.
As Don mentioned, in Australia, where we introduced a more robust value platform in mid March, comparable sales are steadily improving as consumers migrate beyond the value platform to the rest of the menu. This overall trend is in line with what we’ve seen in other markets, when new value platforms are introduced.
Turning to G&A, second quarter cost increased 8% in constant currencies, primarily due to higher employee cost, our biennial worldwide convention in April and investments in technology enhancements. Our convention was a great success with 16,000 attendees walking away focused and aligned on our key strategies. It also provided a great opportunity to learn and share ideas from markets around the world, allowing us to better leverage our size and scale. Looking to third quarter, we expect a double-digit increase in G&A given our sponsorship of the upcoming Summer Olympics and Paralympic games in London.
With regard to other operating income, gains on sales of restaurants included the sale of 13 restaurants in two provinces in China to developmental licensees, bringing our total number of franchised restaurants in China to 54.
The second quarter effective tax rate was 33%, 120 basis points higher than a year ago. Last year’s second quarter rate reflected a non-recurring tax benefit related to certain foreign operations. For the year, we continue to expect the effective rate to be between 31% and 33%.
Our business model continues to generate significant amounts of cash. Our first priority remains reinvesting this cash in our business to build future returns and enhance shareholder value. This year these investments are balanced between opening more than 1,300 new restaurants and reimaging over 2,400 existing locations.
We remain committed to this effort and are making steady progress. Through June, we have opened 450 new restaurants globally. Regarding reimaging, over half of our 33,700 restaurants operate current contemporary interior, while more than a third of our exteriors reflect a new look. Reimaging our restaurants is powerful, because it is a multiyear, multilayered initiative that can enhance restaurant operations, capacity, menu and perceptions of our brand.
We continue to invest on a scale that is unmatched in our industry. It is an increasing point of differentiation and is foundational to our long-term success. Our franchisees are financially strong and have sufficient access to capital allowing them to co-invest with us to secure our collective future. Through the first six months, we have completed over 330 reimages in the U.S., 350 in Europe, and 230 in APMEA. We continue to be encouraged by the results of our reimage locations around the world.
Lastly, let me discuss foreign currency translations, which negatively impacted second quarter results by $0.07. At Friday’s exchange rates, we expect third quarter EPS to be negatively impacted by $0.08 to $.10, with a full year negative impact of $0.21 to $0.23. As usual, take this as directional only, because rates will change as we progress throughout the second half of the year.
In closing, we remain focused on positively impacting those things within our control, and executing on our strategy that has proven to be a winning formula. We will continue to prudently invest today to drive growth into the future, while our business model is resilient. we are not immune from the effect of the ongoing significant global economic challenges. At the same time, we are making some short-term tax co-adjustments to address the current environment, while continuing to build a solid foundation for long-term success. We will not waver in our commitment to create enduring value for our shareholders and the entire McDonald's system.
Thank you. Now I'll turn it over to Kathy, to begin the Q&A.
Thanks, Steve. I’ll now open the call for analyst and investor questions. (Operator Instructions) So let’s begin. First is Michael Kelter from Goldman Sachs.
Michael Kelter – Goldman Sachs
Hi, guys. I wanted to ask about the focus on value and the potential impact of profitability. So, in the short and mid-term, what are the risks that you have to meaningfully invest your margins from here to achieve the traffic results you’re looking for? And then in the long-term, how do you balance any potential risk for the McDonald’s brand itself in Europe and the world – when you refocusing the conversation on value and [sensibly] training consumers who want to pay less for your products?
Hey, Michael, this is Don. Just, first of all thanks for the question. A couple of different things, relative to value this is part of a – its part of the platform relative to any of the media expenditures in any one of the countries that we operate in. So, value is not a new thing. The question is how much you address it relative to your marketing and media mix.
