Chipotle Mexican Grill's CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: Chipotle Mexican (CMG)

Chipotle Mexican Grill, Inc. (NYSE:CMG)

Q42012 Earnings Call

February 05, 2013 4:30 pm ET


Alex Spong - Director of Investor Relations

Steve Ells - Chairman and Co-Chief Executive Officer

Monty Moran - Co-Chief Executive Officer

Jack Hartung - Chief Financial Officer


Joe Buckley - Bank of America Merrill Lynch

David Palmer - UBS

Andrew Barish - Jefferies

Michael Kelter - Goldman Sachs

Paul Westra - Cowen and Company

Jeffrey Bernstein - Barclays Capital

David Tarantino - Robert W. Baird


Good afternoon and welcome to the Chipotle Mexican Grill's Fourth Quarter 2012 Earnings Conference Call. All participants are now in a listen mode only. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded. Thank you.

I would now like to introduce Chipotle's Director of Investor Relations, Alex Spong. You may begin your conference.

Alex Spong

Thanks, Angela. Hello, everyone, and welcome to our call today. By now, you should have access to our earnings announcement released this afternoon for the fourth quarter and full year 2012. It may be also found on our website at in the investor relations section.

Before we begin our presentation, I will remind everyone that parts of our discussion today will include forward-looking statements as defined in the securities laws. These forward-looking statements will include projections of the number of restaurant we intend to open, comp restaurant sales increases, food cost trends, effective tax rates, investment costs and capital expenditures, as well as statements regarding potential menu price increases and other statements of our expectations and plans.

These presentations are based on information available to us today and we are not assuming any obligation to update them. Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from forward-looking statements. We refer you to the risk factors in our Annual Report on Form 10-K, as updated in our subsequent Form 10-Qs for discussion of these risks. Our discussion today will also include non-GAAP financial measures, a reconciliation of which can be found on the presentation page on Investor Relations section of our website.

I'd like to remind everyone that we've adopted a self-imposed quiet period restricting communications with investors during that period. The quiet period begins on the first day of the last month of each fiscal quarter and continues until the next earnings conference call. For the first quarter, it will begin March 1st, and continue through our first quarter release in April.

On the call with us today are Steve Ells, our Chairman and Co-Chief Executive Officer; Monty Moran, Co-Chief Executive Officer; and Jack Hartung, Chief Financial Officer.

With that, I'll now turn the call over to Steve.

Steve Ells

Thanks, Alex. We are pleased with our results for the fourth quarter of 2012 as well as our performance for the full year. While higher than expected food costs impacted our earnings, our top line performance for the quarter was strong with the comp sales increase of 3.8% and total revenue increasing 17.2% to $699.2 million, adding up to a diluted earnings per share of $1.95 for the quarter.

Results for the full year met or exceeded the guidance we provided in every area, including a comp sales increase of 7.1% for the year and total restaurant openings, of 183, 60 of which were opened in the fourth quarter. Our strong openings and comps drove revenues to $2.73 billion for the full year, an increase of 20.3% over 2011 and diluted earnings per share of $8.75.

The continued strength of our performance is a direct result of our focus on the most important things that drive our business, primarily our unique food culture and unique people culture. With regard to our food, we are always pushing ourselves to find better, more sustainable sources for all of the ingredients we use and to refine our preparation and cooking techniques, so that we are offering our customers the very best tasting food we can and with regard to our people, we continue to develop a culture where we systematically focus on identifying top performing employees and develop them, and empower them to become the future leaders of our company. Through this culture we are ensuring that we have the talent and leadership we need to continually improve our existing restaurants and to open new restaurants with the highest of standards. Through this special culture, we are providing leadership opportunities for all who join the company.

Heading into 2013, we are launching a new catering program to give customers a different way to experience Chipotle. Catering is now available throughout the Colorado market and will be rolled out to all of our restaurants nationwide in the coming months. Our catering menus are available for groups of 20 to 200 people and include everything customers need to make their own tacos and bowls, including the choice of responsibly raised meats, Cilantro Lime Rice, Pinto or vegetarian black beans, fresh salsas, house made guacamole, cheese and sour cream. It has been exciting to see people enjoy Chipotle catering for the first time when they realize they have the chance to serve themselves through smaller version of the Chipotle line and create their own special meal with exactly the combination of ingredients and portions they want. Even though the customers appreciate that they can customize their meal when they visit Chipotle, this is their first hands-on experience serving up our delicious ingredients.

For customers who want a smaller option, we are also offering a chips and salsa spread, which includes guacamole and a variety of salsas, or for smaller and more streamlined catering orders customers can choose our Burritos By The Box option, which allows them to mix and match their choice of chicken, steak, barbacoa, carnitas, or vegetarian burritos. These burritos come with White or Brown Rice, along with black beans, fresh tomato salsa and cheese. Burritos By The Box includes chips, tomatillo green chili salsa, guacamole and sour cream.

We have also created a new menu item called Sofritas which will be available in our San Francisco Bay Area restaurants for the first time next week. Sofritas is a delicious and flavorful vegetarian option made with shredded organic tofu. It's braised with roasted tomatoes, Chipotle and poblano peppers and a blend of aromatic spices. We will explore options for expanding Sofritas to other markets based on customer reaction in the Bay Area. We will keep you apprised of our progress with both Sofritas and catering as we progress throughout the year.

