Chipotle Mexican Grill, Inc. Q4 2008 Earnings Call Transcript

 |  About: Chipotle Mexican Grill, Inc. (CMG)
by: SA Transcripts


Good day and welcome to the Chipotle Mexican Grill fourth quarter 2008 Earnings Call. (Operator Instructions).

It is now my pleasure to turn the floor over to your host Kate Giha, Investor Relations for Chipotle Mexican Grill. Please go ahead, ma'am.

Kate Giha

Hello everyone and welcome to our call today. By now you should have access to our earnings announcement released this afternoon our fourth quarter and year end 2008. It may also be found on the website at in the Investor Relations section.

Before we begin our presentation today, I will remind everyone that parts of our discussion will include forward-looking statements within the meanings of the securities laws. These forward-looking statements will include projections of restaurant comp sales trends, margins, food costs, other expense items, the number of restaurants we intend to open and other statements of our expectations and plans.

These forward-looking statements 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 the forward-looking statements.

We refer you to the risk factors in our SEC filings including our Annual Report on Form 10-K for 2008, which we expect to file later in February for discussion of the risks that could impact our future operating results and financial conditions.

Our discussion today will include non-GAAP financial measures, a reconciliation of which can be found on the presentation page of the Investor Relations section of our website.

I want to remind everyone that we have adopted a self-imposed quiet period restricting communications with investors during sensitive periods. This 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 quarter, it will begin March 1st, and continue until our first quarter release in April.

On the call with us today are Steve Ells, our Founder Chairman and Co-Chief Executive Officer; Monty Moran, our Co-Chief Executive Officer; Jack Hartung, our Chief Financial Officer. After the comments, we'll open the call for questions.

With that out of the way, I'd like to turn the call over to Steve.

Steve Ells

Thank you, Kate. While 2008 was a challenging year for the restaurant companies including Chipotle, few remained focused on our vision to change the way the world thinks about any best food. And our ability to remain focused on this vision helped us deliver a 5.8% comp for the year. A revenue increase of roughly 23% to $1.3 billion and an 11% increase in diluted earnings per share for the year to $2.36.

We made some important announcements recently, and I want to share some perspective with you about what this means for the company. First, we announced that Monty and I will now share the role of Co-CEO.

Monty's promotion is recognition of the tremendous impact he had had on our business, including his creation of a special people culture at Chipotle that rivals our unique food culture. But this move also allows me to focus more of my time on the things that I am most passionate about, which I believe can add the most value to Chipotle.

Specifically, I intend to spend the vast majority of my time on improving our food, improving the design of our restaurants, and ensuring that our marketing efforts drive transaction growth by educating our customers about our leadership position with Food with Integrity and creating a lasting bond with our customers.

While we have done a good job in these areas over the years. I believe that we can do much better and significantly improve our restaurant experience and our business. To help us continue making progress in our efforts to serve food made with better, more sustainably raised ingredients in 2009, we asked Bill Niman to join Chipotle as sustainable agricultural advisor.

Bill, who founded Niman Ranch, which provides much of our naturally raised pork and some of our naturally raised beef is a pioneer in the sustainable food movement. He is very well known and well regarded in food and sustainability circles.

In his new capacity, Bill will work closely with us to improve the quality of the ingredients we use, broaden our commitment to sustainable agricultural and provide another voice to help carry our message of making foods from sustainable sources available and affordable, so everybody can eat better.

Throughout the year, we made considerable progress on our effort to provide food with integrity. Specifically, we reached the important milestone of serving 100% naturally raised chicken in all of our US restaurants, and increased the quantity of naturally raised beef we are serving, which is now more than 60%. Of course, 100% of the pork we serve is also naturally raised.

Beyond increasing the amount of naturally raised meat we serve. In 2008 we also launched a program to serve locally grown produce, making Chipotle the only national restaurant company with a significant commitment to using produce from local farms. Under this program, we met or exceeded our goal to serve at least 25% of at least one produced item when seasonally available in all of our markets.

The produce we are serving as part of this program comes from within about 200 miles of our restaurants, and that’s in contrast to 1,500 miles, which is the distant most produce has to travel to its final destination.

In 2009, we plan to increase this percentage of locally raised produce to 35% from 25%. And while Bill Niman, will help advance our Food with Integrity initiative by revisiting all facets of our supply chain. I plan to spend much more time in the restaurants cooking to make sure that all of our food prep, cooking techniques and equipment are the best they can possibly be.

Cooking has always been a passion for me and frankly I have not had the time to do as much of it as I have liked to in recent years. There are so many subtleties that makes our food delicious, and by focusing more of my time on every detail of how our food is prepared and cooked. We can be sure that we will serve the very best tasting food using these top quality ingredients.

I can say the same thing with regard to the design of our restaurants. We’ve always been praised for a unique and innovative approach to the design of our restaurants basis. But truthfully there's a lot of opportunities here as well. I believe that by carefully focusing on this area, we can come up with a great design that will enhance the customer experience, allow more operating efficiencies and reduce our investment costs.

I have been working extensively with an outside architect over the last year and I am very excited about the possibilities that this focus has for our business model. I also plan to devote more of my time to advancing our marketing strategy.

We recently announced the addition of Mark Crumpacker as our first ever Chief Marketing Officer. Mark comes to us from Sequence, a San Francisco based brand-consulting firm, he co-founded. Mark has a longstanding tie with Chipotle having developed our original logo and the original identity package.

