McDonald's Q2 2006 Earnings Conference Call Transcript (MCD)

| About: McDonald's Corporation (MCD)
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McDonald's Corporation (NYSE:MCD)

Q2 2006 Earnings Conference Call

July 25, 2006 11:30 am ET


James A. Skinner - Vice Chairman of the Board, Chief Executive Officer

Matthew Paull - Chief Financial Officer and Corporate Senior Executive Vice President

Mary Kay Shaw - Vice President of Investor Relations


John Glass - CIBC World Markets

David Palmer - UBS

Glen Petraglia - Citigroup

Joseph Buckley - Bear, Stearns & Co.

Larry Miller - RBC

Jeffrey Bernstein - Lehman Brothers

Steven Kron - Goldman Sachs

Mark Wiltamuth - Morgan Stanley Dean Witter

Jeffrey Omohundro - Wachovia Securities

John Ivankoe - JPMorgan Chase & Co.

Rachael Rothman - Merrill Lynch


Hello and welcome to McDonald's July 25th, 2006 investor conference call. At the request of McDonald's Corporation, this conference is being recorded. Following today's presentation, there will be a question-and-answer session for investors. At that time, investors only may ask a question by pressing star, one on their touch-tone.

I would not like to turn the conference over to Miss Mary Kay Shaw, Vice President of Investor Relations for McDonald's Corporation. Miss Shaw, you may begin.

Mary Kay Shaw

Hello, everyone and thank you for joining us today. With me on our call are CEO Jim Skinner and CFO Matthew Paull. This conference call is being webcast live and recorded for replay late today via phone, webcast, and podcast.

As always, the forward-looking statements which appear in our earnings release and 8-K filing also apply to our comments. Both the earnings release and our 8-K, with supplemental financial information, are available on investor.mcdonald', as are reconciliations of any non-GAAP financial measures mentioned on today's call with their corresponding GAAP measures.

In addition, in connection with the proposed disposition of our stock in Chipotle through an exchange offer, Chipotle will file with the SEC a registration statement and prospectus that will have important information about the offer. Investors will be able to obtain a free copy of the prospectus and related documents filed with the SEC when available on the SEC's website as well as on our and Chipotle's website, as applicable.

Now I will go ahead and turn it over to Jim Skinner.

James A. Skinner

Thanks, Mary Kay, and good morning, everyone. We appreciate your interest in McDonald's and certainly your participation in this call.

I am proud to say this quarter was the strongest since we announced our revitalization plans. Our momentum continues around the world, with a comparable sales increase of 5.5% and operating income growth of 12%.

Margin percentages were up around the world for the second consecutive quarter, indicating that more is flowing to our bottom line. Notably, our performance is not being driven by a single country or region but is the result of solid contributions from all of our areas in the world.

The underlying health of our business is strong and we remain focused on delivering long-term sustainable growth. We believe our growth opportunities are enormous and we have created a strong foundation for this growth over the past few years.

Over the last three years, on average, we have grown top-line 6% in constant currencies and delivered double-digit EPS growth. By focusing on being better, not just bigger, we have proven that we can not only capture more of the existing market but also create new opportunities for growth.

The key to success is a simple yet powerful concept. Strategic focus and balance across the five P’s of our Plan to Win. Whether in the area of people, products, place, price or promotion, we strive for the right balance between innovation and disciplined execution.

Currently, we are focused on three critical strategies to drive performance.

First, striking an effective balance between consistent promotion of our core product offerings with the successful introduction of new food menus. No matter how familiar our core menu is to customers, we know that featuring these products in our restaurants and marketing them drives sales and guest counts. During the recent World Cup, for example, Germany, France, China and Taiwan were successful with promotions linked to the Big Mac and extra value meals.

On the new food side, we continue to introduce products that are relevant to customers' tastes and lifestyles. The U.S. is strengthening its position in chicken with the launch of the Chicken Snack Wrap, a premium chicken strip inside a heated tortilla with lettuce, cheese, and ranch sauce.

We are also broadening drink offerings, a process that began with our coffee upgrade and continues with testing of grab-and-go drinks in resealable containers, such as fruit juices and flavored waters.

Around the world, we have been adding new choices to our Happy Meals, from milk and drinkable yogurt to fruit bags and carrot sticks. Australia is taking this to the next level in August with the of Pasta Zoo, a kid's Happy Meal entrée that has strong nutritional profiles. The product has already received positive reaction from Australia's food and nutrition community and we are confident that moms and kids will feel the same.