The other thing that we have to do is to make sure that we have a consistent value platform. So, we have talked about consistently last year and this year, several markets, whether they’d be Australia, which was facing some economic difficulties in tough times and the need to have a consistent value base and now they have loose change, which was implemented really at the end of the first quarter and really into the beginning of the second quarter.
We talked about Germany relative to McDeals. Our new Chief Operating Officer, Tim Fenton was just out with them. And it is in a feeling value to consumers. At the same time, we mentioned that we have to also have a premium product messaging in the marketplace. And so we have not given up on that. All it is a tweak if you would relative to our media expenditures. But we’ll continue to talk about the premium products, whether it would be in the U.S., Australia, Germany, Japan, France, any of these markets.
All right, thank you. Next question is David Palmer from UBS.
David Palmer – UBS Investment Bank
Good morning, guys.
Good morning David.
David Palmer – UBS Investment Bank
Just a question on the cost side, when I listened to other global consumer companies often on the stable side, they talk about managing the cost and scrutinizing CapEx particularly as the going get tough. I was wondering and thinking, as you think about these coming years, it doesn’t look like this environment is going to be easy going forward. And right now McDonald’s is in a, what it looks like to be an investment phase both on the overhead side and the CapEx side. Is that aside when it comes to cash flow and P&L are you thinking about those things and thinking about scrutinizing those a little bit more as you kind of settle into a reality that’s tougher?
David, that’s a good question. First of all, I’ll say, around McDonald’s we’ve always had a practice of securitizing the costs. So while you reference the investment in overhead, I think we try to make it clear while we talked about the $100 million of incremental G&A this year that, that’s not necessarily a run rate that you can project into the future. Two of those items, the Olympic and the Convention are isolated to 2012 and our investments in technology while those will continue the rate of increase relative to prior year, next year will not be at the same level that it was this year. So take those things aside, we were always scrutinizing cost and looking to be as effective and reallocate cost to drive more sales as we can.
Regarding CapEx, while you indicate the environment going forward maybe a little tougher, we don’t see a fundamental shift in our business model. And so we continue to know that if we reimage our restaurants, we will create that brand differentiation, we know that even in these environments there continues to be increasing demand for brand McDonald's going forward. So we will continue to build new restaurants where we see there is to be good opportunities then we can generate good returns. So well, we are a little more cautious going forward, we don’t see a dramatic change.
All right. Thank you. Next question is John Glass from Morgan Stanley.
John Glass – Morgan Stanley
Thanks. I also wanted to come back at the margin questions, maybe just a little more specifically, your global comps are 3.7 this quarter, so nearly 4% in that than you had in the store level including food costs now, you didn’t really lever labor and some of the other items, and on the franchise side, you got a little bit of leverage, but not much. So is this just an expression of the minimum comp you need and we have a view that comps are going to go now below this and so in the third quarter, is there a risk to de-levering those items or going back to the prior question, are you able to flex? And then secondly, since you talked about food cost pressures abating in the back half, which is good news, obviously, the current commodity market doesn’t suggest that’s going to stay good news for long, can you maybe comment about your early views about ’13 in that context? Thanks.
Hey, John, I’ll talk a little bit about the flex piece and then ask Pete to talk a little more specifically about margins. One of the things that we do on a routine basis is we have clearly reviews and visits with all of the markets around the world particularly our top 10 markets. And what we really talk about is where they are positioned in terms of the opportunity to grow the business. As we look at the totality of all the markets, we then make any adjustments or capital allocations, reallocations, necessary for us to go to the real market opportunity, but always being mindful of what’s taking place from consumer a level. So there are markets today then initially we began out thinking we would deploy even more capital into, but right now, we may not be performing at a level to manage that kind of capital based upon comparable sales increases and therefore returns. So we on a constant basis, look at each of the markets and how we will flex in and out in terms of any of the investments that we make. And then I’ll ask Pete to speak to some of your margin questions.
