Earnings Call: Q2 2012

Jul 23, 2012

Welcome to McDonald's July 23, 2012 Investor Conference Call. At the request of McDonald's Corporation, this conference is being recorded. Following today's presentation, there will be a question and answer session for investors. I'd now like to turn the conference over to Ms. Kathy Martin, Vice President of Investor Relations for McDonald's Corporation. Ms. Martin, you may begin. Thank you, and good morning, everyone. With me on the call are our President and Chief Executive Officer, Don Thompson and Chief Financial Officer, Pete Benson. Today's conference call is being webcast live and recorded for replay via phone, webcast and podcast. And before I turn it over to Don, I want to remind everyone, as always, the forward looking statements in our earnings release and 8 ks filing also apply to our comments. Both of these documents are available on www. Investor. Mcdonalds.com as are reconciliations of any non GAAP financial measures mentioned on today's call with our corresponding GAAP measures. And now I'd like to turn it over to Don. Thank you, Kathy, and good morning, everyone. My pleasure to join you today in my new role as CEO, and I'm honored to lead this great system of 1st class owner operators, supplier partners and company employees. And I'm confident that together, we will continue to build this business for all of our stakeholders under the umbrella of our global plan to win. As I said on our last call, we will stay the course. The recent change in management does not mean a change in strategy. With that, let me provide a perspective on the quarter results and an overview of our plans as we continue to navigate this environment in the short term and drive the business for the long term benefit of our system and our shareholders. McDonald's continued its solid performance in the 2nd quarter. We've continued to grow market share despite a slowing global economy. For the quarter, global comparable sales were up 3.7%, operating income increased 3% in constant currencies and earnings per share reached $1.32 a 3% increase in constant currencies. And in July, global comparable sales are expected to be positive but less than 2nd quarter. We're experiencing stronger headwinds on both the top and bottom lines. Some of the headwinds are macroeconomic, such as declining consumer sentiment and higher commodity and labor cost. Other pressures are the result of planned strategic decisions we've made to grow the business. These include actions we've taken to enhance our value platforms, our worldwide owner operator convention that brings the system together every 2 years and investments in technology initiatives. Despite these demands, the system remains aligned around the plan to win in our 3 global priorities to optimize our menu, modernize the customer experience and broaden accessibility to brand McDonald's. We're focused on driving results in this environment by continuing to refine our efforts around these priorities to address local market conditions. So let's start with the U. S, where comparable sales increased 3.6% for the quarter and operating income rose 2%. The U. S. Continues to build sales and guest counts. It is, however, happening at a slower pace amid an unpredictable economic environment and increased competition. Sales gains during the quarter were driven by everyday value across a variety of price points and new menu news. Breakfast continued a strong momentum with local market emphasis on core breakfast sandwiches and the introduction of blueberry banana nut oatmeal in May. Beverages were also a key contributor to growth. The new Cherry Berry Chiller helped drive beverage sales on top of last year's strong results from the launch of frozen strawberry lemonade. Relative to our core products, our 20 piece Chicken McNuggets were highlighted on the new Extra Value menu, which provides value across multiple price tiers. As a result, total sales of Chicken McNuggets increased nearly 11% during the promotional period when compared to the same time last year. Now our focus remains on driving guest counts and we are refining our plans as the environments shift. These plans are balanced across product categories and price tiers. For example, we're enhancing everyday value with new news and promoting core and premium products through exciting games like the Olympics high end, which is starting today. And to ensure customers have more reasons to visit us in the near term, we will continue to leverage promotional food events like spicy chicken McBites and also additional McCafe flavors. Our new product pipeline also includes several new beef and chicken products and additional innovations around breakfast and beverages. We're currently testing a number of new products, some of which have been adapted directly from other areas of the world. Turning to Europe. 2nd quarter comparable sales were up 3.8% and operating income grew 8% in constant currencies. The UK and Russia delivered strong sales for the quarter. And while France and Germany are also positive, these two markets are feeling the pressure of the ongoing eurozone difficulties. Europe's IEO industry is contracted as austerity measures continue to impact consumer purchasing power and confidence. Despite this, however, the U. K, France and Spain have gained market share. And in Germany and Italy, we are maintaining our share. So although year to date guest counts are down in several markets, we are faring better than the competition. Europe is reenergizing its 2012 plans. Those plans are being reenergized to drive traffic in this environment. Markets are also placing an even stronger focus on value offerings across the menu and on promotional food events featuring premium products. The U. K. Success has mainly been driven by a balance of popular menu offerings in the Q2. The Great Taste of America food event, as an example, boosted average check. A focus on daypart expansion also contributed to results, especially at breakfast, with a new wrap that offers pork sausage, bacon, eggs, potatoes and cheese wrapped in a soft flour tortilla. Russia also continues to perform quite well with a strong focus on breakfast, lunch and beverages. 