MCD - Transcript 2002.3Q

FINAL TRANSCRIPT 2002-10-22
McDonald's Corp (MCD US Equity)
Q3 2002 Earnings Call
Company Participants
Jack Greenberg, Chairman,CEO
Mary Healy, Vice President of Investor Relations
Matthew Paull, CFO, Exec. VP
Mike Roberts, President
Other Participants
Alan Hickock, Analyst, Piper Jaffrey
Coralee Whitter, Analyst, Goldman Sachs
Janice Meyer, Analyst, Credit Suisse First Boston
Joe Buckley, Analyst, Bear Stearns
John Glass, Analyst, CIBC
Mark Canowski, Analyst, Solomon Smith Barney
Mitch Spieser, Analyst, Lehman Brothers
Peter Oaks, Analyst, Merrill Lynch
Unidentified Participant, Analyst, Unknown
Vladimir Ivelcom, Analyst, Tudor Investments
Presentation
Operator
The conference shall be getting under way momentarily. Following today's
presentation there will be a formal question-and-answer session. If you would like to
ask a question, please press Star 1 on your telephone touch pad. To cancel that
question, press Star 2. If you would like to presubmit your question or ask your
question anonymously, please press star 0 and an operator will assist you. Once
again if you would like to ask your question anonymously or presubmit it, simply
press star zero and the operator will assist you. Thank you. (Pause).
All sites, please stand by. Your conference is about to begin. Hello, and welcome to
the McDonald's October 22, 2002, investor conference call. At this time, I'd like to
turn the conference over to Miss Mary Healy, Vice President of Investor Relations. You
may begin.
Mary Healy {BIO 19299079 <GO>}
Hello, everyone. And welcome this conference call is being webcast live and
recorded for replay on the Web. Earlier today, we issued a press release with our
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third quarter results. The language in that release regarding forward-looking

statements also applies to our comments today. Our third quarter performance was
in line with the expectations we outlined last month and the details are in this
morning's release. We know your primary interest is our plan for 2003. So we will
spend most of our time today on that. I am joined by Matthew Paull, our CFO, Mike
Roberts, President of McDonald's USA, and Jack Greenberg, our Chairman an CEO,
who will begin our prepared remarks.
Jack?
Jack Greenberg {BIO 1397619 <GO>}
Well, good morning. We're here on the call again after what to our people feels like
the longest month in our history. The stock market's reaction to our September third
quarter update and US initiatives has been very painful and upsetting. In fact, it's
been a difficult year for you, our investors, and for our people. You should know that
the worldwide McDonald's system has an intense sense of urgency on improving the
momentum of our business as I do. Our entire management team is committed to
optimizing the existing business during this challenging economic and world
environment.
You should also know that McDonald's fundamental business model is strong even
with all the worldwide cyclical factors that have negatively affected us the last couple
of years, there is positive news to report. As disappointed as we are in the third
quarter results, McDonald's earnings per share before special items this year and last
are up 5% through September. Importantly in the US, we see increases in sales in the
first few days of the national value campaign. Equally important, we continue to see
improvement in restaurant operations in the United States based on mystery shop
scores and the recent survey on drive-through performance. Mike will tell you more
about these in a few minutes.
In the last few months our under the circumstances company operated restaurants
have outperformed franchise restaurants in sales growth and -- franchise restaurants
in sales growth and profitability. It's been an important goal. But in part due to the
US organizational changes made late last year, we are seeing progress. In Brazil, our
largest Latin-American market, we generated positive comparable sales each month
throughout the quarter giving us the strongest quarterly sales performance years. In
Europe, we continue to have good momentum in France and have increased our
market share against our major quick service restaurant competitors in the UK. In
Germany, we have maintained our share despite a declining eating-out market.
For perspective, it's useful to reflect on the fundamental attributes of our business.
We fill a basic need. People want to eat out more often. Convenience and saving
time are important to people as is value. A break from the hassles of daily life and
the reward of an occasional indulgence are also clear needs. Few of the companies
you own or follow are in businesses that fill such basic needs or are so well
positioned to take advantage of them. We have a strategy to grow this business. We
have a plan.
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In the short term, our strategy is to optimize the existing business. We recognize the
world has changed and right now optimizing our current restaurant base is our first
priority. Optimizing includes intense focus on building comparable sales, dramatic
reduction in new restaurant openings, reallocation of capital from reduced openings
to reinvest in existing restaurants to build comparable sales. And review the small
number of international markets for possible restructure. Our success has always
required an appropriate balance between new restaurant openings and comparable
sales growth. Optimizing the existing business requires a change of emphasis to
more aggressively grow same-store sales.
Our longer-term strategy is about growing the business. It's about being the world's
best quick-service restaurant experience. About evolving the brand and experience
to stay relevant and about developing concepts that grow the business with
examples like McDonald's with the diner inside, the recently opened three in one
restaurant and Chipotle. All of this effort is about taking one of the 10 best brands in
the world and making it the world's best brand. We are very confident of the
opportunities for long-term growth just as we are committed to optimizing the
existing business for now.
With that, I'll ask Matthew to update you on our capital allocation plans.
Matthew Paull {BIO 4209230 <GO>}
Thanks, Jack. As you've probably noted in today's release, we expect capital