Our marketing this year will continue to focus on building the Chipotle brand and will also include heavier emphasis on driving traffic and encouraging trial than it did in the past year. Marketing programs this year will include a significant ad buy in many of Chipotle's markets beginning in March, including radio, print and outdoor. Additionally we have significant well-developed local sales building plans in 25 of our best markets. We will strengthen our brand and develop a deeper relationship with our customers through our successful non-traditional marketing techniques. This year we will continue to build our signature Cultivate event series by hosting events in Chicago, Denver and San Francisco. Following up last year's successful Back to the Start animated short film, we are developing new content programs that will continue to strengthen the Chipotle brand and that sparks conversation and important issues relating to food.

We continue to plant seeds for future growth opportunities with our international expansion and for ShopHouse. Currently we have 12 international restaurants and one ShopHouse. Of our international restaurants, five are in Canada where we started almost 5 years ago, six in London where we started over two years ago and one in Paris which just opened last year. In 2013, we plan to add to our international portfolio with four more restaurants, one of which will be in Germany.

We currently have one ShopHouse in Washington D.C. and plan to expand there with one more restaurant in the second quarter, and also open our first in Los Angeles, also in the quarter. Our focus our international expansion has been introducing the Chipotle brand, establishing relationships with like-minded suppliers and developing leaders to support our expansion. We continue to run all of these restaurants without significant infrastructure under the leadership of the few restaurateurs, while hiring and developing empowered teams of top performers to support potential future growth.

I would like to compare our international expansion approach to the way we look at growth in the United States. Growth in the U.S. has been done with what we call our portfolio strategy where the majority of our new restaurants are opened in our proven markets. Proven markets are those where the Chipotle brand is well-known, and where we can accurately predict how well new restaurants will perform. Investing in these proven markets has provided strong and reliable returns and has allowed us to allocate a portion of our capital to new markets and to developing markets, knowing that these markets may not currently be as strong as our proven markets, but with confidence that they will develop and transition into proven markets. This happens as the Chipotle brand becomes better, known and accepted.

As we apply the same portfolio strategy to international, all of our markets outside the U.S. today would be considered new markets where the Chipotle brand is still being discovered. Canada has been open the longest with our first restaurant opening in Toronto almost five years ago, Toronto as well as way being considered a proven market with volumes similar to those in the U.S. and margins and returns not far behind.

London was our second international market with our first London restaurant opened in about two-and-a-half years ago, and four of the six London restaurants have been opened less than a year. And while we are proud of the team and the Chipotle restaurant experience in London, our awareness there is still quite low, and so London volumes are much lower than our restaurants in the United States and Canada.

We recently completed a research study in London to help us better understand customer perceptions about our brand and about our competitors. The results from this research show that customers who have visited Chipotle really like the food and the overall experience, but the research also indicated that unaided awareness of Chipotle among fast-casual diners is very low, only 1% compared with 15% for compared to Pret A Manger or 23% for McDonald's.

Aided awareness for Chipotle is only 34% as compared with 97% from McDonald's, 94% for Subway and 91% for Pret A Manger. The top reason listed for not visiting at Chipotle was lack of a known location. Given our low awareness, it's not surprising that our sales in London have started out slow. However, this is very reminiscent of our initial entry into new U.S. markets. It's also important to note that research also indicated that customers are hearing about Chipotle via word-of-mouth at nearly twice the rate than our direct competitors. We find it's very encouraging as it also mirrors our trends in the U.S. and suggest once people visit Chipotle, they become loyal customers.

Moving forward, we plan to increase our marketing efforts in London in order to increase awareness of the Chipotle brand and encourage customers to visit. While Paris is still very new, we are encouraged by the customer feedback so far and we'll learn more as our second restaurant opens early this summer.

Our non-Chipotle growth feed ShopHouse in Washington D.C. continues to perform well and reminds me very much of the first Chipotle when I opened it almost 20 years ago. Customers immediately noticed that it's very different from the typical Asian offerings out there, much in the same way that they noticed that Chipotle was different than their typical Mexican restaurant experience, and I am encouraged and excited about the potential because of the strong customer loyalty we are starting to see.

I think it is already showing that Chipotle's long-term potential isn't just about burritos and tacos, but rather is about the possibility of serving great tasting food made with great quality ingredients, prepared according to classic cooking methods and served in an interactive service format. We'll leverage our top-performing field teams to open the second and third ShopHouses that are under construction in Washington D.C. and Los Angeles both, of which are slated to open during the first half this year.

While all four of our growth seeds are currently considered new markets following our portfolio strategy, I am most encouraged by Canada and ShopHouse so far, and feel that they are the two most likely to move on to proven market status in the near or medium-term.

France is still very new and it looks likely that London will be a developing market for a while until our awareness is raised there. We believe that all of these seeds that we have planted from international expansion in Toronto, Vancouver, London and Paris to ShopHouse will all be successful. Even though we are unable to predict when a market will reach proven status, this strategy of planting a few potential seeds in been investing more over time based on things like how well the team is performing and the quality of the food and the experience and the awareness in sales of the restaurants is a great way for us to ensure that we are developing growth options for the future while being responsible and thoughtful with how and where we are investing today.

I will now turn the call over to Monty.

Monty Moran

Thank you, Steve. We continued to make significant strides in the development of our people culture during the quarter and throughout the year, and as the year came to an end we promoted two special leaders both of whom have had a tremendous impact on our culture and will help us accomplish even more in the coming years. Gretchen Selfridge, who previously served as Regional Director of our Rocky Mountain region and Mike Duffy, who was our RD for the Pacific region are now both Restaurant Support Officers. Both Gretchen and Mike started as general managers when we had just a handful of Chipotle's which is a great indication to all of our current crew and managers about what's possible at Chipotle.