2nd quarter marks the 7th consecutive quarter of double digit comparable sales growth in Russia. In France, we're increasing our media spend to further strengthen our share of voice and increasing the focus on our popular Petit Plaisir lineup of smaller premium sandwiches that are priced at a mid tier value. German consumers remain deal conscious in an increasingly competitive environment. We stepped up our value messaging to consistently remind customers of the great everyday value that they can get at McDonald's. The market recently implemented McDeal, a value meal that offers a chicken classic, a McChicken classic or a hamburger royale with cheese, along with a fry and a drink for €3.79 This contributed to strong sales and guest counts in the month of June. Germany is also leveraging its nearly 800 mid cafes with new news, including Bubble Tea. This is helping strengthen multiple dayparts, including breakfast and afternoon snacking. From value and variety on our menu, including the McWrap, which is now available in 24 markets, to our ability to offer more convenience options like cashless payment in 85% of our restaurants, we are providing European customers with what they want. And our commitment and ability to execute a great relevant experience for the customer is evident in our improving customer satisfaction scores as well. Now shifting to Asia Pacific, Middle East and Africa, or APMEA. Comp sales were up 0.9% for the quarter and operating income increased 1% in constant currencies. Across this region, we're seeing fragile consumer confidence in Australia, Japan's uneven recovery and an economic slowdown in China. We're positioning our markets appropriately in this environment with strong value platforms to build traffic. And we'll complement these platforms with average check builders that include new food news and brand extensions. Australia's 2nd quarter comparable sales growth was due in part to strong breakfast results as well as the successful launch of its Olympics promotion. Additionally, the loose change menu introduced in late March has helped drive guest counts and sales. And as expected, once customers realize that this value offering is not going away, the use of the menu has leveled out and they're beginning to trade up to other items like extra value meals. Japan continues to grapple with a difficult economy, coupled with ongoing disaster recovery and anticipation of energy restrictions. This is taking a toll on consumers who are now eating more meals at home. Despite a significantly contracting IEO market, we continued to grow share this quarter. We responded to customers' needs by rolling out a new multi tier platform, the 100, 250, 500 yen menu. We're appealing to even more customers with this new branded affordability platform. And like any market that implements value, our strategy is to drive sales and profitability by trading these visits up to extra value meals and other premium offers. Utilizing our philosophy to learn, share and scale, Japan is growing its beverage business by promoting trial of iced coffee from the U. S. Through sampling events. Turning to China. In China, consumers are reacting with greater caution as the economy has slowed. We've seen this particularly in our Tier 1 cities where we are more heavily concentrated. We're also seeing heightened competitive activity focused on value. In China, branded affordability has been a key part of our strategy over the last few years, and we are staying the course. Value Lunch and the recently launched Value Dinner are driving sales and guest counts that contributed to 2nd quarter's comparable sales increase of 2.2% and market share gains in our top 5 cities. China's fastest growing daypart continues to be breakfast. Our ability to bundle convenience with uniquely McDonald's products is resonating with customers. Not only does this daypart now represent more than 9% of sales in China, it continues to grow. We're also making sure that the brand is accessible. We remain on track to open 225 to 250 restaurants this year and also continue to focus on conveniences like McDelivery and Dessert Kiosk. As you can clearly see, we are operating in a more difficult global environment. And this environment requires us to be even more flexible and aggressive, particularly as economic and consumer volatility persists. And although we've continued to deliver positive results, let me be very clear, we're not satisfied. We remain focused on appealing the customers more than anyone else as we run the business for the long term. The headline is this. We have a resilient business model, a talented and aligned system and experience in every type of operating environment. We're staying focused on the things that will continue to differentiate us like our new restaurant designs. We've already reimaged 1,000 restaurants around the world this year and remain on target to meet our goal of more than 2,400 reimages in 2012. And we are on course to build over 1300 new restaurants this year in emerging markets like China, Brazil, India and Russia, and also in more established markets, including the U. S, France, Germany and Australia. We will continue to go after these new store development opportunities when and where appropriate. We have the discipline, the capital and resources to continue to do this successfully. Now as our business grows and continues to generate significant levels of cash, our philosophy for its use remains the same. We will reinvest in the business first, and after that, we'll return all free cash flow to shareholders. In fact, in the Q2, we returned $1,600,000,000 to shareholders through a combination of dividends and share repurchases. In closing, we understand what we are facing from the macroeconomic environment to an increasingly competitive landscape. We've been in situations like these before and we're drawing on that knowledge and experience to manage through these times. By remaining committed to our long term strategies to optimize our menu, modernize the customer experience and broaden accessibility to brand McDonald's, while continuing to fortify our short term plans, I am confident we will continue to grow the business for the system and our shareholders. And with that, I'll turn it over to Pete. Thanks, Don, and hello, everyone. Our focus on the plan to win and the 3 global priorities of optimizing the menu, modernizing the customer experience and broadening accessibility continued to fuel solid top line performance. I'd like to start with a few higher level comments about the quarter and then get into more detail on the results. As you know, the macroeconomic environment for the past several years has been challenging and unpredictable. Our global diversification has been an advantage as pressures fell in certain markets were often balanced with stronger performance than others. In Q2 2012, this wasn't necessarily the case. While we faced significant cost pressures as expected, we also experienced slower sales growth in most of our major markets. Persistent unfavorable economic conditions are weighing on consumer sentiment and spending. And in many markets, we're continuing to experience flat to declining IEO traffic along with a heightened competitive landscape. We're employing different tactics in each market to address this, with the common theme being increasing the emphasis on value in the short term to drive traffic, which is a critical element of long term sustainable growth. These tactics are likely to take hold beginning later this year. Relative to cost pressures, company operated margins are negatively impacted by higher commodity and labor costs. In many markets, this was on top of mid single digit commodity cost increases last year. Higher G and A expenses were also a headwind. As previously communicated, the $100,000,000 of incremental G and A investments this year are negatively