expenditures to total about $1.9 billion in 2003. 100 million less than expected for
this year.
I'll walk you through how we arrived at this amount and some of our key
considerations. While we don't expect total capital spending to be dramatically
different year over year, how we allocate those dollars is quite different. Please be
aware, our 2002 expenditures are not yet final, so when I talk about changes versus
2002, the amounts are estimates. Still, the direction and trends are very clear. We are
focusing on our existing business. Thus, we will dramatically reduce the amount of
capital spent on new restaurants in 2003 by nearly $500 million, or almost 40%. We
will invest almost $100 million of these savings in new buildings for US franchise
restaurants. As most of you know, over the past few years, US owner-operators had
the opportunity to own the buildings themselves. While reducing their rent, it had
the effect of increasing their leverage. We are making this change to where we will
own new franchise buildings in order to ensure that our best owner-operators, those
with whom we want to grow, have the financial flexibility to invest in more restaurants
and reinvest in their existing restaurants. Of course, as a result of our owning these
new buildings, our rent revenues will increase providing a good return on our
investments.
Our total expenditure on new restaurants in 2003 will be about $875 million. Of this,
about $750 million will be invested in new McDonald's restaurants and $125 million
will be invested in partner brand restaurants. We will double the number of Chipotle
openings to about 140 in 2003, as it continues to post strong comparable sales and
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unit level returns. In 2003, we will increase the capital spending on existing
restaurants by about $225 million for a total of $825 million. These investments in
refreshing, remodeling and rebuilding restaurants around the world include the
$300 to $400 million planned for US franchised restaurants. The balance of our
capital expenditures will be for other assets. This gives you a broad perspective on
the overall capital budget for 2003.
Now let's turn to how we will prioritize new capital investments. A few people have
suggested that we eliminate expansion completely in 2003. We think this is extreme.
More importantly, we think it would be the wrong decision for shareholders because
we firmly believe we have tremendous opportunity to grow restaurants profitably.
We develop our expansion plans considering each market's return on investment
trends, comparable sales trends, new restaurant performance, the competitive
situation, maturity, potential for scale, short and long-term economic outlook and
finally demographics. We also take a very hard look at returns on incremental
invested capital over a period of several years. While could you argue for a shorter
time frame, we believe that a multi-year period gives a better perspective. We
combine this with the review of over all annual review of capital and expect new
returns on restaurants in a marketplace. For example, our five-year returns on
incremental invested markets in some markets in Asia-Pacific and Latin America have
frankly been very disappointing. Clearly they have been affected by deteriorating
economies. In fact, returns here were generally very strong only a few years ago. The
intervening years brought a great deal of economic turmoil, and as a result, our
operating results and returns declined.
Over the past few years, we have imposed much more stringent criteria for
expansion. Still, in reviewing recent results, we knew we needed to continue to
adjust our expectations for growth and our related opening plans. So in 2003, we
plan to reduce capital expenditures in Asia-Pacific and Latin America by more than
40% or nearly $200 million compared with 2001. We'll spend less than 15% of our
total capital here, and most of that will go to a few selected markets. For example,
our plans call for more than 100 new restaurants in China this year and next as this
market is showing great potential. It has produced a steadily increasing return on
investment from single digits in 1998 to low teens last year. With a population of 1.25
billion people and just over 500 McDonald's restaurants we have barely scratched
the surface. As we continue to grow in China, we will achieve increasing economies
of scale which in turn will continue to improve our returns. In general, our five-year
returns on incremental invested capital in Europe, the United States and Canada
have been very strong. Accordingly, we are investing nearly 85% of our restaurant
capital in these segments.
We certainly want to acknowledge that even within these higher return segments
there are certain markets where we plan very little new growth. For the time being, in
those markets, we will maintain our presence and focus on existing restaurants to
grow our customer base. The headline here is that we are dramatically reducing
expansion and concentrating our openings in a few strategic markets. In fact, in
2003, there are only 11 markets worldwide in which we expect to add more than 10
restaurants. Overall in 2003, we'll add about 600 net traditional McDonald's
restaurants globally. This is about 450 fewer traditional McDonald's restaurants than
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in 2002 and 510 fewer than 2001. Net traditional openings by segment are expected
to be about 210 in Europe, 200 in Asia-Pacific, 100 in the US, 70 in Canada, and less
than 20 in Latin America. By the way, so far, I've talked exclusively about traditional
restaurants because while we will open some satellite, these require relatively little
capital investment and this investment is already incorporated in the capital figures I
have given you.
We obviously don't have a final cash flow statement for 2002 at this time. And we
aren't going to forecast next year's results today, so please don't take this as a
projection. But just to put our capital plans in perspective, let's assume cash from
operations grows about 5% annually both this year and next. That would make 2003
cash from operations approximately $3 billion. Deducting $1.9 billion for capital
expenditures leaves $1.1 billion. We currently expect to use these funds to buy back
at least $500 million of stock, pay dividends of more than $300 million, increase the
number of company-operated restaurants in the US, fund other investments as
needed, and invest in technology.
I'll spend just a moment on our technology plan. We will continue a long-term
project to leverage our size to an even greater degree and maximize our efficiency
by standardizing processes, restaurant technology platforms, and information across
markets. This project will primarily benefit the supply chain and operations aspects
of our business. With that, I'll turn the call over to Mike to update you on our US
initiatives.
Mike Roberts {BIO 19273597 <GO>}
Thanks very much, Matt. McDonald's USA as you know operates 13,000 restaurants
and serves 20 million customers each day. We are proud to hold a higher market
share than Burger King and Wendy's combined. And today, one of our biggest
advantages is our entire system and its aligned focus behind one strategy. That focus
is working, and we're seeing results. These strengths are why I'm extremely
optimistic that we're moving in the right direction and gaining positive momentum.
We're beginning to move the needle on service. Our mystery shop measurements
prove it, and the most recent drive-through study validates it with our rise from 10th
place a year ago to 4th place this year.
Let's take a closer look at these results. We've conducted more than 137,000 mystery
shops since February, and the scores indicate we are improving. We've set extremely
high standards for execution in our restaurants, and we're seeing some positive
movement. Especially noteworthy are the service scores up more than 3percentage
points since February. And when we brake down our service scores, we note that fast
is up 4 points, friendly is up 4 points in the same period, and the accuracy score
already high, but it's even higher now increasing more than 1 point itself. Quantity
and cleanliness scores also high, to begin with but they have increased since
February over a point.
The restaurant operations improvement process has proven itself as the right tool to
improve our business. It lets our restaurant managers and owner-operators collect
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and act on objective restaurant-specific data and identifies areas needing