Through Sequence, Mark has been doing some consulting work with Chipotle over the last several months and led the search effort for a new ad agency. Mark and I have been working very closely together to develop a new marketing strategy. We believe the new strategy will be much more effective in communicating to our customers what makes Chipotle a special restaurant experience, and will encourage new customers to visit Chipotle and existing customers to come more often.

For ten years, while we were enjoying double-digit comps, we did not need or expect marketing to contribute to our business results. We looked at marketing more as brand building. It did not really measure the results of these efforts or hold the team accountable to driving more visits to the restaurants.

I fully expect that our new marketing effort will drive business results and we plan to carefully measure the effectiveness of our marketing going forward. In this way, we will be certain that the significant investment that we make each year in marketing is providing us with a solid return.

Just last month, we announced a hiring of our new advertising agency Butler, Shine, Stern & Partners. This decision came after a very thorough review that started with 27 agencies, and was narrowed to three finalists who were each hired to do a project for us.

Through this very methodical approach, we had the opportunity not only to see what each of the finalist agencies was capable of in terms of work product, but also to see what it would be like to work with them on a day-to-day basis. We believe that Butler Shine is the right partner for us, and will help us to elevate our marketing, both creatively and strategically.

We have been working closely with the team at Butler since their announcement, and you can expect to see initial creative from these efforts during the second quarter of this year.

One of the things that continue to contribute to Chipotle's success is our commitment to constant improvement. With these changes, I think we are in a stronger position than ever to continue our work to change the way the world thinks about and eats fast food. I will now turn the call over to Monty.

Monty Moran

Thanks, Steve. I had a chance to spend a lot of time in our restaurants around the country during the fourth quarter and continue to be impressed with what I see. Our managers and our crews are empowered. They are serving delicious food and providing great customer service.

Our pipeline of potential new managers is better than it has ever been, and I continue to meet great managers on their way to becoming restauranteurs.

If I were to use what I see in our restaurants and the enthusiasm that I feel when I am there as the only benchmark of the economic environment, I wouldn't believe that there was any recession at all.

Our restaurant operations are stronger than ever. Our people are optimistic than ever about the opportunities they have with Chipotle, and our customers still lineup with the expectation of a great dining experience.

But, the reality is, the recession has affected and will likely continue to affect the amount of people out shopping and eating meals away from home. While we cannot control the economy, we can do everything within our power to make each customer’s experience at Chipotle the best dining experience possible. So, when they do go out to eat, Chipotle will be at the top of their list of restaurant choices.

Our managers and our restaurant teams understand this and are committed and ready to delight each customer. Because of this, the number of positive customer service comments through our web site today has doubled what it was a year ago.

While we have held out better than many other restaurant companies in this environment, our comps have slowed and our margins have declined. That has caused us to take a fresh look at what we do to make sure our business is as strong as it can possibly be. This includes critically analyzing our restaurant staffing model, reviewing the way we prepare our food, analyzing how we source our ingredients as well as the business terms with all the key suppliers. Looking at the way we design our new restaurants and how we maintain them is just a few examples.

We are looking at the current situation as an opportunity to look at everything we do to make sure that we are as disciplined and as efficient as possible without compromising on the taste or quality of our food or the quality of our customers dining experience.

We do not have anything yet to report on what this critical review might lead to in terms of its impact on our results, but I am confident that we will leave this recession stronger than when we entered it in terms of the quality of our people, the quality of our restaurant operations and the strength of our business.

We remain convinced that the single most important thing we can do to ensure the success of our company is to build the very best people culture possible; a culture which attracts and empowers the highest performing people. We can see that we are having a lot of success building this culture every time we visit our restaurants. The energy and optimism is apparent from the moment you step into the restaurant.

Each member of the team knows that they have a bright potential future ahead of them. This is very different than what you might find in other organizations, where managers are usually hired from outside the company and crew are not expected to advance, where promotions happen because of seniority and not based on merit, where people focus on short-term results and not a long-term vision, where mid-management level employees police and micromanage, but do little to empower their people, where favoritism or internal politics count more than real leadership.

What we are doing is very different. We hire people who have those certain characteristics that you just can't train, and we teach those people the skills that they need to be successful at Chipotle.

The crews that we're hiring in our restaurants are better than ever. In fact, the current economic conditions are actually helping out a bit in this respect. There are more top performing people wanting to join Chipotle. And as soon as they start working with us, we give them a very clearly defined path to success.

We remove obstacles that may limit their progression by eliminating politics, geography and low performers who may impede their effectiveness. And then we empower these top performers to take on roles of the increased leadership and reward them when they do so. In fact, we've already decided that there will be no across the board cuts to bonuses for our restaurant managers in 2008.

Restaurant managers are the most important people in the company and we believe it's important that we set the right example by rewarding our top performers.

As you know, the foundation of our culture is the restauranteur. We now have a 112 restauranteurs, each of whom was personally selected by Steve, and myself, and the impact of these restauranteurs can be felt across all of our restaurants. All of our general manager's inspire the restauranteurs and in striding towards this elite position, they are working to create excellent restaurant experiences, while developing their crews to be our future leaders.

We are also making improvements and becoming more efficient in our field management structure. Five years ago, each of our area managers oversaw only five and a half restaurants on average. Today, they are responsible for nearly twice that many. This enables us to do more with less, without compromising quality or service and it also allows us to better retain and reward our top performing mid level leaders. This is contributed to a decline in G&A as a percentage of sales over the years, with 2008 G&A at 6.7%, which is our lowest level ever.