Through these promotions, all of our restaurants around the country are going to benefit from Gretchen and Mike's extraordinary leadership and ability to develop restaurateur cultures in their restaurant. Their track record in leading teams to develop restaurateur cultures is unmatched at Chipotle. Gretchen began her career at Chipotle as a general manager in 1996 and became a regional director in 2001. Since the beginning of our restaurateur program, Gretchen's region has developed 129 restaurateurs. Her passion for getting to know her people and then inspiring her team is a model for many future leaders at Chipotle. As an RD, Gretchen and her team oversaw hundreds of general managers and I am certain, that Gretchen could tell you a personal story about each and every one of her managers.

Mike also began working at Chipotle as a general manager in 1996 and moved up quickly. In 2005, he took over a struggling Pacific region and under his leadership it has become one of our most successful regions. Mike truly understands our people culture and has been very successful building our culture in the Pacific region, leading the company in restaurateur development in both 2011 and 2012 and having among the strongest field leadership in the country. As Restaurant Support Officers, all of our restaurants and field leadership teams will benefit from Gretchen and Mike's leadership. They are two of our leaders who have been most involved in building our people culture.

Now, Gretchen, Mike and Jack Hartung will all join Steve and I interviewing restaurateur candidates so that we can keep pace with the heightened level of restaurateur development that we are seeing in our ranks. We believe the time is ripe for these terrific leaders to become more actively involved in the restaurateur signoff program given their demonstrated ability to identify these cultures and ultimately lead them. The strength of our field leadership has allowed us to grow without having to add new layers simply by expanding the span of control of new and established leaders. Instead, we have been able to develop new leaders and expand the scope of their leadership to allow us to effectively manage our growth without complicating our structure with unnecessary layers.

We continue to accelerate the development of managers to restaurateurs. In 2012, we promoted more than in any other year finishing the year with 190 new restaurateurs, as well as 210 or plus promotions. Similarly, we are seeing a higher percentage of candidates being promoted to restaurateurs than ever before, more than 86%, which tells us that our field teams better understand what makes a restaurateur and the quality of our managers in our restaurants is getting better all the time.

During the fourth quarter alone, we promoted 59 new restaurateurs out of 67 candidates interviewed, a selection rate of 88%. We also promoted 43 R pluses, eight apprentice team leaders, nine team leaders and two team directors and one of our team directors has committed to open all eight of his new restaurants this year after restaurateur level. My hope is that I will hear from other team directors that they have similar expectations for their new restaurants, as I am finding that our new managers who are promoted from a restaurant to restaurant don’t know any other way to open a new restaurant than to open it with a team of top performing empowered teams who achieve high standards, in other words, a restaurateur culture from the very first day.

We are pleased that all of these metrics of internal promotions far too the pace from the fourth quarter 2011 when we had 25 new restaurateurs promoted with a selection rate of only 66%. The strength of our people culture and the cultures we are building in individual restaurants is paying off for us in a number of ways. Our restaurants are running more efficiently and our unit economics is strengthening. We are also providing better and better customer service and throughput.

The reason for this is simple. Empowered top performers do a better job. Even though the fourth quarter is slower than the second and third quarters, our emphasis on throughput continued. We are able to an average of three transactions per peak hour compared to the fourth quarter of 2011. On Friday's, typically our busiest day of the week, transaction rates were up one transaction per 15 minute interval during peak hours. The number of transactions per day in our restaurants increased 2.4% over the fourth quarter of 2011 and for the full year it increased 5% over 2011. But its important to us that the percentage of transactions during our peak hours, that is to say between 12 and one lunch time and between six and seven for dinner, outpaced the all-day rates in 2012 demonstrating that our throughput ability during the busiest times is improving more than it would simply due to the increase in people coming through our doors.

While our comps decelerated a bit throughout the year, our managers and crews continued to pay attention to the throughput recognizing that the better throughput provides a better customer experience that our customers really appreciate. As we head into our busiest months seasonally, we will continue to emphasize throughput with our managers and crews and believe that we will see additional improvements at that time as restaurant volumes increase.

Turning to our real estate development plans, things were looking very strong and we've been able to find great sites for new restaurants which allowed us to open more restaurants in 2012 than the high-end of the estimates that we provided for the year. Additionally, our new restaurants are opening at very favorable volumes giving us tremendous returns on invested capital.

With strong real estate performance in 2012, and a slight recovery in new construction, we are confident in the guidance that we had provided to open 165 to 180 new starts poised this year, but about 40% of these restaurants opening new developments, up from 30% at the low in 2010. This year nearly 20% of our new restaurants will be A model locations, which you will recall are full functioning to poised both, lower occupancy costs, lower operational costs, as well as lower development cost, making them very attractive locations for us.

This quarter our real estate strategy has helped us to find relocations while provide attractive returns given the lower cost associated with these sites. It gives us a great sense of optimism heading into 2013 that the culture and our restaurants is accelerating quickly enough to allow us to continue to grow terrific restaurant operations and the type of dining experiences that will continue to create significant demand for new Chipotle restaurants.

Looking over the first part of this year, I think it's entirely possible that we may name around 150 new restaurateurs by mid-year given the extraordinary leaders that are coming up to our ranks. This bodes very well for our future.

I'll now turn the call over to Jack Hartung.

Jack Hartung

Thanks, Monty. We're extremely proud of results that our restaurant teams delivered during the fourth quarter and for the entire year of 2012. And while achieving these strong results is quite an accomplishment, what's more important is that our food culture, our people culture and our business model all continue to get stronger.

Sales in the fourth quarter increased 17.2% to $699.2 million, driven by new restaurant openings and a comp increase of 3.8%, which is driven mostly from increased traffic. For the year, sales increased 20.3% to $2.73 billion and comp for the full year was 7.1%.