improvement. ROIP also creates an environment of accountability. We know which
restaurants are consistently meeting or failing to meet our QSC&V standards. We are
ranking restaurants now based on their mystery shop scores. In the near future we
will communicate that ranking to owner-operators and managers across the system
so they know exactly where their restaurants place within their regions. They will also
know in which percentile they place nationally. Restaurants will be flagged as
underperformers if they consistently scoreless than 80% on our internal evaluations
of quality, service and cleanliness, or if their mystery shop scores put them in the
bottom 20% of our restaurants. We are holding company-operated restaurants to
the same high performance standards. We have sold some underperforming
restaurants to outstanding owner-operators or made company restaurant
management changes. We will use this objective data to hold tough conversations
and discussions with underperforming owner-operators and restaurant managers.
We continue to focus on service emphasizing staffing, especially the peak hours of

11:00 to 1:00. Our experience demonstrates restaurants that staff up for peak periods
do a better job of satisfying our customers and increasing sales. Take, for example,
South Florida. Even though we just recently implemented this service standard on a
national basis, 81 restaurants in South Florida implemented this in July. The results
demonstrated that their average monthly sales were 2.3% higher than the rest of the
region during the third quarter. When considering just the lunch period, these 81
restaurants showed an even larger improvement of about 7% versus the rest of the
region. We will implement this peak staffing program in other key day parts.
We've improved our marketing. With our current dollar offerings and upcoming
dollar menu, we have one nationally-focused message. The introduction dollar Big
and Tasty and the dollar McChicken launched on October 4 is the first nationally
advertised branded value campaign we have conducted since 1997. In November,
we will introduce the dollar menu which adds six more items to provide even more
value and choice to our customers including side salads and parfaits. The campaign
is supported by new creative, pairing national personalities with our McDonaldland
characters discussing the art of the deal and the great value at McDonald's. You'll
see commercials with more celebrities in the future, Donald Trump, Cedric the
Entertainer, the Williams sisters, and more to come. These spots are testing well with
higher-than-average unaided awareness across all demographics and the value
message awareness is also extremely high. The results are encouraging. In the first 14
days we have seen incremental sales increases of 1.5 to 2% above our trend line and
our comparable sales are positive. Our average check is also relatively stable.
One other critical part of our plan is making our restaurants more contemporary,
unique and inviting through our reimaging plan. We plan to remodel, relocate or
rebuild in excess of 2,000 US restaurants over the next year. As Matt said earlier, we
plan to spend $300 to $400 million for these improvements and expect to generate
a return based on increased sales or rent increases. Our objective is to create a
compelling choice for the customer that is clean, comfortable, unique and
competitive. Not every restaurant needs to be remodeled. And we won't spend
$150,000 on every restaurant. We want to provide a superior service experience with
the optimal drive-through and front counter configurations. Examples of work to be
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done in these areas include reconfiguring drive-through paths and adding double-
lane drive throughs or outside order-taking technology. Inside the restaurants, we'll
look at improvements such as expanding front counters and installing self-service
beverage bars. We also want to deliver clear uniform messages through consistent
front counter and drive-through menu boards. These include branded signage in the
drive-through and new menu boards highlighting desserts, breakfast, the new taste
menu, and the dollar menu. And we want to create warm, inviting, and distinctive
interiors tailored to the local customer base and their communities. This could
include anything from updating the bathroom to completely refurbishing the lobby
and the dining room. This initiative is about making our restaurants stand out in the
marketplace and giving the customer a better experience.
As we previously discussed, we believe these investments in refreshing, remodeling

and rebuilding our restaurants will drive sales increases and generate good returns.
Looking at company-operated restaurant remodels over the past four years, we had
an average sales increase of nearly $200,000 with an average investment of
$184,000. This indicates that reinvestment in such things as dining rooms, exterior
and interior signage, drive-through enhancements and menu boards works. We are
reviewing all of our restaurants now to determine what is actually required for each
of them to enhance our customers' experience. We will prioritize these investments
based on need and QSC performance, and we plan to begin remodeling early next
year.
One final note about the US business. We'll continue to address our relevance with
today's customers with new food news. For example, our premium salad line which is
now in 600 restaurants will roll out nationally next month and be advertised
nationally in the spring. And next year, we'll bring back strong performers like our
chicken flatbread sandwich and introduce innovative new products like McGriddles,
a combination of our hotcakes and breakfast sausage.
Our initiatives reimaging our restaurants, focusing on service and value, improving
our menu and people practices, were designed to create growth by optimizing our
core business, enhancing the customers' experience, and moving forward with a
strong and profitable owner-operator base. It's about reinventing McDonald's USA.
It's about who we are today and who our customers want us to be in the future. I
remain supremely confident in the course we're taking to drive the US business. We
have the unprecedented support of our entire owner-operator community, our
employees are engaged, and my management team and me are committed and
determined to make a difference.
To recap, we're improving service. Not just the speed of it, but the experience of it,
as well. We've got a highly competitive value offer that's on national TV and print and
radio that our customers are really responding to. We have marketing now that
people are talking about, creating a buzz, cutting through the clutter. And as for our
food, the best is yet to come. All of this is my way of illustrating that McDonald's USA
is on the move. Thanks so much.
And now I'll turn the call back over to Mary.
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Mary Healy {BIO 19299079 <GO>}
Thanks, Mike. We'll now open the call for your questions.
Questions And Answers