We are taking a disciplined approach to reviewing all of our practices, starting with the selection of sites and continuing through the way we source ingredients, the way we prepare food and the way we interact with our customers. And this approach will continue to make Chipotle a stronger company, allowing us to continue to increase the quality of the dining experience we offer, which we believe will increase shareholder value, over the long-term.

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

Jack Hartung

Thanks, Monty. We remain as committed as ever to delivering superb customer service and treasuring each and every customer who visits Chipotle, especially in this economic environment. Staying focus on what we do best, providing a great dining experience, with great customer service, with food made from high quality ingredients, and prepared using class A cooking technique, will keep us strongly on a path where revision to change the way the world things about any fast foods. And it's imperative that we do all this while managing the business in a discipline manner, so we can remain financially strong in this environment.

Our healthy balance sheet and strong economic model has allowed us to continue to open restaurants, plenty of operating cash flow, deliver restaurant level margins, higher than most competitors and opportunistically pursue the $100 million buyback, we announced in our third quarter call.

For the fourth quarter, our revenue increased 19.5% to $345.3 million from $288.9 million last year. Our fourth quarter revenue included a one-time gift card breakage catch up benefit of $2.3 million for the recognition of estimated unredeemed gift card balances. Our revenue for the full year was up 22.7% from last year to $1.3 billion.

Our comps for the fourth quarter were 3.5% and we ended 2008 with full year comps of 5.8%. Menu price increases were about 7% overall in the quarter, with about 3.5% coming from previous increases and 3.5% coming from price increases during the quarter. We actually increased prices by about 6%, which was done market-by-market throughout the quarter, which resulted in the effective 3.5% incremental increase for the quarter.

And not every market saw an increase. For example, California's prices were not changed, since they've received an increase in the second quarter when they received naturally raised chicken. As we discussed on the last call historically, our price increases have been met with little or no resistance. As they typically we had been associated with the roll out of naturally raised meats.

But as expected, given the economic environment and the absence of additional Food with Integrity news, we have seen resistance to the most recent price increases. Though is impossible to identify how much of the loss traffic is the effect of general economic conditions and how much is due to price resistance, and net effect seems to be that we've been able to retain a little less than half of the incremental 6% price increase in the quarter.

Looking ahead to 2009, the price increases taken to date, will roll over with an effective increase of about 6% for the full year, higher in Q1 and lower in Q4. Based on transaction trends, we have seen so far and assuming the economy does not worsen, we expect comps in the low single-digit for 2009. If the economy weakens further, and then unemployment continues to rise in the absence of improved customer confidence, we would expect comps in the very low end of that range, if not worse.

Food, beverage and packaging cost for the quarter were 32.1%, 20 basis points higher than Q4 of last year, but down 90 basis points from the third quarter. The decrease from the third quarter is mainly due to the menu price increase. For the entire year, food, packaging and beverage costs were 32.4% or 50 basis points higher than the prior year. Higher avocado, chicken and cheese costs were the main drivers behind the increase and were partially offset by the menu price increase.

We now expect 2009 food inflation in the 2% to 3% range. Lower than the mid single-digits we expected during our third quarter call. This lower expected inflation is result of establishing pricing agreement that lower prices in 2009 for cheese and tortillas and is offset by the higher cost of chicken and beans during the year. Overall, we expect food costs for 2009 to be in the same ballpark the 32.1% we saw in the fourth quarter.

So the more modest commodity inflation is certainly a welcome trend over the past few months. Unfortunately, it has been accompanied by worsening economy, including rising unemployment, which increases the likelihood of worsening transaction trends. So despite the more favorable food inflation, we still anticipate margins in that 19% to 20% range, as we are concerned that a continued de-leveraging, due to weakening transaction trends will offset the modest positive impact of lower food inflation.

Labor costs were 26% for the quarter, down 20 basis points from last year and for the year, labor costs were 26.4% down 30 basis points from 2007. The leverage on this line for the quarter and for the year is largely attributed, to the impact of the menu price increases, and we expect to see no additional labor leverage in 2009.

Occupancy cost for the quarter $28.4 million or 8.2% of revenue and that’s up 110 basis points from last year, and for the full year occupancy cost were at $98.1 million or 7.4% of sales, up 40 basis points from prior year.

Occupancy cost in the quarter included a one time non-cash straight line rent expense adjustment of $2.6 million, and without this adjustment occupancy would have been 7.5% in the quarter or 40 basis points higher than last year.

And as we've discussed in previous calls this increase is driven by opening proportionally more restaurants, in more expensive densely populated areas such as Boston, New York, Philly and Florida combined with decelerating comps.

Other operating costs remained relatively flat from the prior year 12% for the quarter, but were up slightly 20 basis points to 12.3% for the full year. The increase for the year was driven by utilities, repair and maintenance costs and a higher bank and credit card fees.

Our G&A for the quarter was $24.3 million or 7% of revenue down 10 basis points from last year. And for the year G&A was $89.2 million or 6.7% of revenue, which is down 20 basis points from last year as a result of the menu price increase and lower performance-based bonus accruals.

We will not know the full impact of stock comp expenses till the equity grants are approved by our comp committee, which will occur during the first quarter. However, based on our current estimate considering historical facts, we anticipate our stock comp expense to be in the $14 million to $5 million range in 2009, up slightly from above $12 million in 2008.