impacting operating income growth, especially in 2nd and third quarters. We believe these investments in technology enhancements, Olympic sponsorship and our worldwide convention are foundational to future growth and the long term health of our business and brand. While we are not satisfied with these 2nd quarter results, they are not entirely unexpected. We previously communicated that 2nd quarter operating income growth would be affected by the volatile global economy and related headwinds along with our near term investments. In keeping with our historical practice, we will not be updating or providing earnings guidance going forward. While earlier this year, we disclosed that we expected to meet our long term average annual constant currency financial targets, Based on what we know today, considering recent trends, along with the heightened global economic challenges, it appears likely that we will end 2012 at or somewhat below the 6% to 7% constant currency operating income growth target. Now turning to results. In 2nd quarter, system wide sales increased 6% in constant currencies. We continue to grow both global comparable sales and guest counts and are now serving 69,000,000 customers per day, 3,000,000 more than a year ago. This contributed to a 6% constant currency growth in franchise margin dollars. And at $1,900,000,000 they represent approximately 70% of total restaurant margin dollars. The franchise margin percent was up 10 basis points to 83.2%. Global company operating margin dollars for the quarter totaled $850,000,000 and were up 1% in constant currencies. The margin percent decreased 80 basis points to 18.2% as a result of softer top line results, coupled with increased cost pressures. To put that 18.2% into perspective, it is our 3rd highest second quarter margin since the year 2000. In the U. S, 2nd quarter company operating margins declined 90 basis points to 19.8% as positive comparable sales were more than offset by 5% higher commodity costs and to a lesser extent, higher labor and occupancy costs. As a result of risk management efforts and supplier production efficiencies, the full year outlook for the increase in our U. S. Grocery basket has been lowered to 3.5% to 4.5%. This implies a second half increase of approximately 2%, which should be fairly balanced between 3rd and 4th quarters. In terms of pricing, the U. S. Is running about 3% for the trailing 12 months. The Food Away From Home Inflation Index is projected to be up 2% to 3% in 2012. If it ends the year closer to the bottom end of the range, we may have a little less room to take pricing in the back half of the year. As always though, we will be thoughtful with future price increases seeking to maintain positive guest counts. In Europe, 2nd quarter company operated margins decreased 30 basis points to 19.3%, primarily impacted by higher labor expenses, 4% higher commodity costs and to a lesser extent higher occupancy costs. Europe's projected full year commodity cost increase remains at 2.5% to 3.5%, which implies a second half increase of approximately 2% to 3%. As noted earlier this year, we have less pricing power in Europe than in the U. S, primarily due to the austerity measures. Our price increases vary by market, with Russia at the high end due to its significant inflation and all other markets averaging about 2% year over year. As we lap prior year increases during the second half of this year, we will likely replace them with lower increases. Turning to Asia Pacific, Middle East and Africa. Company operating margins for the quarter decreased 170 basis points to 15.3% as modestly positive comparable sales were more than offset by higher labor, commodity and occupancy costs. In addition, new restaurant openings in China negatively impacted the segment's margin percent. APMEA's guest count increases significantly outpaced comparable sales increases for the quarter. So we are encouraged by the efforts of our franchisees and company employees that resulted in increased demand for brand McDonald's throughout the region. As Don mentioned, in Australia, where we introduced a more robust value platform in mid March, comparable sales are steadily improving as consumers migrate beyond the value platform to the rest of the menu. This overall trend is in line with what we have seen in other markets when new value platforms are introduced. Turning to G and A, 2nd quarter costs increased 8% in constant currencies, primarily due to higher employee costs, our biennial worldwide convention in April and investments in technology enhancements. Our convention was a great success with 16,000 attendees walking away focused and aligned on our key strategies. It also provided a great opportunity to learn and share ideas from markets around the world, allowing us to better leverage our size and scale. Looking to Q3, we expect a double digit increase in G and A given our sponsorship of the upcoming Summer Olympics and Paralympic Games in London. With regard to other operating income, gains on sales of restaurants included the sale of 13 restaurants in 2 provinces in China to developmental licensees, bringing our total number of franchise restaurants in China to 54. The 2nd quarter effective tax rate was 33%, 120 basis points higher than a year ago. Last year's 2nd quarter rate reflected a non recurring tax benefit related to certain foreign operations. For the year, we continue to expect the effective rate to be between 31% 33%. Our business model continues to generate significant amounts of cash. Our first priority remains reinvesting this cash in our business to build future returns and enhance shareholder value. This year, these investments are balanced between opening more than 1300 new restaurants and reimaging over 2,400 existing locations. We remain committed to this effort and are making steady progress. Through June, we have opened 450 new restaurants globally. Regarding reimaging, over half of our 33,700 restaurants offer a current contemporary interior, while more than a third of our exteriors reflect a new look. Re imaging our restaurants is powerful because it is a multi year, multi layered initiative that can enhance restaurant operations, capacity, menu and perceptions of our brand. We continue to invest on a scale that is unmatched in our industry. It is an increasing point of differentiation and is foundational to our long term success. Our franchisees are financially strong and have sufficient access to capital, allowing them to co invest with us to secure our collective future. Through the 1st 6 months, we have completed over 3.30 re images in the U. S, 350 in Europe and 230 in APMEA. We continue to be encouraged by the results of our re image locations around the world. Lastly, let me discuss foreign currency translation, which negatively impacted 2nd quarter results by $0.07 At Friday's exchange rates, we expect 3rd quarter EPS to be negatively impacted by 0 $0.08 to 0 point 10 dollars with a full year negative impact of $0.21 to $0.23 As usual, take this as directional