A - Mary Healy {BIO 19299079 <GO>}
Please press star one if you have a question and Star 2 if you want to remove
yourself from the question queue. We would like to get to as many of you as
possible so I'll ask for your cooperation again. I'd like to you try to limit yourself to
one question and press Star 1 again if you do have another question.
We do have one question that was presubmitted. So perhaps I'll start with that one.
The questioner asked if we could address the $100 million that's being allocated to
the new buildings for the US in terms of some flavor on how this will be spent. I think
we might have answered a little bit of this in our comments, but wondered if it was
remodel money, relocation money and are we taking a more active position in real
estate? I can not tell you this is all new restaurants. So it's not remodel money. This is
all new restaurants. Some are relocations. And keep in mind that the 100 openings,
new additions in the US we talked about is a net number, so the gross number of
traditional restaurants openings is higher and that would be where we are with the
spending money on buildings. And also keep in mind that we will have a higher rent
percentage when we pay for these buildings that we'll collect from our franchisees
and that will result in us earning a good return on these investments.
So the first question we have is from Michael Sharison [ph]. Michael?
Q - Unidentified Participant
Thanks. You talked about reducing unit openings. Historically you talked about 4 to
5% of your growth coming from unit optimization. What can we expect as we look at
sort of a two to three-year time frame in terms of unit openings? I know you have
commented before that '04 would be lower than '03 and is part of this -- does part
of this also include the acquisition of underperformers in terms of the cash that you
are talking about for Cap Ex? Thanks.

Michael, I'd like to clarify one point on that is first, the growth that we'll get from new
unit openings in '03 really will come from our 2002 openings because as you know,
most of our openings occur towards the end of the year. So in terms of it looking at
next year, you can probably look at around a 4% new sales growth rate from new unit
openings. And then the other thing I'd like to clarify is I don't think we have definitely
decide what our 2004 openings will look like yet compared to '03. As you know, we
have just completed that process. So clearly, I think that Jack sent the message that
we're focused for the near term on optimizing our existing business but we'll have to
take a look what the that level of openings will be as we move through the year.
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A - Matthew Paull {BIO 4209230 <GO>}

And Michael, this is Matthew. Your question about acquisition of underperforming
stores to the extent we engaged if that activity and we will have some of that. That is
not in our Cap Ex number, it shows up in the other investments category. And we are
allowing for some of that during 2003. Thank you.

And again, I guess just to put your -- to tag on to that, that we're opening about 600
traditional restaurants in 2003 compared to a little over 1,000, more like 1,050 in
2002. So you know, you could presume that the new sales from new restaurants will
go down by about that same relationship.
Thanks.

The next question is from Coralee Whitter at Goldman Sachs.
Q - Coralee Whitter
Hi, actually just want to follow up on that question. How are you thinking about
longer term, what the appropriate rate of growth is? Should we be thinking about
this cut in unit growth in '02 as a, uhm, somewhat temporary measure in order to
refocus on increase the comps, or has there been a fundamental shift in how you
view your growth opportunities? And related to that, what do you see as your long
term earnings growth rate potential once we get past the next couple of years?

Coralee, this is Matthew. I'll answer the first part of that question. In terms of how we
think about this, we're trying to optimize the business for now and when we see our
returns comps and margins returning to the levels we like, we will give ourselves
permission to begin opening more stores again. But we're not predicting that is
going to happen in 12 months f things get better in 12-18 month, I think we'll do more
openings in 12-18 months but if they don't, I think we'll stay where we are.
A - Jack Greenberg {BIO 1397619 <GO>}

This is Jack Greenberg. I think it's also important to point out that the reduction in
new traditional openings that's been described on this call and the release isn't
proportionate. We have been very careful about selecting restaurants that will open
that have the high returns on profitability that we expect and that I know you do. And
so I don't think this is a pro rata thing. As economies change, your markets change,
we'll be making individual decisions that way. But clearly, our intense focus now is to
optimize the existing business. I think to try and predict the long-term growth rates at
this point, Coralee, would be a mistake. Thank you.
Page 9 of 21

Thanks. Our next question is from Mark Canowski of Solomon.
Q - Mark Canowski
I apologize if this was addressed earlier, but in the release today it's looking at ways
of trimming G&A spending. There had been a Dow Jones news article out on
October 15th saying that a significant round of layoffs could be coming up in coming
weeks. And just wonder if we should be looking for an announcement on this front in
the near term. And to that extent, any comments that you can make on a preliminary
basis at this time.