Menu price increases mostly from increase taken in 2011, up to full year comps by 2.8%, and our average restaurant now generate sales over $2.1 million. Our underlying comp transactions were also 3.8% in the quarter that we had 90-basis point of price in the fourth quarter related to the Pacific price increase from last March that was offset by fewer drinks as more customers order their meal to go and by slightly smaller group size as our larger online and fax orders were down slightly from the previous year.

We'll see harder comparisons in the first quarter as we will lose two days or about 200 basis points of comp due to weekday and Easter. And in addition, we are comparing some mild winter weather in the fourth quarter of last year, when benefitted by an estimated 200 basis points.

Our new restaurants continue to perform well, opening with sales at or above the high-end of our communicated range of $1.5 million to $1.6 million. We opened 60 new restaurants in the quarter, bringing our year-to-date openings to 183, which exceeded the high end of our guidance range for 2012 ending the year with 1,410 restaurants. As we mentioned during our last earnings call, we plan to open between 165 and 180 new restaurants in 2013, and we expect these openings will occur relatively evenly throughout the year.

Diluted earnings per share for the quarter was $1.95, an increase of 7.7%, restaurant level margins decreased in the quarter by 150 basis points to 24.6% as food cost increased by 130 basis points over Q4 of 2011.

EPS was $8.75 for the full year 2012, an increase of 29.4% from 2011. Efficiencies from higher comps allowed us to leverage nearly every line item on restaurant P&L except for food, which for full year 2012 was up 10 basis points compared to 2011. Restaurant level margins for the full year were 27.1%, an increase of 110 basis points.

Food costs were 33.5% in the fourth quarter up 130 basis points from 2011, and sequentially higher by 90 basis points from the third quarter. This represents higher than expected inflation of 2.8% over Q3 and about 5% over Q4 of 2011. The inflation was driven by higher, beef and cheese cost, as well as slightly higher cost for Salsa.

While food cost increased faster than expected in the fourth quarter, they level off bit and December, so we are optimistic that food inflation will be relatively modest over the next few quarters or so, and overall we expect food cost in 2013 will be in the 33.5% to the 34% range before the impact of any menu price increase. While we have made no decision on a menu price increase for this year, the inflation we have seen so far makes it more likely that price increase may be warranted but we will monitor trends such as additional inflation going forward, our comp trends, general economic and consumer confidence trends and based on these factors, we will make a menu price decision later this year.

Labor costs were 23.9% of sales in the quarter, an increase of 10 basis points from 2011. Labor deleveraged slightly as wage inflation, including promotional increases more than offset any leverage from the comp. For the full year, labor costs were down 40 basis points from 2011 due to leverage from the higher comp of 7.1%. Other operating costs were 11.5% in the quarter, which was flat compared to 2011, but that was up 100 basis points sequentially from Q3, higher marketing and promotional activity in the quarter accounted for most of the sequential increase.

For the full year, other operating costs were 10.5% or down 60 basis points, compared to 2011 on favorable sales leverage. Marketing was 1.8% in the quarter compared to 1.6% in the fourth quarter of 2011. We invested more in marketing during the quarter, which included our Cultivate event in Denver as well as some new content program we are working on which Steve mentioned. Our marketing, which is 1.3% of sales in 2012, we expect it will be closer to our historical rate of about 1.7% of sales in 2013. G&A was 6.2% in the quarter or 20 basis points lower than 2011 due to favorable sales leverage.

For the full year, G&A was 6.7% or 10 basis points higher than 2011. The non-cash noneconomic stock comp expense was $66 million for the full year of which $64 million was included in G&A. Stock comp expense for the fourth quarter, included in G&A was about $12 million and this is $3 million higher in the quarter and $22.4 million higher for the year compared to 2011 and this is as a result of stock options issued at a much higher stock price, which resulted in much higher calculated accounting charge.

For the year, our underlying cash G&A, adjusting for the higher non-cash stock comp expense is lower as a percentage of sales as a result of our continuing efforts to grow our underlying cash G&A at a slower rate than our sales growth. In 2013 we expect G&A, as a percent of sales, to be about the same or perhaps slightly less than in 2012 as the benefit from not having the expense from our all manager meeting will be offset by higher non-cash stock comp expense.

Based on today's stock price total non-cash stock comp expense for 2013 is estimated to be in the range of $72 million to $77 million, assuming a similar number of options are granted. Our 2012 effective tax rate was 39.3% and this is 80 basis points higher than in 2011 primarily is as a result of a hire act expiring and several credits not reflected in our 2012 tax rate, including the Work Opportunity Tax Credit and the R&D Tax Credit. These credits were renewed by Washington for 2012 and 2013 but they were not approved until January 2013, which prevents us from adjusting our accounting tax rate into 2012.

As a result of these credits being approved, we estimate our annual effective tax rate for 2013 will be about 38.5%, with the first quarter tax rate being lower by approximately 100 basis points to 150 basis points when we recognize those 2012 tax credits in our first quarter tax rate. Each of the remaining three quarters will have a higher tax rate with the overall rate for next year estimated to be about 38.5%.

We were opportunistic with our share buybacks in 2012 and have invested about $229 million buying back our stock since January 1, 2012, up until today. During the first six months of 2012, we repurchased about 74,000 shares for about $29 million. Then from July 1 until today, we invested another $200 million to repurchase about 683,000 shares. We still have about $80 million remaining on our current $100 million authorized share buyback and our board has already approved an additional $100 million. Over the past four years, we have invested over $520 million to repurchase our stock at an average share price of $135.

In 2012, our average development cost in U.S. were about $800,000 and capital expenditures totaled about $187 million in 2012 and has net of landlord credits of about $10 million, primarily related to new restaurants, along with continued reinvestment in existing restaurants, along with other company initiatives. In 2013, we anticipate CapEx will be around $200 million, again, net of landlord credits, the majority of which relates to new restaurant construction.