Peter J. Bensen
Yeah, John, regarding the commodities, our supply chain folks, our suppliers, our treasury folks really spend a lot of time earlier this year in looking at the markets and did a great job in securing a lot of our grains and other commodities at cost before they ran up related to the recent drought. And so that’s why we’re able to lower our outlook for this year and you can imagine, while we won’t get into specific details, we’ve taken a greater amount of coverage for the next year, sitting here at this time, than we did half a year ago. So we feel pretty good that the impacts from the drought are going to be minimized, our next year’s results as well to the extent we can see that sitting here today. But as you referenced, margins are still a top line game. And so they are dramatically impacted by our comp sales and to the extent the comp sales soften, that’s where you see that deleveraging.
Our next question is Jeff Bernstein from Barclays.
Ashwin Gorur Shandilya – Barclays Capital, Inc.
Hi, this is Ashwin Shandilya filling in for Jeff. I just wanted to ask basically, in Europe where you’re emphasizing more value in other markets as well. Using history as a guide, can you maybe talk about the consumer response such are focused in the short-term? I mean, I know maybe some pressure on the average check in the short-term, but for how long does that occur before customers refer it back to more normal delivering behavior. And secondly, are there major markets where you’re perhaps being more or less aggressive on value and what are the expectations of those markets. Thanks very much.
Thanks for the question. There are certain markets that we have focused quite intensively on, this year and also the latter part of last year to establish what we call as a value platform and we’ve talked about some of those markets, Australia, Germany where we knew consumer confidence was really in question relative to the expenditures and they also have a higher propensity for savings. France, we've talked about relative to consumer confidence in the event of austerity measures.
Japan, we’ve talked about relative to what they come through now in this post-recovery from the Tsunami, they’re also in a tough economic environment, and clearly markets like the Spain’s and Italy’s of the world, and at southern part of Europe that are having some difficulties. In the U.S., value will always be a major factor, but we have to balance it as one of the earlier questions was mentioned, with premium products, with some of the beverages to offset some of the potential erosion in margin. relative to how long it takes before you recover and what you see initially. Typically, when you bring forward a new value platform, as I mentioned in the comments, customers are not used to that. in some times, I think it’s going to go away. so what they begin to do initially is that they will use that menu from a purchase intent perspective much more slow initially. That usually does vain, sometimes, it may take six months; sometimes, it may take a little less or little more depending upon the overall economic situation in the country.
Okay. Our next question is Keith Siegner from Credit Suisse.
Keith Siegner – Credit Suisse
Thanks. I have a question just more about the branded affordability in the U.S. I know you just talked about how it’s always been a major factor, always been important. But one of the things that was mentioned in the call was, should the food-away-from-home inflation kind of come in at the low end of your expectation, it may limit your ability to take some pricing in the second half. Just looking back over the last couple of years, I think it’s interesting because after several years of running below food-away-from-home inflation kind of year-to-date, you’ve been kind of in line, maybe even slightly above. and thinking longer-term, how do we think about the broad-based positioning against that? And kind of may be regardless of the outlook, should we think of a low-cost pricing environment in the U.S. to continue to maybe come back some of the competitiveness?
Hey, Keith, there are a couple of things and Pete may have a comment on this as well. So food away from home is one – it’s the baseline, it’s the most predominant measure that we’ve historically reuse. But I have to say this, we’ve also used food at home from a grocery store price index perspective, as well as commodity costs and labor costs. And so what we have to do is, look at what we think will be – what will be within the range of price sensitivity and acceptable to a consumers which has typically been food away from home. But also we have to look at what the direction of commodity. So if commodities like they’re going to really ramp up. We want to make sure we’re in a position to minimize the impact of margin erosion by taking appropriate price increases.
There are times when we will bump up against as you mentioned food away from home or even for a very short period, we may actually eclipse it, but we’ll bring that right back in line. And that’s just part of the ongoing management of what’s taking place in a broader marketplace in terms of food costs, labor pressures, and then understanding what’s happening with consumer confidence and disposable income.