Mark, Jack Greenberg. We are absolutely in the middle of reviewing G&A. Matthew
pointed out that we have some G&A spending that will make a difference to our
efficiency and effectiveness in the long run, and we want to make sure that we cover
a good deal of those costs from our existing spend levels. We are going through a
review of all of our G&A around the world right now. It's too preliminary for to us
give you any specific guidance. We obviously are intent, if you going to optimize the
exit existing business and running it as efficiently and as effectively as we can, so I
think you are going to have to give us some time. I this it is likely there will be some
job loss. We don't expect or hope -- we hope that it won't be a significant, but we
don't know yet.
Q - Mark Canowski
Thanks.

Thank you. Next question is from John Glass, CIBC.
Q - John Glass {BIO 2450459 <GO>}

I wanted to go back to the $100 million you are going to spend on the US franchise
stores, and I guess I am unstill is the motivation for change the strategy. Is it because
franchisees are unwilling to spend money as they have in the past opening and
building their own buildings? Are they overleveraged? Could you give me a sense of
is it a financial condition issue? Is it a willingness issue?

Sure. Can you address that Matt?

John, I'd say it's a combination of things. I think a significant majority of our
franchisees weren't in love with the program, but more importantly I think we are in a
turning point of the history of the US business, and we are trying to be ascertain as
many of our stores as possible are in the hands of our best-performing owner-
Page 10 of 21
operators. And if we let them overleverage themselves by asking them to pay for
buildings, when opportunities come along to acquire new stores, or to invest in their
existing stores, they might not be in a financial position to do that. So it was that
combination of circumstances that led us to eliminate this opportunity going
forward. Let me clarify that it has no effect on the buildings that have been
purchased by operators in the past. We are not going to change that situation.

And Jack Greenberg again just to add a thought to that. I don't think this was a lack
of interest or willingness on the majority of operators because in fact our experience
where they were given the option was that the significant majority of them, vast
majority of them, took the option. I think we're more worried -- worried in our
operator leadership, more worried about the implications for the future in terms of
having all that additional debt and what its impact might be on their acquisition
opportunities and their reinvestment opportunities. Thank you.

Thanks, John. Next question is from Janice Meyer at Credit Suisse First Boston.
Q - Janice Meyer {BIO 1498657 <GO>}

I tell you, I have so many it's hard to cut it back to the one you'll let me ask.
(Laughter). Let’s see. If I -- if your goal is to get the stores in the hands of the good
operators, $100 million, I guess at your current cost per store fully loaded, not leased,
and I don't know how you're going to do this, is about 70 stores or something like
that. So on a base of 13,000, that doesn't really do it. And the 300 to 400 remodel
program is nice, but again that touches a couple of thousand stores depending on
the how much per store and that's going to your best operators. So how many stores
do you want to get in the hands of the good operators, and how long do you think
it's going to take to you get there, given these programs?

Janice, this is Matt. I'll take the first stab at this. We don't have a specific number of
stores in mind. I think you heard Mike say earlier that be you know, we're flagging
anybody whose mystery shop scores are in the bottom 20%. You know, the issue for
us is that we just want to do everything we can to make this happen quickly and
because of the opportunity to invest with our best operators $150,000 per store, we
have a chance to accelerate the process. So however long it was going to take, the
fact that we're in discussions with our operators about with whom we want to grow
and with whom we don't, it gave us a chance to accelerate the process. So I can't
give you a specific time frame or a specific number of stores.

I would just add the $100 million in terms of the amount we are going to spend on
buildings, I think it's important to also understand that many owner-operators do
have capacity today to take on additional debt to buy new stores and so it's not as if
only those operators that, if you will, are not going to ask to buy a new store next
year because we're paying for the building, uhm, are going to be in the situation to
Page 11 of 21
be capable of buying out operators so I'm not sure I would look at that $100 million
as some kind of a limitation. In addition, I think we also commented just in terms of
movement within the system that we are interested in increasing our company-
operated restaurant base somewhat next year. So that will be another use of funds.

To put this in context, we had this program for the last few years in the United States
only on new restaurant buildings only. Not every new restaurant operator took the
option. And so this is a relatively modest change in the scheme of this worldwide
business. We wanted to be sure to let you know about it because it's an element of
the capital expenditures. It's not meant to change the world. It will not. But we think
it's philosophically right to do, and we know that many of our operators support this
and agree with it. So I don't think we should make so much out of it in terms of the
overall restaurant operations a proven process. I think we have a lot of things
working toward improving our restaurant operations and this is just one small
element of it.

Thanks. The next question is from Joe Buckley at Bear Stearns.
Q - Joe Buckley {BIO 1491816 <GO>}

Thank you. Just got another question on the capital allocation announcements. You
are taking $500 million out of unit expansion, $100 million is going to go for the
franchisee buildings and $300 million will be reinvested in existing restaurants. Is
that the company operator restaurants, is that going to be primarily in the US and
what kind of projects is that $300 million going to be targeted for.

Can I clarify something, Joe? That is, that the incremental spending on existing
restaurants is the $225 million that we mentioned in the -- in this speech, and that
brings that number up to about $825 million total worldwide across the board. So
that's the restaurants, that also includes the 300 or 400 million that we'll spend on
US franchise restaurants, that amount. So $300 million that you might have seen in
the release and might be thinking of we said that was primarily towards increasing
investment in existing restaurants, but there's also a little incremental investment in
the other categories. So hopefully that clarifies that. But again, we're in the investing
and a couple of restaurants as we always do as well as a significant increase in the
amount spent on franchise restaurants here in the US with the special program. Does
that respond to your question?

Thank you.