only because rates will change as we progress throughout the second half of the year. In closing, we remain focused on positively impacting those things within our control and executing on our strategy that has proven to be a winning formula. We will continue to prudently invest today to drive growth into the future. While our business model is resilient, we are not immune from the effects of the ongoing significant global economic challenges. At the same time, we are making some short term tactical adjustments to address the current environment, while continuing to build a solid foundation for long term success. We will not waver in our commitment to create enduring value for our shareholders and the entire McDonald's system. Thank you. Now, I'll turn it over to Kathy to begin the Q and A. Thanks, Pete. I'll now open the call for analysts and investor questions. So let's begin. First is Michael Kelter from Goldman Sachs. Hi, guys. I wanted to ask about the focus on value and the potential impact to profitability. So in the short to mid term, what are the risks that you have to meaningfully invest your margins from here to achieve the traffic results you're looking for? And then in the long term, how do you balance any potential risk to the McDonald's brand itself in Europe and the world when you're refocusing the conversation on value and sensibly training consumers to want to pay less for your products? Hey, Michael, this is Don. Just first off, thanks for the question. A couple of different things. Relative to value, this is part of a base it's part of the platform relative to any of the media expenditures in any one of the countries that we operate in. And so value is not a new thing. Question is how much you address it relative to your marketing and media mix. The other thing that we have to do is to make sure that we have a consistent value platform. So we have talked about consistently last year and this year, several markets, whether they be Australia, which was facing some economic difficulties and tough times and the need to have a consistent value base, and now they have loose change, which was implemented really at the end of the Q1 and really into the beginning of the Q2. We talked about Germany relative to MiG deals. Our new Chief Operating Officer, Tim Fenton, was just out with them, and it is an appealing value to consumers. At the same time, we've mentioned that we have to also have a premium product messaging in the marketplace. And so we have not given up on that. All it is, is a tweak, if you would, relative to our media expenditures. But we'll continue to talk about the premium products, whether it be in the U. S, Australia, Germany, Japan, France, any of these markets. All right. Thank you. Next question is David Palmer from UBS. Good morning, guys. Good morning, David. Just a question on the cost side. When I listen to other global consumer companies often on the Staples side, they talk about managing the costs and scrutinizing CapEx, particularly as the going gets tough. And I was wondering and thinking, as you think about these coming years, it doesn't look like this environment is going to be easy going forward. And right now, McDonald's is in what it looks like to be an investment phase, both on the overhead side and the CapEx side. Is that the side when it comes to cash flow and P and L, are you thinking about those things and thinking about scrutinizing those a little bit more as you kind of settle into a reality that's tougher? David, that's a good question. First of all, I'd say, we've around McDonald's, we've always had a practice of scrutinizing the costs. So while you referenced the investment in overhead, I think we tried to make it clear when we talked about the 100,000,000 dollars of incremental G and A this year that that's not necessarily a run rate that you can project into the future. 2 of those items, the Olympics and the convention are isolated to 2012 and our investments in technology, while those will continue, the rate of increase relative to prior year, next year will not be at the same level that it was this year. So take those things aside, we're always scrutinizing costs and looking to be as effective and reallocate costs to drive more sales as we can. Regarding CapEx, while you indicate the environment going forward may be a little tougher, we don't see a fundamental shift in our business model. And so we continue to know that if we reimage our restaurants, we will create that brand differentiation. We know that even in these environments, there continues to be increasing demand for brand McDonald's going forward. So we'll continue to build new restaurants where we see there to be good opportunities and we can generate good returns. So while we're a little more cautious going forward, we don't see a dramatic change. All right. Thank you. Next question is John Glass from Morgan Stanley. Thanks. I also wanted to come back at the margin question maybe just a little more specifically. Your global comps were 3.7% this quarter, so nearly 4% and that yet on the store level excluding food costs now, you didn't really lever labor and some of the other items. And on the franchise side, you got a little bit of leverage, but not much. So is this just an expression of the minimum comp you need? And if we have a view that comps are going to go now below this and say the Q3, is there a risk to delevering those items? Or going back to the prior question, are you able to flex? And then secondly, since you talked about food cost pressures abating in the back half, which is good news, Obviously, the current commodity market doesn't suggest that's going to stay good news for long. Can you maybe comment about your early views about 13 in that context? Thanks. Hey, David, is this John? I'll talk a little bit about the flex piece and then ask Pete to talk a little more specifically about margins. One of the things that we do on a routine basis is we have clearly reviews and visits with all of the markets around the world, particularly our top 10 markets. And what we really talk about is where they're positioned in terms of the opportunity to grow the business. As we look at the totality of all the markets, we then make any adjustments or capital allocations, reallocations necessary for us to grow to the real market opportunity, but always being mindful of what's taking place from a consumer level. So there are markets today that initially we began out thinking we would deploy even more capital into that right now may not be performing at a level that merits that kind of capital based upon comparable sales increases and therefore returns. So we, on a constant basis, look at each of the markets and how we will flex in and out in terms of any of the investments that we make. And then I'll ask Pete to speak to some of your margin questions. Yes, John, regarding the commodities, our supply chain folks, our suppliers, our treasury folks really spent a lot of time earlier this year looking at the markets and did a great job in securing a