As expected we saw little leverage in G&A for 2008 and continue to expect the same for 2009. Loss on disposal of assets was $4.1 million for the quarter, which included write-offs related to remodels in about 125 restaurants in Colorado and California, as well as an impairment charge for a restaurant that we closed of about $1 million.

Our cash preservation strategy in this unstable banking environment led us to continue to invest most of our cash in US treasuries. This naturally led to a significant reduction in interest income and tax exempt interest in 2008.

So as a result, interest and other income was 0.1% of sales in the quarter down 40 basis points from last year and down 30 basis points for the full year to 0.3%. For the quarter, income from operations was 27.9%, a 1.5% increase over last year and for the year op income was $124 million up 14.7% from last year.

Our effective tax rate for the quarter was 39.5% compared to 39.3% from last year and for the full year the effective tax rate was 38.5% compared to 38.1% last year. The increase for the year was driven by lower tax exempt interest partially offset by a lower effective state tax rate.

We opened 39 restaurants in the quarter and a total of 136 for the year. All of which were funded from operating cash flow. We now anticipate opening an additional 120 to 130 restaurants in 2009. This is down from our previous guidance of 135 to 145, which reflects our continued concern about many developers ability to complete projects and deliver our space in time to support our 2009 opening. Delays have caused our time lines to be extended and about two-thirds of our restaurants will open in the second half of the year.

With that in mind, along with the growing financing and leasing challenges facing developers, we determined it was necessary to pull back on our guidance. There may still be risk in this guidance, which is outside of our control.

We made nice progress on $100 million share repurchase plan we announced in October. Through the end of last week, we repurchased about 880,000 shares for $39.1 million, an average price of just over $44 per share.

Now it's difficult to predict when the buyback will be completed as its dictated by the market, and is depended upon the share price and the trading volumes. And our repurchases did slowdown over the past several weeks based on the price and trading volume. So, I would caution you, again simply extrapolating our progress so far, and predicting how quickly we can complete the repurchase.

Finally, we're investigating the possibility of collapsing our dual class stock structure. We've been working with outside tax counsel and have discussed the issue with both McDonald's and the IRS. And it's important to understand that, in cases where other companies have collapsed, dual share structured after split up.

There has generally been a ruling from IRS at the time of the originally transaction, which was not obtained with our split-off transaction. That's a really complicated issue of getting an IRS ruling. And because this area of the tax law is very complex, it's not fair that we'll able to obtain an opinion counsel that would satisfy the requirements of the separation agreement.

Thanks for your time today. At this time, we'd be happy to answer any questions that you might have. Operator, please open the line.

Question-and-Answer Session


Thank you. (Operator Instructions). And we'll go first to David Tarantino with Robert W. Baird.

David Tarantino - Robert W. Baird

Hi. Good afternoon.

Steve Ells

Good afternoon.

David Tarantino - Robert W. Baird

Jack, just a question on the commentary related to the price increase and the traffic subsequent to that. Can you give us a little bit more color on how you determined it was the price increase rather than just the economy in general that caused a little bit of traffic softness?

Jack Hartung

Well, you really can't, David. And what my comments intended to say was, we can't separate how much is just general softening and traffic and how much is resistant to the price increase. And so, just looking at what our transactions trends were before the price increase in the various markets and what they were afterwards. We are holding on to something less than half of that. But I can't tell you. It's a great question. I just can't tell you, how much is just general economy, softening economy that softer transactions might have happened anyway, and how much was specifically resistant to the menu price increase?


And we go next to John Glass with Morgan Stanley.

John Glass - Morgan Stanley

Thanks. I was hoping maybe just to get little more clarity on what you’ve talked and what you are seeing in trough counts right now. I guess in the fourth quarter, you are saying down about 6% or 7% would be the simple math. Is that a stable trend as you enter the first quarter or maybe you can talk about how the trends progressed as you took the pricing as well? Thanks.

Jack Hartung

Well, it wouldn’t be down 7%, John because we had a positive comp of 3.5%. We had effective menu. The overall effective menu price increase was 7% so the negative transaction was somewhere in that 3.5% to 4% range. So it wouldn't be as deep as 7. I would say we are still looking at this market by market because some of the markets took the increases early in October and we have more data, more trends for those markets.

Some took the increases as late as in the middle of December and we have less data to track. And in the last several weeks, the weather has been really kind of up and down. We've had some pretty extreme weather on the cold and snowy side in much of the country and then we've had some warm weather.

So, we are still watching the patterns John, but when we sort it altogether and throw all our markets together, the ones that went first, the ones that went last, try to factor out weather etcetera, we kind of net out that. It looks like we are keeping right around something less than half of the increase. That's the best way we can summarize it for you.


And we'll go next to Jeffrey Bernstein with Barclays Capital.

Jack Hartung

Hi, Jeff. Are you there?

Jeffrey Bernstein - Barclays Capital

Yes, sir. Can you hear me?

Jack Hartung

Yeah. Now we can.

Jeffrey Bernstein - Barclays Capital

Great, thank you. Just a clarification on the prior question. I don't know if you were intending to or whether you kind of gave any directional trends in terms of how January and early February faired in kind of a broader system rather than market that took pricing earlier versus later? Just wondering if there is any color in terms what we have seen over the past six weeks?