Longer term, we are supporting food innovation with the European Food Studio in Paris and now its counterpart, the Food Studio and Quality Assurance Center in Hong Kong, which got up in operation in June.

The second strategic focus involves the relationship between everyday value offerings and appealing mix of premium products. Success here has played a key role in driving results around the world, most recently in Europe. Pasta-conscious Europeans can rely on value platforms such as the Pound Saver Menu in the U.K. and Einmal Eins in Germany. These everyday menus are complemented by premium sandwiches such as the Big Tasty in Germany and the Chicken Mythic in France. Longer term, markets such as Japan are working to optimize pricing on the core menu, while in China, we are exploring menu pricing that is tiered by both market and restaurant to help address the vast differences in purchasing power across that country.

A third opportunity involves maintaining a relevant dining experience while expanding our convenience through drive-thru’s, extended hours and, in some parts of the world, delivery.

Re-imaging increases the relevance of our restaurants and positively impacts customers perceptions. By the end of 2006, we will have a re-imaged or rebuilt over 8,000 restaurants over a four-year period, representing 30% of our traditional restaurant base. In the U.S., this translates to more than 5,000 of our 13,700 restaurants re-imaged and rebuilt by the end of the year.

Leveraging our convenience advantage also remains a significant area of growth opportunity. Extending our hours of operation continues to drive results in the U.S., where more than 90% of the restaurants participate in some way. We are expanding this opportunity as appropriate in Europe, Asia and Latin America.

In China, our development strategy is focused on opening more restaurants with drive-thru’s to capitalize on the increasingly mobile population there. This strategy received a significant boost in June with the signing of a strategic partnership with Sinopec, China's largest petroleum retailer.

The agreement gives McDonald's first right of refusal of co-developed drive-thru restaurants at existing and new Sinopec outlets, which number more than 30,000. It is great having a choice and our initial plan, of course, is to identify and prioritize the best locations across China.

Balance is important, not only in our restaurant activity but also in the broader management of our system. As we mentioned in previous calls, we have been working to find the right balance between company and local ownership in our system.

As previously announced, we plan to convert 15 to 20 markets to a developmental license, or DL, arrangement. In a DL structure, the local entrepreneur uses his or her capital, real estate and local knowledge to build the brand and optimize results. McDonald's collects a royalty but invests no capital, unlike with traditional franchise agreement.

So far this year, we have completed DL conversions for three countries -- Nicaragua, Honduras, and Bulgaria, and we will soon convert another market in Asia-Pacific and Middle East/Africa.

Similarly, the United Kingdom is working to shift the balance of its restaurant ownership so that more restaurants are in the hands of franchisees. This can be accomplished through converting company-owned restaurants to franchises, or through joint ventures in which the company and a partner share a stake in the restaurants.

Year-to-date, 24 company-owned restaurants have been franchised and three joint venture partners have been formed, representing 40 stores. In addition, we plan to franchise or JV another 50 U.K. stores later this year.

We at McDonald's are energized by both the success we are achieving today and the great opportunity for growth that lies ahead. We recognize, however, that we have things to do to realize our potential.

We must continue to push the boundaries placed on our brand, earning our customers' permission to try more new things under the Golden Arches. Our operating systems, both at the counter and the kitchen, must keep pace with the demands of our customers and our business.

We have incredible variety in our restaurants around the world -- different menus, floor plans, operating hours and traffic patterns. We have learned that one size does not fit all, so we are working on a next-generation operating system that you have talked with us about before, that will have flexible components that can be plugged in depending on the restaurant's needs. We are calling it the flexible operating platform.

While the flexible operating platform is under development, we are implementing the bridge operating platform in countries that need help with their operations now. The bridge operating platform is a customized solution that combines elements from our made-for-you and traditional grill direct systems in ways that are best suited to the needs of a particular restaurant. As the name suggests, it acts as a bridge to the flexible operating system of the future.

To me, our most important challenge is to maintain and build trust of our customers. We must do this, and we are. We are driving efforts around the world to tell the facts about the quality of our food, our great employment opportunities and our corporate values.

We are working directly with moms, the gatekeepers of the family's trust, through our newly formed global mom's panel.

We are connecting with customers on their terms, whether it is through internet blogs, text-messaging, or conventional advertising.