lot of our grains and other commodities at cost before they ran up related to the recent drought. And so that's why we're able to lower our outlook for this year. And you can imagine, while I won't get into specific details, we've taken a greater amount of coverage for the next year sitting here at this time than we did have a year ago. So we feel pretty good that the impacts from the drought are going to be minimized on next year's results as well to the extent we can see that sitting here today. But as you referenced, margins are still a top line game. And so if they are dramatically impacted by our comp sales and to the extent the comp sales soften, that's where you see that deleveraging. All right. Our next question is Jeff Bernstein from Barclays. Hi. This is Ashwin Shandelia filling in for Jeff. I just wanted to ask basically in Europe where you're emphasizing more value in other markets as well. Using history as a guide, can you maybe talk about the consumer response such a focus in the short term? I mean, I know maybe some pressure on average check-in the short term, but for how long does that occur before customers revert back to more normal ordering behavior? And separately, are there any major markets where you're perhaps being more or less aggressive on value? And what are the expectations in those markets? Thanks very much. Thanks for the question. There are certain markets that we have focused quite intensely on this year and also the latter part of last year to establish what we call as a value platform. And we've talked about some of those markets, Australia, Germany, where we knew consumer confidence was really in question relative to their expenditures, and they also have a higher propensity for saving. France, we've talked about relative to consumer confidence and the advent of austerity measures. Japan, we've talked about relative to what they've come through. And now in this post recovery from the tsunami, they are also in a tough economic environment. And clearly, markets like the Spain's and the Italy's of the world and that southern part of Europe that are having some difficulties. In the U. S, value will always be a major factor, but we have to balance it, as one of the earlier questions was mentioned, with premium products with some of the beverages to offset some of the potential erosion in margin. Relative to how long it takes before you recover and what you see initially, typically when you bring forward a new value platform, as I mentioned in the comments, customers are not used to that and sometimes think it's going to go away. So what they begin to do initially is that they will use that menu from a purchase intent perspective much more so initially. That usually does wane. Sometimes it may take 6 months, Sometimes it may take a little less or a little more depending upon the overall economic situation in the country. Our next question is Keith Signer from Credit Suisse. Thanks. I have a question just more about the branded affordability in the U. S. Food away food away from home inflation kind of come in at the low end of your expectations that may limit your ability to take some pricing in the second half. Just looking back over the last couple of years, I think it's interesting because after several years of running below food away from home inflation, kind of year to date, you've been running kind of in line, maybe even slightly above. And thinking longer term, how do we think about the broad based positioning against that? And kind of maybe regardless of the outlook, should we think of a low pricing environment in the U. S. To continue to maybe combat some of the competitiveness? Hey, Keith. A couple of things, and Pete may have a comment on this as well. So food away from home is 1 it's the baseline. It's the most predominant measure that we've historically used. But I have to say this, we've also used food at home from a grocery store price index perspective as well as commodity cost and labor cost. And so what we have to do is look at what we think will be within the range of price sensitivity and acceptable to a consumer, which has typically been food away from home, but also we have to look at what with the direction of commodities. So commodities look like they're going to really ramp up. We want to make sure we're in a position to minimize the impact of margin erosion by taking appropriate price increases. There are times when we will bump up against, as you mentioned, food away from home. Or even for a very short period, we may actually eclipse it, but we'll bring that right back in line. And that's just part of the ongoing management of what's taking place in the broader marketplace in terms of food costs, labor pressures, and then understanding what's happening with consumer confidence and disposable income. And I think Keith, it also is fair to assume in that kind of pricing equation, if you will, or pricing formula. We do look at what's going on, on the menu boards at the competition. So the competitive environment does also factor into it. But Don highlighted that the more macro factors that we do look at. Our next question is from Matt DiFrisco from Lazard. Thank you. Pete, I wondered if you could talk about the dynamic of the franchise margin in the U. S. And try and help us understand maybe how that looks going forward. As far as it's been several quarters of a run of margin expansion on the franchise side in the U. S. And now it's sort of flat year over year. If you could put that into the context of what how those how that dynamic works going forward in an environment where I think at the press release you said that the same store sales are going to be a little or guided to be a little slower in July and ahead than they were in 2Q? All right, Matt. First, let me July and I know this is generally out there, but July, we are facing a negative 1.8% trade day impact. So that is impacting July as well as the fact that Ramadan is starting started last week. So we're going to have 10 days impact of Ramadan this year in July when that was entirely in August last year. So those are a couple of things to think about when reflecting on that July guidance. But as we said earlier, the same thing applies to franchise margins even more so that applies to company operating margins is that they are a top line game. So they are really driven. We get tremendous leverage when we're driving comps and they tend to slow down as comp sales slow. The other thing specific to the U. S. Is with the reimaging that's going on, we are seeing a greater increase in depreciation expense. So typically, depreciation is one of those fixed costs that you can leverage with the increased sales. But with the progression of increasing the re imaging, we are continuing to layer on some additional depreciation expense, which that will continue into the near future. All right. Our next question is from Joe Buckley from Merrill Lynch. Thank you. Pete, I was wondering if maybe you've done this already, but could you break down the $100,000,000 of G and