Jack Hartung

Jeff, we didn't give specifics on what we saw in January and February. What we did do though is we took that into account along with what we saw as a reaction to the price increase during the fourth quarter to provide guidance for the year. And we think the right guidance is in that low single-digit range. But that's all depended on the economy.

If the economy worsens as most people are predicting, I would expect that we could end up in the low end of that range. And if the economy continues to worsen even further, I think we could maybe even fall below that range. And so I say the biggest wildcard is what happens to the economy, what happens to consumer confidence? But, I would tell you we took into account the January and February results so far in putting that guidance together.


And we'll go next to Nicole Miller with Piper Jaffray.

Nicole Miller - Piper Jaffray

Good afternoon. Just a couple of housekeeping things, Jack. What was CapEx in '08 and what is projected for '09?

Jack Hartung

Nicole, CapEx was just over $150 million for the year. It looks our average investment costs for all the opening was around $916,000. So, it was a little over about the $900,000 we have been trending for the last few years. I would expect our investment cost to be similar to that on a per-store average, and we haven't announced this yet. I think, we might have this in our 10-K that will come out. But, it should be somewhat lower, Nicole just based on the lower expected openings but kind of in that same ballpark, and maybe to the tune of $140 million and $150 million in total.


Our next question comes from Larry Miller with RBC Capital Markets.

Larry Miller - RBC Capital Markets

Thanks very much. Jack, can you give us a little bit more color on that 19% to 20% margin? I thought you said that food and beverage cost might be flat in that 32% range. So, where is the major source of pressure as you are seeing it in the line items in 2009? Thanks.

Jack Hartung

Yes Larry. The thing I'm most concerned about is de-leveraging. That we are still seeing, even with this price increase in the fourth quarter and even though we have respectable margins in the fourth quarter, we still saw our margins decline because of the effect of de-leveraging -- and we continued to have negative transactions throughout. We ran negative transactions in the fourth quarter. As we continue to have negative transactions throughout the year, and that negative transaction may get worse if the economy worsens.

The impact of de-leveraging on the P&L and on the margins can have a pretty significant effect, and we think that could potentially eat up most or all of the menu price increase that we just took. And so, if the economy stabilizes Larry we have a shot at doing better than that margin range, but because of the uncertainty with the transaction trends, and what might happen with the economy, we are just very hesitant to move that margin range up.


And we'll go next to Sharon Zackfia with William Blair.

Sharon Zackfia - William Blair

Hi. Good afternoon.

Jack Hartung

Hi, Sharon.

Sharon Zackfia - William Blair

Jack, it seems pretty clear from your commentary that comps worsened as the fourth quarter progressed. I have two questions on that, could you give us order of magnitude as to how the first half looked versus the second half? And then secondarily, in your low single-digit guidance for 2009, are you expecting comps to get better against the easier comparison or are you handicapping for the probability that that may not happen?

Jack Hartung

On the transactions throughout the quarter; it was hard for us, Sharon, to get a real pattern throughout the quarter because we are taking menu price increases throughout the quarter, and weather was very choppy throughout the quarter. I will tell you that transactions did worsen from the third quarter to the fourth quarter because based on the third quarter where we had a 3.1% comp and 4% pricing we only had a 1% overall negative transaction for that quarter.

Whereas in the fourth quarter with 7% pricing and 3.5% comps, our transactions did worsen and they were in that kind of negative 3.5% to 4% range. There's nothing specific in the patterns throughout the quarter that I would tell you is significant to add, mainly because it was kind of choppy like I said, as we took price throughout the quarter and because of choppy weather.

And then in terms of 2009, as we are concerned churn that even though we are going up against softer numbers, we haven't seen any signs that the economy has hit bottom. We haven't seen any signs that consumers are ready to go out and eat again. We've seen a very strong correlation between the unemployment rate and as that has increased in the impact on our transactions.

And so, we feel like consumers are confident again, until we feel like the unemployment rate has bottomed out and will start to increase, I do think that the trends will likely worsen. And so, I do think that even though we're going up against softer trends at the end of the year that the affects of the economy may take away that benefit of going up against those softer prior year comps.


And we'll go next to Jason West with Deutsche Bank.

Jason West - Deutsche Bank

Hi. Thanks. Just wanted to clarify where pricing is coming out of the fourth quarter, it sounds like you took 6% incremental, and then you had 3.5% still on the menu. So, was it around 9.5% then coming out of the fourth quarter? And when would the 3.5% start to roll off? And also, since it sounds like with pricing being so significant here in the first part of the year that earnings may be somewhat front half loaded, as well as margins and then trail-off in the back half. So could you clarify if that's what you're thinking? Thanks.

Jack Hartung

Yeah. On the pricing Jason, it's not as high as 9%, because we had some price increases that were built in the prior quarters that were rolling off, they were price increases that we took in the fourth quarter of 2007. So, as you're rolling at the first quarter, the effective price increase will be something a little bit more than 8%, then the price increase will level-off in the second and third quarters into the 6% range, and then it will be lower in that fourth quarter as we bump up against the increase we just took, more in kind of that 3% to 4% range to give you an idea.

And I think in terms of the impact on margins, there might be a little bit of a front loading. It just depends on whether resistance continues or not. But if resistance continues, and if transactions do continue to soften with the weak economy, then the deleveraging effect would have a sequential deteriorating effect on our margins throughout the year. So I do think that is possible, probably likely that we may see margins get tougher throughout the year.