In addition to our normal reinvestment for existing restaurants, we invest in initiatives, such as converting our restaurant lighting to LED, completing a few major remodels from our old design in New York to our current design, and we plan to upgrade the planchas or our grills in many of our restaurants this year. We were able to increase our total cash and investments by $79 million during the year, even after funding the opening of 183 new restaurants and repurchasing stock through our buyback agreements totaling over $200 million.

We continue to believe that investing in a high returning new restaurants remains the best use of our cash and we are confident that the growth options we are seeding today, including ShopHouse and Chipotle in London, Toronto Paris Vancouver and beyond, will provide value enhancing growth opportunities in the future. In the meantime, we will continue to invest in our high returning domestic restaurants and will opportunistically repurchase our stock to enhance shareholder value.

So, thanks for your time today, and we would be happy to answer any questions you may have. Operator, please open the lines.

Question-and-Answer Session


Thank you. (Operator Instructions). And we will take our first question from Joe Buckley from Bank of America Merrill Lynch.

Joe Buckley - Bank of America Merrill Lynch

Thank you. Could you run through the year-over-year changes in marketing, I guess, the percent of revenues expectations, so just a number of markets where you be active this year versus last year and how are you defining moving towards more transaction driven or traffic driving marketing.

Steve Ells

Yes. Joe, I will clarify in terms of the marketing spend. I think you caught that, we do plan to spend more. Historically, we spent about 1.7%, but the last couple of years as we have been trying different know marketing initiatives, we've under spent that amount last year, we spent about $1.03. Next year, we do expect to get closer to that $1.07, but then your other question was about which markets we plan to focus on and where we intended to invest our marketing dollars. Is that the follow-up to your other question?

Joe Buckley - Bank of America Merrill Lynch

Yes. You are aware that's great, but just in terms of percentages of the store base that would be covered by more active marketing programs and how are you defining that?

Monty Moran

Yes. I think the best way to answer this without getting into your a very, very detailed discussion is, we cover all of the restaurants 100% of the restaurants, but in larger markets where we've got a lot of restaurants and where it's efficient of buy media, we will do the full complement of media, which we are going to do some of that as Steve mentioned in margin and I think he said 25 of our markets. In those markets, we are going to invest in billboards and if it's efficient, we'll do radio. We will do some print as well.

We can't do that in some of our smaller markets or where it's very to buy the media, so those markets we will do local store marketing. For sure, we also will invest in social media as well, and so each of our markets have a unique marketing strategy depending on how many restaurants, we've got, how efficient it is to buy the media and based on needs how well of our brand is recognized. How loyal the customers are and so our marketing plan is going to be customized market-by-market.

Joe Buckley - Bank of America Merrill Lynch

And has 25 markets where you do the forecast and it's a media compared to what you did in 2012.

Monty Moran

It's more. I do not know offhand. We have done in number of markets this past year, but we are going to be doing more of that kind of marketing in 2013 episode, so that explains that's where part of our additional it investment from 1.3% to 1.7% is going to be to providing more coverage you of that kind of the billboards and radios and alike in more of our markets in 2013.

Joe Buckley - Bank of America Merrill Lynch

Okay. The action, how are you kind of defining that?

Monty Moran

What you said, again, Joe?

Joe Buckley - Bank of America Merrill Lynch

Well, you indicated that you were get more traffic focus with the marketing I am just curious how define that versus what you've done historically, so I think a lot of that has to do with creative, Joe. I mean in years past, a lot of our marketing or I should say most of our marketing was what we called building, market which brand building marketing which spoke to food with integrity, the quality of the restaurants, experience, the way we're different, things like that.

Jack Hartung

Mark and his team has made a concerted effort to actually create devices, for instance, in the new short films and shows that are currently under production to the ones that were similar Back To The Start, have components which can direct people online to get engaged and to take opportunities of going in for some kind of a promotion, buy one get one, something like this, where in the past, we sort of left that opportunity on table with Back To The Start, where there wasn’t a transaction driving the component. So I think you can see more things like that that actually push people in to the restaurants rather just talk about brand building in general.

Joe Buckley - Bank of America Merrill Lynch

Okay, that’s helpful. Thank you.


We will take our next question from David Palmer with UBS.

David Palmer - UBS

With regard to the marketing, is that something that you would use in particular to support catering, for example?

Jack Hartung

Yes, catering, marketing is going on in Denver as we speak and certainly that is very much directed at getting people to go in to the restaurants and try it. It specifically talks about how it works, come in and try it. What you can expect the experience to be. So, yes, that’s definitely marketing that’s getting people to actually go in and place their catering order or place it online.

David Palmer - UBS

I guess, I am sorry if I interrupted there but I was just thinking about the marketing and the brand awareness, there is there is often a phenomenon where certain chains get up to a certain scale in an individual market and the fact that they get up to that scale in and of itself and that brand awareness, just by the number locations helps the comps. Are you finding that you get up to a certain amount and just adding that extra layer of marketing, and whether it be billboards and keep that above average market awareness curve going in the right direction. Is that essentially what you are doing here in certain developed markets?

Steve Ells

It is certainly not the main intent of this marketing of catering. The main intent is to introduce people to catering. I think because it's so heavily marketed and because this is really new news in a very well developed market, I think you are going to have the affect of just helping to bring renewed awareness to Chipotle in general. Our hopes would be, yes, that would help drive traffic. I think that will be an offshoot of that.


We will take our next question from Andy Barish with Jefferies.