To close, I want to emphasize how confident I am in the future of McDonald's. There is great opportunity ahead and we are committed to capturing it for the benefit of our customers, our system, and our shareholders.

Thank you, and now I will turn it over to Matthew Paull, our CFO.

Matthew Paull

Thank you, Jim, and good morning, everyone.

New products, convenient service and hours, clean, comfortable restaurants, and marketing linked to popular properties and events have combined to make the McDonald's experience even more relevant. The connection we have built with our customers, along with our commitment to discipline in operations and in financial management, continues to deliver solid results.

As Jim just highlighted, sales growth was strong in every area of the world, driving total brand McDonald's margin dollars up 12% to a record $1.7 billion in the second quarter. Breaking this down, McDonald's franchise margins, which represent about two-thirds of total margin dollars, were $1.1 billion and, as a percent of revenues, rose 80 basis points with every area of the world showing improvement.

McDonald's company-operated margin dollars grew 20% to nearly $620 million in the second quarter. Company-operated margins increased 130 basis points as every segment showed improvement for the second consecutive quarter.

I will highlight the drivers behind this margin growth in the U.S., Europe, and Asia-Pacific.

In the United States, company-operated margins improved 60 basis points to 19.8%, the highest in more than 10 years. The increase was driven by strong sales partly offset by higher labor, utility and promotional expenses.

In the second quarter, we enjoyed a benign cost environment for beef, chicken, and cheese. For the year in the United States, we expect beef and chicken costs to be relatively flat and cheese to be down.

In Europe, company-operated margins increased an impressive 170 basis points to 16%. More than half of the increase was driven by strong comparable sales growth in the United Kingdom and Germany. Compared with last year, commodity costs for beef and chicken were down in Europe, while cheese was flat. Our outlook for the full year is for all three to be basically flat.

Importantly, our initiatives to improve performance in the U.K. are beginning to gain traction. We have been working very hard to enhance our brand image by emphasizing the quality of our food and the opportunities a McDonald's job provides. Also, we are aggressively showing the facts about McDonald's in interviews and internet blogs.

In the second quarter, we promoted flagship core menu sandwiches like the Quarter Pounder and Big Mac, and marketed our brand with an innovative text message to win World Cup tickets game. We are optimistic that the U.K.'s re-franchising strategy, which contributed slightly to the quarter's progress, will help company-operated margins going forward.

We are encouraged with the U.K.'s progress but there is much more we can and will do. We are confident our plans and the focus of our U.K. team will deliver results.

Asia-Pacific generated a 170-basis point increase in company-operated margins, primarily driven by Australia's ongoing strong performance and improved results in China and Hong Kong. The strategic menu price adjustments that Jim mentioned contributed to China's improvement.

Designed to deliver value to customers while encouraging trade-up, margins are beginning to benefit from extra value meals becoming a larger portion of our sales mix in China. In addition, supply chain and operating efficiencies helped lower costs.

Turning to G&A, as expected, G&A in the second quarter increased at a faster rate than sales and revenues. This was due to an increased accrual for incentive-based compensation and our very successful biannual owner-operator convention, which was held in May. We expect the rate of G&A spending to slow in the second-half of the year and, as a percent of revenues, to end the year below 2005 levels.

Consolidated operating income for the quarter was more than $1.1 billion, up a healthy 12%, primarily due to the strong margin improvements we delivered.

This brings us to quarterly earnings per share. Last year's second-quarter EPS was $0.42, including $0.09 of incremental tax expense resulting from our decision to bring home earnings under the Homeland Investment Act.

Second-quarter '06 earnings per share is $0.67. This includes a non-operating gain of $0.10 from the sale of a portion of our Chipotle stock; $0.01of impairment, primarily related to the anticipated sale of a market in Asia-Pacific to a developmental licensee; and $0.01 of incremental tax expense from a tax law change in Canada.

Turning briefly to Chipotle, subject to market conditions, we are moving forward with plans to completely separate from Chipotle to a tax-free exchange. This will allow us to buy back McDonald's shares using highly appreciated Chipotle stock with no tax on the appreciation. As we previously indicated, the proceeds from the secondary sale of Chipotle stock, which we completed in May, will also be used to buy back stock. All of this is on top of at least $5 billion to $6 billion we expect to return to shareholders in 2006 and 2007 combined.