I know. We didn't let you tell us that but I think that answers it. Thanks. The next
question is from Alan Hickock at Piper Jaffrey.
Page 12 of 21
Q - Alan Hickock
Good afternoon. Say in Mike's remarks there was a comment I just want to make sure
that I understand this correctly. That in the remodels, you expect to generate a return
based on increased sales or rent increases. I assume you're saying by we, you're
saying McDonald's Corporate does. And maybe you meant to say and, but I can
understand increased returns on increased sales but-- increased returns strictly on
rent increases benefits McDonald's but not the franchisees so I was just wondering if
we could get a clarification on that comment.

Sure. Alan, this is Matt. I'll try to clarify. You might remember this, the way this
investment works is that in effect, we are putting 30% up in saying we'll take our
chances with getting a return on net. The other 70% that we put up is sort of a
financial perk that's potentially imposed on the operator if we don't get a very large
sales bump in the first two years, and so what we are saying we think the primary way
we are going to get a return is that sales will go up and on average we get 13 to 14%
of every sales dollar as rent and service fees. But if at the end of two years we
haven't seen a 15% sales bump, then the rent percentage we collect in year 3 and
beyond increases and we'll get some return there, as well.

Thanks, Alan. The next question is from John Ivanco [ph].
Hi. Thanks. Actually, just to switch subjects to Europe, if I may, it looked like comps
did some a little bit in September, so I just wanted to get a sense of what was done
in September to drive sales from what was a disappointing previous two months but
I guess more importantly, what's really upcoming, now, on the continent or kind of in
your European business to drive sales in the near term. Thanks.
A - Mike Roberts {BIO 19273597 <GO>}

I can't start it. Our think our Europe -- I can start it. I think our European sales
situation as I think we discussed with you last month and I think had talked about
since then is that Germany's sales situation is disappointing and difficult. There's a
serious economic issue in Germany that I think you all know about. I think the whole
informal eating out market has contracted based on all the work that we've done,
and you got a declining economic situation, unemployment is almost 10%. You have
what's been called a Euro hangover and there are a lot of other issues that have
shaken the confidence of the customer in Germany, and we're struggling with the
sales situation there. I talk about Germany specifically because of its importance to
all of European results. We have aggressive marketing plans that should start soon
and be for the rest of the quarter. They involve price value propositions, as well.
Again, we are dealing with a very difficult economic situation. I think it's hard to
predict the results of those.
Page 13 of 21
The only thing I would add, John, is that the comparison in some of those market
was a little more difficult in September than it was in July and August. Going against
last year. Thank you. The next question is from Andy Barish [ph].
I just wanted to get some clarification back on the US same-store sales. Mike talked
about the comps moving positive from recent trend line levels or incrementally
moving up 1 1/2 to 2% to get positive from recent trend line, even though the trend
line was down 2 1/2 or so in the third quarter. So trying to get some sense of the
base or trend line that you're using. And then do you expect the national dollar
menu advertising to continue to keep some of that momentum moving just given it's
a broader effort than the two products you're doing?

Andy, this is Mike. We do -- we have seen an incremental move that's very, very
encouraging through the first 14 days. I just have been handed 21 days. And in our
company-operated restaurants we're plus both in sales and in TCs. We're very
encouraged by this two regions that are really excelling and executing let's do lunch
at the front counter Indianapolis, is up over 8%. And Florida is up over 5% in comp in
our company-operated restaurants. And this of course is after three brief weeks of
our national program here that's holistic as I know you know. We start the middle of
November with our advertising of the dollar menu. I'm very excited about it because
as I discussed and I think you know, it's about choice. And it's about value. People
can have a large red meat or white meat sandwich plus a parfait and side salad all for
$3. The celebrity accompaniment I think is going to add a lot more excitement to it.
And so, Andy, we're very encouraged by what we z we know we have to execute
better at each and every restaurant but the data is suggesting that we have made
significant improvement here since February.
Thank you.

The next question comes from Mitch Spieser at Lehman Brothers.
Q - Mitch Spieser
Thanks very much. A question on the dollar offerings and the dollar upcoming dollar
menu. You know, I guess over the past 21 days, can you give us a sense of how -- of
how extra value male sales have been performing you? Did say that sales are up
incrementally for your company-operated stores. I was wondering what the level of
extra value meals sales are and how perhaps the margin side of the equation is
holding up. And along those lines, Jack, just a bigger picture question. Along these
lines, while focusing on the dollar men usual what do you think the risk of of
conditioning consumers just to come for the dollar menu versus your extra value
meals, which are I would think probably higher margin in nature and have a higher
average check? Thank you.
Page 14 of 21

In terms of your first question I don't think we are going to get into that level of
detail for competitive reasons, but you will recall that in our comments we
mentioned that average check was relatively stable. So I think that speaks to the
whole issue of what are we seeing in terms of the impact from the dollar menu.

Right. I think also that -- it's Jack Greenberg. I think our whole historic experience is
that when you have a compelling offer that people know about, they come into the
restaurant more often. And we have found through all kinds of programs like this
and particularly the latest one but even for a lot of things we have done in the past,
that people start to buy what their favorites are and start to experiment with our
menu and so I don't think that advertising a national price point which says that you
have everyday low prices at McDonald's is something that gives you more choice is a
problem of conditioning the customer other than to reestablish our leadership as
the price value leader which is what built this business.

And Mitch, just two other points that are very important in terms of operator
profitability. Our average check is only down about 2 cents which is very
encouraging and speaks to the point Jack is making that they are buying a lot of
other things and our food costs is up less than a half a percent. Are very, very good
signs for us and barometers of profitability in the business.