Andrew Barish - Jefferies

Question on just the comp direction so far year-to-date. Should we look at it as if we take the fourth quarter trends and take out the two point trading day shift? Is that kind of the way you guys are thinking about the start of the year?

Jack Hartung

I wouldn’t do it that way, Andy. Here is why. We started a trend. I like to look back to 2009 as our baseline year. That was during the year of the depth of the recession. During the year we had four quarters of 2% comp. We started our sales increase. We started our recovery from the recession in the first quarter of 2010. Then built sales in the second quarter and the third quarter and so they are higher in Q2 of 2010 and higher in Q3 and then higher in Q4.

Then in the next year, we did a double-digit comp and now continue the double-digit comp. So I think it was seven quarters and so we had this stair step building quarter-by-quarter-by-quarter for 12 quarters over the last three years. Now we are 2013 comparing against all three of those years.

So we have some very, very tough comparisons. So I wouldn’t look at the 3.8 that we did in the fourth quarter and say that’s our starting point. I would look at it as we are comparing now against three years worth of comp in the fourth quarter. As a total, it is almost 30%. We are up almost 30% in the last three years.

When you look back over the four quarters and you look at our comparison since we recovered from the recession, this quarter is going to be our toughest comparison of all. It is toughest for the reasons I mentioned in my prepared comments where we had extraordinary mild winter weather last year and so we had a very high comp on top of the very high comp from the year before. We benefited from an extra day last year. In addition to those two tougher comparisons, we are losing a day this year with Easter.

So I am not quite sure how to tell you what the first quarter, how it will turn out, to be honest, but I wouldn’t start with 3.8. I think it is going to be a tougher hill decline than starting with 3.8.

David Palmer - UBS

Okay, thanks. Then, one quick clarification, just on the food cost. So, again, the starting point is the fourth quarter, the 33.5%, am I correct in saying that food cost will kind of run in that 33.5% to 34% until we see your next pricing action?

Jack Hartung

That's exactly right. That's what our hope is. The inflation that we expected hit us harder and faster than we thought it would in the fourth quarter, but now as we look ahead it looks like we'll stay in kind of the ranging that in 33.5 to 34. It looks like it's going to stay in that range for a few quarters, so we don't have any specific plans to our menu price increase. I wouldn't expect that we'll even consider doing something in the first half of the year, so I think the earliest, we might use something would mid-year, but as long as inflation stays in that we'll get through the next few quarters and then we'll look at what the outlook for inflation the second half of the year what the economy looks like and what our transaction trends look like and then we'll make a price decision at that time.

David Palmer - UBS

Just finally real quick, what was the sauce issue that hit you guys in the fourth quarter?

Jack Hartung

We have two one things. One, we bought more of our white corn. We've been moving away from the yellow corn into white corn, and so there is a little bit of not a big amount, but that contributed to it. And then we actually had to source some of our tomato salsa from the West Coast during the quarter just because we are having just because we are having trouble keeping up with supply for some of our East Coast restaurants, we had to pay a premium just to get some of the Tomato salsa from the West Coast into the East Cost. That's always more temporary. The white corn is going to be more of an ongoing, premium that we'll pay to continue to source white corn.


We will take our next question from Michael Kelter with Goldman Sachs.

Michael Kelter - Goldman Sachs

The food cost question, I mean that 33.5% of sales, it's the highest it has been in any quarter in recent history and the guidance 33 5 to 34 is in line to higher than that. Why are you letting yourselves get behind on pricing, like what's the relevance to keep with inflation and especially in light of the previous comments you made about your belief that the elasticity for the Chipotle brand is limited why wait?

Jack Hartung

Because, Michael, the most importantly to us right now is to build customer loyalty and to build transaction momentum., the thing we'd rather not do as we saw our transaction level off and you we're happy you 3.8% transaction growth, but that one low transaction growth what you that we have seen over the last three years and so what we don't want to do is, during a time when the economy seems to be okay but not great. It is not clear what happened.

As we hit the debt ceiling crisis and you know how people are feeling with their payroll tax increasing we'd rather be more patient, we rather see what happens with the economy what happens with our transaction trend, and if we are little late to the game in raising prices, that's okay because as soon as you raise prices the margin of our model bounce right back to where they can and should be on a going forward basis. So, the headline is, we don't want to risk interrupting trends that are causing transaction to soften during the time like this. That's why we rather be more patience.

Michael Kelter - Goldman Sachs

Very helpful. Then, yes, the other thing was on labor costs which I was looking there roughly flat as a percentage of sales over the second half of '12, so I guess the same-store sales in the other current range and now be Affordable Care Act flows through within about a year, or so might labor costs actually start to de-lever unless comps meaningfully reaccelerate?

Jack Hartung

Yes. We need without considering any increase in healthcare costs. We've always talked about we need kind of a mid single-digit transaction driven comp in order to just hold on for labor line and you saw that play out in the quarter where we had a slight increase in basis points, so let's call that basically flat with 3.8% comp. If we had slightly higher comp maybe 4.5%, it probably would have been exactly flat. I mean that's consistent with what we've said really over the years that we need kind of a mid single-digit comp.

The reason for that is, when it's driven, we need to add labor hours. We actually have a labor chart that has a prescribed number of hours at as we add additional transactions and so when you get that mid single-digit comp so we you won't deleverage or you won't lever labor.

To the extent that we have additional cost with healthcare next year that will cause our labor is now we think that the first year, Michael, it won't be that big increase. We think 2014, the penalty for employee not opting. Our plan right now is to offer insurance to qualify hourly employees, but the penalty for employee not electing insurance is so low than the cost of them electing insurance, their cost is so high, we think it is likely that most people won't elect it. So we think our cost in 2014 is not likely to be that extreme. We think that those costs are likely to hit us more so in '15 and '16 as that penalty begins to increase.