In the second quarter, we bought back $800 million of stock, bringing year-to-date total share repurchase to $1.8 billion, or 53 million shares. You should be aware however that until we complete our separation from Chipotle, we cannot be in the market buying back our stock. When the exchange transaction is completed in the fourth quarter, we expect to be repurchasing stock again.

Rest assured, we understand and share your focus on reducing our share count. It was part of the reason behind the compensation mix changes made last year that resulted in fewer options being granted.

In fact, as a result of exercises and reduced grant levels, total options outstanding at year-end 2005 were more than 30% lower than in 2002. We are absolutely committed to reducing our share count and fully expect the count to continue to head in the right direction. The count has declined by about 25 million diluted shares since year-end '05 and should continue to add to our EPS growth rate.

I would like to update you on a few other guidance items.

Based on current exchange rates, we expect foreign currency translation to have a slightly positive impact for the remainder of the year and a minimal impact for the full year.

Because of our actions under the Homeland Investment Act, our debt and cash levels are higher than they otherwise would have been. Due to this higher debt level, current interest rates and foreign currency exchange rates, we now expect interest expense to be up 11% to 13% for the year. However, offsetting this is higher projected interest income.

Since implementing our Plan to Win in 2003, we have delivered the most consistent and solid operating performance in McDonald's history. Significantly, in the second quarter, every area of the world contributed to our performance, demonstrating the Plan to Win's adaptability and applicability to the unique local environment in which we operate our restaurants.

I am confident that as we further evolve our Plan to Win and strengthen our connection with customers, we will build on this track record of strong, consistent results.

Thank you. Now I will turn the call back over to Mary Kay Shaw.

Question-and-Answer Session

Mary Kay Shaw

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

(Operator Instructions)

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

The first question is from John Glass at CIBC.

John Glass - CIBC World Markets

Thank you. I actually wanted to follow up on the Sinopec agreement with a couple of details. Who operates the restaurants? Who puts in the capital? Most importantly, 30,000 locations is a significant number, but what would be a good near intermediate-term expectation for development under that agreement? How many of your units in china, for example, maybe on a percentage basis would be in those type of locations?

James A. Skinner

The details of the arrangement, it is a 20-year agreement and we have the first right of refusal, as I mentioned. The arrangement relative to capital invested, et cetera, the details are not public at the moment. It is a matter of working that on a deal-by-deal basis.

In terms of numbers, they do have 30,000 locations, but that is the beauty of having the first right of refusal. We would never have an agreement with a company like this where we had to do all 30,000, and you can imagine why.

As a retailer and the biggest petroleum company in the country, I am sure they have terrific sites among those 30,000, but they probably also have some that may not be as good. It is very important for us to get off to a good start with them in the selection of the original sites. We are pretty good at this, and I think we will do a careful job and we will get off to a good start. But we cannot really predict what the total number would be and I do not think we have looked at it that way. We just know there is a huge opportunity there.

Matthew Paull

John, we will operate the restaurants in all situations. It is possible that in some cases, Sinopec would be our landlord, but in a lot of other cases they will not be. We are still working that out, as Jim said.

We want to emphasize that we have said that one of our issues in the past in China was we did not get off to the best start in terms of site selection. We love this deal for all the reasons that Jim mentioned, especially the fact that it has, from our point of view, tremendous option value. There is no minimum or maximum number of restaurants we have to build. If things look good to us, we will build more. There is no cost to us and in terms of option value, the option value is unlimited to us because we have a choice.

Mary Kay Shaw

Thank you. The next question is from David Palmer at UBS.

David Palmer - UBS

Congratulations on the quarter. I have a question on the bridge operating platform. This is something that could greatly improve your menu innovation flexibility in Europe. How will you roll that out? Could you give us a timetable on that? When you might be done a certain market? I would imagine you are going to be doing company and franchise at similar timetables, but could you give us an idea of when you might be able to be switched on with the new platforms, with the idea that we might see a better innovation pipeline come on-stream at that point, that would catch up to the new platform? Thank you.

James A. Skinner

Well, the bridge operating platform will simplify our operations, and that combination of Made For You and grill direct that we talked about, which does enhance the work environment for the crew, and it also gives us the opportunity, as you said, to deliver a variety of experiences for our customers around food.

It is currently being tested in a couple hundred restaurants in the U.K., France and Germany. Also in Italy, Spain, Sweden, Russia and Hungary. Over the next year or so, we will probably convert around 1500 restaurants.