Now keep in mind, seasonality wise, our two best quarters from the market standpoint are typically the second and third quarter. But just here in terms of sequential challenges, yeah I think the challenges get tougher as the year unfolds.


And our next question comes from Paul Westra with Cowen and Company.

Paul Westra - Cowen and Company

Hi. Good afternoon. I just had a question to follow-up on -- really your margin outlook again Jack, I just want to make – you've clarified a little bit more here for us. The 19%, 20% obviously, assume its about 200 basis points of de-leveraging from line items other than food, and it seems as though that's in a conservative at a minimum. Are you saying that because you – you're assuming your comp guidance is correct in the low-single digits? Is that your official guidance assuming that the comp stores negative, so you still believe you're going to see that much de-leveraging?

Jack Hartung

I think we might Paul, with us just being in February, just having taken the price increase and with no sign that the economy is going to recover. Yeah, we are taking a cautious and thoughtful view of what the impact on softer transactions might have on the margins. Certainly, if transactions hold up, and if we just continue this kind of trend throughout the year, we do have a shot at beating those margins. We're not confident enough in what will happen to transactions to go ahead and up the guidance on the margins.


And we go next to Tom Forte with Telsey Advisory.

Tom Forte - Telsey Advisory

Great. Thank you very much. I wanted to know if you can give us an update on your thoughts regarding menu flexibility, for example, I think you've talked a little about the fact that you sell one taco versus three, and in that regard you have some items that are at lower price points, which maybe perhaps better suited for the weakening economy? And then also to what extent do you plan on perhaps advertising these messages?

Monty Moran

Sure. Well first, I think that we recognized that we have not done a good job of communicating the different combinations of things that one can get, when one goes to Chipotle. It's not just burritos and tacos, and bowls and salads. You can definitely customize and get things for kids like small quesadillas or a single taco. And so, we are in the process of developing a new menu board, although we haven't honed in on one particular format.

We're experimenting with a number of different formats in different markets right now, in order to do a bunch of things. One is to address all the different kinds of combinations and tastes and sizes and price points that you can arrive at from our already existing menu. But we also want to generally feel more welcoming to first timers and to families. We also think that, we can do better with more consistent pricing from restaurant-to-restaurant when we give this sort of customized individual quesadillas or tacos or things like that.

And we also want to use this menu board, to help people discover new tastes and encourage experimentation with different combinations of flavors. We think this could, actually reduce the burnout rate for long-time customers. We think also, since it is confusing and a little daunting for the first time customer, we think that we can help increase throughput by showing how streamlined it can be if you understand the ordering process.

So, I think, that this will probably not be through advertising per se, but more through the re-imaging of the menu board.


And we'll go next to Bryan Elliott with Raymond James.

Bryan Elliott - Raymond James

Good afternoon. Jack, a clarification, you mentioned a couple times a language, if I remember correctly, that you think you are getting about 3.5% of the price increase that actually was realized in the fourth quarter. Are you just netting the traffic declines against there or are you seeing trade down in average ticket decline and therefore an impact on the average check, as a reaction to the price increase?

Jack Hartung

Well, Bryan that the 3.5% is really a function, we took six, probably because we took some in October and some in November and some in December. It just works out to a weighted average price, just impacted in the quarter of 3.5%. So that's just the time when we took the whole thing.

So I did not weight that down at all by any kind of resistance whatsoever. But in terms of the full 6%, when you look at the full 6% fully loaded by the time the quarter was over, it looks like we are only keeping less than half of that.

So we are keeping something less than 3% from a sales standpoint. And so that basically helps understand why we went from something in the negative 1% margin in the third quarter to something in the more negative 3%, 3.5% or so negative transaction in the fourth quarter. So there are two different concepts running if that makes sense.


And we go next to Steven Rees with JPMorgan.

Steven Rees - JPMorgan

Hi. Thanks. Just on the new unit volumes, buyer model looks like they are fairly stable in the quarter, about 20% discount. Jack, how should we be thinking about, the new store growth in 2009 in terms of the opening volumes and then maybe you can talk about the ramp-up period, if you are still seeing them ramp-up over the two to three year time frame you talked about in the past. And if the stores are comping or out comping the overall base once they enter the comp base?

Jack Hartung

Okay, our new volumes, our new openings that we saw during the year, we're opening presetting that same range we've been talking about, a $1.350 million to $1.4 million. From a comp standpoint, the new stores generally have comps at a higher level, you might see a month or month and half or so where you are going up against grand opening where you might see softer comps, but after that, that very short period, we have seen our new stores even during this period typically out comp our average store.

What we don't know is the answer to your question about the ramp-up. I don't know how that's going to work out, because our pattern had been that we would open up new restaurants and they would comp at really high levels for the first couple of years and really they would continue to comp at high levels in the double-digit range, which is why we have had double-digit comps for 10 years before this year.

So it's hard to tell what the ramp-up is going to be for stores we just opened up in 2008 without knowing when the economic processes are going to end and what's going to happen after that. But the way we look at is, if we open up in this $1.350 million to $1.4 million and if we have a couple of years of, call it even mid single-digit kind of comps, which is very reasonable even in this environment. It doesn't take long to get up to a $1.5 million in average volumes.

In a single margin in the 19% to 20% range, within a few years, we can do a Quesadillash-on-Quesadillash return of between 30% and 35% on a 900,000 or 9, you know something slightly over that, Quesadillash-on-Quesadillash investment. So, those are the unit economics that we're looking at. So, as long as our new store volumes hold up, as long as we expect to have even modest comps in that mid single-digit range for a couple of years.