We will take our next question from Paul Westra with Cowen and Company.

Paul Westra - Cowen and Company

Just on your CapEx budget, can you give us a little more detail and then you outline the little bit extra spending here but obviously CapEx looks to be up about $13 million in the EOE you might have even last openings and back into what incremental cost for the grills? Can you give us maybe more color of how many remodels you will be doing and on the grills what impact they might have on the expenses? Do you have a payback for the new grills? Or is that a quality investments?

Jack Hartung

Paul, we are planning on a similar number of openings. It's in a same kind of ballpark. But yes, we are going to spend an extra about $13 million. The grills are going to be, depending on how many we replace a few million dollars. It could be $3 million, $4 million, $5 million range.

There is an extremely favorable payback. These new grills not only produce better tasting food, they are easier to maintain but the utility usage on these new grills is dramatically improved such that we can get a payback within a matter of a few years. So those make a ton of sense.

Same thing with the LED lights. That will cost us a few million dollars as well. We have no choice, because we have to get rid of the old bulbs we have to move towards LED. The old bulbs just won't be available. They stopped manufacturing them. Those will have an early payback as short as the grills, maybe even shorter. It could be that we have a payback on those as short as one year.

So these investments make a lot of sense for a lot of reasons. Then we are going to do a few remodels. These are a handful in New York where our users from older restaurants where we went in to a very old building. Very tough, from a construction standpoint and the building is holding up that well and it is our old look. So we are going to invest in remodeling those restaurants.

I would not expect us to be doing a bunch of major remodels every single year. That’s a matter of a few million dollars that we are going to invest in upgrading a handful of restaurants in New York.

Paul Westra - Cowen and Company

How many stores have the new grill, as of now?

Jack Hartung

I think it’s a handful right now. Yes, it’s a handful. I mean, Steve and his core team has worked on this grill for quite some time now and it is better in every single way and we have been anxious to get the new grill in as many restaurants as possible and we think, in 2013, we are going to be able to make a big dent in that.

Paul Westra - Cowen and Company

You can cover most of the base in a matter of a couple of years, going out?

Jack Hartung

Yes, we can do it in a couple of years. Yes, we think we can.


We will take our next question from Jeffrey Bernstein with Barclays.

Jeffrey Bernstein - Barclays Capital

Great, thank you very much. Two questions. I guess first, just following on the earlier topic of pricing. I know you talked about, at the earliest, maybe mid-year, but I am just wondering, theoretically how you think about it. I know in the past you did what seems like these pricing going forward but it would be more nationwide rather than in one specific market with the rollout with, say premium ingredients. I am just wondering how you think about it, whether, up in the past you talked about you would prefer to do one larger increase rather than smaller increases. So I am just wondering, with the current inflation level, what pricing would you consider and are there any the concerns when there is only a few well-recognized items on the menu in terms of how you take that price?

Steve Ells

Let me take a crack. There is a lot to that. But let me try that in a condensed answer to try to cover all those, Jeff. In terms of the percentage increase, if we are talking about inflation in that kind of mid single-digit range of 3%, 4%, 5%, a price increase would, in that same kind of 3%, 4%, 5%,range, if you exactly match the food inflation that would allow our food cost to bounce right back to where it was before this inflation. It would allow all of our other line items to get better.

Okay, so it wouldn’t take much of an increase to get our food cost back right where it should be and get our margins back to where it was before the inflation, or maybe even better. As a perspective, a 4% or 5% increase on a burrito is about $0.25 or $0.30. So it's not that much.

If you compare that, some have assets who will instead of doing one price increase in a year or one every other year, want to do a few small ones, but we're only going to do a 4-ish or 5-ish. Let's say 4 for example. Instead of doing 4, you could do increases and you do 2% of the time now, what now what you are talking about doing is an increase of at rate of maybe $0.10, or $0.15 earlier in the year, and then do another $0.10 or $0.15 later in the year and we would rather not nickel and dime.

Our customers really can't do it one-time, would rather have the conversation with conversation with them one-time, because a lot of cost don't necessarily notice the amount of the increase but I do noticed when you're increasing it multiple times and so our real desire is to not increase prices. We'd rather find efficiencies ourselves and that's why we have always been patient, we've always tried to make sure that that we can find as many efficiencies within our existing business model before having to raise prices, but in cases like this where we think we are finding most of efficiencies or have most efficient in our model where inflation has cooked our food cost up into this range strength 33.5% or 34%, or so.

We find that we have no choice, but to raise prices, so does that helps you? Does that answer your question?

Jeffrey Bernstein - Barclays Capital

Yes. The 4 to 5 wouldn't be unreasonable. You kind of look at it as I'd rather raise the quarter one-time rather than multiple.

Jack Hartung

I think two things though that we've been thinking. Yes. We'd rather do what we did three or four years ago where we waited three years or more in a lot of our market and then we raise prices 7%, 8%, 9%, okay? That we want to avoid cost, but we are not about quarter or so, we think that's not an unfair increase to take.

Jeffrey Bernstein - Barclays Capital

Got it. Then just separately on the new unit productivity. I know that there was some noise in the middle of 2012 with your new unit openings. I am just wondering if as you look out 2013 as it relates to kind of this productivity. I think you said it was 40% in new developments in 20% a sites, but putting that all together would that as a mix and we will year expectation for productivity, what would have maybe the most or least impact on just so we are prepared for pull ups some new productivity based on what you know today in terms of your unit openings.

Monty Moran

Well, our new unit productivity has increased sort of steadily over the years as our comp sales have increased, our new units have kind of followed too and been a substantial percentage of the amount of our average unit volumes, so when you talk about a stir in the middle of 2012, with regard to new unit productivity.