A among the three things you mentioned, the April convention, the Olympics and the technology program? So, Joe, we've somewhat broken it down in that we've said half of that relates to the convention in the Olympics and the other half relates to the IT investments. Okay. Thank you. All right. Our next question is from Mitch Fizer from Buckingham Research. Great. Thanks very much. And I'd like to ask another question about margins. And the global margin at the store level, I believe was down about 80 bps. And Pete, is it possible just to give us a sense of maybe how much of that contraction was due to increased focus on value? And as we look out over the next couple of quarters, do you expect that emphasis to heighten or are we kind of there already? Thanks. Yes, Mitch. It's hard to pinpoint precisely how much of that is related to our increased focus on value. And specifically, Don alluded to this a little bit, when we say value, it's not just that entry point value. So it's not just the dollar menu or the 1 euro items menus. It's also some of those premium food events that are a relative value compared to the rest of the marketplace. So I know we talk a lot about value to drive transactions and the implication there is that is the entry level value and a lot of that is, but it also has different forms across the menu board. But I would say that as we focus more over these next couple of quarters, it is likely that the impact will be a little bit more will be greater in the next couple of quarters. And Mitch, just one point on this one is what we're facing now from a global economic perspective is we're just seeing more markets that have consumer confidence issues at what we would consider to be more substantial levels. So this notion of value and the way we're talking about branded affordability, while it is not necessarily new in all of the markets, what we're finding is that we have to again crank up our messaging, our GRPs, our marketing spend just a little bit more to appeal to some of these consumers who frankly have less confidence in the overall economy and therefore reduce their disposable spending. And so that's why we're having as many conversations about it. But having said that, we've been doing this in each of these markets over time. So it's not they're not typically new things. There are a couple of markets where it's new, where Japan, say, or in Australia would lose change. The petite plazers have been in France. The U. S. Has had a value based menu. Germany has had SMS. But what we're finding is we may need to crank that up just a little bit more to appeal to some of these consumers. This is a time for us to really focus on guest count growth and market share gain. And so we really go at this very hard in times like these, even though it means an investment. Our next question is from John Ivankoe from JPMorgan. First, just a really quick follow-up and then the question. Pete, will any of that IT investment recur in fiscal '13 or is it the $100,000,000 gone from fiscal 'thirteen? So that's the first question. And secondly, just thinking about the U. K, I mean, obviously, there is the Jubilee and the Olympics and there's just been so much kind of going on in that market overall. I mean, how do you think about the U. K. In general in the second half of the year and in the 'thirteen? And is McDonald's doing anything proactive to perhaps see prepare for, I don't know if it happens or not, but a slowdown that could happen in the UK per the rest of Europe as some of these events come in the past? Hey, John, I'll take the first part of your question and then Don can give you a perspective on the UK. But the $50,000,000 incremental technology investment spending this year, that will stay in our base and that level of spending will recur next year. So said differently, $50,000,000 for the Olympics and convention does not repeat next year, but the technology spend continues, but obviously it's a zero increase if we spend the same amount. With that, I'll ask Don to talk about the U. K. Hey, John. Beijing so if I look back, Beijing, Vancouver, post the Olympics, what we typically do is we go back to business as usual. So we don't foresee a huge shift or change in terms of our base trend line in the U. K. As we move forward. Now having said that, the U. K. Will be facing some tougher austerity measures in the latter half of the year. And so as those things come into play, we've got to again make sure we're looking at all of the macroeconomic factors in the market and making appropriate adjustments. We have done quite well in the U. K. With balancing our growth across all the menu tiers, and that will continue. But we'll have to continue to look at the market. But right now, we don't foresee anything that will cause a substantial change in the base trend line. All right. Our next question is from Jason West from Deutsche Bank. Yes. Thanks, guys. I just wanted to talk about the U. S. Market a little bit. You've obviously seen somewhat of a downshift in the sales trends though, though they're still healthy. You've seen a slowdown from the last couple of quarters. If you talk about how much of that is kind of consumer macro driven, seeing people trading down to dollar menu, value menu, things like that versus competitive activity that you've alluded to. It seems like the competitive activity not necessarily value oriented all the time, so it's new product oriented and just marketing oriented. If you could just kind of compare that to maybe other periods of slowdown? Thanks. Great question, Jason. Couple of things. We are seeing heightened competitive activity across the IEO marketplace, which is an interesting point because it's not just in QSR. We're seeing it across all of IEO from fast casual to convenience and grocery stores. Having said that, for us as McDonald's, what matters most is to remain focused on what's within our realm of control. So we'll talk about the value platforms, talked about beverages, breakfast. We talked about premium based products and promotional food events like McBites. We've just got to make sure that we're appealing to customers more so. But we are seeing, to your point, we are seeing that competition. Now the other thing is that there is an increase in terms of marketing spend by many of the folks in the competitive set. And so we have to clearly be able to make sure that our strength of voice and our share of voice is still resonating with consumers out there and we build awareness for the McDonald's brand. So this is not new. We go through competitive pressures and there will be resurgences and it kind of ebbs and flows from time to time. But what it means for us is we just got to be focused on our business plan and execute that at the highest level. All right. Our next question is from Andy Barish from Jefferies. Yes. Can you just give us a little sense on sort of the China business, how much the last quarter slowdown was kind of your thoughts internally, more value, kind of value dinner having a negative impact on