Thanks, Mitch. Our next question comes from Peter Oaks at Merrill Lynch.
Q - Peter Oaks
Hi, uhm. Good afternoon. Jack, I wanted to follow up on what's going on in Europe.
You did mention some. Weaker trends, particularly in Germany. About the sales have
definitely slowed down here the last few months. So do we need to think of some of
the tougher markets in the Europe being a hostile environment to the macro
program or are these programs capable of moving the needle for new that contrast?
And for the second question, real quickly, Mike Roberts, how are the sales tests
going give that this time of year probably is not probably top of mind for sale
through program.

I think that the answer to your first question about whether these macro problems
can be dealt with a specific price value tactics is a question that will be answered by
each different market. I don't think they are all the same. I think the problems in
Germany are very different than the problems in the UK as I think we've indicated,
France continues to do well and our customers continue to respond. There are a lot
of markets in Europe that are doing reasonably well. Of course, when Germany and
the UK aren't doing as well it has an impact overall but I think we are going to have
Page 15 of 21
to wait and see in Germany. We're obviously hopeful. We are going to do everything
we know how to do to make that economic environment as benign as possible with
aggressive advertising and price tactics. But I think time will have to tell. I think the
UK is probably a little different story and their problems economically aren't as
serious and I'm very hopeful that you'll see improvement there. The salad news, I'm
going to ask Mike. He has some exciting news about salads that I want him to share
with you, you about the fact that we're accelerating the national rollout tells you we
really like what we see so far.

Peter, we're selling on average 3 to 400 salads a week in the 600 stores that are in
test. I know you have had them and I know you told me in New York you liked them.
The salad shakers that we currently have are selling on average about 150 a week. So
we're very encouraged that we have a product that's very compelling. Here at our
Arch at McDonald's headquarters we're selling 100 of them a day. So we like them
and our customers are telling us they like them, as well.

And it's not just about how many units we're selling. The price point on these new
salads is much, much higher. They're generally 3.99. Thank you.

Thank you. Our next question is from Michael Sharison at Morgan Stanley.
Thanks. Just a follow-up. I think it was Jack's comments or Matthew's, you talked
about relooking at international and potentially restructuring some relationships. I
was wondering if you could elaborate on that comment. And also if you could just --
yes.

Go ahead, I'm sorry.
I was going to -- if you could just comment a little bit, European unit level margin was
much stronger than I would have thought while the US was soft. If you could just give
us some color behind those too.

I'll deal with the first piece of your question, Michael. I did make a comment that we
are looking at a small number of international markets for possible restructuring.
That work is very early in the process. I thought it was important that investors know
that everything is on the table, that we're examining this business to optimize our
current business. That's part of it. I think it's way premature for us to speculate on
what that result is. And I think you'll just have to give us some time. But I thought the
Page 16 of 21
fact that we're looking at it carefully and trying to figure out what our options are in
some of these markets, whether it's changes of ownership, et cetera, is what I had
reference to. So on the second piece, I'm not sure, Mary --

Michael, I think -- I guess I'm a little surprised by your question because your
company -operator margins declines more quarter over quarter in the third quarter
versus what we saw in the second quarter, and we would attribute that, of course, to
the weaker comps, most -- is the biggest impact, and then we continue to see
pressure on labor in a number of key markets and those are the two key factors.
Thanks.

We are going to take another question, the next one is from Vladimir Ivelcom of
Tudor investments.
Q - Vladimir Ivelcom
Hi, everybody. Did you -- could you run, please, through the advertising and promo
calendar as we go through the year through the end of the year? Thanks.

I tell you, I think you are asking about the US marketing question.

Vladimir, it will primarily focus on the dollar menu. We will, between now and
November 15th, be featuring the dollar big and tasty and the dollar McChicken. The
middle of November, we will start the national launch of the dollar menu and you'll
see this through the end of the year.

Thank you. We have another question from Coralee Whitter at Goldman Sachs.
Q - Coralee Whitter
Hi. I just wanted to clarify a couple of factual points. The first is the 600 net opening
rate, can you also tell us what the gross opening rate is? And then the second one is I
just want to make sure I understood what you said about the impact of the dollar
menu. You said it was positive for company-owned stores. Is it also positive for the
whole system or just the company-owned stores?

Matthew?
Page 17 of 21

On the openings, net versus gross, Coralee, in general, year to year, normal closings,
probably run between 200 and 350 in a normal year. Our closings for '03 will be in
that same range.

And Coralee, in terms of sales, I don't have 21-day sales yet for our operators or had
that read, but in 14-day sales I indicated they were up and they are up.

Thank you. We have a follow-up from Janice Meyer.
Q - Janice Meyer {BIO 1498657 <GO>}

Yes. On your unit the scaling back your units it seems to be centered in Asia-Pacific
and Latin America. Yet those markets relative to profitability are very, very small
contributors. Why not focus more in Europe, you talked about Germany being weak,
and it sounds like you believe Germany is a longer-term issue as opposed to short
term and since Europe is so important for you and can really have a meaningful
impact on improving your returns, would you consider focusing further unit cutbacks
in Europe?

Janice, this is --

Sorry.