From our standpoint there wasn't any stir. You are probably referring is that there were some talks about like new unit productivity falling off in 2012. From our perspective that's really not what happened. What did happen was that we had a pretty exemplary 2011 with very high new store opening volumes, driven in large measure by the fact that we were opening a great deal of our restaurants in proven markets and the proven markets have, as Steve mentioned in his opening words, a very high likelihood of great returns and so in 2010-2011, we opened a lot of restaurants in these proven markets.

Our A models in 2010 and 2011 were almost all in proven markets at that point and that was very intentionally done by us to basically stacked the deck in our favor of our A model strategy being successfully and it worked much, much better even than we thought it might with new unit volumes for our A-models that were literally adjust about at pace for traditional openings, but with the lower cost structures associated with the A models I mean that our returns on the A models were extraordinary.

In fact, during those years much better than our traditional openings, so we went into 2012 for that year began, we explained to you guys that we would be continuing on with our A model strategy, but doing it and it is taking some more risk with it and going into developing markets, experimenting with the A model strategy in those developing markets. We did so, it's been very successful. The A models now are still are opening newly at that new store opening range lower than the traditional models now in terms of openings, though with returns that are really at pace, very, very similar to the returns of our traditional unit.

So, we feel very, very strongly about new unit productivity. We felt that it's been an uninterrupted increase of new store productivity over the years with the possible exception that 2011 was an outlier to the good and an extraordinary year due to having so many in proven markets and having so many A models in proven markets and taking a little bit more risk thereafter.

Jeffrey Bernstein - Barclays Capital

Got it, '13 is more normalized based on the lap of '12 versus the anomaly of perhaps '10 and '11?

Jack Hartung

Yes. I think that is a fair estimate. We'll see how it goes, but we feel very, very good about the way they are opening and don't see any reason why we wouldn't continue to have this success with our new stores that we've come to rely upon.


We will take our next question from David Tarantino with Robert W. Baird.

David Tarantino - Robert W. Baird

Hi, good afternoon. Jack, just a quick clarification question on the turns in the first quarter. Perhaps maybe if you could talk about what you have seen so far and if you are seen any change in the momentum of the business? And if you feel comfortable giving some directionality on the comps, that would be great.

John Hartung

Yes, David, I usually do give some kind of indication based on how sales are doing. I am really unable to do it this time. The reason is because there is not really a pattern that I could see in January that I could tell you that would give you an idea of what's going on in the rest of the quarter.

The reason for that is we had some days and some weeks that were really nice mild winter weather and our comps looked better than expected. I know we have had some snow and cold and some normal winter weather. Then the comps fell off quite a bit as you would expect. So I have not been able to really pick-up the pattern, but I could tell you what I expect during the quarter.

So the only thing I can tell you at this point is, the quarter is a tough comparison for the reasons I mentioned because we are comparing to the three year, nearly 30% and we are missing a couple of days when comparing to. We are just now comparing, by the way, to some of the really mild weather, most of the mild weather we saw last year was in February. So, the first quarter trend stays is still to be rewritten. So I am sorry, but there is nothing I can tell you to give you insight in terms of how the quarter might finish.

David Tarantino - Robert W. Baird

Okay, fair enough, and then Steve, a big picture question on Chipotle brand. It seems like you are talking a lot more about traffic drivers in terms of advertising and catering and a new menu item. I am just wondering if you think the brand is reaching a point at which you need those traffic drivers to continue to sustain the unit volumes that you are seeing currently?

Steve Ells

I don't know if need is the right word. Over the years we have had a lot of requests. We have ignored a lot of those requests for fear that it might upset the focus that we have, which contributes to a great economic model, as you know. But a couple of things appear to be really important requests, we think, and that has been the ability to enjoy Chipotle in people's school or office or some of the large venue kind of areas.

That's why we think catering is a really good option for that. People did these catering events, but we would make boxes and boxes of burritos and we feel that this is a completely different experience that we thought that people would enjoy and they are enjoying it. It's really a new way to experience the same stuff and it's very, very efficient for us to do.

The other item, the Sofritas, we think, is really, really important because it speaks to not only a new taste and new experience in Chipotle, but it speaks to this idea of food with integrity that even if one is not a vegetarian or a vegan, you can participate in this idea that eating less meat is somehow environmentally responsible or maybe better for your health. A lot of people think that eating less meat is more healthful.

So we have created this exciting new thing called Sofritas. It's very, very savory. It has this umami flavor. This flavor which is something that a lot of vegetarian offerings don't have. Vegetarian offerings at a lot of restaurants seem to be the dish, but without meat. This is something that's very deliberate in creating something that's vegan and quite delicious.

So these are things that we have been thinking about for a long time mainly by listening to our customers and deciding if it actually fits into the economic model or doesn't degrade the economic model. In fact, I think catering has the potential to dramatically improve it because we can serve these two to 200 people much more efficiently, much more quickly than if they were to come through the service line.

The Sofritas is quite easy to prepare. It's braced and has lots of ingredients, but the actual preparation, the finishing preparation in the restaurants, quite efficient and it only takes up one of our service containers on the line. So I think both of these are going to help people enjoy Chipotle more often and perhaps in different ways without degradation to the model, so hard to really answer your question whether we need this, but it seems like the time is right and its fun to try new things in a very sort of measured way.


That concludes today's question-and-answer session. At this time, I'd like to turn it back to the speakers for any additional remarks.

Steve Ells

Thanks for joining us, everyone, and we look forward to speaking with you next quarter.


Ladies and gentlemen, this concludes today's conference. We thank you for your participation.

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