Peter J. Bensen
And I think Keith, it also – it’s fair to assume in that kind of pricing equation if you will or pricing formula, we do look at what’s going on the menu boards at the competition. So, the competitive environment does, also factor into it, but Don highlighted that, it’s the more macro factors that we do look at.
Our next question is from Matt Difrisco from Lazard.
Matthew Difrisco – Lazard Capital Markets
Thank you. Pete, I wondered if you could talk about the dynamic of the franchise margin in the U.S., and try and help us understand maybe how that looks going forward, as far as it’s been a several quarters of a run of margin expansion on the franchise side in the U.S. and now it’s sort of flat year-over-year. You can put that into the context of what, how those – how that dynamic works going forward in an environment where – I think in the press release you said that the same store sales are going to be a little or guided to be a little slower in July and ahead than they were in 2Q?
Peter J. Bensen
All right, Matt. First, let me – July, and I know this is generally out there, but July we are facing a negative 1.8% trade day impact. So that is impacting July, as well as the fact that Ramadan is staring – started last week, so we are going to have 10 days impact of Ramadan this year in July when that was entirely in August last year. So those were a couple of things to think about when reflecting on that July guidance.
But as we said earlier, the same thing applies to franchise margins even more so that applies to company operated margins is that they are a top line gain. So they’re really driven, we get tremendous leverage when we are driving comps and they tend to slowdown as comp sales slow.
The other thing specific to the U.S. is with the reimaging that’s going on. We are seeing a greater increase in depreciation expense. But typically depreciation is one of those fixed costs that you could leverage with the increased sales, but with the progression of increasing the reimagings, we are continuing to layer on some additional depreciation expense, that will continue in to the near future.
All right. Our next question is from Joe Buckley from Merrill Lynch.
Joseph Buckley – Bank of America/Merrill Lynch
Thank you. Pete, I was wondering if maybe you’ve done this already, but could you breakdown the $100 million of G&A among the three things you’ve mentioned, the April convention, the Olympics and the technology program?
So, Joe, we’ve somewhat broken it down, and that we’ve said, half of that relates to the convention in the Olympics and the other half relates to the IT investment.
Joseph Buckley – Bank of America/Merrill Lynch
Okay. Thank you.
All right. Our next question is from Mitch Speiser from Buckingham Research.
Mitch J. Speiser – Buckingham Research Group, Inc.
Great, thanks very much. And I’d like to ask another question about margins. In the global margin at the store level, I believe it was down about 80 bps. And Pete, is it possible just to give us a sense of maybe how much of that contraction was due to increased focus on value? And as we look out over the next couple of quarters, do you expect that emphasis to heighten or are we kind of there already? Thanks.
Peter J. Bensen
Yeah, Mitch, it’s hard to pinpoint precisely how much of that is related to our increased focus on value. And specifically, Don, alluded to this a little bit, when we say value, it’s not just that entry point value, so it’s not just the dollar menu or the one euro items in that menus. It’s also some of those premium food events that are a relative value compared to the rest of the marketplace. So I know we talk a lot about value to drive transactions and the implications there, that is the entry level value and a lot of that is, but it also has different forms across the menu board. But I would say that as we focus more over these next couple of quarters, it is likely that the impact will be a little bit more, will be greater in the next couple of quarters.
Hi, Mitch, just one point on this one is, what we’re facing now from a global economic perspective is, we’re just seeing more markets that have consumer confidence issues, and what we will consider to be more substantial levels. so this notion of value and the way we’re talking about branded affordability, while it is not necessarily new in all of the markets, what we’re finding is that we have to again quake up our messaging, our GRPs, our marketing spend just a little bit more to appeal to some of these consumers who frankly have less confidence in the overall economy, and therefore reduce the disposable spending. and so, that’s why we’re having as many conversations about it.