Janice, this is Mary. When you work through the numbers you will actually see that
we have cut back substantially in Europe in terms of net traditional holdings. By my
calculations, I'd say it's down more than 100 maybe 120 or so against what we expect
for this year. On a base of roughly 330 for this year, which is a little lower than where
we even started out expecting the year to be.
So you can see we have cut back. Importantly, though, too, I think is as much as we
have discussed some current issues in Germany, in fact you know, there are
incremental return on invested capital continues to be pretty strong and when you
look at the return on investment, over the kind of the trailing 12-month period it's
very high, it's about 20%. And incrementally, it's in the mid-teens.
So it's not necessarily where we want to open zero stores but we are being very
careful about where we open stores and as we mentioned, we're concentrating our
openings in a small number of markets. I think if you recall, we said that there are
only 11 markets next year worldwide that -- where we'll open more than 10 stores.
Page 18 of 21
Clearly, we've also made some reductions in the US which I know you didn't ask
about and the US has good returns as well on new restaurant optimizations but I
think there we do want to focus more on the existing business and on the midsizing
our existing assets but you'll notice that that probably another cut back of a couple
of hundred on a net basis.
So the -- a lot of the dollar cut back in total capital is Asia and Latin partly because in
the US we're reinvesting more in the existing business. But as you go through the
numbers of openings, I think you'll see that we have made adjustments in a number
of markets. Thank you. We have time for about one more question. Joe Buckley has a
follow-up.

Yes. Could you talk about plans to buy units from franchisees and give us a rough
sense of how many and how much money you might expend on that?

Thanks, Mitch.

Joe, this is Matt.

Sorry.

We don't have a specific number in mind. We have set aside some amount of capital
to do this because we can see our company-owned store base growing from maybe
15% to 16. It's not going to go from 15 to 18 or 15 to 20 or anything like that. So we
don't have a specific number of stores in mind. But you can kind of do the math.
Going from 15 to 16 isn't the huge number of stores but we think it's important
message to send because we have a lot of faith in our ability to profitably grow
McCopco.

As I made my comments, Joe, in my opening remarks, I think one of the pieces of
good news here is the fact that our company-owned restaurants are performing very
well both operationally and financially. And are now I think in general leading the US
system. And we consider that a big positive because it has implications not about
what we own, because we're a franchising business, but what it means to our
franchisees. So we're very pleased about that.

Thank you. With that, I'd like to ask Jack to make a couple of quick closing
comments.
Page 19 of 21

I thought I would just mention because nobody asked, I thought I would ask myself a
question-and-answer t Mary doesn't let me do this very often so I didn't get
permission. But we did open this three in one concept in Lincoln, Nebraska, a week
ago and it's an interesting experiment. I thought it would be useful to just take one
minute and tell you about it. The 3-in-1 concept specifically involves a planner and
sandwich section of the restaurant which is made to order hot and cold sandwiches
and matters. It's got a bakery and ice cream, homemade ice cream section and it's
got a traditional McDonald's. And we were doing in this one restaurant we were
doing a couple of million dollars of volume is my recollection in the final year before
we did this change, this experiment.
The first seven days here, it's generating over $70,000 in volume in that first week in
that first seven days and that's with no advertising and no particular promotion. And
it just -- again, it's one of the experiments. It's not a national program, but I thought it
would be interesting to share with you. If gives you an example of the kinds of things
that our people are working on that creates I think a very strong pipeline for
innovation. I think this morning it's clear that we've talked about several strategic
changes in our business. They're all designed to build comparable sales and
optimize the performance of our core business. We've covered a lot in this call. But I
think I can sum up most of it in a few sentences. We are making the tough decisions
necessary to optimize the business. We are focused on our core business. We are
generating momentum and we are moving forward. I thank each of you for your
interest in McDonald's.

Good-bye.

Good-bye.
Operator
This concludes today's McDonald's teleconference. Thanks for attending and have a
great day.
This transcript may not be 100 percent accurate and may contain misspellings and
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the purchase or sale of securities or commodities. Any opinion expressed in the
Page 20 of 21
transcript does not necessarily reflect the views of Bloomberg LP. © COPYRIGHT
2024, BLOOMBERG LP. All rights reserved. Any reproduction, redistribution or
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FINAL TRANSCRIPT 2002-10-22

McDonald's Corp (MCD US Equity)

Q3 2002 Earnings Call

Mary Healy {BIO 19299079 <GO>}

third quarter results. The language in that release regarding forward-looking

Jack Greenberg {BIO 1397619 <GO>}

Matthew Paull {BIO 4209230 <GO>}

Thanks, Jack. As you've probably noted in today's release, we expect capital

Mike Roberts {BIO 19273597 <GO>}

and act on objective restaurant-specific data and identifies areas needing

We continue to focus on service emphasizing staffing, especially the peak hours of

As we previously discussed, we believe these investments in refreshing, remodeling

And now I'll turn the call back over to Mary.

Mary Healy {BIO 19299079 <GO>}

Questions And Answers

So the first question we have is from Michael Sharison [ph]. Michael?

A - Mary Healy {BIO 19299079 <GO>}

A - Matthew Paull {BIO 4209230 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Matthew Paull {BIO 4209230 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

Q - John Glass {BIO 2450459 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Matthew Paull {BIO 4209230 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

Q - Janice Meyer {BIO 1498657 <GO>}

A - Matthew Paull {BIO 4209230 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

Q - Joe Buckley {BIO 1491816 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

Q - Joe Buckley {BIO 1491816 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Matthew Paull {BIO 4209230 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Mike Roberts {BIO 19273597 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Mike Roberts {BIO 19273597 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Matthew Paull {BIO 4209230 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mike Roberts {BIO 19273597 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mary Healy {BIO 19299079 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Matthew Paull {BIO 4209230 <GO>}

A - Jack Greenberg {BIO 1397619 <GO>}

A - Mary Healy {BIO 19299079 <GO>}