It is important to know though that it is a bridge operating platform and the end state vision for the long term is for us to be able to have the flexible operating platform. That would be step two, although this is not something that we will be doing in every market, but right now it looks like around 1500 restaurants. Obviously that is company restaurants and franchise restaurants as well.

David Palmer - UBS

Thank you.

Mary Kay Shaw

Thank you. The next question is from Glen Petraglia at Citigroup.

Glen Petraglia - Citigroup

Good morning. If you could perhaps comment on the U.S. and some of the trends you are seeing, from whether it be a traffic or an average check perspective. I am wondering if you are seeing any signs that consumers are being a little bit more cautious with how they spend their dollars, i.e., are you seeing increases in Dollar Menu purchases, et cetera?

James A. Skinner

We continue to benefit from the combination of initiatives in the United States. As you know, the big factors in this quarter, as we talked about, were breakfast, driven by coffee, and then certainly the premium chicken salad, the Asian Salad, the Happy Meals, and the extended hours -- all of those things contributing positively.

I am happy to say that the demand for the Dollar Menu continues to support the base of our business. We are not seeing a shift in consumer buying habits around the Dollar Menu, which is very important.

Obviously we have been able to operate above the noise for now, relative to fuel costs, which has been something that we are very, very pleased with.

It is possible that traffic could start to fall off. We do not know but thus far, we have been very fortunate regarding that and the trends are very positive for us.

Matthew Paull

On the issue of guest counts, year to date in the U.S., about 40% of the comp is from guest count increases.

Glen Petraglia - Citigroup

Thank you.

Mary Kay Shaw

The next question is from Joe Buckley at Bear Stearns.

Joseph Buckley - Bear, Stearns & Co.

Thank you. I wanted to ask a question about the U.K. It sounds like your plans to re-franchise or do joint ventures is moving a little bit faster than you first thought. I am curious if the joint venture aspect is something new, and if you can describe in a little bit more detail what kind of potential that might have.

James A. Skinner

The first part is regarding the franchising. We are re-franchising about 125 McOpCo’s and developing franchising plans as we move to 2007, 2008. We are about halfway through what we had planned to do this year, as I mentioned in my comments.

We could argue that maybe we are a little bit ahead of schedule, but I think in the end, we are right about where we wanted to be, and we will transition about 125 of those restaurants throughout ’06.

I did not get the second question.

Matthew Paull

The joint venture way of operating is something we are very used to. We use it heavily in France. We use it in the U.S.

I would like to point out this: we set our goal at a minimum is to get to less than 50% of the restaurants being company-owned in the U.K. over time. When we started, we were at 63%. Right now, year-to-date we are at 58%. We are making good progress. We are going to take it below 50%, but we did not predict exactly how long that would take. Thank you.

Mary Kay Shaw

The next question is from Larry Miller at RBC.

Larry Miller - RBC

Thank you. This is a question on marketing. You talked about evolving the “i'm lovin’ it” campaign. I just had a question -- is it still as effective today as when you first rolled it out? Is that still the plan, to evolve the marketing? Can you give us any previews of what direction that might take, if you have any? Thank you.

James A. Skinner

We have talked a lot about this, Larry, and that being that we are looking at “i'm lovin’ it” next generation. It continues to be relevant with our consumers in the marketplace, and of course, the messaging and the communication in the framework of “i'm lovin’ it” around the world varies.

We are working very hard right now to work on the next generation of “i'm lovin’ it”, focusing on the it -- that being the food and the moments and the feelings that are so important to our customers and their relationship with McDonald's.

We are tying in with World Cup and Olympic Alliance and our popular global events like the World Cup and McDonald's has unparalleled ability in this arena. That is sort of the way we are working on it.

We expect that we will be able to move along positively in this regard.

Mary Kay Shaw

Thank you. The next question is from Jeff Bernstein at Lehman Brothers.

Jeffrey Bernstein - Lehman Brothers

Thanks very much, just a question on the strong European margins.

I am wondering if you could dissect the reported company-operated margin number into the three major markets for the quarter this year versus last, just so we could see the trends in each. What would be the overall European margin similar to quarter's past if you exclude the U.K., which I believe you said was a positive contributor? I am still guessing it was the low man on the pole. Lastly, what your outlook is for company-operated European margins for the back-half of the year?

Matthew Paull

We do not make predictions on margins -- sorry about that.