But having said that, we've been doing this in each of these markets over time, so it's not – they're not typically new things, there are a couple of markets where it's new, Japan let’s say or in Australia with loose change, but particularly as they’ve been in France, the U.S. has had a value based menu, Germany’s had SMS. What we’re finding is we may need to quack that up just a little bit more to appeal to some of these consumers. This is the time for us to really focus on guest count growth and market share gains. And so we’d really go at this very hard in times like these even though that means an investment.
Our next question is from John Ivankoe from JPMorgan.
John Ivankoe – JPMorgan
Hi, great. Thanks. First, just a really quick follow-up and then the question. Pete, when is that IT investment recur in fiscal ‘13 or is it the $100 million gone from fiscal ’13, so that’s the first question? And then secondly, just thinking about the UK, I mean obviously, there is the Jubilee and the Olympics and there has just been so much kind of going on into that market overall. I mean how do you think about the UK in general and in the second half of the year and in the ‘13 and is McDonald’s doing anything proactive to perhaps prepare for, I don’t know if that happens or not, but a slowdown like it happened in the UK for the rest of Europe as some of these events come in the past?
Peter J. Bensen
Hey, John, I'll take the first part of your question, and then Don can give you a perspective on the UK But the $50 million incremental technology investment spending this year, that will stay in our base and that level of spending will recur next year. So to say it differently, $50 million for the Olympics and conventions does not repeat next year, but the technology spent continues, but obviously, at a zero increase, if we spend the same amount. With that, I’ll ask Don to talk about the UK.
Hi, John, Beijing – so if I look back to Beijing, Vancouver, post the Olympics, what we typically do is, we go back to business as usual. So we don’t foresee a huge shift or change in terms of our base trim line in the UK as we move forward. Having said that, the UK will be facing some tougher austerity measures in the latter half of the year, and so as those things come into play, we’ve got to again make sure, we’re looking at all of the macro economic factors in the market and making appropriate adjustments. We’ve done quite well in the UK, we’re balancing our growth across all the menu tiers and that will continue. But we’ll have to continue to look at the market, but right now, we don’t foresee anything that will cause a substantial change in the base trend line.
All right. Our next question is from Jason West from Deutsche Bank.
Jason Taylor West – Deutsche Bank Securities, Inc.
Yeah, thanks guys. I just wanted to talk about the U.S. market a little bit, you’ve obviously seen somewhat a down shift in the sales trend though the others are still healthy. You’ve seen a slow down from the last couple of quarters. If you could talk about how much of that is kind of a consumer macro driven, I’ve seen people trading down to the dollar menu, value menu, things like that versus competitive activity that you’ve alluded to. It seems like the competitive activity not necessarily value oriented all the time, some of its new product oriented and just marketing oriented. If you can just kind of compare that to maybe other periods of slow down? Thanks.
Great question, Jason. A couple of things, we’re seeing a hike in competitive activity across the IEO marketplace, which is an interesting point because it’s not just in QSR, we are seeing it across all of IEO from fast-casual to convenience and grocery stores. I haven’t said that, for us as McDonald's what matters most is to remain focused on what’s within our realm of control. So we will talk about the value platforms, we talked about beverages, breakfast, we talk about premium based products and promotional food events like McBites. We’ve just got to make sure that we are appealing the customers more so, but we are seeing to your point, we are seeing that competition.
Now, the other thing is that there is an increase in terms of marketing spend by many of the folks in the competitive segment. So we have to clearly be able to make sure that our strength of voice and our share of voice is still resonating with consumers out there and we build awareness for the McDonald's brand. So this is not new, we go through competitive fresher’s and there will resurgences and a kind of ebbs and flow from time to time. But what it means for us is we just got to be focused on our business plan and execute that at the highest level.
All right. Our next question is from Andy Barish from Jefferies.
Andy M. Barish – Jefferies & Co., Inc.