As long as we keep our margins in the 19% to 20% range or higher, we still think we can invest with confidence in getting superior Quesadillash-on-Quesadillash returns. What we really expect is when the economy improves that all those measures will move up and we can get our Quesadillash-on-Quesadillash returned back to that 40% or above range, which is where we prefer to operate, but we still invest with confidence, knowing that we can get that 30% to 35% or so return in sort of the world we are in today.


And we'll take our next question from Mitch Speiser with Buckingham Research.

Mitch Speiser - Buckingham Research

Thanks very much. Jack, just another question on the fourth quarter comp trends if I may. Putting aside traffic, just in terms of same-store sales, can you give us a sense of what the trends were from October to December?

Jack Hartung

We don't normally do that Mitch and there is nothing really meaningful. I think what's most important is that we took into account all the trends throughout the quarter. We took into account the best of our ability to measure what resistance was, what the impact to the economy was, what the transaction trends were, and we tried to build those into our guidance for the year. I would tell you there is not anything meaningful in the month-to-month trends throughout the quarter that would add any value to the guidance that we've already given.

Mitch Speiser - Buckingham Research

Okay. And separately, just on the unit productivity question. I guess it's been in that 76% to 79% range I guess as a total of the average, just given what you said, and again it's maybe more of a victim of your own success, but if the overall average is going up but the new store average unit volumes are flattish, should we imply that that spread or that percentage has come down a little bit?

Jack Hartung

Well, the percentage really came down earlier this year and we talked about that. We talked about that being a function of, I am sorry, last year, in 2008. So we talked about that percentage coming down from something to mid-80s to that mid-70 to high 70s range. The percentage is meaningless. That was a way for us to talk about how our new stores were opening, and as they were keeping pace, it was an easy way for us to talk about the fact that new stores were opening up at as increasing volumes, and they kept pace with the average sales volume for our typical store.

I would encourage you to think in terms of what are the unit economics, which is the way we really think about it. What are they opening at in terms of sales, you know, dollar volume? What kind of comp can you expect? What kind of margin can you expect and what kind of Quesadillash-on-Quesadillash return can you expect?

And so, the percentage itself isn’t as meaningful as long as when we put those numbers together, we have superior returns. Even if we had a high percentage, Mitch, if the high percentage resulted in a weak Quesadillash-on-Quesadillash return. For example, if our investment comps were too higher or if our margins were too low, I would tell you that it's a weak story even if the percentages were higher.

So I would encourage you to forget about the percentages and focus on the dollars, and I think that would be more meaningful and gives us a greater confidence when we invest our dollars, and hopefully it will you that confidence as well.


We'll now take a question from Nicole Miller with Piper Jaffray.

Nicole Miller - Piper Jaffray

I just wanted to follow-up and I meant to ask also about the advertising and when we might see a change there. You talked about the new agency, what should we be looking for and how are you going to monitor that success?

Monty Moran

Well, we have been working actively now with our new agencies, but prior to that with Mark, we've been restructuring the marketing department. So, we’ve been doing a lot of work behind the scenes. You should see new creativity out there in advertising format second quarter, and we will measure that through increased traffic.


We'll go next to Jeffrey Bernstein with Barclays Capital.

Jeffrey Bernstein - Barclays Capital

Great. Thank you. As you look at the lease terms, the one that you have on existing stores, and the two that you are kind of looking at with your next round of 130 or so. Just wondering if you could talk about what you are seeing in terms of trends there? Whether or not you’ve been able to renegotiate some of the existing terms and the impact from co-tenancy and anything you can do? And talk about the real estate outlook on both your existing stores and the new stores? Thanks.

Jack Hartung

Jeff, on existing tenants first. We are taking a look at a number of our leases, but our focus is really on the leases that have either expirations or options coming up within the next few years. Those are the ones where there is something to negotiate, where we have an option to extend or when the lease ends outright. Most of them we have options on.

So, those are the ones we are focusing on and those are the ones we are going back to landlord. And nothing to report yet in terms of whether there is going to be any room for us to negotiate a better deal in the option language. Typically our options will include the ability to extend the lease with a stated rent, a fixed rent amount. So, nothing to report in terms whether we can beat that number.

I will tell you in terms of new stores that we are looking at, we are seeing some flexibility, but on the business terms they are not really that material. The deals that you are hearing about or are reading about are in C-location and D-locations that we don't want.

The areas that we want to go into which are more desirable areas and they are typically more sophisticated and more well capitalized landlords. We are seeing certainly some relaxation in the terms, and I would say more of the terms of the lease, and we are getting a little bit better business terms, a little bit better lease terms. But nothing material that will dramatically change our outlook for unit economics for our 2009 openings.


We'll take our next question from Larry Miller with RBC Capital Markets.

Larry Miller - RBC Capital Markets

My question was asked. Thank you.


We will now take a follow-up question from Paul Westra with Cowen And Company.

Paul Westra - Cowen and Company

Hi. Just one more question. Do you mind following up on a little bit more color on your loss in line item there? You mentioned the remodels I think in Colorado and California, do you expect more of those, and your closed stores as well, as you look at 2009?