I will be able to address your other questions. The U.K. was a significant contributor to the overall improvement in Europe through comps, through store mix and through more favorable commodity costs in the U.K. After the U.K., Germany was a big contributor and that was about comps offset by higher labor costs.

Beef costs and chicken costs in Europe were down about 4% each in the second quarter. I would say we like where we are headed with Europe. We like that the improvement is coming from the U.K. and Germany. France continues strong, but it did not improve significantly compared to the other two countries, and I do not really have the math in front of what we would have looked like without the U.K., so we will have somebody in investor relations get back to you on that one.

Mary Kay Shaw

Okay. The next question is from Steven Kron at Goldman.

Steven Kron - Goldman Sachs

Thank you. Good morning. I had a quick question on the U.K. business when we think about brand image and the sustainability of what seems to be improving trends there.

Math, I know you mentioned that it seems as though you are getting traction from messaging, but if I think about a year or two ago, there was a lot of talk about school lunch programs, nutritional content, childhood obesity. It seemed to be very front and center in the media. Can you just talk about the current environment there, whether those types of media stories have died down a bit? Maybe you can share with us a little bit on consumer feedback more recently in the U.K. market. Thank you.

James A. Skinner

I will start, and then Matt can follow up with whatever comments he wants to make.

I think the environment there has changed, but it has changed because of the job we are doing regarding the communication around our food. As you know, the U.K. is an environment in which the intensity of tabloid nature communication probably does not change much over time. The issues change from time to time, but the fact is the issues around obesity, the issues around lunch programs, the issue around the quality of food and the issue around choice continues to be there.

I think the reason we are improving, and we like the trends right now, including consumer feedback, which we were fortunate over the last few months to have very good mystery shop scores, and Plan to Win scores around the attributes and the consumer perception in the U.K. was leading the pack. We are very proud of that and we think we have done a good job there.

Relative to the environment, the environment really does not change that much. It is a matter of how we respond to it and how we manage our affairs, which I think we have done a very good job with.

Steven Kron - Goldman Sachs

Thank you.

Mary Kay Shaw

The next question is from Mark Wiltamuth at Morgan Stanley.

Mark Wiltamuth - Morgan Stanley Dean Witter

I wanted to explore the European margin power. Clearly you had a big turnaround here in the margins this quarter. Could that 16% margin turn into an 18% or 19% number over time? Where do you think the big margin opportunities lie? Are they really in closing underperformers or re-franchising, or is it just improving the average restaurant sales?

Matthew Paull

We have been very careful over the last three years to say that we have a global margin goal, which is to get back to year 2000 company-operated margin levels, which were 16.9% for the full year, but we are not going to break it out by country or area of the world.

When we look at where the biggest opportunity lies, it still lies in the U.K. Even though we saw improvement, there is a long way to go.

Part of it is about growing sales through extended hours and offering breakfast more aggressively. Part of it is through the re-franchising that we have begun. We still have a long way to go.

We are not going to pick a specific goal, but there is still a lot of room for improvement.

Mary Kay Shaw

Thank you. The next question is from Jeffrey Omohundro.

Jeffrey Omohundro - Wachovia Securities

I wonder if you could elaborate a little bit more on the new product front, in particular the chicken snack wrap test, how that has proceeded and how are the consumers using the product? Is it being used as an add-on, for example?

Matthew Paull

The national launch will run from August 1st through September 4th. The suggested price point will be about $1.29.

We love the product for a whole variety of reasons, one of which you hinted at, which is how people are going to use it. It is sometimes an add-on, it is sometimes a snack.

We also think it gives us a really wonderful opportunity to make an existing product better. It is the same chicken select that is used in our Chicken Select offering, and that product, which is one of my favorite products, is even better if we have enough volume to keep it really fresh. By using the snack wrap, based on the same core product, we can do bigger volumes, keep it fresher, and we think our customers will like it, our operators will like it and our profitability will show.

Lastly, the food and paper percentage on that product at $1.29 price point is very attractive. It is well below double cheeseburger, well below salads, it is below our other chicken sandwiches.

From every way we look at this, it looks like something that will make a lot of sense for us.

James A. Skinner

It did very well in the test markets. We would expect that it will be a hit with our customers. Have you had it yet, Jeff?

Jeffrey Omohundro - Wachovia Securities


Mary Kay Shaw

Okay. Thank you. The next question is from John Ivankoe at JP Morgan.