Yeah, can you just give us a little sense on sort of the China business, how much the last quarter slowdown was kind of – your thoughts internally, more value kind of value dinner having a negative impact on mix et cetera versus sort of the external environment, if there is a way you are sort of looking at that?
Yeah, Andy, relative to China, so clearly we’re seeing a little bit of a slowdown economically and we talked about the Tier 1 cities, which is where we are, which is where our presence is absolutely the strongest, it’s where we are concentrated. Those markets seem to be facing much stronger macro economic pressures than clearly the Tier 3s, 4s, those cities that are outside of the core in terms of where our focus has been. So we are seeing some macro economic pressures.
On the value side, we are seeing a little bit more media and marketing around value-based products. Clearly, I think we are in a pretty good position there relative to the overall marketplace in China. But the other thing is that, for us, it’s got to be consistent when you execute value. So, if you look at last May, June timeframe, we were running 13% and 16% comps. And so as we went into this year, we knew that those were fairly high hurdles.
Nonetheless, if we execute the existing value lunch strategy, value dinner adding strategy; breakfast is our fastest growing take part in China. We’ll continue to do well in the marketplace. But we have focused on a little bit more based on consumer confidence measures. We have focused a little bit more on a value side in China as well.
Our next question is from Howard Penney from Hedgeye.
Howard W. Penney – Hedgeye Risk Management LLC
Hi, thanks very much. I was wondering if you might be able to quantify what you are seeing in the global markets as you’ve described in the call today, the slowdown anyway that you are seeing from the consumer, because you’ve done 5.4% comps for the six month this year, your worst year in the last five was 2008 at 3.8% for you or 2009 at 3.8%.
So, you’re doing, I think significantly better and you had a better earnings performances, I don’t believe you missed the numbers back in 2008, 2009. So, what is that in the global marketplace that you are seeing is causing the issue McDonald’s is seeing, from a top line perspective you’re doing much better than what is arguably a far more difficult economic environment in 2008, 2009?
Peter J. Bensen
Howard, couple other things, one is that we started this year and we had the benefit of the leap year and we had the benefit of the unusually warm winter, in a lot of places around the world. So the first quarter while it was strong, there were a couple of things that boosted that beyond the wherewithal normal performance churn event. But as you look around the world, I’d say, one of the changes is just the length of this economic challenging period. Back in ’08 and ’09, I think people thought this was an issue, it was going to come, it was going to go, it didn’t dramatically change consumer behavior. They did change some, but not dramatically, and I think now, that it’s persistent for so long, and especially in Europe, it’s gotten so much deeper in some of these countries that it is really starting to constrain consumer behavior, several of the markets there, the Eating Out market is just simply declining. People are staying at home, they aren’t going out and the magnitude of the issues in Europe are having ripple effects around the world. And the most significant is, it is impacting the consumer’s behavior and whether that means they are saving more or they’re just going out less. All in all it is meaning more flattish to declining eating out generally around the world.
An interesting point, we look at it quite often is, we’ve been at points what we’ve seen is one or two markets of our top 10, maybe three or four that might be experiencing some of these consumer confidence issues, this is one of the first times when we’ve seen in a much broader base perspective, so it’s a little bit more than European cold, if you would, it’s kind of a little bit more a global piece that we’re seeing, across the board. So what all it means for us is that the things that we’ve employed historically, we’ve got to make sure that we’re in the best position again to drive in, additional traffic in the restaurant to be able to trade those up, but we’re making substantial investments to be able to do that now in all of the markets that we’ve talked about. And we’re seeing some results in terms of some of that the guest count movement, but we may not necessarily see those sales flow down to bottom line until we’ve got into a point where we can really trade those guest counts up.
All right. Our next question is R.J. Hottovy from Morningstar.
R.J. Hottovy – Morningstar, Inc.