Jack Hartung

Paul, I don't think we expect a whole lot more. What we did was; the main part that remodeled, it's about 125 restaurants in Colorado and California was, we changed the frontline. The new front counter has a lot more glass and the glass extends all the way down really to the top of the stainless steel where we serve our food. And so it's much more appealing. We think it presents our food in a much better way. All of our new restaurants are opening up with this new counter and we just took the opportunity to look at our very oldest market Colorado and changed at all the restaurants their.

And then we also decided to take another market and we decided to take California, as well. We are not going to do any kind of across the system change with the counters. I think what we'll do Paul, as we have remodel opportunities with very old restaurants just kind of throughout the country, if the opportunity presents itself, we'll go ahead and put the new counter in. So I wouldn't expect a repeat of this.

And then the other thing was we did close a restaurant. We had one restaurant in Indianapolis that we opened about four or five years ago. It was a real estate mistake. It wasn't performing that well and there's going to be major road construction that's going to hit us within a matter of a few months here. And so we thought, bad was going to go to worse, so took the opportunity to get out of that deal and close that restaurant. And that was about a $1 million write-off.


And we'll take a follow-up question from Bryan Elliott with Raymond James.

Bryan Elliott - Raymond James

Hey. I just wanted to follow-up maybe with Steve and Monty a bit. Monty, you talked about the testing some menu changes and reconfigurations and sort of letting people know the bigger breadth that's really available that may not be clear. Could you address how that might impact speed and throughput which has been primary focus for sometime?

Steve Ells


Bryan Elliott - Raymond James

And how you see balancing those two issues?

Steve Ells

Sure. Actually it was me, Steve, addressing those issues before. But I actually think this new menu board configuration the desired outcome is to make sure that it's easier for people to understand the offerings at Chipotle. Since I opened the first restaurant over 15 years ago, the menu board has been very confusing for first-time customers.

For the experienced customer, they know they can make all kinds of combinations, not only for different tastes, but for different diets.

It's the new customers that we think we can help, understand the menu a lot better, we think with that, comes better throughput. So I don't believe at all it's a trade-off, as you explain the menu and explain all the different combinations, I don't think that slows things down. In fact, quite the opposite, I think it'll help us to be more efficient.


And we'll take our next question from John Glass with Morgan Stanley.

John Glass - Morgan Stanley

Thanks. I actually would like to follow-up on that menu board question. In terms of both the timing, which you think in terms of rolling that out system wide? And do you contemplate adding bundles to that there might be discounts for the current menu prices that exist today or is it simply just identifying assortments that are grouping them together with no discounts?

Steve Ells

Sure. Well there are a number of different ideas about how the menu board can be configured and as we dive into this project, we noticed that it becomes more and more difficult to figure out what the right answer will be. So, we have different configurations that will go into different test markets. And we will watch those test markets very, very closely and then after sometime, which is undetermined as of yet, after sometime, we can decide when a system wide rollout might be effective.

Now your question about bundling in such, we've never really considered bundling, because we think it hampers -- we thought that it would hamper the customer's ability to get exactly what they want. One of the things that we like to encourage at Chipotle is for people to get exactly what they want, not only for taste, but for diet. And as soon as you start putting things in some sort of a bundled package, it helps direct them. Although, that might not be a bad idea and we've actually discussed maybe that that would help first time customers.

In terms of whether those would be discounted or not, I couldn't answer that now. But certainly, one thing that we have always said is that, we want to make great sustainably raised food that's cooked according to classic cooking methods. We want to make this available to everybody. We want to really change the way people think about fast food, and we know that we won't be able to do that unless we're accessible to everybody.

And so the right price, especially in these economic times, these very tough economic times is key to that. So I wouldn't rule out something that would facilitate easier ordering and maybe there is a standardized price associated with that. That is very accessible.


We'll take our next question from Steven Rees with JPMorgan.

Steven Rees - JPMorgan

Hi. Thanks. I just had a follow-up on the commodities. Can you just talk about any contracts you may have in place for your key commodities like chicken, beef, pork, avocados, rice and dairy that gives you visibility of that positive 2% to 3% increase you're expecting?

Jack Hartung

Yeah, Steven. We do have contracts for cheese for the year, for tortilla for the year. We have contracts for beans for not quite the whole year. We don't really have long-term contracts more than like a quarter at a time for any of our meats. We don't have contracts for avocados at all. We do have a contract for rice for two to three quarters and corn. We have corn for three years and Coke. Coke is the last thing we've got locked in. So, we've got a lot of items locked in, but some of our biggest items like the meats and the avocados, we are not able to lock in.


Due to time constraints we'll take our last question from Nicole Miller with Piper Jaffray.

Nicole Miller - Piper Jaffray

I’m sorry. So, just don’t want to scrip pre-opening and the P&L, so how many stores opened per quarter, give or take?

Jack Hartung

In the fourth quarter?

Nicole Miller - Piper Jaffray

No, for all of '09, the 120 to 130. How do they spread out throughout the year?

Jack Hartung

The best I can tell you, Nicole, right now is about two-thirds in the second half of the year, so I would say the one-third in the first half of the year relatively even. The two-thirds, if I was going to handicap it, I would say of the two-thirds, even that is going to be weighted more towards the fourth quarter. The timeline for the deals that are further out just continue to slip. So, it's really quite back loaded.

Nicole Miller - Piper Jaffray

Thank you.

Jack Hartung

Thanks, Nicole.


That concludes the question-and-answer session.

Jack Hartung

Okay. Thanks everyone.


This concludes today's conference. We thank you for your participation. You may now disconnect. Have a wonderful day.

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