John Ivankoe - JPMorgan Chase & Co.

I actually have some questions on the re-imaging of the restaurants themselves. If I am right, I think the rate of re-imaging in the U.S. will slow at the end of 2006. Is that still right?

Matthew Paull

The original plan that we announced was a three-year plan that was scheduled to mature at the end of '06, you are right about that.

But we have learned some things through this plan, which is that we cannot ever afford to let the brand grow old and tired. So there is the possibility that when we look at the chance to do something with the exteriors of our restaurants, we will decide to use a similar kind of program to re-image the exteriors.

We are talking with operator leadership about it. We have not made any decisions yet, but you are right -- the original program expires at the end of '06, but if we see something that excites us, we are certainly willing to co-invest with our franchisees to send the message that the brand is getting even more contemporary.

If you take a look at the restaurants that we have externally re-imaged in Columbus and Tulsa, you will see how exciting it looks for a very, very small investment.

James A. Skinner

But the pace that we are on for '06, you had said we would slow down in '06. The original understanding comes to an end in '06, John, but we are at about the same pace we were in '04 and '05 regarding '06 in the year.

Mary Kay Shaw

Okay. The next question is from Rachael Rothman at Merrill Lynch.

Rachael Rothman - Merrill Lynch

Good morning. Just as a follow-up to that, would you guys mind recapping your $1.8 billion in cap-ex, and maybe giving us an update on re-imaging overseas, or how that cap-ex will be spent? Thank you.

Matthew Paull

The rough breakdown is a bit over $900 million is being reinvested in existing stores. Some of that is maintenance cap-ex but the vast majority of it is re-imaging of various types in various parts of the world. Probably a little over $650 million is to build new restaurants, about 800 gross new restaurants, and that is up a little bit from prior years.

Mary Kay, do you recall the latter part of the question?

Mary Kay Shaw

Just the total outside of the U.S. For example, about 30% of the total cap-ex will be Europe, 13% Asia, 5% Canada, 4% Latin and the 44% U.S., but that is total, so that is new reinvestment and other.

The next question is from David Palmer at UBS.

David Palmer - UBS

This kind of builds on some of the other questions, just the broader question of cash usage heading into '07 and beyond, thinking about some of the major buckets, such as cap-ex, share repurchase, debt pay-down, dividend -- how might these change?

For instance, I can see that maybe net debt reduction might slow in '07 and beyond. We have had some increasing clarity on the tax treatment of dividends, and there might even be a shift in the cap-ex needs. Could you perhaps go into some of these? Thank you.

James A. Skinner

David, we followed with great interest what happened with the tax law. We are very happy that it was extended through 2010. That is one of many factors in what we do with our cash.

I will review what we have always said, and some of this has not changed. Our first priority has always been and will continue to be to invest in high-return projects inside brand McDonald's. Obviously, when we separate from Chipotle, that frees up a little bit more capital than we had.

Then we like to look at share repurchase and dividends. We like dividends. You will remember three years ago when we began dramatically increasing the dividend, we said it is very consistent with where we want to take the company. If we are going to be better, not bigger, we can afford to be paying a higher dividend as a way of reminding people of how strong and steady our cash flow generation is.

We do, however, like to reserve a little flexibility, which is why we have not been specific about how much of the cash that goes back to shareholders will be in the form of dividend versus share repurchase. Frankly, it is a function of where our stock is trading and how the other things look to us. So we want to, to the extent possible, reserve flexibility.

We have signaled at least $5 billion to $6 billion will be returned to shareholders in '06 and '07, but we do not want to be specific on how much takes the form of dividend versus share repurchase, and we do not want to be specific of how much in '06 versus '07.

Mary Kay Shaw

Thank you. Now, I will get back to Jeff Bernstein's earlier question. I think U.K. contributed about 40 basis points to the improvement in the Europe margins for the quarter.

It looks like we are out of questions, so I will go ahead and turn it over to Jim for some closing remarks.

James A. Skinner

Thanks again for your participation and in closing, I want to reinforce our commitment to providing value for our customers, the McDonald's system and our shareholders. We are proud of the success we are achieving today and excited about the opportunity for growth in the future.

Our Plan to Win remains our framework for success and we will continue achieving the right balance of innovation and disciplined execution, and will generate growth around the world.

In the end, I am confident that our strong performance will continue. Thank you.


This concludes today’s conference. We thank you for your participation.

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