Good morning. And I just wanted to follow-up on the product pipeline that Don had mentioned in the U.S. You gave some hints about some new products that maybe in the pipeline. but maybe the broader question just more specifically what we may be seeing in the back half of the year in 2013, and based on the success of McBites program earlier in the year, there’s any learnings or any product platforms you’ve seen elsewhere in the world that may be successful or do you think, it may have potential is the U.S. just any commentary on that would be helpful? Thanks.
Peter J. Bensen
Yeah. R.J., a couple of them, you guys have seen that we’ve showed at whether it was a NIM or some of you saying these in business to the innovation center et cetera. but clearly the beverage platform, we’re seeing has quite a bit of resonance and it is being looked at by many markets around the world as we move forward there. But also wraps it’s a platform, you guys have seen the wraps, the wraps are being looked at in many markets around the world, we’re in quite a few countries across Europe right now, but the variations in the wrap whether beef or chicken, your ability even going to shrimp and fish have been quite tremendous, we’ve even done some breakfast work with those wraps as I mentioned today.
So we’re seeing those kind of platforms move around quite a bit. On the premium sandwich side, that was – I think it was at the Investor Meeting, we showed you guys a burger called the Pub Burger in the U.S., those type sandwiches that are more premium beef sandwiches and we can also do premium chickens are some of the sandwiches that have resonated in Europe. And so you can look forward to seeing some sandwiches similar to that, next year for sure impossibly, possibly even the latter part of this year.
And our next question is from Sara Senatore from Sanford Bernstein.
Sara H. Senatore – Sanford C. Bernstein & Co., LLC
Hi, thank you. I wanted to sort of ask the question about the unit growth that you are seeing, you mentioned them growing in emerging markets and then you also subsequently made comments about thinking about allocating CapEx and making sure that the returns are there. I guess when I think about your growth algorithm, the one you laid out, and you said – that you expect to return too. It’s usually I think has some low single-digit comps, or a single-digit unit growth with the top line. I’m just trying to understand, if your growth shifts more toward emerging markets, shouldn’t that mean that for any given amount of unit growth, you probably have less of a contribution to the top line, because they tend to be either lower volume or in the case of Latin America license. So should we be thinking, will that mix become more pronounced over time, I guess this is the question, so that your system wide unit growth may increase, but it will have a diminishing impact on your revenue growth?
Hi, Sara. So we talked about Brazil, I highlighted Brazil as one of those countries, but in Brazil as a development licensee, it was the only country that I have mentioned in large part that is a development licensee wholly from that perspective, When you look at the other countries we’re growing in, whether it be China, yes, lower average unit volumes, but we’re growing quite aggressively as you know in China, the growth that we have in some of the others, the India’s and the Russia’s, other world. In India, we have a developmental licensee and a joint partner; in Russia, that is a wholly-owned market, so it’s all McOpCo; the U.S. we have a mix; markets like France we have a similar mix and closer to that 80% to 90% franchise kind of a range, but it is the traditional franchise. So, we have growth across many markets and the ownership structures are a little different. So as we look at the allocation of capitals, we're looking how we can get maximum returns, but we are also look into see what customers want more McDonald's. That’s the first and most important thing, where are the true growth opportunities to build the business and build a system wide sales.
Our next question is from Phillip Juhan from BMO Capital Markets.
Phillip A. Juhan – BMO Capital Markets
Yeah. Thanks guys. This is Phillip Juhan at BMO. Pete, I was hoping you can may be quantify some of the labor wage rate pressure you’re seeing and where that might be the most secured in terms of geography, it’s a little tough to reconcile with 2% to 3% pricing in place. How you guys are actually thinking, deleverage on that line against the back drop of sort of economic softness in general?
Peter J. Bensen
Phillip, we're seeing wage pressure in virtually every market around the world. U.S. there continues to be increases in the average rate. I think there were seven states that hit normal wage at the beginning of the year at a 4% to 5% clip, which are impacting that. In addition in the U.S. we continue during the quarter to invest labor enrolling in the peek hour and so that added a little bit of pressure to the labor line. If you go into Europe, not only our wage is increasing but some of the austere measures in Europe include, additional social charges, an additional payroll type taxes, that are putting pressure on the wage rates. And in Asia, a lot has been written about China and the pressure on wages there, so we're experiencing wage pressure there as well, so it’s clearly a global phenomenon for us.