mix, etcetera, versus sort of the external environment, if there's a way you're sort of looking at that? Yes, Andy. Relative to China, so clearly, we're seeing a little bit of a slowdown economically. And we talked about the Tier 1 cities, which is where we are which is where our presence is absolutely the strongest, it's where we're concentrated. Those markets seem to be facing much stronger macroeconomic pressures than clearly the Tier 3s, 4s, those cities that are outside of the core in terms of where our focus has been. So we are seeing some macroeconomic pressures. On the value side, we are seeing a little bit more media and marketing around value based products. Clearly, I think we're in a pretty good position there relative to the overall marketplace in China. But the other thing is that for us, it's got to be consistent when you execute value. So if you look at last May, June timeframe, we were running 13% 16% comps. And so as we went into this year, we knew that those were fairly high hurdles. Nonetheless, if we execute the existing value lunch strategy, value dinner was added strategy, breakfast is our fastest growing daypart in China, We'll continue to do well in the marketplace. But we have focused a little bit more based on consumer confidence measures. We have focused a little bit more on the value side in China as well. Our next question is from Howard Penny from Hedgeye. Hi, thanks very much. I was wondering if you might be able to quantify what you're seeing in the global markets as you've described it on the call today. The slowdown anyway that you're seeing from the consumer because you've done 5.4% comps for the 6 months this year. Your worst year in the last 5 was 2,008 at 3.8% or 2,009, excuse me, at 3.8%. So you're doing, I think, significantly better and you had a better earning performance. I don't believe you missed the numbers back in 2,008, 2,009. So what is it in the global marketplace that you're seeing is causing the issues McDonald's is seeing? Because from a top line perspective, you're doing much better than what is arguably a far more difficult economic environment in 2,008, 2,009? Howard, a couple of things. One is, we started this year and we had the benefit of the leap year and we had the benefit of the unusually warm winter in a lot of places around the world. So the Q1, while it was strong, there were a couple of things that boosted that beyond the what I would say our normal performance trend had been. But as you look around the world, I would say one of the changes is just the length of this economic challenging period. Back in 2008 and 2009, I think people felt this was an issue. It was going to come. It was going to go. It didn't dramatically change consumer behavior. They did change some, but not dramatically. And I think now that it's persisted for so long and especially in Europe, it's gotten so much deeper in some of these countries that it is really starting to constrain consumer behavior. Several of the markets there, the eating out market is just simply declining. People are staying at home, they aren't going out and the magnitude of the issues in Europe are having ripple effects around the world. And the most significant is it is impacting the consumers' behavior and whether it means they're saving more or they're just going out less, all in all, it is meaning more flattish to declining eating out generally around the world. Hey, Howard, an interesting point and we look at it quite often is we've been at points what we've seen is 1 or 2 markets of our top 10, maybe 3 or 4 that might be experiencing some of these consumer confidence issues. This is one of the first times where we've seen it in a much broader base perspective. So it's a little bit more than a European cold, if you would. It's kind of a little bit more of a global piece that we're seeing across the board. So what all it means for us is that the things that we've employed historically, we've got to make sure that we're in the best position again to drive in the additional traffic in the restaurants to be able to trade those up. But we are making substantial investments to be able to do that now in all the markets that we've talked about. And we're seeing some results in terms of some of the guest count movement, but we may not necessarily see those sales flow down the bottom line until we've gotten to a point where we can really trade those guest counts up. All right. Our next question is RJ Hadavi from Morningstar. Good morning. And I just wanted to follow-up on the product pipeline that Don had mentioned in the U. S. You gave some hints about some new products that may be in the pipeline. But maybe the broader question, just more specifically what we may be seeing in the back half of the year in 2013. And based on the success of McBytes program earlier in the year, there's any learnings or any product platforms you've seen elsewhere in the world that may be successful or you think may have potential in the U. S? Just any commentary on that would be helpful. Thanks. Yes, R. J, a couple of them you guys have seen that we showed at whether it was NIM or some of you have seen these and visited Innovation Center, etcetera. But clearly, the beverage platform we're seeing has quite a bit of resonance and it is being looked at by many markets around the world as we move forward there. But also wraps as a platform, you guys have seen the wraps are being looked at in many markets around the world. We're in quite a few countries across Europe right now. But the variations of the wrap, whether beef or chicken, the ability to even go into shrimp and fish have been quite tremendous. We've even done some breakfast work with those reps, as I mentioned today. So we're seeing those kind of platforms move around quite a bit. On the premium sandwich side, there was I think it was at the investor meeting, we showed you guys a burger called the Pup Burger in the U. S. Those type sandwiches that are more premium beef sandwiches and we can also do premium chicken are some of the sandwiches that have resonated in Europe. And so you can look forward to seeing some sandwiches similar to that next year for sure and possibly, possibly even the latter part of this year. And our next question is from Sara Senatore from Sanford Bernstein. Hi, thank you. I wanted to sort of ask a question about the unit growth that you're seeing. You mentioned growing in emerging markets, and then you also subsequently made a comment about thinking about allocating CapEx and making sure that the returns are there. I guess when I think about your growth algorithm, the one you laid out, you said that you expect to return to, it's usually I think has some low single digit comps, low single digit unit growth for the top line. I'm just trying to understand if you if your growth shifts more towards emerging markets, shouldn't that mean that for any given amount of unit growth you do, you probably have less of a contribution to the top line because they tend to be either lower volume or in the case of Latin