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McDonald's profits drop 11 percent; Fewer openings planned

| Wednesday, Oct. 23, 2002

CHICAGO (AP) — McDonald's Corp., reporting lower profits for the seventh time in the past eight quarters, said Tuesday it will pare new restaurant openings nearly in half in 2003 and invest more heavily in its sluggish U.S. business.

Third-quarter earnings of $486.7 million were an 11 percent drop over the previous year and reflected lower sales in the United States, Germany, Britain and Japan — all of its five biggest markets but France — among restaurants open at least a year.

The hamburger giant, struggling amid the glut of U.S. restaurants and perceptions of poor service, among other problems, also said it needs a "significant improvement" in sales to achieve its full-year earnings target.

But industry experts saw nuggets of hope that the McSlump might soon end.

Analysts took heart from McDonald's commitment to putting less on its plate in terms of expansion and from its report of an October rise in long-stagnant U.S. sales, thanks to strong early results from its promotion of $1 menu items.

"Their third quarter was nothing to write home about," Merrill Lynch analyst Peter Oakes said. "But it looks like the tide's starting to turn on the U.S. front."

Shares surged as much as 9 percent and closed up 65 cents to $18.95 on the New York Stock Exchange. The stock had sunk to a seven-year low of $15.75 on Oct. 10.

The Oak Brook, Ill.-based company said it now plans to open 600 traditional McDonald's restaurants worldwide next year, down from 1,050 in 2002, including just 100 in the United States — less than a third of this year's total.

It also will step up its investment in the other chains it owns and expects to open 150 to 175 of those restaurants in 2003, primarily involving Chipotle Mexican Grill but also Boston Market and Donatos Pizzeria.

"There was modestly positive news in the fact that McDonald's recognizes it needs to deflect its focus on growth to improving the financial performance of its existing asset base," said U.S. Bancorp Piper Jaffray analyst Allan Hickok. "The company has opened 8,000 units since early 1997 and its stock price has recently lost 60 percent of its value. So obviously growing has not contributed to shareholder value."

Net earnings equated to 38 cents a share and were down from $545.5 million, or 42 cents a share, a year earlier.

That continued a McDonald's trend of posting lower earnings than the year-earlier quarter — a trend that had been interrupted in the second quarter with a 13 percent increase in profit over the prior year.

The results met analysts' consensus estimate, compiled by Thomson First Call and lowered last month after McDonald's warned it wouldn't meet its quarterly target.

Revenues rose 4 percent to $4.05 billion from $3.88 billion, and systemwide sales, which include both company-operated and franchised restaurants, rose 3 percent to $10.91 billion from $10.63 billion. The gains resulted from the usual expansion push; existing restaurants' sales were down.

"This year certainly has proven to be even more challenging than we had anticipated," said chairman and CEO Jack Greenberg.

Greenberg said the company has noticed improvements this month in both same-store sales and service in its flagship U.S. business, including not only the heavily marketed nationwide dollar menu but in drive-through service times.

"Clearly now, our focus is trying to optimize the existing business," he said. "We are generating momentum, and we are moving forward."

Asked about reports McDonald's plans to lay off several hundred administrative employees, Greenberg said "it is likely there will be some job loss" once a review of worldwide expenses is completed. "We hope it won't be significant, but we don't know yet."

McDonald's cut about 700 jobs last year, affecting both its headquarters staff and at U.S. regional offices.

By dramatically reducing new restaurant openings, which peaked at nearly 2,000 in 1996, McDonald's will slice nearly $500 million off this year's capital budget and free cash to beef up its more than 13,300 U.S. restaurants, where sales have been flat.

Greenberg said $300 million will be used to increase reinvestments in existing restaurants and nearly $100 million will go toward new buildings for U.S. franchised restaurants.

Much of the pullback will occur in regions with weak economies. The company said it will significantly reduce its investment in the Asia-Pacific region, the Middle East, Africa and Latin America, and will pare back "somewhat" on openings in Europe.

For the first nine months of 2002, net income was $1.24 billion, or 96 cents a share, compared with $1.36 billion, or $1.04 a share, a year earlier. Revenues were $11.5 billion, up 4 percent from $11.1 billion, and systemwide sales rose to $31 billion from $30.5 billion.

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