All right. We’re about out of time but we’ve got a couple additional folks in the queue. So, we’re going to take these next couple of questions; Joe Buckley from Merrill Lynch.
Joseph Buckley – Bank of America/Merrill Lynch
Yeah, just want to ask about the European same store sales increase in the month of June, actually it was pretty strong and you mentioned McDeal in Germany, but when more value initiatives in place, what sort of the timing of the – [you said about] focus on value in Europe?
Hey, Joe, thanks for the question. Couple of different things, clearly in Germany, SMS and we talked about this back, I think it was April or May, SMS has been stepped up. We have to put more marketing dollars, immediate dollars behind it. Also they created the €3.79 McDeal. So Germany, they did implement that albeit toward the end of the second quarter.
In France, Petit Plaisir is across the Board now. It’s something else that we had mentioned and what they don’t have yet is a one sandwich type price point value but their base value platform is Petit Plaisir. So we haven’t gone all the way to Eurosaver there. At this stage, the franchisees are discussing next steps. But we believe we’re in a pretty good competitive position in France right now.
The UK has continued on Eurosaver’s. Markets like Spain and Italy are in a value proposition called Uno por Uno, and I would tell you Spain has executed this quite well over the last several years and they are performing well even in the state that the economy in Spain has had, but there are other markets.
Italy is a tough market for us. Italy right now even with the value proposition for those of you who visited Italy, you know there is a lot of street side cafes and their value proposition is a lower tier even than what we proposed at McDonald’s Uno por Uno. So, we have to continue to try to see how we can breakthrough in a marketplace like that. So it does vary a bit, but we are seeing some early results nonetheless we have to stay diligent in all of those markets.
And our final question is from Peter Saleh from Telsey Advisory Group.
Peter Saleh – Telsey Advisory Group LLC
Great thanks. I know it’s a little early to be talking about 2014, just wondering what your thoughts are on healthcare costs and if you have any kind of estimates around what that could do on a per unit basis. And what steps could you take in 2013 to kind of get ahead of that.
Peter J. Bensen
Peter, our current estimate is healthcare is going to impact each individual restaurant in the range of $10,000 to $30,000. That obviously a wide range, but there is a lot of different factors when you look at the healthcare law that impacts the number of employees, the number of full time employees, what is the current healthcare offering from the owner operator for McOpCo. So there are a lot of variables, but I will tell you that we are significantly increasing now that the Supreme Court has ruled increasing our conversation and disclosures with franchisees around what this mean for brand McDonald's. So that they can be as educated as possible around what’s happening so that they can start to anticipate and make any changes that they have to try to minimize the impact of this.
And on a just a dollar basis that $10,000 to $30,000, we have years like last year where commodity cost increases were even greater than that. So while this is a significant item and it’s gaining a lot of attention as the P&L item we’ve managed through items of this magnitude in the past and I’m hopeful we can do that in future.
All right. I’ll turn it over to Don now with the few closing comments.
First, I want to thank everyone for joining us this morning. In closing, we continue to deliver solid results, because the entire McDonald’s system, franchisees and supplier partners, company employees, it is the most aligned it has ever been as we continue to execute our plan to win, and the three global priorities that we’ve established in optimizing our menu, modernizing the customer experience, and broadening accessibility to our brand.
I’m also confident that with our solid strategic plans to gain market share over the long-term and the experienced senior leadership team that we have and the ongoing communications we have with franchisees, we’ll continue to grow the business for the system and for our shareholders. We remain steadfast in our commitment to our long-term strategies as we make smart and strategic decisions to mitigate short-term pressures in these challenging times. So, again, thanks for joining us today. And have a great day.
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