America license. So should we be thinking will that mix become more pronounced over time, I guess is the question so that your system wide unit growth may increase, but it will have a diminishing impact on your revenue growth? Hi, Sarah. So we talked about Brazil. I highlighted Brazil as one of those countries. But Brazil is a developmental licensee. It was the only country that I mentioned in large part that is a developmental licensee wholly from that perspective. When you look at the other countries we're growing in, whether it be China, yes, lower average unit volumes, but we are growing quite aggressively, as you know, in China. The growth that we have in some of the others, the Indias and the Russias of the world, In India, we have a developmental licensee and a joint partner. In Russia, that is a wholly owned market, so it's all Macapko. The U. S, we have a mix. Markets like France, we have a similar mix and closer to that 80% to 90% franchise kind of a range, but it's a traditional franchise. So we have growth across many markets and the ownership structures are a little different. So as we look at the allocation of capital, we're looking to see how we can get maximum returns, but we're also looking to see where customers want more McDonald's. That's the first and most important thing. Where are the true growth opportunities to build the business and build system wide sales? Our next question is Philip Zuhan from BMO Capital Markets. Thanks guys. It's Philip Zuhan at BMO. Pete, I was hoping you could maybe quantify some of the labor wage rate pressure you're seeing and where that might be the most acute in terms of geography? It's a little tough to reconcile with 2% to 3% pricing in place, how you guys are actually seeing deleverage on that line against the backdrop of sort of economic softness in general? Philip, we're seeing wage pressure in virtually every market around the world. U. S, there continues to be increases in the average rate. I think there were 7 states that hit minimum wage at the beginning of the year at a 4% to 5% clip, which are impacting that. In addition, in the U. S, we continued during the quarter to invest labor in growing the peak hour. And so that added a little bit of pressure to the labor line. If you go into Europe, not only are wages increasing, but some of the austerity measures in Europe include additional social charges and additional payroll type taxes that are putting pressure on the wage rates. And in Asia, a lot's been written about China and the pressure on wages there. So we're experiencing wage pressure there as well. So it's clearly a global phenomenon for us. All right. We're about out of time, but we've got a couple of additional folks in the queue. So we're going to take these next couple of questions. Joe Buckley from Merrill Lynch. Yes. I just wanted to ask about the European same store sales increase in the month of June. Actually, it looked pretty strong. You mentioned McNeil in Germany, but were more value initiatives in place? What's sort of the timing of the stepped up focus on value in Europe? Hey, Joe. Thanks for the question. A couple of different things. Clearly, in Germany, SMS, and we talked about this back, I think it was April or May, SMS has been stepped up. We have put more media dollars behind it. Also, they created the €3.79 McNeil. So Germany, they did implement that, albeit toward the end of the second quarter. In France, Petit Plaisir is across the board now. It's something else that we had mentioned. And what they don't have yet is a 1 sandwich type price point value, but their base value platform is Petite Plaisir. So we haven't gone all the way to a EuroSAVER there. At this stage, the franchisees are discussing next steps, but we believe we're in a pretty good competitive position in France right now. The U. K. Has continued on Eurosavers. Markets like Spain and Italy are in a value proposition called uno per uno. And I would tell you, Spain has executed this quite well over the last several years, and they are performing well even in the state that the economy in Spain is at. But there are other markets. Italy is a tough market for us. Italy right now, even with the value proposition, for those of you who visited Italy, you know there's a lot of street side cafes and their value proposition is a lower tier even than what we propose at McDonald's through uno per uno. So we have to continue to try to see how we can break through in a marketplace like that. So it does vary a bit, but we are seeing some early results. Nonetheless, we'll have to stay diligent in all of those markets. And our final question is from Peter Saleh from Telsey Advisory Group. Great, thanks. I know it's a little early to be talking about 2014. Just wondering what your thoughts are on health care costs and if you have any kind of estimates around what that could do on a per unit basis and what steps could you take in 2013 to kind of get ahead of that? Peter, we are our current estimate is healthcare is going to impact each individual restaurant in the range of $10,000 to $30,000 So obviously a wide range, but there's a lot of different factors when you look at the healthcare law that impact the number of employees, the number of full time employees, what is the current healthcare offering from the owner operator or Macavco. So there are a lot of variables, but I will tell you that we are significantly increasing now that the Supreme Court has ruled increasing our conversations and disclosures with franchisees around what does this mean for Brand McDonald's, so that they can be as educated as possible around what's happening, so that they can start to anticipate and make any changes if they have to, to try to minimize the impacts of this. And just a dollar basis, that $10,000 to $30,000 we have years like last year where commodity cost increases were even greater than that. So while it is a significant item and it's gaining a lot of attention as a P and L item, we have managed through items of this magnitude in the past and I'm hopeful we can do that in the future. Great. All right. I'll turn it over to Don now with a few closing comments. First off, I want to thank everyone for joining us this morning. In closing, we continue to deliver solid results because the entire McDonald's system, franchisees and supplier partners, company employees is the most in line it has ever been as we continue to execute our plan to win and the 3 global priorities that we've established in optimizing our menu, modernizing the customer experience and broadening accessibility to our brand. I'm also confident that with our solid strategic plans to gain market share over the long term and the experienced senior leadership team that we have and the ongoing communications we have with franchisees, will continue to grow the business for the system and for our shareholders. We remain steadfast in our commitment to our long term strategies as we make smart and strategic decisions to mitigate short term pressures in these challenging times.